T-2099-86
Parkland Operations Ltd. (Plaintiff)
v.
Her Majesty the Queen (Defendant)
INDEXED AS: PARKLAND OPERATIONS LTD. V. CANADA (T.D.)
Trial Division, Jerome A.C.J.—Edmonton, Sep-
tember 7, 8, 1989 and February 22, 1990; Ottawa,
October 19, 1990.
Income tax — Income calculation — Deductions — Direc
tors and minority shareholders misappropriating funds —
Loss due to theft deductible — Expense to gain income from
business — Within exception in s. 18(1)(a) — Interpretation
Bulletin, stating loss through theft by employee not deductible
if senior official or major shareholder, not binding — Tax
Court recently holding level of employment should not affect
deductibility.
This was an appeal against the plaintiff's income tax assess
ment for 1982 and 1983. The plaintiff corporation was one of
seven "rim" companies organized around one "hub" company
which provided management and accounting services. The
intent behind this "wheel" of related companies was that the
"hub" company could arrange financing for those on the "rim".
Police investigations failed to secure sufficient evidence upon
which to base criminal prosecutions but it appeared that two
directors and minority shareholders had misappropriated
$563,396 from the plaintiff. The issue was whether the plaintiff
could deduct this loss. The defendant relied on an Interpreta
tion Bulletin which stated that loss through theft by an
employee is not allowed as a deduction if he is a senior official
or major shareholder.
Held, the appeal should be allowed.
The expense was incurred to gain income from a business
and it was incurred in accordance with the principles of accept
ed business practice. The funds were wrongfully drawn from
the company's operating line of credit which constituted a part
of the company's normal revenue receiving activities. The
expense was within the exception in paragraph 18(1)(a) and
therefore deductible.
Although the Interpretation Bulletin is merely the Depart
ment's interpretation of the legislation it administers and is not
binding on the Court, it is in line with much of the case law
dealing with the "level of the thief". The Tax Court, however,
recently has held that the level of the thief should not make a
difference as to whether theft by an employee is deductible.
The minority shareholders did not misappropriate the funds in
their capacity as shareholders, but as thieves with neither the
knowledge nor consent of the other shareholders. They misap
propriated the money while dealing with it in the course of the
company's activities, and not by exercising some overriding
control over the funds which existed outside of those activities.
The amount lost due to the wrongful taking was a non-capital
loss, the deduction of which was contemplated by generally
accepted accounting principles and is not prohibited by the Act.
STATUTES AND REGULATIONS JUDICIALLY
CONSIDERED
Income Tax Act, S.C. 1970-71-72, c. 63, ss. 9(1),
18(1)(a),(b), 20(1)(p), 172(2) (as am. by S.C. 1980-
81-82-83, c. 158, s. 58).
CASES JUDICIALLY CONSIDERED
APPLIED:
Cassidy's Ltd. (formerly Packer Floor Coverings Ltd.) v.
M.N.R. (1989), 89 DTC 686 (T.C.C.); W G Evans & Co
Ltd v Commissioner of Inland Revenue, [1976] 1 NZLR
425 (S.C.); Mattabi Mines Ltd. v. Ontario (Minister of
Revenue), [1988] 2 S.C.R. 175; (1988), 53 D.L.R. (4th)
656; [1988] 2 C.T.C. 294; 87 N.R. 300; 29 O.A.C. 268.
COUNSEL:
Neil W. Nichols for plaintiff.
James N. Shaw for defendant.
SOLICITORS:
Neil W. Nichols Professional Corporation,
Edmonton, for plaintiff.
Deputy Attorney General of Canada for
defendant.
The following are the reasons for judgment
rendered in English by
JEROME A.C.J.: This matter came on for hear
ing on September 7, 1989, in Edmonton, Alberta.
In due course, the decision of Cassidy's Ltd. (for-
merly Packer Floor Coverings Ltd.) v. M.N.R.
(1989), 89 DTC 686 came to my attention. It is a
decision of the Tax Court of Canada, released
October 26, 1989. Since it appeared to all parties
that the Cassidy's decision might have a bearing
on this matter, I arranged for further submissions
on the relevancy of the Cassidy's jurisprudence,
and that argument took place on February 22,
1990.
The action is brought pursuant to subsection
172(2) of the Income Tax Act, S.C. 1970-71-72, c.
63, as amended [by SC. 1980-81-82-83, c. 158, s.
58], by way of appeal of the plaintiff's tax liability
for its 1982 and 1983 taxation years. During the
period in question, the plaintiff suffered a loss of
$563,396 which it seeks to deduct in calculating its
income tax liability. An agreed statement of facts
and issues submitted by counsel has greatly simpli
fied the matters in dispute, and the only issue
before the Court is whether the taxpayer is entitled
to deduct the loss of $563,396, which amount itself
is not in dispute.
The plaintiff, Parkland Operations Ltd. (Park-
land) is an Alberta corporation which carried on
an oilfield construction and service business in an
oil patch near Drayton Valley, southwest of
Edmonton. The ownership of Parkland changed in'
1980, when the company was purchased by four
individuals who soon thereafter transferred their
stock in the company to their respective holding
corporations. These corporations, and the four
individuals corresponding to them were Neil Orser
Holdings (Neil Orser), 226614 Alberta Ltd.
(Michael Piro), E. Dyck Holdings Ltd. (Earl
Dyck), and 223015 Alberta Ltd. (James Herring-
er). In August 1980, Joelene Holdings Ltd.
(Joseph Makarowski), and Lyle McGinn Holdings
Ltd. (Lyle McGinn), former Parkland sharehold
ers, reacquired 10% each of the common shares of
Parkland from the four existing corporate share
holders, leaving 20% each of the company's
common shares to the other four shareholding
corporations.
At the time of the change in ownership, Park-
land became part of a corporate structure referred
to by all witnesses as a "hub". The intent, as I
understand it, was to form a "wheel" of related
companies, with Supercorp Management Inc.
(Supercorp) at the "hub" and seven other compa
nies, including Parkland, at the "rim". The "hub"
concept was developed by Mr. Orser, and the
intent was that it would enable each company in
the wheel to help the others, particularly in finan
cial matters. Supercorp was to provide accounting
and management services, and its presence was to
assist in arranging financing for the companies on
the rim.
Mr. Makarowski and Mr. Orser explained the
corporate structure involved here. The hub concept
was an idea of Mr. Orser and one premise of the
concept was that Supercorp would be able to
arrange financing to the companies on the rim.
The existence of the hub enabled each company in
the wheel to help the others, particularly in finan
cial matters. In the direct examination of Mr.
Orser, the following exchange took place: (Case, at
page 56)
Q Can you tell the Court how the notion of the hub concept
came about, and relate that to the various companies
shown in this diagram.
A The hub company was Supercorp, which was to be the
accounting and the sort of the management of the other
companies involved.
Q When you considered investing in Parkland, what was
important about Parkland?
A Parkland had a good cash flow and excess cash.
Q And can you expand for us how that would fit into the
concept of having Supercorp at the hub.
A Well, if the other companies were ever in trouble or
needed financing, it was supposed to have been a lot
easier to arrange a loan through Supercorp to keep the
other companies floating.
Parkland had a $750,000 operating line of credit
with the Canadian Imperial Bank of Commerce. A
"signature card" on which the signatures of all six
shareholders appeared does not explicitly make
joint signatures necessary to carry out a banking
transaction. The set-up of the card does, however,
and it leaves the impression that a joint signature
requirement was intended. Based on the appear
ance of this card and discussions among the par
ties, both Makarowski and Orser, the only princi
pals who appeared as witnesses, were of the view
that two signatures would be required for with
drawals from Parkland's funds: one at least of
Makarowski or McGinn, and one of the four
"new" owners, Orser, Piro, Dyck, or Herringer.
Many cheques were signed in that manner. Mr.
Makarowski, who had taken steps to acquire sign
ing authority for cheques precisely so that he
would have knowledge and some measure of con
trol over Parkland's spending, signed most of the
cheques, and Herringer and Dyck, between them,
signed all the cheques. Nonetheless, some with
drawals were made without the knowledge or
approval of either Mr. Makarowski or Mr.
McGinn, or even Mr. Orser, and funds were
moved by Earl Dyck and James Herringer which
have yet to be accounted for.
In effect, Dyck and Herringer were in control of
Supercorp, but by the fall of 1981 there was
growing dissatisfaction with them. Mr. Makarow-
ski became aware of the more than half a million
dollars paid out by Parkland to Supercorp, which
came as a surprise to him since despite the
arrangement within the company whereby he
and/or Mr. McGinn were to sign all cheques
issued, these withdrawals had been made without
his knowledge. On December 16, 1981 Earl Dyck
and James Herringer were removed as directors of
Parkland.
Staff Sergeant David Bradley of the RCMP
testified that he received complaints concerning
diverted funds from Parkland and Island Recrea
tional Inc., another company on the "rim", which
led to an RCMP investigation. There was suffi
cient evidence to proceed against Dyck and Her-
ringer in one criminal matter, the one concerning
Island Recreational. Dyck and Herringer evidently
sold property belonging to this company and mis
appropriated a sum of about $200,000, for which
they were convicted and served a term of imprison
ment. With respect to Parkland, however, Staff
Sergeant Bradley was of the view that while they
were certain that the funds had been diverted by
Dyck and Herringer from these companies, they
were not satisfied that there was sufficient evi
dence to support criminal proceedings, particularly
due to some vagueness in the banking arrange
ments or signing authority.
Mr. Jack Foulds, the chartered accountant in
charge of the books for Parkland was also called as
an expert witness. He testified as to Generally
Accepted Accounting Principles, based in part on
his interpretation of sections 3480 and 3610 of the
accounting profession Handbook. He expressed the
opinion that an unlawful misdirection or disap
pearance of funds, which is not a capital transac
tion, is a loss that should be claimed as an expense
deduction. According to him, the loss here would,
in accounting circles, be considered deductible as
an extraordinary item, as defined in section 3480
of the CICA Handbook, and therefore one on
account of income. Mr. Foulds was also of the
opinion that based on the assumption that the
plaintiff carried on a money lending business, this
loss would again be deductible on the basis of the
money lending business as an enterprise of the
plaintiff.
Subsection 9(1) of the Act provides that, subject
to Part I of the Act, "a taxpayer's income for a
taxation year from a business or property is his
profit therefrom for the year". Plaintiff contends
that the losses suffered by Parkland as a result of a
"wrongful taking" of funds by Dyck and Herring-
er are deductible in computing Parkland's profit
from a business and are not prohibited by virtue of
any provisions of the Act. Alternatively, it is
argued that the losses arose in the course of the
taxpayer's sideline business of money lending, and
are therefore deductible under section 9 or para
graph 20(1)(p) of the Income Tax Act.
The defendant, however, takes the position that
the sum is not deductible because there was no
wrongful taking, and if there was wrongful taking,
it did not constitute an expense incurred for the
purpose of earning or producing income from a
business. The defendant further takes the position
that the plaintiff did not carry on a sideline busi
ness of money lending.
The decision of the Tax Court in Cassidy's
came shortly after I took this matter under
reserve, and following further arguments of coun
sel, I gave the matter further consideration. I am
called upon to consider, therefore, whether the
facts establish that the money which was wrong
fully taken firstly was expended for the purposes
set out in paragraph 18(1)(a) of the Income Tax
Act, in order that it come within the exceptions
contained in that section. Both counsel appear to
agree that while Generally Accepted Accounting
Principles do not constitute an overriding principle
and cannot be used to determine the question of
deductibility, where the amount is not prohibited
from deduction by paragraphs 18(1)(a) or (b), the
amount is deductible from income in accordance
with Generally Accepted Accounting Principles.
It is agreed that the deduction, if allowed, and if
based on the "wrongful taking" theory, applies
fully to the 1982 tax year; if based on the sideline
money lending premise, the deduction applies in
full to the 1983 taxation year.
Paragraphs 18(1)(a) and (b) of the Income Tax
Act state as follows:
18. (1) In computing the income of a taxpayer from a
business or property 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 the business or property;
(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 expressly permitted by
this Part;
The right to claim a deduction pursuant to
paragraph 18(1)(a) was reviewed thoroughly by
Mr. Justice Rip in the Tax Court of Canada in the
Cassidy's decision. I am satisfied that the position
taken by counsel in this case is in accord with the
position advanced by Mr. Justice Rip at page 690,
with respect to the relevance of Generally Accept
ed Accounting Principles to the provisions of the
Act. I turn, therefore, to a consideration of the
conditions necessary to establish a right to claim a
deduction pursuant to paragraph 18(1)(a).
Was the "expense" in question incurred by the
taxpayer for the purpose of gaining or producing
income from the business? The plaintiff submits
that:
In Parkland, it is noteworthy that the embezzled funds came
out of the operating funds of the company by drawing down its
operating line of credit which was secured by its trade receiv-
ables. This stamps the transaction as being an income account.
The plaintiff has referred me to the case of
Mattabi Mines Ltd. v. Ontario (Minister of Reve
nue), [1988] 2 S.C.R. 175, wherein Madame Jus
tice Wilson, in the Supreme Court of Canada, has
quoted [at page 187] with approval the following
comments of President Thorson of the Exchequer
Court of Canada in Royal Trust Co. v. Minister of
National Revenue, [ 1957] C.T.C. 32:
The essential limitation in the exception expressed in Section
12(1) (a) is that the outlay or expense should have been made
by the taxpayer "for the purpose" of gaining or producing
income "from the business". It is the purpose of the outlay or
expense that is emphasized but the purpose must be that of
gaining or producing income "from the business" in which the
taxpayer is engaged ... . Thus, in a case under the Income Tax
Act if an outlay or expense is made or incurred by a taxpayer in
accordance with the principles of commercial trading or accept
ed business practice and it is made or incurred for the purpose
of gaining or producing income from his business its amount is
deductible for income tax purposes. [Emphasis added.]
The plaintiff takes the view that the "expenses" in
this case came out of the income earning process
and are thus not prohibited from deduction by
paragraph 18(1)(a).
The defendant, of course, submits that the
expenses claimed were losses occasioned through
theft and defalcation by an employee, officer and
director of the plaintiff, and did not constitute
expenses incurred for the purpose of earning or
producing income from a business within the
meaning of that section. To quote from the defend
ant's submission:
In the case at bar the money at the time of the theft was not in
the till, not in the form of receipts, not in the nature of trade
accounts and not part of the normal revenue receiving activities
of the company. When stolen, the money was not at any stage
of the income earning process.
Notwithstanding this submission, I am satisfied
that in the case before me the expense in question
was incurred by the taxpayer for the purpose of
gaining or producing income from a business; and
further that this expense was incurred in accord
ance with the principles of accepted business prac
tice. I find that the funds in question were wrong
fully drawn from the company's operating line of
credit which, as the plaintiff suggests, stamps the
transaction as being on account of income. I
cannot accept the defendant's submission that the
money at the time of the theft was not part of the
normal revenue receiving activities of the com
pany. The funds in question came out of the
company's operating funds, which indeed consti
tute a part of the company's normal revenue
receiving activities.
I have reached the conclusion, therefore, that
the expense in question is contemplated by the
exception set out in paragraph 18(1)(a). The
defendant, however, has also raised the issue of
Interpretation Bulletin IT-185, dated November
4, 1974:
I. A loss of trading assets such as stock in trade or cash
through theft, defalcation of embezzlement normally is
allowed as a deduction in computing income where a taxpay
er's business involves this risk. In determining whether such a
loss is allowable the Department uses the following
guidelines.
2. Loss through
(a) theft, holdup or robbery by a stranger, or
(b) theft, defalcation or embezzlement by an
employee, unless he is a senior official or major
shareholder, is allowed. Loss through theft, defalca-
tion or embezzlement by a partner is not allowed.
Based on this Bulletin, it is the defendant's sub
mission that, whether it has the force of law or not,
if it correctly interprets the law and establishes
policy dealing with the level of the theft, then the
plaintiff cannot succeed. The plaintiff argues, on
the other hand, that a Departmental Interpretation
Bulletin is merely that: the Tax Department's
interpretation of the legislation it administers —
its version of the law or a public warning of the
assessing practice it intends to adopt, and therefore
not binding on the Court. I accept and endorse this
position. Nevertheless, counsel for the defendant is
correct in suggesting that this Bulletin, particular
ly inasmuch as it suggests that a loss will not be
allowed where it is occasioned by theft by an
employee who is a "senior official or a major
shareholder", is in line with much of the jurispru
dence dealing with the "level of the thief". This
was the problem raised in the Cassidy's decision,
which I felt required further argument here.
In reaching the conclusion that the mere fact
that a thief is a senior employee should not pre
clude the deduction, Rip J. referred to a New
Zealand decision, W G Evans & Co Ltd v Com
missioner of Inland Revenue, [1976] 1 NZLR 425
(S.C.), at page 435:
The fact that he was also a director, shareholder and officer of
the company does not alter the fact that he misappropriated the
money while dealing with it as part of the company's activities,
and not by the exercise of overriding power or control outside
those activities altogether, as did the sole managing director in
Curtis's case. The risk of such defalcations was inherent in the
operations of the company carried on by necessity in this way,
and accordingly the resulting loss is fairly incidental to the
production of the assessable income and is deductible.
The reasoning of Mr. Justice Casey in Evans is
particularly appropriate here. Dyck and Herringer
may have been minority shareholders of Parkland,
but they misappropriated the funds in question not
in their capacity as shareholders, but rather as
thieves, with neither the knowledge nor consent of
the other shareholders. They misappropriated the
money while dealing with it in the course of the
company's activities, and not by exercising some
overriding control over the funds which existed
outside of those activities. The principle which
ultimately decided Cassidy's, that the distinction
in the level of employment should not make a
difference as to whether an employee theft is
deductible is no less applicable here. The taxpayer
is entitled to the same relief where a minority
shareholder, oblivious to the plans or desires of the
other shareholders, misappropriates funds as he
would be where a senior employee was the thief.
The amount lost due to the "wrongful taking"
committed by Dyck and Herringer was a non-capi
tal loss, the deduction of which is contemplated in
accordance with Generally Accepted Accounting
Principles, and is not prohibited by any of the
provisions of the statute.
The appeal is therefore allowed and the matter
is referred back to the Minister of National Reve
nue for the appropriate reassessments in accord
ance with these reasons. The plaintiff is entitled to
costs.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.