Davidson v. R., 99 DTC 933, [1999] 3 CTC 2159 (TCC)

Bowie T.C.J.:

The issue in this appeal is whether the Appellant, at the time she received a certain loan, made bona fide arrangements for its repayment within a reasonable time. If she did, then the requirements of subsection 15(2) of the Income Tax Act (the Act) are met. If she did not, then they are not met, and the amount of the debt is to be taxed as income in her hands in the 1990 taxation year.

The following are the pertinent parts of subsection 15(2), as it read at the relevant time:

Where a person (other than a corporation resident in Canada) or a partnership (other than a partnership each member of which is a corporation resident in Canada) is a shareholder of a particular corporation, is connected with a shareholder of a particular corporation or is a member of a partnership, or a beneficiary of a trust, that is a shareholder of a particular corporation and the person or partnership has in a taxation year received a loan from or has become indebted to the particular corporation, to any other corporation related thereto or to a partnership of which the particular corporation or a corporation related thereto is a member, the amount of the loan or indebtedness shall be included in computing the income for the year of the person or partnership, unless

(a) ...

(ii) in respect of an individual who is an employee of the lender or creditor or the spouse of an employee of the lender or creditor to enable or assist the individual to acquire a dwelling...

and bona fide arrangements were made, at the time the loan was made or the indebtedness arose, for repayment thereof within a reasonable time; or

Counsel for the Appellant set out in writing the following facts, which are not in dispute.

1. At all relevant times the Appellant was an employee and shareholder of 3408 Investments Ltd. (the “Company”).

2. On or about August 28, 1990, the Company advanced a loan to the Appellant in the amount of $95,000 to enable the Appellant to acquire a personal residence (the “Housing Loan”). The loan was interest free.

3. The Appellant provided the Company with two demand promissory notes in the aggregate amount of $95,000 ($70,000 and $25,000) as security for the Housing Loan.

4. At the time that the Housing Loan was made, the sole director of the Company, Ken Davidson (the husband of the Appellant) passed a resolution approving the making of the Loan. This resolution is evidenced in writing.

5. The Appellant included interest calculated in her income as interest pursuant to section 80.4 of the Income Tax Act (the “Act”) in her income in each year in respect of the Housing Loan.

6. By Notice of Reassessment dated May 12, 1994 the Minister of National Revenue reassessed the Appellant to include in her income for the 1990 year the amount of the Housing Loan, pursuant to subsection 15(2) of the Act, on the basis that no bona fide arrangements were made for the repayment of the loan within a reasonable time.

7. By Notice of Reassessment dated July 15, 1996 the Minister reassessed the Appellant in respect of her 1990 taxation year, pursuant to subsection 165(3) of the Act by, inter alia, decreasing her income by $3,356 in respect of “loan interest”, but otherwise confirmed the inclusion of the Housing Loan in her income for the year.

It is therefore common ground that the Appellant is entitled to succeed in this appeal if she can shown that bona fide arrangements were made to repay the loan within a reasonable time.

Mrs. Davidson’s husband testified that, following a career in banking, he took a job with the British Columbia Enterprise Corporation, where he worked during the latter part of the 1980s. Initially, most of his work was in Vancouver, but as time went on it took him increasingly to Victoria. Eventually, his employer requested that he move to Victoria, which he agreed to do in 1990. Mr. and Mrs. Davidson had a young family, and they decided to buy a house in Victoria. For this they had to borrow $95,000.

The arrangement by which they chose to fund the purchase was this. Mr. Davidson had earlier formed the Company. He owned 35% of the shares, all of class A. The Appellant owned 35%, and the remaining 30% were held by a trust for their minor children, of which Mr. and Mrs. Davidson were the trustees. The Appellant’s and the trust’s were class B shares. The Company had assets of $90,000 in the form of term deposit certificates which were to mature in September 1990, shortly after the closing of their house purchase in Victoria, which was to take place at the end of August. The Company borrowed $90,000, which it then loaned to the Appellant, who used it to make the down payment on the house. The proceeds of the term deposits were then applied in September to retire the Company’s bank loan.

Mr. Davidson was aware that there were certain requirements that had to be met to avoid tax becoming payable on the full amount of the loan. He said in his evidence that he had an informal discussion with a tax lawyer at the Vancouver firm of Russell & Dumoulin about this proposed method of financing the purchase, and was advised that, in order to avoid the pitfalls of subsection 15(2) of the Act, bona fide arrangements must be made for repayment within a reasonable time. This, he was told, meant five years. The director’s resolution and the promissory notes were prepared for him by other lawyers in the firm, one a business lawyer and the other a tax lawyer. The lawyer whom he consulted corroborated this evidence.

Mr. and Mrs. Davidson both testified that they discussed the matter of repayment prior to the transaction, and that they agreed that the loan would be repaid within the five-year period. The repayment was to be effected by declaring a dividend on the class B shares of $90,000, which would be used to repay the loan. At that time Mrs. Davidson was pursuing studies at Kwantlen College in Vancouver. Their original intention was that she would resume her course at Camosan College in Victoria in the fall of 1991, and complete it by the fall of 1992, and then be able to re-enter the work force. At this time she would have income that would enable her to pay the tax that would be exigible on the dividend.

The first problem that arose for the Appellant was that, when she applied for admission to Camosan College in Victoria, she discovered that it was not possible to complete the course that she had begun in Vancouver in one year, as she had planned. She and Mr. Davidson then amended their original plan. Instead, she enrolled in a course at the University of Victoria, and they decided to declare the dividend and effect the repayment of the loan in January, 1994. This would be well within the five-year period agreed on earlier, and would give her until April 1995 to pay the tax on the dividend.

The Appellant’s second problem arose in the fall of 1993, when Revenue Canada decided to audit the company, and this loan transaction attracted the attention of the auditor. Mr. Davidson testified that he told the auditor of their plan to make repayment within the five-year period, but the auditor, unmoved by this, reassessed Mrs. Davidson for the 1990 year on the basis that there was no bona fide arrangement made in August 1990 for repayment of the loan within a reasonable time. He also testified that the repayment was not made in 1993, or thereafter, only because the Revenue Canada auditor told him that they should not do so pending the completion of the audit. Nor was repayment made in 1995, because by then Mrs. Davidson had paid the tax pursuant to the reassessment. If the appeal succeeds, he said, then the repayment will be made.

The question whether the Act’s requirement that a bona fide arrangement for repayment be made at the time of the loan transaction raises a number of questions in the context of these facts.

1. Must the arrangement for repayment be in writing, either as part of the borrowing document, or otherwise?

2. Must the arrangement be contractually binding?

3. Must the arrangement provide for repayment on a date certain?

4. Does the requirement that there be a bona fide arrangement require that the Court examine the proposed source of the funds from which repayment will be made? If so does the proposed use of the dividend to be paid on the trust’s shares negate the bona fides of the arrangement?

5. If it is found that a bona fide arrangement was made as the Act required, is it negated by the failure to make the repayment in accordance with that arrangement?

Before I address these questions, however, I wish to make two observations. The first is that the Respondent, quite correctly in my view, did not suggest that five years is more than a reasonable time for the repayment of a housing loan. Counsel for the Respondent put the case squarely on the basis that the Appellant and her husband were not to be believed. He referred to their evidence as “reverse tax planning”, by which he really meant ex post facto tax planning, or, less politely, fabrication of a story which would meet the requirements of subsection 15(2) after the audit began. Regrettably, he did not put this theory to the witnesses when they testified. He cross-examined Mr. Davidson only briefly, and made no suggestion to him that his evidence concerning the repayment arrangement was a fabrication. He did not cross-examine the lawyer at all. His cross-examination of the Appellant was even more brief than that of her husband, and it too did not even hint at an issue of credibility. Counsel who proposes to invite a finding that the other party’s witnesses are lying has a duty to raise that with them when cross-examining. Failure to do so is unfair to the witness, and ought not to be countenanced. [1] In these circumstances, I will not make a finding that the witnesses fabricated their evidence.

The second observation which I make here is that it is apparent that the Appellant’s husband was the architect of the arrangement by which the down payment was to be made. Mrs. Davidson’s evidence indicated that she was, at best, vaguely conversant with the manner in which the arrangement was to work. I do believe, however, that she acquiesced in what her husband proposed, and, in particular, that she agreed with him that repayment would be made before the elapse of five years from August 28, 1990. She did so because she believed that that was what the Act required of her if she was not to be taxed on the full $90,000 in 1990. The purpose of the loan, and its repayment at a later date, was to permit the Appellant and her husband to use the $90,000 accumulated in the Company as a down payment, while deferring the need to pay income tax on the dividend until a later date. There is, of course, nothing wrong with that, so long as the arrangement for repayment meets the requirements of the Act.

I turn now to the questions which I have identified above.

question 1

I see no reason to require that the arrangement for repayment be part of the instrument which evidences the borrowing, or that it be in writing at all. No such requirement is imposed by the words of paragraph 15(2)(a). Had Parliament wished to require a written arrangement, it could easily have added the words “in writing”. I have no mandate to add words to the Act, absent something in the context requiring it. [2]

question 2

Parliament’s use of the expressions “bona fide arrangements” in the English version and “des arrangements ont été conclus de bonne foi” in the French version seems clearly intended to include arrangements which are not contractually binding. The plain meaning of the word arrangement, in both languages, indicates that. The proper meaning of the word, in the context in which it appears, is as it was described by Lord Denning, giving the advice of the Privy Council in Newton v. Commissioner of Taxation of the Common wealth of A ustralia : [3]

Their Lordships are of opinion that the word “arrangement” is apt to describe something less than a binding contract or agreement, something in the nature of an understanding between two or more persons — a plan arranged between them which may not be enforceable at law.

This describes accurately the arrangement made between the Appellant and her husband, acting for the Company.

question 3

Counsel for the Respondent relies on the decisions of this Court in Kanters* [4] and Perlingierif [5] and on the decision of the Federal Court of Appeal in Sildenfi [6] for the proposition that without a date certain being specified for repayment of the loan there cannot be compliance with the requirements of paragraph 15(2)(a). In Kanters, the loan was made by an oral agreement, with no provision for repayment being discussed. The intent was apparently that repayment would be made when the borrower became financially able to do so. In Perlingieri , the loan was payable on demand, but there was no collateral arrangement, as there is here, as to when repayment would take place. The loan in Silden was to be repaid by the Appellant to his employer only if he left the company’s employ, or if he ceased to own the house. Pratte J.A., speaking for the Court, said: [7]

The real question therefore is not whether the arrangements relating to the repayment of the loan were reasonable but whether, pursuant to those arrangements, the loan was to be reimbursed within a reasonable time. That question cannot, in this instance, be answered in the affirmative since the arrangements that were made at the time of the loan did not permit to determine with any certainty the time within which it had to be reimbursed.

It is not a provision for repayment on a date certain which the Act requires, but simply an arrangement for payment within a reasonable time. In the present case there was an arrangement which placed a five year limit on the duration of the loan, a factor which was not present in any of the cases relied on by counsel for the Respondent. This is sufficient to satisfy the requirement for an arrangement for repayment within a reasonable time. Support for this result is found in the judgment of McArthur J. in Dionne c. R. [8]

question 4

I expressed some concern during the hearing of this appeal about the evidence of Mr. Davidson to the effect that his intention, which I believe the Appellant subscribed to, was that the house loan would be repaid to the Company with the proceeds of a dividend of $90,000 to be declared on the class B shares, 46% of which were owned by the trust for minor children. It appeared from his evidence that the intention was to apply the dividend payable to the trust against the Appellant’s indebtedness. I raised the question whether this was a bona fide arrangement. Counsel for the Respondent did not address this in argument. The position of counsel for the Appellant, as I understood him, was that the expression “bona fide" in paragraph 15(2)(a) modifies only the obligation or the intent to make the repayment, and that the Court ought not to inquire into appropriateness of the intended source of funds. Upon consideration, I have concluded that the sphere of inquiry which this paragraph in the legislation raises does not go beyond the genuineness of the Appellant’s intention to repay the loan in accordance with the requirements of the arrangement. Evidence tending to show that funds will, or conversely will not, be available to satisfy the debt at the appropriate time is relevant to this inquiry, but it must be weighed along with all the other evidence relevant to the bona fides of the arrangement.

I do not believe that Mr. Davidson’s evidence as to his intention to use the dividend to repay the loan negates the bona fides of the arrangement in this case. There is no evidence before me as to the terms of the trust, nor does the evidence establish that Mr. and Mrs. Davidson, in their capacity as the trustees, would simply make a gratuitous payment of trust funds for the benefit of Mrs. Davidson. Mr. Davidson said in his evidence that if necessary they could borrow the funds, or part of them, to make the repayment when the time came. They might well have done so, either as the result of taking legal advice, or otherwise.

question 5

Counsel for the Respondent asks me to consider the fact that the loan had not been repaid at the time of the hearing, some eight years after the indebtedness arose, and three years after the date when, according to the evidence, repayment was to be made. As with the previous question, I start with the observation that what the Act calls for is a bona fide arrangement made at the time the loan was entered into. If that is established, then the Appellant is saved from the inclusion of the amount of the loan in the computation of income that would otherwise flow from the opening words of subsection 15(2). Again, if Parliament had intended to deny the taxpayer the benefit of non-inclusion in those cases where the arrangement for repayment was not fulfilled, it could easily have enacted words to bring about that result.

Evidence that payment was not made in accordance with the arrangement is relevant to the issue of bona fides, but it is not conclusive on that issue. It calls for an explanation, and the explanation given by both the Appellant and her husband was that the Revenue Canada auditor told Mr. Davidson, in effect, that the status quo should be maintained until the audit was completed. Completion of the audit brought with it the assessment now under appeal. The Appellant has paid the tax, and it is understandable that she would not wish both to pay the tax under section 15, and also to repay the loan to the Company, which is now dormant, and have to pay tax a second time on the same $90,000 when a dividend is declared. I do not accept counsel’s suggestion that the Appellant was bound to call the auditor to corroborate the evidence as to this discussion. If it was not true, then the Respondent could have called the auditor to give that evidence. No such suggestion was even put to Mr. Davidson or Mrs. Davidson in cross-examination. I accept their explanation, and I find that the fact that the loan was not repaid within the five year period does not detract from the bonafides of the original arrangement.

To summarize, I find that when the housing loan was made from the Company to the Appellant in 1990 there was a bona fide arrangement made at the same time that she would repay it within five years. I also find that five years was, in the context, a reasonable time.

The appeal is allowed, with costs.

Appeal allowed.