Kempo, T.C.C.J.:—This appeal concerns the appellants 1983 taxation year. Having sold a $342,633 trade account receivable for $50,000 during that year, the appellant claimed a deduction for the amount foregone in the computation of its profit for the year pursuant to subsection 9(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").
The respondent disallowed the claimed amount as an ordinary business expense and, rather, treated the disposition of the debt as giving rise to a capital loss within the meaning of paragraph 39(1)(b) of the Act.
In a nutshell, the appellant claimed that the disposition of the account receivable was on income account while the respondent asserted it was a capital transaction attracting capital treatment. Thus the issue was joined.
The E.C.E. Group Ltd. was formed on December 31, 1982 on the amalgamation of three companies which had previously carried on business as a partnership in the E.C.E. Group. For the purposes of what is in issue in this appeal, it was agreed by counsel for each party that no significant difference existed between the operations of the E.C.E. Group partnership and the corporate appellant. Therefore, and whether it concerns a pre- or a post-incorporation period, the appellants name will be used throughout these reasons for the sake of simplicity and clarity.
Evidence was given by Mr. Jack Chisvin who is an engineer and is the appellants chairman of the board. The appellant provides consulting services in the field of mechanical and electrical engineering in the areas of environment and energy. Specifically within the management aspect of its services, the appellant designed and managed mechanical energy systems for use within commercial buildings which included air conditioning, heating, lighting and power distribution. Their design and management services were directed to the efficient and cost effective distribution and consumption of such energy. This kind of service had been provided by them since 1955.
During the 1970s the appellant had developed engineering skills and knowledge in doing energy audits in existing buildings followed up by their design of improved control systems to reduce the energy consumed within the existing structure. This was heavily dependent on ongoing monitoring and, as the numbers of clientèle grew over a larger geographic area, the appellant realized the impracticality of sending individuals around from building to building over growing territories. However, the appellant lacked the technological experience of running central computer stations.
Dominion Electrical Products Ltd. (” Dominion") was then in the business of running central stations in the security and alarm fields. It was a wholly-owned subsidiary of an American public company, American District Telegram Incorporated, which had started a prototype system, as envisaged by the appellant, in New Jersey. Apparently they were not successful due to their lack of expertise in the energy side of the business. Dominion's expertise was in the remote monitoring of buildings as well as in collecting and directing data back to a central station. They also had the techniques in pricing and revenue management.
A.D.T. Energy Systems Ltd. ("A.D.T.") was incorporated under the laws of Ontario in the latter part of 1978. The appellant and Dominion were the sole shareholders, and each was to contribute their unique respective skills in order to enter into a new market. The appellant acquired 49 per cent of the shares for which it paid $196,000, and Dominion held 51 per cent for $204,000. Mr. Chisvin testified that each party felt the $400,000 capitalization would be sufficient to meet A.D.T.'s projected operational needs.
The parties entered into a shareholders’ agreement (tab 1 of the Book of Documents, Exhibit A-1) by which they agreed, inter alia:
— to buy-sell rights under which only Dominion had the right, after January 1, 1984, to call for the purchase of the appellant's shares. After that date the appellant could initiate the call for a sale of its shares to Dominion; it had no rights to acquire Dominion's shares. The price included matters of book value however under certain circumstances, regardless of book value, the minimum value of the shares was to be $300,000 after January 1,1984 and the appellant's shares would be 49 per cent thereof or no less than $147,000;
— to non-competition restrictions and conditions applicable during pre- and post-sale time periods;
— to discretionary borrowings as approved by the board; and
— to making further monetary contributions under certain conditions to meet board approved budgets.
A management services agreement (tab 2) was executed by Dominion and a consulting services agreement (tab 3) was executed by the appellant. The initial $400,000 treasury capital was expended to initiate the business and to acquire the required equipment. According to Mr. Chisvin, Dominion, on its own volition, had caused a considerable sum of non-budgeted expenditures to be made on the relocation and furnishing of the central monitoring station to its own premises. The appellant did not make any contributions thereto, nor had it ever made any monetary contributions to any non-budgeted expenditures throughout the three-year period for the reason that the financial projections in each year had indicated sufficient cash flow from operations to fund any such requirements.
Under its consulting services agreement the appellant provided the called- upon services on a fee-for-service basis. Invoices were prepared and delivered to A.D.T. on a monthly basis in the same matter and form as was used for the appellants other clientèle during 1981, 1982 and 1983. Invoice copies representative of those sent from A.D.T. to the appellant throughout the subject periods were reproduced under tab 4 of Exhibit A-1. They portray standard invoicing forms with a date, a project number and location, the period covered, and matters concerning progress billings if such was the case. The names of the individuals providing the services were disclosed along with the number of service hours they had expended on the described project.
Mr. Chisvin testified that, for the period 1979 to 1983, A.D.T. represented a very small proportion of the appellant's work. He said that of approximately $22 million in billings over that time, A.D.T.'s represented only around $343,000, that A.D.T.'s unpaid accounts were treated the same as all of the others for accounting and collection purposes, and that he had never regarded the accumulating and growing receivable as a form of loan to, or as a shareholder's investment in, A.D.T.
A statement of account dated November 30, 1983 (tab 5) details the appellant's unpaid invoices owed by A.D.T. per project commencing in 1979 which amounted to $342,632.88 as at that time. A significant number of the projects involved in these receivables concerned properties owned or managed by some of the appellant's largest and major “ blue-chip” type of clientèle whose goodwill and continuity of business was of prime concern to them in the area of new designs incorporating current energy technology for their new buildings which remained outside the non-competition agreement. Mr. Chisvin testified that the new-building projects falling outside the non-competition arrangement and the existing-building projects being serviced within the agreement both attracted the identical personnel, equipment, skill and knowledge of the appellant and thus any performance failures by A.D.T. may have negatively impacted on its own business with its own largest and best clients. Mr. Chisvin explained there were two basic business reasons why the appellant continued to provide services to A.D.T. during the three-year period while their payables to them were accumulating and growing. The first reflected the appellant's faith in A.D.T.'s potential; the second (and more important) concerned goodwill maintenance with the mutual clientèle just described. Other than the regular provision of invoices, no aggressive demands or postures for payment were taken. Mr. Chisvin was familiar with A.D.T.'s financial affairs; he said that until the latter part of 1982 he had remained optimistic about its prospects notwithstanding its operational losses. This soon changed, however.
During 1982 interest rates soared causing A.D.T.'s clients to be more concerned about debt servicing costs than costs related to energy saving matters. It became increasingly difficult to interest prospective clients in energy management when it represented a relatively minor cost of building management at that time as energy matters throughout North America became a non-issue. The appellant's optimism of A.D.T.s financial prospects waned. In response to these changing economic times, A.D.T. was considering changing its business focus into selling control systems outright which the appellant could not countenance as it would have put them in a conflict position whereby on the one hand they would design and specify systems and on the other they would have a financial interest in the company that would be selling them.
By 1983 it became apparent that it was in Dominion's interest to own A.D.T. outright. Informal discussions as to a buy-out eventually led to a formal agreement being executed as of October 7, 1983 (tab 6). Mr. Chisvin said that Dominion had become very aggressive in wanting the matter to be finalized before January 1, 1984 and that he did not know the reason for this urgency.
During price negotiations both parties were aware of A.D.T.'s financial state. According to accounting evidence, infra, it was then insolvent. It owed Dominion roughly $1.3 million, with no significant assets on hand. It owed $342,000 to the appellant in respect of the invoices fur professional services. The bargaining, and its results, were described in direct examination by Mr. Chisvin thusly:
Q. How was the amount of $50,000 for those accounts receivable arrived at? Do you recall?
A. It was just hard negotiation between two parties. Without being acrimonious, we tried to find an equitable distribution or value of the cost and eventually we ended up with $50,000 as being probably both sides being unhappy.
Q. Would you have had an eye to the financial statements or financial liability of A.D.T. in negotiating the sale of that debt?
A. Yes, we all knew exactly the state of A.D.T.
Q. Did you expect that there was a possibility of ever getting more for that debt than $50,000?
A. Highly unlikely.
Q. Why was that?
A. Because the company was. . .if a third party would look at the statement, they would say that the company was insolvent.
Q. I notice also in article 2.02, E.C.E. also sold its 49 per cent shareholding interest in A.D.T. to Dominion Electric for $170,000.
A. That's correct.
Q. Can you recall how that number was arrived at?
A. Again, it was a negotiation. D.E.P. probably took the position, as I recall, that there was no book value for the shares. E.C.E. said they had $196,000 that they paid for the shares and if we waited until 1984 we would receive at least $147,000 and we bargained the best we could to get something more than $147,000.
Q. Do you recall when you received the $50,000 for the account receivable?
A. It was probably in December of 1983.
Q. When you received the $50,000 for the account receivable, did you have any idea as to A.D.T.'s financial position at that point in time?
A. Yes.
Q. What was that?
A. It was essentially insolvent.
Q. Did it owe any money to Dominion Electric?
A. Yes, it did.
Q. Do you recall how much roughly?
A. $1.3 million or something of that nature.
Q. In light of the changes in the energy market that you mentioned in 1983, did you feel that more than $50,000 could have been obtained for that debt?
A. Certainly not from a third party. [T.39-41]
During his cross-examination, Mr. Chisvin acknowledged his awareness of A.D.T.’s continuing loss position. He said that if A.D.T. had shown its debt to the appellant on its financial statements as a long-term debt, it was then without particular significance to him. He pointed out that in 1981 the appellant had considered these receivables to be in the doubtful category and denied that A.D.T. was undercapitalized at its inception. He explained that a great deal of A.D.T.’s debt to Dominion arose out of non-budgeted, discretionary expenditures made by them which Dominion felt had fallen under their own managerial prerogative.
Mr. Peter Bill is a chartered accountant and was a member of the accounting firm in charge of the appellant's accounting matters. That firm was William Eisenberg & Co. which is now merged with Peat Marwick Thorne of which Mr. Bill is a partner. Mr. Bill’s knowledge and dealings with the appellant began in 1963. He verified that the receivables from A.D.T. were treated the same as all other receivables with the exception of the advantage gained by having access to A.D.T.'s financial statements, and that up until January 1, 1980 collection of A.D.T.'s accounts were not considered doubtful in his discussions with the appellant's management. Beginning in the year January 1, 1981 however, the accumulated unpaid accounts receivable from A.D.T. at that point of time, $158,185, was considered doubtful. The appropriate sums of this amount had been taken into income in the periods 1979, 1980 and 1981 but then the whole amount was removed from income in 1981 because there was then a doubt as to its collectibility. It was then added back into income in 1982 along with current receivables amounting to $164,251 for a total (rounded-out) of $322,443 which was then removed from income as being a doubtful debt. In 1983 the $322,443 was taken back into income plus an additional current receivable from A.D.T. of $20,190 which made up the $342,633 total receivable sold for $50,000. The sale proceeds were included in income and the appellant wrote off the foregone amount of $292,633.
Mr. Bill testified that he had reviewed A.D.T.'s financial statements to the end of 1982, that it was his opinion that A.D.T. then did not have the ability to pay the subject debt and that it was then insolvent. He became aware of the sale of the receivable after the fact.
On cross-examination Mr. Bill acknowledged that by using hindsight, and there being no value to goodwill at that point, A.D.T. was insolvent by the end of 1981. A.D.T.'s financial statements had been prepared by Price Waterhouse which consistently had described their payables to the appellant as "related party transactions" for the years ended December 31, 1980, 1981 and 1982. The explanatory note accorded to A.D.T.'s liability identified as “due to parent”, “due to associate" read as follows:
3. Related party transactions:
The company is 51 per cent owned by Dominion Electric Protection company and 49 per cent owned by The E.C.E. Group. The company is dependent upon its shareholders for certain management, administrative and technical services.
The amounts owing by the company to its shareholders are interest free and have no formal repayment terms.
Mr. Bill testified that the latter statement was incorrect because the appellant's invoices to A.D.T. had been issued in their normal course of business and subject to the appellant's normal repayment terms. As noted earlier Mr. Chisvin, as a board member of A.D.T., indicated he has probably seen this representation on its financial statement but that it was without any significance to him at the time. Mr. Bill said he was not consulted with respect to business-related matters of the appellant.
One of the facts relied upon by the respondent, as reflected in paragraph 5(f) of the reply to notice of appeal, was that"A.D.T. paid the full amount of its payable to [Dominion] in 1983”. No direct evidence was led with respect to this aspect of the matter by either party. This amount must have been paid after Dominion had exclusive control over A.D.T.'s affairs; the reason for, or methodology of, its payment is unknown and therefore remains merely speculative.
No accounting opinion evidence of an expert nature was called by either party.
The nub of the respondent's assessing position is reflected in paragraph 5(e) of the reply; and is summarized in paragraphs 6 and 7 thereof:
5. In assessing the appellant to tax for its 1983 taxation year, the respondent proceeded upon the following facts:
(e) the appellant never made any effort to collect its receivable from A.D.T.; indeed, following its claim for an allowance for doubtful debts as at January 1, 1982, the payable by A.D.T. was increased by $97,407 and $20,189 in 1982 and 1983 respectively;
(f) A.D.T. paid the full amount of its payable to D.E.P. in 1983;
(g) the disposition by the appellant of A.D.T.'s indebtedness to it was not a transaction occurring in the ordinary course of the appellant’s business;
(h) the appellant's receivable from A.D.T. was not a doubtful account or a bad debt during the appellant's 1983 taxation year;
(i) as at the end of its 1983 taxation year, the appellant did not have a debt owing to it from A.D.T.;
(j) the disposition by the appellant of its receivable from A.D.T. resulted in a capital loss to the appellant in its 1983 taxation year.
6. The respondent relies, inter alia, upon sections 3, 9, paragraph 20(1)(p) and 40(2)(g)(ii) of the Income Tax Act, R.S.C. 1952, c. 148 as amended ("the Act").
7. The respondent respectfully submits that the appellant has properly been assessed for its 1983 taxation year as it did not have a debt owing to it which had become a bad debt in the year, and therefore no deduction is available to the appellant in respect of the prior indebtedness of A.D.T. under paragraph 20(1)(p) of the Act. The respondent submits that the disposition of the debt to D.E.P. gave rise to a capital loss to the appellant for its 1983 taxation year, the deduction of which is governed by sections 38, 39,40, 53, 54, 111 and 3 of the Act. He further respectfully submits that the appellant and D.E.P. were not dealing with one another at arm's length, and therefore the loss from the disposition of the debt to D.E.P. is deemed to be nil by virtue of subparagraph 40(2) (ii) of the Act.
With respect to the allegation in the last part of paragraph 7 that the loss ought to be nil rather than as capitalized by the respondent, counsel for the appellant was quite correct, in my view, in her submission that to now accede to this position would amount to allowing the respondent an appeal from his own assessment which cannot be done.
Additionally the respondent has effectively recognized and accepted an arm's length situation between the appellant and Dominion in that not only did he allow a loss but also in his reply, by paragraph 2, he specifically admitted the appellant's pleading in paragraph 4 of their notice of appeal that the appellant had sold A.D.T.'s debt "to an arm's length purchaser".
Counsel for the appellant submitted:
— the loss here did not arise in a capital context but rather arose on an income account receivable incurred in the very course of carrying on its revenue earning activity. A.D.T.’s debt to the appellant was not a shareholder’s loan or investment vehicle. It arose in the same manner and received identical treatment as those of the appellants other clientèle. The decision to continue providing services was a normal business decision founded on solid business reasons. The simple passage of time does not convert a trade receivable into a shareholder investment, or a loan by deficit financing, in the absence of the appellants intent to do so. A.D.T.’s representations in its financial statements merely conformed with normal accounting rules whereby related company transactions were to be shown separately;
— the account receivable sold by the appellant to Dominion at a loss was a trade account receivable from A.D.T. which arose from, and was disposed of in, the course of the appellant's business;
— at the time of the sale the debt was uncollectible and bad as A.D.T. was then financially insolvent;
— there exists no logical reason which compels the appellant to bring into income and pay tax on $342,633 of revenues when it received only $50,000 of those revenues;
— essentially, when a trade debt is sold other than in the course of the sale of an entire business, any loss therefrom remains an ordinary business expense.
This may be so because section 22 of the Act attracts capital treatment on the sale of receivables in the course of selling the whole business out of which it arose. When that is not the factual case, income treatment is the appropriate one, provided it was a trade debt;
— the claimed amount of $292,633 was a loss arising in the appellant's business which is deductible pursuant to subsection 9(1) of the Act, otherwise its profit for the year becomes grossly overstated.
Counsel for the respondent submitted:
— the true characterization of A.D.T.'s debt to the appellant was in the nature of deficit financing through the provision of services route. The account was always in arrears and was allowed to increase from year to year by the provision of further services at a time when A.D.T.'s deficits were growing from $176,000 in 1979, $524,000 in 1980, $705,000 in 1981 to $1,013,489 in 1982. As at 1982 there existed a minimum of $818,000 in available losses to A.D.T. The original $400,000 injected was inadequate, and this was the appellant shareholder’s way of injecting further financing;
— A.D.T.'s financial statements had been prepared by a reputable firm of chartered accountants which reflected the subject liability was not an ordinary account payable;
-— the appellant disposed of the right to receive the A.D.T. debt which is a Capital transaction;
— the subject receivable was in the nature of a capital asset on the appellant's balance sheet which it disposed of in 1983 and the respondent has recognized the disposition of that asset as giving rise to a capital loss;
— it is common ground that the appellant had treated the subject receivables in accordance with proper accounting principles and in conformity with the Act, and paragraph 20(1)(p) does not apply because there was no A.D.T. debt in existence at year-end to be written-off thereunder.
Analysis and conclusions
I. (a) With respect to the first branch of the case, the evidence fails to support respondent-counsel's submission that the true nature of the trade account was deficit financing and thus an investment in A.D.T. Rather, the evidence was that it arose as an ordinary trade debt. Mr. Chisvin's explanations concerning the annual increases and non-payment were, in my opinion, appropriately founded on reasonable business reality and on justifiable expectations at that time that marketing matters would improve. Concurrently, his concerns about disturbing existing clientèle relations was realistic and reasonable. His evidence, that A.D.T. had been appropriately capitalized at the outset and that its subsequent losses arose out of unforeseen changes in the market place and non-controllable decisions made and carried out by Dominion, has not been refuted nor diminished in any way.
(b) The two to three-year period of growth in and non-payment of this receivable account is not of itself determinative. In D.W.S. Corporation v. M.N.R., [1968] 2 Ex. C.R. 44, [1968] C.T.C. 65, 68 D.T.C. 5045 (Ex. Ct.), affirmed without written reasons 69 D.T.C. 5023 (S.C.C.), the Court concluded that ten years of non-payment did not attract capitalization of the trade debt. The analysis of Thurlow, J. at page 76 (D.T.C. 5052), is equally applicable to the case at bar:
It was said first that the evidence showed that the appellant's liability for a large portion of the balance owing in the account had been in existence for more than ten years and that it should on that account be regarded as having been a capital rather than a trading obligation. With respect to this submission I am unable to see how, in the absence of any applicable statutory provision, the mere length of time in which the obligation was outstanding has any effect in a situation of this kind in changing what was, at the time it was incurred a trading obligation into an obligation on capital account.
(c) Further, the characterization of the debt as being a trade debt at all times has not been diminished by reason of its recording in A.D.T.'s financial statement as related party transactions rather than as trade liabilities. The situation in Sutherland v. Canada, [1991] 1 C.T.C. 495, 91 D.T.C. 5318 (F.C.T.D.), a decision not cited by either counsel, involved an analogous issue as to the characterization of two years of unpaid management fees which the debtor, while suffering ongoing operational losses, had classified as shareholder's advances in the notes to its financial statements. The taxpayer-creditor sought to deduct the unpaid fees as a bad debt rather than as an allowable business investment loss as the Minister had treated it. The taxpayer had included the full amount of the fees as earned income for each of the two years. The Court noted the debtor was at all times financially incapable of paying it even if a demand had been advanced. Noting that the taxpayer's subjectively based assertions had the support of the testimony of his accountant as to the true nature of the unpaid management fees, the Court, at page 502 (D.T.C. 5324), determined
The notes to the [financial] statements were not intended to be a definitive classification of the nature of the various liabilities for any purpose, but rather, were intended to inform third parties that such liabilities did in fact exist.
An identical conclusion is applicable here. The notes to A.D.T.'s financial statements themselves do not prevail over the testimony of Messrs. Chisvin and Bill that the subject liabilities had at all times been perceived and treated as arising out of the appellant's trade.
(d) In summary, the evidence establishes that the appellant's trade account with A.D.T. had not at any material time constituted a form of equity financing or investment in A.D.T., that its genesis was the appellant's income earning operations, that it had not gained any separate characteristics by the passage of time or by the manner it was reflected in A.D.T.'s financial statements and that it remained a trade account until its disposition.
II. Respondent-counsel's alternate submission that the transaction here was capital because it represented the sale of a right to collect the account (i.e., a capital property) is not sustainable. Analytically, this perception contemplates the presence of two severable elements within this account; one being a right to its receipt and the other as something else. No authorities were advanced in support. Indeed, and interestingly enough, other taxpayers have, unsuccessfully, advanced similar logic on seeking to capitalize-out foreign exchange gains arising out of payments made on their trade accounts: cf. Eli Lily and Company (Canada) Ltd. v. M.N.R., [1955] C.T.C. 198, 55 D.T.C. 1139 (S.C.C.) and Tip Top Tailors Ltd. v. M.N.R., [1957] S.C.R. 703, [1957] C.T.C. 309, 57 D.T.C. 1232. In D.W.S. Corporation v. M.N.R., supra, the Minister, unsuccessfully, sought to disallow a deduction for foreign exchange losses suffered by the taxpayer in paying trade accounts by, inter alia, isolating foreign exchange matters out of these liabilities. M.N.R. v. Independence Founders Ltd., [1953] 2 S.C.R. 390, [1953] C.T.C. 310, 53 D.T.C. 1177 is another example in which the taxpayer was unsuccessful in the attempt to isolate a capital element out of its ownership of certain investment certificates which it held for the purposes of its business.
III. There are two aspects to the final branch of the case.
(a) All parties agreed the appellant had throughout the period complied appropriately with paragraph 20(1)(e) of the Act. The annually determined trade receivables from A.D.T. had been included in the appellants income for each year, it was then fully deducted at each year-end as a doubtful account followed thereafter by its inclusion in income in the immediately following taxation year. The fiscal problem as I understand it arises because the debt, having been disposed of during the year, was not owned by the appellant at its 1983 year-end. If it had been held and written off fully at year-end as a bad debt (which was to all intents and purposes qua the appellant uncollectible and bad at its disposition), it would have attracted full deductibility as and on account of an income-based trade account.
Within this line of thinking, counsel for the respondent submitted that subparagraphs 20(1)(e) and (p), infra, of the Act are a complete code respecting doubtful and bad debt deductibility, and that if the factual situation does not fall within its parameters there is no statutory vehicle permitting deduction. In other words, once the prior years' trade receivable had been taken into income as a doubtful account at the commencement of the 1983 taxation year, there is no statutory mechanism for its deductibility if it was not owned by the appellant at its year-end.
The material provisions of subsection 20(1) the Act as they read in 1983 follows:
20. Deductions permitted in computing income from business or property.
(1) Notwithstanding paragraphs 18(1) (a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:
(e) Reserve for doubtful debts.—a reasonable amount as a reserve for
(i) doubtful debts that have been included in computing the income
of the taxpayer for that year or a previous year,
(p) Bad debts.—the aggregate of debts owing to the taxpayer
(i) that are established by him to have become bad debts in the year,
and
(ii) that have been included in computing his income for the year or
a previous year;
In my view, respondent-counsel's interpretative conclusion bears some scrutiny as it is not without difficulty. There is a line of authority which requires that a determination of debt collectibility ought to be made at or near the creditor's year-end. However, that is not the precise issue here. In the first place, this provision does not say in clear and unambiguous language that the debt is to be owned at the end of the taxation year. Such desirable clarity is found, for example, in subsection 50(1) which states, and I am paraphrasing, that for the purposes of subdivision (c) (taxable capital gains and allowable capital losses) where a debt owing to a taxpayer at the end of a taxation year is established by him to have become a bad debt in the year the taxpayer is deemed to have disposed of the debt at the end of the year and to have reacquired it immediately thereafter at a cost equal to nil.
The language of paragraph 20(1)(p), supra, is not worded in the prohibitive. Rather, it permits a deduction in the computation of business income for debts owing to the taxpayer in the year that have become bad in the year. The word "owing" ostensibly has formed the foundation for the respondent's longstanding interpretative conclusion that it means owing at a point of time which is at year-end when the income for the full fiscal year is known and is being computed. In my opinion, it is equally reasonable that the word "owing", when interpreted contextually with the other words of paragraph 20(1)(p), may also be read in the past tense to include matters which had happened during the year. In other words, the mixed tenses of the terminology employed of "owing" and “to have become” may well reflect legislative intent to permit a deduction for a trade debt that had been owing in the year and which had gone bad in the year. As I see it this interpretative approach harmonizes the actual text and its tenses, and it avoids internal disharmony. It would also be in accord with section 11 of the Interpretation Act which states:
Every enactment shall be deemed remedial, and shall be given such fair, large and liberal construction and interpretation as best ensures the attainment of its objects.
The objects of paragraphs 20(1)(e) and 20(1)(p), supra, are in recognition of ordinary and sensible commercial accounting principles wherein the actual realization of profits, which are to be included in income at the time they are earned, may either be delayed or not received at all. The appellant's receivables from A.D.T. had already been recognized as income in the calculation of profit under subsection 9(1), and paragraphs 20(1)(e) and 20(1)(p) simply maintain that status. That being the case, there is no logic driving paragraph 20(1)(p) to mean that a loss on a bad debt is deductible as a business loss only if it is held to the creditor's year-end but is not deductible as a business loss if it was sold during the year in an arm's length transaction for some consideration.
In respondent's Interpretation Bulletin IT-442R, paragraph 1, the highlighted portions appear to address the appellant's situation. It reads:
Discussion and Interpretation
Bad Debts
1. Subparagraph 20(1)(p)(i) authorizes a deduction for a bad debt if the following requirements are met:
(a) the debt was owing to the taxpayer at the end of the taxation year, (b) the debt became bad during the taxation year, and
(c) the debt was included or is deemed to have been included in the taxpayer's income for that taxation year or a previous taxation year.
The requirement in (a) above prohibits a deduction under subparagraph 20(1)(p)(i) where a debt was sold, discounted or assigned absolutely by the taxpayer during the course of the year, even though the taxpayer may remain liable to indemnify the purchaser or assignee if the debt should prove to be uncollectible.
However, where such a debt was of a kind that would have qualified for consideration as a bad debt had it been retained until the end of the taxation year, any loss at the time of its disposition, or later because of non-payment by the debtor, would normally be deductible by the taxpayer as a general business expense. Such loss would be deductible provided the disposition of the debt was made in the ordinary course of the business or as part of trading in accounts receivable.
[Emphasis added.] In my view respondent-counsel's submissions, that paragraph 20(1)(p) is part of a complete code which in turn operates to prohibit the deduction, are not sustainable. The words employed, together with its want of linguistic clarity, weighs against these conclusions. Further, any doubts arising out of ambiguous provisions are to be resolved in favour of the taxpayer. Accordingly, paragraph 20(1)(p) does not preclude the deduction sought for the loss.
(b) There is a further approach which logically flows from and arises out of the present analysis. It is this. If paragraph 20(1)(p) neither governs nor applies to the actual factual situation, then the entire matter remains to be accountable under ordinary accounting principles under subsection 9(1) of the Act. Associated Investors of Canada Ltd. v. M.N.R., [1967] 2 Ex. C.R. 96, [1967] C.T.C. 138, 67 D.T.C. 5096 was not raised by either counsel. There, the Minister’s counsel urged (as it was here urged) that no deduction for a bad debt could be made unless it was authorized by paragraph 11(1)(f), which is now paragraph 20(1)(p), of the Act. Jackett, P. (after finding the advances made by the taxpayer to its sales employees which had become non-recoverable were made as an integral part of the business operations) said at page 149 (D.T.C. 5102):
Section 11(1)(f) [now 20(1)(p)] does not, in terms, prohibit any deduction for "bad debts". It does, however, expressly authorize in qualified terms a deduction that could have been made, in accordance with ordinary business principles, in the computation of profit from a business. /t might therefore have been thought, as the respondent contends, that a deduction for a "bad debt" that is excluded from section 11(1)(f) by the qualifications expressed in it is impliedly prohibited. Such an interpretation would however, have results that cannot, in my view, have been contemplated. For example, a bond dealer, who, in effect, buys and sells debts would, on such interpretation, be precluded from taking into account losses arising from bonds becoming valueless by reason of the issuing company becoming insolvent. If section 11(1)(f) is not to be interpreted as impliedly prohibiting such an obvious and necessary deduction in arriving at the profits of a business, I am of opinion that it is not to be interpreted as impliedly eluding the deduction of the losses that are in question in this appeal, which, in my opinion, are just as obvious and necessary in computing the profits from the appellant's business.
[Emphasis added; footnote omitted.]
These observations and findings, and its rationale, are all equally applicable to the matter at bar and the loss on the sale of A.D.T.s debt would be deductible under subsection 9(1) in the calculation of the appellant's business profit for its 1983 taxation year which reads:
9. Income from business or property.
(1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.
The following proposition expounded by Hannan and Farnsworth in Principles of Income Taxation, (England: Stevens & Sons Ltd., 1952) at page 438 is applicable to the matter at hand. It was raised and relied upon by counsel for the appellant:
Any loss incurred in the course of operations directed to the earning of profits is, in principle, an allowable deduction. The principle necessarily excludes losses of a capital or private nature. . . .
The commonest examples of such losses are afforded by bad debts for goods supplied to customers. Where the relevant charges have been brought to account and treated as income derived. . .there is no rational ground for refusing a deduction in respect of losses incurred through the non-realisation of that income. . . .
Non-realization of earned business income can happen in many ways. Full write-off is just one, sale at a discount triggering a loss is another. The purported fiscal non-recognition of the loss which arose here leads to absurdity, and it results in taxation of non-realized income. The appellant appropriately included the $50,000 proceeds of disposition in income in the calculation of its profit for 1983 pursuant to subsection 9(1), and in my opinion it appropriately deducted the net loss arising therefrom as a business loss in accordance with that provision.
Conclusion
For the reasons given, I find that the appellant has shown error on the part of the respondent and that the amount of the claimed loss is deductible pursuant to subsection 9(1) of the Income Tax Act. Accordingly the appeal for the appellants 1983 taxation year is allowed, with costs, and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the appellant is entitled to a deduction from income for the year in the amount of $292,633 pursuant to subsection 9(1) of the Income Tax Act.
Appeal allowed.