Quemet Corp. v. The Queen, 81 DTC 5359, [1981] CTC 472 (FCTD)

Addy, J.:—Both the plaintiff (hereinafter called “Quemet”) and the added party (hereinafter called “Magog”) were in the business of buying and selling scrap non-ferrous metals and metal alloys.

The Minister of National Revenue had disallowed a deduction of $17,471.83 for expenses for the 1972 taxation year of Quemet on the grounds that the amount was not expended for the purchase of metals for resale. Quemet appeals that disallowance.

Before the case came to triai and following investigation of the books of Magog by departmental investigators, the defendant applied for and obtained an order pursuant to section 174 of the Income Tax Act adding that party to the action and requiring that two common questions affecting the assessments of both the Quemet and Magog for the 1972, 1973, 1974, 1975 and 1976 taxation years be determined. The order was granted by my brother Walsh, J on August 28, 1979 and all pre-trial proceedings were subsequently taken in accordance with the provisions of that order. It provided in part that the following two questions be determined at trial of the action:

1. Whether for the fiscal years 1972 to 1976 respective Quemet Corp’s alleged payments to Magog Metal Co Inc for used metal were bona fide payments or resulted in whole or in part from the creation of fictitious invoices and hence were never received by Magog Metal Co Inc or if received retained by them as proceeds of bona fide sales.

2. In the event that it be found that these receipts by Magog Metal Co Inc resulted from bona fide sales to Quemet Corp whether Magog Metal Co Inc then created by fictitious invoices disbursements which were not bona fide made by it, to set off against such income receipts in whole or In part.

The issues raised were the following: according to Mr Justice Walsh’s findings, Quemet deducted from its gross revenue the following amounts for purchases allegedly made from Magog:

1972 - $17,471.83 (the amount in issue in the main action)

1973 - $27,509.56

1974 - $89,349.49

1975 - $21,908.85

Total $156,239.76

Magog added those amounts to its declared income but claimed expenses corresponding to same, less what it alleged to be commission of one cent per pound of metal involved in the transactions. To substantiate those expenses, Magog prepared invoices from fictitious vendors for the purchases. It alleges that though the invoices were in fact false in so far as the names of the payees are concerned, they were correct in so far as amounts remitted were concerned and were in fact accommodation invoices made to represent moneys returned in cash to Quemet and prepared solely to offset the income produced from the purchases by Quemet. It pleads, in other words, that the moneys paid by cheque to it by Quemet for those sales were in fact returned to Quemet in cash less one cent per pound kept as a commission as above mentioned. Such invoices were issued by Magog in the following amounts:

For 1972 - $ 2,698.80

For 1973 -$14,065.94

For 1974 - $57,120.62

For 1975 - $62,763.63

For 1976 - $10,281.83

Total $146,930.82

Although all scrap metal dealers in the area are now obliged to transact business with their suppliers by cheque, it appears that, until a few years ago and, in any event, during the relevant periods, the market was mostly a cash one and the great majority of suppliers which included peddlers, other scrap dealers and some persons who delivered metals obtained from certain industrial plants, insisted on being paid in cash without furnishing receipts. In these cash transactions the price would invariably be considerably lower (between thirty and fifty per cent) than the price which otherwise would prevail in the case of a payment being made by cheque. It appears that many of the suppliers wanted to avoid paying income tax on the amount received and in other cases (these appear to be quite numerous) certain peddlers and certain persons delivering on behalf of large industrial plants, would include in their loads of scrap metal, extra metal or, at times, bring in extra loads of metal which they had appropriated or improperly obtained from their employers, or other persons, and would retain for their own use the proceeds of these cash sales.

Magog, whose plant was in Magog, Quebec, some seventy miles away from that of Quemet in Montreal, would always deal in cash with its ordinary suppliers. Quemet, however, for reasons which it claimed to be financial control of its own business and security, always dealt by cheque. In order to remain competitive, however, in what appears to me to have been to a very large extent a cash under the table market, Quemet arrived at a special arrangement with Magog.

Quemet claims the arrangement to have been to the effect that, whenever the suppliers for cash showed up at its plant, where Quemet decided there was a requirement for that particular load of metal and where a price, satisfactory to Quemet could be negotiated, Magog would be contacted, advised of the details of the sale and a cheque would be made out to Magog for the negotiated price plus one cent per pound of metal in the delivery. It, in return, would send back to Quemet cash to cover the amount of the sale which cash would then be turned over to the person who had delivered the metal. It goes without saying that no receipt was signed for the cash so turned over.

Quemet claimed that the loads were not being sold to it by the suppliers but rather to Magog and resold by the latter to Quemet at one cent per pound of metal over Magog’s purchase price. None of these loads were ever delivered to Magog but always left at the Quemet plant.

I completely reject evidence led on behalf of Quemet to the effect that this scheme of sale to Magog and resale to it at cost plus one cent per pound was devised because Quemet had been advised by its auditors to always deal by cheque and also because of the danger of theft if it were known that Quemet was dealing in cash. From an accounting standpoint, it would have been just as easy or indeed much easier for Quemet to have written cheques for cash at its bank, received the money, paid it to the suppliers on the spot and then entered the suppliers’ names in its own books to account for the disbursements without ever having to pay any commission to Magog. In so far as security is concerned, the evidence indicates that the trade undoubtedly knew that deliveries for cash could be made at the Quemet’s plant and that cash would be paid at that place for goods delivered. There was even greater danger of theft in transporting cash some seventy miles from Magog, Quebec, to Montreal in order to pay the suppliers than to obtain at Quemet’s bank in Montreal and pay on the spot. On all of the evidence, including that of one of the owners of Quemet, I find that the real reason for this system being devised was that Quemet knew that a considerable proportion of that trade consisted of loads of metal which were not the legal property of the suppliers and desired, in so far as possible, to avoid being directly involved in the receiving of stolen property.

In so far as the sales are concerned, they were in fact and in law sales from the suppliers to Quemet and not sales to Magog. Magog never saw the goods, never had any say as to what was to be purchased or what price was to be paid, never had anything to do with the negotiations and, before the bargain was concluded, never even knew the identity of the vendor. Even after the bargains were concluded, on many occasions, Magog was never told who the vendors were. Finally, Magog received the price of one cent per pound of metal as a commission or gratuity regardless of the type of metal sold. This, of course, is completely inconsistent with what a bona fide seller would normally require since there is a considerable difference in price between various qualities and kinds of metal. I find that the sales were made by the suppliers to Quemet and that Magog was paid one cent per pound of metal solely for the privilege of lending its name to the transactions so that the names of the vendors would never appear in the books of Quemet and that the only vendor appearing in the latter’s books for those sales would be that of Magog. Magog on the other hand was expected by Quemet to enter the names of the suppliers in its books. This it did not do for the obvious reason that it wished to protect the suppliers from prosecution and itself from being associated with the actual transactions.

I find that the amounts, that were entered in the invoices prepared by Magog, were correct in so far as the cash being returned by Magog to Quemet was concerned although they were fictitious in so far as the names of the payees or the true nature of the transactions were concerned.

The evidence, however, establishes to my full satisfaction that Quemet actually received and paid for deliveries of metal totalling the amounts received in cash from Magog and that those purchases were made for the purposes of resale in the normal course of trade. I am equally satisfied that Magog only received and retained the amount of one cent per pound of metal bought by Quemet, the total sum of which is represented by the difference between the above-mentioned invoices and the amounts of the purchases reported by Quemet as being made from Magog and paid to it by cheque.

The appeal of the plaintiff Quemet is therefore allowed. Its assessment for the 1972 taxation year will be returned to the Minister for assessment accordingly. The two questions put to the court pursuant to the order of The Honourable Mr Justice Walsh are answered as follows:

1. For the fiscal years 1972 to 1976, all of Quemet’s alleged payments to Magog were in fact bona fide payments in the sense that they were made for metals actually purchased by Quemet but were not bona fide in that they were not made to Magog as vendor of the metals but were, after deducting Magog’s commission of one cent per pound of metal, intended to be made and were in fact made to third party vendors from whom Quemet and not Magog was purchasing. Magog retained one cent per pound of metal from the proceeds of those sales which were bona fide only in the limited sense which I have just mentioned.

2. Magog did create invoices covering the sales and these invoices were fictitious in the sense that they did not cover purchases from the vendors mentioned therein nor purchases by Magog. They did, however, represent actual business disbursements made in cash by Magog which disbursements were set off against the amounts received by cheque from Quemet with respect to those transactions.

Notwithstanding the fact that the plaintiff, Quemet, and the added party, Magog, were successful as to the substance of their claims, this is certainly not a case where costs should follow the event: both these parties falsified their books for illegal purposes. They knowingly assisted others to either defraud the Department of National Revenue or dispose of stolen property or both. Had proper books of account been kept, showing the true nature of each transaction and the names of the vendors, this litigation would never have arisen. The defendant was perfectly justified in the circumstances in insisting that the matter be examined in Court, for, even up to and including the actual trial, Quemet attempted to maintain the charade of bona fide purchases by it from Magog and bona fide sales by the latter to it. Witnesses for Magog and Quemet at trial, who should have been able to testify on the matter, maintained that they were unable to recall the identity of the third parties involved in any of the specific transactions. I remain totally unconvinced as to this portion of the evidence. No records whatsoever of the names of the persons involved were kept by either party.

For these reasons, the plaintiff shall pay the defendant’s costs up to the time of the application to add Magog and, both the plaintiff and Magog shall be jointly and severally liable for the costs of the defendant for all proceedings thereafter. All costs payable to the defendant shall be taxed on a solicitor-and-client basis. There shall be judgment accordingly.