Ozawa v. R., 97 DTC 1500, [1998] 2 C.T.C. 2035 (TCC)

Sarchuk T.C.J.:

• (i) in the 1987 taxation year, the amount of $208,000 arising from a series of shareholder loans made to him by Canadian Thermal Paper Inc. (CTP) and a shareholder benefit arising from a deemed interest benefit of $5,735;

• (ii) in the 1988 taxation year, shareholder benefits arising from a deemed interest benefit of $19,325, from personal travel expenses of $3,929 paid by CTP and from personal expenses related to the purchase of golf equipment and clothing by CTP to the value of $1,854;

• (iii) in the 1989 taxation year, shareholder benefits arising from a deemed interest benefit of $6,056 and from personal travel expenses paid by CTP of $10,090; and

• (iv) in the 1990 taxation year, shareholder benefits arising from a deemed interest benefit of $9,399.

2 CTP was incorporated in Ontario in 1985 and commenced operations on March 1. It acted as the sole Canadian distributor of thermal paper and transfer ribbons produced by Ricoh Electronics Inc. At all relevant times the Appellant held 80% of the outstanding shares of CTP with the balance being held by his wife. As well, since approximately 1975, the Appellant and his wife carried on the business of importing, wholesale distributing and retailing of Japanese food and giftware items from their residence. Ozawa Canada Inc. (OCI) was incorporated in 1985 to take over this business and also commenced operations on March 1. The Appellant and his wife each held 50% of the outstanding shares of OCI. The fiscal year end of both CTP and OCI was February 28.

The Shareholder Loan

3 During 1987, the Appellant received a number of loans from CTP in the net amount of $208,000. This amount was not repaid at any time prior to February 28, 1989 and in fact remained outstanding throughout the Appellant's 1990 taxation year. No bona fide arrangements were made at the time the loans were received for their repayment within a reasonable time.

4 The Appellant does not dispute the fact that in all of the years in issue, he obtained a number of loans from CTP. The Appellant also concedes that in taxation year 1987 the net amount borrowed from CTP was $208,000; that all of the monies advanced were deposited into his personal account and that a very substantial portion thereof was used to complete the construction of a new family residence. However, he says that throughout the years, he advanced money to both OCI and CTP. He further explained that in the first few years following the incorporation, OCI was attempting to increase both the volume and the scope of its imports and thus, given the nature of its business, it was the primary recipient of such funding. He said the sale of a rental house provided one source of the funds and he also spoke of a second mortgage on a rental house, a portion of which was advanced to OCI. The Appellant concedes that he kept no track of the amounts advanced to OCI (or to CTP) in the taxation years in issue or the years prior thereto. He can only say that the amounts were fairly substantial.

5 Since OCI was, according to the Appellant, generally unknown to potential suppliers it was initially only possible to purchase inventory by making personal contact and paying for purchases in cash or by way of a bank draft.[FN1: <p>The Appellant conceded that certain contacts were made during the 10 years the import business was carried on prior to incorporation.</p>] To this end, the Appellant or his wife visited Japan several times each year (on a rotation basis). To finance the required purchases, funds were borrowed from CTP. Other sources of funds were also used, such as a personal bank account in Japan and advances from his brother who lived there.[FN2: <p>The Appellant also made references to being a beneficiary of his mother's estate but also left the impression that his brother in some manner had management or control over these funds. Although his evidence on this point is unclear, as I understood him these funds were another source of payment for OCI purchases.</p>] Few documents were available to confirm when and what amounts he and his wife had advanced for OCI's inventory purchases in Japan. To cast some light on the matter, the Appellant instructed his office manager, Margaret L. Smale (Smale), to analyze all available OCI documents in an effort to determine the cost of the inventory acquired and if possible, to establish the total amount paid by OCI for this purpose. Her review of invoices and other documents on a shipper-by-shipper basis disclosed an “invoice total” for the period May 1, 1985 to February 28, 1990 of 70,116,098 Japanese yen (yen). Then by reference to the available documentation, Smale found support of “proof of payment” for these invoices in the amount of 42,653,766 yen. She testified further that she was unable to specifically match “payments” amounting to 5,693,149 yen to any purchases of inventory.[FN3: <p>These documents included invoices, customs forms and bank documents such as cable transfers, bank drafts, outgoing remittance and confirmation forms, foreign exchange confirmations, and other bank statements.</p>] The records also disclosed payments of $56,854 (CAN) which, she said, reflected foreign payments made on behalf of OCI by its bank, but she was unable to establish to whom or for what purpose these payments were made. Her summary also includes a $7,000 (US) transfer from OCI to the Appellant in Japan which he asserted was used for direct payments to suppliers.[FN4: <p>Exhibit A-5 - “Purchases in Japan Summary”.</p>]

6 The Appellant's position is that the discrepancy between the total of the foregoing payments (yen and dollars) and the total amount invoiced for inventory purchased represents payments made in cash to suppliers in Japan by the Appellant or his wife in the taxation years in issue.[FN5: <ul>In the course of the submissions being made by Counsel for the Appellant, this issue arose and the following exchange took place:<li><p>HIS HONOUR: I take it your position is that the differential exceeds, by a substantial amount, the $208,000 borrowed by the Appellant?</p></li><li><p>MR. LAI: I believe this amount wouldn't exceed $208,000.00.</p></li><li><p>HIS HONOUR: It would not?</p></li><li><p>MR. LAI: It would not exceed—hold on. Mr. Ozawa advised me that he believes it would exceed $200,000.00.</p></li><li><p>HIS HONOUR: It which?</p></li><li><p>MR. LAI: It would exceed $200,000.</p></li><li><p>HIS HONOUR: Let us work on the assumption that the argument is that from 1985 to 1990, the items in respect of which it is alleged that payments were made but are not supported by any documents that exceeds $200,000. Proceed on that basis just for the sake of argument.</p></li><li><p>MR. LAI: Mr. Ozawa has just advised me that that amount would be about $250,000.</p></li></ul>] Although a number of receipts and invoices were referred to by the Appellant (many written in Japanese), no effort was made by the Appellant to adduce evidence as to the quantum of these payments in Canadian dollars.[FN6: <p>The Appellant's testimony was that there was substantial fluctuation and variation in the exchange rates in the taxation years in issue. To put the Japanese yen numbers in this paragraph into some perspective the exchange rate at one stage in 1986 was 10,000 US = 1,781,000 Japanese yen. Quantification of the alleged payments is further made difficult by the fact that the Appellant, whentraveling to Japan, first converted Canadian currency to US currency and then to Japanese yen.</p>]

7 At all times the records and books of account of OCI were kept by the Appellant and his wife.[FN7: <p>The Appellant testified that in December 1986, Smale was hired as an office manager to do the books for both companies. Smale testified that she was employed by CTP and was in charge of “order entry, customer liason, accounts receivable, accounts payable for the day-to-day invoices, just the general overseeing of the office”. She specifically stated that she did not keep the booksfor OCI and was not privy to the organization of OCI's records during the relevant periods of time.</p>] As to the lack of records with respect to the purchases in Japan, the Appellant testified that he was only an engineer and that his and his wife's skills in bookkeeping were very poor. He does not dispute that at all relevant times, the corporations' financial statements were prepared by accountants but, he said, there was never sufficient time to check them for accuracy. He alleges he reviewed them at a much later point of time, “found some things funny”, and in particular questioned the gross margins for fiscal years 1987 and 1988 shown on the OCI Statements of Income and Retained Earnings.[FN8: <p>Exhibit A-2.</p>] These, he said, failed to reflect the fact that the Appellant and his wife spent their own money to purchase inventory for OCI in Japan. He placed blame for this lapse on the accountants, suggesting that they may have ignored or overlooked receipts and other documents because they were written in Japanese.

8 In substance, the Appellant asserts that the amounts advanced over the years, principally to OCI (both before and after 1987), exceeded the amount borrowed from CTP in 1987. His counsel submitted that the companies were closely connected, they shared premises and the shareholders and officers were the same. As Counsel said:

It was Mr. Ozawa's evidence that the money he put into the companies was moved from company to company, as needed, mostly from Canadian Thermal to Ozawa Canada, and that he also, himself, put up money for Ozawa Canada. It's our position that the money that he put up for Ozawa Canada, when he received money from Canadian Thermal, that was to be a reimbursement of his personal monies for Ozawa Canada, and in that respect, those would then be treated as a loan from one corporation to another resident — both corporations are resident in Canada, and in that instance, subsection 15(2) relates — refers or has an exception for corporations resident in Canada.

9 The issue is whether the evidence adduced by the Appellant supports this assertion. Setoff is an amount which is or may be set off against another in the settlement of accounts. In Gannon v. Minister of National Revenue,[FN11: <p>(1988), 88 D.T.C. 1282 (T.C.C.), at 1283.</p>] the Appellant had argued that “ ... it is fundamental both in common law and under the tax law that the principle of setoff be honoured” and that the Minister erred in failing to recognize the indebtedness of the Company to him. The Court held that there is no authority for the proposition advanced which in essence was that mutual debts cannot co-exist and that in all cases where they might arise, a setoff is automatically effected. In his judgment, Bonner J. referred to Bank of Montreal v. Tudhope, Anderson & Co.[FN12: <p>(1911), 21 Man. R. 380 (Man. C.A.).</p>] and stated:

...The authority cited by the Appellant does not support his position. In Bank of Montreal v. Tudhope, Robson J. referred at page 386 to Watson v. Mid-Wales Railway Company and said:

Willes J., points out that mere cross-claims do not necessarily give an equity to set off, much less so when they are in futuro. He says: “It is necessary to shew mutual credit: I do not mean in the sense of mutual credit under the statutory provisions of the Bankrupt Law, but in the sense of there being an agreement or contract made or to be inferred that one debt was to liquidate the other. Where the balance only is to be the debt, there is a clear equity that one of the parties is not to have any detriment by the act of the other. But here the debts are payable at different times. There is nothing from which we can infer that one liability was to liquidate the other, or that the balance only was to be considered due”.

10 As to the Appellant's position that the monies advanced to the companies were moved from company to company as needed and thus could be treated as loans from one corporation to another, I make reference to Wolf v. Minister of National Revenue[FN13: <p>(1992), 92 D.T.C. 1858 (T.C.C.).</p>] in which Rip J. noted at page 1860:

A right of setoff applies only against cross-demands which are connected with each other. There must be mutual debts due between the same parties and in the same right: Richards v. Bank of B.N.A. (1901), 8 B.C.R. 209 at 213.

There is no question that if one consolidates the accounts of Holdco and Ottawa, Wolf is a creditor and not a borrower. However, the accounts are those of three distinct parties, Holdco, Ottawa and Wolf, and each party has a different legal relationship with the other. Wolf is creditor of Holdco but debtor of Ottawa, Ottawa is creditor of Wolf but debtor of Holdco. There were no mutual debts due between any two of these parties which could be said to cause setoff to apply.

11 In Tick v. Minister of National Revenue,[FN14: <p>(1972), 72 D.T.C. 6135 (Fed. T.D.).</p>] the facts were even more similar to the case at bar. The Appellant, Tick, owned five corporations and was indebted to four, but the fifth corporation owed the Appellant an amount greater than the aggregate of his debts to the others. He asserted that since he was an overall creditor rather than a debtor, the debts he owed to the four corporations should not be included in his income as deemed dividends. Heald J. stated at page 6139:

I cannot agree with this submission. I have to look at the relationship between the Appellant and each of the four corporations whom, the Respondent alleges, “loaned” money to him. I cannot look at a fifth corporation to whom he may have loaned money. Nor can I treat these transactions as only involving one company or “one pot” as the Appellant seeks to do.

...he testified that he put so much money into the companies that he thought he was taking -- when he took money out, he was taking his own money out.

...whenever one company needed money, it was taken from the other one or from himself, if he had the money available. It's our position that this whole series of events was closely connected in that he put money in, he took money out and he thought...

12 There is another reason why the Appellant cannot succeed. A reasonably accurate quantification of the mutual debts is imperative but in this case the evidence does not even provide a basis for an informed guess as to the amounts alleged to have been advanced to or expended on behalf of OCI. The onus is on the Appellant to establish both the existence of his right to a setoff and the amount of the setoff. The Appellant has failed to do so.

Deemed Interest Benefit

13 During his 1987, 1988, 1989 and 1990 taxation years, the Appellant was, from time to time, indebted to CTP in amounts exceeding $208,000. He paid nil percent interest on the total debt owed to CTP during those taxation years.

14 It is the Respondent's position that the Appellant received a benefit from the fact that he was charged nil interest on the total debt owed to CTP and that the benefit so received by the Appellant was an amount equal to the deemed interest on the net shareholder debt in excess of $208,000, being $5,735, $19,325, $6,056 and $9,399 in the taxation years in issue, respectively, which benefit was conferred on the Appellant in his capacity as a shareholder of CTP.[FN15: <p>Exhibit R-9 consists of, in part, schedules reflecting the Adjusted Section 80.4 Interest Calculations for each of the taxation years 1985 to 1987 inclusive. These calculations, prepared by Revenue Canada, have been accepted by the Appellant as correct and are not in dispute.</p>]

15 The Appellant's position is that the transactions giving rise to these inclusions were not in the nature of a shareholder debt. In view of my conclusion on the previous issue, this position is not tenable.

Las Vegas Trip

16 In July 1988, Ricoh Electronics Inc. held a reception to celebrate its 15th anniversary at its offices near Los Angeles, California. The Appellant, as executive officer of Ricoh's Canadian distributor, and his family were invited. The Appellant testified that business meetings with Ricoh staff were held for approximately three days following which he had further meetings with current and potential suppliers of Japanese products to OCI, located in the Los Angeles area. On the intervening weekend the Appellant and his family flew to Las Vegas at, he said, his own expense. There is no suggestion by the Appellant that he conducted any business in Las Vegas.

17 CTP maintained a charge account with American Express Canada for payment of its business expenses. Five pages of the account dated August 3, 1988 were produced by Counsel for the Respondent.[FN16: <p>Exhibit A-12.</p>] Upon cross-examination, the Appellant conceded that the bulk of the trip expenditures which had been charged to CTP were in fact personal in nature. In addition, it was also conceded that several other charges (unrelated to the Las Vegas trip) were personal. Last, although several items on the account may have been related to the business affairs of CTP, the Appellant was unable to provide sufficient particulars to establish that as a fact.

18 This issue was virtually conceded by the Appellant during the course of the trial. The several items which he questioned (reflecting restaurant and automobile charges) were not, in my view, adequately identified as corporate expenses. Accordingly, the Appellant cannot succeed.

Golf Equipment

19 In 1988, the Appellant purchased a number of items of clothing and golf equipment at the Beacon Hill Golf Club (the Club) where he was a member. CTP paid the amount of $1,854 in respect of these personal expenses. The Appellant testified that a set of Ping golf clubs was purchased to be used as a sample by OCI in order to expand its line of products. The Club, although directed to do so, failed to bill the Appellant personally for the cost of the equipment and ultimately, by mistake, it was paid for by a cheque drawn on CTP's account. He asserts that these golf clubs were sold to a customer and at no time were put to personal use. I note with respect to the golf clubs that there is no record evidencing a receipt of funds by OCI or CTP with respect to this sale nor was any evidence offered in this regard by the Appellant.

20 The Appellant's testimony is not convincing. He conceded that one item, a golf bag, was purchased for his own use. He also said that certain other smaller items of men's wear were purchased for personal use or for customers but was unable to be more specific. On balance, I must find that the Appellant has failed to establish that the items purchased were anything other than personal expenses and thus, the payment in respect thereof made by CTP constituted a benefit conferred on the Appellant.

Cash Advance

21 In 1989, the Appellant caused CTP to issue a cheque for $10,090 (US) made payable to the order of cash. The Minister assumed that CTP paid the amount of $10,090 (CAN) in respect of a personal trip to California made by the Appellant during his 1989 taxation year. The Appellant said this amount was not a personal travel expense. The funds were drawn on an American currency account maintained by CTP in order to purchase $9,000 (US) in traveller's cheques which together with $1,000 in cash were taken to Japan, exchanged for yen and used to purchase inventory for OCI. The Appellant made reference to a series of documents to establish some of the purchases made during his week-long stay in Japan.[FN17: <p>Exhibit A-3.</p>]

22 It is fair to say that some of these funds may have been used to purchase goods in Japan for resale by OCI in Canada. However, the onus is on the Appellant to establish on a balance of probabilities both the fact of purchase and the amounts so expended. That has not been done. The Appellant said that almost the whole of the amount in issue was spent by him on OCI purchases. However, the receipts referred to by him appear to reflect the expenditure of approximately 112,000 yen.[FN18: <p>I note from his testimony that during this visit, he exchanged US currency in Japan, receiving 133,150 yen for $1,000 US. Exhibit A-3, page 42.</p>] Furthermore, the receipts themselves being written in Japanese (and not translated or otherwise authenticated) are not capable of providing independent proof of either purchase or cost.[FN19: <p>I feel obliged to note that most of the documents referred to in the various exhibits filed by the Appellant for the purpose of establishing both the existence of the purchases and their quantum, are written in Japanese. These documents were filed without objection. Credibility, particularly the accuracy of a witness's recollection of stale-dated events is always in issue. If the contents ofthese documents had direct or corroborative value, it was the responsibility of Counsel for the Appellant to ensure that they were put before this Court accompanied by a certified translation or some other acceptable form of synopsis of their contents.</p>] It is not my intention to impugn his credibility, however, in this case, the documents referred to can be given very little weight and thus, it is not possible to verify the accuracy or completeness of the witness's testimony. I am, on balance, unable to conclude in favour of the Appellant on this issue.

23 One additional comment is warranted. The Appellant advanced his lack of expertise in the art of keeping records and proper books of account as a factor to be considered (in his favour) by the Court.[FN20: <p>It must be noted as well that no explanation was offered by the Appellant as to why the services of Smale were restricted to the business activities of CTP.</p>] It was also suggested on his behalf that in small corporations, many decisions are made and business transactions carried out in informal and expeditious ways. That may be so but this does not entitle the Appellant to ignore the requirements of subsection 230(1) of the Income Tax Act which reads:

• 230(1) Every person carrying on business and every person who is required, by or pursuant to this Act, to pay or collect taxes or other amounts shall keep records and books of account (including an annual inventory kept in prescribed manner) at his place of business or residence in Canada or at such other place as may be designated by the Minister, in such form and containing such information as will enable the taxes payable under this Act or the taxes or other amounts that should have been deducted, withheld or collected to be determined.

• 230(4) Every person required by this section to keep records and books of account shall retain

  • (a) the records and books of account referred to in this section in respect of which a period is prescribed, together with every account and voucher necessary to verify the information contained therein, for such period as is prescribed; and

  • (b) all other records and books of account referred to in this section, together with every account and voucher necessary to verify the information contained therein, until the expiration of six years from the end of the taxation year to which the records and books of account relate.

24 The appeals are dismissed, with costs.