Tax Court of Canada Judgments

Docket: 2001-2796(IT)G

BETWEEN:

OTTERBROOK PERCHERONS LIMITED,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

____________________________________________________________________

Appeal heard on February 12 and 13, 2004 at Fredericton, New Brunswick

Before: The Honourable Justice Brent Paris
Counsel for the Appellant:	Eugene J. Mockler Nicole Beaulieu
Counsel for the Respondent:	John Smithers

____________________________________________________________________

JUDGMENT

          The appeals from the reassessments made under the Income Tax Act for the 1995, 1996 and 1997 taxation years are allowed, with costs, and the reassessments are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.

Signed at Ottawa, Canada, on this 30th day of July, 2004.

"B. Paris"

Paris, J.

Citation: 2004TCC517

Date: 20040730

Docket: 2001-2796(IT)G

BETWEEN:

OTTERBROOK PERCHERONS LIMITED

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Paris, J.

[1]      Kenneth Creelman and Ross Creelman are father and son, and are equal shareholders through personal holding companies in several companies that produce wood products in New Brunswick and Nova Scotia. The Creelman family has been involved in this business since the 1920's when Kenneth's father, Horace Creelman, started out logging and milling lumber. Three generations have built up the business to the point where the Creelman group of companies now employs close to 400 workers, and has annual sales of approximately $80 million. The companies' products include treated wood, utility poles, deck accessories, wood siding and wood pellets.

[2]      Kenneth and Ross are also equal shareholders in the Appellant, whose only activity (the "Activity") is exhibiting Percheron horses at shows and parades in Canada and the United States. Percheron horses are a breed of work horses although they now appear to be used mostly as show animals. The Appellant exhibits the horses as a form of advertising for Cape Cod Finished Wood Siding, one of the Creelman's wood products, manufactured originally by Marwood Inc. and, after September 1, 1995, by Atlantic Pressure Treating Ltd. ("APT").[1]

[3]      In 1995, 1996 and 1997, the Appellant incurred large losses from its operations, and reported those losses as losses from a business in its returns of income. The Minister of National Revenue, by Notices of Determination of Losses, has denied those losses on the basis that there was no source of income, and the Appellant appeals that decision.

Issues

[4]      The issues in this appeal are:

(i)       Whether the question of whether the Appellant carried on the Activity for profit or with a reasonable expectation of profit is res judicata;

(ii)       Whether the Appellant carried on the Activity for profit or with a reasonable expectation of profit such that it constituted a source of income under the Income Tax Act[2] (the "Act.");

(iii)      Whether the expenses incurred in the Activity were laid out to earn income from business; and

(iv)      In the alternative, whether the Appellant was acting as the agent of Marwood or APT for the purpose of carrying on the Activity.

Is the question before the Court res judicata?

[5]      The Appellant's counsel takes the position that the issue of whether or not the Appellant was carrying on the Activity for profit or with a reasonable expectation of profit has already been determined in the Appellant's favour by this Court in an earlier appeal filed by the Appellant from a reassessment of GST. In his submission, the rule of res judicata prevents the Respondent from challenging that determination again in these proceedings.

[6]      The evidence shows that the Appellant was reassessed under the Excise Tax Act[3], ("E.T.A.") on March 6, 1998 to disallow its claim for all input tax credits it claimed for the periods between March 1, 1994 and October 31, 1997. The input tax credits were disallowed on the basis that the Appellant's sole Activity of raising and exhibiting Percheron horses was not carried on for profit, or with a reasonable expectation of profit.

[7]      The Appellant appealed that reassessment to this Court by Notice of Appeal dated March 17, 2000. The Appellant and the Respondent subsequently entered into a Consent to Judgment in the matter which read as follows:

The Appellant and the Respondent consent to judgment allowing the appeal with respect to an assessment under Part IX of the Excise Tax Act for the period March 1, 1994 to October 31, 1997, by Notice of Assessment No. 01CB0303163 dated March 6, 1998, and referring the matter back to the Minster of National Revenue for reconsideration and reassessment on the basis that the Appellant is entitled to the input tax credits claimed in the period under appeal totalling $83,370.53.

[8]      Judgment was issued by this Court accordingly.

[9]      In order for issue estoppel to apply the following conditions, as set out in the House of Lords decision in Carl Zeiss Stiftung v. Rayner & Keeler Ltd. (No. 2)[4] must be met:

1.        The same question must have been decided by a Court in earlier proceedings;

2.        The judicial decision which is said to create the estoppel must be final; and,

3.        The parties to the judicial decision or their privies must be the same persons as the parties to the proceedings in which the estoppel is raised or their privies.

[10]     It is not disputed that the second and third conditions set out above have been met in this case.

[11]     With respect to the first condition, it must be shown that the question sought to be estopped has been clearly and unequivocally decided by a Court in another proceeding. "It is not necessary to show that the issue is specifically decided so long as it can be shown that it was a necessary logical consequence of the point actually decided. It is pure logic, not probability, likelihood or speculation"[5].

[12]     It has been held that issue estoppel may arise, therefore, with respect to an unstated premise underlying a Consent to Judgment[6] where that premise is pre-requisite to the conclusion reached by the parties in the consent document.

[13]     The Consent to Judgment form in this case sets out only that the Appellant is entitled to the input tax credits that it had claimed. It does not set out any additional facts or the reasoning by which the parties arrived at that conclusion.

[14]     Given that the Consent to Judgment does not specifically address the question of profit motive or reasonable expectation of profit in carrying on the Activity, the Appellant's counsel asks me to infer that an admission that the Appellant had a profit motive and a reasonable expectation of profit in carrying on the Activity was made because it was a pre-requisite of the Appellant's entitlement to the input tax credits under the E.T.A. I am not satisfied that this is correct.

[15]     I am unable to conclude that the Consent to Judgment was based on an admission that the Appellant's Activity was carried on for profit or with a reasonable expectation of profit because the Appellant's entitlement to input tax credits was not dependent on it fulfilling either of these conditions. A corporation may claim input tax credits regardless of whether it carries on its activities for profit or with a reasonable expectation of profit. This flows from the definition of "business" and "commercial activity" found in Paragraph 123(1) of the E.T.A.

"business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever, whether the activity or undertaking is engaged in for profit, and any activity engaged in on a regular or continuous basis that involves the supply of property by way of lease, licence or similar arrangement, but does not include an office or employment;

"commercial activity" of a person means

(a)         a business carried on by the person (other than a business carried on without a reasonable expectation of profit by an individual, a personal trust or a partnership, all of the members of which are individuals), except to the extent to which the business involves the making of exempt supplies by the person.

(b)         an adventure or concern of the person in the nature of trade (other than an adventure or concern engaged in without a reasonable expectation of profit by an individual, a personal trust or a partnership, all of the members of which are individuals), except to the extent to which the adventure or concern involves the making of exempt supplies by the person, and

(c)         the making of a supply (other than an exempt supply) by the person of real property of the person, including anything done by the person in the course of or in connection with the making of the supply;

[16]     Consequently, the assumptions to which I have referred relating to profit motive and reasonable expectation of profit that were made by the Minister in assessing the Appellant to disallow the input tax credits did not provide a basis in law for the assessment nor would they provide a basis in law for the Consent to Judgment. I can draw no inference from the Consent to Judgment that the Consent was based on the admission alleged by the Appellant. Therefore, I find that the Appellant has not shown that the same issue before the Court in this case has previously been decided between the parties, and no issue estoppel has been made out.

Did the Appellant's Activity constitute a source of income?

Factual Background

[17]     Ross Creelman, his brother Doug, and Mike Kimball, an accountant for the Creelman group testified for the Appellant.

[18]     Ross Creelman joined the family business in the mid-1970's and has worked in an executive capacity with the family companies since then. Doug Creelman first joined the family business in around 1988 and was later responsible for setting up a wood siding operation near Halifax.

[19]     The wood siding operation was a new venture for the Creelman family. Marwood had acquired a defunct woodworking plant in Hammond Plain, Nova Scotia in about 1992, and Doug conceived a plan to manufacture painted pine wood siding there. This coincided with Ross's desire to expand the family business to include more value-added wood products. Production of the siding began in 1993 under the name of Cape Cod Wood Siding. Sales increased dramatically each year and reached over $11 million in its latest fiscal year.

[20]     As the name would suggest, Cape Cod Wood Siding is used to give a traditional appearance to buildings, and the target market for the siding was upscale residential and small commercial buildings. In order to develop the Cape Cod brand in these markets, Ross and his father decided to purchase a team of Percheron horses and to exhibit the horses at shows in Canada and the United States. Their investigations had shown that the high-income potential customers often attended horse shows.

[21]     The Creelmans chose Percherons as the symbol for Cape Cod Wood Siding because of their beauty, strength and durability, the same image they wished to project for the siding. Percherons had also been used in the early days of logging in the Maritimes, to haul logs to the mill and lumber to port, and the use of the horse in advertising highlighted this heritage.

[22]     At the horse shows, the Percherons were exhibited in a hitch of eight horses, with a wagon bearing the name of Cape Cod Wood Siding and the corporate logo. Booths were also set up at the shows to distribute literature and talk with potential customers. Ross claimed that significant sales of siding have been made in geographic areas where horse shows have been attended and gave examples of contacts made at the shows which have led to large orders and product placement in building supply stores. The Percherons have been exhibited at shows in many states such as Florida, Michigan, Kentucky, South Carolina, Illinois, Massachusetts, New York and Pennsylvania and several provinces.

[23]     Ross Creelman noted that horses such as Percherons and Clydesdales are used by large corporations such as Heinz, Budweiser, Petsmart, and Lowes Building Supplies in the United States for advertising purposes and have been very successful in promoting those brands.

Relevant Law

[24]     The Supreme Court of Canada has held in Stewart v. Her Majesty the Queen[7] that the following two stage approach is employed in order to determine whether a taxpayer's endeavour constitutes a business or property source of income under the Act:

(i)       Is the Activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavour;

(ii)       If it is not a personal endeavour, is the source of the income a business or property.

The Court went on to say that equating "source of income" with an Activity undertaken "in pursuit of profit" accords with the traditional common law definition of "business" ie., "anything which occupies the time and attention and labour of a man for the purpose of profit".

[25]     Where there is a personal element to the Activity or endeavour, a taxpayer must be able to show that his predominant intention was to make a profit from the Activity and that the Activity was carried out in a sufficiently commercial fashion.

Was there a personal element to the Activity?

[26]     According to the Reply to Notice of Appeal in this case, the Minister assumed that the Appellant was not carrying on the Activity for profit. He also assumed that there was a personal element to the Activity in that it provided a recreation or pastime for Kenneth Creelman, and that the Appellant had no reasonable expectation of profit.

[27]     However, at the hearing, the auditor who prepared the loss determinations gave evidence that he did not conclude that the Appellant's operations contained any personal element or provided any personal benefit to Kenneth Creelman or any other person. He denied that he formed the view in the course of his audit that "Kenneth Creelman had a personal hobby interest in the Activity and derived a personal benefit and enjoyment from the Activity" as set out in paragraph 18(j) of the Reply to Notice of Appeal. In his words, any such personal element was "insignificant".

[28]     Given that this assumption was not made in the course of determining the Appellant's losses, the onus to prove it lies on the Respondent. I am not satisfied that the Respondent has met this onus. Kenneth Creelman did not testify due to ill health, but Ross, and his brother, Doug, both denied that the Appellant's activities were conducted as a hobby for their father. In fact, the only evidence before me that the Activity contained a personal element was a statement in a newspaper article that stated the Percherons were a hobby for Ken Creelman as well as a promotional vehicle for Cape Cod Finished Wood Siding. The author of the article was not called to testify to determine the source of his statement, and as such it constitutes hearsay and is inadmissible. On the question of the existence of a personal element, I accept the evidence of Ross and Doug Creelman and find that no such element was present in the Appellant's Activity.

Was the Appellant conducting Activities for profit?

[29]     Ross Creelman testified that the Appellant was set up as a separate corporation primarily to limit the liability of the operating companies for any damage or injury that the Percheron horses might cause at the exhibitions in Canada and the United States. The Appellant's operations were funded by a related company, Ashmore Ltd., through inter-company loans. The Appellant was to receive payment from Marwood and from APT after September 1995 for its services advertising Cape Cod Finished Wood Siding. This contract was not put in writing but the parties had agreed on the fact that the Appellant would be paid and, in its first year, Marwood paid the Appellant $270,000 for its services.

[30]     However, the Appellant did not invoice Marwood in 1995 nor APT in 1996 or 1997 for the advertising work. According to the company's accountant, Mike Kimball, the Creelman group suffered a loss as a whole for the first time in its history, due to adverse economic circumstances, and when he was preparing the financial statements for the companies in the group he recommended that the Appellant defer charging advertising fees until the companies returned to profitability. This suggestion was accepted and the deferral continued through the three years under appeal. Mr. Kimball emphasized that the deferral of the advertising fees was only temporary, and that Marwood and APT intended to pay the fees as soon as it was able. The intention that the Appellant was to charge fees for the use of the horses to advertise the Cape Cod Wood Siding was confirmed by Ross Creelman, as was the arrangement to defer charging for the advertising until Marwood and APT were back in the black. Neither of these witnesses were challenged on this evidence in cross-examination.

[31]     Although it is not entirely clear, it appears that the fees were not subsequently paid, but rather that the Appellant was amalgamated with APT. This would have resulted in the debt owed by APT to the Appellant disappearing as a result of the merger of the debtor with the creditor.

[32]     It is interesting to note that the auditor for Revenue Canada who made the loss determinations stated in his testimony that, had Marwood and APT been invoiced for the advertising that the Appellant did for it, he would have allowed them to deduct those expenses. He said that he considered that the way in which a company chose to advertise was a business decision and that he would have seen no reason to disallow it. It was clear that Marwood was allowed a deduction for the $270,000 payment it made to the Appellant in 1994.

[33]     The evidence satisfies me that there was a contract between Marwood and the Appellant in 1995 and between APT and the Appellant in 1996 and 1997 to pay fees for advertising sufficient to cover the Appellant's costs. Along with prize money from exhibitions and receipts from the sale of horses that were no longer needed in the operation, the fees would have been sufficient to make the Appellant profitable. This confirms that the Appellant was carrying on business with a view to a profit, and therefore had a business source of income within the meaning of section 3 of the Act.

Were the expenses of the Appellant's Activity incurred for the purpose of gaining or producing income from a business?

[34]     The Respondent also pleaded in the Reply to Notice of Appeal that the disallowed amounts were not incurred for the purpose of gaining or producing income from a business or property and that their deduction was prohibited by paragraph 18(1)(a) of the Act. This argument was raised for the first time in the Reply to Notice of Appeal. In the loss determinations in issue the auditor did not disallow the deduction of any particular expense or expenses; he denied the losses claimed by the Appellant on the basis that it did not carry on its Activity for profit or with a reasonable expectation of profit and therefore that there was no source of income from which the losses could be said to have arisen.

[35]     Since the question of deductibility of expenses issue was not part of the original basis for the loss determinations, the onus to prove that the expenses were not laid out to earn income is on the Respondent. In this case, there was no evidence of any non-business purpose to the expenditures made by the Appellant, and no evidence that they were not, in the words of Wilson J. in Mattabi MinesLtd. v. Ontario (Min. of Revenue)[8]"legitimate expense[s] made in the ordinary course of business with the intention that the company could generate a taxable income some time in the future" and therefore there is no basis for disallowing them pursuant to paragraph 18(1)(a) of the Act. The Respondent has not made out its case on this issue.

Was the Appellant acting as agent for ATP?

[36]     The Appellant's counsel also argued in the alternative that the Appellant carried on the Activity as agent for Marwood and ATP. He also said that the separate corporate existence of the Appellant could be ignored because of the common ownership structure of the Creelman group of companies and the fact that the companies had common directors and management.

[37]     However, even if I were to find that the Appellant was acting as the agent for Marwood and ATP, this would not allow me to give the Appellant the relief it is seeking in this appeal. As pointed out by counsel for the Respondent, if the Appellant incurred the expenses of its horse operation on behalf of another party, the expenses would be the expenses of that other party and not those of the Appellant. In law, the actions of an agent are treated as the actions of the principal, and the tax consequences of the agent's activities are attributed to the principal. In this case, if the Appellant were to succeed on this point, it would mean that Marwood and APT should have claimed the expenses of the Activity in the calculation of their income in the relevant taxation years and that the Appellant would not be able to deduct the expenses itself, and would not have any losses in those years.

[38]     Counsel for the Appellant suggested that a finding that the Appellant was acting as agent for Marwood and APT would oblige the Minister to reassess the latter companies for the relevant taxation years to allow them to deduct the losses claimed by the Appellant. The short answer to this submission is that the assessments of those taxpayers are not before me and I would have no jurisdiction to require the Minister to make any changes to those assessments.

[39]     In any case the evidence does not show that the Appellant was acting as agent for any other party in carrying on the horse operation. Agency is a contractual relationship and in this case there is no evidence of an agreement, written or otherwise, making the Appellant the agent of Marwood or APT. The fact that the Appellant was set up as a separate company to provide the operating company with protection from any liability that might arise as a result of exhibiting the horses tends to contradict this suggestion. If the Appellant were agent for Marwood or APT, the principals Marwood or APT would still be liable in tort for the Appellant's actions despite the Appellant being a separate corporation, thus defeating the main purpose for which it was set up. It was not shown that the Appellant or Marwood or APT ever represented to any other party that the alleged agency arrangement existed. In the absence of any convincing evidence of such an arrangement, I find that the Appellant was at all time acting on its own behalf, and there is no basis for disregarding its separate legal existence from Marwood and APT. In this regard I would repeat what was said by Cattanach, J. in Denison Mines Ltd. v. the Minster of National Revenue[9] :

...it is important to bear in mind that limited companies that carry on businesses are separate taxable persons and the profits of their respective businesses are separate taxable profits whether or not one be the subsidiary of the other. Any attempt to erode this principle must be based upon clear and unequivocable facts leading to the irrebutable conclusion that one legal entity is acting as the agent of another and that legal entity is really doing the business of the other and not its own at all.

Summary

[40]     For all of the foregoing reasons, I conclude that the Appellant did conduct its operations for profit in the years under appeal, and that the losses it incurred were losses from business pursuant to sections 3 and 9 of the Act. Therefore the appeal will be allowed with costs.

Signed at Ottawa, Canada, on this 30th day of July, 2004.

"B. Paris"

Paris, J.

CITATION:

2004TCC517

COURT FILE NO.:

2001-2796(IT)G

STYLE OF CAUSE:

Otterbrook Percherons Limited v. Her Majesty the Queen

PLACE OF HEARING

Fredericton, New Brunswick

DATE OF HEARING

February 12 and 13, 2004

REASONS FOR JUDGMENT BY:

The Honourable Justice B. Paris

DATE OF JUDGMENT

July 30, 2004

APPEARANCES:

Counsel for the Appellant:

Eugene J. Mockler Nicole Beaulieu

Counsel for the Respondent:

John Smithers

COUNSEL OF RECORD:

For the Appellant:

Name:

Eugene J. Mockler Nicole Beaulieu

	Firm:	Mockler Peters Oley Rouse & Williams
For the Respondent:		Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada

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