[OFFICIAL ENGLISH TRANSLATION]
1999-2309(IT)G
BETWEEN:
L.D.G. 2000 INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on April 9 and 10, 2002, at Montréal, Quebec, by
the Honourable Judge François Angers
Appearances
Counsel for the Appellant: Daniel Bourgeois
Counsel for the Respondent: Nathalie Goyette
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1993, 1994 and 1995 taxation years are dismissed, with costs.
Signed at Edmundston, New Brunswick, this 11th day of December 2002.
|
"François Angers" |
J.T.C.C.
Translation certified true
on this 25th day of April 2003.
Erich Klein, Revisor
[OFFICIAL ENGLISH TRANSLATION]
Date: 20021211
Docket: 1999-2309(IT)G
BETWEEN:
L.D.G. 2000 INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Angers, J.T.C.C.
[1] This case involves appeals from two reassessments made by the Minister of National Revenue (the "Minister") on May 21, 1996, and confirmed on February 8, 1999, for each of the 1993 and 1994 taxation years, and from a reassessment made by the Minister for the 1995 taxation year, which was also confirmed on February 8, 1999. The Minister disallowed the small business deduction claimed by the appellant for the three taxation years in question as well as a deduction of $57, 304 on the grounds that this amount was a non-deductible capital outlay under paragraph 18(1)(b) of the Income Tax Act (the Act) and not an operating expense.
[2] To explain the background of the dispute as it relates to the disallowance of the small business deduction for the three taxation years, the parties, by consent, produced in evidence as Exhibit A-2 an organization chart of the various corporations and their Shareholders, which I reproduce as follows:
[3] In addition, Bermex owns 100% of the shares of a corporation called SPEQ Régionale Maskinongé Inc. (hereinafter "SPEQ") and 80% of the shares of Bermex Construction Inc. (hereinafter "Bermex Construction"), of which the other 20% is owned by one Maurice Lafrenière.
[4] It should be noted at the outset that the appellant company was called Ébénisterie Cardinal Inc. during the years at issue and until October 5, 1998. At that time, it became L.D.G. 2000 Inc., which explains the style of cause of this case. Since December 17, 2001, the company has been called Meubles D'Autrey Inc.
[5] During the years at issue, L.D.G. manufactured furniture from raw materials, but did not apply the finish. It sent its furniture to Chez Soi or Bermex to have the desired finish applied. Bermex, in addition to finishing furniture manufactured by L.D.G., stored the finished products with a view to their eventual sale to retailers. It also sold some of the furniture at retail itself. For its part, Chez Soi, in addition to finishing products manufactured by L.D.G., did such work for other suppliers.
[6] Richard Darveau testified for the appellant. He is an accountant by profession and also a director and vice-president, finance, of Gestion. As we know, Gestion holds 50% of the appellant's shares. It has owned an interest in L.D.G. since 1989. At that time, Gestion was looking for table manufacturers, and André Cardinal and Stéphane Lamarche, who were operating L.D.G. under its former name, offered their services and products. Being interested by the offer and satisfied with the products, Gestion bought 50% of the capital stock of L.D.G. Messrs. Cardinal and Lamarche held the other 50%, each having a 25% interest. After this purchase, Messrs. Cardinal and Lamarche were assigned to production while Gestion took care of management. After the years at issue, that is, in 1999, Gestion became the owner of 100% of L.D.G.'s capital stock and subsequently sold part thereof and eventually changed the name of that company.
[7] From 1993 to 1995, André Cardinal was the president of the appellant and, according to Mr. Darveau, he managed the business. Together with Stéphane Lamarche, he handled the purchasing, production and new product development and signed 98% of the appellant's cheques. Depending on its production cycle, the appellant could have as many as fifty employees; André Cardinal was in charge of hiring and firing. For his part, although he was not an employee of the appellant, Richard Darveau checked the invoices, ensured that the best prices were obtained for purchases and paid the bills. As for Denys Laberge, the other shareholder of Gestion, through "Promotions", he saw to the development of the products to be manufactured, assisted by André Cardinal and Stéphane Lamarche. André Cardinal's wife did the bookkeeping. According to Richard Darveau, the day-to-day decisions were made by Messrs. Cardinal and Lamarche. The shareholders met once or twice a year only to discuss major investments, as that kind of decision was made collectively.
[8] Again according to Richard Darveau, the furniture sent to Bermex for finishing was purchased by that company. L.D.G. sometimes sold its products to companies other than Bermex, just as Bermex during the years at issue, sometimes dealt with suppliers other than L.D.G. According to Mr. Darveau, L.D.G. had never been indebted to Gestion.
[9] On March 21, 1992, a shareholder agreement (A-3) was signed by the following parties, namely: André Cardinal, Stéphane Lamarche, Gestion, L.D.G. (Ébénisterie Cardinal), Denys Laberge, Richard Darveau and Jacques Gagnon. This agreement contained, inter alia, provisions concerning the transfer of shares, the conditions of transfer, the voluntary departure of a shareholder and the exercise of powers. The relevant clauses are the following :
[Translation]
6. TRANSFER TO A MANAGEMENT CORPORATION
6.1 Notwithstanding the provisions of section 5 above, a Shareholder may sell, assign or transfer all, but not part, of that Shareholder's shares to a management corporation (hereinafter referred to as the "Gesco"), controlled by that Shareholder, provided that the Gesco be bound by the terms and conditions of this agreement, with necessary changes, and that it participate for that purpose in this agreement. In addition, no shares of the capital stock of the Gesco shall be issued unless the issue is first approved in writing by the Shareholders.
6.2 Similarly, each Owner may sell, assign or transfer all, but not part, of that Owner's shares of the capital stock of a Shareholder to a Gesco that is controlled by that Owner provided that the Gesco be bound by the terms and conditions of this agreement, with necessary changes, and that it participate for that purpose in this agreement. In addition, no shares of the capital stock of the Gesco shall be issued unless the issue is first approved by all Shareholders.
6.3 Furthermore, each Shareholder and each Owner agrees that, notwithstanding the transfer of their shares to a management corporation as referred to above, they shall continue to be bound by the provisions of this agreement that are applicable to them individually, and they each personally guarantee, jointly and severally, the obligations of such management corporation under this agreement, and renounce for these purposes the benefits of division and discussion.
7. CONTROL
For the purposes of this agreement, a Shareholder or an Owner controls a management corporation if the Shareholder or Owner holds or is the recipient, otherwise than by way of guarantee only, of more than seventy-five per cent (75%) of all voting, issued and outstanding shares of the capital stock of the management corporation, thus giving the Shareholder or Owner at all times the right to unconditionally elect a majority of the directors of the management corporation in accordance with the articles of incorporation and by-laws and the shareholder agreement, if any, governing the rights and obligations of the Shareholders of the management corporation. In addition, a Shareholder or an Owner must indirectly control all of the corporations controlled by the management corporation that the Shareholder or Owner controls.
8. CONDITIONS OF TRANSFER
. . .
8.3 Where a Shareholder or an Owner transfers shares belonging to that Shareholder or Owner to a management corporation, in accordance with the terms and conditions prescribed above, and where the control of a Shareholder changes hands or a Shareholder or Owner loses the control of a Gesco for whatever reason, without the express written consent of the other parties to this agreement, the Shareholder concerned shall immediately offer that Shareholder's shares for sale to the other Shareholders in accordance with the provisions of paragraph 13.4 of this agreement.
. . .
13. VOLUNTARY DEPARTURE
13.1 Should "Cardinal" and/or "Lamarche" and/or "Gestion" decide to leave the Corporation voluntarily, the redemption price for the shares shall be based on the book value of the corporation as follows:
- 50% of the book value of the shares of the Shareholder resigning from the Corporation if "Cardinal" or "Lamarche" or "Gestion" have been Shareholders for more than two (2) years and less than five (5) years.
- 75% of the book value of the shares of the Shareholder resigning from the Corporation if "Cardinal" or "Lamarche" or "Gestion" have been Shareholders for more than five (5) years and less than ten (10) years.
- 85% of the book value of the shares of the Shareholder resigning from the Corporation if "Cardinal" or "Lamarche" or "Gestion" have been Shareholders for more than ten (10) years.
13.2 The shares transferred by the resigning Shareholder shall be redeemed by the remaining Shareholders in proportion to the number of shares in the capital stock of the Corporation held by each remaining Shareholder.
. . .
13.4 If a Shareholder or the Owner of the Shareholder makes an assignment of the Shareholder's property for the benefit of that Shareholder's creditors, if the Shareholder becomes manifestly insolvent or goes bankrupt, if the Shareholder is declared to be under an interdiction by a court of competent jurisdiction, or if the assets of the Shareholder are seized and not released within a period of fifteen (15) days, the share redemption price shall be equal to twenty-five (25) per cent of the book value of the shares of the insolvent Shareholder of the Corporation.
. . .
19. EXERCISE OF POWERS
For the purposes of the exercise by the Shareholders of the powers and rights conferred on them and granted to them under the Quebec Companies Act, the Shareholders agree that, notwithstanding the provisions of the by-laws of the Corporation, the proportion of votes required for the adoption of a resolution or decision by the Shareholders shall be sixty-six per cent (66%) of the votes of the Shareholders.
[10] An addendum to this agreement was entered in evidence as Exhibit A-4. According to the addendum, it was signed on May 28, 1992, and it amends clauses 13.2 and 2.4 of the agreement as follows:
[Translation]
ADDENDUM TO THE AGREEMENT BETWEEN THE SHAREHOLDERS OF EBENISTERIE CARDINAL INC. DATED MARCH 21, 1992
The parties unanimously agree that article 13.2 of this agreement is revoked.
The parties agree that, if Cardinal sells his shares, Lamarche shall redeem Cardinal's shares and, if Lamarche sells his shares, Cardinal shall redeem Lamarche's shares.
The parties also agree to amend the definition of the term "invalidity" in article 2.4 and elsewhere in the agreement. The term "invalidity" shall be replaced by the words "permanent invalidity". In addition, the parties agree to add, at the end of article 2.4, the phrase "for an indeterminate duration".
[11] The date of signature of the addendum was questioned by the respondent. Richard Darveau does not remember where the addendum was signed, but he does remember where the agreement was signed because there were several people present. I shall come back to this matter later.
[12] With regard to the expenses relating to the roof, Richard Darveau explained that L.D.G. had leased the building in question until August 17 1992, when it purchased it for $285,000. Since the former owner had neglected to repair the roof, there was water leakage every spring to the point that there were plastic sheets hanging just about everywhere. They accordingly obtained an estimate for the cost of the repairs, which would consist of removing the sheet metal and mineral wool and redoing the trusses. They finally decided to put a new roof on top of the existing one so that the old roof would serve as a partition. This also made it possible to alter the slope of the roof.
[13] They also built an addition to replace a factory called Industrie Gervais that had been demolished by a hurricane in 1991. Since the two projects were not carried out at the same time, L.D.G.'s financial statements indicate that the cost of the new part, that is, the addition, was capitalized and the cost of the repairs was recorded as an operating expense: this is one of the points in dispute. Property taxes rose from $244,100 in 1991, that is, before the construction, to $575,300 for the triennial roll for 1993, 1994 and 1995. However, the property tax bill for the period from 1993 to 1995 predated the construction of the new roof.
[14] On cross-examination, Mr. Darveau explained that Gestion was involved in the manufacture of furniture through Bermex and through its subcontractors before it purchased L.D.G. In addition, as we know, Bermex had been wholesaling its production to merchants since its creation in 1983. L.D.G., whose shareholders were Messrs. Cardinal and Lamarche, was one of the subcontractors of Bermex whose manufacturing component was less than 3%. Mr. Darveau admitted that, following the purchase by Gestion, Bermex subcontracted, on average, 50% of its orders to L.D.G. He also admitted that Gestion, at the time it purchased 50% of L.D.G.'s shares, created "Chez Soi" to finish the furniture manufactured by L.D.G. and Bermex's other subcontractors. The shareholders of Chez Soi were Richard Darveau's two brothers who each held 15% of the shares, and Gestion, which held the rest.
[15] Two other companies were mentioned during the cross-examination, namely, Bermex Construction Inc. (hereinafter "Bermex Construction") and SPEQ Régionale Maskinongé Inc. (hereinafter "SPEQ"). Gestion held 80% of the shares of Bermex Construction which was the company that rebuilt the plant destroyed by the hurricane. As for SPEQ, Gestion held 100% of its shares. SPEQ was a corporation that manufactured wood panels, whose production and, ultimately, whose machinery, were sold to L.D.G. The witness acknowledged that Gestion was merely a holding company.
[16] The appellant's financial statements for the taxation years at issue contain the following note: [TRANSLATION] "the sales figures for L.D.G. come almost entirely from two affiliated companies, one of whose shareholders is also a shareholder of the corporation". The witness Darveau explained, however, that in 1995 a little more than 75% of the sales, not almost all of them, were accounted for by those companies. In fact, the appellant's financial position went from loss to profit due to the fact that it sold its production to Bermex and Chez Soi and had increased its volume of production. When asked why L.D.G. could not obtain financing from the banks, Mr. Darveau stated that 100% of L.D.G.'s production was sold to only two companies. Mr. Darveau explained that L.D.G. had just two customers, had no receivables and was dependent on Bermex. This meant that L.D.G. could not obtain bank financing. Richard Darveau admitted that Bermex had financed L.D.G. during the years at issue, but qualified this by wondering whether it was financing or the payment to L.D.G. of an account payable. However, at the examination for discovery, he admitted that Bermex had obtained bank loans because it was the only corporation that had accounts receivable. In fact, he said that Bermex was the only corporation that had taken out loans and that it had a $4 million line of credit. He added that L.D.G. and the shareholders had guaranteed part of Bermex's debt, but he did not specify what percentage of the debt.
[17] L.D.G. had agreed with Bermex and Chez Soi that the price on sales to those two companies would be grossed up by 15% to ensure a gross profit margin for them, according to Mr. Darveau. The sale price was therefore adjusted to ensure that return, and the adjustment was often made at the end of the year. Mr. Darveau admitted that he could do this with L.D.G. because it was an affiliated company, whereas he could not do the same with his other subcontractors.
[18] On October 31, 1994, Bermex Construction signed an agreement with L.D.G. in which it undertook to provide labour to help L.D.G. renovate its Berthierville building. The agreement did not provide for any payment in consideration of this service, except the billing of L.D.G. for the actual cost of the renovation.
[19] In 1997, André Cardinal left L.D.G., and Gestion became the majority shareholder of that company by purchasing Mr. Cardinal's shares.
[20] The appellant also called Jacques Gagnon, CA, to testify. Mr. Gagnon said he was not an employee of L.D.G., but held 25% of the shares of Gestion through his company AJMEH. At the time, Mr. Gagnon was in charge of personnel at Bermex. He supervised the accounting and examined L.D.G.'s monthly and interim financial statements. According to Mr. Gagnon, L.D.G.'s bookkeeping was done in-house; personnel management was handled by Messrs. Lamarche and Cardinal; and purchasing was done by Mr. Lamarche.
[21] Mr. Gagnon produced a chart (Exhibit A-10) showing L.D.G.'s long-term debt and to whom it was indebted. From the chart it can be seen that the percentage of debt held by the Bermex group during the years at issue was nil in 1992, 36% in 1994 and 66% in 1995. A second chart (Exhibit A-11) was filed showing the percentage of L.D.G.'s sales to the other members of the group. In 1993, 95% of L.D.G.'s sales were made to Bermex and Chez Soi; in 1994, 85%; and in 1995, 79%.
[22] The shareholder agreement (Exhibit A-3) was drafted by Jacques Gagnon. He explained some of its clauses and added that, at the request of Messrs. Lamarche and Cardinal, the addendum (Exhibit A-4) was prepared in order to enable either of the two to purchase the shares of whoever of them should leave, so as to retain 50% of the shares. According to Mr. Gagnon, the addendum was signed in May 1992.
[23] On cross-examination, Mr. Gagnon was asked to compare his chart (Exhibit A-10) with excerpts from L.D.G.'s general ledger (Exhibit I-2). L.D.G.'s debts to Bermex for the years at issue shown on Mr. Gagnon's chart corresponded to the excerpts from the general ledger, with the exception of the debts dated February 28, 1993: for that date the general ledger indicates a total of $507,643.90 whereas Exhibit A-10 does not show any debt. The explanation provided by Mr. Gagnon with respect to this was that the general ledger was not definitive, and that he had prepared his chart on the basis of L.D.G.'s audited financial statements. He admitted that the first debt on the list, namely, the debt owing to Garage Côté Laroche Inc., an unaffiliated company, was a non-interest-bearing loan, with no repayment terms, in the amount of $300,000 taken out during the years at issue. He also admitted that a $75,000 debt owed by L.D.G. in 1995, was owed to a company called Servan RDAJ Inc., 66% of the shares of which were owned by Richard Darveau and the other 33% were held by the wife of Denys Laberge. Mr. Gagnon added, however, that he considered that debt in the percentage of debts owed to the Bermex group.
[24] Also on cross-examination, Mr. Gagnon acknowledged that, further to a conversation in August 1998 with Irène Lalonde, an auditor with the respondent, he had promised to send her documents, which she apparently did not receive until September 24, 1998. Those documents were the shareholder agreement and addendum. The letter faxed by Mr. Gagnon with the documents explained that, in 1992, when they met with a notary, the notary had had them amend the agreement so that L.D.G. would not be affiliated with Bermex. Mr. Gagnon could not explain, however, why the addendum was not sent until September 24, 1998, and no longer recollected what he had told Ms. Lalonde about the signing of the two documents.
[25] Stéphane Lamarche stated that he was the co-founder of L.D.G. (formerly Ébénisterie Cardinal), but had not held shares in that company for two and a half years. During the years at issue, he was responsible for new production models and managed the employees. He explained that André Cardinal and he handled the day-to-day decision making while the other decisions were made by all the shareholders. The meetings often took place over dinner and the provision on the exercise of powers in article 19 of the agreement was followed. Mr. Lamarche testified that, when André Cardinal left L.D.G., he was not interested in purchasing the latter's shares. Concerning the addendum, he said he had a rough recollection of it, but thought he had signed it on the date indicated, namely May 28, 1992.
[26] On cross-examination, Mr. Lamarche acknowledged that he had had a telephone conversation with the respondent's counsel in the week before the trial and had told her that, in his opinion, the agreement had been signed by the parties while they were in an area north of Montreal, but he did not remember where the addendum had been signed. The lawyer, he said, had faxed him a copy of the addendum that same day and, when she called him back to discuss it, he had not spoken to her, on the pretext that he was talking to a government representative on another line.
[27] The date of signature of the addendum was seriously questioned by the respondent. Marc Gaudreau testified and explained what he had done to have the document analysed in order to determine whether or not it had been signed in 1992. Thus, one of his employees took a sample of the ink used in each of the three signatures on the addendum. In his affidavit, produced in evidence by the appellant as Exhibit A-12, he reported that the expert had concluded that André Cardinal's signature could not have been written in 1992 because the ink used in his signature was not available commercially until 1995.
[28] The expert in question, Gérald Laporte, testified as an expert in the analysis of documents, which included the chemical and physical analysis of various types of ink and paper. He explained the process the samples underwent and the analysis he performed on them. Through such an analysis, using a database of more than 7,600 samples of ink from all over the world, he can identify the manufacturer of ink and thus ascertain when it was available on the market. On the basis of his analysis, he was able to conclude that the ink from the Bic pen used for André Cardinal's signature was not available commercially until January 1995 and that its production only began in June 1995. He testified that the samples received were carefully sealed and kept in separate containers. Although the database was not exhaustive, it was regularly updated and he was satisfied that it contained all the ink samples.
[29] In 1996, Jean-François Normand was a business auditor with the Department of National Revenue's tax services and he conducted an audit of the appellant for the years at issue. He was in contact primarily with Jacques Gagnon and he attended at the place of business of Bermex and L.D.G. According to Mr. Normand, the appellant was affiliated with SPEQ, Chez Soi, Bermex Construction, Bermex and Gestion. He reached this conclusion on the basis that Gestion was the corporation that controlled de facto all the others, and he maintained that his conclusion was in accordance with the concept of control in subsection 256(1) of the Act. The factors that he took into consideration in reaching his conclusion were those that are enumerated in Interpretation Bulletin 64R3 and that allow one to determine, by examining the facts, whether there was indeed de facto control.
[30] Mr. Normand accordingly took into consideration the ownership of L.D.G.'s shares having regard to article 19 of the agreement (Exhibit A-3) and noted that the proportion of votes required for the adoption of a shareholders' resolution was 66%, and that this was so despite the corporation's by-laws. Since Gestion held 50% of the shares, it could block any decision by itself.
[31] Mr. Normand also took article 20 of the agreement into account, noting that the shareholders undertook therein to exercise their voting rights in such a way that Denys Laberge and Richard Darveau would be appointed directors. These two people, through their companies, Promotions and 2765791, were Gestion's majority shareholders. Mr. Normand added that the appellant's board of directors consisted of five directors. According to Exhibit I-2, Tab 11, the directors were Richard Darveau, Denys Laberge, Jacques Gagnon, Stéphane Lamarche and André Cardinal. Each director was entitled to one vote and all matters submitted to the board were to be decided by a simple majority (see Exhibit I-2, Tab 14, paragraph 9.09). Gestion's three shareholders, through their respective corporations, thus controlled the decisions of the appellant's board of directors and also controlled Gestion.
[32] Article 9 of the agreement deals with the remuneration of Messrs. Lamarche and Cardinal, including salary increases, vacation, and repayment of leave from work. According to Mr. Normand, these were conditions normally found in a contract of employment rather than in a shareholder agreement. Accordingly, this demonstrates control, that is, it indicates who was really directing the appellant. He also took into account the contributions to the capital stock shown in Tab 5 of Exhibit I-1, which showed that Gestion held 50% of the issued and paid up shares. He further noted that Bermex had agreed to advance funds to the appellant. That agreement seemed obvious to him since Gestion controlled Bermex. With respect to the long-term debts listed in Exhibits A-10 and I-2, Mr. Normand claimed that there should have appeared in Exhibit A-10 a debt of $507,643,90 owed to Bermex in 1993, as shown on page 2 of Exhibit I-2. He maintained that an adjusting entry could have had an impact in this regard, but asserted that there was no adjusting entry. He also noted that the second page of Exhibit I-2, namely the one numbered 103, was dated January 24, 1995, and was therefore subsequent to the financial statements at Tab 5 of Exhibit I-1, which were dated October 20, 1994.
[33] Mr. Normand maintained that the conditions enunciated in clauses 4.1 and 4.2 of the shareholder agreement had not been met because the loans from Bermex were non-interest bearing and clause 4.2 could not be complied with since the loan was not made in accordance with clause 4.1 of the agreement, which reads as follows:
[Translation]
Any investment that may become necessary for the proper administration of the Corporation shall be invested by the Shareholders in proportion to their holdings of common shares, at no interest. Should circumstances require that one of them make an advance greater than the required proportion, the portion of the advance that exceeds that proportion shall bear interest at the rate of 10% per annum.
There was no written contract governing the terms and conditions of L.D.G.'s debts with respect to the advances from Bermex. Mr. Normand noted that L.D.G. was economically dependent on Bermex and that its sales figure rose from $309,000 in 1990 to over $3,000,000 in 1995 by virtue of the fact that it did business with Bermex and because Gestion held 50% of the shares of L.D.G. Mr. Normand also questioned the year-end adjustment whereby a supplementary invoice was prepared to increase the appellant's sales or create an operating expenditure in order to ensure a profit for the appellant (Tabs 17 and 18). This was not a common practice in the case of independent corporations.
[34] Mr. Normand also took into account the fact that insurance policies had been grouped together so that the insured, Bermex, was defined as including the appellant and other corporations, although he acknowledged that this in itself was not a decisive factor. He added, however, that a lawyer's bill dated January 21, 1992, in respect of the appellant, L.D.G., had been sent to the address of Bermex (see Tab 21 of Exhibit I-1). An invoice for a business plan for the appellant had been sent for the attention of Jacques Gagnon at the address of Bermex (Tab 22, Exhibit I-1). A purchase order that can be found at Tab 23 of Exhibit I-1 was signed by Richard Darveau instead of André Cardinal, who was the president and handled the day-to-day management of the appellant.
[35] Another fact that Mr. Normand took into consideration was the agreement between the appellant and Bermex Construction to provide labour to L.D.G. for the renovation of one of its buildings. He found that the terms of the agreement were not the customary ones and did not provide for any consideration (see Tab 28 of Exhibit I-1). The cost of the services provided was recorded (see Tab 29 of Exhibit I-1), and payment of that amount by the appellant to Bermex Construction was made following advances of funds by Bermex to the appellant.
[36] Mr. Normand said he never saw the addendum (Exhibit A-4) during his audit although he had asked to see all the documentation. Such requests are standard practice when an audit is conducted.
[37] With regard to the expenses relating to the roof, Mr. Normand considered four criteria in order to determine whether they were operating or capital expenses. The work done provided a lasting benefit as well as a very appreciable improvement of the property in that the slope of the roof was altered and insulation and more durable materials were used. The relative value of the repairs by comparison to the purchase price, without the land, was 23%, and the repairs were made shortly after the date of purchase, that is, about two months later, which indicates that the appellant was aware of the state of the roof at the time of the purchase.
[38] On cross-examination, Mr. Normand acknowledged that he had seen mutual insurance in the case of companies that were at arm's length and that it is possible for a manufacturer to supply all of its production to a single customer.
[39] Irène Lalonde is a large business auditor with Revenue Canada and was the appeals officer in the appellant's case. Concerning the matter of de facto control, she testified that she had read Mr. Normand's conclusions on this issue and was in agreement with him. In addition, she examined the shareholder agreement and concluded that there was also de jure control. As an example, she explained that article 13.2 provided for the redemption of the shares of a shareholder who resigned by the remaining shareholders in proportion to the number of shares in the capital stock of the corporation held by each of those remaining shareholders. In other words, if Stéphane Lamarche or André Cardinal left, Gestion would find itself with 66% of the shares, whereas if Gestion left, Messrs. Lamarche and Cardinal would each have 50% of the appellant's shares. According to Ms. Lalonde, by virtue of subsection 251(2) of the Act, the effect of such a clause is that a person who has the right, whether immediate or future, conditional or not, to purchase shares of a corporation is deemed to be in the same position in terms of the control of the corporation as if that person owned the shares at that time.
[40] She continued her testimony by explaining the steps she had taken and, specifically, by relating a conversation she had had with Jacques Gagnon in which he told her that she would be receiving a certain document early in September 1998. Subsequently, she contacted a secretary, on September 23, 1998, to inquire about the availability of the document in question and was informed by the secretary that it was ready but not signed. The following day, she received the documents found in Tab 37 of Exhibit I-1, that is, the shareholder agreement and the addendum.
[41] Ms. Lalonde subsequently met with another representative of the appellant, namely Me Marcoux, and discussed with him clause 8.3 of the agreement, which in her view triggered the application of subsection 251(2) of the Act, since clause 8.3 conferred the right to purchase shares, which put the holder of that right in a controlling position regarding the corporation. As for the expenses relating to the roof, she agreed with Mr. Normand's conclusion.
Analysis
[42] A "Canadian-controlled private corporation" that carries on an active business in Canada throughout a taxation year is eligible for a reduced rate of tax on the first $200,000 of its income from that business (subsections 125(1) and (2) of the Act). This tax reduction is limited, however, to corporations that were not associated during the taxation year with one or more other Canadian-controlled private corporations. Where such a relationship exists, the business limit of the corporation for the taxation year is nil (subsection 125(2) of the Act). These statutory provisions prevent corporations that are associated or that belong to the same group of associated corporations from taking advantage of the above-mentioned reduction. However, subsection 125(3) of the Act allows a group of associated corporations to file an agreement whereby they allocate an amount to one or more of them for the taxation year so that the amount so allocated or the total of the amounts so allocated is $200,000, and in that case the business limit for the year of each of the corporations is the amount so allocated to it. In the case at bar, for each of the years at issue, Gestion, Bermex, Chez Soi, SPEQ Régionale and Bermex Construction filed with the Minister of National Revenue such an agreement whereby they allocated the total business limit to Bermex for the purposes of the small business deduction. The appellant did not participate in that agreement.
[43] The first issue is, therefore, whether Gestion exercised de jure control, de facto control, or both de jure and de facto control, over the appellant such that the appellant may be considered to have been associated with Bermex for the three taxation years in question. Paragraph 256(1) of the Act defines the expression "associated corporations" as follows:
256: Associated corporations.
(1) For the purposes of this Act, one corporation is associated with another in a taxation year if, at any time in the year,
(a) one of the corporations controlled, directly or indirectly in any manner whatever, the other;
(b) both of the corporations were controlled, directly or indirectly in any manner whatever, by the same person or group of persons;
(c) each of the corporations was controlled, directly or indirectly in any manner whatever, by a person and the person who so controlled one of the corporations was related to the person who so controlled the other, and either of those persons owned, in respect of each corporation, not less than 25% of the issued shares of any class, other than a specified class, of the capital stock thereof . . . .
[44] Subsection 256(5.1) explains that, where control in fact is involved and the expression "controlled, directly or indirectly in any manner whatever," is used, a corporation shall be considered to be so controlled by another corporation, person or group of persons (in subsection 256(5.1) referred to as the "controller") at any time where, at that time, the controller has any direct or indirect influence that, if exercised, would result in control in fact of the corporation.
[45] The term "control" is not defined in the Act. Formerly, that is, before the provisions of subsection 256(5.1) were enacted, the term "control" meant that a shareholder held a number of shares that allowed the shareholder to appoint the members of the board of directors. Such control was called "de jure control" and was recognized as such by the courts: see, for example, the decisions of the Supreme Court of Canada in M.N.R. v. Dworkin Furs (Pembroke) Ltd. et al., 67 DTC 5035 and Duha Printers (Western) Ltd. v. Canada, [1998] 1 S.C.R. 795. The addition of subsection 256(5.1) to the Act created a new concept of control called "de facto control", as Iacobucci J. stated moreover in Duha Printers (supra) at paragraph 52:
52. Moreover, as Wilson J. correctly observed in her dissent in Imperial General Properties, supra, taxpayers rely heavily on whatever certainty and predictability can be gleaned from the Income Tax Act. As such, a simple test such as that which has been followed since Buckerfield's is most desirable. If the distinction between de jure and de facto control is to be eliminated at this time, this should be left to Parliament, not to the courts. In fact, while it is not directly relevant to the outcome of this appeal, I would observe nonetheless that Parliament has now recognized the distinction between de jure and de facto control, adopting the latter as the new standard for the associated corporation rules by means of s. 256(5.1) of the Income Tax Act, enacted in 1988.
[Emphasis added.]
[46] In Interpretation Bulletin IT-64R3 dated March 9, 1992, the concept of de facto control was summarized as follows in paragraphs 17, 18 and 19:
17. De facto control consists of all forms, other than de jure control, by which a person may exercise control over a corporation. De facto control may even exist without the ownership of any shares. It can take many forms, e.g. the ability of a person to change the board of directors or reverse its decisions, to make alternative decisions concerning the actions of the corporation in the short, medium or long term, to directly or indirectly terminate the corporation or its business, or to appropriate its profits and property. A potential influence, even if it is not actually exercised, would be sufficient to result in de facto control.
18. The moment when the influence must exist, for the purposes of the de facto control test, depends upon the context in which the notion of control is applied. For example, in the case of the small business deduction, where the status of "Canadian-controlled private corporation" (paragraph 125(7)(b)) is critical, the potential control will be examined for the whole year for which the deduction is claimed. In the case of the investment tax credit (section 127.1), the reference period will be the year in which the allowable expenses are incurred.
19. Whether a person or group of persons can be said to have de facto control of a corporation, notwithstanding that they do not legally control more than 50 per cent of its voting shares, will depend on each factual situation. The following are some general factors that may be used in determining whether de facto control exists:
(a) the percentage of ownership of voting shares (when such ownership is not more than 50 per cent) in relation to the holdings of other Shareholders;
(b) ownership of a large debt of a corporation which may become payable on demand (unless exempted by subsection 256(3) or (6)) or a substantial investment in retractable preferred shares;
(c) Shareholder agreements including the holding of a casting vote;
(d) commercial or contractual relationships of the corporation, for example, economic dependence on a single supplier or customer;
(e) possession of a unique expertise that is required to operate the business; and
(f) the influence that a family member, who is a Shareholder, creditor, supplier, etc., of a corporation, may have over another family member who is a Shareholder of the corporation.
Although the degree of influence is always a question of fact, close family ties (between parents and children or between spouses) especially lend themselves to the development of significant influences. Generally, these persons must demonstrate their economic independence and autonomy before escaping presumptions of fact which apply naturally to related persons.
[47] There is no doubt that the concept of de facto control and the direct or indirect influence that the existence of such control may entail can have consequences when applied to subsection 256(5.1) of the Act. Since a question of fact is involved, the facts must be analysed with care. In the case at bar, a number of factors must be taken into consideration in determining that question.
[48] It was admitted in the evidence that Gestion, Bermex, Chez Soi, SPEQ Régionale and Bermex Construction filed with the Minister an agreement in accordance with the provisions of subsection 125(3) of the Act, whereby they allocated to Bermex the entire business limit for the purposes of the small business deduction. It is also clear that Gestion, which held all of the shares in Bermex, was looking for a furniture manufacturer. Having previously done business with the appellant, it decided to purchase half of its capital stock. The division of responsibilities after the purchase leaves no doubt about the new orientation the appellant was to have. It became a major supplier of unfinished furniture, which it sold almost exclusively to Bermex. The fact that André Cardinal and Stéphane Lamarche together held 50% of the shares would not, in my opinion, have changed the role that Gestion had given to the appellant. It is true that André Cardinal and Stéphane Lamarche were responsible for the day-to-day management of the appellant's operations, but decisions concerning sales and purchasers were undoubtedly the responsibility of Gestion. It was Gestion, moreover, that, through Richard Darveau checked the invoicing of the appellant's only two customers-with which the appellant was associated-and ensured that purchases were made at the best price and that the bills were paid. Denys Laberge's role was to help Messrs. Cardinal and Lamarche develop products for manufacturing. Since Bermex bought almost everything, it seems clear to me that Denys Laberge played an important part.
[49] It is also important to note that, after the acquisition of the shares by Gestion, the appellant's sales figure went from $369,000 to over $3 million and the proportion of its sales to Bermex and Chez Soi rose from 30% to 95% in 1993, 85% in 1994 and 79% in 1995 (see Exhibit A-11). The appellant's financial statements contain a note indicating that the appellant's sales came almost entirely from two affiliated corporations.
[50] It must be remembered as well that Gestion created Chez Soi at the time of its purchase of the shares in the appellant for the purpose of also doing the finishing of products manufactured by the appellant and others. Chez Soi belongs to Richard Darveau's two brothers.
[51] Because the appellant had only two customers, had no receivables and was dependent on Bermex for the sale of nearly all its production, it was impossible for it to obtain financing. Consequently, Bermex provided it with the financing necessary for its operations, which financing was described by Richard Darveau as being advances relating to Bermex's accounts payable to the appellant. Regardless of how this financing is described, the appellant's activities were financially supported by Bermex. In addition, the appellant guaranteed in part Bermex's $4 million line of credit for the financing of its activities as a whole. The appellant's sales to Bermex were grossed up by 15% representing administrative expenses, and the transactions between it and Bermex were adjusted at the end of the year to ensure that profit to the appellant. These adjustments were only possible in the case of the appellant, because, according to Richard Darveau, the same could not be done with Bermex's other subcontractors.
[52] The effect of these financial, contractual and commercial arrangements was, in my opinion, to make the appellant economically dependent on Bermex. It also seems clear to me that the know-how and influence of the directors of Gestion and Bermex were behind the appellant's economic revival and its profitability, and this put the appellant under their control.
[53] Furthermore, the document in Exhibit A-10 provides details about the appellant's long-term debt. For the years 1993, 1994 and 1995, that document shows a loan of $300,000 from Garage Côté Laroche Inc. with no repayment terms or interest and, for 1995, a loan of $75,000 from Servan RDAJ Inc., a corporation 66% of the shares of which were held by Richard Darveau and 33% by Denys Laberge's wife. The chart filed as Exhibit A-10 by the appellant did not match, for 1993, the excerpts from the corporation's general ledger for that year, which fixed the appellant's debt to Bermex at $507,643.90 at the end of the fiscal year. With the exception of the mortgage, the appellant's financing during the years at issue was provided largely by Bermex and, in 1995, by Servan RDAJ Inc.
[54] Returning to the matter of the management of the appellant, there is evidence from which it can be concluded that the administration of the appellant was directed by Gestion and Bermex. The appellant's insurance policy (Exhibit I-1, Tab 19) was sent to Bermex and was in its name; the appellant's correspondence was sent to Bermex's address (Exhibit I-1, Tab 21); and a business plan for the appellant was sent to Jacques Gagnon at Bermex's address. Taken together, these are significant indications of the role of Bermex in the appellant's activities.
[55] According to article 20 of the shareholder agreement, the presence of Denys Laberge and Richard Darveau on the board of directors was assured. According to the appellant's registers, the board of directors consisted of five people-namely, the two specified in the agreement, as well as Jacques Gagnon, Stéphane Lamarche and André Cardinal-during the three years at issue. Each was entitled to one vote and matters submitted to the board were decided by a simple majority of the directors who voted. Gestion therefore controlled the board of directors during the years at issue. As well, the fact cannot be overlooked that, under article 19 of the agreement, resolutions by shareholders had to receive 66% of the votes in order to be passed. It was accordingly possible for Gestion, which held 50% of the votes, to block any proposal by the other shareholders.
[56] The sudden existence of the addendum in 1998 and the issue of when it was signed create serious doubt about the credibility and the testimony of Richard Darveau, Jacques Gagnon and Stéphane Lamarche. In my opinion, the addendum was not signed on the date indicated and those concerned tried to blur the facts surrounding its signing. The fact that the addendum was not produced before September 1998, the comment by the secretary in Mr. Gagnon's office and the expert opinion of Gérald Laporte satisfy me that the document was signed in September 1998 in order to minimize the impact that the Shareholder agreement could have on the determination of the existence of de jure control.
[57] Nor can I overlook the fact that Bermex Construction performed the work of expanding the appellant's plant at actual cost, without making any profit. This, in my view, constitutes a privilege comparable to the privileges encountered among associated or friendly corporations and is therefore not a normal business transaction. The business relationship between Bermex and the appellant was very special in that the appellant could adjust its billings at the end of its fiscal year so as to ensure that it would receive a profit set at 15% of its sales to Bermex. This, again, is inconsistent with usual business transactions between two parties dealing with each other at arm's length.
[58] Taking into account the whole of these facts, I conclude that Gestion, through Bermex, of which Gestion had 100% control, exercised control over the appellant so as to make the two of them associated corporations under paragraphs 256(1)(a) and (b) of the Act during the three years at issue.
[59] In view of this conclusion, it is unnecessary for me to consider the matter of de jure control.
[60] The second point at issue concerns the expense of $57,304 incurred to repair the roof of the building in which the appellant's activities were carried on. The appellant treated this cost as an operating expense whereas the respondent maintains that it was a capital outlay.
[61] The appellant was the tenant of the building and its officers were aware of the condition of the roof when the appellant decided to purchase the building in August 1992. After taking into consideration the cost of repairs that would involve redoing the roof, it was decided to construct a new roof on top of the existing one and thus change the slope of the roof. A photograph (Exhibit A-7) of the north side shows the new roof. It must also be remembered that a new annex was built during the same period, which contributed to raising the value of the property for property tax purposes (see Exhibits A-8 and A-9). Exhibit A-9 was prepared before the roof repairs in question. The new assessment, therefore, did not take into account the new roof.
[62] Counsel for the parties both submitted case law setting out a variety of criteria and tests that can be used in determining this issue. Earl v. Canada, [1993] 1 C.T.C. 2081, a decision of this Court, sets out the various tests used by the Federal Court of Appeal and the Quebec Court of Appeal, and the facts in Earl bear some similarity to those of the case at bar. Without repeating all of the references cited by Judge Rowe in his decision, I would like to reproduce some excerpts from what he said about the case law he considered.
[63] Referring to Gold Bar Developments Ltd. v. the Queen, 87 DTC 5152, he cited Jerome A.C.J. of the Federal Court-Trial Division:
I think it is more helpful to emphasize the purpose of the outlay by the taxpayer. What was in the mind of the taxpayer in formulating the decision to spend this money at this time? Was it to improve the capital asset, to make it different, to make it better? That kind of decision involves a very important elective component-a choice or option which is not present in the genuine repair crisis.
[64] Jerome A.C.J. went on to say:
There remain two other considerations that arise from the jurisprudence. An expenditure which is in the nature of repair will not be allowed as a deduction from income if it becomes so substantial as to constitute a replacement of the asset. See Canada Steamship Lines Limited v. M.N.R, 66 DTC 5205, [1996] CTC 125; M.N.R. v. Haddon Hall Realty Inc., 62 DTC 1001, [1961] CTC 509; and M.N.R. v. Vancouver Tugboat Company, Limited, 57 DTC 1126, [1957] CTC 178. Here, however, while the sum of money is certainly substantial, the undisputed evidence is that this building's value at the material time was in the range of $8,000,000 so that the sum in issue represents less than 3% of the value of the asset. There is no justification therefore to reclassify the expenditure on that basis.
Finally, there have been a number of decisions in which repairs, either alone or in combination with other work, have rendered the capital asset not simply restored to its original condition, but greatly improved because of its new-found resistance to those factors which caused the deterioration.
[65] Judge Rowe also considered the decision in Le sous-ministre du Revenu du Québec c. Denise Goyer, [1987] R.D.F.Q. 159, in which the Quebec Court of Appeal, after examining the relevant case law, ruled as follows, through Vallerand J.A. on the distinction between capital outlays and operating expenses:
[TRANSLATION]
. . .
Maintenance and repairs are effected to preserve a capital asset. As a rule, it is of little importance if a few boards on a balcony and a few lengths of pipe are replaced each year-the expenses incurred would unquestionably be considered current maintenance expenses-or that having neglected to maintain the property, major and lasting repairs have to be done. As long as a new capital asset is not created, that the normal value of the capital asset is not increased and that an asset that had ceased to exist is not replaced by a new one, the repairs and maintenance in question are effected to restore the asset to its normal value.
. . .
[66] The contention of counsel for the appellant is based on this decision. He maintains that the new roof in the case at bar is merely a component of capital and its replacement is equivalent to a simple repair.
[67] In the case at bar, the appellant was aware of the condition of the roof at the time of purchase and knew repairs would have to be made. The appellant, through Richard Darveau, had evaluated two other possibilities: either repairing the old roof or constructing a new one, with a different slope, on top of the old roof, which would then serve as a partition. The choice made by the taxpayer constitutes a full replacement of the roof, whose new slope seems to have improved its effectiveness, and, on the whole, the replacement gave the appellant a more lasting improvement. The value of this expense in relation to the purchase price, exclusive of the land, was 23%, according to Mr. Normand. No evidence was led on the basis of which I might find that the repair increased the value of the property.
[68] Judge Rowe's conclusion in Earl (supra) reads as follows:
Basically, the jurisprudence comes down on the side of treating the expenditure by the appellant as one on account of capital. In principle, there is no real difference between the installation of a new roof and the expenditures in Goyer, when the purpose was to maintain the asset in its normal revenue-producing condition. However, with the exception of the decision in Goyer, the line of authority is consistent that work of the nature undertaken by the appellant will, barring unusual circumstances, be regarded as capital in nature.
The Minister was correct in treating the expenditure as one on account of capital.
[69] The treatment by the Minister of the expenditure relating to the roof was therefore correct. The appeals are dismissed, with costs.
Signed at Edmundston, New Brunswick, this 11th day of December 2002.
|
"François Angers" |
J.T.C.C.
Translation certified true
on this 25th day of April 2003.
Erich Klein, Revisor