E.H. Price Limited v. Minister of National Revenue, 91 DTC 135, [1991] 1 CTC 2045 (TCC)

Taylor, T.C.J.:—These are appeals heard in Winnipeg, Manitoba, on September 14, 1990, against income tax assessments for the years 1983, 1984 and 1985 in which the Minister of National Revenue imputed interest income to the appellant under section 17 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act"). The notice of appeal reads in part as follows:

The Taxpayer formed an affiliated company, which ended up as Brickell Enterprises Ltd. (“Brickell”), in Hong Kong in association with Dunn Air Conditioning of Australia ("Dacal" or "Dunn") in 1982. Each participant invested capital money in such entity to start up and fund its business operations (copy of Agreement of Intent dated February 7, 1983 attached).* The first use of these funds was to purchase all shares of an existing business in Hong Kong, Dunn Air Conditioning Asia Ltd., which was a sales organization. Price had day to day operational and management control of Brickell Enterprises Ltd. and initially provided all product sold by that Company and its subsidiaries in South East Asia.

Hong Kong law not permitting a Hong Kong company to buy back its own shares and the participants wishing to keep their options open, as to eventual return of capital and not wishing the permanent locking-in of the capital advanced, such advances were set up by way of shareholders advances.

The Taxpayer made various remittances of investment money to this affiliated company in Hong Kong in 1983 (Paragraph 3 of Agreement)* and these sums were reflected on the books of the Taxpayer as an investment.

*Exhibit A-2—referenced later—significant parts quoted.

At the time the moneys were remitted, the Hong Kong company was a noncontrolled foreign affiliate of the Taxpayer. The Hong Kong company remitted the funds to Price Asia Manufacturing (Pamco"), a wholly owned subsidiary Singapore company which eventually commenced manufacturing, with sole E.H. Price Limited know-how and expertise, for South East Asia the same Titus products manufactured and sold by the Taxpayer in North America.

The Minister has added to the Taxpayer's income pursuant to subsection 17(1) of the Income Tax Act, deemed interest of $36,205 in 1983, $55,523 in 1984 and $52,793 in 1985.

For the respondent, the assumptions of fact were:

— at all material times, the appellant was a duly incorporated corporation resident in Canada;

— at all material times, Brickell Investments Ltd. (Brickell") was a non-resident person;

— in the 1983 taxation year the appellant loaned Brickell the amount of $503,123.27 in total;

— as at the end of the 1985 taxation year, the full amount of the loan of $503,123.27 remained outstanding and unpaid;

— no interest on the loan was included by the appellant in computing its income for the 1983, 1984 or 1985 taxation years;

— the appellant was deemed to have received the amounts of $36,205 in 1983, $55,523 in 1984 and $52,793.00 in 1985 in accordance with the provisions of subsection 17(1) of the Act;

— Brickell was at no material time a subsidiary controlled corporation of the appellant.

The essentials of the position put forward by the appellant were:

— The object and spirit of Section 17 is to prevent a corporation that is resident in Canada from employing capital abroad by way of a non-interest bearing loan so as to avoid Canadian Income Tax on profits derived therefrom but accruing to the benefit of non-resident purposes. Section 17 is aimed at transactions that are not at arm's length such as those between a Canadian subsidiary and a noncontrolled foreign parent contrived for purpose of applying the income to the non-resident rather than to the Canadian Corporation.

— The advances were not set up as loans in the books of E.H. Price Ltd., the Taxpayer.

— It is the Taxpayer's view that this deemed interest should not be imputed for the years being reviewed.

— The advances were not loans in the ordinary sense in that the recipient never signed any loan agreements nor did it provide any signed promissory notes.

— The amounts invested have always represented a long term investment by the Taxpayer and the funds used for the manufacturing and sales business of Brickell Enterprises Ltd. As a result these funds have been set up as a type of equity investment as opposed to a loan receivable. The Taxpayer's position has been one of an investor and not a creditor.

— If the amounts advanced were a loan, they would have been of questionable value in each, of the years under review and generally accepted accounting practices would have required write-offs reducing the accrued value of such loans. Further, if interest had been charged and accrued for each year, same would have been written off as uncollectible, which has the effect of reducing the return to zero.

— In the alternative, the Taxpayer submits that as it acquired control of Brickell Enterprises Ltd. in 1985, it should be entitled to the benefits of Section 17(3), which exempts the provisions of Section 17(1) with respect to the imputing of interest.

The respondent noted:

The Respondent relies, inter alia, upon the provisions of sections 3, 9, 17 and 248(1) of the Income Tax Act, R.S.C. 1952, c. 148 as amended and Regulation XLIII of the Income Tax Regulations, C.R.C., 1978, c. 945, as amended.

In my view, the evidence failed to leave available to the appellant the alternative argument above—that Brickell had been acquired in 1985 by the appellant, and accordingly the thrust of this decision will deal with the direct issue of whether the interest amounts involved were properly assessed under subsection 17(1) of the Act as it read for the years 1983, 1984 and up until October 29, 1985 when the section was slightly amended. No issue was raised at the hearing with regard to the 1985 amendments, and accordingly I shall deal only with the terminology which follows from the 1983 Act:

Where a corporation resident in Canada has loaned money to a non-resident person and the loan has remained outstanding for one year or longer without interest at a reasonable rate having been included in computing the lender's income, interest thereon, computed at a prescribed rate per annum for the taxation year or part of the year during which the loan was outstanding, shall, for the purpose of computing the lender's income, be deemed to have been received by the lender on the last day of each taxation year during all or part of which the loan has been outstanding.

The point in dispute, as I comprehend it, is whether it can be said that “the corporation has loaned money to a non-resident person . . .” (see subsection 17(1) above).

In evidence and testimony, the appellant through its president, Mr. G.D. Price, provided the Court with details regarding the efforts to establish its operations in Asia, including the financing arrangements referenced in both the notice of appeal and the reply to notice of appeal, supra. An agreement had been reached between Price (this appellant) and a Mr. Robert Riddell Dunn of Australia (representing his own company earlier in these reasons called "Dacal", or "Dunn"), and a Mr. Robert Ross Scown (Scown") of Hong Kong to formalize these efforts (Exhibit A-2). Scown was a minor shareholder andparticipant, in fact was out of the venture at a fairly early stage. The real actors soon became Price and Dacal, with Price for all intents and purposes the source of financing. Price rapidly became also the source of expertise, not only in the manufacture of the product to be sold, but also in the field of sales and representation, an area originally expected to be filled by Dacal. In addition to Price (this appellant) Dacal and Brickell, Price did establish in Asia another corporation Price Asia Manufacturing Company C Pamco") which was intended to be the eastern manufacturing arm of the appellant. By virtue of the agreement between Price and Dacal, both Dacal and Pamco became one hundred per cent equity owned by Brickell. During the times material, however, Price did not have control of Brickell—accordingly it was not a subsidiary corporation to Price (see earlier comments).

From Exhibit A-2 (the agreement dated February 7, 1983), the following paragraphs have been extracted:

— Capitalization

It is contemplated that the joint enterprise will require an initial investment of approximately HK$6,000,000 Hong Kong Dollars, which amount other than enterprise borrowing, will be put up by the Parties hereto as set out on Schedule “A” attached hereto.*

If guarantees are required by any Lending Institution, such Guarantees will be on the basis of each Party guaranteeing his proportion of the Total in the same percentage as the equity ownership of such guaranteeing Party, with a maximum limit as unanimously agreed upon at that time.

Capital shall be agreed upon from time to time as required, with each of the Parties undertaking to be responsible to raise, either by direct investment or by guarantee of debt financing provided to the Company on terms approved by the Board of Directors, the appropriate percentage of the capital as it relates to the equity ownership of such Party, until the manufacturing operation is underway.

— Shareholder's Loans

Price and Dunn may make loans to the joint enterprise over and above their proportionate share of the agreed upon investment. In the event such advances or loans are made, the joint enterprise shall pay interest to the Party making the advance in such amounts as agreed upon by the Board of Directors. It shall also be agreed upon at that time as to the Security for the protection of such advance(s).

Schedule “A”

Hong Kong Holding Company Initial Capitalization (H.K. $)

	E.H. Price
	Limited	R.R. Dunn	R.R. Scown	Total
Shares
Common A—voting	225			225
Common B—voting		225		225
Common C—non-voting			50	50
Total shares	225	225	50	500
Shareholder^ Loans
— in proportion to equity	337,275	337,275	74,950	749,500
— additional loans by	2,625,000	2,625,000	—	5,250,000
Price & Dunn
Total loans	2,962,275	2,962,275	74,950	5,999,500
Total capitalization	2,962,500	2,962,500	75,000	6,000,000

Rob Scown’s total agreed contribution is $300,000 (HK) with an initial contribution of $75,000 (HK) and the balance is to be paid by retention of up to 50% of any bonuses payable to him.

The financial statements of the appellant at December 31, 1983, showed the following under Note (3)—Investments:

(b) Affiliated companies:

Brickell Enterprises Limited, foreign affiliate:

The company's equity in Brickell Enterprises Ltd. as reported in the audited financial statements of the affiliated company at June 30, 1983 is $32,042. Manage- ment estimates that the company's share of the operating loss for the six months ended December 31, 1983 is $130,000, and estimates that for the next six months ended June 30, 1984, operations will show a small profit.

225 Class A ordinary shares	42
Loan (Canadian dollar cost—$855,802)	784,818

The corresponding references for December 31, 1984 read:

I have made no particular attempt to reconcile these amounts year to year—but I am satisfied from the evidence provided by the appellant that they are in order. The important part, for this appeal, is the reference to the "ordinary shares . . . $42.00” and the various amounts shown as "loans". The particular identification given to these amounts in the financial statements is certainly not the deciding factor—they will be determined to be what they are, not what they are called—but it does provide the basis for the respondent's computation (above). Another critical piece of evidence was entered as Exhibit A-1, and detailed the build-up of the amounts at issue in this appeal, totalling $503,123.26* as follows:

E.H. Price Ltd. Investment in Brickell 1983 to 1986

			Amount DNR
		Amount	deems loans
Date	Source	(at cost)	for interest
1983
		(Cdn. $)	(Cdn. $)
Feb. 8/83	Funds tsf from Canada	280,050.00	280,008.00
	Portion for shares	(42.00)
Apr. 14/83	A/R owed Price
	tsf to Brickell	57,364.84	57,364.84
"' Shown as $503,123.27 in the reply to notice of appeal, supra.

Apr. 18/83	A/R owed Price
	tsf to Bricked	75,075.66	75,076.66
May 5/83	Misc. expenses converted	5,473.22	5,473.22
May 13/83	Tooling Charges
	from E.H. Price	58,930.51
May 18/83	A/R owed Price
	tsf to Bricked	17,551.41	17,551.41
June 1/83	A/R owed Price
	tsf to Bricked	67,650.13	67,650.13
July 13/83	Tooling costs owed Price	43,748.70
Dec. 31/83	A/R Paid converted	250,000.00
Balance Dec. 31/83		855,802.48	503,123.26
1984
March	to adjust A/R converted	(2,433.87)
Dec. 31/84	A/R owed Price by
	—converted to	122,962.49
	investment
Balance Dec. 31/84			976,331.29
1985
Transactions		nil
Balance Dec. 31/85			976,331.09
1986
Dec.	Funds tsf	79,844.00
Balance Dec. 31/86		1,056,175.09

Explanations were provided regarding the amounts which constitute the first column (above) called "Amount—at cost" which were not carried over to the second column entitled “Amounts D.N.R. deems loans for interest” (D.N.R. meaning Department of National Revenue). The explanations can be summarized as—

(1) the original funds advanced of $280,008 (not counting that of $42 for which shares were received) were regarded by D.N.R. as "investments" subject to the terms of subsection 17(1) of the Act;

(2) the balance of the amounts—$57,364.89, $75,075.66, $5,473.22, $7,551.41 and $67,650.13 referenced accounts receivable owing from Dacal (the company originally owned by Mr. Dunn) which amounts had resulted from product sales by Price to Dacal for the purpose of resale by Dacal in Asia;

(3) in general, the other amounts—not regarded as falling under the provisions of subsection 17(1) of the Act by D.N.R.—resulted from accounts receivable to Pamco.

I readily admit that I was not convinced that there was any substantive difference between the amounts receivable for Dacal and those for Pamco— both corporations were 100 per cent subsidiaries of Bricked, and both were used in serving the Asian market. However, this case deals only with those accounts receivable to Dacal which amounts were transferred to Bricked as part of the reorganization of the Asian operations, and by which eventually Price gained majority ownership and thereby control of Bricked from Dacal. According to the evidence, Mr. Dunn through Dacal had not been able to provide his share of the capital contribution as per the schedule forming part of Exhibit A-2 (above). In effect, Price by transferring the Dacal trade amounts to Bricked settled these outstanding unpaid capital contributions which Mr. Dunn had not been able to make. This understanding between Mr. Dunn (Dacal) and Price was finalized by an agreement dated December 13, 1985 (Exhibit R-2) which read in part:

— And Whereas Price and Dunn have advanced moneys by way of loans to Brickell and/or its subsidiaries;

— And Whereas it has been agreed between the Parties that payment of the Price trade accounts and intercompany accounts will have to be deferred for some time and that Debenture security is to be given therefor;

— And Whereas as a result of the deferment it has been agreed between the Parties that Price will become the registered holder of 70% of the issued shares of Brickell with Dunn holding the other 30% thereof.

— This Agreement is to supercede [sic] the Agreement between Price, Dunn and Robin Romer Scown, dated the 7th day of February, 1983 and such Agreement and the terms thereof are hereby suspended and substituted by the terms of the within Agreement.

— The Parties agree that a further 300 Class "A" Ordinary Shares of Brickell Enterprises Ltd. shall be issued to Price for a consideration equivalent to par value following which the issued "A" and"B" shares of Brickell Enterprises Ltd. will be:

Price 525 Class ‘A’ Ordinary Shares

Dunn 225 Class‘B‘ Ordinary Shares

In addition to a detailed argument from each party dealing with the term ” loan"—parts of which will be noted later, another argument of counsel for the appellant revolved around a contention that since the respondent had not included in the amounts subject to subsection 17(1) of the Act, the accounts receivable of Pamco, that it was unreasonable that the respondent should have regarded similar amounts arising out of trade amounts receivable with Dacal to be treated differently and the subject of deemed interest charges.

Analysis

Despite the capable analysis and argument together with related case law presented by counsel for the appellant, I have no difficulty whatever in considering the amount of $280,008 above as a simple loan—caught by the provisions of subsection 17(1) of the Act. With respect to that amount, "a corporation (the appellant) resident in Canada has loaned money to a non-resident person. . .”. While I do agree that there may be as much logic to include in the calculations of the deemed interest, the amounts relevant to Pamco, as there is to deal with the amount relevant to Dacal, it is not my view that the exclusion of one (Pamco) should result in the necessary exclusion of the other (Dacal). The amounts at issue relevant to Dacal—a balance of $213,115.26 ($503,123.26— $28,008) must be subjected to the same review under subsection 17(1) of the Act as the above amount of $280,008.

On that score, the point becomes whether it can be said that Price. . .has loaned money, when the transactions at issue by which Brickell became indebted to Price were ones whereby the trade accounts receivable of Dacal were taken over by Brickell as a result of intercorporate arrangements between Price, Dacal and Brickell to balance up the "investment" accounts of Price and Dunn (HKD 5614,163.52 each above), while giving Price 70 per cent of the share capital as opposed to 30 per cent remaining for Dunn. The position of the respondent on this point is that there was no substantive difference in Price providing $280,008 by way of direct cash infusion to Brickell—determined above to be subject to subsection 17(1) of the Act—and Price providing credit by way of trade accounts receivable to Dacal, which became the eventual obligation of Brickell in the amount of $213,115.26 above. First, it should be noted from the 1985 notes to Price financial statements, supra, that the complex intercorporate arrangements between Price, Dacal and Brickell, noted above, did not result in any increase in the cost of the shares of Brickell held by Price. Price originally held 225 Class A ordinary shares, at a cost of $42 (see 1983 Notes to financial statement above) and when the number of shares reached 560 in 1985 (agreement and notes above) the cost was still shown at $42. Therefore, the only item affected was the so-called “investment” or “loan” amount, which went from $784,818 in 1983 to $1,040,481 in 1985 shown as a loan, and a further"deferred receivable” of $1,055,888. In addition to these amounts, the trade receivables with affiliated companies (including Brickell) went from $284,094 in 1983 to $657,520 in 1984, then dropped to $92,909 in 1985 (again from the relevant financial statements of Price).

It cannot be said that during the period Price was advancing credit to Dacal, that it was doing so to one of its subsidiaries, which would permit the use of subsection 17(3) of the Act—referenced earlier. There appear to be two words which must be met for the respondent to invoke the provisions of subsection 17(1) of the Act—"loaned" and "money". I say "invoke" because the interest under subsection 17(1) of the Act is not interest declared by the taxpayer, it is certainly not interest received by the taxpayer. It is a calculation, which the respondent imposes on the taxpayer, in a situation wherein the taxpayer has not the benefit of the income therefrom—" interest thereon shall be deemed to have been received. . .”. To do so in my opinion, the respondent must be on the firmest possible grounds— all the "‘i‘s" dotted, and all the "t's" crossed. Counsel for the appellant made reference to the standard definition of "loan" from the texts—but in my opinion almost all the situations he referenced dealt with the word “loan” as a noun, whereas in the context of subsection 17(1) of the Act the term” has loaned" arises out of the transitive form of the verb "to lend”. The Living Webster definition of "to lend” is as follows:

“lend, lend, v.t.-lent, lending. [O.E. laenan, to lend, < laen, a loan, (< lihan = G. leihen, to lend); cf. D. leenen, Dan. laane, Icel. lana, to lend.] To grant to another for temporary use; to furnish on condition of the thing or its equivalent in kind being returned; to afford, grant, or furnish in general, as assistance. -refl. to accommodate; to adapt so as to be assistance, as: He lent himself to the scheme.- v.i. To make a loan.-lend a hand, to assist,-lend-er, n."

As I see it therefore the Minister of National Revenue must be prepared to show that a clear action can be attributed to the appellant which can accurately be described as "has loaned", in the sense of the above definition: “. . . To grant to another for temporary use; to furnish on condition of the thing or its equivalent in kind being returned; to afford, grant, or furnish in general, as assistance . . .”.

The circumstances of this part of the amount at issue—trade accounts receivable credit provided to Dacal, a subsidiary of Brickell—do not fulfil the definition of “has loaned" as between Price and Brickell. Even using the basis for the appellant’s argument—the noun "loan" which I have questioned above—the amount at issue does not constitute a "loan" as I believe that term should be understood in order to provide to the Minister of National Revenue the authority that “interest thereon . . . shall . . . be deemed to have been received . . . (subsection 17(1) of the Act), from Brickell, since it is from Brickell that the calculation of interest to Price is "deemed" to have arisen. "Trade accounts receivable" even to a subsidiary might form the basis for somewhat similar consideration under different sections of the Act (i.e. section 15— “funds or property", benefit or advantage", loan or indebtedness”), but I am not called upon to consider that situation. I am simply satisfied that the term "has loaned" has not been fulfilled, and if indeed something was “loaned”, that something was "trade accounts receivable”, which I do not regard as “money” in the context of subsection 17(1) of the Act. I understand the position of the respondent in this matter, that allowing Dacal to have ''trade accounts receivable credit" which amount was eventually transferred to Brickell, can be looked at as merely another form of the "investing" which was set up and intended by Exhibit A-2 above. But I do not agree that such an allocation or provision of capital or funds in these circumstances completes the terminology "has loaned money", as that is necessary to support the respondent invoking the "deeming" provisions of the Act.

The appeals are allowed in order that the amount of the alleged “loan” of $503,123.27 be reduced by an amount of $213,115.20, so that only the remainder of $280,008 shall be subject to the deeming provisions of subsection 17(1) of the Act. In all other respects the appeals are dismissed. The entire matter is referred back to the Minister of National Revenue for reconsideration and reassessment. The appellant is entitled to party-and-party costs.

Appeal allowed in part.