Tonolli Canada Ltd. v. Minister of National Revenue, 91 DTC 520, [1991] 1 CTC 2607 (TCC)

Mogan, T.C.J.:—The appellant is resident in Canada. All of the issued shares of the appellant are owned by IFIM International B.V. (‘IFIM”) a corporation resident in the Netherlands. In the period 1984-1985, in particular circumstances, IFIM stated that it would pay $460,295 to the appellant. The respondent concluded from those circumstances that IFIM had "received a loan from or became indebted to" the appellant within the meaning of subsection 15(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). Accordingly, the respondent issued a notice of assessment to the appellant levying tax of $69,044 (being 15 per cent of $460,295) on the assumptions that the appellant was deemed to have paid a dividend to IFIM and had failed to withhold and remit tax with respect to that deemed dividend in accordance with subsection 15(2) and paragraphs 212(2)(a) and 214(3)(a) of the Act. The issue in this appeal is whether, in the particular circumstances referred to above, IFIM became indebted to the appellant within the meaning of subsection 15(2).

The appellant is engaged in the business of recycling, smelting and refining lead. It purchases old batteries and scrap metal; extracts and processes the lead; and refines the lead in ingot form for sale. The appellant is the largest recycler of lead in Canada ana one of the largest in North America. The appellant commenced business in Canada in 1961 and, by the early 1970s, exports from the appellant to the U.S.A. were so large that IFIM caused a new subsidiary ('Tonolli Corporation") to be incorporated in the U.S.A. Tonolli Corporation built a plant in southern Pennsylvania. In 1976-1978, the appellant and Tonolli Corporation through their plants in Ontario and Pennsylvania could supply all of Canada, the northeast and midwest of the U.S.A., and the eastern seaboard down to Georgia and Florida but they needed a plant in the far west to service California and Arizona.

In 1979, the appellant caused the incorporation of Tonolli Western Inc. ("Tonolli Western") under the laws of Delaware; and the issued shares of Tonolli Western were allocated as follows:

The preference shares of Tonolli Western were designated as ten per cent non- cumulative, voting, redeemable and retractable. The certificate of incorporation provided inter alia that (i) the preference shares had equal voting rights with the common shares; (ii) the preference shares were retractable at any time after two years following their date of issuance for a redemption amount" equal to the paid-up capital per share plus 50 per cent; and (iii) the preference shares were redeemable at any time for the same per share redemption amount. Having regard to the above provisions, IFIM held 89 per cent of the equity in Tonolli Western but the appellant could outvote IFIM 166,500 to 133,500. Also, if Tonolli Western were successful, the appellant could cause the redemption or retraction of its preference shares with a paid-up capital bonus of 50 per cent. These comments are, of course, subject to the fact-of-life observation that the appellant was a wholly owned subsidiary of IFIM.

Tonolli Western purchased a 40-acre site in California in 1979 intending to construct a $30 million lead processing plant. There were delays obtaining environmental approval and, before construction could begin, the price of lead dropped in 1981 along with the price of other metals. The project had to be suspended and, when metal prices did not recover in the short term, the California project was abandoned in 1983.

Tonolli Western had no funds except for its paid-up capital of $300,000 (U.S.). The purchase of the 40-acre site was financed primarily with a mortgage but the appellant paid the interest and other expenses. After the project was abandoned, the 40-acre site was sold for an amount approximately equal to its cost but all the other expenses left the appellant with an outlay in excess of $500,000 which could not be repaid by Tonolli Western. Prior to 1984, there had been no discussions between the appellant and its parent, IFIM, concerning how the loss of the California project might be allocated between them. The subject was raised by the appellant's outside auditors at the end of 1984 when the California land had been sold and the amount of the loss could be ascertained. The matter was resolved when IFIM agreed to absorb 89 per cent of the loss on the California project because it had held 89 per cent of the common shares of Tonolli Western. On March 15, 1985, the following telex was sent by IFIM to the attention of the appellant's auditors:

We accept 89 percent of the loss suffered from Tonolli Western Inc. and agree to reimburse Tonolli Canada Ltd. for 89 percent of the total loss (which 89 percent will not exceed an amount of US$ 432,261) they have financed on our behalf.

Although IFIM agreed to accept 89 per cent of the loss and to reimburse the appellant, there was no agreement between the appellant and IFIM as to a precise date when the reimbursement would be effected. The appellant's fiscal period is the calendar year. At December 31, 1983, the appellant's balance sheet disclosed as an asset the amount of $376,590 identified as its investment in and advances to Tonolli Western. At December 31, 1984, the appellant's balance sheet consolidated its advances to Tonolli Western with its advances to its parent, IFIM, and to Tonolli Corporation, the sister corporation in the U.S.A. with the plant in Pennsylvania. At December 31, 1985 and 1986, the appellant's balance sheet showed $460,295 as "Advances to parent and affiliated companies". This amount of $460,295 was the 89 per cent in Canadian dollars which IFIM had agreed to reimburse with respect to the California project.

It was the appellant's understanding that the reimbursement would be effected by set-off when one or more dividends became payable by the appellant to IFIM. On February 8, 1988, the appellant declared a dividend in the gross amount of $1,511,439 payable to IFIM as sole owner of all the appellant's outstanding common shares. According to the only witness who testified in this case, no part of the dividend was actually remitted to IFIM because the after-tax amount was contraed against IFIM's 89 per cent portion ($460,295) of the loss on the California project and a prior loan by the appellant to IFIM of $900,000. The dividend was "paid" as follows:

It is apparent that the gross amount of the dividend ($1,511,439) was determined so that the precise after-tax amount would permit the two set-offs. It is also apparent that the dividend was declared after the appellant had received the notice of assessment described below.

By notice of assessment dated September 1, 1987, the respondent assessed a 15 per cent tax under Part XIII of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") on the basis that the appellant had failed to deduct and remit tax of $69,044 on the amount of $460,295 paid or credited in 1984 to IFIM, a non-resident of Canada. This assessment is based on the interaction of subsection 15(2), paragraphs 212(2)(a) and 214(3)(a), subsections 214(3.1), 215(1) and (6), and paragraph 227(10)(b), all provision of the Income Tax Act. The real issue, however, is the application of subsection 15(2) in which the relevant parts provide:

15.(2) Where a person . . . is a shareholder of a particular corporation, . . . and the person . . . has in a taxation year . . . become indebted to the particular corporation, . . . the amount of the . . . indebtedness shall be included in computing the income for the year of the person . . .

Both counsel argued this issue on the question of whether IFIM, by accepting 89 per cent of the loss suffered through Tonolli Western, had ''become indebted” to the appellant within the meaning of subsection 15(2). The respondent argued that there was an agreement between the appellant and IFIM that the appellant would be reimbursed in the amount of $460,295; the agreement was reflected in the telex of March 15, 1985 and the audited financial statements of the appellant; and the agreement created an indebtedness from IFIM to the appellant. The appellant argued that there was no consideration for IFIM's promise to accept 89 per cent of the loss; the promise was therefore not enforceable by the appellant against IFIM; the resulting obligation, if any, was contingent upon a set-off against some future amount that may become owing from the appellant to IFIM; and the contingent nature of the obligation was proved when a set-off against some future amount that may become owing from the appellant to IFIM; and the contingent nature of the obligation was proved when a set-off was used to effect payment of the dividend declared in 1988.

There is no doubt that the appellant financed Tonolli Western as it struggled to get off the ground before the California project was abandoned. Although the telex of March 15,1985 from IFIM refers to the amount which the appellant had "financed on our behalf", I infer from the evidence that the funds were provided by the appellant because (i) the appellant was big and successful in the North American market; (ii) the appellant in fact provided hands-on management in the attempt to develop Tonolli Western; (iii) there was the usual optimistic expectation at the beginning of any enterprise that it would be successful and that any loans from the appellant would be soon repaid; and

(iv) the appellant had an opportunity to recover a 50 per cent bonus on the redemption/retraction of its preference shares. In other words, I conclude that the loans from the appellant to Tonolli Western from time to time were at least in part self motivated and not made at the specific request of IFIM. After the collapse of Tonolli Western, IFIM was required to recognize that the appellant's financing of Tonolli Western was, in part, on behalf of IFIM.

When the California project was abandoned and the appellant's loans to Tonolli Western could not be repaid, the appellant and IFIM had to decide how the loss would be borne as between the two corporations. The actual allocation of the loss was practical and seemingly fair: pro rata to the equity that each corporation held in Tonolli Western. I cannot find any consideration flowing from the appellant to IFIM in exchange for IFIM's promise to absorb 89 per cent of the loss. The appellant had its own commercial reasons to finance Tonolli Western including the 50 per cent bonus on preference shares and an expansion of the North American market for the Tonolli Group. Even if the financing had been provided at IFIM’s request, such financing would have been past consideration in 1984-1985 when the two corporations allocated the loss. Therefore, I conclude that IFIM's promise in March 1985 was gratuitous and not enforceable. If the appellant had become bankrupt in the summer of 1985, I doubt that a trustee in bankruptcy could have been successful in an action against IFIM for the amount $460,295.

I do not question the judgment of the auditors in showing the amount of $460,295 as a receivable from the parent corporation in the appellant's financial statements at December 31, 1985 and 1986. The auditors confirmed the position of IFIM by telex and they relied on the good faith arrangement between the appellant and IFIM concerning the allocation of the loss. Ordinarily, the audited balance sheet of a corporation is a fair presentation of its financial position as at the balance sheet date. And this was true of the appellant as at December 31, 1985 and 1986. It must be remembered, however, that an audited balance sheet cannot by itself convert a good faith promise to pay into an enforceable debt.

Referring to the words in subsection 15(2) of the Act, the important question is whether IFIM "became indebted" to the appellant through its promise to pay the amount $460,295. IFIM would become indebted to the appellant only if a debt existed between IFIM and the appellant. In the absence of a special statutory definition, "debt" means a sum payable in respect of a liquidated money demand, recoverable by action (See Diewold v. Diewold, [1941] S.C.R. 35 at 39). I have already concluded that the amount $460,295 was not recoverable by action of the appellant. Therefore, there was not a debt owing by IFIM to the appellant but only a good faith promise to pay. Accordingly, IFIM did not become indebted" to the appellant through its promise in 1984-1985 to pay the amount of $460,295.

I accept the appellant's further argument that payment by IFIM of the amount $460,295 was contingent upon a set-off against some future amount owing by the appellant to IFIM. Mr. Bailini, the appellant's vice-president, Finance was the only witness and, when asked about discussions with IFIM concerning the sharing of the Tonolli Western loss, he replied in part:

All the expenses have been paid by Tonolli Canada and Tonolli Canada was just oing to bear them. Some informal talks were held with IFIM but IFIM’s reply was: "our only source of income are [sic] the dividends from Tonolli Canada, and if Tonolli Canada is not paying dividends because it is not making money, there is no way we can pay anything else”.

(page 18, Transcript)

Although the witness stated that "some informal talks were held with IFIM”, there was entered in evidence the telex of March 15,1985 (quoted above) from IFIM to the appellant's auditors in which IFIM accepted 89 per cent of the loss. I regard the declaration of the dividend in February 1988 and the resulting setoff by the appellant of its receivable from IFIM in the amount of $460,295 as corroboration of Mr. Bailini's understanding of the arrangement even though the dividend was declared after the appellant had received the notice of assessment under appeal herein. IFIM's promise to pay was contingent on a future set-off.

The notice of assessment dated September 1, 1987, which levied the tax of $69,044 under Part XIII of the Act was pleaded but was not before the Court. Assuming that the amount of $69,044 was the only amount of tax levied in that assessment, the appeal is allowed with costs and the assessment is vacated. If other amounts of tax were levied in that same assessment, then I will have to hear further from counsel by written submissions.

Appeal allowed.