Citation: 2005TCC116
Date: 20050314
Docket: 2003-3523(IT)G
BETWEEN:
Marlene Proulx-Drouin,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
[1] Marlene Proulx-Drouin appeals her income tax assessment
for 1997 in which her claim for an allowable business investment loss ("ABIL")
was denied.
[2] Mrs. Proulx-Drouin is the wife of Jean Drouin. Mr.
Drouin carried on the construction business through various corporations. He
was the sole shareholder and director of 139093 Canada Inc.
("Société"), a company incorporated to carry on the business of
general contractor and to build a commercial building on the Trans Canada
Highway in Ville St. Laurent, Québec (referred to as the "Trans Canada
building" or "Trans Canada property").
[3] The facts, in short, are that Société was in financial
difficulty and in order to increase its line of credit with its banker,
Mr. Drouin guaranteed to the Banque National du Canada
("BNC") the payment of a line of credit to Société to the extent of
$570,000, plus interest and costs. To assist her husband and Société Mrs.
Proulx-Drouin became an additional guarantor to BNC by hypothecating the family
residence which she owned. Eventually the BNC sold the family residence and the
appellant lost a substantial sum of money.
Facts
[4] There are other corporations in which Mr. Drouin and his
wife had interests. The appellant has introduced these corporations in an
attempt to demonstrate that she had a monetary or an income interest in
guaranteeing Société's line of credit. 143466 Canada Inc. ("143466")
is a company whose shareholders are members of the Drouin family; apparently
Mrs. Proulx‑Drouin held 25 per cent of the shares of
143466, Mr. Drouin, 50 per cent of the shares and their son,
25 per cent of the shares. 143795 Canada Inc. ("143795")
was incorporated to own - and did own- the Trans Canada building. 143466 originally
owned 25 per cent of the shares of 143795. Société owned no shares of
143795 and 143795 owned no shares of Société.
[5] The Trans Canada building originally had rental space of
25,000 square feet, some of which was rented to other shareholders of 143795.
Several years after the completion of the building one of the tenants required
an additional 10,000 square feet and the owners of the building agreed to
expand the building. Société was the general contractor of the expansion. At
the time, in June 1987, one of the shareholders of 143795 sold its 35 per cent
interest and 143466 increased its interest in 143795 to
38.46 per cent.
[6] Unfortunately, the tenant who required the expansion
became bankrupt and 143795 found itself with 14,000 square feet of vacant area.
The bankruptcy, together with increased cost of construction and difficulty in
obtaining rent, caused financial problems to 143795. There were lots of
receivables, said Mr. Drouin. Société was not getting paid by 143795 for
construction of the addition. In February 1990 another shareholder was forced
to sell its interest in 143795 and 143466's interest in 143795 increased to
50 per cent of the issued shares.
[7] This led to the situation before me. Société required
funds to continue to operate, in particular to maintain the Trans Canada
building and to pay sub‑contractors who worked on the expansion and who
registered privileges against the building because of the non‑payment.
Société's bank required guarantees as a condition of continuing its line of
credit. In 1990 Mr. Drouin personally guaranteed the line of credit of
$570,000 to Société. On April 23, 1990 Mrs. Proulx‑Drouin agreed
to provide additional guarantees of $470,000 to the BNC with respect to
Société's line of credit and hypothecated the family residence in favour of the
bank to the extent of $470,000. By deed dated February 12, 1991 Mrs. Proulx‑Drouin
increased her guarantee to the bank and the amount of the hypothec to the sum of
$570,000.
[8] In her Notice of Appeal, Mrs. Proulx-Drouin states that
she agreed to guarantee Société's line of credit because:
a) she believed
she held a 12.5 per cent interest in the Trans Canada building;
b) she
considered the building's difficulty only temporary and that the Trans Canada
building was potentially profitable;
c) Société had
financed the renovation of another building ("Bélanger building")
in which she held a 8.33 per cent interest; and
d) her husband
promised to transfer to her one‑third of the shares he owned in a
corporation, Lapidia Inc. ("Lapidia"), if the financial situation of
the Trans Canada project did not rapidly improve; this would increase her
interest in the Belanger building from 8.33 per cent to 41.33 per cent.
[9] The Belanger building is situated on Bélanger Street in Montréal. The building was
owned by Lapidia. The shares of Lapidia were owned as to one‑third each
by Mr. Drouin, a brother of Mrs. Proulx-Drouin and Avolyn Corporation, in
which Mrs. Proulx-Drouin owned 25 per cent of the shares. It was only in
October 1990 that Mr. Drouin transferred his shares of Lapidia to the
appellant. Mrs. Proulx‑Drouin was not a shareholder of Lapidia when she
guaranteed the line of credit on April 23, 1990.
[10] Neither 143795, Lapidia nor Avolyn owned shares in
Société.
[11] By 1996 Société was in default of its loan from the BNC. On
February 29, 1996, pursuant to articles 2757 and 2758 of the Civil
Code of Quebec, the BNC served Mrs. Proulx‑Drouin with a prior
Notice that it was exercising its rights under the provisions of the deed by
hypothec; the BNC filed the Notice at the registry office of the Superior Court
on March 5, 1996. The BNC informed Mrs. Proulx‑Drouin that the bank
would exercise its hypothecary rights and seize the family residence unless,
within 60 days from the date of filing of the Notice, she took advantage of the
rights accorded to her under article 2761 of the Civil Code by paying the
bank the amount due plus costs. Mrs. Proulx‑Drouin did not make any
payment nor did she contest the action by the BNC.
[12] On July 8, 1996 judgment was issued by Québec Superior
Court in favour of BNC ordering Mrs. Proulx‑Drouin to vacate the home
in favour of BNC. The bank was declared owner of the family residence as of
March 5, 1996. BNC sold the property for $455,000 in August 1996 and
applied that amount to Société's debt. The appellant's loss on the guarantee
was $469,356, that is $455,000 with respect to the debt and $14,356 for legal
costs incurred by BNC. She claims 75 per cent of this amount as an ABIL.
[13] According to an Industry Canada Corporations Database
Online, the Director under the Canada Business Corporations Act ("CBCA")
gave notice on May 5, 1991 that Société was liable to be dissolved and on May
5, 1996 Société was dissolved in accordance with section 212 of the CBCA
for failure to file annual returns. There is no evidence of any attempt by
Mrs. Proulx‑Drouin, as creditor of Société, or Mr. Drouin, as
shareholder, to revive the corporation pursuant to section 209 of the CBCA.
Also, documentation produced at trial confirmed that on December 22, 1997
Société filed a proposal in bankruptcy; Mrs. Proulx‑Drouin was not
listed as a creditor on Société's list of creditors.
[14] [In the latter part of the 1990's Mrs. Proulx-Drouin was
suffering from cancer. Naturally she was much more interested in trying to
survive her illness and do all things to help her survive than address her mind
to financial matters. Thus, she did not claim the ABIL until she asked for an
adjustment to her 1997 tax return in 2001; by then, her 1996 taxation year
was statute‑barred. Also in 2001, she filed a claim in the amount of
$455,000 as creditor of Société with the trustee in bankruptcy of Société's
estate.]
[15] Société's financial statements for the year ending
December 31, 1995, record that the corporation had no income of any kind.
In 1994 it had a gross income of $111,654. Expenses for 1995 aggregated $89,646
and included administration costs of $14,000, travel of $1,469, insurance,
taxes and permits of $2,176, an office expense of $139, banking fees of $55,960
and a loss on disposition of fixed assets of $15,402. This compared to total
expenses of $122,468 in 1994. The financial statements for both 1994 and 1995
are dated August 28, 1996. Federal income tax returns for 1994 and 1995 are
signed by Mr. Drouin but are not dated; it appears from copies of the tax
returns that they were not filed until November 18 and 26, 1996, respectively.
[16] No financial statements nor income tax returns were
produced or filed by Société for the years after 1995 notwithstanding that Mr.
Drouin stated that Société continued management functions after 1995. He explained
that Lapidia paid to Société administration fees for services rendered to it. He
produced a copy of a cheque dated January 4, 1995 from Lapidia to Société and a
bundle of copies of cheques dated throughout 1995 from Lapidia to himself. The
cheque payable to Société in the amount of $9,000 and cheques payable to Mr.
Drouin aggregating $45,500, were deposited into Société's bank account at the
BNC. Other cheques, aggregating $44,500, although payable to, and endorsed by, Mr. Drouin,
were also endorsed by Mrs. Proulx‑Drouin and apparently were deposited
in her bank account. He also testified that in 1996 Lapidia issued cheques
payable to him for services rendered by Société; these cheques, aggregating
$81,800, were deposited in the appellant's bank account. Lapidia also issued at
least two cheques in 1997 payable to Société; the cheques were deposited in
Société's new account at the Toronto‑Dominion Bank. Mr. Drouin's
rationale for not depositing the cheques to Société's account at BNC was that
the BNC was threatening to seize the funds and he wanted to protect Société's
revenue.
[17] Mr. Drouin could not explain the reason for Société not
filing income tax returns for its fiscal years after 1995 although it was, he
insisted, carrying on business and earning income after 1995. There was no
evidence to explain the reason the amounts of the cheques were not included in
Société's income in its financial statements and its tax returns for 1995.
Arguments and Analysis
[18] The appellant declares that she is entitled to an ABIL
with respect to her guarantee because all the conditions of paragraph 39(1)(c),
subsections 39(12) and 50(1) and subparagraph 40(2)(g)(ii) of the Act
have been satisfied, namely that:
i) a debt owing
to her by Société at the end of 1997 became bad in 1997 [subsection 50(1)];
ii) Société was
a Canadian‑controlled private corporation that was a small business
corporation at all relevant times [paragraph 39(1)(c) and subsection
39(12)], and
iii) she
provided the guarantee to the BNC for the purpose of earning income
[subparagraph 40(2)(g)(ii).
If Bad Debt
[19] The appellant says that the debt from Société to her
became bad in 1997. According to her counsel, Mrs. Proulx-Drouin knew Société
was providing management services during the years 1995, 1996 and 1997. She was
a shareholder of Lapidia and knew Lapidia was paying Société for services. Mr. Drouin
testified that Société also provided services to the Bélanger property owned by
Lapidia and in 1995 and 1996 Société was paid for the services, even though Lapidia's
cheques were payable to Mr. Drouin.
[20] Counsel for the appellant argued that Mrs. Proulx-Drouin
was not wrong in waiting until 1997 to recognize that Société's debt to her was
bad. It is the creditor of the debt who is thoroughly conversant with the facts
of the particular debt and possibly the debtor who is in the best position to
determine when a debt becomes bad.
Because she believed Société was still providing services in 1996, she
considered the debt good, notwithstanding the bank's actions.
[21] The respondent's position is that the debt became bad
before 1997. Société no longer carried on a business after 1995 and that any assets
it had after 1995 were insufficient to pay the debt. The respondent obviously does
not agree that Mr. Drouin received cheques for the benefit of Société.
[22] It is clear from Société's financial statements for 1995
that the corporation did not have sufficient assets to pay off the loan to the
BNC. Total assets in Société's balance sheet as of December 31, 1995 were
$31,580; liabilities aggregated $676,085. Indeed, Société could not have paid
the debt at the end of its 1994 fiscal period when its liabilities were
$560,829 more than its assets. The BNC apparently considered the debt bad in
1995; there was no evidence that Société's financial situation was any better
when Mrs. Proulx‑Drouin was subrogated in the rights of the bank.
[23] I agree that it is usually the creditor of the debt who is
thoroughly conversant with the facts of the debt and possibly the debtor who is
in the best position to determine if and when a debt is bad. However, in making
such a determination the creditor should take into account various factors in
determining whether a debt has become bad, as described by Rothstein J.A. in Rich
v. R.,
such as:
1. the history and age of the
debt;
2. the financial position of
the debtor, its revenues and expenses, whether it is earning income or
incurring losses, its cash flow and its assets, liabilities and liquidity;
3. changes in total sales as
compared with prior years;
4. the debtor's cash, accounts
receivable and other current assets at the relevant time and as compared with
prior years;
5. the debtor's accounts
payable and other current liabilities at the relevant time and as compared with
prior years;
6. the general business
conditions in the country, the community of the debtor, and in the debtor's
line of business; and
7. the past experience of the
taxpayer with writing off bad debts.
This list is not exhaustive and, as Rothstein J.A. stated,
depending on the circumstances, one factor or another may be more important. In
the appeal at bar the appellant did not consider factors 2, 3, 4, 5 and 6 in
the above list. These, in my view, are important factors which colour the
financial situation of Société at the time.
[24] I also have some concern whether the cheques deposited in
Société’s bank account in 1995 were payments for services it rendered. As I
explain later in these reasons, Société did not carry on any business after
1994 and had no expectation of income and its assets could not realize the
amount of the debt. The debt was bad from the time the appellant was subrogated
in the rights of the BNC and became a creditor of Société.
If a Small Business Corporation When Amount First Became
Payable
[25] Paragraph 39(1)(c) of the Act describes how
the amount of a taxpayer's business investment loss from the disposition of any
property is determined. Where a guarantee is involved, subsection 39(12) adds that:
|
For the purpose of paragraph (1)(c), where
(a) an amount was paid by
a taxpayer in respect of a debt of a corporation under an arrangement under
which the taxpayer guaranteed the debt,
(b) the amount was paid
to a person with whom the taxpayer was dealing at arm's length, and
(c) the corporation was a
small business corporation
(i) at the time the debt was
incurred, and
(ii) at any time in the 12 months before the
time an amount first became payable by the taxpayer under the arrangement in
respect of a debt of the corporation,
that part of the amount that is owing to the taxpayer by the corporation
shall be deemed to be a debt owing to the taxpayer by a small business
corporation.
|
|
Pour l'application de l'alinéa (1)c), dans le cas où, aux termes d'une
entente de garantie de dette, un contribuable paie à une personne avec
laquelle il n'a aucun lien de dépendance un montant au titre de la dette
d'une société qui est une société exploitant une petite entreprise au moment
où la dette est contractée et à un moment donné au cours des 12 mois
précédant le moment où un montant devient payable pour la première fois par
le contribuable aux termes de l'entente au titre d'une dette de la société,
la partie du montant que la société doit au contribuable est réputée être une
créance de celui-ci sur une société exploitant une petite entreprise.
|
[26] There is an issue between the parties as to when the
"amount first became payable" by Mrs. Proulx-Drouin for purposes of
subsection 39(12). The appellant says the amount first became payable by her on
March 5, 1996 when the BNC filed with the registry of the Superior Court the
prior notice it served on the appellant that it intended to exercise its
hypothecary rights. The
appellant relies on the reasons for judgment in the Estate of the Late
Fabian Aylward v. The Queen
which held that letters to the guarantor demanding payment to the creditor was
the time when an amount first became payable by the guarantor under the
guarantee.
[27] Appellant's counsel argued that at any time in the 12
months before March 5, 1996 Société was a small business corporation. A
"small business corporation, at a particular time" is defined in
subsection 248(1) of the Act for purposes of this appeal as "a
Canadian‑controlled private corporation all or substantially all of the
fair market value of the assets of which at that time is attributable to assets
that are used primarily in an active business carried on primarily in Canada
..." including, for the purpose of paragraph 39(1)(c), a
corporation that was at any time in the 12 months preceding that time a small
business corporation ...".
[28] The term "active business" is defined in
subsection 248(1) to mean any business carried on by a taxpayer other than a
specified investment business or a personal services business.
[29] Respondent's counsel says the
time the amount first became payable by the appellant was when the Superior
Court issued its judgment on July 8, 1996. She relies on Armstrong v. Canada
in which the trial judge calculated the 12 months from date of payment.
Counsel explained the reason for the 12 month period described in
subparagraph 39(12)(c)(ii) is because it is not unusual for a
debtor corporation to cease carrying on a business when the creditor calls on
the guarantor to pay under its guarantee. The guarantor is usually called to
pay because the debtor cannot. The 12 month period permits the business
investment loss provisions to be available even though the debtor has stopped
carrying on its active business.
[30] I agree with the appellant's counsel.
In the case at bar the guarantee first became payable by the appellant when the
60 days described in the prior notice served on the guarantor started to
run, that is, on March 5, 1996. The judge in Armstrong did not consider
when the guarantee first became payable; he concluded on the facts of that
appeal that the amount became payable when it was paid. Armstrong does
not assist the respondent.
[31] The next problem is whether
Société carried on a business after March 5, 1995 and was a small
business corporation. There is no issue that it was a small business
corporation in 1990 and 1991 when Mrs. Proulx-Drouin provided her guarantees.
The evidence suggests that by 1995 Société had ceased to carry on a business.
[32] I am not satisfied that the
cheques paid by Lapidia in favour of Mr. Drouin during 1995 and later years were
for services rendered by Société, even if several of them may have been
deposited into one or both of Société's bank accounts. Société reported
absolutely no income in its financial statements for 1995. It did not report
any income for 1995 for tax purposes. There is no disinterested evidence of
Société carrying on a business after 1995. Deposits of cheques into a bank
account are not proof of the carrying on of a business, in particular when the
maker of the cheque, the payee of the cheque and the person in whose account
the cheque is deposited do not deal with each other at arm’s length. To this
are added the facts that Société’s financial statements and income tax return for
1995 show no gross or any income and no tax return has been filed for any
taxation year after 1995. Expenses for 1995 do not suggest ongoing activity. Société’s
financial statements for 1994 and 1995 are dated August 28, 1996. The
corporation's officers apparently did not see any pressing need to prepare the
financial statements earlier. I infer from the lack of proof of any business
carried on by Société in 1995, the tardiness in preparing the financial
statements for 1994 and 1995 and the contents of the financial statements and
income tax return for 1995 that Société was no longer carrying on a business in
1995.
"For the Purpose of Earning
Income"
[33] Another condition for the appellant to be successful is
for her to establish that she acquired Société’s debt for the purpose of
earning income from a business or property. Once her home was sold in August,
1996, appellant’s counsel argued, she paid Société’s debt to the BNC and was
subrogated in the rights of the bank. I agree.
[34] Appellant's counsel also argued that the appellant originally
provided the guarantee for the purpose of earning income. She would earn dividend
income from the rental income earned once the Trans Canada building was rented
and the corporations 143795 and 143466 paid dividends, the former to the
latter, and then to her. Counsel also suggested that the appellant's husband’s
promise in 1990 to transfer to the appellant his one‑third interest in
Lapidia was valuable consideration to her for agreeing to the guarantee and was
a potential source of income.
[35] Appellant's counsel asserted that Mrs. Proulx-Drouin wanted
Societé to complete work on the Trans Canada building because she knew the
corporation and the person behind it, her husband. The Trans Canada building
was owned by 143795; once the building would be rented 143795 would earn rental
income and be in a position to pay dividends to its shareholders. A person
owning 50 per cent of the shares of 143795 on February 17, 1991 was
143466.
And since Mrs. Proulx‑Drouin owned 25 per cent of the shares of
143466 she would be entitled to dividends declared by 143466 from dividend
income it earned from 143795.
[36] By means of piercing the corporate veil of 143466,
appellant's counsel declared that his client had a 12.5 per cent interest in
143795. In turn, he then pierced 143795's corporate veil to conclude that his
client owned an undivided interest in the Trans Canada property. Thus,
appellant's counsel concluded that Mrs. Proulx-Drouin guaranteed Societé's line
of credit for the purpose of earning income.
[37] It is true that once the Trans Canada building was
completed and rented, rental income would flow to 143795 and 143795 may be in a
position to apply the rental income as payment of dividends to 143466 which, in
turn, could apply the dividends to pay dividends to its shareholders, including
Mrs. Proulx‑Drouin.
[38] The appropriate time to consider whether a taxpayer had
an income‑earning purpose is at the time the guarantee was given. In The Cadillac‑Fairview
Corporation Limited v. The Queen
Bowman J., as he then was, explained:
In many cases
if a guarantor is obliged to make good under a guarantee it is because the
principal debtor in unable to pay the obligation. From this, it follows that
the guarantor's right of subrogation against the principal debtor is, at the
time of acquisition, likely to be, in many instances, worthless or virtually
worthless. A narrow and mechanical reading of subparagraph 40(2)(g)(ii)
would lead one to conclude that on the payment of the guaranteed amount the
guarantor's acquisition of the worthless subrogated debt could not possibly
have as its purpose the gaining or producing of income from a business or
property. Such an interpretation in my view lacks commercial sense. A
functional and more commercially realistic interpretation would subsume in the
purpose of the acquisition of the subrogated debt the purpose for which the
guarantee was originally given.
[39] The "income‑earning purpose" for the
guarantee need not be the sole purpose or even the primary purpose for the
guarantee, so long as it is a purpose, to meet the exception described in
subparagraph 40(2)(g)(ii).
[40] I have no doubt that at the time Mrs. Proulx-Drouin
executed her guarantee to the BNC her purpose in doing so was influenced more by
the fact that her husband was the shareholder of Societé than any other fact. As
I tried to explain in Elliott v. The Queen,
it is normal for a spouse to guarantee the debt of a company, the shares of
which are owned by the other spouse. Such guarantees are for the purpose of
earning income for the family, if not the guarantor. The appellant also
suggested that she wanted to have the Trans Canada building completed by
Societé rather than a contractor she did not know. Notwithstanding these
purposes, if there were also an income‑earning purpose in making the
guarantee, that would suffice for purposes of subparagraph 40(2)(g)(ii).
[41] The problem in this appeal is one raised by McDonald
J.A. in The Queen v. Byram:
[23] In situations where the taxpayer
does not hold shares in the debtor, but rather is a shareholder of a parent
company or other shareholder of the debtor the taxpayer is not entitled to
dividend income directly from the debtor. Generally speaking, the burden of
demonstrating a sufficient nexus between the taxpayer and the dividend income,
in such cases, will be much higher. The determination of whether there is
sufficient connection between the taxpayer and the income earning potential of
the debtor will be decided on a case by case basis depending on the particular
circumstances involved.
[42] There is a remoteness between the appellant's guarantee
and the alleged purpose of earning income from the guarantee. The appellant is
not a shareholder of Societé nor is she a shareholder of any corporation owning
shares of Societé. Appellant's counsel tried to identify her as an owner of the
Trans Canada and the Belanger buildings so as to put her closer to Societé
(and, in any event, she had no interest in Lapidia at time of the guarantee).
This, of course, required him to pierce the veil of two corporations with
respect to each of the two properties. This only emphasized the distant degrees
of separation between the appellant and the two properties, to say nothing of
Societé, and the chasm between her and Societé.
[43] I am not satisfied there is a sufficient connection
between the appellant and Société so that one may reasonably conclude that she
guaranteed Société's debt to the BNC to earn income. However, this finding is
not necessarily fatal to the appellant.
[44] Once a guarantor is subrogated
in the rights of the creditor, the guarantor is a creditor of the main debtor.
Once the bank has exercised its hypothecary rights under the guarantee, the appellant's
guarantee was extinguished and what is left is a debt between the appellant and
Société. The debt so acquired by the appellant from the bank, even if by law,
could be said to have been acquired for the purpose of earning income, the
income being the rate of interest Société was obliged to pay to the bank. This,
in my view, would qualify to meet the requirement of subparagraph 40(2)(g)(ii).
At time of subrogation a debtor corporation may be actively carrying on a
business, as in the case of Elliott, may be solvent or may be reasonably
expected to increase its fortunes in short‑term, say, by successfully
bidding on a contract yet to be awarded. When one of the situations is present
the debt may be susceptible of yielding income and the guarantor, who may have
more faith in the corporate debtor than the bank, has an income purpose when subrogated
in the debt. An examination of the corporate debtor at time of subrogation is
therefore required.
[45] Unfortunately, on the facts I have already described, I
cannot find any income purpose by the appellant at time of subrogation when the
guarantee was extinguished in 1996. At that time, and for some time earlier,
Societé was no longer carrying on any business and had no assets that could
conceivably service the debt, at least there was no evidence of any such assets.
There was no potential for the appellant to earn income from the debt.
[46] The appeal is therefore dismissed, with costs.
Signed
at Ottawa, Canada, this 14th day of March 2005.
"Gerald J. Rip"
Email this Content