Paramount Bio-Chemicals Ltd. v. Minister of National Revenue, [1986] 1 CTC 2206, 86 DTC 1144

Brulé, T.C.J.:—

Issue

The issue in this appeal relates to the 1981 taxation year of the appellant and the disallowance by the Minister of the deduction of interest payments thereby reducing business losses.

Facts

The appellant is a Manitoba corporation which at all relevant times was 80 per cent owned by Peter Vis and his wife and carried on the business of manufacturing and selling livestock feed. Gardenton Farms Ltd. (“Gardenton”) is a Manitoba corporation which during the relevant times was owned by Vis and his wife and carried on a commodities trading business.

The food materials that the appellant purchased for use in the manufacturing of the livestock feed were commodities that were subject to fluctuations in value. The purpose of Gardenton's involvement in commodities trading was largely to provide a hedge against the fluctuations in the price of the food materials that the appellant used in the manufacturing of the livestock feed.

In its 1979, 1980 and 1981 taxation years the appellant had outstanding loans from its bank on which it paid interest. The loans from the bank were made for the purpose of earning income from its business and the appellant deducted the interest paid to the bank in computing its income for the said years. Also in its 1979, 1980 and 1981 taxation years, the appellant lent funds to Gardenton on which no interest was payable by Gardenton to the appellant. These funds were used by Gardenton for the purpose of earning income from its business.

By notices of reassessment dated March 1, 1983, the Minister of National Revenue reassessed the appellant in respect of its 1979 and 1980 taxation years and by a notice of reassessment dated June 6, 1983, the Minister of National Revenue reassessed the appellant in respect of its 1981 taxation year, disallowing as a deduction in each of these taxation years the proportion of the interest paid to the bank by the appellant that the Gardenton loans were of the appellant’s borrowings from its bank in each of those taxation years.

The amount of interest disallowed as a deduction by the Minister in each taxation year was as follows:

1979 — $25,000

1980 — $50,000

1981 — $70,000

At all relevant times the appellant had retained earnings in excess of the Gardenton loans.

The reassessments for the 1979 and 1980 taxation years that were issued by the Minister were nil assessments, however the Minister’s disallowance of the deduction of interest by the appellant in those taxation years has resulted in a reduction of the business losses available for carry forward by the appellant into its 1981 taxation year by the aggregate amount of interest which was disallowed in 1979 and 1980, being the sum of $75,000.

Appellant's Position

The appellant’s position is that the money borrowed from the bank was used by the Company to build up its infrastructure and the evidence did not disclose any of the borrowed funds finding their way to Gardenton. The assumptions made by the Minister were not disputed by counsel for the appellant other than that the funds loaned by the appellant to Gardenton were borrowed by the appellant to cover commodity trading losses suffered by Gardenton and were not employed in the course of the appellant's business for the purpose of gaining or producing income.

In support of the appellant’s position several cases were put forward to the Court.

The case of No. 695 v. M.N.R., 24 Tax A.B.C. 92; 60 D.T.C. 195 had many similar circumstances to the present appeal. Money loaned by the appellant to a company controlled by the same shareholder while making several bank loans on its own behalf. The Court held that interest on those loans was deductible and even though, if contended that a portion of the bank loans was used to pay the borrowing company's bills, it remained that the loans by the appellant were used to earn income in the business and accordingly interest was deductible.

A similar decision was reached in the case of Total Holdings (Australia) Pty. Limited v. Federal Commissioner of Taxation, 78 A.T.C. 4286 (S.C.N.S.W.).

The case of Lakeview Gardens Corporation v. M.N.R., [1973] C.T.C. 586; 73 D.T.C. 5437 was advanced for the proposition that where funds were borrowed and used for certain appropriate purposes some amounts should be considered as having been made at least in part out of the company’s available surplus.

Respondent's Position

Counsel for the Minister took the approach that the Income Tax Act provided that interest may be deductible as an expense if it was paid pursuant to a legal obligation to do so and if money borrowed was used for the purpose of earning income. It was claimed that the onus is on the appellant who claims a deduction to prove his entitlement to it, and in support of this, cited the cases of Lumbers v. M.N.R., [1943] C.T.C. 281; 2 D.T.C. 635, affirmed by the Supreme Court of Canada at [1944] C.T.C. 67; 2 D.T.C. 652; and Sheaffer Pen Co. Ltd. v. M.N.R., [1953] C.T.C. 345; 53 D.T.C. 1223.

Counsel then went on to point out, quoting several authorities, that in order to be deductible by a taxpayer the borrowed money on which the interest is paid must have been used to produce income in that taxpayer's own business. This is so even if the borrowed money is lent to a related company and eventually increases the income of the lender. Each company is separate and must be so taxed.

Analysis

I cannot but agree with the argument by counsel for the Minister, but such argument must be applied to the facts in the case.

Subparagraph 20(1)(c)(i) of the Income Tax Act provides as follows:

20 (1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property . . .

In his evidence, Mr. Vis, the only witness before the Court, explained the relationship between the appellant Company and Gardenton. The latter was a buying arm for Parliament and was involved in commodities. Paramount paid many of the bills of Gardenton using ledger entries for these inter-company transactions. There were no loan documents. It was stated that the appellant’s bankers knew that Gardenton's activities were for Paramount purposes.

The amounts owing by Gardenton were always less than the retained earnings of Paramount and this was shown by Exhibit A-3. The financial statements of both companies were introduced as evidence.

From the evidence presented it was unrefuted that any of the funds borrowed by Paramount were directly loaned to Gardenton, but were used for their own income earning purposes.

It is not very helpful to the Court when no full examination of the facts is forthcoming. Mr. Vis testified that any inter-company transactions with Gardenton always came from funds on hand and that the borrowings by Paramount were for current needs and capital expansion. The very limited cross-examination by counsel for the Minister did not contradict any evidence presented by the witness.

In a typical case under appeal, the Minister puts forth certain assumptions which the appellant must rebut. This is done by the appellant or witnesses on his behalf and by exhibits presented to the Court. It is then up to the Minister's counsel to discredit the evidence by cross-examination or to introduce evidence on behalf of the Minister. In this case neither was carried out.

The assumptions made by the Minister were rebutted by the only evidence before the Court, and the argument presented by the Minister's counsel and the cases referred to are easily distinguishable on the facts before me.

The end result is then that this appeal is allowed and the appellant is entitled to costs on a party and party basis.

Appeal allowed.