Tax Court of Canada Judgments

Date: 20020509

Docket: 1999-4643-IT-G

BETWEEN:

BIG COMFY CORP.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Rip, J.

[1]            Big Comfy Corp. appeals the income tax assessment for its 1996 taxation year in which the Minister of National Revenue ("Minister") denied its claim for a Canadian film tax credit provided for in section 125.4 of the Income Tax Act ("Act").

[2]            In the Minister's view the appellant Big Comfy Corp. ("Big Comfy") is not entitled to the tax credit since three other taxpayers who advanced funds for a video production undertaken by the appellant had interests in the production that permitted each of them, respectively, to deduct an amount in respect of the production in computing their incomes for the year: subsection 125.4(4).[1] Respondent's counsel advised that the intent of subsection 125.4(4) of the Act is to ensure that incentives and favourable tax treatment are focused on producers of film and video productions (and production companies) rather than on those persons who invest in the productions.

[3]            Big Comfy produces a children's television series called "The Big Comfy Couch". The fourth season of the series, which is relevant to this appeal, contained thirteen episodes ("Series IV"). Principal photography of these episodes began on July 4, 1995 and ended on August 5, 1995. The series is distributed throughout the world and the appellant receives income from the broadcast and syndication of the episodes.

[4]            Funding for the production of the episodes was derived from several sources:

(a)                  participants ("Participants"):

(i)                    Canadian Film Development Corporation ("Telefilm") ($385,000);

(ii)                  Shaw Communications Inc. (doing business as "Shaw Children's Programming Initiative" and referred to as "Shaw") ($95,000);

(iii)                 YTV Canada, Inc. ("YTV") ($40,000);

(b)                  licencing and other fees:

(i)                    YTV ($265,042);

(ii)                  Cable Production Fund ($176,694);

(c)                  three private persons (the "Investors"):

(i)                    Everything But The Kitchen, Inc. ("EBTK") ($10,000);

(ii)                  William John Murtagh ($10,000);

(iii)                 Lillyann Goldstein ($95,000);

(d)                  producer amounts ("Producers"):

(i)                    Radical Sheep Productions Inc. ("Radical Sheep") ($361.33);

(ii)                  Owl Television Inc. ("Owl") ($180.67); and

(e)                  distribution advances from Hollywood Ventures ($308,000).

[5]            A Canadian film or video production tax credit may, by virtue of subsection 125.4(3), be claimed by a "qualified corporation" in respect of a Canadian film or video production and is equal to 25 per cent of the corporation's "qualified labour expenditure" for the year in respect of the production.[2]

[6]            However, according to subsection 125.4(4)[3], a Canadian film or video product tax credit is not available:

... where an investor, or a partnership in which an investor has an interest, directly or indirectly, may deduct an amount in respect of the production in computing its income for any taxation year.

... à la production cinématographique ou magnétoscopique canadienne à l'égard de laquelle un investisseur, ou une société de personnes dans laquelle un investisseur a une participation directe ou indirecte, peut déduire un montant relativement à la production dans le calcul de son revenu pour une année d'imposition.

[7]            The parties agree that Big Comfy is a qualified corporation that incurred a qualified labour expenditure and filed with its 1996 tax return a video production certificate in respect of its video production and other information on prescribed forms required by subsection 125.4(3).

[8]            The issue before me is whether EBTK, Mr. Murtagh and Ms. Goldstein, the Investors, have a degree of ownership in Series IV so that they may deduct an amount - for example, capital cost allowance ("CCA") - in respect of the production of Series IV in computing income. If so, the appellant is precluded from claiming the tax credit.

[9]            The appellant states that at no material time did any of the Investors own any copyright or distribution rights in Series IV and therefore the Investors had no right of ownership in the film or video production and could not deduct any amount in respect of Series IV.

[10]          Each of the Investors entered into a separate Investment Agreement, dated July 11, 1995, with the appellant and Nestor Productions Inc.[4], under which the Investor contributed or loaned funds to the appellant to be used by the appellant to produce Series IV episodes ("Agreement"). The Investors were entitled to recover (recoup) their contribution from the net revenues, as that term is defined in the Investment Agreements, of the production out of what is called the "first-tier recoupment". The Producers and Participants were also entitled to receive a partial return of their contributions, approximately 10.46 per cent of their contribution. Once the Investors were fully reimbursed and the Participants and Producers recouped a portion of their contributions, the Participants and Producers were entitled to further payments out of net revenues. Thereafter each Investor, Participant and Producer was entitled to receive on a pro-rata, pari-passu basis or share in 50 per cent of the net revenues. The remaining 50 per cent belonged to Big Comfy.

[11]          As at December 31, 2001, the Investors received a return equal to 100 per cent of their investments.

[12]          In each Investment Agreement, the Investor appointed the appellant as its exclusive agent for the "purposes of exploiting the interest acquired" by the Investor.

[13]          The Investment Agreements between the Investors and Big Comfy differed from the agreements the appellant had with each of Telefilm and Shaw. In the latter agreements, the appellant granted Telefilm and Shaw undivided copyright ownership interests in all versions of the production and in all subsidiary rights and works owned or controlled by the appellant. In the agreement with YTV, the appellant granted YTV the first right to exhibit the episodes but the appellant retained ownership. There is no apparent transfer of ownership rights in the Investment Agreements between the appellant and each Investor. Each of these agreements state the contributor "agrees to advance to the producer, as an investment in Series IV, . . ." the amount of their respective investments.

[14]          Big Comfy received financial assistance from the Ontario Film Development Corporation ("OFDC"), an agency of the Ontario government. The purpose of the OFDC is to contribute to Ontario's culture by developing policies and providing programs, among other things, to stimulate the independent film and television industry in Ontario. One of the programs is the Ontario Film Investment Program ("OFIP") which provides cash rebates to eligible investors for Canadian-content film and television production independently produced in Ontario and distributed domestically by Ontario based theatrical distributors or broadcast in Ontario.

[15]          Each of the Investors and Big Comfy was an eligible investor in the production within the meaning of that term in the OFDC Guidelines, dated April 1, 1995, respecting the OFIP.

[16]          According to paragraph C.a) of page 10 of the Guidelines of the OFIP, effective April 1, 1995 an OFIP rebate is calculated as a percentage of the 'Eligible Investment Amount', as defined:

For the purposes of these Guidelines, the Eligible Investment Amount means the amount invested by any investor (including the producer and production entity) to purchase an ownership interest in an Eligible Production or in its copyright . . .

The OFDC determined that $678,584 was the Eligible Investment Amount with respect to the episodes produced by the appellant.

[17]          In 1996, each of the Investors and Big Comfy received a rebate from the OFDC with respect to their investment in the production, as follows:

                                                EBTK                                                                              $1,800

                                                W.J. Murtagh                                                                $1,800

                                                L. Goldstein                                                                  $17,100

                                                Big Comfy                                                                  $101,445

[18]          Mr. John Leitch, President of Radical Sheep, which has a 50 per cent interest in the appellant, testified that the OFDC "gave up its position" requiring an investor "to purchase an ownership interest" in a production due to "backlash" from producers. The OFDC's position at the time the Investors invested in the Series IV episodes, Mr. Leitch stated, was that investors "had to have money at risk".

[19]          Each of the Investors is an investor, within the meaning of subsection 125.4(1) of the Act, since each was a person, other than a prescribed person, who is not actively engaged on a regular, continuous and substantial basis in a business carried on through a permanent establishment in Canada that is a Canadian film or video production business.

[20]          The Canadian Audio-Visual Certification Office ("CAVCO") of the Government of Canada issued a Canadian film or video certificate within the meaning of subsection 125.4(1) of the Act to Big Comfy on April 11, 1997 estimating the amount for determining its qualified labour expenditure for 1996 in respect of the production as $ NIL.

[21]          Mr. David Weisdorf is a chartered accountant who prepared Big Comfy's tax returns since 1993. The appellant's balance sheet as at March 31, 1996 reflects as a liability, advances of $155,542 representing the contributions from the three Investors as well as YTV (of $40,000), Radical Sheep (of $362) and Owl ($180). (The appellant originally recorded the amount of $155,542 as income but was adjusted to a liability).

[22]          In any event, when distributions of net profits were made to the Investors, the distributions were not treated by the appellant as repayments or reductions of loans. Mr. Weisdorf was asked by respondent's counsel whether, in the case of a loan, if a borrower repays the loan should the principal amount of the loan not be reduced. Mr. Weisdorf replied: "In certain cases". When the appellant repaid the principal amount of the loans from the contributors, counsel suggested, it is an accurate reflection to reduce the amount of the loan payable. Mr. Weisdorf acknowledged that that "is one way to record the transaction". The most accurate way to record the transaction is to reduce the capital of the loan so there is no excess above that portion of the amount of the loan that has been distributed.

[23]          In the view of Big Comfy's counsel, the sum advanced by the Investors "would be an amount paid to acquire rights to certain amounts, and that would be a recoupment of the investment, plus an interest in the profits". Counsel states that "it may well be property, but it is intangible property, and falls within no schedule of the CCA schedules contained in the regulations, and therefore, the investors would not be able to deduct any CCA with respect to their investment". Even though the investment may not be a loan, it is still not an acquisition of ownership of any asset that is depreciable property.

[24]          The amounts advanced by the Investors were treated as liabilities on the financial statements of Big Comfy. If the money had been advanced as consideration for an interest in, or a portion of, the copyright to the series (whether a legal or beneficial interest) the amounts would not have been treated as liabilities, appellant's counsel stated. The amounts advanced to the appellant by Telefilm and Shaw for assignment of copyright were not treated as liabilities on the financial statements. The Telefilm and Shaw agreements also indicate that GST is chargeable on the transfer of copyright, while the agreements with the Investors do not contain this provision. Further, if the amounts advanced by the Investors were for consideration of a transfer of copyright, whether it was a legal transfer or an equitable interest, the aggregate amount of $115,000 that they advanced would have been deducted from the balance of the undepreciated capital cost of the production and this was not done, Mr. Weisdorf did not purport to make this adjustment.

[25]          Counsel for the appellant referred to the Canadian Customs and Revenue Agency ("CCRA") Interpretation Bulletin IT-441, Capital Cost Allowance - Certified feature productions and certified short productions. The Bulletin states that to qualify for capital cost allowance an investor must beneficially hold an undivided proprietary interest, whether alone or jointly with other persons, in all the components of the film or tape property and not merely an interest in some elements thereof. The Bulletin lists elements of a property which the investor must acquire to establish ownership, one of which is copyright.

[26]          Subsection 13(4) of the Copyright Act requires that, to be valid, any assignment of copyright must be in writing and signed by the owner of the right. Counsel for the appellant noted that while the Investment Agreements between the Investors and the appellant are in writing, there is no clear statement in the Agreements to assign any portion of copyright to the Investors and the Agreements, in and by themselves, therefore, are not capable of transferring a copyright interest.

[27]          In Canada Deposit Insurance Corp. v. Canadian Commercial Bank ("CDIC")[5], Iacobucci J. found that if a transaction contains features of both debt and equity, an effort must be made to determine the true "substance" of the relationship between the parties:

As I see it, the fact that the transaction contains both debt and equity features does not, in itself, pose an insurmountable obstacle to characterizing the advance of $255 million. Instead of trying to pigeonhole the entire agreement between the Participants and CCB in one of two categories, I see nothing wrong in recognizing the arrangement for what it is, namely, one of a hybrid nature, combining elements of both debt and equity but which, in substance, reflects a debtor-creditor relationship. Financial and capital markets have been most creative in the variety of investments and securities that have been fashioned to meet the needs and interests of those who participate in those markets. It is not because an agreement has certain equity features that a court must either ignore these features as if they did not exist or characterize the transaction on the whole as an investment. There is an alternative. It is permissible, and often required, or desirable, for debt and equity to co-exist in a given financial transaction without altering the substance of the agreement. Furthermore, it does not follow that each and every aspect of such an agreement must be given the exact same weight when addressing a characterization issue. Again, it is not because there are equity features that it is necessarily an investment in capital. This is particularly true when, as here, the equity features are nothing more than supplementary to and not definitive of the essence of the transaction. When a court is searching for the substance of a particular transaction, it should not too easily be distracted by aspects which are, in reality, only incidental or secondary in nature to the main thrust of the agreement.[6]

[28]          The Agreements between the Investors and Big Comfy appear to be hybrid in character. This duality is demonstrated through the conflicting results obtained when contrasting the statement that the investors retain the appellant as their "exclusive agent and nominee for the purposes of exploiting [their] interest" with the glaring absence of any transfer of copyright interest to the investors. That the contradictory nature of the Agreement appears to have arisen more from a clumsiness in drafting rather than a "creativity" in fashioning the Agreements to meet the various needs of the parties, as envisioned by Justice Iacobucci, does not change the reality of the incompatible provisions. I must determine the true substance of the relationship between the Investors and the appellant.

[29]          Justice Iacobucci further stated in CDIC that:

As in any case involving contractual interpretation, the characterization issue facing this Court must be decided by determining the intention of the parties to the support agreements. This task, perplexing as it sometimes proves to be, depends primarily on the meaning of the words chosen by the parties to reflect their intention. When the words alone are insufficient to reach a conclusion as to the true nature of the agreement, or when outside support for a particular characterization is required, a consideration of admissible surrounding circumstances may be appropriate.[7]

[30]          The intentions of the parties to the Investment Agreements may not be gleaned solely from the words chosen to be included in the agreements. The Agreements attempt to retain the appellant as the Investors' agent to exploit their "interest", while at the same time the Agreements do not transfer or assign any interest to the Investors that could be exploited. Further, if the Investment Agreements did transfer an ownership interest to the Investors, as the respondent asserts, this would probably have created a partnership, a relationship which is specifically denied in the Agreements. Of course, a declaration in an agreement that a relationship is not a partnership does not preclude me from determining that in substance the relationship is just that. However, it does present inconsistent interpretations of the intentions of the parties as demonstrated through the meaning of the words chosen by them. It is difficult, therefore, if not impossible, to gain an accurate understanding of the intentions of the parties purely through an interpretation of the words contained in the agreements. I believe that in the circumstance it is appropriate for me to consider surrounding circumstances and look to the larger picture of what relationship the parties to the Investment Agreements were intending to create.

[31]          As I have already stated, the issue in this case is not whether the investors entered into a loan agreement with the appellant and a debtor/creditor relationship exists. The issue is whether the appellant intended to transfer an ownership interest in a certain asset to the investors, by virtue of which they would be entitled to deduct an amount in respect of the production in computing income, by claiming capital cost allowance or some other deduction, or whether they intended to create a relationship in which no ownership in the production was transferred. Big Comfy did not intend to transfer ownership to the Investors and the Investors did not intend to acquire an ownership interest. The appellant and the Investors did not create agreements that were capable of doing so.

[32]          In assessing intentions of the parties and the true nature of a relationship established by an agreement that is hybrid in character it is important to decide the weight that should be afforded to the conflicting aspects of the agreement. In CDIC, Iacobucci J. noted that:

[t]he weight to be given one aspect of the support agreements over another in assessing the true intention of the parties. . .

was the primary factor that underlaid the differing characterizations of the transaction by the chambers judge and the Alberta Court of Appeal.[8]

[33]          The respondent argues that the Investors' acquired incidents of title in the form of use and risk. Respondent's counsel referred to M.N.R. v. Wardean Drilling Ltd.[9] for the proposition that property is legally acquired when normal incidents of title, possession, use and risk are acquired. Counsel suggested that the Investors acquired an ownership interest in Series IV since they acquired the use of an asset and the risk associated with it. For example, a production is used by those who own it through generating revenues by negotiating distribution and merchandising agreements. Counsel is of the view that the agreements between the Investors and the appellant contemplate the Investors' participation in this use. His analysis of the investors' right to "use" the asset is largely tied to the clause in the agreement stating that the investors appointed the appellant as their "exclusive agent and nominee for the purposes of exploiting [their] interest". The "interest" referred to in the agreements, counsel declared, is not the contractual right to a stream of returns of revenues or this type of contractual right need not be exploited. The "interest", he asserts, is the right to participate in the exploitation of the production, the participation in the use of an asset. I place little weight on this appointment provision. As I have noted, the Agreements do not assign any interest to the Investors that is capable of being exploited and, in contrast to agreements entered into by the appellant with Telefilm and Shaw, for example, it does not assign to the Investors any right in copyright. The Agreements do not give the Investors an interest in rights to distribute, copy, license or in any way control the use of the production. In effect, it may be said that the Agreements attempt to assign a right to exploit an interest without assigning the interest itself. The respondent appears to argue that the clause in the Agreements attempting to assign to the investors a right to exploit a non-existent interest is indicia of the investors' right to use the asset. This "use" is an incident of ownership and establishes the investors' beneficial ownership of the production and in copyright. The beneficial ownership thereby creates the interest that may be exploited. This, to my mind, is circular logic.

[34]          In CDIC, among other things, agreements limited the Investor's return to the amount of capital invested plus interest. Respondent's counsel suggested that Iacobucci J. concluded that the true nature of the agreements was one of debt rather than an investment of capital because the investor could not receive more than he invested, plus interest. Counsel reasoned that where there is a maximum amount, a limit, to the Investor's return from his contribution, the investor does not participate in the fortunes that may result from the use of the asset. On the other hand where there is no limit, then the investor has an unfettered use of the asset subject to the extent of the Investor's proportionate ownership.

[35]          The respondent therefore argued that the Investors' unfettered right to share in a percentage of profits after the recoupment of the principal amount invested is a further indication of the Investors' right to use the asset.[10] Earlier in submissions, however, respondent's counsel described the use of a production as the ability to "generate revenues by negotiating distribution and merchandising agreements". The Investors are entitled to share in the revenues of the production but they do not have any right in directing the use of the production to generate those revenues. Further, it was very unlikely that the Investors would ever realize on this interest to a share of profit. While this does not change the character of the interest, it does dictate how much weight should be placed on the consideration of its importance in determining the true substance of the agreement. This, again, is illustrated through comments by Iacobucci J. in CDIC.

. . . It is also true, at least in theory, that by fully exercising their warrants the Participants would own 75 percent of the common shares issued by CCB. However, it is evident on the face of the record that this possibility was not only a mere hypothesis, but it was unlikely to occur. . . . Undoubtedly, the warrants are an equity feature of the transaction supporting a conclusion that the advance was an investment. However, in the facts of this case, only minimal weight should be given to this factor in the overall characterization of the agreement.[11]

[36]          While the entitlement to share in profits is indicative of some measure of the Investors' right to use the asset, the connection is tenuous as the Investors do not have any right to direct the use of the asset and that little weight should be placed on this aspect.

[37]          Respondent's counsel further argued that the sum contributed by the Investors was linked directly to the asset, Series IV episodes, rather than tied to the business of the Big Comfy as a whole. By making the Series IV episodes, the production, the object of the investment and repayment, counsel suggests that the Investors shared in the risk that Series IV would not be profitable. Counsel suggests that the Investors recognized their risk since the Investment Agreements require the appellant to provide insurance, including a completion guarantee, naming the Investors as beneficiaries. This sharing of risk, counsel submits, is indicative of an incident of ownership. Again I would place little weight on this aspect. The Investors' risk was strictly limited to the amount of their investment. While the object of the investment was the production of Series IV, the Investors were not exposed to any claims by creditors of the series beyond the amount of their original investment. For example, suppliers, employees and actors could not look to the investors for satisfaction of their claims if the production failed. Respondent's counsel appears to argue that since the Investors had incidents of ownership, they became beneficial owners of the production and unwittingly entered into a partnership with the owners. As the Investors were in substance beneficial owners, they would be exposed to the same risk as the appellant with regards to the production. The creditors, therefore would be entitled to look to the Investors for payment. This, argues counsel, demonstrates that the investors acquired a normal incident of ownership, being risk. Again, I find the rationale that the conclusion of the analysis (finding that the investors acquired beneficial ownership in the production) somehow expands the original basis for the determination (that the investors acquired incidents of ownership) to be circular logic.

[38]          The Agreements featured aspects of both debt and equity. The Agreements did not, however, assign any right in copyright to the Investors, nor did they transfer outright any interest in ownership, beneficial or otherwise. At no time did the Investors attempt to take a deduction in relation to the production. The sums advanced by the Investors were treated as liabilities on the books of the appellant. As a whole, the Investment Agreements and the surrounding circumstances indicate that both the Investors and the appellant did not intend the Agreements to transfer interests in ownership. The able submissions of respondent's counsel do demonstrate features of the relationship which could be held to demonstrate certain incidents of ownership held by the Investors. I do not believe, however, in light of the above analysis that much weight should be attributed to these aspects of the Investment Agreements. The relationship between the appellant and the Investors was not a partnership and the Investors did not obtain any interest in the ownership of the production. The Investors, therefore, were not entitled to a deduction "in respect of" the production and the appellant is not precluded by virtue of the exception found in subsection 125.4(4) from claiming the federal tax credit for a film or video production available under section 125.4 of the Act.

[39]          The appeal is allowed with costs.

Signed at Vancouver, British Columbia this 9th day of May 2002.

J.T.C.C.

COURT FILE NO.:                                                 1999-4643(IT)G

STYLE OF CAUSE:                                               Big Comfy Corp. and

Her Majesty the Queen

PLACE OF HEARING:                                         Toronto, Ontario

DATE OF HEARING:                                           March 20, 2002

REASONS FOR JUDGMENT BY:      The Hon. Judge Gerald J. Rip

DATE OF JUDGMENT:                                       May 9, 2002.

APPEARANCES:

Counsel for the appellant:                   Richard B. Thomas

Counsel for the respondent:                               Franco Calabrese

COUNSEL OF RECORD:

                For the appellant:

                                                Name:                      McMillan Binch

Barristers & Solicitors

                                                Firm:                                        Royal Bank Plaza

                                                                                                Suite 3800, South Tower

Toronto, Ontario M5J 2J7

For the respondent:                                              Morris Rosenberg

                                                                                                Deputy Attorney General of Canada

                                                                                                Ottawa,Canada

1999-4643(IT)G

BETWEEN:

BIG COMFY CORP.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeal heard on March 20, 2002 at Toronto, Ontario, by

the Honourable Judge Gerald J. Rip

Appearances

Counsel for the Appellant:                  Richard B. Thomas

Counsel for the Respondent:                              Franco Calabrese

JUDGMENT

The appeal from the assessment made under the Income Tax Act ("Act") for the 1996 taxation year is allowed with costs and the matter is referred back to the Minister of National Revenue for reassessment and reconsideration on the basis that the appellant is entitled to claim a federal tax credit for a film or video production in accordance with section 125.4 of the Act.

Signed at Vancouver, British Columbia, this 9th day of May 2002.

J.T.C.C.