Uphill Holdings Ltd. v. MNR, 93 DTC 148, [1993] 1 CTC 2021 (TCC)

Kempo, T.C.J.:—These appeals, on consent application, were joined for hearing on common evidence as the issues are interrelated. Counsel for the respondent advised the Court that the penalties levied against each appellant pursuant to subsection 163(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") were no longer being pursued and that this matter was being abandoned.

Issues

Uphill Holdings Ltd. (“ Uphill Holdings") was incorporated for the principal purpose of holding Mr. Nigel Hill's shares in a public company, Develcon Electronics Ltd. There is one issue raised here. For its 1984 fiscal period ending June 30, the respondent disallowed certain amounts claimed as deductions from income for legal and accounting fees on the basis that they were not in their entirety made or incurred for the purpose of gaining or producing income from business or property pursuant to paragraph 18(1)(a) of the Act.

Mr. Hill’s appeals raised three issues. The first one is a consequence of the one just described in that the amount denied to Uphill Holdings was added into his own income for his 1984 taxation year as an appropriation pursuant to subsection 15(1) of the Act. The second concerned the denial of losses arising from the rental of property during 1983 and 1984 for the reason that there was no reasonable expectation of profit therefrom during that period of time. The third and major issue concerned Mr. Hill’s shareholder loan account in Uphill Holdings during 1983 and 1984 from which certain amounts were added by the respondent into Mr. Hill’s income for each year pursuant to subsection 15(2) of the Act on the basis that none of the exempting provisions of paragraphs (a) and (b) of subsection 15(2) were applicable to exclude these amounts.

The rental property—Nigel Hill: 1983, 1984

On December 8, 1982 Mr. Hill acquired a 0.45 acre ocean view property on Salt Spring Island, B.C. with a two-bedroom 1,500 square foot home located thereon for $100,000. A two-year mortgage of $75,000 at 14.25 per cent was placed, the balance being paid in cash. Mr. Hill said that after making some inquiries and searching through local papers he had determined a net rental of $300 per month (he would pay for the insurance only) would be reasonable. He also said that his mother, who was to occupy the premises, desired the arrangement between them to be of a commercial nature. In order to attract a significant property tax reduction, Mr. Hill entered into a written five-year lease with his mother with a stated rental of one dollar per year. This figure, he said, was wrong and had gone unnoticed by him. His mother actually paid $300 per month pursuant to their earlier verbal arrangement and she maintained responsibility for all costs involving upkeep, maintenance and utilities.

The 1983 and 1984 losses claimed arose essentially out of the shortfall between the annual rental income of $3,600 and the interest paid on the mortgage during each year which was $10,772 for 1983 and $6,174 for 1984. The mortgage was paid out on December 3, 1984. The 1985 situation showed a profit due to the mortgage debt being extinguished.

In my view Mr. Hill has not shown, on the balance of probabilities, that the respondent had erred in this matter. Losses were expected to occur because of undercapitalization with only some vague plan on his part that some time in the future the mortgage may be paid down. Further, the evidence was sparse respecting either the reasonableness of, or the fair market value of, the rental rate obtained or obtainable.

The facts in Paikin v. M.N.R., [1987] 1 C.T.C. 2041, 87 D.T.C. 6 (T.C.C.) are, in my opinion, markedly dissimilar to those before me and therefore its outcome is of no real assistance. The D.T.C. headnote caption of the decision in Paikin reads:

Held: The taxpayer's appeal was allowed. The Court found that the taxpayer purchased the property as a revenue-producing asset and not for his own or his mother's personal benefit. The mother had agreed and was expected to pay rental at fair market value while in possession. Furthermore, it could not be said that there was no reasonable expectation of profit. The evidence established that, from the outset, there was a thoughtful, well-researched business approach to the investment. Of greater significance was the fact that the taxpayer subsequently paid off his share of the mortgage which supported the taxpayer's assertion that the original investment was part of a well-orchestrated plan for profit-making.

[Emphasis added.]

In Lorentz v. M.N.R., [1985] 1 C.T.C. 2144, 85 D.T.C. 131 (T.C.C.) Christie, A.C.J.T.C. said at page 2145 (D.T.C. 132):

The issue must be determined by objective testing. In order to discharge the onus which rests upon him in the circumstances of this case, the appellant need not show that in purchasing the property he acted on the basis of some unbiased sophisticated analysis or advice regarding the prospects of rental income vis-a- vis rental expenses. Nevertheless, he must place evidence before the Court from which it can be objectively concluded that his conduct was that which could be expected of a reasonably prudent person becoming involved in a commercial undertaking designed to extract profit from renting real estate.

[Emphasis added.]

Mr. Hill has failed, in my opinion, to satisfy this evidentiary onus and therefore this aspect of his appeal fails.

The professional fees—Uphill Holdings and Nigel Hill—1984

During 1983 and 1984 the assistance of expert professional advice in the areas of corporate law, tax law, securities law and matrimonial property law were required by both Mr. Hill and Uphill Holdings due to Mr. Hill’s marriage breakdown. Claims to marital assets were being advanced by Mrs. Hill and there is little doubt but that Uphill's affairs and assets were material in the whole matter.

Mr. Hill testified that the law firm of Goldstein and Goldstein represented himself as well as Uphill Holdings in their capacity as its general corporate counsel. The two law firms, McKercher McKercher, and Lawson Lundell, were retained for corporate, tax and securities purposes and the chartered accounting firm of Peat Marwick for tax and accounting purposes. It was the evidence of Mr. Hill and Mr. Terry Grieve, a chartered accountant, that all of the professional firms were instructed to ensure their accounts designated either personal or corporate matters and that each was to be segregated from the other where possible.

The issue at hand arose because of the particulars stated in the subject professional accounts. Those indicating an obvious mixture of corporate and of personal services were allowed by the respondent as to 50 per cent to corporate deductibility. The balance was determined to be a subsection 15(1) appropriation of company funds and therefore added to Mr. Hill’s income. His counsel suggested that a greater amount ought to have been given to corporate-related matters. However nothing of an objective substantive nature was advanced. With respect to these accounts which totalled $26,282.08, the respondent's 50-50 allocation has not been shown to be erroneous in any particular way and will not be disturbed.

The respondent disallowed corporate deductibility in total of the particular McKercher account dated 25 October 1983 on the basis that it related solely to Mr. Hill's personal matters. Similarly, this sum was included in Mr. Hill’s income as a subsection 15(1) appropriation. The particulars recited therein of the services rendered read as follows:

RE: HILL V. HILL

To all attendances involved in assisting Mr. Goldstein to prepare for trial, and subsequently negotiate a settlement of outstanding matters between Mr. and Mrs. Hill between June 18, 1983 and October 17, 1983 including:

To review of pleadings;

To review of examinations for discovery;

To interviewing client;

To drafting notice of motion and affidavit;

To preparation for examinations for discovery;

To conducting examination for discovery of Mrs. Hill;

To conducting legal research;

To preparing draft brief of law for trial;

To attending consultations with client;

To attending consultations with Mr. Goldstein;

To negotiating settlement with Mrs. Hill’s lawyers;

To assisting in drafting settlement documents and roll over agreements; To all telephone attendances;

To all correspondence;

To all miscellaneous attendances not referred to above;

Mr. Hill expressed surprise, upon reviewing these particulars, that that firm had been so taken up with the personal aspects of the divorce. This account had been directed to Uphill Holdings Ltd. c/o Goldstein & Goldstein and was paid in early 1984 by an Uphill Holdings cheque.

Given all of the evidence, I find no error on the part of the respondent in any of the aspects of the professional accounts matters, and the appeals of Mr. Hill and Uphill Holdings fail in these respects.

Shareholder loan account—Mr. Hill 1983, 1984

The crux of this matter is found in the pleadings. The respondent's argumentative position is reflected in clause 17 of the reply to notice of appeal that

. . . the amounts of $756,053.88 and $299,451.85 . . . were loans from the corporation to the appellant in the 1983 and 1984 taxation years and none of the exempting provisions of paragraphs (a) and (b) of subsection 15(2) of the Act were applicable to exclude the said amounts from the computation of the appellant's income in his 1983 and 1984 taxation years.

The facts relied upon by the respondent were pleaded in clause 14(b) of the reply thusly:

(b) With respect to the shareholders’ loan account:

(i) The appellant incorporated Uphill Holdings Ltd. (hereinafter referred to as the corporation) in December 1980.

(ii) The appellant, at all times material to the matters herein, maintained a shareholder loan account with the corporation.

(iii) The taxation year end of the corporation was June 30.

(iv) From June 30, 1982 to June 30, 1985, the balances outstanding in the said shareholder loan account at the times material hereto, were in a debit balance, as follows:

Date	Balance
June 30, 1982
Dec. 31, 1982	$42,257.41 DR
June 30, 1983	32,857.65 DR
Dec. 31, 1983	788,911.53 DR
June 30, 1984	1,088,363.38 DR
Dec. 31, 1984	1,210,152.78 DR
June 30, 1985	310,211.62 CR

(v) The corporation, in its 1983 and 1984 taxation years, made loans to the

appellant, as shareholder of the corporation, in the following amounts:

1983	$756,053.88
1984	299,451.83

(vi) The said amounts referred to in paragraph 12(b)(v) [sic] herein were debts to the corporation's loan account and were for personal expenditures of the appellant and accordingly, were properly included in the computation of the income of the appellant in his 1983 and 1984 taxation years.

(vii) The indebtedness referred to in paragraph 12(b)(v) [sic] herein, constituted a series of loans and repayments, and as such are included in the appellant's income in the year the indebtedness occurred.

(viii) As at June 30, 1985; the loan balances of the corporation were repaid by the appellant entitling the appellant to deduct the amount of loans, being $1,055,505.73 from his income in 1985, in accordance with paragraph 20(1)(j) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

Mr. Hill expressed his position in his notice of appeal in this way:

B. Treatment of “ Shareholders Loan Account” 1983, 1984, 1985

FACTS:

1. In December of 1980 the taxpayer caused to be incorporated Uphill Holdings Ltd., a Saskatchewan incorporated company in which the Taxpayer was sole officer, director and, in effect, shareholder.

Uphill Holdings Ltd. acquired from the taxpayer the shares in Develcon Electronics Ltd. and other like shares and investments.

2. During the period July 1, 1982 to June 30, 1985 the taxpayer withdrew funds from Uphill Holdings Ltd., but in each case these funds were repaid to the corporation, by the end of its fiscal period, either by way of dividends declared or by way of salary paid to the taxpayer.

3. The Minister added the sum of $756,053.88 to the taxpayer's income for 1983 and the sum of $299,451.85 to the taxpayer's income for 1984. He deemed these sums to be the amount of shareholders loans unrepaid at the end of the taxpayer's (calendar) taxation years 1983 and 1984, and therefore, taxable pursuant to subsection 15(2) of the Act.

4. Inasmuch as the taxpayer had paid back these sums to the corporation by the end of its 1985 fiscal year end, June 30, 1985, the Minister applied paragraph 20(1)(j) of the Act and deducted from the taxpayer's 1985 income the total of the said sums, $1,055,505.73.

REASONS:

1. The amounts received by the taxpayer from the corporation in the period July 1, 1983 to June 30, 1984 were all repaid within one year from the end of the taxation year of the corporation in which the funds were advanced. For that reason alone no such amounts should be included in the taxpayer's income for 1983 and 1984 pursuant to subsection 15(2) of the Act.

2. Advances to a shareholder should be considered as loans only at the end of the financial year of the corporation. It is then that amounts owing by a shareholder might be considered as forming “ part of a series of loans or other transactions and repayments". At the end of each of the corporation’s taxation years there was no amount owing by the taxpayer to the corporation, the taxpayer having repaid the same by way of dividend declared or salary paid to him. Such dividends or salary were duly declared by the taxpayer and any tax liability on account thereof was reported and paid by him.

3. For the above reasons and since any indebtedness of the taxpayer to the corporation was fully repaid by the end of the corporation's 1985 fiscal year end, the amounts included in the taxpayer's income under subsection 15(2) in 1983 and 1984 should be deleted. At the same time the deduction allowed to the taxpayer's income in 1985 under 20(1)(j) of the Act should be reversed.

Mr. Hill’s 1985 taxation year was not on appeal before the Court.

Mr. Hill’s chartered accountant, Terry Grieve, confirmed that Uphill Holdings had very few stock transactions, and that his services had not extended beyond preparation of working papers reflective of these matters and the cash advances to Mr. Hill. He said that as far as he was concerned the overall plan was to ensure dividends in sufficient amounts would be declared and paid to Mr. Hill in order that his indebtedness to Uphill Holdings would be paid in full at the appropriate time. He emphasized that dividends amounting to $300,000 paid to Mr. Hill out of the capital dividend account had been accepted by the Minister as a repayment of the loan account because of the deduction applied thereto under paragraph 20(1)(j) of the Act for Mr. Hill's 1985 taxation year.

On cross-examination, Mr. Grieve confirmed that a $1.2 million transfer from an affiliated company (Uphill Investments Ltd.) into Mr. Hill’s shareholder loan account on Uphill Holdings’ year-end date, 30 June 1984, was merely a book entry and that this amount was then retransferred, again by book entry, to that affiliate one month later. He agreed that it was really a non-event. Apparently the respondent's officials had similarly viewed this transaction as a non-event as is shown on the 30 June 1984 entry in their written analysis:

(EXHIBIT A-3, Page 5)

ANALYSIS OF SHAREHOLDER'S LOAN—NIGEL HILL 1982-1985

	Balance	Increase/Decrease
June 30, 1982	0	1982	1982
		$	32,857.65
December 31, 1982	$42,257.41 DR.	$32,857.65
June 30, 1983	32,857.65 DR. 1983		1983
		$ 756,053.88
December 31, 1983	788,911.53 DR.	1,055,505.73
June 30, 1984	1,088,363.38 DR. 1984		1984
		$ 299,451.83
December 31, 1984	1,210,152.78 DR.	(1,088,363.38)
June 30, 1985	310,211.62 CR.		1985
		$(1,088,363.38)

*The June 30, 1984 balance has been adjusted to exclude the journal entry reducing the shareholder's loan by $1,200,000. This entry was made at year end and reversed immediately afterwards.

As such, we cannot accept this as a bona fide repayment since this is a series of loans and repayments.

		SUMMARY
	1982 1983 1983		1984 1984	1985 1985
Change	$32,85 7.65	$756,053.88	$299,451.85	$(1,088,363.38)
	32,857.65	Subsection 15(2)	Subsection 15(2)	32,857.65
	0	Adjustment	Adjustment	$(1,055,505.73)
				Paragraph 20(1)(j)
				deduction
Note 1:

The 1982 balance is statue [sic] barred for reassessing purposes. See separate schedule for subsection 80.4(2) interest benefit calculation until repayment.

Note 2:

Part of the 1985 repayment can be applied to 1984 but this will result in a subsection 80.4(2) interest benefit until repayment.

The testimony of both Mr. Hill and Mr. Grieve confirmed the particulars of the many cash advances made through Mr. Hill’s shareholder loan account for and on his personal behalf. For Mr. Hill's 1983 calendar year they included many diverse miscellaneous matters as well as a $66,000 mortgage payout on a house, $10,000 for personal legal fees, $20,000 on a cattle venture, $41,500 to a personal bank account and $565,000 to his wife respecting the divorce settlement. For his 1984 calendar year the amounts totalled $75,500 to his own personal account, $527,000 to his wife pursuant to their settlement, $16,000 for furniture, around $15,000 for the cattle operation and $75,426.85 for the mortgage payout on the Salt Spring Island rental property. With respect to payments made by Mr. Hill into this account, the evidence was as follows:

Without the purported $1.2 million book entry transfer from an affiliate on 30 June 1984 noted earlier there would have been a debit balance of $1,108,363.38 in the shareholder loan account at that time. The June 29, 1985 payments into the account as shown above resulted in a credit balance of $310,261.62.

The purported plan to draw on the account for personal needs and to actually repay it in full at Uphill Holdings’ fiscal year end did not happen in 1984. The formulated plan to draw down and then repay at the appropriate time has been ongoing since Uphill Holdings' incorporation in December of 1980. No records were introduced respecting particulars of pre-1983 advances and repayments.

The law

Paragraph 15(2)(b), with the appropriate deletions, provides as follows:

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

(b) the loan or indebtedness was repaid within one year from the end of the taxation year of the lender or creditor in which it was made or incurred and it is established, by subsequent events or otherwise, that the repayment was not made as part of a series of loans or other transactions and repayments.

Paragraph 20(1 )(j) was also raised. It reads:

20(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:

(j) such part of any loan or indebtedness repaid by the taxpayer in the year as was by virtue of subsection 15(2) included in computing his income for a preceding taxation year (except to the extent that the amount of the loan or indebtedness was deductible from the taxpayer's income for the purpose of computing his taxable income for that preceding taxation year), if it is established by subsequent events or otherwise that the repayment was not made as part of a series of loans or other transactions and repayments;

Submissions of the parties

Counsel for the respondent submitted that this case was the classic example of a "running" or a “drawings” account situation. Mr. Hill did not take any salary or bonuses. There was a pattern of advances and repayments which constitutes a series of loans or others transactions and repayments within the meaning of paragraph 15(2)(b).

The object and purpose of the provision is to prohibit a loan account from being used by a shareholder as a running or drawings account for the purpose of deferring taxable income. Further, payment being made in full at the end of the series, in this case June 30, 1985, does not mean a series had not existed up to that point of time.

The application of paragraph 20(1)(j) respecting Mr. Hill's 1985 taxation year concerning his June 30, 1985 shareholder's loan payment was solely a matter of departmental practice at that time. It is not an answer to the statutory applicability of paragraph 15(2)(b) during Mr. Hill's 1983 and 1984 taxation years as aforenoted.

Counsel for the appellant conceded there was no issue as to the subject amounts being advanced or lent, that they had been recorded and treated as loans, and that they were personal expenses.

The frequency of the advances is immaterial. The key is the repayment. Parliament has granted a repayment period within which the advances must be paid. The mischief paragraph 15(2)(b) seeks to preclude is perpetual tax deferral by the taking of new loans or advances to pay off the current one. That is the series.

The June 30, 1985 payment by Mr. Hill via his dividends was bona fide. That its source was out of Uphill Holdings' capital dividend account, and was thus non taxable, is irrelevant. The affiliated company transaction of $1.2 million on 30 June 1984 (the "non-event" transaction) is also irrelevant because the sole material and operative time was June 30, 1985 which was when all the advances had been paid in full. The June 30, 1985 repayment itself was not part of a series of loans and repayments. It was not sourced in reborrowings giving rise to a series of loans and repayments.

Paragraphs 15(2)(b) and 20(1)(j) are symmetrical. Each disallows a loan repayment deduction if it was made as a part of a series of loans or other transactions and repayments. If the 20(1)(j) prohibition was satisfied on these selfsame facts for Mr. Hill’s 1985 taxation year, then the identical prohibition in 15(2)(b) is similarly satisfied for his 1983 and 1984 taxation years.

Analysis

In my opinion, the submissions of counsel for the appellant are persuasive and ultimately are determinative of these appeals.

I agree that the object of 15(2)(b) is to prevent the use of a shareholder loan account for indefinite tax deferral purposes through loans, advances and other transactions followed by repayments involving reborrowings. As noted in counsel's submissions, which I believe to be the essence of the whole matter, if the repayment in question was itself part of a series of loans or other transactions, then the purpose of 15(2)(b) is offended and the preclusion becomes operative.

I also concur with appellant-counsel's submissions, for the reasons he advanced, that the repayment source being a tax-free dividend and the 30 June 1984 related company transaction are each irrelevant. Neither offends the essential mischief to which 15(2)(b) is directed.

While the case of Joel Attis v. M.N.R., [1992] 1 C.T.C. 2244, 92 D.T.C. 1128 (T.C.C.) did raise double taxation concerns because the advances there were paid within the 15(2)(b) statutory time frame by way of bonuses and dividends, I fail to see why the payment source being tax free should make any difference. As determined earlier, the repayment source is material when it arises directly or indirectly through or out of the shareholder's company which forms part or a continuum of loans and repayments. Payment by way of a bonus, a taxable dividend or a non-taxable dividend does not partake or this effect.

The above interpretation is countenanced within the words of 15(2)(b) which mandates that the repayment itself is not to be part of a series of loans and repayments. Mr. Hill's payment on 25 June 1985 was not that kind of repayment. His appeals on this issue succeed.

Decision

The appeals of Nigel T. Hill for his 1983 and 1984 taxation years are allowed, with costs, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the amounts included in his income for each such taxation year pursuant to subsection 15(2) of the Income Tax Act are to be deleted and that the subsection 163(2) penalties assessed for the appellant's 1984 taxation year are to be deleted.

The appeal of Uphill Holdings Ltd. for its 1984 taxation year is allowed, without costs, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the penalties levied pursuant to subsection 163(2) of the Act be deleted.

Appeal allowed in part.