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Citation: 2008 TCC 637
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Date: 20081208
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Docket: 2006-924(IT)G
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BETWEEN:
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VALIANT CLEANING TECHNOLOGY INC.,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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AMENDED REASONS FOR JUDGMENT
Campbell J.
[1] These
appeals deal with the Appellant’s taxation years ending February 28, 2000 and
February 28, 2002.
[2] The
Parties filed a Partial Agreed Statement of Facts, which I have attached to my Reasons
as Schedule “A”. The Appellant conceded that the initial investment amount of
$1,031,450, in respect to the share purchase, together with the first two
advances to its subsidiary of $780,150 and $531,930 for a total of $2,343,530,
were capitalization activities (see diagram at paragraph 11 of the Partial
Agreed Statement of Facts). In other words, they are strictly capital losses
which may be deducted against capital gains. It is the losses with respect to
the subsequent cash advances, totalling $12,639,732 $11,327,652,
that the Appellant is arguing should be properly treated as current in nature
and, consequently, used to offset the Appellant’s income.
[3] The
issue before me is straightforward: whether the Appellant can treat the
subsequent cash advances to its subsidiary as current or non-capital losses.
[4] The
Appellant is involved in the business of designing and supplying highly
sophisticated industrial pressure washers to the automotive industry. This
equipment washes and cleans the assembly line components to remove all debris
from the finished product. The Appellant is referred to as a Tier 1 supplier
within the automotive industry. Its chief customer is Ford Motor Company
(“Ford”). According to the evidence of Michael Solcz, Senior, the Appellant is
one of only a few Canadian suppliers in this area of automotive activity and
the only Tier 1 supplier in the Windsor area.
[5] In
the 1990’s each of the major automotive players, including Ford, implemented a
globalization plan which involved reducing the number of Tier 1 suppliers that
supplied each commodity worldwide within the industry. The Tier 1
suppliers were those companies that the major players called upon directly to
fulfil certain contracts. The lower tiers, Tier 2 and Tier 3, supplied to the
Tier 1 group. Certainly, according to the evidence, the best position to
be in was Tier 1 in respect to both the volume of business and the revenue.
Accompanying the decision to reduce the number of Tier 1 suppliers came a
demand that the Tier 1 suppliers have a global presence not only in North America
but also in Europe. The Appellant had already commenced its own globalization
by establishing a presence in the United States (“U.S.”) in the late 1980’s.
[6] Over
a number of months, meetings were held with the then current Tier 1
suppliers. Some of these Tier 1 suppliers abandoned the globalization plan
because they were unable or unwilling to meet the demands. According to Michael
Solcz, Senior, it was imperative that the Appellant remain a Tier 1 supplier as
“… otherwise we will not have Ford as a customer” (Transcript page 135).
It was also clear from his testimony that the Appellant possessed knowledge and
certification concerning the washing technology that Europeans did not have and
which would be valuable to Ford in its globalization plans. This would ensure
global uniformity of equipment being produced in the automotive industry.
[7] The
Appellant decided to retain its Tier 1 status and, consequently, Ford supplied
it with European contacts for potential acquisitions in the Appellant’s requirement
to now establish itself in Europe. The first company acquired was in Belgium in 1995. The Appellant then focused on a United Kingdom (“U.K.”) based
industrial washer group, Reiss-Elan. That company was no longer interested in
staying in the washer business and so became available to be purchased. Reiss‑Elan
had an established European base with Ford, BMW and Mercedes. It was acquired
in 1996 and, subsequently, the Valiant Group in Canada incorporated Valiant Elan Systems Limited (U.K.) (“Elan”). Elan became a
subsidiary in the U.K. of Valiant Elan Systems Limited (Canada) which later changed its name to Valiant Cleaning
Technology Inc., the Appellant in these appeals. For its customers and
potential customers, this meant that the Appellant would more appropriately be
able to service those customers in both North America and Europe.
[8] Between
1999 and 2001, the Appellant made cash advances to Elan to enable Elan to
complete its ongoing contracts. At the date of the purchase of Elan, it was
experiencing poor performance because, although it had ongoing projects, it was
still unable to generate profits. By May 2000 the bank required the Appellant
to re‑capitalize Elan and advances were forwarded so that projects could continue
to be completed. Elan’s bank overdrafts were subsequently guaranteed by the
Appellant in an effort to cover these operating costs. These financial
transactions were outlined at paragraph 11 of the Partial Agreed Statement
of Facts. According to Tony Parete (Executive Vice President), the advances
were made so that projects that Elan had originally undertaken could be
completed. The advances were used to purchase materials and pay for labour and
overhead costs so that customers’ contracts would not be abandoned. Mr. Parete
explained that once an order was received from a customer, the washing
equipment had to be designed, manufactured, shipped and, lastly, installed on
the customer’s floor. Between 1997 and 1998 the Appellant’s financial statements
show a considerable increase in the amount of the advances which Mr. Parete
testified were the result of Elan’s larger projects. Eventually these advances
were converted to interest bearing notes receivable. When asked if these
advances were an investment in the subsidiary, Mr. Parete stated that the
advances were made “… to pay for work completed for the projects that they had
in England … [including] current expenses.”
(Transcript page 223).
[9] By
1999, Elan was facing serious financial problems, again arising from
difficulties in completion of its projects. These difficulties were numerous
and were in respect to pricing and technical areas, such as engineering and
design, and extended to the actual building of the washer equipment itself. On
some occasions, Canadian employees travelled to the U.K. to assist in reworking the equipment. This increased costs and losses
resulted. In addition some of the U.K. contracts
were subsequently completed in Canada, negatively
impacting upon Elan’s ability to meet its financial obligations. Subsequent to
the write‑down of approximately $7.4 million in 2000, the decision was
made to send new advances to Elan because, according to Mr. Parete, more
projects had been received by Elan due to the confidence the customers had in
the company. These new projects had to be completed to preserve the Appellant’s
reputation within the automotive industry and particularly with Ford, or, the
Appellant would, as Mr. Parete testified “… get reduced to a non-supplier”
(Transcript page 231).
[10] According to Note 6 of the financial statements for the period ending
February 28, 2001, the Appellant was showing its investment in Elan as zero.
Mr. Parete testified that the investment’s write-down to zero represented the
cumulative effect of losses over a number of years and the decision that
recovery would be impossible. By 2001, approximately $13.6 million had been
written down. About this time, it was also decided to close down the U.K. operation because Elan was simply unable to generate
profits from its projects.
[11] Toward the end of Mr. Parete’s testimony, he proceeded to review the
sales summaries for the Appellant in 1997, 1998 and 1999, identifying the many
sales that were generated for the Appellant in Canada through the Appellant’s U.K. presence.
[12] Until 2004, the Appellant characterized these losses as capital losses
on its financial statements and reported them in the same manner. During a 2004
audit, these losses were re-characterized as current expenses pursuant to the
advice of Nick Sauro (Chief Financial Officer) who had just been hired by the
Valiant Group. When Canada Revenue Agency (“CRA”) refused to consider
the losses as current, the Appellant submitted a request for a Determination of
Losses from the Minister which would enable the Appellant to submit Notices of
Objection respecting the fiscal treatment of the losses.
[13] I heard from eleven witnesses, ten called by the Appellant, one called
by the Respondent. Susan Swiatoschik, the Appellant’s corporate comptroller,
was involved in the preparation of the Appellant’s tax returns and financial
statements. She testified respecting the re-characterization of the losses in
2004 from capital losses to current expenses as well as the Appellant’s
purpose in making the advances. Nick Sauro also provided evidence in respect to
the Appellant’s purpose in continuing advances to a subsidiary that was in
severe financial difficulties. Michael Solcz, Senior, the founder of the
business, provided an interesting account of the history of the industry
generally and the start-up and progress of his business from a small tool shop
in the 1950’s to a Tier 1 supplier to some of the automotive giants such as
Ford and GM. He also testified respecting the purpose of these advances. His
three sons, Michael, Jr., Len and Marty are all involved in the business and
gave evidence regarding the move to globalization. Tony Parete, the Appellant’s
Executive Vice President and a key player in the decision to continue to send
advances to the subsidiary, testified regarding the purpose of the acquisition
of the U.K. subsidiary and the subsequent advances
to it. Dennis Staudt and Thomas O’Brien, both chartered accountants with
Price Waterhouse Coopers, rendered audit opinions on the Appellant’s financial
statements and provided tax planning advice respectively during the years under
appeal. Both witnesses testified respecting the treatment and
re-characterization of the losses. Timothy Moore, the line operation
supervisor with Ford Motor Company during the periods under appeal, testified
respecting the meetings which occurred between Ford and its suppliers on the
globalization requirement.
[14] The Respondent’s witness, Stanley Kerr, financial analyst to Mr. Parete,
identified several documents representing his projections of November 27, 2000
for the subsidiary, Elan.
[15] The Appellant’s position is that the advances to Elan, with the
exception of the concessions made at the commencement of the hearing, were
integral to its income earning process. The expenditures were incurred by the
Appellant on its own behalf but through the U.K. operations to establish a global presence so that it could maintain its
Tier 1 status as a supplier in the automotive industry. The advances were made
to Elan for the benefit or in the interests of the Appellant and more
particularly to protect the Appellant’s revenue stream in Canada. In so doing it was not attempting to invest in and
capitalize the U.K. operation.
[16] The Respondent’s position is that the cash advances were properly
characterized initially by the Appellant as capital losses in its accounting
and tax treatment of these amounts. The nature of the losses cannot be altered
and neither can the legal nature of the relationship between the Appellant and
Elan as two separate legal entities. Form matters in income tax issues
and the Appellant held shares and interest bearing notes which were capital in
nature. It was a simple business decision by the Appellant to expand globally,
to acquire the subsidiary and to loan it working capital to continue its
business. The Respondent claims these are the same facts as those in the cases
of Stewart & Morrison Limited
v. Minister of National Revenue,
72 DTC 6049, and Cathelle Inc.
v. The Queen, 2005 DTC 858. Even if the Appellant was compelled to
establish a global presence in Europe, it must have
intended a long term presence and therefore the advances to Elan were on
capital account and cannot be considered a business expense for the purpose of
earning income. The Appellant does not fall within the recognized exceptions to
the general presumption that losses of the nature at issue in these appeals are
on capital account. The advances cannot be matched to the Appellant’s income
and are therefore capital outlays in the form of shares and notes. More
precisely the Respondent contends at paragraph 25 of its Reply that:
Appellant is neither a money
lender, did not extend credit to a client and did not hold shares and notes
issued by its U.K.
subsidiary as a trader in such assets or part of an adventure in the nature of
trade.
[17] Finally, the Respondent contends that the Appellant chose to acquire a
separate legal entity by investing in Elan’s shares and establishing notes
receivable when it could have set up its own European branch operation,
enabling it to include income/loss from that branch operation in its Canadian
income.
Analysis
[18] The determination of whether an expenditure will be on capital or
current account is for the most part a factually driven issue. The Appellant
has conceded that the initial investment in the shares of Elan in 1996 as well
as the first two advances were on capital account for the purpose of expansion
into the U.K. The Appellant states that the intent,
respecting the initial acquisition and the first two investments, was to obtain
a benefit for both the Canadian operation and the U.K. operation by virtue of income generation in the subsidiary, Elan. The
question then becomes: Did the Appellant’s intent subsequently change with
regard to the subsequent advances made between 1999 and 2001 so that they could
then be properly characterized as being on current account? This requires a
finding that these advances, although filtered through the U.K. operation, were in reality for the benefit of the
Canadian operation.
[19] The Appellant faces two problems here. First, the advances were
initially treated as capital outlay both in its accounting records and in its
tax returns. As a result of a change in the corporate administrative personnel,
they were re‑characterized as non-capital losses. Second, the advances
were made to a separate and distinct legal entity in the U.K. over a number of years and in which it held shares
and notes.
[20] In my review of the facts and the general principles to be considered,
I have concluded that the Appellant has successfully overcome both these
hurdles. The evidence is uncontradicted that the Appellant was required to
secure a global footprint not only in the U.S. but in Europe if it was to remain a Tier 1 automotive supplier. Business decisions
were made to forge ahead with the globalization plan, which to a large extent,
had been forced upon all Tier 1 suppliers by the large automotive players.
A business decision had to be made to either climb onboard the global train,
that the automotive giants had orchestrated and superimposed, or stay behind as
Tier 2/Tier 3 suppliers. To compete and to protect its revenue stream,
particularly with its largest customer, Ford, the Appellant took its seat on
that global train and through Ford’s suggestion eventually purchased the U.K. operation, Elan. Clearly at the outset, the
Appellant intended to expand into the U.K. market by way of
its investment in Elan. The share purchase and those first two advances are
rightly characterized as capital expenditures. There is little doubt that these
first cash injections were to capitalize the subsidiary’s operations. It must
be remembered that from the outset Elan was experiencing some financial
difficulties and required these advances. It had the project contracts and
customers but remained unable to generate profit for a number of reasons. However,
the evidence suggests that the Appellant made a business decision to have these
companies come together with a global view to expansion of services to a wider
band of customers.
[21] Initially these companies were “a good fit” (Transcript page 137) and
the purchase of Elan allowed the Appellant to put another piece of the puzzle
in place in meeting Ford’s larger plan. In the first ten months of Elan’s
operation after the purchase it was in a break-even situation, according to Mr.
Parete, but more importantly, it had a backlog of projects waiting in the
wings. So the decision to forward two larger advances to Elan is no surprise
and the Appellant made the appropriate call in my opinion that these advances would
be on capital account. However, as may often occur in the business world, the
best laid plans do not materialize. Elan experienced mounting financial
difficulties, although it retained projects and customers. Ordinary business
sense and common sense would suggest that the Appellant would take stock of its
losses and close Elan, but it did not. It continued to infuse Elan with large
advances. To answer the question “why?”, it is imperative to look at the
history of these advances in the larger context of what was occurring generally
with both the Appellant and Elan.
[22] I believe that these advances changed in nature from being initially
on capital account to expenditures made solely for the purpose of protecting
the revenue stream of the Canadian operation. In this respect, I consider this
case unique to its particular facts. In deciding that these advances changed in
nature over a period of time, I am in no way suggesting that this decision be
used to allow a window of opportunity for deductibility of financing activities
between a Canadian parent company and its foreign subsidiary.
[23] To determine the dominant nature of these advances and for whose
benefit they were incurred, jurisprudence instructs that I look for evidence of
both objective and subjective factors. Key to the subjective factor is the
Appellant’s intent in making the expenditures. Obviously there should then
be objective factors which will confirm that intent. The Respondent asks that I
look at the accounting and tax treatment to ascertain objectively this intent.
The Supreme Court of Canada in the following three decisions:
1.
Canderel Limited
v. The Queen, [1998] 1
S.C.R. 147;
2.
Ikea Ltd. v. The
Queen, 98 DTC 6092; and
3.
Toronto College
Park Ltd. v. The Queen,
[1998] 1 S.C.R. 183,
has unequivocally stated that generally accepted accounting principles
(“GAAP”) are interpretive tools only, which may or may not reflect a taxpayer’s
fiscal reality. Respondent conceded that financial statements and tax returns
are not necessarily indicative in every situation of what a taxpayer’s intent
is. They may be useful but they are not rules of law and will never be
absolutely determinative.
[24] The evidence of all the Appellant’s witnesses definitively establishes
that there was a decision to continue the advances when it was an absolute
given that they would never be recovered in terms of repayment. The last advances
in particular were written off almost immediately. I cannot look at the paper
treatment of these losses in a vacuum. If I were inclined to do so, which I am
not, I would be ignoring the objective evidence of a parade of witnesses who
all confirmed that these advances were made to protect the revenue in the
Canadian operation. From 1999 onward, they were not made to ensure the
continuing successful existence of Elan, which would translate into obtaining
an advantage in the U.K. of an enduring nature. Ms. Swiatoschik,
in cross-examination, testified that the reasons for the advances changed from
“true advances” in the initial years to needing to “save face with a customer”
and to preserve the reputation of the Valiant group in latter years (Transcript
pages 81-82). Michael Solcz, Senior, when questioned on the necessity of
making these advances stated: “We had no choice otherwise we lose our business here”
[in Canada] (emphasis and explanation added)
(Transcript page 139). Mr. Solcz went on to state:
So we had no choice because if we
don’t complete it what happens
to us by General Motors or Ford, you know, there was a threat of closing us
down and there was no way that we could afford to be out of business.
(Transcript page 144).
Tony Parete
(Executive Vice President) also confirmed that the Valiant group felt it had no
choice but to complete the U.K.
projects to save its reputation. At page 229 of the Transcript he states:
… we
have to complete the projects. We couldn't let the customer down because when
they want to launch a program they're dependant on all their suppliers and if
you don't meet the requirement of that launch, I mean, they'll reduce you as a
supplier real quick if they can't depend on you. So we had to ensure that we
met our requirements.
[25] The Supreme Court of Canada in Shell
Canada Limited. v. The Queen et al., 99 DTC 5669, provides
two caveats to the general rule that the economic reality of a transaction
takes precedence over the legal form:
1.
Economic reality can
never be used to re-characterize a taxpayer’s bona fide legal
relationship. Re-characterization is only permissible if the label attached by
the taxpayer to the particular transaction does not properly reflect its actual
legal effect.
2.
Where the provision
at issue is clear and unambiguous, its terms must simply be applied. Elan was
maintained as a separate U.K. entity from the Appellant. The
Respondent uses this legal relationship as its basis to claim that the advances
were capital because they were made solely for the share acquisition and the
benefit of Elan. However, Chief Justice McLachlin in Shell states at
paragraph 47:
… Yet, as Dickson, C.J. made clear in Bronfman
Trust, supra, at p. 46, the reason for a particular method of borrowing
is irrelevant to a proper consideration of s. 20(1)(c)(i). The
issue is the use to which the borrowed funds are put. It is irrelevant
why the borrowing arrangement was structured the way that it was or, indeed,
why the funds were borrowed at all.
This quote makes it clear that the use of the funds is of utmost
importance in a determination of deductibility. My conclusion in these appeals
that, on a balance of probabilities, the dominant purpose of advancing the
funds was to safeguard the Appellant’s stream of income as the primary use of
the funds, is in line with this Supreme Court statement in Shell. Protecting
this stream of income of course involves, as the witnesses suggest, keeping its
customer base happy and saving its reputation. In focusing on these end
results, it protected its Tier 1 status - its ultimate goal. There was no
benefit to Elan or if there was, it was of a secondary nature only and very
minor since Elan was on the road to bankruptcy.
[26] The Respondent referred me to the case of Stewart & Morrison Ltd. v. M.N.R., [1974] S.C.R. 477, where advances to an American subsidiary were treated as loans on the
books and were found to provide working capital to enable it to get started and
to continue to operate. At first glance, these facts would appear to mirror the
facts in these appeals. However, as all of these cases are factually driven,
there are factors which distinguish it from the case before me. In Stewart
& Morrison the Appellant taxpayer set up an American subsidiary to
carry on business in its own name and to be a source of income and profit for
the Appellant taxpayer. In contrast, Elan was already established in the U.K. with its own customer base and projects or jobs in
progress. The advances to Elan covered the operational costs to ensure those
projects were completed, the customer base satisfied and the reputation of the
Valiant Group preserved. However, the long term predominant feature was to
preserve Valiant’s Tier 1 status and thus its income stream – its very
livelihood. The facts in Stewart & Morrison are not the
same. The taxpayer there decided to expand globally by entering the U.S. market but it failed. The conclusion in that case
with those facts was correct – that the advances were of a capital nature
because the expectation was that the U.S. subsidiary would
be successful and endure as a profit making operation. That is not the case in
the facts before me when in 1999 it was clearly evident that Elan could never hope
to survive financially. With no hope or expectation that Elan could become a
viable U.K. operation why would the Appellant
continue to pay such enormous advances to Elan? Surely it could never have intended
to salvage an operation with no future. To suggest that an otherwise successful
business operation would continue to throw huge sums of money in Elan, which
was close to financial ruin, is ludicrous. It would be akin to boarding that
global train set in motion by the automotive giants, realizing their ticket was
taking them in the opposite direction of where they intended to go and yet not
getting off at the very first available stop. There can only be one business purpose,
as all of the testimony suggests, and that is to ensure that those contracts
were completed by Elan so that the Canadian operation could be protected in
respect to reputation, revenue and Tier 1 status. That is the ultimate intent
behind the use of these borrowed funds. The evidence fully supports my finding
that these advances were of no benefit to Elan.
[27] Stewart & Morrison distinguishes the decision in L.
Berman & Co. Ltd. v. Minister of National Revenue, 61 DTC 1150, where
payments were made to the suppliers of the subsidiary for the purpose of
protecting its own goodwill since the subsidiary had defaulted on its
obligations to those suppliers. There are striking factual resemblances between
Berman and the present appeals. Several statements by Thorson, P. are
particularly relevant to my conclusions. At page 1154, with regard to the
importance to be afforded accounting methods in determining deductibility, he
states:
I can
see no object in going into the books of account except as to the payments in question. Indeed,
the question before the Court is not how the transactions between the appellant
and United were recorded but what the true nature of the payments in question
was and what purpose they served in the appellant's business including its
Toronto venture.
[28] The distinguishing factor in Berman is that the advances were
made directly to the subsidiary’s suppliers to preserve its reputation and
ongoing commercial relationship with them whereas in the case before me
advances were made directly to Elan so it could complete its projects. I do not
believe that this distinction is significant, as Valiant obtained the same
result indirectly by sourcing the payments to Elan. In Berman, although
the subsidiary remained a separate legal entity, as in the present appeals,
Thorson, P. concluded at page 1154 that the subsidiary was for all
practical purposes a branch of Berman which was incorporated “… to extend the appellant's china and glass import
business in Eastern Canada”. L. Berman & Co. made a decision to maintain
the subsidiary’s suppliers because they “… helped the appellant in the Canadian
market.” (page 1155). This is analogous to the Appellant’s intention in
the present appeals where advances went to Elan beginning in 1999 to complete
its contracts even though it could never be a viable European operation for the
Appellant. Completion of those contracts had a direct economic impact on the
Appellant’s revenue, reputation, livelihood and future. This is much the same
scenario as in Berman.
[29] Thorson, P. in Berman at pages 1156-1157 cites the 1924 case of
Robert Addie & Sons'
Collieries, Limited v. Commissioners of Inland Revenue, (1924) S.C. 231-235, as authority
for the test of deductibility of expenses:
What is “money
wholly and exclusively laid out for the purpose of the trade” is a question
which must be determined upon the principles of ordinary commercial trading. It
is necessary, accordingly, to attend to the true nature of the expenditure, and
to ask oneself the question, Is
it part of the Company's working expenses; is it expenditure laid out as part
of the process of profit earning?
[30] J. Lamarre-Proulx in Cathelle Inc. v. Canada, 2005 DTC 858,
concluded that loans to a subsidiary were made for the purpose of providing it
with working capital as in Stewart & Morrison. Again this case can
be distinguished on the facts because the loans were made in the expectation
that the subsidiary would be a continuing profitable and viable operation for
its parent company. That is contrary to my finding in the case at bar. The
decision in Cathelle distinguished both Berman and the case of The Queen v. F.H. Jones Tobacco Sales Co. Ltd., 73 DTC 5577. J. Lamarre-Proulx distinguished Jones Tobacco because
the payments, in respect to the guarantees of customer loans, were made to protect
a direct source of income where the customer promised in return to deal with Jones Tobacco.
At page 5580 of Jones Tobacco, Noël A.C.J. made the following comments:
… The Court must consider the situation from a
businessman’s point of view, and not dwell on technicalities which may be
relevant in other types of proceeding in which, for instance, the company
challenged the existence of the obligation, but which have no relevance here.
The payment … by the Jones company was undoubtedly made for commercial
reasons, in accordance with ordinary business principles.
Again this is a factually similar situation
because the survival of the customer base was absolutely linked to the income
stream of Jones Tobacco. In the present case the sole purpose in
continuing advances to Elan was to ensure contract performance in a subsidiary
that was clearly on a path to failure. The purpose was not to enhance or
protect anything of an enduring nature in Elan but rather to protect the
Appellant’s Tier 1 status and ultimately ensure its survival within the
automotive industry.
[31] J. Lamarre-Proulx relied on the comments of Strayer, J. in Morflot Freightliners Limited v. The Queen, 89 DTC 5182, where he stated at pages 5184‑85:
Normally payments made by a parent company
to a subsidiary to help finance the operations of a subsidiary are regarded as
capital payments ...
It has frequently been said in cases of
this nature that one must try to characterize a situation from a practical
business point of view to determine the intent with which the money was
provided... . I believe the critical distinction here is as between the
preservation of an enduring asset on the one hand and the expenditure of money
for direct and more immediate gaining of profit through sales, or, as in this
case, the earning of commissions ...
In Morflot, Strayer, J. concluded that advances to a legally
separate subsidiary were made:
… with a long-term objective in mind,
namely, to preserve for the indefinite future its U.S. subsidiary as a viable contracting party,
through which its agency responsibilities ... could be carried out …
(Page 5185)
Again this is clearly a different factual conclusion than the facts in the
present appeals. When Valiant made the subsequent advances beginning in 1999
there was no expectation that Elan would continue as a viable entity and
certainly no expectation that those advances would ever be repaid.
[32] In Easton et al. v. The Queen et al., 97 DTC 5464, Robertson,
J. at page 5468, referred to two exceptions, alluded to previously in my
reasons, to the general rule that an advance or outlay on behalf of a
corporation will be treated as a loan for the purpose of providing working
capital:
There are two recognized exceptions to the
general proposition that losses of the nature described above are on capital
account. First, the taxpayer may be able to establish that the loan was made in
the ordinary course of the taxpayer's business. The classic example is the
taxpayer/shareholder who is in the business of lending money or granting
guarantees. The exception, however, also extends to cases where the advance
or outlay was made for income-producing purposes related to the taxpayer's own
business and not that of the corporation in which he or she holds shares.
For example, in L. Berman & Co. Ltd. v. M.N.R.,
[1961] C.T.C. 237 (Ex.Ct.) the corporate taxpayer made voluntary
payments to the suppliers of its subsidiary for the purpose of protecting its
own goodwill. The subsidiary had defaulted on its obligations and as the
taxpayer had been doing business with the suppliers it wished to continue doing
so in future. [Berman was cited with
apparent approval in the Supreme Court decision in Stewart & Morrison
Ltd. v. M.N.R., [1974] S.C.R. 477 at 479].
The second exception is found in Freud.
Where a taxpayer holds shares in a corporation as a trading asset and not as an
investment then any loss arising from an incidental outlay, including payment
on a guarantee, will be on income account. This exception is applicable in the
case of those who are held to be traders in shares.
(Emphasis added)
Although the Respondent only briefly referenced these exceptions, I
believe that the Appellant falls squarely within the confines of this first
exception. First, the above passage cites with approval the decision in Berman
which I believe is on “all fours” factually with this case. The sentence, for
which I have added my own emphasis, indicates that the Federal Court of Appeal
has expanded this first exception beyond a money lending business to a
situation where it can be established that a payment is made for the benefit of
the income producing process of the business that makes the payment. Based on
my factual conclusions the Appellant fits within this first exception. In
summary those factual conclusions are:
1.
Major automotive
players, such as Ford and GM, made the decision to reduce the number of Tier 1
suppliers and to force those companies retaining Tier 1 status to expand
globally to allow for close geographical proximity with the major players’
factories and plants.
2.
Maintenance of Tier 1
status was essential to the survival of the Canadian operations.
3.
The Appellant made a
business decision to retain Tier 1 status and expand globally.
4.
A presence in the
U.K. was essential to this expansion and Ford put the Appellant in touch with a
U.K. corporation, Reiss-Elan.
5.
Advances made in 1999,
and subsequent thereto, were made to purchase material, pay labour and cover
other operating expenses for contracts to which the subsidiary was already a
party.
6.
Advances were made even
when it was clear that Elan was headed for bankruptcy or at the very least,
closure of its operations.
7.
The only reason, for
the making of such payments of the U.K. operational
expenses in the face of its insurmountable financial difficulties, in terms of
common sense and commercial realities, had to be to protect its Tier 1
status and its own economic viability within the industry.
[33] The Respondent also maintains that in order to be deductible the
advances would need to result in a direct source of income for the Appellant
and that there is a lack of direct benefit to the Appellant here. However, case
law indicates that the source need not be a direct one. In the case of Minister
of National Revenue v. Algoma Central Railway, 68 DTC 5096, the taxpayer
sought to increase its business income by a most indirect method of surveying mining
possibilities in the geographical area of its transportation system, in the
hope of using favourable results from the surveys to draw industrial
development which would in turn lead to increased business activity and
therefore income. This would certainly appear to be an indirect expenditure
which nevertheless was allowed as a deduction by the Supreme Court of Canada.
The Respondent makes the point that through the advances, Elan was generating
its own income and accounts receivable which in turn were being used to pay
down its bank debt, a loan which would be guaranteed by the Appellant. However,
the Respondent in making that assertion relies heavily on financial statements
which are not necessarily an accurate picture of the fiscal circumstances of
either the Appellant or Elan. Although the evidence was inconclusive, there may
have been one area that favoured some capital investment on the part of the
Appellant. Elan did more than complete ongoing projects. According to the
evidence it took on new contracts in this period. It was unclear what
percentage, if any, of the advances went toward the new contracts. I also have
Mr. Sauro’s evidence that the contracts to be completed by Elan were with
American clients of the Canadian operations. The non-performance of those
contracts would therefore have a direct impact on the Appellant’s operations in
Canada. In addition, all of the evidence
supports my conclusion that loss of the Tier 1 status would directly and
severely impact upon the Canadian operation. However, in concluding that the
dominant purpose or intent of the advances to Elan was to protect the Appellant’s
income stream, even if the evidence supported a secondary effect of the
advances in respect to the new contracts, it would not be fatal to that
deductibility. The cases of B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth
of Australia, [1966] A.C. 224, and Robinson (Inspector of Taxes) v.
Scott Bader Co. Ltd., [1981] 2 All E.R. 1116 (C.A.), although both
factually different, provide some of the general principles to be utilized in
determining the deductibility of losses. The Bader case talks of the
importance of identifying for whose benefit advances are made. Canadian courts,
including the Supreme Court of Canada in Algoma Central Railway, have
often quoted the following from the decision of Dixon, J. in B.P. Australia at page 264:
The solution to the problem is not to be
found by any rigid test or description. It has to be derived from many aspects
of the whole set of circumstances some of which may point in one direction,
some in the other. One consideration may point so clearly that it dominates
other and vaguer indications in the contrary direction. It is a commonsense
appreciation of all the guiding features which must provide the ultimate
answer. Although the categories of capital and income expenditure are distinct
and easily ascertainable in obvious cases that lie far from the boundary, the
line of distinction is often hard to draw in border line cases; and conflicting
considerations may produce a situation where the answer turns on questions of
emphasis and degree.
The decision went on to quote Dixon, J. in Hallstroms Pty. Ltd. v. Federal Commissioner
of Taxation, (1946) 72 C.L.R.
634:
That answer:
“depends on
what the expenditure is calculated to effect from a practical business point of
view rather than upon the juristic classification of the legal rights, if any,
secured, employed or exhausted in the process.”
(Page 264)
Lord Pearce in B.P. Australia summarized the Appellant’s position
in that case as follows:
The advantage which B.P. sought was
to promote sales and obtain orders for petrol by up-to-date marketing methods,
… Since orders were … only obtainable from tied retailers, it must obtain ties
with retailers. Its real object, however, was not the tie but the orders which
would flow from the tie. To obtain ties it had to … [pay] out sums for a period
of years …. The payment of such sums became part of the regular conduct of the
business. It became of the current necessities of the trade.
(Page 265) (Emphasis added)
Lord Pearce dissected the transaction to discover the true purpose of the
expenditure. In doing so, he looked at the exact raison d’être of the
payments made by B.P. Australia. On their face the payments appeared to
be for the purpose of establishing ties to retailers but looking further he
found that their fundamental nature was to secure orders through those retailer
ties.
[34] What then was the true purpose of the advances to Elan? All of the
Appellant’s witnesses provided the same evidence, which remained unchallenged
on cross-examination, and that was: the immediate need to retain its status as
a Tier 1 supplier in the face of a massive globalization effort by the major
automotive players. The methods employed to maintain its Tier 1 status,
including the completion of Elan’s contracts by sending advances to that
subsidiary, had the fundamental purpose of securing its Canadian stream of
income and therefore its economic survival. The dominant feature of these
advances therefore points to a “current necessity”, which counters any
secondary or contrary indications pointing to capital outlay.
[35] Finally my decision in Excell Duct Cleaning Inc. v. The Queen,
2006 DTC 2040, clarified that protecting existing goodwill and
increasing profitability go to the income nature of an expense while increasing
goodwill will relate to a purpose which will be capital in nature. Although not
cited by either party, that decision clearly has application to the issue in
this appeal. The Appellant’s actions in advancing the subsequent funds to Elan
were always viewed as protection of its reputation and Tier 1 status and thus
its income stream – that is, protecting its existing goodwill and
profitability. Excell Duct Cleaning reiterates that loans made in an
effort to “preserve an ongoing source of … income” will be treated as
deductible.
[36] In summary, although there exist vaguer and secondary indications
pointing in a capital outlay direction, when I consider all of the evidence in
the context of what the advances, on a balance of probabilities, were meant to
achieve, from both a business and practical evaluation, I conclude that they
were made to protect the Appellant’s stream of income and its future as a Tier 1
supplier. In arriving at this conclusion, I have made factual findings based on
common sense and the uncontradicted evidence of approximately ten witnesses,
all of whom confirmed essentially the same purpose to these advances. The
commercial realities within which it was operating at the time dictated that
the Appellant, from both a business perspective and common sense approach, make
a calculated business decision to either shut down Elan in 1999 and risk losing
its Tier 1 status within the industry or continue the advances to ensure its
survival, protect that status and therefore its income stream.
[37] For these reasons the appeals are allowed. The Appellant is entitled
to costs on the basis of one set of counsel fees.
Signed at Ottawa, Canada, this 8th
day of December 2008.
Campbell J.
Schedule
“A”
2006-924(IT)G
TAX COURT OF CANADA
(General Procedure)
BETWEEN:
VALIANT CLEANING TECHNOLOGY INC.
Appellant,
and
HER MAJESTY THE QUEEN
Respondent.
PARTIAL AGREED STATEMENT OF FACTS
Mtre
Wilfred Lefebvre, Q.C. Susan
Shaughnessy
Mtre
Dominic C. Belley Justice Canada
Ogilvy Renault LLP Complexe
Guy-Favreau
1981 McGill College
Avenue 200 René-Lévesque Blvd West
Suite 1100 East Tower, 9th Floor
Montreal (Quebec) H3A 3C1 Montreal (Quebec) H2Z 1X4
Telephone: (514)
847-4440 Telephone: (514)
283-3655
Telephone: (514)
847-4318 Fax: (514) 283-3103
Fax: (514)
286-5474
Attorneys for the
Appellant Attorneys for the
Respondent
2006-924(IT)G
TAX COURT OF CANADA
(General Procedure)
BETWEEN:
VALIANT CLEANING TECHNOLOGY INC.
Appellant,
and
HER MAJESTY THE QUEEN
Respondent.
PARTIAL AGREED STATEMENT OF FACTS
THE PARTIES,
THROUGH THEIR UNDERSIGNED ATTORNEYS, AGREE ON THE FOLLOWING FACTS:
1.
During the relevant
period, the Appellant, Valiant Cleaning Technology Inc., was involved in the
design, engineering and installations of assembly line cleaning technologies
for the automotive industry.
2.
The Appellant provided
cleaning solutions for products manufactured prior to assembly or along the
assembly line process.
3.
The cleaning solutions
involve high and low pressure washing for the purpose of removing dirt, dust
and metal filings from the product manufactured.
4.
The Appellant is
considered a “Tier 1” supplier in the automotive industry.
SIMPLIFIED CORPORATE CHART
5.
During the relevant
period, the Appellant was part of a group of corporations (the “Valiant
Group”) which may be illustrated as follows:
6.
As shown in the above
chart, during the relevant period, the Appellant owned all of the shares of
Valiant Elan Systems Limited (“Elan”), a corporation resident of the United
Kingdom (“U.K.”).
AUDIT
7.
In 2004, the Appellant
was subject to a review carried out by a representative of the Minister of
National Revenue (the “Minister”), Mr. William Cornies following an
audit of Valiant Corporation.
8.
The review focused
strictly on the nature of certain financial transactions carried out between
the Appellant and Elan, its subsidiary.
9.
The review was the
result of a request made by the Appellant to recognize previously reported
capital losses and re-characterize them as non-capital losses.
TRANSACTIONS SUBJECT TO THE AUDIT
10.
In 1996, the Valiant
Group had acquired U.K.-based Reiss Elan, subsequently known as Valiant Elan
Systems Limited (Elan).
11.
For the years ended
February 28th, 1997 to 2002, the Appellant reported the following in
its audited financial statements with respect to Elan and it its income tax
returns for the relevant taxation years:
|
Years ended February 28th
|
Shares in Elan
|
Advances to Elan
Notes Receivable
|
Write down of investment in Elan:
|
Capital Loss Reported on Income Tax Return
|
|
02/1997
Investment:
10,000 common shares and 490,000 5% cumulative redeemable preference shares
Notes receivable (as
restated in 1998 financial statements)
|
$1,031,450
|
$780,150
|
|
|
|
02/1998
Advances:
|
|
$531,930
|
|
|
|
02/1999
Advances:
Allowance with
respect to Notes Receivable:
Write-down of
investment:
|
|
$2,444,810
|
$3,400,000
$1,000,000
|
|
|
02/2000
Advances:
Conversion of
notes to preference shares:
Write-down of
investment:
Capital loss
reported on T-2 income tax return
|
$6,251,000
|
$2,654,445
($6,251,000)
|
$3,042,785
|
$6,251,000
|
|
02/2001
Advances:
Write-down of
investment:
|
|
$6,228,397
|
$6,228,397
|
|
|
02/2002
Capital loss
reported on T-2 income tax return:
|
|
|
|
$7,420,182
|
|
TOTAL:
|
$7,282,450
|
$6,388,732
|
$13,671,182
|
$13,671,182
|
12.
Elan was put into
administration effective March 29, 2001 as part of the formal plan to wind-up
its operations.
NOTICES OF DETERMINATION OF A LOSS
13.
On December 30, 2004,
subsequent to the review, the Minister issued Notices of Determination of a
Loss bearing numbers 64957, 64958, 64959 and 64960, in respect of taxation
years of the Appellant ending on February 28, 2000, February 28, 2001, February
28, 2002 and November 30, 2002, under which the Minister considered the losses
incurred by the Appellant as capital losses incurred in its taxation years
ending February 28, 2000 and February 28, 2002 as reported by the Appellant.
14.
On February 17, 2005,
the Appellant duly filed Notices of Objection against the Notices of
Determination of a Loss.
15.
On October 17, 2005,
the Minister issued its Notice of Confirmation under which it confirmed the
Notices of Determination of a Loss.
ISSUE TO BE DECIDED
16.
The issue to be decided
is whether the losses, or any part thereof, incurred by the Appellant for the
taxation years ending February 28, 2000 and February 28, 2002 in the amounts of
$6,251,000 and $7,420,182 respectively with respect to Elan are non-capital
losses or capital losses.
17.
The Appellant submits
that said losses should be characterized as non-capital losses.
18.
The Respondent submits
that said losses should be characterized as capital losses.
Montreal, May 15,
2008 Montreal, May 14, 2008
“Dominic C. Belley” “Susan
Shaughnessy”
Mtre Wilfrid Lefebvre, Q.C. Susan
Shaughnessy
Mtre Dominic C. Belley Justice
Canada
Ogilvy Renault LLP Complexe
Guy-Favreau
1981 McGill College Avenue 200 René-Lévesque Blvd West
Suite 1100 East Tower, 9th Floor
Montreal (Quebec) H3A
3C1 Montreal (Quebec) H2Z 1X4
Telephone: (514) 847-4440 Telephone: (514)
283-3655
Telephone: (514) 847-4318 Fax: (514)
283-3103
Fax: (514) 286-5474
Attorneys for the Appellant Attorneys
for the Respondent
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