In Hanmar Motor Corporation v. The Queen,1 the Tax Court of Canada upheld the Minister of National Revenue's (the "Minister") decision to disallow the deduction of a settlement payment made under the Employment Standards Act of Ontario (the "ESA").2 The Minister's decision was upheld because Hanmar Motor Corporation (the "Appellant") was required to make the settlement payment under a provincial statute, as an incident to its ownership of shares in a related business and not for the purpose of gaining or producing income.
The Appellant was a manufacturer of motor homes. At the relevant time, its sole shareholder was Jeffrey Hanemaayer, and its directors were Jeffrey and his father, Jacobus Hanemaayer. Jeffrey Hanemaayer and Jacob Hanemaayer owned all the shares of Community Expansion Inc. ("CEI"), a real estate holding company, and 798894 Ontario Ltd., a manufacturer of non-motorized recreational vehicles. The Appellant owned all of the shares of 1148346 Ontario Inc. ("114"), an inactive holding company, and 930943 Ontario Ltd. ("930"), a manufacturer of non-motorized recreational vehicles. It was the ownership of these shares of 930 that was in issue in this case.
930 ceased operations after becoming insolvent in 1995, leaving its former employees with unsatisfied claims for unpaid wages, including vacation pay, severance pay and termination pay. These unpaid employees pursued the remedies available to them under the ESA. On July 4, 1996, an Employment Standards Officer made an order under paragraph 65(1)(c) of the ESA requiring the employer to pay a total of $1,155,615.81 to these former employees of 930, which amount was later reduced to $252,297.00 (the "Order").
Under s. 1 of the ESA, the term 'employer' was defined as:
- any owner, proprietor, manager, superintendent, overseer, receiver or trustee of any activity, business, work, trade, occupation, profession, project or undertaking who has control or direction of, or is directly or indirectly responsible for, the employment of a person therein, and
- any associated or related corporations, individuals, firms, syndicates or associations treated as one employer under section 12, where any one has control or direction of, or is directly or indirectly responsible for, the employment of a person therein...
Section 12 of the ESA read:
- Where...associated or related activities, businesses, works, trades, occupations, professions, projects or undertakings are or were carried on by or through more than one corporation, individual, firm, syndicate or association, or any combination thereof, and a person is or was an employee of any of such corporations, individuals, firms, syndicates or associations, or any combination thereof, such corporations, individuals, firms, syndicates or associations, or any combination thereof, shall be treated as one employer for the purposes of this Act, if the intent or effect of the arrangement is to defeat, either directly or indirectly, the true intent and purpose of this Act.
- The corporations, individuals, firms, syndicates or associations treated as one employer shall be jointly and severally liable for any contravention of this Act and the regulations.
The employer was specified in the Order to be 930, the Appellant, CEI, 114, Jeffrey Hanemaayer and Jacobus Hanemaayer. Before the end of the 1998 taxation year, the Appellant satisfied the Order by making the payment of $252,297.00. In its 1999 tax return, the Appellant claimed a loss carryforward from 1998. The Minister reduced the amount of that carryforward by disallowing the deduction in the 1998 taxation year of the $252,297.00 payment.
The issue in this case was whether the payment made pursuant to the Order could be deducted by the Appellant in computing its profit or loss for the 1998 taxation year under s. 18 of the Income Tax Act.3 The court had to determine whether or not the Appellant incurred the obligation to make the payment for the purpose of gaining or producing income, either from its manufacturing business, or from the ownership of the shares of 930. The Appellant gave evidence that it had incorporated 930 in order to manufacture a product line that would be complimentary to its business of manufacturing motor homes, and that the interaction between the two businesses resulted in an economic advantage to both businesses. It argued that as a result of this interaction, the Appellant's obligation to make the payment was a legal obligation arising out of, and in the ordinary course of, the ownership of the shares of 930, thus making the payment an expense incurred in the course of the Appellant's business. The Minister argued that the expenditure was not deductible under s. 18 of the Income Tax Act because it was capital in nature, or alternatively, it was not made for the purpose of gaining or producing income.
4. The Decision
The court accepted the Appellant's evidence that the interaction between the two businesses resulted in an economic advantage for both, but refused to accept the argument that the payment was a deductible business expense of the Appellant. In coming to its decision, the court stated that if 930 had been in a position to satisfy the Order, the payment would have been deductible in the computation of 930's profits. The same could not be said of the Appellant, because its designation as an employer under the Order was simply a statutory fiction created for the financial protection of the unpaid employees.
For the payment to be deductible, it must have been made by the Appellant for the purpose of gaining or producing income. The court found that the payment made by the Appellant did not meet this test because the Appellant's obligation to make the payment arose as an incident to its ownership of the shares of 930, and not from any activity in the course of operating its own business. There was no connection between the payment to compensate the employees of 930 made under provincial statute and the revenue earning process of the Appellant. The Appellant was included as an employer in the Order because of s. 1 and s. 12 of the ESA, and the obligation to the employees was not part of its business.
The payment also did not contribute to the production of any income for the Appellant from the shares of 930. At the relevant time, 930 had ceased to operate, so the shares were not capable of producing any income for the Appellant either. It was not necessary for the court to deal with the Minister's argument that the payment was made on account of capital, since the court found that the payment was not made for the purpose of gaining or producing income.
To be deductible, a business expense must be made for the purpose of gaining or producing income. If a taxpayer is ordered to make a settlement payment under a statute based on their ownership of shares in a related business, the court is likely to find that the payment was made as an incident to that ownership, and not for the purpose of gaining or producing income for the taxpayer.
1. 2007 T.C.C. 618.
2. R.S.O. 1990 c. E. 14.
3. R.S. 1985, c. 1, 5th Suppl.
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