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Decision Information

Decision Content

The Queen (Plaintiff)
v.
F. H. Jones Tobacco Sales Co. Ltd. (Defendant)
Trial Division, Noël A.C.J.—Montreal, May 1; Ottawa, May 29, 1973.
Income tax—Individual guaranteeing loan to customer in return for exclusive sales rights—Default on loan—Guaran- tor called on to make good—Payment made by company controlled by guarantor—Whether deductible in computing company's income.
Jones guaranteed a $200,000 loan to a cigarette sales company to enable it to acquire a cigarette manufacturing company. In return for the guarantee, Jones was given the exclusive right to supply tobacco to the tobacco manufactur ing company. Subsequently, the cigarette sales company defaulted on the loan and Jones was called on to pay $115,369 in consequence. The sum was, however, paid not by Jones but by defendant company which Jones controlled. Defendant company sought to deduct the amount of the payment as a business expense in computing its income.
Held, the company was entitled to the deduction. From a commercial point of view the obligation incurred in respect to the loan was that of defendant company and not that of Jones personally. Moreover, the purpose of the payment was to increase defendant company's sales and thus its profits, and not to create an enduring benefit.
L. Berman & Co. Ltd. v. M.N.R. [1961] C.T.C. 237; M.N.R. v. Freud [1969] S.C.R. 75 referred to.
APPEAL from Tax Review Board. COUNSEL:
Jean Potvin and Gaétan Drolet for plaintiff.
Michel Gilbert and Maurice Paquin for defendant.
SOLICITORS:
Deputy Attorney General of Canada for plaintiff.
Lemay, Paquin and Gilbert, Montreal, for defendant.
NOEL A.C.J.—An appeal is brought from the decision of the Tax Review Board of April 28, 1972, allowing appellant's appeal from an assessment by the Minister for 1966, by which
the latter rejected an amount of $115,369.33 which the company claimed to be entitled to deduct, and added the said amount to its declared income, thereby levying a tax of $65,666.02.
Since 1961 defendant, F. H. Jones Tobacco Sales Co. Ltd., has operated a business growing and selling tobacco. F. H. Jones is its president and principal shareholder, owning 99 per cent of the shares.
In 1963 La Société des Tabacs Québec Inc., a distributor of cigarettes, sought to acquire con trol of Tabacs Trans-Canada Ltée, a company in the business of manufacturing cigarettes. A loan of $200,000 was necessary for this purpose, as well as the endorsement of a solvent person.
On September 27, 1963 an agreement was made between La Société des Tabacs Québec Inc. (hereinafter called the company) on the one hand, and F. H. Jones on the other hand, by which
(1) F. H. Jones agreed to sign a guarantee to repay a loan of $200,000 made by the com pany for the purpose of acquiring control of Tabacs Trans-Canada Ltée, payable to a Mr. Pilonnière, acting on behalf of the Richelieu Corporation, the lending company, at the rate of approximately $5,000 a month;
(2) the company appointed Mr. F. H. Jones, and undertook to have him appointed by Tabacs Trans-Canada Ltée, as exclusive agent for the purchase and supply of leaf tobacco, at the best possible price having regard to market conditions;
(3) both personally and in his capacity as president and majority shareholder of F. H. Jones Tobacco Sales Co. Ltd., F. H. Jones undertook to supply the company and Tabacs Trans-Canada Ltée with leaf tobacco, at the best possible price having regard to market conditions;
(4) the aforementioned guarantee would be provided by the endorsement of one or more promissory notes making a total of $200,000.
Prior to this agreement Tabacs Trans-Canada Ltée had purchased 80 per cent of its tobacco from suppliers other than F. H. Jones Tobacco Sales Co. Ltd.
Jacques Hurtibise, president of La Société des Tabacs Québec Inc., indicated to F. H. Jones that if he signed as surety for the sum of $200,000 all tobacco purchases would be chan nelled to F. H. Jones Tobacco Sales Co. Ltd. Because of the vigorous competition in the market for the sale of tobacco, F. H. Jones felt that it would be advantageous to his company to make certain of, and increase, its sales to a customer like Tabacs Trans-Canada Ltée. He therefore affixed his signature to a document or note relating to the loan of $200,000 needed to enable La Société des Tabacs Quebec Inc. to acquire control of Tabacs Trans-Canada Ltée.
After the agreement was signed on September 27, 1963 between La Société des Tabacs Québec Inc. and F. H. Jones, all the tobacco needed by Tabacs Trans-Canada Ltée was bought from F. H. Jones Tobacco Sales Co. Ltd.
In 1966 La Société des Tabacs Québec Inc. became insolvent, and the surety was asked for the sum of $115,369.33 on the loan of $200,- 000. F. H. Jones Tobacco Sales Co. Ltd. paid the said amount of $115,369.33, and as we have seen claimed it as an expense or a loss in computing its income for 1966.
The plaintiff, Her Majesty the Queen, relies on two propositions in disputing defendant's right to deduct the sum of $115,369.33.
Firstly, she contends that there is no legal connection between the creditor of the debt for $115,369.33 and defendant, and so the latter was under no obligation to pay the said amount. She adds that this debt was a personal one of F. H. Jones, and therefore cannot be considered as an outlay or expense made or incurred by defendant for the purpose of gaining or produc ing income from defendant's business.
Alternatively, if the agreement made on Sep- tember 27, 1963 between La Société des Tabacs Québec Inc. and F. H. Jones was legally binding on defendant, the amount of $115,369.33 would still not be deductible in computing defendant's income, for the following reasons:
(1) the amount of $115,369.33 was not a bad debt deductible in computing defendant's income within the meaning of s. 11(1) of the Income Tax Act. This was a ground of appeal accepted by the learned Member of the Tax Review Board, but abandoned by counsel for the defendant, for reasons which are obvious. The sum of $115,369.33 was not the result of loans made in the ordinary course of defend ant's business, which did not even partly involve the lending of money; moreover, the amount in question was not included by defendant in computing its income for 1966, or for any prior year;
(2) the amount of $115,369.33 represented an outlay, loss or replacement of capital, or a payment on account of capital, and pursuant to the provisions of s. 12(1)(b) of the Income Tax Act, could not be deducted in computing defendant's income.
Let us now return to plaintiff's first proposi tion, namely that there is no legal connection between the creditor of the debt for $115,- 369.33 and defendant, so that the latter was under no obligation to pay the amount, since the sum of $115,369.33 was a personal debt of F. H. Jones, not of his company, and so it cannot be considered as an outlay or expense made or incurred by defendant for the purpose of gain ing or producing income from its business.
In order to fully understand the questions before the Court, I feel we must ascertain the facts which gave rise to Jones' endorsement and the circumstances in which this undertaking was made. It should first be noted that he is practi cally outright owner of F. H. Jones Tobacco
Sales Co. Ltd., since he holds 99 per cent of its shares. We are therefore concerned with a com pany whose ownership is in the hands of a single man, F. H. Jones, and he is its president. Before being incorporated, however, this busi ness functioned under a trade name owned entirely by F. H. Jones. Indeed, the company's incorporation seems to have had no effect on the activities of F. H. Jones, who continued to run the business as in the past, and to act as if no company existed.
According to Jones the company purchased tobacco and finished it before it was rolled into cigarettes.
Jones stated that his company began supply ing tobacco to Tabacs Trans-Canada Ltée around 1960. At that time ten per cent of the Jones company's sales were to Tabacs Trans- Canada Ltée. The Tabacs Trans-Canada factory was subsequently sold to Mr. Jacques Hurtibise, and he set up a company known as La Societe des Tabacs Quebec Inc.,, which became the successor to Tabacs Trans-Canada Ltée, since the aforesaid company bought the shares of Tabacs Trans-Canada Ltée. Jones testified that in 1963 he was approached by Hurtibise or other representatives of his company, who told him that they intended to buy Mr. Brisebois' shares in the company, and continue to manu facture the "Québécoise" cigarette. They said they needed a lot of tobacco, and Jones stated "I found this was a very good thing for our company".
He was also asked for his endorsement up to the sum of $200,000 to enable them to buy the shares of the Tabacs Trans-Canada company. At the time it was indicated that if he did not want to give the endorsement, they would go to certain of his competitors, companies in Ontario which were subsidiaries of American firms. Jones said he did not want to lose the opportu nity of selling the tobacco he had on hand then, and future sales as well, "in the interests of our company first of all", as he said. He told them that "$200,000 is a lot of money", and asked if they intended to repay the money promptly.
They replied that they would be doing so "with- in three months", that they intended to sell shares on the open market, and that he had nothing to worry about. Jones stated that he discussed the matter with his board of directors, who he said gave him authority to sign on behalf of the company, and he did so. An extract was produced from the minutes of a meeting of the directors of F. H. Jones Tobacco Sales Co. Ltd., dated August 26, 1963, that is a few days before Jones signed the agreement between La Société des Tabacs Québec Inc. and himself on Septem- ber 27, 1963, by which he undertook to guaran tee repayment of $200,000. This document was his authority, he said, to sign for the company. It reads as follows:
On motion duly made and seconded, it was resolved that Mr. F. H. Jones, the President, be and he hereby is duly authorized for or on behalf of the company to sign or endorse agreements with prospective customers who manu facture tobacco in the province of Quebec.
Whereby the company, namely F. H. Jones Tobacco Sales Co. Ltd, will have exclusive rights to purchase and process tobacco with a mutual understanding as to the price and will take all measures at his disposition to see that the tobacco purchased for any company is well protected and is the property of F. H. Jones Tobacco Sales Co. Ltd until fully paid.
As far as the endorsement itself is concerned, he said he was not too sure what kind of docu ment he signed, and added, "it was a contract". He was unable to produce it because, he said, he gave it to his lawyers at the time, and they cannot find it. Further, this document might have disappeared when the tax inspectors took certain documents in connection with an excise matter involving La Société des Tabacs Québec Inc. I understand from a statement by counsel for the plaintiff at the hearing that inspectors from the Excise Branch, Department of Nation al Revenue, saw this document on that occa sion, and its existence is admitted. All the com- pany's assets were seized on that occasion, including the tobacco, and sold for whatever they would bring. Jones said he was left with the endorsement for $200,000, of which he was asked to pay the sum of $136,000. A cheque for this amount was then issued by his company in settlement of this obligation.
Jones maintained that he acted on behalf of his company at all times in endorsing payment of the sum of $200,000, and that he did so in reliance on the resolution of his board of direc tors, mentioned above.
It is not for me to decide here whether an action on the note against the Jones company would succeed. I must simply determine wheth er this was a purely personal debt of Jones, or a debt which may and should be regarded as a debt of the company.
As we have seen, Jones claims that this was at all times simply a debt of his business or his company, and I feel the evidence shows this was indeed the case, not only in the view of Jones but in that of Jacques Hurtibise, president of La Société des Tabacs Québec Inc., as well. At the hearing before the Tax Review Board (evidence which was included in the record of this case by consent), Hurtibise said the follow ing in response to questions from Jones' coun sel, concerning the latter's endorsement for $200,000, at pages 35 et seq.:
Q. Were you aware of this transaction? A. Certainly.
Q. Did you see the document?
A. Yes, as I remember, yes, I saw all the documents.
Q. Was the endorsement by Mr. Jones or by the
company?
A. As I remember, F. H. Jones appeared throughout.
Q. F. H. Jones; what does F. H. Jones refer to? A. The company.
Hurtibise then said, at p. 37:
Definitely, once the transaction was complete, that is, the one involving the purchase of Trans-Canada by La Société des Tabacs Québec—definitely, in the space of a few months tobacco purchases were directed to the F. H. Jones company. Certainly after that our former suppliers came to us on several occasions. I saw them myself, because it must be remembered that before La Société des Tabacs Québec took over Tabacs Trans-Canada, 70, 75, 80 per cent of the tobacco supplied to us came from other sources besides Mr. Jones.
A little further on he added that the Jones company in fact supplied most of the tobacco required by La Société des Tabacs Québec Inc.
Cross-examined by counsel for the plaintiff, Me Potvin, he repeated what he said earlier, namely that so far as he was concerned Jones always stood for the Jones company:
Mc Potvin:
Q. On the last question, Mr. Hurtibise, you mentioned a moment ago that you were not too sure who you were dealing with when Mr. Jones signed the documents, whether it was with him personally or his company?
A. What I mean is, in our opinion, F. H. Jones was present throughout, quite simply.
THE PRESIDENT:
Q. To you Mr. Jones was the same as the F. H. Jones
Company?
A. That's correct.
Further, Hurtibise's testimony indicates clear ly that the lender's representative, one Pilon- nière, did not know Jones personally, and was introduced to him by the witness, who added in answer to a question by plaintiff's counsel that Pilonnière was not aware of the fact Jones was a person of substance, and that this enabled him to act as surety for the sum of $200,000.
How can it be said, in these circumstances, that the amount of $115,369.33 (that is $136,- 000 less certain sums paid by the co-endorsers) paid by the defendant company was only a personal debt of Jones, and not of the com pany? The Court must consider the situation from a businessman's point of view, and not dwell on technicalities which may be relevant in other types of proceeding in which, for instance, the company challenged the existence of the obligation, but which have no relevance here. The payment of the amount of $115,369.33 by the Jones company was undoubtedly made for commercial reasons, in accordance with ordi nary business principles. On this see L. Berman & Co. Ltd. v. M.N.R. [1961] C.T.C. 237 per Thorson P., at p. 247:
There is no doubt in my mind that the appellant made the payments in question as a business person intending to continue in business would reasonably do and that, conse quently, they were made in accordance with the ordinary principles of commercial trading or well accepted principles
of business practice and I am unable to find any ground in Section 12(1)(a) for their exclusion.
Even if the appellant had not been legally bound to make the payments that did not prevent them from having been made in accordance with the ordinary principles of commer cial trading. There is strong authority for this statement in Usher's Wiltshire Brewery, Limited v. Bruce, [1915] A.C. 433. In that case the tenants of the appellants' tied houses were by agreement bound to repair their houses and pay certain rates and taxes. They failed to do so. The appellants, though in no way legally or morally bound to do so, paid for these repairs and paid these rates and taxes. They did so, not as a matter of charity, but of commercial expediency, in order to avoid the loss of their tenants, and, consequently, the loss of the market for their beer, which they had acquired these houses for the purpose of affording. It was held that, although they were not legally or morally bound to make these payments, yet they were, in estimating the balance of the profits and gains of their business for the purposes of assessment of income tax, entitled to deduct all the sums so paid by them as expenses necessarily incurred for the purposes of their business.
I therefore feel that defendant legitimately paid the claim resulting from the endorsement for $200,000.
Let us now turn to plaintiff's last proposition, namely that the sum of $115,369.33 was an outlay, loss or replacement of capital, or a pay ment on account of capital, and that by virtue of the provisions of s. 12(1)(b) of the Income Tax Act, it cannot be deducted in computing defend ant's income.
Section 12(1)(a) and (b) reads as follows:
12. (1) In computing income, no deduction shall be made in respect of
(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer,
(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as express ly permitted by this Part, ... .
Clearly, as I have already indicated, the pay ment made by the Jones company was one which fell within the exception provided in paragraph (a) of section 12(1). It was in fact made for the purpose of gaining or producing income from defendant's business, and the evi dence establishes that until the bankruptcy of La Société des Tabacs de Québec Inc. it actually yielded considerable income by the sales of
tobacco made by the company to the latter concern.
The only question the Court must now deter mine is whether the payment of this amount falls within paragraph (b) of section 12(1), as an outlay, a payment on account of capital, or a loss of capital. Plaintiff's counsel argued that it does, and it is possible that in certain circum stances it might be so regarded.
For some years, however, our courts have been inclined to accept certain expenses or losses as deductible, considering not so much the legal aspect of the transaction, but rather the practical and commercial aspects.
To see this we need only refer to the remarks of the Chief Justice of the Supreme Court, when he dismissed the appeal from the decision of Jackett P. in Algoma Central Rly. v. M.N.R. [1967] 2 Ex.C.R. 88, in which the latter had allowed deduction of certain amounts spent on a study designed to assist industries to locate in the area served by the Algoma Central Railway, and so generate income for its railway operation.
At p. 449 of the M.N.R. y. Algoma Central Rly. decision ([1968] S.C.R. 447) Fauteux C.J. referred to and adopted the following statement of Lord Pearce in B.P. Australia Ltd. v. Com missioner of Taxation of Australia [1966] A.C. 224, at p. 264:
The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects
of the whole set of circumstances, some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indica tions in the contrary direction. It is a cpmmonsense
appreciation of all guiding features which must provide the ultimate answer.
It was in Hallstroms Pty. Ltd. v. F.T.C. 8 A.T.D. 190, however, that the Court held, at p. 196, that a realistic attitude must be adopted toward deduction of expenses or losses. Indeed, it stated that in such cases the solution
"depends on what the expense is calculated to effect from a practical and business point of view, rather than upon a juristic classification of the legal rights, if any, secured, employed or exhausted in the process".
Certain decisions of this Court, and of the Supreme Court, were cited at the hearing. To decide as to the deductibility of the sum of $115,369.33 paid by defendant I feel I need only quote at some length from a Supreme Court decision by Pigeon J., in M.N.R. v. Freud [1969] S.C.R. 75 at pp. 81-84, in which he accepted as deductible monies advanced to a company for the construction of an automobile prototype, but unfortunately used up to no pur pose since the venture did not succeed:
Appellant further contends that the disbursements made by respondent should be considered as a loan to the com pany. This is somewhat doubtful because while reimburse ment of the sums advanced to the company could probably have been claimed as money had and received, the sums paid direct to third parties might well have been considered as voluntary payments and not recoverable (Halsbury's Laws of England, 3rd ed., vol. 8, p. 231).
Assuming that the whole amount should properly be con sidered as a debt due by the company, this does not neces sarily imply that the outlay was an investment. Obligations to pay money can be trading assets just like other things (Scott v. M.N.R. [1963] S.C.R. 223, [1963] C.T.C. 176; M.N.R. v. Maclnnes [1963] S.C.R. 299, [1963] C.T.C. 311; M.N.R. v. Curlett [1967] S.C.R. 280, [1967] C.T.C. 62). It is true that in those cases the conclusion that the acquisition of mortgages at a discount was a speculation, not an invest ment, rests upon a consideration of the large number of operations of a similar nature that were effected. But, on account of the definition of "business", this is not the only basis on which this conclusion can be reached. As previous ly pointed out, a single venture in the nature of trade is a business for the purposes of the Income Tax Act "as well in the case of an individual as of a company".
It is, of course, obvious that a loan made by a person who is not, in the business of lending money is ordinarily to be considered as an investment. It is only under quite excep tional or unusual circumstances that such an operation should be considered as a speculation. However, the circum stances of the present case are quite unusual and exception al. It is an undeniable fact that, at the outset, the operation embarked upon was an adventure in the nature of trade. It is equally clear that the character of the venture itself remained the same until it ended up in a total loss. Under those circumstances, the outlay made by respondent in the
last year, when the speculative nature of the undertaking was even more marked than at the outset due to financial difficulties, cannot be considered as an investment. Whether it is considered as a payment in anticipation of shares to be issued or as an advance to be refunded if the venture was successful, it is clear that the monies were not invested to derive an income therefrom but in the hope of making a profit on the whole transaction.
At this point, the decision of this Court in M.N.R. v. Steer [1967] S.C.R. 34, [1966] C.T.C. 731, must be considered. In that case, it was held that a guarantee given to a bank for a company's indebtedness was a deferred loan to the company and that a large sum paid to the bank to discharge this indebtedness was a capital loss. The decision cannot imply that loans are always investments but only that such was the character of the loan in the circumstances of that case because, as we have seen, there are at least three recent cases in this Court where loans were held to be trading operations with the consequence that profits and losses were on income not capital account. It must also be added that the decision cannot imply that an outlay for the acquisi tion of an interest in an oil well drilling venture such as the company involved in the Steer case, can never be a trading venture because in Dobieco Ltd. v. M.N.R. [1966] S.C.R. 95, [1965] C.T.C. 506, such an interest was treated as a trading asset of an underwriting and trading firm. As we have seen while there is a presumption against an isolated operation having such a character in the hands of an individual, this presumption can be rebutted and it may be shown that even a single operation is in fact a venture in the nature of trade and therefore a "business" for income tax purposes.
In the present case as we have seen, the basic venture was not the development of a sports car with a view to the making of a profit by going into the business of selling cars but with a view to a profit on selling the prototype. There fore, the venture, from its inception, was not for the purpose of deriving income from an investment but for the purpose of making a profit on the resale which is characteristic of a venture in the nature of trade. Nothing indicates that the character of the operation had changed when the outlays under consideration were made. On the contrary, the ven ture had become even more speculative, it was abundantly clear that respondent could have no hope of recovering anything unless a sale of the prototype could be accom plished. The outlays cannot be considered as a separate operation isolated from the initial venture, they have none of the characteristics of a regular loan.
In my view, the payments made by respondent could not properly be considered as an investment in the circum stances in which they were made. It was purely speculation. If a profit had been obtained it would have been taxable irrespective of the method adopted for realizing it. Such being the situation, these sums must be considered as out lays for gaining income from an adventure in the nature of trade, that is a business within the meaning of the Income Tax Act, and not as outlays or losses on account of capital.
I also conclude that the loss sustained by defendant when it was called on to act as surety must be treated as an outlay made for the pur pose of gaining or producing income in the operation of its business undertaking, and not an outlay or loss on account of capital.
Indeed, the evidence establishes that for a number of years before 1966 defendant had been selling hundreds of thousands of dollars worth of tobacco to Tabacs Trans-Canada Ltée. Realizing the poor financial condition of Tabacs Trans-Canada Ltée, and that the latter would be unable to pay for and take delivery of large quantities of tobacco on order, defendant through its president agreed to act as surety in favour of La Société des Tabacs Québec Inc., for the amount of $200,000, so that the latter could purchase the shares of Tabacs Trans- Canada Ltée, otherwise La Société des Tabacs would have obtained a guarantee from defend ant's Ontario competitors and defendant would thus lose a good customer.
In effect, defendant sought through this guar antee to ensure continued growth of its sales to Tabacs Trans-Canada Ltée, and at the same time make certain that the latter would be able to proceed with large orders for tobacco made.
It is thus clear that the actions taken by Jones for his company were of a nature that would benefit the latter, at least for a time. Their sole purpose was to increase its sales, and hence its profits, and this moreover is what did happen, at least for some time, that is to say until La Société des Tabacs Québec Inc. ceased operations.
It is true that by signing the agreement of September 27 defendant company secured a certain priority in supplying tobacco to La Société des Tabacs Québec Inc., but this was nevertheless "at the best possible price having regard to market conditions", as stated in clause one of the agreement.
Counsel for the plaintiff sees this as an exclu sive right, giving defendant a permanent asset, and argues that for this reason the payment of
$115,369.33 should be regarded as a capital payment.
In the first place, this exclusive right to supply tobacco at the market price is rather relative, since it was only enjoyed by defendant if it sold its tobacco at the lowest price on the market. It was thus at the mercy of its competi tors. With regard to the period for which this exclusive right was to exist, I feel that taking into consideration the circumstances described in the evidence it was quite short. Jones stated that it would only last a few months, or as he was informed, the time necessary to repay the amount of $200,000 from the proceeds of the sale of shares in La Société des Tabacs Québec Inc. Furthermore, this period only lasted in fact until this company was wound up a few months after the agreement.
In these circumstances I am unable to see the existence of an exclusive or permanent right sufficient to warrant a finding that defendant obtained a continuing benefit from his surety.
The appeal is accordingly dismissed with costs.
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