Date: 19980330
Dockets: 96-1335-IT-G; 96-1336-IT-G
BETWEEN:
GEORGE SIDAWI, CYLINDRIX MFG. CO. INC.,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
(Delivered orally at Montréal, Quebec, on February 27, 1998 and subsequently revised at Ottawa, Ontario, on March 30, 1998)
Lamarre, J.T.C.C.
[1] George Sidawi ("the appellant") is appealing assessments made with regard to the 1991, 1992 and 1993 taxation years. Cylindrix Mfg. Co. Inc. ("Cylindrix") is appealing assessments made with respect to the 1990, 1991, 1992 and 1993 taxation years. Several points were at issue when the Notices of Appeal were filed. At the hearing counsel for the appellants admitted the validity of the assessments, except for three items that are still in dispute.
[2] First, the appellant disputes the inclusion by the Minister of National Revenue ("the Minister") of an amount of $228,840 (US$200,000) in his income for 1991. Relying on ss. 15(1) and 56(2) of the Income Tax Act ("the Act"), the Minister submits that this amount was paid to Chaouki Dagher by Cylindrix, of which the appellant is the sole shareholder, on the appellant's instructions and with his agreement, for the appellant's personal benefit or as a benefit which the appellant wished to confer on Mr. Dagher, and that if this amount had been paid to the appellant he would have had to include it in his income. The appellant argues that this amount was paid to Mr. Dagher to purchase the basement of a building in Beirut, Lebanon, for the operation of Cylindrix's business. In this connection, Cylindrix now admits that the rental expense which it had claimed over five years on this amount was not a rental expense that could be deducted from its income.
[3] Second, the appellant disputes the inclusion by the Minister of an amount of $5,000 in his income for 1992. Relying on ss. 15(1) and 18(1)(a) of the Act, the Minister included an amount of $26,501 in the appellant's income and disallowed its deduction as an expense by Cylindrix on the ground that it was paid by Cylindrix for the appellant's personal benefit. He also argues that this expense could not have been incurred by Cylindrix in order to produce business income since it had no expectation of earning profits from a business in Lebanon. The appellant now admits that of the $26,501 an amount of $21,501 is taxable in his hands and not deductible from Cylindrix's income; he claims however that the sum of $5,000 was a promotion expense incurred by Cylindrix with respect to an expansion project in Lebanon and so was an expense incurred in order to produce income from his business, and thus could not be regarded as a personal expense of the appellant.
[4] Third, the appellant disputes the inclusion by the Minister in his income of amounts of $9,972 in 1991, $1,060 in 1992 and $950 in 1993, representing expenses for travel to Beirut paid by Cylindrix. The Minister also relied on s. 15(1) of the Act in assessing the appellant on these amounts, and on s. 18(1)(a) of the Act in disallowing these expenses as deductions by Cylindrix, on the ground that the expenses were incurred for the appellant's personal benefit and with no expectation of earning profits from a business in Lebanon. The appellant argues that these travel expenses were incurred by Cylindrix in order to produce income from its business.
[5] I heard the testimony of George Sidawi, his wife Samia Sidawi, his daughter Nada Sidawi, George Badra (Cylindrix's external accountant), and Nicolas Dilibero (the Revenue Canada auditor).
[6] The facts in evidence may be summarized as follows.
[7] George Sidawi, who is of Syrian origin, came to Canada with his family in 1967. At the time he held a degree in engineering and architecture obtained in his country. In 1974 he founded Cylindrix in Canada with three other partners. The company specialized in the design, manufacture and sale of hydraulic and pneumatic jacks for heavy industry. In 1987 the appellant became the company's sole shareholder.
[8] The company, whose fiscal year ends on June 30 of each year, apparently experienced sustained growth until 1990, at which time it had a turnover approaching $2 million. According to George Sidawi, 90 percent of its business was done in Canada. In 1991 the appellant thought of opening up a new market abroad. He first looked at the United States, but realized that his business was not competitive. As the Gulf War was drawing to its close in the Middle East and labour was cheap there, the appellant thought he might find market openings for his business.
[9] As the machinery for his business in Canada, which made small cylinders, had become obsolete here, he and his wife apparently thought of transferring the machinery to a warehouse purchased in Beirut, Lebanon, and operating it cheaply with local labour. Samia Sidawi, who was familiar with and handled the business's accounting, said that the initial purpose of the venture in Lebanon was to clear out the small machinery from the workshops in Canada to make way for large machinery that was more productive here. George Sidawi thought the small machinery could be used in Lebanon to produce small hydraulic cylinders that could be sold in the field of residential and commercial construction, for example, in making elevators.
[10] George Sidawi apparently then instructed a Lebanese lawyer, Chaouki Dagher, to find premises in Beirut. According to Mr. Sidawi's testimony, he knew little of Mr. Dagher. However, Mr. Dagher was a tenant of George Sidawi's in Canada and Mr. Dagher's wife had apparently worked for Cylindrix in Canada for a year.
[11] In July 1991 Mr. Dagher allegedly contacted the appellant by telephone to tell him he had found the building he needed and asking him to send him US$180,000 without delay for the purchase of the building. The appellant told the Court that this was the price for the basement of the building, which had a floor area of 600 square meters. The appellant entered in evidence a document showing that this amount had been transferred from Cylindrix's account to Mr. Dagher's account in Lebanon on the same day. A month later, Mr. Dagher allegedly informed the appellant that he had never received the money. It was then that the appellant apparently began to have doubts about Mr. Dagher's honesty. A few months later Mr. Dagher contacted the appellant again, asking him to send a further amount of US$20,000 to cover the cost of registering the building and also to pay electricity charges. The appellant agreed to send him this amount. He now says that he still had some hope of recovering his initial investment.
[12] The appellant was subsequently unable to obtain confirmation that the money had been used to purchase the building. Mr. Dagher apparently told him that the purchase could not be made by a Canadian company and suggested that a company be created in Lebanon to make the purchase directly. According to what the appellant allegedly told the Revenue Canada auditor, Mr. Dilibero, this company was created in April 1991 under the name "Hydraulic Cylinders of Middle East" (Middle East), whose sole shareholder was Mr. Dagher.
[13] The appellant apparently finally obtained confirmation of the registration of title to the property in Beirut in his own name in March 1993. The appellant explained that because he was of Syrian origin it was the only way he could keep the building.
[14] In view of all these problems, Cylindrix never sent the machinery to Lebanon. Moreover, George and Samia Sidawi both said that the building was not fit for use. At the time the building was bought they were aware that it was without electricity and yet electricity was an essential component in the operation of a welding business. However, they thought the Lebanese government, which was emerging from a long war, would remedy the situation. This belief was based on what they heard through the media. There were also sewer problems with the building.
[15] The appellant conducted no serious market analysis before going ahead with purchase of the building. He had Syrian friends in the Government of Syria but did not want to take things any further in that country since all businesses were nationalized and he did not think he could make any profits there. As to the steps he took in Lebanon, he apparently went there alone three times after purchasing the building (according to the documents entered in evidence), and he went another time, at Christmas, with his entire family (including his wife, his daughter, who was still only a student, and his two sons, then aged 15 and 16 years old), since he had relations in Syria and a few in Lebanon. He also allegedly sent a Cylindrix employee to look into market possibilities for a business in Lebanon.
[16] Additionally, here in Canada Mr. Badra, who prepared Cylindrix's financial statements, allegedly told the appellant he could not record the building in Lebanon as a fixed asset in the company's 1992 financial statements since there was no title proving that Cylindrix was its owner. Cylindrix's in-house accountant then apparently had the idea of fabricating a false lease under which Cylindrix would be the tenant of the building in question. This lease was entered in evidence. Middle East, represented by Mr. Dagher, appeared therein as the lessor and Cylindrix as the lessee. The lease indicated a rental of US$40,000 a year for a five-year period, beginning on June 1, 1991.
[17] Mr. Badra indicated that from a professional standpoint he could not show in the financial statements a building that did not officially belong to Cylindrix, but that he saw no problem with indicating a rental expense that was in fact fictional. He said that this expense would disappear in five years, whereas the fixed asset would remain apparent and without explanation in subsequent years. According to him, he saw no other way of recording this disbursement of US$200,000 by Cylindrix.
[18] At the time of the audit of Cylindrix's tax returns by Revenue Canada in January 1994, neither the appellant nor Mr. Badra mentioned to the auditor that the lease was false. Nor did the appellant see fit to produce the title deed which he had had since August 1993 and which indicated that the building was in his name. At the hearing the appellant said he admitted having lied at the time of the audit. He explained that as he saw it the lease was the only way of getting proof that Mr. Dagher had pocketed the money and it provided a basis for a possible court action against him in Canada. At the same time, the appellant admitted he had never read the lease.
[19] Samia Sidawi said the same thing regarding the obtaining of the lease. She said that she saw the lease for the first time in December 1991 and that she read it very quickly. She did not notice that the lessor was the Lebanese company, not Mr. Dagher. She did not take part in the meetings with the auditor. As to Mr. Badra, he stuck to the lease story because he did not want to contradict the appellant.
[20] The auditor, Mr. Dilibero, explained that he had understood from the interview with the appellant and the external accountant that Cylindrix had leased the building in question with all the equipment required to operate the business. That is in fact what the lease appeared to indicate. However, he finally disregarded the lease and disallowed the rental expense claimed by Cylindrix because he was not satisfied that the money had been used for the payment of rental.
[21] The appellant first mentioned the title he held to the building in Lebanon when he objected to the assessments.
[22] Moreover, in April 1994 Cylindrix made an application to the Canadian government for financial assistance for the manufacture of a new product that would be sold in Lebanon and the Middle East. No reference was made in the application document to the building which had allegedly been purchased in Lebanon on behalf of Cylindrix.
[23] Counsel for the appellants argues that George Sidawi made a business decision when he decided he wanted to extend Cylindrix's market into the Middle East. He considered that the travel and promotion expenses were incurred by Cylindrix in order to carry out market appraisals over there. As regards the building, counsel submits that as president of Cylindrix, of which he was the sole shareholder, George Sidawi held a general mandate to act on the company's behalf. It would have been in this capacity that he purchased the building in his own name, given the special circumstances preventing a Canadian company from making the purchase directly.
[24] Counsel for the respondent challenged the appellant's credibility, suggesting that the expenses incurred by Cylindrix were only for his personal benefit. In counsel's view Cylindrix carried on no commercial activities in Lebanon which could give rise to any expectation of profit and he accordingly concluded that it operated no business there. He applied the same reasoning to the sum of US$200,000 spent by Cylindrix in 1991. He considered that this amount was not used to purchase a building for Cylindrix but for the personal benefit of George Sidawi.
Analysis
[25] Leaving aside for the moment the question regarding the acquisition of the building, I will first examine whether the expenses incurred by Cylindrix with a view to extending its market to the Middle East are current operating expenses for that company.
[26] I cannot conclude from the testimony of Samia and George Sidawi that they intended to seek out potential customers in the Middle East for products manufactured here in Canada. They suggested that they wished to transfer the obsolete machinery, not being used in Canada, to Lebanon in order to open up a new market there. In Canada the business serves an industrial clientele such as saw mills, dams and aluminum plants. In Lebanon they were thinking of making small cylinders locally for residential and commercial construction. In my opinion, this was not an expansion of the Canadian business, but rather the establishment of a new business with a completely different operating structure.
[27] Assuming that the building in Beirut was purchased by Cylindrix, the mere fact of buying a building is not a sufficient basis for asserting that the business in Lebanon was in operation. This was only a preliminary step towards creating the structure of the new business. This is even more apparent in the instant case, where neither electricity - an essential part of a welding business -, nor sewers, nor machinery was in place for the operation of the business. To the extent that the structure of the business to be operated was not even in place it cannot be said that the preliminary expenditures made in setting up the business are deductible (see the decision of Judge Dussault of this Court in Samson et Frères Ltée v. The Queen, 97 DTC 642, in which he referred to the judgment of the Federal Court of Appeal in M.N.R. v. M.P. Drilling Ltd., 76 DTC 6028).
[28] In Interpretation Bulletin IT-364, cited with approval by this Court in Samson et Frères, supra, and in Gartry v. The Queen, 94 DTC 1947, the following is stated in paragraph 2:
Where an activity consists merely of a review of various business possibilities in the expectation or hope that information will be obtained to justify going into a business of some kind, such an activity does not represent the commencement of a business. . . . The comments in this paragraph do not apply, of course, to an existing business that is considering expansion or diversification as distinct from the undertaking of a new and separate business.
[29] As I mentioned above, this is not in my view a case in which Cylindrix was attempting to expand or diversify the activities of its existing business in Canada; rather, it was trying to set up a separate business in Lebanon. In this regard the situation here differs from that in SPG International Ltée v. The Queen, 98 DTC 1093, cited by counsel for the appellants.
[30] In that case the Canadian company manufactured products which it sold in Canada and throughout the world. Its American subsidiary had been established specifically to attempt to penetrate the American market. The subsidiary manufactured nothing in the year in question: it only sold products purchased from the Canadian company. Accordingly, every sale made by the American subsidiary was also a sale for the Canadian company. It was thus plausible to conclude that the expenses incurred by the Canadian company, and not billed to the American subsidiary, were expenses incurred by the appellant for the purpose of producing income from its own business.
[31] The situation is quite different here. In SPG, supra, the subsidiary was already established and operational. Furthermore, it was marketing products sold to it by the Canadian company. Here, no structure had yet been put in place. Moreover, the purpose of this operation was not the marketing of products manufactured by Cylindrix in Canada but the setting up of a new business which would have manufactured its own cylinders for commercial purposes different from those associated with the business in Canada. In my opinion, the intention was to set up a business completely separate from the one in Canada.
[32] On the evidence, the steps taken to this end hardly went beyond studying the various commercial possibilities. It cannot be said in the instant case that the expenses incurred for this purpose were so incurred in order to produce income from a business, as no business existed. Further, it would be hard to maintain that the expenses claimed did not have a personal connotation. Indeed, the appellant did not deny that he had family in Syria and Lebanon and the expenses claimed were travel and promotion expenses. The evidence did not show that Cylindrix had any expectation of making a profit from its activities in Lebanon. Consequently, these expenses are not deductible from Cylindrix's income.
[33] In addition, the Minister included the amount of these expenses in the appellant's income on the ground that he had derived a personal benefit from them. The Minister likewise included in the appellant's income US$200,000 which the latter claimed he had used to purchase the building in Beirut on behalf of Cylindrix.
[34] On this point, it is difficult on the evidence I have before me to reconcile the explanations provided by the appellant, his wife and his accountant, and so to reach a conclusion favourable to the appellant. It is difficult to understand the entire strategy involved in the lease. If the appellant in fact thought that he had been the victim of a fraud committed by Mr. Dagher, I find it hard to understand why he advanced him another US$20,000 to be used to register the building and cover costs relating to electricity. Furthermore, Mr. Dagher was a tenant of the appellant's in Canada. The appellant must therefore have had some idea as to the sort of person Mr. Dagher was before doing business with him. Cylindrix was a very profitable company managed by the appellant. It seems unlikely that he would have been taken in that way.
[35] Further, as the appellant is a Syrian himself he should have known at least something about doing business in the Middle East. He himself said he had friends in the Syrian government. He should have known - if such was actually the case - that a Canadian company could not purchase a building in Beirut. In that event it seems to me it would have been possible for him to instruct the accountant to record the fixed asset in the books by adding a note to the financial statements to explain the true situation and attaching a resolution by Cylindrix. I have some difficulty understanding why a professional accountant would be more comfortable with entering false rental expenses in the financial statements than a real capital expenditure, even if, because of exceptional circumstances, such expenditure cannot be supported by a title deed.
[36] Moreover, if the appellant's explanations are legitimate, why did he not provide them to the auditor at the time of the Revenue Canada audit? Why did he persist in his story of the fabricated lease? As an informed businessman he must have known that the method used was not the most appropriate one.
[37] What all this suggests to me is that the money paid by Cylindrix to purchase the property in Beirut was paid for the appellant's personal benefit. He still holds title to the property and there is nothing to indicate that when the building is sold the money will go into Cylindrix's coffers. The appellant has not succeeded in persuading the Court on a balance of probabilities that he did not derive a personal benefit from both the US$200,000 paid by Cylindrix and the other expenses which this company paid on his behalf, and which are also at issue in the instant case. Apart from the airfare of $1,060 paid for an employee of Cylindrix, I consider that the other amounts were properly included in the appellant's income pursuant to ss. 15(1) and 56(2) of the Act.
[38] Consequently, the appeal from the assessment issued with respect to George Sidawi for 1992 is allowed to the extent that the amount of $1,060 should not be included in the appellant's income for that year. The assessment remains unchanged in all other respects.
[39] The appeals from the assessments issued with respect to George Sidawi for the 1991 and 1993 taxation years are dismissed.
[40] The appeals from the assessments issued with respect to Cylindrix for the 1990, 1991, 1992 and 1993 taxation years are dismissed.
Signed at Ottawa, Canada, this 30th day of March 1998.
"Lucie Lamarre"
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
Translation certified true on this 25th day of September 1998.
Erich Klein, Revisor