BETWEEN:
and
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Appeals heard on December 4, 2006, at St. John's, Newfoundland.
Before: The Honourable Justice François Angers
Appearances:
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JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 2003 and 2004 taxation years are dismissed in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 13th day of March 2007.
"François Angers"
BETWEEN:
JANET M. GLYNN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
[1] The appellant is appealing a notice of reassessment dated September 29, 2005, in which the Minister of National Revenue (Minister) disallowed the claim of an allowable business investment loss (ABIL) for the appellant's 2004 taxation year and also denied the appellant's request to have the unused portion of the ABIL carried back to her 2003 taxation year.
[2] The appellant reported a total business investment loss (BIL) of $35,864 in relation to Thomas Oxford Inc. (TOI), of which $26,426 was claimed in 2004 at a 50% inclusion rate for an ABIL deduction of $13,213. The appellant requested an adjustment for her 2003 taxation year so that she could claim the remainder of the $35,864 BIL, namely $9,438, at the 50 % inclusion rate, for an ABIL of $4,719.
[3] TOI was incorporated on September 26, 1994. Its original name was National Wood Products Inc. (NWP). It became TOI on April 29, 1999. NWP was incorporated to produce and manufacture wood doors and other value-added wood products. To get NWP started, the appellant and her spouse loaned the company $19,467. It is agreed by the parties that the terms of the loan did not provide for a reasonable rate of return. The appellant and her spouse also sold inventory to NWP on September 26, 1994, for $66,499. The inventory, as per the contract between NWP and the appellant's spouse, was sold on consignment and any unused inventory was to remain the property of the appellant's spouse. The evidence does not indicate whether all the inventory was used by NWP. It should be noted that the consignment agreement with NWP identifies the appellant's spouse as the only other party to the agreement. His evidence, though, is that he and the appellant worked as a team and both owned the inventory. The respondent relied on that fact in her reply to the notice of appeal.
[4] NWP ceased its manufacturing operations during the summer months of 1998 and sold its remaining inventory and raw materials. The following spring, the appellant's husband transferred to NWP title to a house that he had inherited from his mother, his intent being to set up a bed-and-breakfast business; NWP became TOI on April 29, 1999, for that purpose.
[5] TOI provided rental accommodations from 1999 to 2004 and reported rental revenues of $2,424, $8,076, $13,505, $12,600, $2,700 and nil respectively for those years. TOI reported no other source of revenue for the years at issue. The rental revenues were not generated from the operation of a bed-and-breakfast by TOI but from renting the house it acquired. The bed-and-breakfast business never materialized because of a change in parental responsibilities for the appellant and her spouse, and TOI ceased operating on November 23, 2004, as evidenced by a Certificate of Dissolution from the Government of Newfoundland and Labradordated December 21, 2004.
[6] The only assumption of fact in the respondent's reply to the notice of appeal that the appellant denies is that her spouse was the sole shareholder of TOI. No corporate documents, minutes books, share ledger or other such documents were produced at trial. A financial statement for TOI that was attached to its tax return for its 2004 taxation year indicates that the appellant's spouse owned all the shares in TOI. A notice of change of directors dated June 12, 2003, indicates that the appellant and her spouse became directors on December 31, 2002, and that Annette Glynn ceased to be a director on that date.
[7] The appellant's spouse testified that, on the incorporation of NWP, his two daughters were the shareholders but that it was he and his wife who had incorporated the company. His brother, two daughters and he were the directors. His brother eventually left and the appellant became a director. The appellant's spouse also acknowledged that TOI's tax returns for 2003 and 2004 indicate that he was the only shareholder, but he added that the tax return preparer must have assumed that to be the case. He corroborated the appellant's evidence that the intent, upon transferring the house, was to set up a bed-and-breakfast business and not a rental business. The rent TOI collected was to be used to service its debts with the bank.
[8] The annual return of TOI for the year 2002 describes TOI's main type of business as that of a holding company. No other annual returns were produced.
[9] The following are the relevant provisions of the Income Tax Act (Act):
38. Taxable capital gain and allowable capital loss
For the purposes of this Act,
(a) subject to paragraphs (a.1) and (a.2), a taxpayer's taxable capital gain for a taxation year from the disposition of any property is 1/2 of the taxpayer's capital gain for the year from the disposition of the property;
(a.1) a taxpayer's (taxable capital gain for a taxation year from the disposition of any property is 1/4 of the taxpayer's capital gain for the year from the disposition of the property if
(i) the disposition is the making of a gift to a qualified donee (as defined in subsection 149.(1)), other than a private foundation, of a share, debt obligation or right listed on a prescribed stock exchange, a share of the capital stock of a mutual fund corporation, a unit of a mutual fund trust, an interest in a related segregated fund trust (within the meaning assigned by paragraph 138.1(1)(a)) or a prescribed debt obligation, or
(ii) the disposition is deemed by section 70 to have occurred and the taxpayer is deemed by subsection 118.1(5) to have made a gift described in subparagraph (i) of the property;
(a.2) a taxpayer's taxable capital gain for a taxation year from the disposition of a property is ¼ of the taxpayer's capital gain for the year from the disposition of the property where
(i) the disposition is the making of a gift to a qualified donee (other than a private foundation) of a property described in respect of the taxpayer, in paragraph 110.1(1)(d) or in the definition "total ecological gifts" in subsection 118.1(1), or
(ii) the disposition is deemed by section 70 to have occurred and the taxpayer is deemed by subsection 118.1(5) to have made a gift described in subparagraph (i) of the property;
(b) a taxpayer's allowable capital loss for a taxation year from the disposition of any property is 1/2 of the taxpayer's capital loss for the year from the disposition of that property; and
(c) a taxable allowable business investment loss for a taxation year from the disposition of any property is 1/2 of the taxpayer's business investment loss for the year from the disposition of that property.
39.(1) Meaning of capital gain and capital loss
For the purposes of this Act,
. . .
(c) a taxpayer's business investment loss for a taxation year from the disposition of any property is the amount, if any, by which the taxpayer's capital loss for the year from a disposition after 1977
(i) to which subsection 50(1) applies, or,
(ii) to a person with whom the taxpayer was dealing at arm's length
of any property that is
(iii) a share of the capital stock of a small business corporation, or
(iv) a debt owing to the taxpayer by a Canadian-controlled private corporation (other than, where the taxpayer is a corporation, a debt owing to it by a corporation with which it does not deal at arm's length) that is
(A) a small business corporation,
(B) a bankrupt (within the meaning assigned by subsection 128(3)) that was a small business corporation at the time it last became a bankrupt, or
(C) a corporation referred to in section 6 of the Winding-up Act that was insolvent (within the meaning of that Act) and was a small business corporation at the time a winding-up order under that Act was made in respect of the corporation,
exceeds the total of
(v) in the case of a share referred to in subparagraph (iii), the amount, if any, of the increase after 1977 by virtue of the application of subsection 85(4) in the adjusted cost base to the taxpayer of the share or of any share (in this subparagraph referred to as a "replaced share") for which the share or a replaced share was substituted or exchanged,
(vi) in the case of a share referred to in subparagraph (iii) that was issued before 1972 or a share (in this subparagraph and subparagraph (vii) referred to as a "substituted share") that was substituted or exchanged for such a share or for a substituted share, the total of all amounts each of which is an amount received after 1971 and before or on the disposition of the share or an amount receivable at the time of such a disposition by
(A) the taxpayer,
(B) where the taxpayer is an individual, the taxpayer's spouse or common-law partner, or
(C) a trust of which the taxpayer or the taxpayer's spouse or common-law partner was a beneficiary
as a taxable dividend on the share or on any other share in respect of which it is a substituted share, except that this subparagraph shall not apply in respect of a share or substituted share that was acquired after 1971 from a person with whom the taxpayer was dealing at arm's length,
(vii) in the case of a share to which subparagraph (vi) applies and where the taxpayer is a trust referred to in paragraph 104(4)(a), the total of all amounts each of which is an amount received after 1971 or receivable at the time of the disposition by the settlor (within the meaning assigned by subsection 108(1)) or by the settlor's spouse or common-law partner as a taxable dividend on the share or on any other share in respect of which it is a substituted share, and
(viii) the amount determined in respect of the taxpayer under subsection (9) or (10), as the case may be.
50(1) Debts established to be bad debts and shares of bankrupt corporation. For the purposes of this subdivision, where
(a) a debt owing to a taxpayer at the end of a taxation year (other than a debt owing to the taxpayer in respect of the disposition of personal-use property) is established by the taxpayer to have become a bad debt in the year, or
(b) a share (other than a share received by a taxpayer as consideration in respect of the disposition of personal-use property) of the capital stock of a corporation is owned by the taxpayer at the end of a taxation year and
(i) the corporation has during the year become a bankrupt (within the meaning of subsection 128(3)),
(ii) the corporation is a corporation referred to in section 6 of the Winding-up Act that is insolvent (within the meaning of that Act) and in respect of which a winding-up order under that Act has been made in the year, or
(iii) at the end of the year,
(A) the corporation is insolvent,
(B) neither the corporation nor a corporation controlled by it carries on business,
(C) the fair market value of the share is nil, and
(D) it is reasonable to expect that the corporation will be dissolved or wound up and will not commence to carry on business
and the taxpayer elects in the taxpayer's return of income for the year to have this subsection apply in respect of the debt or the share, as the case may be, the taxpayer shall be deemed to have disposed of the debt or the share, as the case may be, at the end of the year for proceeds equal to nil and to have reacquired it immediately after the end of the year at a cost equal to nil.
125(7) Definitions - In this section
"specified investment business" carried on by a corporation in a taxation year means a business (other than a business carried on by a credit union or a business of leasing property other than real property) the principal purpose of which is to derive income (including interest, dividends, rents and royalties) from property but, except where the corporation was a prescribed labour-sponsored venture capital corporation at any time in the year, does not include a business carried on by the corporation in the year where
(a) the corporation employs in the business trough the year more than 5 full-time employees, or
(b) any other corporation associated with the corporation provides, in the course of carrying on an active business, managerial, administrative, financial, maintenance or other similar services to the corporation in the year and the corporation could reasonably be expected to require more than 5 full-time employees if those services had not been provided;
"active business carried on by a corporation" means any business carried on by the corporation other than a specified investment business or a personal services business and includes an adventure or concern in the nature of trade;
"Canadian-controlled private corporation" means a private corporation that is a Canadian corporation other than
(a) a corporation controlled, directly or indirectly in any manner whatever, by one or more non-resident persons, by one or more public corporations (other than a prescribed venture capital corporation), by one or more corporations described in paragraph (c), or by any combination of them,
(b) a corporation that would, if each share of the capital stock of a corporation that is owned by a non-resident person, by a public corporation (other than a prescribed venture capital corporation), or by a corporation described in paragraph (c) were owned by a particular person, be controlled by the particular, or
(c) a corporation a class of the shares of the capital stock of which is listed on a prescribed stock exchange;
248(1) Definitions - in this Act
"active business", in relation to any business carried on by a taxpayer resident in Canada, means any business carried on by the taxpayer other than a specified investment business or a personal services business;
"small business corporation", at any particular time, means, subject to subsection 110.6(15), a particular corporation that is a Canadian-controlled private corporation all or substantially all of the fair market value of the assets of which at that time is attributable to assets that are
(a) used principally in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it,
(b) shares of the capital stock or indebtedness of one or more small business corporations that are at that time connected with the particular corporation (within the meaning of subsection 186(4) on the assumption that the small business corporation is at that time a "payer corporation" within the meaning of that subsection), or. . . .
[10] In order for a taxpayer to deduct an ABIL the loss must arise from a debt owing to the taxpayer by a small business corporation or from the disposition of a share of a corporation that is a small business corporation. The respondent has refused the deduction in this case on the grounds that TOI was not a small business corporation as defined in both subsections 125(7) and 248(1) reproduced above.
[11] A small business corporation, as defined above, means a Canadian-controlled private corporation whose assets are used principally in an active business carried on primarily in Canada or whose assets consist of shares or debts of connected small business corporations, or a combination of both. For the purposes of determining a BIL, a corporation that was a small business corporation at any time in the 12 months before the disposition of shares or debt, as the case may be, will be considered to be a small business corporation.
[12] "Active business" and "active business carried on by a corporation" are defined above. They both exclude a specified investment business. A specified investment business is defined to be a business the principal purpose of which is to derive income from property. Such income includes, among other things, rent; there are exceptions having to do with a minimum number of full-time employees, but those exceptions, are not applicable to the case at bar.
[13] The expression "principal purpose" is not defined in the Act but is generally considered as being what the corporation actually does and what its source of income is. In Gill v. Minister of National Revenue, 98 DTC 2048, Judge Brulé reviewed as follows cases in which this term has been considered:
[27] The term "principal purpose" was judicially considered in Mayon Investments Inc. et al. v. M.N.R. [1991] 1 C.T.C. 2245, 91 DTC 364, where Brulé, T.C.J., stated at page 369, that with respect to the definition of "specified investment business" what is meant by "the principal purpose of which is to derive income from property" is ". . . when the source of revenue, the nature of the assets held and the purpose of the corporation are to derive income from property, such as interest income.
[28] In Ed Sinclair Construction & Supplies Ltd. et al. v. M.N.R., [1992] 1 C.T.C. 2218, 92 DTC 1163, Bowman T.C.J., considered "principal purpose" in the context of a "specified investment business" as it related to the small business deduction. His Honour stated at page 1165 in the case of Ben Company Limited v. M.N.R., 89 DTC 242, which is set out at page 244:
In determining the "principal purpose" of a business carried on by a corporation the stated object of the person who carries it on is not necessarily the only, or even the most important, criterion. Of critical importance is what the corporation in fact does and what its sources of income are.
[29] The term "principal purpose" has also been considered in the tax literature. In a cited article by David Phillip Jones, in Reflections on Integration: The Modified Small Business Deduction, Nonqualifying Businesses, Specified Investment Income, Corporate Partnership, and Personal Service Corporations (1982) 30 Can. Tax J. 1 at 5, the author comments on the purpose of the "specified investment income" amendment. At page 5 of his article, Mr. Jones states:
In a series of cases, however, the courts effectively eliminated the idea of passive business and held that virtually any business constituted an active business. The purpose of the "specified investment income" amendment, therefore, was to make certain that income from the business of renting property did not generally constitute active business income, but rather was assimilated to investment income, thereby effectively reversing the jurisprudence on this point.
[14] In paragraph 14 of Interpretation Bulletin IT-73R6 dated March 25, 2002, it is suggested that the principal purpose of a corporation's business must be determined annually after all the facts relating to that business carried on by that corporation in that year have been considered and analyzed. The factors to be taken into account in making the determination include the purpose for which the business was originally commenced, the business's history and evolution, including changes in its mode of operation and purpose of existence, and the manner in which the business is conducted.
[15] TOI was an active business as defined in the Act until it ceased operating in 1999. A year later, it intended to open a bed-and-breakfast business but this never materialized. The activities that it carried on after 1999 were totally different from those carried on before or those it intended to carry on. Its purpose of existence for the following five years, as well as its only source of income, was to carrying on of a rental business. Such were TOI's objects as well as its only source of income. TOI, in my opinion, was a "specified investment business" and therefore not a small business corporation as defined in the Act.
[16] The appeals are therefore dismissed.
Signed at Ottawa, Canada, this 13th day of March 2007.
"François Angers"
Angers, J.
COURT FILE NO.: 2006-1748(IT)I
STYLE OF CAUSE: Janet M. Glynn v. Her Majesty the Queen
PLACE OF HEARING: St. John's, Newfoundland
DATE OF HEARING: December 4, 2006
REASONS FOR JUDGMENT BY: The Honourable Justice François Angers
DATE OF JUDGMENT: March 13, 2007
APPEARANCES:
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For the Appellant: |
The Appellant herself |
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Counsel for the Respondent: |
Martin Hickey |
COUNSEL OF RECORD:
Firm:
For the Respondent: John H. Sims, Q.C.
Deputy Attorney General of Canada
Ottawa, Canada