Dofin Limited, Miller Stationers LTD v. Minister of National Revenue, [1979] CTC 2656, 79 DTC 605

Roland St-Onge:—The appeals of Dofin Limited and Miller Stationers Ltd came before me on May 1, 1979, at the City of Edmonton, Alberta, and counsel agreed that these two appeals be heard on common evidence although the issues were different.

The issue in the appeal of Dofin Limited (hereinafter referred to as “Dofin”) is whether the company is allowed to deduct some losses in its 1971, 1972 and 1973 taxation years and in the appeal of Miller Stationers Ltd (hereinafter sometimes referred to as “Miller”) the issue is whether the amounts paid to acquire goods for resale from Dofin were properly deductible in computing the company’s income in its 1973 and 1974 taxation years.

In Dofin’s appeal, the respondent contends that during the years in question the appellant was not carrying on the business in which the loss was sustained and that, accordingly, the appellant is not entitled to a deduction from income under the provisions of paragraphs 27(1 )(e) and 111(1)(a) of the Income Tax Act.

In Miller, he claims that the amounts of $28,535.29 and $24,497.70 paid to Dofin in 1973 and 1974 respectively were not outlays or expenses made or incurred for the purpose of gaining or producing income from a business within the meaning of paragraph 18(1)(a) of the Income Tax Act nor were they reasonable in the circumstances within the meaning of section 67 of the Income Tax Act.

Mr Ron Smith, president of Miller, was the only witness heard. He explained the following: in December 1967, he started to work as a salesman, in 1969 he became a controller and in 1979, president of Miller Stationers Ltd. Miller is in the business of buying and selling office supplies and furniture of all kinds, it buys from various suppliers and sells at a markup price. It has five salesmen and the sale of furniture represents 50% of the company’s sales.

In 1968 the stationery business was acquired from Sharp-MacNeill Limited. A letter filed as Exhibit A-3 shows that Sharp-MacNeill Limited was to discontinue its operations as an office stationery supplier and wanted to direct all its efforts in the office furniture business of Dofin.

On July 28, 1970, Miller acquired control of Dofin, a corporation engaged only in the design and sale of office furniture and, at that time, the said company had some $68,000 in losses. According to the financial statements filed, the following are the figures of the gross profit of Miller:

Dofin was acquired when the witness’s father was approached by Sonar, one of the Miller company suppliers who had loaned some $15,000 to Dofin. Mr Sharp, president of Dofin, and Miller were interested in the transaction because the former was in financial difficulties and the latter wanted to eliminate a competitor and thereby obtain its goodwill. Moreover, Miller wanted to have Mr Sharp on the staff but in order to do so, it had to buy the company, avoid a bankruptcy and allow Mr Sharp to reimburse the loan. Mr Smith testified that, at the beginning of the negotiation, he did not know to what extent Dofin was in financial difficulty. At the examination of the books, he realized that the expenses were too high compared to the sales volume. He did not want to invest too much in the company because it was a losing enterprise but he was interested in keeping Dofin going because of its particular line of business; also, it was in the same line of business and, by the same token, was eliminating a competitor.

After the acquisition of Dofin, the latter continued to do business as before, except that the number of clients was restricted. Some invoices were filed to prove that Dofin purchased furniture from various suppliers, sold to customers other than Miller at a greater markup than 20% and tried to continue business with various customers as before.

Apparently the main reason in acquiring Dofin was to keep that customer and its goodwill. As a matter of fact, Miller, through the influence of Dofin, obtained some contracts from the Government. After the acquisition of Miller, Dofin kept the same bank account with the Bank of Montreal but the premises were closed down and the furniture taken to Miller’s premises. Dofin carried its name in the telephone book for three years but did not solicit new clients. Mr Smith did all the work for Dofin and was paid by the latter.

Upon cross-examination, it was admitted that if Miller had gone directly to the suppliers, it would have rated 50% of the profits but because it went through Dofin, it rated 40% and Dofin, 10% of the said profits.

Counsel for appellants argued that Miller, which was in the stationery business, had an opportunity to acquire Dofin, a competitor owned by Mr Sharp whose company had goodwill and by the same token Miller had the opportunity to obtain the services of Mr Sharp. He also stated that Miller was acquiring the goods for profit and that the amounts paid were reasonable and could be compared with those paid to the third parties.

He also referred the Board to the following cases: Sigma Explorations Ltd v The Queen, [1975] CTC 215; 75 DTC 5122; Simard-Beaudry Inc v MNR, [1974] CTC 715; 74 DTC 6552; to show that there was no artificial transaction or sham and that the furniture was acquired for resale as it had been done in the past; that the Dofin business was identical before and after the transaction and that the change in customer did not change the nature of the business; that in 1973, Dofin had to pay 50% on a taxable profit of some $24,000 and also that, at the end of that year, the goodwill element had served the purpose. It was good business for Dofin to cease its operation.

Counsel for respondent argued that to determine whether or not Dofin was carrying on the same business was purely a question of fact; that prior to the acquisition, Dofin had customers, salesmen, and a delivery set-up but after the transaction, it had no premises, did not advertise or obtain any new clients and that Dofin was only an agent for Miller. Counsel also argued that, in the circumstances, the 20% markup was not a reasonable price for the goods within section 67 of the Act and that there was no reason to have Dofin buy for Miller; that the latter could have made the whole profit of 50% instead of only 40% and that Dofin was kept alive only to benefit from the losses.

According to the evidence adduced, the Board is of the opinion that Dofin never ceased to do business and never changed the operation, even if it changed the means or reorganized the company in order to earn income. As a matter of fact, Dofin did, after the change of control, what it used to do before, namely buying furniture from various suppliers and selling them to clients but this time at profit. After the transaction, Dofin cut the operating expenses and was able to sell at a profit.

There is ample evidence to show that Dofin was not acquired as a sham but in order to eliminate a competitor, to obtain the services of Mr Sharp and to increase its profits. As a matter of fact, the gross profit of Miller from the sale of furniture and stationery in 1970, lumped together, was 33% whereas the sale of furniture alone went up to 24.3% in 1971,26.6% in 1972 and 23.52% in 1973. AS to the reasonableness of the 20% markup paid by Miller to Dofin, there is no evidence to convince the Board that this markup was exaggerated. On the contrary, Mr Smith testified that the pricing arrangements in the Edmonton area at that time were offers by suppliers at a discount from 30% to 50% of the retail price. Consequently it seems that the markup of 20% in the circumstances is reasonable and, furthermore, the respondent did not introduce any evidence to contradict this testimony.

The argument that Dofin was kept alive only to benefit from the losses is not a valid one. There were so many other good reasons, namely to eliminate a competitor, to obtain the services of Mr Sharp, to allow the latter to avoid a bankruptcy of his company and to pay his debts.

The Board prefers to say that Dofin was kept alive to be in a position to earn income and to pay its debts.

For these reasons, both appeals are allowed.

Appeals allowed.