Weed-Master (Western) LTD v. Minister of National Revenue, [1972] CTC 2364, 72 DTC 1296

A J Frost:—This appeal, which was heard at Calgary, Alberta on september 27, 1971 by the Tax Appeal Board as it was then constituted, is from assessments in respect of the appellant’s taxation years 1965, 1966 and 1967.

By its Notice of Appeal (amended) the appellant company stated that, when its principal business, the manufacture and sale of patented weed killers, began to decline due to the expiration of patent rights, management began looking for other sources of revenue to replace lost earnings and, as a result, acquired one-half of the issued shares in Western Industrial Importers Ltd (hereinafter referred to as “Western”), a company engaged in the import and wholesale distribution of certain Japanese goods under the brand name of “Trojan”. Unfortunately the financial position of this company deteriorated to such an extent that the appellant, while still managing the business of Western, began paying Japanese exporters from its own funds for goods ordered either by or for Western. After Western became insolvent, the appellant company decided to carry on Western’s business for its own account using the goods which it had already paid for. On or about July 22, 1965 the appellant company decided that this was an undesirable arrangement and incorporated a new company to conduct these business activities, which were new to the appellant, in order to keep these transactions segregated from the appellant company’s ordinary business. The new corporation was called Trojan Manufacturing Ltd (hereinafter called “Trojan”). A Mr Smith, who was owner of the other 50% in the issued share capital of Western still seemed to have some say in the matter because he obtained an option to acquire 50% in the shares of Trojan, an option he never exercised so that the appellant company became and remained in fact the sole owner of Trojan.

In 1966 a further segregation took place in that the sale of musical instruments, until that time within the scope of business of Trojan, was transferred to a separate company known as Melody Sales Ltd (hereinafter referred to as “Melody”), which company became a wholly-owned subsidiary of the appellant company. These business arrangements whereby the appellant was able to continue its own business operations and at the same time enjoy limited liability in respect of its subsidiary companies met with one serious snag. The Japanese exporters were willing to ship all the merchandise they possibly could to Trojan but on one condition, namely, that payment would be guaranteed. They knew from experience that the appellant company would provide the funds required to pay for the merchandise and they therefore stipulated that the appellant would be responsible for the payments due to them on account of the business transactions with Trojan and Melody.

During the 21/2 years which followed, the incorporation of Trojan’s and Melody’s business did not develop as well as anticipated and, in 1966 and 1967, the appellant company had, at the end of its 1966 and 1967 business years, advances owing to it by these subsidiaries amounting to $96,864.59 and $47,414.56 respectively, which were shown on the financial statements of the company as doubtful if not uncollectable. These amounts were claimed as allowances as doubtful accounts but on reassessment disallowed by the Minister.

In the ensuing dispute between the parties, the appellant defended its claim on two alternative grounds. In the first place it contended that, even though the purchases of the Japanese merchandise had been made in the name of Trojan, the appellant had in fact purchased and paid for these goods and had resold them to its own subsidiaries at a profit of 5% on the laid-down cost and that the appellant company was therefore entitled to claim the allowance for bad debts, like any other person in the business of buying and selling goods at a profit. In the alternative, the appellant contended that the losses which it had suffered in dealing with its own subsidiaries and resulting from the fact that it had advanced moneys to the Japanese exporters, were in fact incurred within the scope of the appellant’s overall business activities and that they should therefore be treated as deductible business expenses incurred in the course of its income-earning activities.

The respondent on the other hand maintained that if the appellant had suffered losses, the appellant could certainly not claim them in the form of bad debts within the meaning of paragraphs 11(1)(e) and

(f) of the Income Tax Act for the simple reason that the appellant had never purchased and resold the said merchandise as part of its regular business, and that, if it had lost money, it was on capital account and not in the course of its business operations within the meaning of paragraph 12(1)(a) of the Act. These respective positions were extensively argued during the hearing of this appeal on September 27 and 28, 1971.

With the able assistance of counsel for both parties, I came to the following conclusions. Realizing that its own original business, the manufacturing and selling of weed killers, was gradually phasing out, the appellant tried in 1965 to enter new fields of commercial activity. The initial experience was not favourable and the fact that a business associate, one Mr Smith, decided not to continue this new line of endeavour after Western had failed, shows that the appellant acted prudently in seeking not to get financially involved and in not integrating the new ventures with its own business. This appeared to the Board to be the main reason for the creating of separate legal entities.

It was unavoidable nevertheless that the appellant company had to advance a certain amount of working capital to the new business in order to provide it with the necessary merchandise. li was, one may say, out of necessity that the appellant had to support Trojan’s credit and it would have been much more in line with the appellant’s desire to stay outside Trojan’s financial adventures if this had been possible. The relationship between the Japanese exporters and the appellant company was nothing but an ordinary agreement of indemnity for which a written document was not required and pursuant to which the appellant made itself principally liable for the debts resulting from the purchases made by Trojan and Melody. it did not make any sense for the appellant to buy the merchandise first and then sell it to Trojan and Melody at a profit.

Invoices were in the name of Trojan and to construe this situation as purchases by the appellant which thereupon sold the merchandise again at a profit of 5% to its subsidiaries is just distorting the real facts. The 5% was nothing but a flat rate which was charged in order to pay for the administrative and financial cost incurred by the appellant in providing the above services. There never was, in my opinion, any intention whatsoever on the appellant’s side to act as an independent trader in these goods and to earn a profit by selling them to its own subsidiaries which were still struggling to get established.

The outlays which the appellant company had to make in order to put Trojan and Melody on their feet were of a capital nature, and although the Board sympathizes with the appellant’s predicament, there is no way in which it could possibly find relief by transferring part of its capital loss to the national treasury. By creating separate legal entities which were to conduct the import and distribution of Japanese products, the appellant company could have gained certain advantages but in fact lost the right to claim the operational losses of those entities, losses which the appellant in all probability had never anticipated.

For the above reasons, the appeal should be dismissed.

Appeal dismissed.