Golden Arrow Sprayers Ltd. v. MNR, 61 DTC 1185, [1961] CTC 318 (Ex Ct)

DUMOULIN, J.:—This is an appeal from a decision of the Income Tax Appeal Board dated July 2, 1959, 22 Tax A.B.C. 260, in respect of the income tax assessment for taxation year 1953, of Golden Arrow Sprayers Ltd., a company having its head office at Calgary, Province of Alberta. The appeal was allowed to the extent only of $1,000.

The material facts giving rise to this litigation offer no complexities.

Golden Arrow Sprayers Limited, incorporated in Alberta, on November 20, 1952 cf. ex. C), replaced to all intents an older firm operating under the style of Golden Arrow Services Ltd., which, for many years, had manufactured farm-chemical sprayers according to patent rights, the property of one John EK. Palmer, its president and manager.

With a view to expanding their field of business, the directors of Golden Arrow Services Limited decided that a proper method of raising additional capital would be the incorporation of another company, Golden Arrow Sprayers Limited, that would purchase and take over the entire assets of the former organization. Arrangements were at once concluded to ‘‘obtain an underwriting on 250,000 shares of the new Company at $1 per share, less 25% commission’’,

In furtherance of the aforementioned decision, original subscribers to the Memorandum of Association met on November 21, 1952, and chose as first directors, John E. Palmer, his son, Harry

E. Palmer, Harold Milburn, secretary of the outgoing Golden Arrow Services Ltd., Harvey Brown and Karl F. Zeise, a foreman in the employ of the above company. Exhibit 2 relates the minutes of this initial meeting.

A further meeting of the newly elected board of Golden Arrow Sprayers took place, the same day, at 3 p.m., designating John

E. Palmer as president of the company (ex. 3). At 3.30 p.m., again on November 21, 1952, a third meeting of directors occurred approving ‘‘. . . the issue and allotment of 200,000 shares of the capital stock of the Company in consideration of the use of the Palmer Patents. Such shares to be issued and allotted when such Company received a certificate to commence business from the Registrar of Companies” cf. Statement of Facts, paragraph 4 and exhibit 5, Section 2). These shares were to be placed in escrow with the Montreal Trust Company pending the issue of a certificate to commence business.

At this same meeting, the sale by Golden Arrow Services to Golden Arrow Sprayers of all its assets was approved as against an allotment by purchaser to vendor of 100,000 shares fully paid up and non-assessable of the purchaser’s capital stock (cf. exhibits D, 4 and A, the latter dated January 2, 1953).

A subsequent Return of Allotment filed with the Registrar of Companies showed “. . . the amount . . . treated as paid up in cash for the 200,000 shares was $0.75 per share, or $150,000”. The incipient company, having obtained the requisite certificate, on or about February 26, 1953, the aforesaid 200,000 shares were then issued and allotted to J. E. Palmer.

For its 1953 taxation year the appellant “. . . claimed a capital cost allowance in respect to the acquisition of the right to use the said patents in the sum of $8,816. This capital cost allowance was disallowed by the Minister and the appellant re-assessed for an additional sum of $3,921.43”.

This much for the facts; now as to the conflict of law, thus occasioned, it is succinctly formulated by appellant in the following lines, under the subtitle ‘‘Statement of Reasons for Objections”, page 3:

“The question now arises as to the amount at which the capital cost to the Company of the licence to use the Palmer Patents should be fixed.

This then raises the question of whether the Company and Palmer were on the 21st day of November, 1952, dealing at arm’s length.”

It seems hardly necessary to note that in the appellant’s opinion J. E. Palmer, albeit president and manager of the purchasing company, was, nevertheless, dealing at arm’s length when he assigned the utilization of his three patents to Golden Sprayers at a ‘‘price’’ of two hundred thousand shares. Exhibit 4, true to say, mentioned that: ‘‘Mr. Palmer wished it to be pointed out to the meeting that he did not vote in respect to the said motion’’, which ratified the transaction in exhibit 5, the agreement between John E. Palmer, Patentee, and Golden Arrow Sprayers Ltd., Licensee, allotting shares for the right to use the patents.

The respondent’s basic argument appears in subsections (a), (b), (c) and (d) of paragraph 9 of its “Reply to Notice of Appeal”; it reads:

“9. . . .

(a) . . . the Appellant in calculating this income claimed as a deduction for capital cost allowance the sum of $8,816.00 in respect of the licence which it had obtained by the agreement dated the 21st day of November, A.D. 1952 with John E. Palmer to use certain patents,

(b) . . . the Appellant at the time it acquired the licence from John EK. Palmer was not dealing at arm’s length with John E. Palmer, and,

(c) that John E. Palmer was the original owner of the patents,

(d) that the capital cost of the patents to John EK. Palmer was nothing, . . .

A brief oral evidence was adduced on appellant’s behalf, consisting of Messrs. John E. Palmer’s and Harold Milburn’s testimonies.

Palmer substantiated the averments of the Statement of Facts, and declared that he ‘‘had not given nor promised to give any of his shares to the other directors of Golden Arrow Spravers Ltd.’’. He also agreed holding presently in his own right 253,000 shares of this latter company, thereby becoming its controlling shareholder.

Mr. Harold Milburn, it will be remembered, was the secretary of the elder organization before assuming a directorship in the younger one.

On November 21, 1952, he attended the 3.30 p.m. meeting “when 200,000 shares of the new concern were granted to J. Hi. Palmer, an allotment that encountered no difficulty whatever’’. According to this witness ‘‘the life of Golden Arrow Sprayers Ltd., was dependent upon the use of Palmer’s patents, and therefore, it seemed reasonable to extend adequate pecuniary appreciation to the patentee’’.

Thus summarized, the case raises, in my mind, a threefold question :

1. Was the right to use Palmer’s patents, acquired by the appellant on November 21, 1952, a ‘‘depreciable property’’, as foreseen in Section 20(2) of The 1948 Income Tax Act (11-12 Geo. VI, c. 52)?

2. Was John E. Palmer dealing at arm’s length with appellant company when he concluded the deals aforecited ?

3. Should the first query receive an affirmative answer, and the second, a negative one, in that event, what would be the capital cost to the taxpayer, i.e., Golden Sprayers, of the depreciable property thus obtained?

Section 127(1) (af) opposite the expression “property” sets forth that it “means property of any kind whatsoever whether real or personal or corporeal and, without restricting the generality of the foregoing includes a right of any kind whatsoever, a share or a chose in action”.

It may be held beyond doubt that a title to the use of Mr. Palmer’s patents assuredly fits into the unrestricted category of “a right of any kind whatsoever’’. Moreover, such right, directly related to patents, is essentially depreciable property, being coextensive to the 17 year duration of the patents themeslves (cf. Patent Act, R.S.C. 1952, c. 203, s. 49).

The second point unquestionably is the pivotal one. Section 127(5) (a), text of 1948, though not purporting to define restrictively ‘‘arm’s length” enacts that:

“127.(5) For the purpose of this Act,

(a) a corporation and a person or one of several persons by whom it is directly or indirectly controlled,

(b) . . .

(e) . . .

shall without extending the meaning of the expression ‘to deal with each other at arm’s length’, be deemed not to deal with each other at arm’s length.”

Reverting to the admitted facts we see that appellant’s executive body had J. E. Palmer for chairman of the board and manager, his son, Harry, and two of the old company’s employees, Harold Milburn and Karl Zeise, as co-directors, one being the secretary, the other a foreman of Golden Arrow Services. Palmer, senior, to all material intents, owned the merging company and could dictate to the nascent one any terms or conditions he wished to impose both as patentee and through his ascendancy over his son and associates or, should I say, his employees. Out of five directors, this man could control four, himself included. At all events, J. E. Palmer undisputably was ‘‘one of several persons by whom it (the appellant corporation) is directly or indirectly controlled”, and therefore cannot be deemed to have dealt at arm’s length with Golden Arrow Sprayers Ltd., in matters pertaining to this appeal.

Two precedents, among many, bear out this interpretation. In Miron & Frères Ltée v. M.N.R., [1955] S.C.R. 678-679; [1955] C.T.C. 182, the factual incidents were substantially these:

“The appellant (in 1948) aequired a farm from one of its shareholders at a price for exceeding the original cost to the vendor. The appellant claimed a capital cost allowance based on the price paid. All the issued shares of the appellant, minus three, were owned by the vendor and his five brothers, with more than one half of the shares being owned by the vendor and any three of his brothers . . .

Held: The appeal should be dismissed. Under s-s. (5) of s. 127 of the Income Tax Act, 1948, c. 52, the appellant and the vendor were deemed not to have dealt with each other at arm’s length.

Per Kerwin C.J. and Fauteux J.: Since the appellant was controlled by the vendor and three of his brothers, the vendor was one of several persons by whom the appellant was directly or indirectly controlled (italics are mine).

Per Taschereau, Kellock and Abbott J.J.: The appellant failed to show error in respect of the Minister’s conclusion that the transaction was not one between persons dealing at arm’s length.”

Mr. Justice Cameron, in the cause of the M.N.R. v. Kirby Maurice Co. Ltd., [1958] Ex. C.R. 77 at pages 84-85; [1958] C.T.C. at pages 48-49, wrote:

“That subsection (5) of Section 139 does not purport to define all transactions which are not at arm’s length is made clear in the case of M.N.R. v. Sheldon s Engineering, Ltd., [1955] S.C.R. 637; [1955] C.T.C. 174, where Locke, J., in delivering the judgment for the Court, said at p. 648 [[1955] C.T.C. 179] :

‘The words (2.e., to deal with each other at arm’s length) do not appear in the Income War Tax Act, though the same subject-matter is dealt with in Section 6(1) (n) of that Act. In addition to appearing in Sections 20 and 127, the term is employed in Sections 12(3), 17(1), (2) and (8), 36(4) and 125(3) of the Income Tax Act. Section 127(5) does not purport to define the meaning of the expression generally; it merely states certain circumstances in which persons are deemed not to deal with each other at arm’s length. I think the language of Section 127(5), though in some respects obscure, is intended to indicate that, in dealings between corporations, the meaning to be assigned to the expression, elsewhere in the statute is not confined to that expressed in that section’.”

On the merits of the case Cameron, J., continues thus:

“The evidence of Maurice satisfies me completely that the transaction by which the franchise came into the hands of the respondent was not one at arm’s length. The Act does not define the expression, and it would perhaps be unwise for me to attempt to do so. It is sufficient to state that in my Opinion, in a vendor and purchaser matter, an arm’s length transaction does not take place when the purchaser is merely carrying out the orders of the vendor, and exercising no independent judgment as to the fairness of the terms of the contract, or seeking to get the best possible terms for himself . . . In effect, Maurice was both vendor and purchaser, and while he was not actually a shareholder at the time the agreement of October 1, 1952 was signed, he had in fact full control of the entire operation.’’

A comparable situation exists here: the all-important patent rights owned by Palmer, the impressive bulk of his stock-holdings, plus his parental connection with one and business ties with two other directors, his presidency of the appellant company, were of such a nature that ‘‘he had in fact full control of the entire operation’’ now under review, and, I repeat, was, therefore, not dealing at arm’s length, with the appellant.

There now remains for determination the assessment of a capital cost to Golden Sprayers Ltd., of the “depreciable property” acquired, in other words the ‘‘right to use’’, these oft- mentioned patents.

Section 20(4) and (a) of this subsection provide the relevant rule:

“20. (4) Where depreciable property did, at any time after the commencement of 1949, belong to a person (hereinafter referred to as the original owner) and has, by one or more transactions between persons not dealing at arm’s length, became vested in a taxpayer, the following rules are, notwithstanding section 17, applicable for the purposes of this section and regulations made under paragraph (a) of subsection (1) of section 11:

(a) the capital cost of the property to the taxpayer (1.e., Golden Arrow Sprayers Ltd.) shall be deemed to be the amount that was the capital cost of the property to the original owner (i.e., John E. Palmer) ”

John EK. Palmer asserted having spent ‘‘about $700 to secure his patents for Spraying Nozzle, Field Marker’ and an appli- cation for a third patent now abandoned’’. This expense, I believe, represents the capital cost of the property to its original owner and should be allowed to the appellant.

For the reasons above, the appeal is dismissed, save that appellant will be granted a capital cost allowance of $700 in respect of its income tax return for taxation year 1953. The Minister of National Revenue is entitled to the costs of this appeal after taxation.