Lake City Industrial Corporation LTD and Brunette Investments LTD v. Minister of National Revenue, [1976] CTC 2344, 76 DTC 1273

A J Frost:—This is the income tax appeal of Lake City industrial Corporation Ltd (hereinafter referred to as “the appellant”) from Notices of Reassessment dated May 15, 1975, in respect of its 1965 to 1971 taxation years inclusive, wherein $90,570.18 was disallowed as an expense on the ground that the said outlay was of a capital nature. lt was agreed that appeal No 76-101 of Brunette Investments Ltd for the taxation year 1971 (hereinafter referred to as “Brunette”) would be heard at the same time on common evidence, and that the decision in this appeal would apply equally to that of Brunette.

Under an agreement dated January 1, 1965 Western Pacific Projects Ltd, hereinafter referred to as “W-P”, agreed to manage certain subsidiaries of Webb & Knapp (Canada) Ltd, including the appellant, Brunette, and North Bay Shopping Centre Ltd, hereinafter referred to as “North Bay”.

North Bay was an unsuccessful business venture and required considerable supervision and the constant infusion of new moneys to keep it alive. This was accomplished by W-P advancing funds to North Bay as follows:

These advances provided working capital to sustain North Bay and pay its operating losses. In the Statement of Administrative Costs and Distribution of W-P for the year ended December 31, 1968 (Exhibit A-3) the above advances were written off as bad debts and included in the total of administrative costs.

The following is a summary of what appears in the above statement:

Administrative costs:

Sundry costs		$269,843.67
Bad debts (including administrative
fees of $5,809.46)		106,442.99
		376,286.66
Less — Recovered by
Consultants’ fees	$75,000.00
Recovered by leasing
commissions	2,115.78
Interest income	809.96	77,925.74
		$298,360.92
Administrative costs distributed:
Brunette 10%	29,836.09
Appellant 90%	268,524.83	$298,360.92
Net income for the year		Nil

The question at issue in this appeal is whether that portion of the bad debt expense included in W-P’s net administrative costs of $298,360.92, which amounted to 90% of the net amount of $100,633.58 (or $90,570.18) and was passed off to the appellant in the form of management fees, can properly be regarded as a deductible item against the income of the appellant.

The effect of these transactions was to transfer the losses sustained by North Bay to the appellant and Brunette. The transfer was recorded in the books of the transferee as “Management Fees”.

The evidence established that, at the time this was taking place, Webb and Knapp (Canada) Ltd were involved in some very heavy real estate deals, and were in a rather difficult financial position. Also the American parent company, Webb & Knapp Inc of New York, was in trouble, which reflected seriously on the credit of the Canadian company. To cite one example, it had been estimated that Place Ville Marie would cost $60,000,000 but its actual cost turned out to be $120,000,000.

In the administration of their affairs, Webb & Knapp (Canada) Ltd treated all real estate holdings as inventory, and all sales of buildings and real estate were reported as income items. In this context, all outlays made with respect to real estate assets were intended to protect or improve their inventory position. In a broad view, it makes some sense to adopt the view that all outlays of the type we are concerned with, should be regarded as items deductible from income.

In a narrow frame, however, the picture changes. Paragraph 12(1)(a) of the Act states that in computing income no deduction shall be made in respect of

an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer,

The important words are “property or a business of the taxpayer”. The language of the section is such that it is difficult to see how more than one taxpayer can be lumped together when the Act speaks in the singular of the “taxpayer’’, not the “taxpayers”.

The management company (W-P) served two purposes in acting on behalf of the managed companies (the appellant and Brunette). Firstly, it acted as a conduit pipe for the levelling of profits, and second, it functioned as a manager under an arrangement with its parent company, Webb & Knapp (Canada) Ltd.

On the evidence, it is clear that the management charges absorbed by the appellant (via W-P as the conduit pipe) included losses sustained by the appellant’s sister subsidiary North Bay. Obviously the outlays, to the extent of $90,570.18, were reimbursed to W-P, the management company, to cover losses of another taxpayer, and, under paragraph 12(1)(a) of the Act, cannot be allowed as a deduction.

Further, W-P, the management company, was not in the business of lending money and, accordingly, its losses with respect to the North Bay operation were of a capital or investment nature.

The only ground for allowing this appeal would be to disregard the corporate veil of all companies concerned, which is not, in my opinion, a reasonable approach, having regard for the provisions of the Act and the fact that the appellant and W-P were distinct legal entities operating separately and apart from each other.

The Board has no alternative but to dismiss the appeals.

Appeals dismissed.