First Pioneer Petroleums Ltd. v. MNR, 74 DTC 6109, [1974] CTC 108 (FCTD)

Mahoney, J:—This is an appeal from a decision of the Tax Appeal Board, as it then was, confirming the respondent’s assessment of the appellant’s corporation income tax for its 1965 and 1966 taxation years on the ground that the corporation income tax payable for those years should have been allowed as a deductible expense in the calculation of the appellant’s taxable incomes for those years. The appellant also seeks an order that the direction of the respondent pursuant to subsection 138A(2) of the Income Tax Act deeming the appellant to be associated with another corporation in both the said taxation years be vacated. A third plea for an order varying or permitting the appellant and the other corporation to vary the agreements made between them allocating the income subject to the lower rate of tax for each taxation year was withdrawn at the hearing.

The appellant’s position on the first matter is set forth in paragraphs 13 and 14 of the notice of appeal.

13. It is axiomatic that the Company, doing business in Ontario, Canada in 1964 and 1965, has, as an expense of its business, the payment of income tax to the Province of Ontario and to Canada and, of all the expenses necessarily laid out for the earning of its income, any other expense could be more easily avoided than the payment of the income tax expense.

14. Calculation of income tax payable has notoriously been considered as a sharing of the profits, but the method of calculation of the tax has nothing whatsoever to do with the fact that it is an expense payable by the Company, in order to do business in Canada.

Counsel for the appellant argued eloquently in support of this position and I am quite prepared to accept that the appellant’s position is sincerely held.

The objective of profit is perhaps the main, if not only, feature that distinguishes a business undertaking from other types of human activity. In measuring its success, those charged with conducting a business are concerned with what is left over after all the costs of doing business and all the involuntary appropriations from profits have been met. To them, the net profit after income tax is the true return on the capital employed and the effort expended. Put another way, income tax is an outlay which those conducting a business seek to have its customers, rather than its owners, bear.

The basic scheme of the Income Tax Act, as it stood in the taxation years in question and as applicable to the circumstances, is that the appellant was obliged to pay income tax on its taxable income for the year. Taxable income is defined by subsection 2(3):

2. (3) The taxable Income of a taxpayer for a taxation year is his income for the year minus the deductions permitted by Division C.

Income is defined by section 3 to include income for the year from all businesses and property and section 4 provides:

4. Subject to the other provisions of this Part, income for a taxation year from a business or property is the profit therefrom for the year.

The Division C referred to in subsection 2(3) embraced sections 26 to 30 inclusive of the Act and the Part referred to in section 4 is Part I embracing sections 2 to 104 inclusive in both taxation years. in the absence of any express provision in Division C or elsewhere in Part I permitting the deduction of federal and provincial income taxes from income to arrive at taxable income or permitting their deduction in arriving at the profit for the year from business or property, the appellant must rely on paragraph 12(1 )(a):

12. (1) In computing income, no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer

Taking section 4 and paragraph 12(1)(a) together, the appellant must establish that the income taxes incurred in each taxation year were incurred for the purpose of gaining or producing income. This he cannot do simply because by their very nature the income taxes were incurred because income was gained or produced and not for the purpose of gaining or producing it.

The authorities clearly reject the proposition that where, as in Canada during the subject years, two separate jurisdictions impose a tax on the same income, in the absence of an express statutory provision to the contrary, the tax paid or payable to one can be taken into account in determining the taxable income for the other. For example, in the case of Roenisch v MNR, [1931] Ex CR 1 at 4; [1928-34] CTC 69 at 71 ; 1 DTC 199, Audette, J said:* [1]

It is self-evident that the amount of the income tax paid to the province is not an expense for the earning of income within the meaning of 6(a).+ [2] When such a payment is made to the province, it is not so made to earn the income, it is paid because there is an income showing gain and profit.

Finally, is the word “profit” itself amenable to the interpretation that the appellant urges? I think not. In Attorney General v Ashton Gas Company, [1906] AC 10 at 12, the Lord Chancellor, the Earl of Halsbury, observed:

Profit is a plain English word; that is what is changed with income tax.

and later in the same judgment said:

The income tax is a charge upon the profits; the thing which is taxed is the profit that is made, and you must ascertain what is the profit that is made before you deduct the tax—you have no right to deduct the Income tax before you ascertain what the profit is.

The appellant was incorporated January 25, 1960 under the laws of Ontario as Niagara Frontier Petroleums Limited and changed its corporate name to First Pioneer Petroleums Limited December 31, 1966. The company with which the appellant has been deemed to be as- sociated was incorporated November 6, 1956 under the laws of Ontario as Murray Hogarth’s Limited and changed its corporate name to First Pioneer Holdings Limited December 31, 1966 and will be referred to herein as “Holdings”. Murray Edgar Hogarth, herein referred to as “Hogarth”, was at all material times president, general manager and a director of both the appellant and Holdings. There is no doubt that, as an individual, and regardless of shareholdings and legal control, Hogarth ran the two companies during the relevant period.

From its incorporation through its fiscal year ended March 31, 1966 Hogarth was the beneficial owner of all of the appellant’s outstanding shares. The beneficial ownership of the 339 outstanding shares of Holdings through its fiscal year ended April 30, 1966 changed and, com- mencing on the undernoted dates, was:

April 2, 1957

Hogarth	252
D H Hogarth	51
Federal Trucks (Windsor) Ltd	36
December 7, 1959
Hogarth	288
D H Hogarth	51
December^ 1, 1959
Hogarth	188
D H Hogarth	51
Diana Hogarth	100
February 1, 1960
Appellant	188
D H Hogarth	51
Diana Hogarth	100
December 29, 1960
Appellant	168
D H Hogarth	51
Diana Hogarth	120
December 18, 1962
Appellant	168
Diana Hogarth	120
E & D Hogarth Ltd	51
March 31, 1966
Appellant	169V2
Diana Hogarth	1691/2

Diana Hogarth is Hogarth’s wife and D H Hogarth is his brother. There is no evidence that appellant, Hogarth or Diana Hogarth had any beneficial interest in E & D Hogarth Ltd.

An appeal taken by Holdings in this Court in respect of the assessment of its 1960 and 1961 income taxes resulted in a judgment based on minutes of settlement whereby it was agreed, inter alia, that Holdings and appellant were not, during their 1961 taxation years, associated corporations within the meaning of subsection 39(4) of the Income Tax Act as it then stood.* [3]

Hogarth is a competent, energetic businessman who has been highly successful in a very competitive and risky field of endeavour—the private brand distribution of gasoline and other petroleum products. The essential elements of the business are the securing of a source of supply; the negotiation of a contract for supply providing for a price at which the distributor can both compete and make a profit and a guaranteed quantity that will permit the distributor to maintain its share of the market and to grow; and, finally, the retail merchandising of the product to the public. The essentials of merchandising in addition to price are good locations and a known brand name. Hogarth estimates that major integrated oil companies account for over 98% of gasoline sales in Ontario. The appellant, with 35 service stations, is presently the largest of the private brand distributors. Gasoline accounts for over 90% of the appellant’s sales.

After graduation from Queen’s University in 1953, Hogarth worked three years as a marketing representative of a major oil company. in November 1956, in partnership with his brother and Federal Trucks (Windsor) Ltd, he went into the business of private brand distribution. The partnership business was taken over by Holdings in April 1957.

Federal was itself a private brand distributor operating under the trade name, Beaver Oils, and it was under this trade name that Holdings operated. During the period that Federal was involved, gas and other products were obtained by Holdings from Federal rather than direct from a refiner. The arrangement with Federal was reflected in a five year contract running to September 1961.

As the business grew Hogarth became uncomfortable in his relationship with Federal. The following extract from a letter he sent Federal January 29, 1959 expresses his major concern:

If we continue under the present contract using the Beaver name and at the end of another two and a half years, after spending thousands of dollars advertising “Beaver” we have nothing. Furthermore, if at that time we wished to continue using the name “Beaver” we would be likely able to do so only at the expense of buying gasoline from Federal at a price higher than their cost no matter what our gallonage Is at the time . . . With no long-term rights to the name “Beaver” our only alternative is to develop immediately another company, using another trade name and mark ...

Inability to arrive at a long-term arrangement led to termination of the relationship under somewhat acrimonious circumstances.

The appellant was incorporated and started marketing gasoline and related products under the trade name “Pioneer”. Holdings owns the land, buildings and fixed equipment. The appellant leases these from Holdings, owns the “Pioneer” trademark and is party to the supply contract. Holdings has other tenants; however, 98% of its revenues are rent and management fees paid it by the appellant.

The reasons given for having two corporate entities arise out of the supply contract. While there have been a series of supply contracts, all have been with the company Hogarth had worked for in its standard form and the material provisions have been identical. Hogarth says, and I accept, that these provisions were not, in a practical sense, negotiable. They were:

Terms: COD or on such terms of credit as may be allowed from time to time by the Credit Manager of the Vendor.

Neither party shall be liable in damages or otherwise nor shall this contract be cancelled for failure to carry out the terms of this contract In whole or in part where caused directly or indirectly by or in consequence of .. . impairment of supplies of the Vendor, or its facilities of production, manufacture, transportation or distribution, commitments of the Vendor to others . ..

The Purchaser covenants and agrees that, if he prepared to sell his business or any portion or part thereof and/or any outlets or service stations owned or operated by him during the term of this agreement, he will give the first refusal to purchase the same to the Vendor . . .

The fact is that the appellant was consistently given 30 days to pay its account and the float was a very important element in its financial operations. Exercise by the Vendor of its right to COD payment or other less favourable terms would clearly have created problems. Hogarth also felt that the appellant was very vulnerable under the force majeure clause and while in fact it was not invoked during the period in question, it was available to the vendor as a tool of coercion. It was therefore decided to remove the fixed assets from the ambit of the first refusal clause by vesting them in an entity not party to the supply contract. The “Pioneer” trademark was not, however, similarly protected.

The other business reason advanced for the type of organization adopted was its flexibility that permitted quick action and decisions. It was not explained how the existence of two companies contributed to flexibility and I take it to be the rationale for Hogarth’s de facto personal control of both the appellant and Holdings rather than of the corporate arrangement itself.

The question of management fees payable by the appellant to Holdings had been disposed of in 1960. Minutes of a meeting of the appellant’s directors held December 2, 1960 record the following resolution:

ON MOTION DULY MADE, SECONDED, AND UNANIMOUSLY CARRIED, it was resolved that the offer of the services of Murray Hogarth’s Limited be accepted, and remuneration is to be determined after the profits for each fiscal year-end before such remuneration is known. During the year, if any funds were required on account of services rendered, the President was authorized to advance such sums to Murray Hogarth’s Limited as he, in his opinion, felt desirable, to be charged to their account as a debt to the Company, and to be repaid within the year following the fiscal year-end of the Company.

The original lease dated December 2, 1960 had provided that the appellant pay Holdings a rental of 40 per gallon of gasoline purchased by the appellant from its supplier. This was later reduced to 2 /2C per gallon. Effective May 1, 1962 an arrangement was adopted eliminating the fixed rental and providing that the rental of the service stations and other equipment and management fees would be determined “after the profits for the year were known”. Then, in 1963, an even more flexible arrangement was made. Minutes of a meeting of the appellant’s board of directors held July 8,1963 record it:

It was resolved that:

1. The action of the President in terminating the lease made as of December 2, 1960, between the Company and Murray Hogarth’s Limited as of May 1, 1963, be and the same is hereby approved, ratified and confirmed.

2. The Company do lease from Murray Hogarth’s Limited such property as may be required for the Company’s purposes from and after May 1, 1963, upon such terms and conditions and for such rentals as may be determined from time to time by the President, and it is understood that should competitive conditions be such as to warrant it, no rent may be charged.

A resolution of Holdings’ board, passed the same day, authorized the same arrangement vesting authority in its general manager to determine the rent and other terms and conditions. These arrangements were in effect during the taxation years in issue. There was no written agreement as to management fees. Management fees payable by appellant to Holdings were to be determined after appellant’s yearly profit was known and were not required to be related to actual services rendered. The only services provided in fact were Hogarth’s personal services. The following table shows what happened with respect to management fees from the authorization of December 2, 1960 through the taxation years in question:

Holdings had a March 31 taxation year-end and the appellant an April 30 year-end. Reassessments resulted in changes, some substantial, in the taxable incomes of both companies in each of the years in question. The reasons for the reassessments are not in evidence however it is reasonable to assume that the reported taxable incomes were derived from the profits which were in mind when the management fee for each year was determined pursuant to the December 2,1960 resolution.

There was no written agreement as to rents. They were determined by Hogarth in his capacity as general manager of Holdings and as president of the appellant. In its 1965 taxation year the appellant leased nine outlets from Holdings and reported paying $113,000 rent for them. In its 1966 taxation year eleven were leased at a reported rental of $235,424.

Hogarth was frank in his testimony that as an officer and director of the companies it was his obligation to arrange their affairs so as to minimize the incidence of income tax. This is, of course, entirely proper and there is ample evidence that income tax considerations were not far removed from his mind on occasions other than when he determined the rents to be paid by the appellant to Holdings. Examples are dis- position of Holdings’ shares on December 29, 1960* [4] and the sale of the Hogarth residence in May 1963 to the trustees of Holdings Retirement Plan with a resultant non-taxable gain of $30,000. Holdings Retirement Plan became effective April 30, 1963; its only members were Hogarth and his wife.

The provisions of the Income Tax Act applicable to this appeal are:

138A. (2) Where, in the case of two or more corporations, the Minister is satisfied

(a) that the separate existence of those corporations in a taxation year is not solely for the purpose of carrying out the business of those corporations in the most effective manner, and

(b) that one of the main reasons for such separate existence in the year is to reduce the amount of taxes that would otherwise be payable under this Act

the two or more corporations shall, if the Minister so directs, be deemed to be associated with each other in the year.

(3) On an appeal from an assessment made pursuant to a direction under this section, the Tax Review Board or the Federal Court may

(b) vacate the direction if

(ii) in the case of a direction under subsection (2), it determines that none of the main reasons for the separate existence of the two or more corporations is to reduce the amount of tax that would otherwise be payable under this Act;

While there appears to have been good reason, unrelated to income tax, for the separate existence of the appellant and Holdings, and it is conceivable that their separate existence might have been maintained in the absence of tax advantage, I am not persuaded that the tax advantage was not a main reason for their separate existence during their 1965 and 1966 taxation years.

I have considered a number of cases where the Court has held that a main reason for separate existence has not been to reduce the amount of taxes that would otherwise be payable as well as a number where a contrary conclusion has been reached.} [5] What emerges from all of them is that the question of fact to be determined is not whether the tax advantage is the main reason but rather whether it is a main reason for the separate existence of the corporations during the particular period in question. I have already indicated that I believe that it was a main reason in this instance. Indeed, if it were necessary to do so, I would be prepared to find that, in the circumstances, it was the main reason.

The appeal is dismissed with costs.