Pineo v. The Queen, 86 DTC 6322, [1986] 2 CTC 71 (FCTD)

The Associate Chief Justice:—This matter, dealing with the interpretation and application of paragraph 40(1)(a) of the Income Tax Act came on for hearing at London, Ontario on December 10, 1985.

The facts are not in dispute and are contained in an agreed statement filed by the parties at the hearing:

1. Melvin and Evelyn Pineo (sometimes herein referred to as “Mr. and Mrs. Pineo”) are husband and wife residing at R.R. #1, Sparta, Ontario.

2. Richard and Susan Pineo are the son and daughter-in-law, respectively, of Mr. and Mrs. Pineo.

3. Melvin Pineo Farms Limited (“Pineo Farms’’) is a corporation incorporated pursuant to the laws of the Province of Ontario whose only shareholders prior to April 30, 1979, were Mr. and Mrs. Pineo. Pineo Farms was at all material times a corporation that carried on the business of farming in Canada in which it used substantially all of its property.

4. By Notice of Reassessment dated the 23rd day of November, 1981, Federal Tax in the amount of $14,987.30 and Provincial Tax in the amount of $6,814.40, and by Notice of Reassessment dated the 23rd day of November 1981, Federal Tax in the amount of $3,625.20 and Provincial Tax in the amount of $1,752.90 was levied against Evelyn Pineo by the Minister of National Revenue (“Minister”), in respect of Evelyn Pineo’s income for her taxation years 1979 and 1980. Such Reassessments arose as a result of the disposition by Mr. and Mrs. Pineo, in 1979, of shares of Melvin Pineo farms then owned by them. As part of the consideration of such transfer, Mr. and Mrs. Pineo received from the purchasers of such capital property, a promissory note in the amount of $650,000.00. The purchasers were Richard and Susan Pineo.

5. By Notice of Reassessment dated the 9th day of November 1981, Federal Tax in the amount of $19,774.20 and Provincial Tax in the amount of $8,920.70 and a penalty in the amount of $500.00 was levied against Melvin Pineo by the Minister in respect of Melvin Pineo’s income for his taxation year 1979. Such Reassessment arose as a result of the disposition by Mr. and Mrs. Pineo, in 1979, of the Pineo Farm shares.

6. By Notice of Reassessment dated April 8, 1983, the Minister deleted the penalty of $500.00 referred to in paragraph 5 herein.

7. In reporting their income for the 1979 taxation year, Mr. and Mrs. Pineo elected to treat the disposition of their shares of Pineo Farms pursuant to the rules established by subsection 73(5) of the Income Tax Act R.S.C. 1952, Chapter 148, as amended, (the “Act”). Mr. and Mrs. Pineo take the position with respect to the proceeds received from the sale of the Pineo Farms shares that they are entitled to a reserve under paragraph 40(1)(a) of the Act.

8. The Minister calculated the capital gain arising in 1979 from the sale of the Pineo Farm shares pursuant to the provisions of subsection 73(5) of the Act being invoked, as follows:

Fair Market Value	$728,748
Less: Amount of the Taxpayers’ cumulative
small business gains	400,000
Deemed Proceeds	$328,748
Less: Adjusted cost base	40
Total Capital Gain	$328,708
Total Taxable Capital Gain	164,354
Melvin Pineo’s share 50%	$82,177
Evelyn Pineo’s share 50%	82,177

In so calculating the taxable capital gain of Mr. and Mrs. Pineo the Minsiter (sic) found that Mr. and Mrs. Pineo did not qualify for a capital gain reserve pursuant to paragraph 40(1)(a) of the Act.

9. By Memorandum of Agreement dated April 30 1979, Mr. and Mrs. Pineo as owners of all the issued and outstanding shares of Pineo Farms agreed to sell all of the said shares to Richard and Susan Pineo, for the sum of $1,070,000 which sum was paid as follows:

(i) Cash	$100,000
(ii) Promissory Note	650,000
(iii) Gift	320,000

Attached hereto are an Escrow Agreement relating to the said shares made July 30, 1979, a a Memorandum of Agreement of the sale of the said shares dated April 30, 1979 and a copy of the Demand Promissory Note dated April 30, 1979 (the “Demand Promissory Note") upon which Mr. and Mrs. Pineo base their claim for a reserve in computing the gain from the disposition of the Pineo Farms shares.

10. As part of the consideration for the sale of the shares of Pineo Farms in 1979, Mr. and Mrs. Pineo received in or about April 30, 1979 the demand promissory note dated April 30, 1979, referred to in paragrpaph (sic) 9 herein, in the amount of $650,000 bearing interest at the rate of 7% per annum, payable annually. During 1979, Mr. and Mrs. Pineo although they could have, did not demand that Richard and Susan Pineo pay the principal sum of the Demand Promissory Note.

11. The issue before this Court is whether the Minister was correct in determining that Mr. and Mrs. Pineo were not entitled to claim a reserve pursuant to paragraph 40(1)(a) of the Act. The claim for the reserve is based on the Demand Promissory Note dated April 30, 1979.

Paragraph 40(1)(a) of the Act provided:

40.(1) Except as otherwise expressly provided in this Part

(a) a taxpayer’s gain for a taxation year from the disposition of any property is the amount, if any, by which

(i) if the property was disposed of in the year, the amount, if any, by which his proceeds of disposition exceeds the aggregate of the adjusted cost base to him of the property immediately before the disposition and any outlays and expenses to the extent that they were made or incurred by him for the purpose of making the disposition, or

(ii) if the property was disposed of before the year, the amount if any, claimed by him under subparagraph (iii) in computing his gain for the immediately preceding year from the disposition of the property,

exceeds

(iii) such amount as he may claim, not exceeding a reasonable amount as a reserve in respect of such of the proceeds of disposition of the property that are not due to him until after the end of the year as may reasonably be regarded as a portion of the amount determined under subparagraph (i) in respect of the property; and [Emphasis added]

[amended S.C. 1980-81-82-83, c.140, subsection 19(1).]

The meaning of the term "due to him" as it appears in subparagraph 40(1 )(a)(iii) was recently considered by the Federal Court of Appeal in The Queen v. Derbecker, [1985] 1 F.C. 160; [1984] C.T.C. 606. It is appropriate to set out the full text of the reasons in that case, delivered from the bench by Hugessen, J.:

Subparagraph 40(1)(a)(iii) of the Income Tax Act [S.C. 1970-71-72, c. 63], allows a taxpayer to take a reserve

4O.(1)(a) ...

(iii) . . . in respect of such of the proceeds of disposition of the property that are not due to him until after the end of the year. . . .

In the present case, part of the proceeds of disposition were represented by a promissory note expressed to be payable “on demand after December 31, 1976”. In the now classic words of Parke, B., in Norton v. Ellam (1837), 2 M. & W. 461 (Exch. of Pleas) at page 464:

. . . a promissory note, payable on demand, is a present debt, and is payable without any demand. . . .

That case has been many times approved.

The learned Trial Judge [[1984] 1 F.C. 840] held that in the absence of a demand in the year 1977 the note in question was not “due” to the taxpayer in that year. She said [at page 844]:

. . . What was intended was to tax the taxpayer not at the time he was entitled to the money but at the time when it was required to be paid to him.

With respect we think that she was wrong and that the words “due to him” look only to the taxpayer’s entitlement to enforce payment and not to whether or not he has actually done so.

Here, the taxpayer, alone and at his sole option, was entitled to enforce payment of the note in 1977. From January 1, 1977, it became a present debt and could be sued on without any demand. It was, therefore, “due to him”.

The appeal will therefore be allowed with costs here and in the Trial Division.

1. Brown v. Brown, [1893] 2 Ch. 300; Royal Bk. v. Hogg, [1930] 2 D.L.R. 488 (Ont. S.C.); Spencer Investments Ltd. v. Hansford (1974), 48 D.L.R. (3d) 474 (Alta. S.C.).

Counsel for the plaintiffs endeavoured to distinguish Derbecker from the case at bar. Here, in addition to the promissory note there is a share purchase agreement entered into by the plaintiffs and the purchasers. Paragraph 2 of that agreement provides:

2. The parties do hereby agree that 4,000 shares shall be held in escrow by Agricultural Tax Service Ltd. and shall continue to be voted by the vendors, W. Melvin Pineo and Evelyn Pineo, until such time as the purchase price has been paid in full and at such time as any debts owing by the company to the vendors herein have been paid and any preference shares held by the vendors have been redeemed. The parties hereby agree that during the said escrow period no dividends shall be paid to the vendors. The vendors shall continue to vote the said shares but shall not transfer any assets of the company out of the ordinary course of business without the consent of the beneficial shareholders, that is, the purchasers herein, nor shall the vendors vote the shares in any way in contradiction to the terms of this agreement.

Paragraph 1 of the escrow agreement provides:

1. Pending the satisfaction of the said purchase price and repayment of the said note in full to the Vendors, the share certificates shall be held in escrow by the Vendors on the following conditions:

(a) The Vendors shall exercise all voting rights attached to the said shares.

(b) The Vendors covenant and agree that unless the said note is in default, they shall not vote the said shares to encumber or sell any assets of the Company, but shall vote the shares to assist in the management of the Company by the Purchasers in a normal businesslike manner.

(c) The Vendors covenant and agree that so long as the said note is not in default, they shall not vote the said shares to pay salaries or bonuses to other than the Purchasers without their consent.

(d) In the event of default by the Purchasers on the said note, the Vendors shall at their option become the sole owners of the said shares free and clear of any right, title or interest of the Purchasers.

(e) The Purchasers covenant that they shall not as managers or directors or shareholders of the Company enter into any agreement to encumber or sell any assets of the Company, nor shall they enter into on behalf of the Company any agreement out of the ordinary course of business without the consent of the Vendors.

(f) It is understood and agreed that the Purchasers shall not assign, transfer or sell their shares, until the said note is paid in full.

On the basis that the promissory note is merely evidence of the debt and that the taxpayers’ rights to recover on it are suspended until the makers of the note fail to honour it, counsel argues that the terms of these two agreements placed a qualification on the taxpayers’ right to enforce payment of the promissory note so that the debt was not due to the plaintiffs in the year in which the note was executed. I do not agree. Essentially, they provided additional security for the debt by establishing the escrow holding of the shares, voting rights and options open to the plaintiffs in the event of default on the note, but the note remained a present debt which was owing and payable to the plaintiffs and, therefore, due to them in the 1979 taxation year.

The respondent was, therefore, correct in determining that the plaintiffs were not entitled to claim a reserve pursuant to paragraph 40(1)(a) of the Act and the action is dismissed with costs.

Action dismissed.