http://decision.tcc-cci.gc.ca/site/tcc-cci/decisions/en/item/65429/index.do
A.P. Toldo Holding Corporation v. The Queen[1] (December 19, 2013) arose out of a settlement of a dispute in a group of family companies. The settlement arrived at involved the corporate appellant buying out the dissenting shareholders:
[11] The Settlement Agreement provided that the sale of the Subject Shares would occur in ten separate transactions. Each transaction was for the sale of 10 Subject Shares for $4 million.
[12] Clauses 3.2 and 3.3 of the Settlement Agreement set out the timing of the payment of the $40 million for the Subject Shares and read as follows:
3.2 Purchase Price. The purchase price of the fifty (50) common shares to be sold pursuant to the first five of the ten share purchase agreements shall be paid by certified cheques, bank drafts or wire transfers at the time of closing on the Closing Date. The purchase price of the fifty (50) common shares to be sold pursuant to the last five of the ten share purchase agreements shall be paid on the Closing Date by delivering to the 2103665 five (5) promissory notes made by APTHC [the Appellant] payable to the order of 2103665 in the amount of Four Million ($4,000,000) Dollars each due one year after the Closing Date with interest at the Bank of Nova Scotia Prime Rate on the Closing Date and payable one year after the Closing Date.
3.3 Closing. The closing of the purchase of the APTHC Purchased Shares [the Subject Shares] pursuant to each of the ten agreements shall take place on the Closing Date at ten minute intervals commencing at 1 P.M.. Each transaction is a separate transaction and one closing shall be completed prior to commencing and completing the next closing. That process shall continue until all of the ten transactions are completed.
[Emphasis added.]
[13] It is clear from the two clauses that the parties intended that the Appellant pay cash of $20,000,000 for the first 50 common shares it purchased from 2103665 and issue promissory notes for $20,000,000 (the “Promissory Notes”) as consideration for the remaining 50 common shares.
[14] On June 5, 2006, 2103665 entered into ten share purchase agreements with the Appellant (the “Share Purchase Agreements”). Mr. Toldo, Donna Curlin as trustee, and Anthony P. Toldo were also parties to the Share Purchase Agreements. Each of the Share Purchase Agreements provided for the sale by 2103665 of 10 Subject Shares for a purchase price of $4 million.
[15] The ten Share Purchase Agreements evidence that the sales of the shares occurred in the order contemplated by the Settlement Agreement. For example, the recitals to the first agreement note that 2103665 held 100 common shares of the Appellant prior to selling 10 of the common shares to the Appellant for $4,000,000 cash. Similarly, the recitals to the second agreement note that 2103665 held 90 common shares before selling 10 additional common shares to the Appellant for $4,000,000 cash, and the recitals to the sixth agreement note that the Appellant held 50 common shares before selling 10 additional common shares to the Appellant in consideration of a $4,000,000 promissory note.
[16] The unconsolidated financial statements of the Appellant state that it had the following stated capital and retained earnings/deficit on December 31 of the noted years.
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2005
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2006
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Stated capital
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600 Class A shares
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$600
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$600
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200 common shares (100 in 2006)
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$200
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$100
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Retained earnings (deficit)
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$6,388,552
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$(32,660,014)
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[17] Since the Appellant paid $20,000,000 cash for the first 50 of the Subject Shares it purchased for cancellation, it had a deficit at the time it issued the Promissory Notes as consideration for the remaining 50 Subject Shares.
[18] The Appellant did not tell the Court where it obtained the $20 million cash it paid for the first 50 Subject Shares and the $6.75 million cash it paid for the Subsidiary’s Shares.
[19] However, it is clear from the unconsolidated and consolidated financial statements of the Appellant that the Appellant borrowed approximately $22.6 million from the Affiliated Companies in 2006. The Appellant’s unconsolidated financial statements state that the Appellant’s loan payable to its affiliates increased from $239,560 at the end of 2005 to $22,825,000 at the end of 2006. The Consolidated Statement of Cash Flows for the Appellant for its 2006 fiscal year shows that the increase in the loan was funded by the internal cash of the consolidated group, which totalled over $164 million at the end of 2005.
[20] Further, the Appellant classified the $22,825,000 loan from its affiliates as a current liability on its unconsolidated financial statements, meaning it intended to repay the amount within 12 months.
[21] The Appellant cancelled the 100 Subject Shares after it purchased those shares from 2103665.
[22] On April 16, 2007, the Appellant paid $21,035,616.44 in satisfaction of the Promissory Notes. This amount comprised $20 million of principal and $1,035,616.44 of interest. Mr. Toldo testified that a portion of these funds came from cash generated by various subsidiaries and a portion from the Bank of Montreal.
[23] In 2007, the Appellant borrowed $17,550,000 from the Bank of Montreal. The Appellant used approximately $10 million of the loan in its operations and the remainder to satisfy the Promissory Notes and pay the related interest.
[24] When preparing its 2006 income tax return, the Appellant claimed a deduction of $687,123 for interest payable in respect of the Promissory Notes. On its 2007 income tax return, the Appellant claimed a deduction of $348,493 for interest payable in respect of the Promissory Notes and $387,862 for interest payable in respect of the loan from the Bank of Montreal.
[25] The Minister denied all of the interest deducted in respect of the Promissory Notes and $166,858 of the interest deducted in respect of the Bank of Montreal loan. The parties agree that the denied interest deductions of $1,202,474 relate to the interest paid on the Promissory Notes and on the money borrowed from the Bank of Montreal to fund the repayment of the Promissory Notes.
[26] The Minister also denied the deductions of $35,568 and $15,627 claimed by the Appellant for 2006 and 2007 respectively in respect of professional fees.
[Footnotes omitted]
The appellant argued in the first instance that the interest payments were ordinary business expenses deductible under section 9 of the Income Tax Act.[2] The court rejected this line of argument:
[57] While there may be situations where interest is deductible when a taxpayer is calculating its profit for the purposes of section 9, the fact situation in front of me is not one of those situations.
[58] The interest was not paid in respect of money borrowed in the course of a money-lending business. I have found as a fact that the Appellant was not in the business of lending money.
[59] Further, I do not accept the Appellant’s argument that the Appellant purchased the Subject Shares from a dissident shareholder in order to protect its income by resolving a shareholder dispute.
[60] The Appellant’s income was dependent primarily on the operations of the companies that paid it dividends: the Affiliated Companies. I did not receive any evidence with respect to how the dispute involving a shareholder who owned only 12.5% of the voting shares of the Appellant and held only 5% of the voting rights negatively affected the operations of the Affiliated Companies and/or the Appellant.
[61] The purchase of the Subject Shares for cancellation did not relate to any business carried on by the Appellant. Rather the purchase represented a large non‑recurring expenditure. In my view, such a payment is on account of capital.
Next the appellant argued that the interest payments were deductible under subparagraph 20(1)(c)(ii) of the ITA. The court also rejected those submissions:
[76] Counsel’s argument with respect to the shareholder dispute is similar to his subsection 9(1) argument. He argued that the Appellant acquired the Subject Shares for the purpose of gaining or producing income or protecting income in the business and the residual outstanding shares of the corporation.
[77] As I have previously noted, I do not accept that that the Subject Shares were purchased to protect the income of the Appellant. Unlike the Court in Penn Ventilator Canada, I was provided with very little evidence with respect to the operations of the Appellant and the impact the shareholder dispute had on these operations.
[78] Counsel for the Appellant emphasized that I should consider the consolidated operations of the Appellant and the Affiliated Companies. However, I was not told what businesses the Affiliated Companies carried on or what impact the shareholder dispute had on these businesses.
[79] In summary, the shareholder dispute involving Ms. Curlin did not constitute an exceptional circumstance.
[80] The “fill the hole” theory does not help the Appellant. The basis of the theory was summarized by Bill S. Maclagan in his paper “Interest Deductibility – an Update”, presented at the 2009 British Columbia Tax Conference, as follows:
. . . The idea in these cases is that the borrowing (or acquisition of shares and issuance of a note) merely fills the hole that would be left if assets were sold, funds were then returned to the shareholders as a return of capital or payment of dividends and then the corporation went out, borrowed money and reinvested it back into its business.
[81] The difficulty for the Appellant is that, at the time the Appellant redeemed the 50 Subject Shares in respect of which it issued the Promissory Notes, it only had $200 of stated capital in respect of the common shares and no retained earnings. In short, there was no material amount of capital to return and no retained earnings to pay out. As a result, I do not have to consider whether there was a “fill the hole” scenario that would constitute an exceptional circumstance.
Similarly, although the taxpayer did not specifically argue the application of paragraph 20(1)(c)(i) of the ITA to the Bank of Montreal loan, the court held these payments were not deductible:
[82] The Appellant did not refer specifically to subparagraph 20(1)(c)(i). However, the Appellant obviously feels entitled to deduct an amount under subparagraph 20(1)(c)(i) in respect of the interest payable on the Bank of Montreal loan to the extent that the loan proceeds were used to repay the Promissory Notes.
…
[86] The Appellant borrowed the approximately $7,550,000 from the Bank of Montreal to satisfy the promissory notes that it issued on the purchase of the Subject Shares for the purchase of their cancellation. In point of fact, the Appellant did not use the borrowed funds directly to earn income from its business or from property.
[87] My comments with respect to the lack of exceptional circumstances in this appeal that would permit the deduction of interest under subparagraph 20(1)(c)(ii) apply equally to the deduction of interest under subparagraph 20(1)(c)(i).
[88] The “fill the hole” theory does not apply and the Appellant did not present the Court with any other facts that would allow the interest on the borrowed funds to be deductible on the basis of an indirect use of the borrowed money.
[89] For the foregoing reasons, I have concluded that the interest payable on the Promissory Notes and on the relevant portion of the Bank of Montreal loan was not deductible.
The court similarly denied the deduction of the disputed professional fees in connection with the share purchase and loan transactions (see paragraph [26] supra):
[92] The Appellant did not provide any evidence to challenge these assumptions. Mr. Toldo testified that the Appellant incurred legal fees with respect to the purchase of the Subject Shares and the loan from the Bank of Montreal. He also stated that the Appellant incurred accounting fees relating to the purchase of the Subject Shares.
…
[94] Counsel for the Appellant argued that the Appellant incurred the professional fees in the course of financing its business operations and is entitled to deduct those fees under subsection 9(1) of the Act.
[95] Counsel for the Respondent argued that the expenses were capital in nature.
[96] I agree with counsel for the Respondent. The professional fees were incurred in the course of acquiring a capital asset, the Subject Shares. Since the fees are associated with a capital transaction, they must be recognized as having been incurred on account of capital.
[Footnotes omitted]
Comment: This case is extremely difficult to evaluate. The Tax Court judge states on a number of occasions (at least four I believe)[3] that he did not receive “any evidence” on material points but when he did receive evidence he was inclined to dismiss it, e.g.:
[30] Mr. Toldo described the activities of the Appellant as follows:
A.P. Toldo Holding Corporation is [a] parent company of many subsidiary companies and it holds those companies as investments. It also acts as banker to those subsidiaries and some related-party affiliates. It also has investments outside the corporate umbrella.
[31] He described its financing and banking activities as follows:
Q. You say A.P. Toldo acts as a banker. What does it do? Can you just expand on that and its role?
A. As the banker, from time to time it finances its affiliates. It also receives deposits or loans from certain of its subsidiaries that may have excess cash. It would take that excess cash, or cash that it borrows, and lends [sic] it down to its subsidiaries or affiliates.
Q. What would be the principal business of this holding company?
A. I would say the principal business is to hold investments in its subsidiaries and part of that is to act as financier of those subsidiaries.
Q. You said it also derives from other investments?
A. Yes.
Q. Investment income? Where would you get that from?
A. Those would be very minor in respect to the economic activity of A.P. Toldo Holding Corporation. That could be bank funds on deposit, where if there is excess cash, it might be invested in GIC’s. There may be some marketable securities from time to time that are held.
Q. Where does the holding company derive its value?
A. From its subsidiaries.
[32] This is the only evidence the Appellant provided with respect to its day‑to‑day activities. I did not receive any evidence with respect to such aspects of the Appellant’s day-to-day operations as who acted on behalf of the Appellant (it does not appear to have any employees), whether it played any role in managing the corporate group, and how it carried on its alleged banking business.
[33] Counsel for the Appellant told the Court that the unconsolidated and consolidated financial statements of the Appellant provided such evidence. I do not agree. In fact, the unconsolidated and consolidated financial statements, in my view, contradict Mr. Toldo’s testimony.
[34] The unconsolidated financial statements of the Appellant do not in my view reflect the activity of a corporation that acted as a banker for its Affiliated Companies. The Appellant simply did not have the financial resources that would have allowed it to make substantial loans to the Affiliated Companies.
[35] I recognize that on December 31, 2005, prior to the Appellant’s purchase of the Subject Shares and the Subsidiary’s Shares, the Appellant held cash and marketable securities of approximately $4.5 million. However, such an amount is immaterial when one considers that the Affiliated Companies had annual sales of approximately $131 million and that on December 31, 2005 the subsidiaries held cash and cash equivalents of approximately $160 million.
[36] I do not know why the Affiliated Companies held such large amounts of cash. In fact, the Appellant did not tell the Court what businesses the Affiliated Companies actually carried on during the relevant years. Whatever businesses they carried on, it is clear from the consolidated financial statements that the businesses generated substantial cash. In fact, the cash held by the Affiliated Companies at the end of 2005, 2006 and 2007 exceeded their annual sales.
[Footnotes omitted]
It is unclear why it should be relevant that the appellant kept surplus funds in its Affiliated Companies rather than consolidating them in its coffers. Clearly the corporate group did not accumulate these large amounts of money by inadvertence; there was obviously a great deal of business acumen involved. It seems odd that the financial statements of the various corporations would give no indication of their business activities. It is similarly unclear whether there was no evidence of the motivation behind buying out dissenting shareholders or whether the court simply did not understand or credit that motivation. On balance this case seems to be an outlier in the abundant jurisprudence of interest deductibility.
[1] 2013 TCC 416.
[2] R.S.C. 1985, c. 1 (5th Supp.), as amended (the “ITA”)
[3] Paras. [32], [38] [60] and [92].