Wp Graphics Inc. v. R., [1996] 2 CTC 2333 (Informal Procedure)

Bowman J.T.C.C.: — These appeals are from assessments for the appellant’s 1990 and 1991 taxation years. The issue is the deductibility of interest paid on loans made to the appellant by Niagara Credit Union Limited. The purpose of the loans was to assist in the acquisition of shares in the appellant.

The sequence of events is as follows: on August 3, 1989, Roger Reynolds and Eileen Stanley-Reynolds (“the Reynolds”) agreed to purchase all of the shares of Welland Printing Company Limited (subsequently WP Graphics Inc.), the appellant (“WPG”) from James Arvay, Laura Arvay and Jeanne M. Pinder (“the Arvays”) for $454,115 plus the value of WPG’s inventory, work in progress and net working capital. The payment was to be by way of a promissory note for $100,000 and the balance, subject to adjustments, in cash on closing. The total purchase price on closing turned out to be $541,821.30, and the balance due on closing was $440,821.30 ($541,821.30 less the $100,000 promissory note and the deposit of $1,000).

This amount of $440,821.30 was paid directly to the solicitors for the vendors out of two loans, $192,000 and $255,000, totalling $447,000, made by Niagara Credit Union Limited to WPG. The loan was secured by two charges on the property of WPG for $192,000 and $340,000. A further line of credit for $100,000 was extended to WPG. The commitment letter of August 16, 1989 refers to the borrower as WPG, and to $100,000 as a revolving line of credit, and $240,000 as an instalment loan “to assist with the purchase of the shares of the Welland Printing Company Limited”. The transaction closed on September 15, 1989. The entire $447,000 advanced by Niagara Credit Union came from the mortgage amounts (land and equipment of $192,000 and $240,000 and $15,000 from the $100,000 line of credit).

Evidently it was recognized by the Reynolds’ lawyers that the tax situation was precarious. Therefore a company, owned by the Reynolds, R2E2 Investments Inc. (“R2E2”) was incorporated on September 28, 1989 and it adopted and ratified the agreement of purchase and sale of August 3, 1989 between the Arvays and the Reynolds.

It was stated in the corporate resolution and in the assumption agreement that the agreement had been entered into by the Reynolds on behalf of, and as trustee for, R2E2.

A resolution of the directors of WPG dated September 15, 1989 declared payable to shareholders of record at the close of business on September 15, 1989 a dividend of $447,000.

The accuracy and dates of these corporate documents appear to have been accepted by the Minister of National Revenue on assessing and I make no further comment on them, apart from observing that the purpose of inserting R2E2 in the chain of ownership was presumably to ensure that the dividend declared by WPG should be a tax-free intercorporate dividend in R2E2’s hands.

In 1990 and 1991, WPG paid interest on the moneys borrowed from Niagara Credit Union Limited as well as on the promissory note for $100,000 given by the Reynolds to the Arvays as part of the purchase price of the WPG shares, and deducted it in computing income.

On assessing, the Minister disallowed interest of $34,287 in 1990 and $31,480 in 1991. He did so on the basis that a dividend of $447,000 was paid to R2E2 which in turn used it to purchase the shares of WPG. He assumed further that the dividend was funded to the extent of $253,196 from WPG’s retained earnings and to the extent of $193,804 from the borrowing of funds from Niagara Credit Union Limited. Therefore, he disallowed only the portion of the interest claimed that was attributable to the excess beyond the retained earnings, i.e. $193,804, and the interest paid on the Reynolds’ $100,000 promissory note. In so doing he applied the principle in the Exchequer Court of Canada case Trans-Prairie Pipelines Ltd. v. Minister of National Revenue, [1970] C.T.C. 537, 70 D.T.C. 6351 (Ex. Ct.). In so doing the Minister, I think, adopted an approach that was very fair to the taxpayer.

Counsel for the appellant, in a very able argument, invited me to apply the Trans-Prairie principle to the remainder of the borrowings from Niagara Credit Union Limited. This would involve extending the principle in two ways: (a) by applying it not only to the retained earnings and paid-up capital of the company but to the entire net value of the company’s assets and, (b) by applying it to moneys borrowed to pay a dividend to enable a third party to buy the shares of the company from the existing shareholders. I do not think that the principle in Trans-Prairie can be pushed that far. The inescapable fact is that the funds went directly to the vendors of the shares, the Arvays. On no view of the matter can it be said that they were used in the business of WPG, even though the payment was characterized (and accepted by the Minister) as a dividend. Their use, in an economic sense, was to assist in the purchase of WPG’s own shares. This is not a use encompassed in the expression “for the purpose of gaining or producing income from a business or property” within the meaning of paragraph 18(l)(a) or “earning income from a business or property” within the meaning of subparagraph 20(l)(c)(i). The “business or property” must, of course, be the taxpayer’s own business or property, not someone else’s.

Trans-Prairie is, I presume, still good law. It was referred to at some length in Bronfman Trust v. R., [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059. It was not disapproved of but it is difficult to discern in the judgment of the Supreme Court any particular enthusiasm to extend its application beyond its own particular facts.

The appeals are dismissed. Since the case was heard under the informal procedure no costs are awarded.

Appeals dismissed.