A J Frost:
1 This is an income tax appeal for the appellant's 1971 and 1972 taxation years, wherein the Minister of National Revenue disallowed the following items:
(a) Mortgage interest in the sum of $3,857.64 and life insurance costs of $452.47 in respect of its 1971 taxation year, and
(b) Legal costs of $800 in respect of its 1972 taxation year.
2 In 1971 the appellant purchased all the outstanding shares of Chapels Limited from Capasu Holdings Ltd by agreement dated October 28, 1971 for a total consideration of $238,006.89. Under the terms of the said agreement, the appellant company was obliged to pay interest on its indebtedness, and to take out a life insurance policy on the life of Philippe Walter Lavack to secure amounts still owing to Capasu Holdings Ltd. Legal expenses in connection with the transaction amounted to $800.
3 It was adduced in evidence that the shares of Chapels Limited were purchased in order to make it possible for the appellant company to earn income from its management business rather than dividends from an investment, and that subsequent to the purchase, a management agreement was in fact drawn up clearly indicating that the intention of the appellant was to earn only taxable income.
4 Mr G J Forest, CA, who represented the appellant, in the early stages of the hearing agreed with the position of the Minister with respect to life insurance costs of $452.47. Mr Forest claimed the amount of $3,857.64 incurred during November and December of 1971 was a proper deduction from management fees earned in the same period, and that only the net amount was taxable. With respect to the legal expenses of $800 he claimed that the appellant had a right to deduct this amount from its 1972 taxation year.
5 The appellant company bought the shares of Chapels Limited, not its assets. The appellant and Chapels Limited are two separate corporations and any future dividends declared by Chapels Limited would be exempt income in the hands of the appellant. However, in this case the shares were purchased to obtain the right to provide management services only and dividends were not a factor. In reality the appellant borrowed money to gain control of Chapels Limited for the purpose of obtaining a collateral advantage in the form of a management contract. Share control was incidental to the aim, object or purpose of the appellant at the time the deal was made. No dividends were contemplated and, further, Chapels Limited was not in a position to pay dividends. For all practical purposes there could be no exempt income.
6 Counsel for the Minister, in his argument, submitted that interest on money borrowed for the purpose of earning exempt income would not be a deductible expense under the old Act. This is true, but it is also true that dividend income of a company from another Canadian company is no longer exempt income under the new 1972 Income Tax Act. The interest issue, therefore, only pertains to the 1971 taxation year. Moreover, with regard to the deductibility of interest expenses, the jurisprudence has, during the last five years, changed considerably. A judgment which introduced a more flexible approach to this matter was the case of Trans-Prairie Pipelines Ltd v Minister of National Revenue, [1970] C.T.C. 537, 70 D.T.C. 6351, in which Mr Justice Jackett found that money borrowed in order to redeem outstanding preferred shares could give rise to interest expenses which would be deductible. In that case the Minister contended that money borrowed for redemption of shares was certainly not to be considered as capital borrowed for the purpose of earning money, and that therefore the interest payable thereon could not be treated as a deductible expense. The Exchequer Court rejected this argument and said that what, in fact, happened was that the operating capital which the company used for its business changed colour in that from now on it no longer consisted of preferred share capital but of “bond” capital, and that in all reasonableness it had to be assumed that this capital so borrowed, like the share capital it replaced, would be used for the purpose of earning money for the business. The interest expense on the bond capital was therefore allowed.
7 Not so long ago the Federal Court (Mr Justice Collier) rendered a decision concerning the acquisition of shares in a Canadian company by a so- called management corporation. In that case, R v Balmoral Holdings Ltd, [1975] C.T.C. 397, 75 D.T.C. 5296, the taxpayer company contended, and proved, that it was in fact not after the shares of another Canadian company as an object of investment but simply because it was necessary to own those shares in order to obtain a management contract in respect of the business of that Canadian company. In other words, the shares were really acquired in order to earn management income which was the official object of the taxpayer company.
8 In the present case we are dealing with only one year of interest expense. Mr Forest, in his argument, contended that the appellant was in the business of providing managerial services and that it was virtually impossible to declare dividends because the profits of the company had to be employed for other purposes.
9 On the evidence, I find that the appellant company did not seek an investment in shares but wanted a management contract which it needed to acquire in order to control another Canadian corporation. In my opinion, the appellant's case is a strong one with regard to both interest expense and legal costs as the ultimate object of the outlays was to earn taxable income.
10 The appeal is dismissed with respect to insurance costs in the amount of $452.47 for the 1971 taxation year, but in all other respects the appeal is allowed.
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