Dunlop v. The Queen, 95 DTC 5351, [1995] 2 CTC 149 (FCTD)

Wetston J.:-This is an appeal from a notice of reassessment, dated September 30, 1985, in respect of the plaintiffs 1981 taxation year, whereby the Minister of National Revenue (the "Minister") reassessed the plaintiff’s tax liability by including, in income, an $80,000 loan, which the Minister determined was unreported income from Canam Investment Consultants Ltd. ("Canam"). The plaintiff, W. Dale Dunlop, a barrister and solicitor in Nova Scotia, represented himself in this action.

Background

By way of agreed statement, the parties admitted the following facts for the purposes of this action:

1. At all relevant times the plaintiff was a major shareholder of Canam Investments Limited (hereinafter ’’Canam”), holding 42.5 per cent of the issued and outstanding shares. There were two other shareholders, namely Mark George (42.5 per cent) and Donald Peverill (15 per cent).

2. In the culmination of complex business manoeuverings involving Canam, the plaintiff and others, 50,000 shares of Onaping Resources Ltd., a public corporation (hereinafter ’’Onaping") were issued to Canam in the first few months of 1981. Also, 25,000 shares of Onaping were issued to Granville Resources Limited (hereinafter "Granville”), a Nova Scotia company controlled by the plaintiffs father, William Bruce Dunlop, of Winnipeg.

3. On May 18, 1981, the plaintiff executed an agreement of purchase and sale to acquire a house at 6344 Norwood Street in Halifax, Nova Scotia, the transaction to be closed on July 31, 1981.

4, On or about May 12, 1981, the plaintiff and Donald Peverill met with Mr. K.R. Dean of N.R. Doane & Company, who was referred to them as a tax expert to discuss, among other things, tax treatment of a housing loan from Canam. Essentially, the advice received was that a housing loan from "Canam" had to be a "legitimate loan".

5. Subsequent to the meeting with Mr. Dean, a meeting with the directors of Canam was held at which it was agreed that a housing loan of $80,000 would be extended to the plaintiff by Canam. In informal conversation some or all of the directors agreed that this loan would be on terms that, as long as the plaintiff continued to render services to Canam, maintained his relationship with Canam, and retained the house, neither the loan nor interest on the loan would be payable.

6. In the spring of 1981, when Canam received its shares in Onaping, they had a fair market value of at least $10 per share. The shares were lodged at that time with the stock brokerage firm of Walwyn, Stodgell, Cochrane & Murray (hereinafter "Walwyn, Stodgell"). These shares comprised the principal asset of Canam.

7. In addition to the plaintiffs housing loan, Canam’s directors (the plaintiff, the other two shareholders, and a Mr. Brian McLellan) had also agreed that Canam would provide guarantees for each of the directors’ trading accounts with Walwyn, Stodgell.

8. In May 1981, the plaintiff contacted Robert Price of Walwyn, Stodgell to advise that Canam was lending him $80,000 which he would require by July 31, 1981. The money was to be raised by the sale of some of Canam’s Onaping shares.

9. Almost immediately, Mr. Price sold approximately $40,000 of Canam’s Onaping shares which money was lodged with Walwyn, Stodgell on Canam’s account.

10. Based upon Mr. Price’s advice that the value of the Onaping shares would rise in the next few months, the plaintiff decided to wait before selling any more shares. By the middle of July, the value of the Onaping shares had not risen, but the plaintiff was persuaded by Mr. Price to have Canam borrow the money from Walwyn, Stodgell instead of selling more Onaping shares before their value rose. This loan to Canam was to be secured by the Onaping shares lodged with Walwyn Stodgell.

11. The plaintiff arranged with Walwyn, Stodgell that on July 21, 1981, the latter would forward him a cheque in the amount of $80,000 consisting of the approximately $40,000 cash in Canam’s account plus $40,000 loan advanced on Canam’s account on the security of Canam’s Onaping shares.

12. On or about July 31, 1981, when the plaintiff contacted Walwyn, Stodgell for the $80,000 cheque, he was told that it would not be issued. Many or most of Canam’s Onaping shares had been removed from Walwyn, Stodgell and lodged as securities for loans with various banks by Mark George. As well, Mr. George had withdrawn approximately half of the cash being held in Canam’s account. The result of these actions by Mr. George was that Canam had insufficient security and cash lodged with Walwyn, Stodgell to secure the loan as contemplated.

At the hearing, the plaintiff testified that in order to purchase his residence, the only way to obtain the loan was to post additional security with Walwyn, Stodgell. The plaintiff submitted that once the security was received, Walwyn, Stodgell advanced the loan and the housing transaction was completed the following day.

Shortly before the scheduled commencement of this trial, the plaintiff sought leave of the Court to amend his statement of claim. In his original statement of claim, the plaintiff pled that the loan was a housing loan and thus exempt from inclusion as income by virtue of subparagraph 15(2)(a)(ii) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the ’’Act”). By way of amendment, the plaintiff sought to argue that the $80,000 received from Walwyn, Stodgell was not a shareholder’s loan within the meaning of subsection 15(2) or subsection 56(2) of the Income Tax Act, but rather was a personal loan. The Court allowed the amendment to the statement of claim so that the real issues between the plaintiff and the Minister would be the subject of this action. The defendant filed an amended statement of defence and additional discoveries were quickly held before the commencement of the trial.

At trial, the plaintiff, W. Dale Dunlop, testified on his own behalf. The only other witness called on behalf of the plaintiff was Mr. Robert Price of Walwyn, Stodgell. The defendant called no witnesses, preferring to rely upon the assumptions of fact in its statement of defence, the notice of reassessment and supporting documentation.

Plaintiff's position

At the outset of the trial, the plaintiff indicated that he would not be able to establish that the $80,000 he received was a shareholder’s loan within the meaning of subsection 15(2), yet exempt from inclusion as income by virtue of subparagraph 15(2)(a)(ii); a position he had maintained for over ten years. His primary argument, therefore, was based upon establishing that the $80,000 he received was a personal loan.

In the plaintiffs submission, the defendant wrongly assessed, pursuant to subsection 15(2) or subsection 56(2) of the Income Tax Act, an $80,000 loan he received in 1981. The plaintiff contends that the facts do not Support the defendant’s assessment of tax pursuant to these subsections. He argues that the defendant inaccurately characterized the transaction as a failed shareholder’s housing loan from Canam to the taxpayer. The plaintiffs oral testimony at the trial was primarily directed to establishing this contention.

The plaintiff admitted that he did intend to obtain a shareholder’s hous- ing loan, pursuant to subparagraph 15(2)(a)(ii), intending to comply with the requirements for the proper documentation and repayment/interest arrangements. However, he contends that, due to circumstances beyond his control, he was unable to complete the intended transaction. Accordingly, in order to complete the housing transaction, the plaintiff contends that he was required to obtain a personal loan from Walwyn, Stodgell, secured by the 25,000 shares of Onaping held by Granville, the plaintiffs father’s company.

In the plaintiffs submission, at no time did Canam loan him $80,000. Moreover, according to the plaintiff, Canam did not have the appropriate equity to secure an $80,000 loan from Walwyn, Stodgell in his favour. He, therefore, contends that the loan was a personal one, from Walwyn, Stodgell to the plaintiff, secured with a pledge of 25,000 shares from his father, W. Bruce Dunlop. The plaintiff contends that if Canam was involved in the transaction at all, it was only as a conduit and not as a lender.

Moreover, the plaintiff further submits that the $80,000 personal loan was repaid to Walwyn, Stodgell, when they subsequently unilaterally liquidated the 25,000 Onaping shares belonging to the plaintiffs father. The plaintiff argues that the sale of the shares by Walwyn Stodgell could only be applied against the loan for which they were originally pledged, namely, the $80,000 personal loan. Alternatively, the plaintiff contends that even if the loan remains outstanding, it is a loan between the plaintiff and his father and, in his words, is a moral loan and not a commercial loan. He otherwise describes the loan as a gift from his father to himself.

Accordingly, the plaintiff argues that by not considering what actually occurred, the defendant inappropriately assessed the $80,000 as shareholder’s loan pursuant to subsection 15(2) or as an indirect payment pursuant to subsection 56(2). In the plaintiffs submission, the defendant failed to consider Granville’s role in its assessment of the plaintiffs income.

Defendant's position

The defendant notes in its statement of defence, as an assumption of fact, that Walwyn, Stodgell advanced $80,000 to the plaintiff, when 25,000 shares of Onaping, held by Granville Resources Ltd., a corporation of which the plaintiffs father was the principle shareholder, were lodged with Walwyn, Stodgell as against all of Canam’s indebtedness to Walwyn, Stodgell. The Minister also asserts that the $80,000 advanced by Walwyn to the plaintiff was with the concurrence of all parties charged to the account of Canam and that at no time was it contemplated that the plaintiff would personally repay the money to Walwyn, Stodgell. While the $80,000 was payable to the plaintiff, the money was lodged in Canam’s account and the plaintiff drew the $80,000 from that account.

The defendant further argues that the loan was repaid by Canam, at the direction of or with the concurrence of the plaintiff and that at no time were arrangements of any kind made between the plaintiff and Canam for repay- ment of the $80,000 to Canam. Indeed, it is contended that the $80,000 was not repaid in whole or in part within one year of the 1982 taxation year of Canam, which was the taxation year in which the advance was made. Essentially, the Minister argues that Mr. Dunlop indirectly borrowed money from Canam, a corporation of which he was a shareholder, to purchase a house. However, he did not complete the transaction, pursuant to the requirements of subsection 15(2) of the Act, so as to exempt his loan from taxation. As such, it is argued that section 56 applies. In this respect, Canam allowed Walwyn, Stodgell to draw on its account the $80,000 to give to Mr. Dunlop who concurred with this transaction. Consequently, Mr. Dunlop should be taxed as if Canam had simply paid him the money as a shareholder’s loan.

As for Granville’s role in the transaction, the defendant argues that the plaintiffs father and Granville Resources Limited are different legal entities. Moreover, it is contended that the plaintiff has no legal liability to his father, as no arrangements were made between the plaintiff and his father regarding the repayment of the loan. Indeed, in the defendant’s submission, there was virtually no evidence before the Court, other than the somewhat unspecific testimony of Mr. Dunlop, regarding what transpired when the Granville shares in Onaping were deposited with Walwyn, Stodgell for the purpose of securing the $80,000 loan to the plaintiff.

Analysis

While the plaintiff may have had every intention of carrying out his plans to obtain a shareholder’s loan from Canam for the specific purpose of buying a house, the Court must have regard to the transaction as it occurred, not as it was intended to occur. Due to unforseen circumstances, that is the appropriation of Canam’s Onaping shares by the company’s president, Mark George, Walwyn, Stodgell refused to grant the loan on the terms the plaintiff intended. According to Mr. Price, of Walwyn, Stodgell, the only way Walwyn, Stodgell would loan the $80,000 was if the plaintiff could post additional security with the firm. The plaintiff sought to obtain the additional security from his father. In this regard, the plaintiff s father lodged his company’s Onaping shares with Walwyn, Stodgell in order to secure the $80,000 loan. After receiving the additional security, Walwyn Stodgell released the funds and lodged them in the Canam account rather than the plaintiffs personal account.

In retrospect, the plaintiff acknowledges that he should have ensured that the funds advanced by Walwyn, Stodgell were lodged in his personal account rather than Canam’s. He argues that the transaction resulted in a personal loan and that Canam’s and his accounts were merely intermingled. However, Mr. Dunlop testified that even after the funds were released he still wanted to carry out his intention of obtaining a shareholder’s loan for the purpose of acquiring a dwelling. In this regard, he attempted to reacquire Canam’s Onaping shares from Mr. George in order to release Granville’s Onaping shares. His attempts were unsuccessful and Granville’s Onaping shares remained as security for the $80,000. Moreover, according to Mr. Price, Walwyn, Stodgell never sought repayment of the loan from the plaintiff in his personal capacity.

The plaintiff discovered, sometime after the money was obtained from Walwyn, Stodgell, that, contrary to his intention, Granville’s shares in Onaping were lodged as security against not only the $80,000 loan but rather against all of Canam’s debts. Accordingly, when Walwyn, Stodgell sought repayment of Canam’s debts, Canam’s account was liquidated and a sellout of Granville’s Onaping shares occurred. The money realized by the sale of Granville’s Onaping shares was applied against all amounts owed to Walwyn, Stodgell by Canam, not only the $80,000 loan.

Mr. Price testified that he did not initiate the liquidation of Canam’s account and the sellout of Granville’s Onaping shares. Apparently, that transaction was conducted by Walwyn, Stodgell’s credit department in Toronto. While Granville brought an action, in the Supreme Court of Nova Scotia, against Walwyn, Stodgell claiming that the brokerage firm inappropriately sold Granville’s Onaping shares, which had been deposited only to secure the $80,000 advanced to Mr. Dunlop, that lawsuit was unsuccessful. Unfortunately, the decision seems to have been lost and according to counsel no decision could be found within the registry of the provincial court.

The defendant contends that the evidence offered by Mr. Dunlop is inconclusive. The only evidence as to what transpired when the Granville shares in Onaping were deposited with Walwyn, Stodgell is the unspecific testimony of the plaintiff. Moreover, it is argued that the evidence is insufficient to overturn the assumptions of fact of the Crown. In this regard, Pollock v. Canada, [1994] 1 C.T.C. 3, 161 N.R. 232, at page 8 (N.R. 237), Hugessen J.A. discusses the burden that is cast on the taxpayer by assumptions made in the pleadings:

The burden cast on the taxpayer by assumptions made in the pleadings is by no means an unfair one: the taxpayer, as plaintiff, is contesting an assessment made in relation to his own affairs and he is the person in the best position to produce relevant evidence to show what the facts really were.

Where, however, the Minister has pleaded no assumptions, or where some or all of the pleaded assumptions have been successfully rebutted, it remains open to the Minister, as defendant, to establish the correctness of his assessment if he can. In undertaking this task, the Minister bears the ordinary burden of any party to a lawsuit, namely to prove the facts which support his position unless those facts have already been put in evidence by his opponent. This is settled law.

There is little doubt on the evidence that originally the plaintiff was to get the money from Walwyn, Stodgell and that the loan would be between Walwyn, Stodgell and Canam. There was to be no personal liability on the plaintiffs part. However, due to the unforeseen circumstances, Canam could not finance the transaction with Walwyn, Stodgell. In other words, it could not borrow the money from Walwyn, Stodgell.

The shares that were deposited to secure the loan were Granville’s shares of Onaping, not shares which belonged to the plaintiffs father in his personal capacity. The plaintiff arranged for Granville’s Onaping shares to be lodged with Walwyn, Stodgell so that the original transaction could be completed. In essence, the nature of the transaction was not changed. Unfortunately, little evidence was provided to the Court to demonstrate the legal nature of the transaction which occurred when the shares were deposited with Walwyn, Stodgell in Winnipeg. There was no evidence of what transpired between the plaintiffs father and Granville. There was no evidence with respect to what transpired between the plaintiffs father and the plaintiff other than the fact that the shares were provided to secure the loan. There was no evidence to indicate what had occurred between the Walwyn, Stodgell office in Winnipeg and Walwyn, Stodgell in Halifax. What is clear, is that the plaintiff got his money from Walwyn, Stodgell and it was drawn on Canam’s account.

There was no evidence before the Court of a properly constructed housing loan pursuant to subparagraph 15(2)(a)(ii) and there was insufficient evidence before the Court of a properly constructed personal loan. If the Court could find on the evidence that there was a loan from Walwyn, Stodgell to the plaintiff in his personal capacity, secured by Granville’s Onaping shares, then the loan would not be taxable, at least to Mr. Dunlop. However, the evidence seems to demonstrate that, despite the plaintiffs desire to structure the transaction otherwise, the Granville shares in Onaping secured the indebtedness of Canam to Walwyn, Stodgell. Consequently, by concurring in the original transaction, the plaintiff is taxed as if Canam had simply paid him the money. This would appear to be the essence of subsection 56(2).

The defendant argued that transactions between corporations and shareholders must be examined strictly. I agree that the tax implications between corporations and shareholders must be examined with considerable scrutiny. In this regard, the following comments by Professor Krishna in The Fundamentals of Canadian Income Tax (Carswell: Toronto) 1989, (3rd) at page 811, are applicable:

The rules in respect of corporate loans to shareholders are very stringent. The rationale for these rules is to discourage corporations from using loans as an indirect means of conferring untaxed economic advantages on shareholders.... Without special provisions to tax loans, long-term loans could be used as an indirect way of withdrawing corporate funds on a tax-free basis.

In Heal v. M.N.R., [1980] C.T.C. 2199, 80 D.T.C. 1169, at page 2202 (D.T.C. 1171), the following similar comments were made regarding section 15:

The risk in perceiving a closely-held private corporation as a mere business extension or alter ego of a shareholder taxpayer personally must be avoided, or the penalty paid. There are only a limited number of mechanisms by which a shareholder may legitimately put himself personally in control of funds of a corporation-salary, dividends, and interest primarily. Any other procedures must be carefully scrutinized by the shareholder to ensure that he is not also assuming an income tax liability personally. The lack of proper advice, or a lack of understanding by the taxpayer does not absolve him of the results however unfortunate or oppressive.

[Emphasis added.]

In order to decide this case, the Court must determine who was ultimately responsible for generating the loan to the taxpayer. If it was a loan from Walwyn, Stodgell, secured by the Granville shares, to the plaintiff, then that loan is a personal loan and is not taxable as income. If, however, the loan was from Canam, directly or indirectly, to the plaintiff, then that loan can be described as a failed housing loan and, therefore, taxable as income. As indicated above in Pollock, supra, the burden is on the taxpayer to produce relevant evidence to show what the facts surrounding the transaction really were. Has the taxpayer rebutted the assumptions of the Minister?

There is little doubt that the plaintiffs contention that his father would not lodge his company’s shares as security for other people’s debts is at first blush compelling. However, these are corporate transactions and there was no evidence regarding the true intention of the taxpayer’s father in this transaction. Moreover, the issue must be examined from the perspective of what really happened and not what was intended to happen. Indeed, the plaintiff wanted to maintain his original idea of obtaining a shareholder’s loan, as evidenced by his attempts to reacquire the Canam shares, even after Granville’s shares of Onaping were lodged as security with Walwyn, Stodgell. While the plaintiff contends that Granville’s role in the transaction was not explicitly considered by the defendant, the onus is on the plaintiff to establish, in evidence, that the defendant’s assessment is somehow deficient. In this instance, the plaintiff has failed to adduce sufficient evidence to rebut the correctness of the defendant’s assessment. Moreover, even if Granville’s role was not considered in its entirety, as contended by the plaintiff, I am satisfied that the Minister has, nevertheless established the correctness of his assessment on the evidence before the Court.

Accordingly, the action is dismissed with costs.

Appeal dismissed.