Date: 19990603
Docket: 97-433-IT-G
BETWEEN:
DUPONT CANADA Inc.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Lamarre Proulx, J.T.C.C.
[1] This is an appeal concerning the Appellant's taxation year ending December 31, 1988. The issue is whether the explosives operations of the Appellant constituted a separate business. An affirmative answer would have the effect of treating the depreciable property used in the explosives operations as property of a separate class within the meaning of paragraph 1101(1) of the Income Tax Regulations (the "Regulations"). The result of this conclusion would be that upon the disposal of that property, the excess of the proceeds beyond the undepreciated capital cost would have to be included in the computation of income pursuant to paragraph 13(1) of the Income Tax Act (the "Act"). A similar result would apply in the case of eligible capital property pursuant to subsection 14(1) of the Act.
[2] The assumptions of fact made by the Minister of National Revenue (the "Minister") in reassessing the Appellant for its 1988 taxation year are described at paragraph 8 of the Reply to the Notice of Appeal (the "Reply") as follows:
(a) the facts herein before pleaded or admitted;
(b) the parties to the purchase and sale of the explosives operations ("Explosives Division") entered into a five year non-competition agreement;
(c) the Explosives Division was sold as a "going concern";
(d) the purchaser of the Explosives Division continued the explosives operations at the same location and without effecting any major changes;
(e) following the sale of the Explosives Division, the Appellant had no other substantial operation in the North Bay/Nipissing area;
(f) the purchaser retained substantially all of the existing employees;
(g) the former site manager of the Explosives Division became the president of the business under the new ownership;
(h) separate financial records were maintained at the North Bay location to establish the Explosives Division's profitability as a separate business;
(i) the Explosives Division operated principally from the North Bay location;
(j) the sales force of the Explosives Division was separate from the Appellant's other divisions;
(k) no other division of the Appellant produced the same or competing product as the Explosives Division;
(l) the Explosives Division was not dependent upon any other operation of the Appellant for its key manufacturing material;
(m) goods and material connected to the Explosives were stored at the North Bay location; and
(n) there was a concurrent sale of the Appellant's U.S. parent's explosives business to a purchaser related to the purchaser of the Appellant's Canadian Explosives Division.
[3] The reasons upon which the Appellant relies to demonstrate that the explosives operations were not a separate business are set out at paragraph 21 of the Notice of Appeal as follows:
(a) While the explosives operations had employees who provided services solely to those operations, there were other employees of the Appellant who provided critical business services to both the explosives operations and other operations of the Appellant such as system and computer services, research and development, freight forwarding, engineering, advertising, payroll, public relations and legal services.
(b) The explosives operations did not have a dedicated purchasing department. All of the purchasing activities for the Appellant were carried out by centralized purchasing groups.
(c) With the exception of certain cost-accounting records, separate accounting records were not maintained at Nipissing Works. Rather, the accounting activities of the Appellant were centralized and head office personnel located at Mississauga did all of the accounting for all of the profit centres including the explosives operations.
(d) The explosives operations did not carry out any of their own financing or banking activities. All of the financing and banking activities (other than the handling of petty cash) were centralized at the head office of the Appellant and all financing arrangements and lines of credit were negotiated by the head office personnel on a corporate, as opposed to an operational or divisional, basis. While the General Manager of Explosives established terms of sale, e.g. 30 days, the actual granting and extension of credit was the sole authority of the credit department, not the explosives operations.
(e) The explosives operations did not have an independent systems and computer services group. Not until one year after the sale did ETI have its own computing facilities and applications software.
(f) There was no senior management of the Appellant dedicated to the explosives operations. The personnel in charge of the marketing and manufacturing organizations of the explosives operations reported to Senior Vice-Presidents of the Appellant who also had responsibility for some of the other operations of the Appellant. In addition, while the General Manager of Explosives and the Site Manager at Nipissing Works worked exclusively in the explosives operations, such persons, in most cases, were moved into explosives from other operations of the Appellant and were often promoted or transferred to other positions which would involve other operations of the Appellant.
(g) Pay levels for all salaried personnel of the Appellant were the same. Accordingly, the salaries of such persons engaged exclusively in explosives at any particular time were not dependent solely upon the earnings of the explosives operations. Rather, the remuneration of such persons was tied only to the operations of the Appellant as a whole.
(h) The explosives operations were developed as part of the natural evolution and expansion of the Appellant's business.
[4] The Appellant did not consider the sale of the explosives division to be the sale of a separate business. As stated by the Appellant, in computing its income for its taxation year ended December 31, 1988, it deducted the amount allocated to the tangibles from the undepreciated capital cost of depreciable property of the applicable prescribed classes in accordance with subparagraph 13(21)(f)(iii) of the Act. The deduction of such amount did not give rise to an income inclusion, pursuant to subsection 13(1) of the Act. The Appellant also deducted the amount allocated to goodwill from its cumulative eligible capital account, in accordance with subparagraph 14(5)(a)(iv) of the Act. This deduction resulted in an income inclusion of $1,114,388 pursuant to subsection 14(1) of the Act.
[5] The witnesses were Mr. Gerald Fox, who over the course of his employment with the Appellant, held the roles of general counsel, vice-president Human Resources, secretary to the company and before retiring was advisor to the president. He has participated in the negotiation to the agreement; Mr. Michael Parks, a chemist, who was the supervisor of operations of the engineering research at Kingston, Ontario and from 1986 to 1988, the site manager at Nipissing Works; Mr. John Nicholson, a civil engineer who worked as a systems analyst for, among other sectors, the Appellant's purchasing sector; and Mr. Blake Donnelly, business analyst, one of the Appellant's employees who was transferred to ETI Explosives Technologies International (Canada) Ltd. ("ETI")at the time of the sale of the explosives division. Mr. John A. Carlos, director of taxation, in the Appellant's legal services, testified at the request of Counsel for the Respondent.
[6] On September 4, 1987, the Appellant entered into an agreement with ETI, for the sale as a going concern of the business assets of the Appellant's explosives operations. (Exhibit A-1, Volume III, Tab 40, pages 874, 881). This agreement was amended on December 15 and December 30, 1987. (Volume III, Tabs 41 and 42, pages 951 and 972). The sale was understood to be the sale of the explosives business by all members of the board of directors as can be seen from the excerpts of these meetings found at Tabs 26 to 29 of Exhibit R-1, Volume II. It must be said however that the question whether it was the sale of a separate business did not appear to be considered then. There is no evidence as to how the sale price was negotiated. The board members did not debate the price offered as it was more than what they called their "indifference price". The evidence did not reveal the basis of the indifference price.
[7] The sale closed on January 22, 1988. The purchase price for the Purchased Assets other than inventory was $55 million (U.S.). The inventory was valued at $3,500,000. The purchase price was allocated as follows (Volume III, Tab 41, pages 952 and 953):
(a) For the land included in the Property $ 200,000
(b) For the buildings included in the Property 3,000,000
(c) For the Tangibles other than office furniture 49,799,000
(d) For the office furniture included in the
Tangibles 1,000
(e) For Intangibles including patents and goodwill 2,000,000
[8] The agreement described the assets sold as the business assets and they were the tangibles, the intangibles, the sales and purchases orders, the contracts, the marketing information, the property, the inventories, the business information and the goodwill (Exhibit A-1, Volume III, Tab 40, pages 881 to 884). It would be too long to reproduce the description of all the assets sold. Suffice it to say that all the assets described appear to be the intrinsic parts of an explosives operation. Whether it was a separate business operation, the issue in this appeal, is the subject of a later analysis.
[9] In the clause entitled "Representations and Warranties of Seller", there is one undertaking regarding "Financial and Other Information". This information is attached to the Agreement as Exhibit 4.5. It is a huge document comprising hundreds of pages, which may be found at Volume IV, Tab 45. It shows the capital costs of the physical assets and the income data as for example the major components of the expenses. These include the sales freight, the distribution costs, the selling expenses, the marketing services, etc.
[10] The following paragraphs of the Agreement are also of interest:
5.6 Intention to operate the business. Buyer currently intends to continue the Business for a period of eight (8) years.
6.2 Conduct of business
(a) ...Seller will carry on the Business in the ordinary course and in substantially the same manner as heretofore...
6.4 Preservation of organization. Seller will use reasonable efforts to preserve the Business organization intact, to keep available to Buyer the present employees of the Business ... and to preserve for Buyer the present relationships of the Business with its suppliers and customers and others having business relations with it.
8. LABOUR AND EMPLOYEE MATTERS
8.1 Employment.
(a) Offers. Buyer will, ..., make offers of employment, ... to all active employees of the Business ...Seller will encourage employees of the Business to accept the Buyer's offer of employment.
8.2 Benefits.
(a) Recognition of service. With respect to Transferred Employees, Buyer shall recognize all service and plan participation recognized under Seller's employee benefit plans for purposes of determining benefit eligibility, participation, vesting and level of benefits under all of Buyer's employee benefit plans and programs including Buyer's pension plan....
8.6 Successor Rights. ... Buyer will be the successor of Seller with respect to the collective agreement ... Seller and Buyer recognize that ongoing co-operation between them after the Closing will be required as to matters of a transitional nature in order to ensure an orderly adaptation of the collective agreement arrangements to Buyer's ownership of the Business, and agree to extend that co-operation to one another.
[11] The witnesses explained that in 1928, C.I.L. abandoned its previous practice of employing separate subsidiary companies and combined all of its operations into a single corporate structure. This divisional organisation was employed by C.I.L. and its successor, the Appellant, up until the time of the sale of the explosives operations in 1988. However, the Appellant insisted that there was a centralized control over three main elements, namely, finance, people and technology. There were general service functions like research which was provided from Kingston, treasury, central pay system, human resources and industrial relations, and systems and computer services which were provided from Mississauga. These services were supplied to the explosives operations as well as to other divisions. Each of these functions was centrally managed and the divisions had little or no autonomy in these areas. There was a divisional allocation of costs for expenses related to general services on a monthly basis or, in some cases, the costs would be charged to the division on a supply basis. The Appellant was insured by a subsidiary of E.I.D., spreading the business risk across all of the Appellant's operations.
[12] At the time of the sale, the explosives operations were located mainly in the area known as Nipissing Works in North Bay. Bulk sites were located at customer's mines. The manufacturing function was supervised by a site manager who also supervised the manufacturing of Fabrene, another product. This site manager reported to the vice-president of the manufacturing group in Mississauga where the corporate offices were located.
[13] The explosives division employed over 200 people. The vast majority of these employees were located at the Nipissing site. There was a group of approximately 30 people who worked for the explosives division in Mississauga. Tab 45, page 1263 of Volume IV shows that the manufacturing part of the explosives division had 161 persons, 129 on the Nipissing site and 32 in the field operation sites, known also as the bulk sites. The charts are shown at pages 1264 and 1265. Page 1266, shows that there is a complement of 25 persons in the marketing section and 3 in the business development.
[14] The site at Nipissing had its own research facilities and a gravel pit where explosives could be detonated. The professional and technical staff was composed of twenty-four persons: four chemists, two computer specialists, three mining engineers, four mechanical engineers and a rock mechanic/electronics specialist. (Exhibit A-1, Volume IV, Tab 45, page 1265). These technicians were not only responsible for the day-to day operations of the site but they also performed testing of new formulations of product modifications that the Nipissing Site would manufacture. The Appellant had a central research laboratory located at Kingston. The research made in Kingston was one that was beyond the capabilities at Nipissing Works, as for example when a difficulty was experienced with a product.
[15] There was a central marketing organization for the explosives division located in Mississauga. There were also persons dedicated to marketing across Canada. The marketing function of the explosives operation reported to the manager of the explosives division in Missisauga who in turn reported to the vice-president of the chemicals group. Exhibit A-1, Volume I, Tab 18, page 402, shows that the marketing managers for the East and West reported to the general manager Explosives. The sales force was also located across the country to service customers and develop business opportunities. Regional sales managers reported to the national marketing manager who worked exclusively for the explosives division.
[16] Following the sale, with the exception of three persons, all of the employees of the explosives division accepted employment with ETI. One of the witnesses testified that the Dupont employees dedicated to the explosives operations did not have any choice but to go with ETI if they wanted to continue working.
[17] There were common suppliers. Managers at Nipissing Works had requisitioning authority but no purchasing authority. That was done in Mississauga.
[18] In 1987 and after, the manufacturing and business operations of the explosives division reported to a single vice-president, at the Mississauga corporate central offices.
[19] Personal computers dedicated exclusively to the explosives business in Mississauga and at the Nipissing Site were sold to ETI. The software specifically designed for the explosives business was also sold to ETI. (Exhibit A-1, Vol. III, Tab 40, page 881, Volume IV, Tab 45, pages 1124 and 1299). The Nipissing site had its own fleet of trucks and heavy equipment. These items were included as part of the sale to ETI. (Exhibit A-1, Volume III, Tab 40;Volume IV, Tab 45, page 1292).
[20] The annual financial plan for the explosives business was prepared by the Nipissing site accounting manager and the business accounting manager working exclusively for the explosives division in Mississauga. The Nipissing site manager would review this budget regularly to ensure that the explosives business was operating within its annual budget.
[21] It is important to note that the explosives division, as did four other operational divisions, had its own accounting. This is clearly stated in the Appellant's balance sheet for the year ending December 1987. (Exhibit A-1, Volume I, Tab 16). The Appellant had the capability to determine the income history of the explosives business and the financial history of the sales revenue of its products in the explosives division for the 1983 to 1986 period. (Exhibit A-1, Volume IV, Tab 45, pages 1272 to 1290.)
[22] At Tab 28 of Volume II, is reproduced the notice of objection written and signed by Mr. Carlos. Paragraphs 21 to 23 appear to me as an accurate description of the tasks performed by the staff dedicated exclusively to the explosives division, and the tasks performed in a centralized manner for the operational divisions of the Appellant. When these latter tasks would be performed for the explosives division, this division would be billed for the services rendered. There were also rules concerning employment and treasury that would apply to all of the Appellant's divisions.
Appellant's Argument
[23] Counsel for the Appellant submitted that the issue is not whether the Appellant could have carried on the explosives division as a separate business, but whether the explosives division was in fact operated by the Appellant as a separate business. In counsel's view, the evidence demonstrated that the explosives division was not operated as a separate business and therefore what was sold to ETI was not a separate business.
[24] The formulation of subsection 1101(1) of the Regulations requires a determination whether, on a balance of probabilities, the explosives operations of the Appellant were another business of the Appellant. An identical issue arises in respect of the Appellant's eligible capital property, since section 14 of the Act requires a separate calculation of eligible capital property in respect of each business of a taxpayer.
[25] The test which has been developed in the case law to determine whether simultaneous business operations of a taxpayer are one business or separate businesses was set out in the leading British case of Scales v. Georges Thompson & Co., Ltd., (1927) 13 T.C. 83 (K.B.) at page 89:
... I think the real question is, was there any inter-connection, any interlacing, any inter-dependence, any unity at all embracing those two businesses; ...
[26] Counsel for the Appellant suggested that, while the Scales test was not developed in the context of paragraph 1101(1) of the Regulations and section 14 of the Act, it has nevertheless been applied in the case law generally to determine whether businesses are separate and has been accepted by Revenue Canada Interpretation Bulletin No. 206R, to apply to this precise situation. The Court must therefore examine the degree of interconnection, interlacing or interdependence and the extent of the unity embracing the business operations. This is primarily a question of fact.
[27] In Scales, the taxpayer was a company engaged in both ship owning and underwriting. The business of underwriting was conducted solely by two nominees. The nominees ceased their activities. In the following year, the company did not include the results of the underwriting activity in its own results, claiming that the two activities were separate. Rowlatt, J. agreed with this position, at page 89:
... I cannot conceive two businesses that could be more easily separated than those two. They both have something to do with ships; that is all that can be said about them. One does not depend upon the other; they are not interlaced; they do not dovetail into each other, except that the people who are in them know about ships; but the actual conduct of the business shows no dovetailing of the one into the other at all. ...
[28] Counsel for the Appellant referred to a decision of the Court of Session, Scotland, in the The Howden Boiler and Armaments Company, Limited v. Stewart (H.M. Inspector of Taxes), (1924) 9 T.C. 205. The taxpayer company was engaged in the manufacturing of boilers. In 1914, it obtained a contract from the French government for the supply of shells. The manufacturing of shells was carried on in new premises erected adjacent to but having no intercommunication with, the original works, which continued to be used exclusively for the manufacture of boilers. Each operation had its own separate plan, separate workmen, technical and clerical staff and separate sets of books and trading accounts. Both operations were, however, under the same general direction and management. All the accounts were brought into one common profit and loss account and balance sheet, bank interest and management expenses being charged against the company generally without apportionment. The shell making business ceased in 1918 and the plant was sold. The Commissioner found that the taxpayer had carried on one business with two departments and not two businesses.
[29] Counsel for the Appellant also referred to Cannon Industries Ltd. v. Edwards (H.M. Inspector of Taxes) [1966], 1 All E.R. 456; and River Estates Stn Bhd v. Director General of Inland Revenue, [1984] S.T.C. 60 (P.C.).
Respondent's Argument
[30] Counsel for the Respondent submitted that the test is not whether the explosives division was in fact carried on as a separate business, but rather if the operation was carried on in such a manner that it was readily separable as a going concern.
[31] Counsel for the Respondent stated that the foremost case in the Canadian jurisprudence is the decision of the Supreme Court of Canada in Frankel Corporation Ltd. v. M.N.R., 59 DTC 1161. He quoted from the headnote, at pages 1161 and 1162 and from the reasons at page 1168:
The business of the appellant company was diversified: it dealt in scrap metals, smelted and refined non-ferrous metals, carried on wrecking and salvage operations, and fabricated and erected structural steel. In 1952 the non-ferrous metals operation, including inventory, was sold to another company. ...
... The sale of the metals inventory, as part of the sale of the assets of the appellant company's non-ferrous metals operation, was not a sale in the business of the appellant, but was made as a part of a sale of a business of the appellant. ...
...
Turning now to the facts in the present case, it may be noted that, while the appellant's non-ferrous metals operation was not separate in all respects from its other operations, it was, nevertheless, separate in many of its features, and as a whole it was readily separable from the others. The sources of the material and supplies used in the operation, the employee of the appellant who bought them, the machinery and equipment used in the operation, and the employees who operated it, the portion of the premises where the operation was carried on, the customers who bought the products, and the employees of the appellant who sold them, the name under which the operation was carried on and the trade mark and trade name used on the products, as well as the supervision provided, were all almost entirely distinct from the other operations. Indeed, the whole process by which profit was earned seems to have been quite distinct from the others, save in respect of the acquisition of minor quantities of scrap material from the wrecking and salvage operation, the combination for some purposes of the accounting with that of the ferrous scrap operation and such general matters as control by the same board of directors, the arrangement of a single union contract for employees of the appellant, employees' pension and insurance plans and the ultimate preparation of the profit and loss account for the operations of the company.
[32] Counsel for the Respondent submitted that the Appellant has attempted to show integration by the control exercised at the upper level of the Appellant's administration, i.e. at the level of vice-president and above. The Appellant has adduced evidence to show that certain functions of the divisions were either controlled (e.g. financial matters) or regulated (e.g. purchases, hiring of upper level employees, payment of taxes) centrally. The Supreme Court of Canada recognized such a control as merely "the duty of the directors to control all departments, one may say, the different businesses of the company"; H.A. Roberts Ltd. v. M.N.R., 69 DTC 5249 (S.C.C.) at 5253. At the operational level, counsel for the Respondent submitted that the explosives division was not integrated with the other divisions of the Appellant. The operating profit of each division was computed separately and at the end combined to show the final profit and loss results of the Appellant. With respect to the sale agreement, it also provided for the sale of goodwill. Goodwill is always connected with a business and cannot exist apart from it. Furthermore, the agreement contained a clause that ETI would become the successor of Dupont with respect to the collective agreement. This obligation is consistent with the jurisprudence which provides that the purchaser of a business assumes the terms of the collective agreement. When all of the provisions of the agreement are considered together, it is clear that the sale of the explosives division was a sale of a readily separable business. The effect of the transaction was to put ETI in possession of a going concern, the activities of which ETI would carry on without interruption.
Conclusion
[33] Before stating my conclusion, I would like to quote a passage of the Supreme Court of Canada in H.A.Roberts Ltd. (supra) at pages 5252 and 5253:
... It is true that the actual decision of this court was that the sale of the inventory was not a sale in the ordinary course of business, but in order to come to that conclusion the court had to hold that the subject of the contract between the Frankel Corporation and the purchaser was the sale of a business despite the fact that that business was not the subject of any separate incorporation. Martland J., giving the judgment of the court, quoted extensively the judgment of the trial judge in the Exchequer Court of Canada and then stated, "I agree with these conclusions".
The learned trial judge in the Exchequer Court had regard for such circumstances as the source of the material and supplies used in the operation, the employees of Frankel who bought the material and supplies, the machinery and equipment used in the operation, the employees who operated such machinery, the portion of the premises where the operation was carried on, the customers who bought the products, the employees of Frankel who sold those products, the name under which the operation was carried on, and the trade-mark and trade name used on the products. He said, in part:
Indeed, the whole process by which profit was earned seems to have been quite distinct from the others, save in respect of the acquisition of minor quantities of scrap material from the wrecking and salvage operation, the combination for some purposes of the accounting with that of the ferrous scrap operation and such general matters as control by the same board of directors, the arrangement of a single union contract for employees of the appellant, employees' pension and insurance plans, and the ultimate preparation of the profit and loss account for the operations of the company.
(Emphasis added)
[34] The concept of separate business expressed in subsection 1101(1) of the Regulations and subsection 14(1) of the Act has to have a meaning. If I were to find in the circumstances of this appeal that the explosives division was not a separate business of the Appellant I fail to see in which circumstances a Court could arrive at such a finding. The fact that there was some unified management at the upper level of the Appellant's administration and centralised services and rules does not mean that there was only one business of the Appellant. For illustration, I would offer the example of the manner in which a government is managed. In a government, certain rules apply generally and certain services are centralised. Thus are rules concerning namely employment and treasury, and services concerning namely legal services and the pay system. This does not mean that departments are not separate from one another.
[35] The principles enunciated by the Supreme Court of Canada in Frankel and H.A.Roberts Ltd. are not different from those enunciated by the British courts in Scales and my analysis of them is the following: there will be one business when there is interlacing and interdependance to such a degree that there may be found only one income producing unit; there will be a separate business when the circumstances are such that the whole process by which profit is earned is quite distinct from the others despite the fact that the business is not the subject of a separate incorporation. I find this interpretation to have the advantage of being in agreement with the concept of business as it is understood in the Act.
[36] It is my view that the evidence has shown clearly that the explosives division was managed as one income producing unit: the manufacturing, the supervision and direction, the marketing, the sales of the products, the staff and the accounting, although certain rules applied generally to all divisions and certain services were provided centrally. Therefore it was a separate business of the Appellant.
[37] The appeal is dismissed with costs.
Signed at Ottawa, Canada, this 3rd day of June, 1999.
"Louise Lamarre Proulx"
J.T.C.C.