REASONS
FOR JUDGMENT
Lamarre J.
Introduction
[1]
These are appeals against reassessments made by
the Minister of National Revenue (Minister) disallowing the deduction of
a capital loss in the amount of $382,219.31 claimed by the appellant for the
year ended September 30, 2006, which in turn had an impact on the
appellant's tax liability for the taxation years ended September 30, 2005,
September 30, 2006, September 30, 2007 and September 30, 2008
(see paragraphs 4 and 7 of the Amended Reply).
[2]
In the calculation of its taxable income for the
year ended September 30, 2006, the appellant claimed to have disposed of a
receivable having an adjusted cost base of $382,219.31 for proceeds of
disposition equal to zero, resulting in a loss in the amount of $382,219.31
(Amended Reply, paragraph 12 (i)).
[3]
The appellant's records indicated that the receivable
consisted of the following loans and advances the appellant claims to have made
to Chun Fai Holdings Ltd. (Chun Fai), an affiliated
corporation:
|
a. Chun Fai Holdings – Land
|
$ 110,000.00
|
|
b. Chun Fai Holdings – Security
|
3,766.88
|
|
c. Chun Fai Holdings – Interest
|
236,455.25
|
|
d. Chun Fai Holdings – General
|
31,997.18
|
|
Total
|
$ 382,219.31
|
[4]
Hill Fai says the debts became bad debts in its
2006 taxation year, thus allowing it to dispose of the debts pursuant to subsection 50(1)
of the Income Tax Act (ITA) and claim the capital losses under paragraph 39(1)(b)
of the ITA.
[5]
The respondent is of the view that the appellant
did not dispose of a debt within the meaning of subsection 50(1) of the ITA
and therefore cannot claim the capital losses. She disputes that the debts even
existed, and if they did exist, that they could properly be said to have become
bad. Alternatively, the respondent argues that if Hill Fai did dispose of a
debt within the meaning of subsection 50(1), Hill Fai did not acquire the
debt for the purpose of gaining or producing income from a business or
property, and therefore Hill Fai’s loss from the disposition of the debt is nil
pursuant to paragraph 40(2)(g) of the ITA.
[6]
The reasons given by the respondent for her
position are set out in paragraphs 12(k) to (o) of the Amended Reply,
which read as follows:
(k) the notes payable by Chun Fai to the Appellant were non‑interest
bearing;
(l) there were no specific terms of repayment for the notes
payable by Chun Fai to the appellant;
(m) no attempts were made to collect the amounts owing from
Chun Fai to the Appellant prior to the Appellant's claim that the debt had been
disposed of;
(n) As of September 30, 2006, the Appellant continued to
hold a mortgage receivable from Chun Fai in the amount of $442,000;
(o) The Appellant did not have documentation to support the
source of funds to the Appellant, the advance of funds by the Appellant to Chun
Fai or the disposition of the receivable in the course of the year ended
September 30, 2006;
[7]
As a secondary matter, Hill Fai takes exception
to the Minister's requirement during the assessment, objection and appeal
stages that Hill Fai file documents supporting the relevant loan transactions
that led to the 2006 capital loss claim. First, Hill Fai says it reported the
transactions in 1994 on the balance sheets it submitted to the Minister, and
therefore the Minister has been aware of the transactions since that date.
Second, Hill Fai says that the ITA only requires taxpayers to keep records for
six years, and since the loan transactions occurred in 1994, Hill Fai only had
an obligation to keep documents until 2000.
[8]
The respondent says that, pursuant to subsections 230(1),
230(4) and 230(6) of the ITA, the six-year time limit is calculated from the
end of the last taxation year to which the documents relate. Since Hill Fai
claimed the capital losses in 2006, the Respondent argues that time began to
run at the end of the 2006 taxation year.
[9]
As a result of the foregoing, the respondent is
of the view that during the taxation year ended September 30, 2006 the
appellant did not incur capital losses within the contemplation of
paragraphs 39(1)(b) and 40(1)(b) of the ITA in the amount of
$382,219.31 and that the appellant is therefore not entitled to deduct under
sections 3 and 111 of the ITA any resulting carry‑over amount in the
calculation of its taxable income for the taxation years ended
September 30, 2005, September 30, 2007 and September 30, 2008.
Relevant Statutory
Provisions
Income Tax Act
R.S.C. 1985, c. 1 (5th Supp.)
39 (1) Meaning of capital
gain and capital loss − For the purposes
of this Act,
. . .
(b) a taxpayer's capital loss for a
taxation year from the disposition of any property is the taxpayer's loss for
the year determined under this subdivision (to the extent of the amount thereof
that would not, if section 3 were read in the manner described in
paragraph (a) of this subsection and without reference to the
expression "or the taxpayer's allowable business investment loss for the
year" in paragraph 3(d), be deductible in computing the
taxpayer's income for the year or any other taxation year) from the disposition
of any property of the taxpayer other than
(i) depreciable property, or
(ii) property
described in any of subparagraphs 39(1)(a)(i), (ii) . . .
. . .
40 (1) General rules − Except as otherwise expressly
provided in this Part
. . .
(b) a taxpayer's loss for a taxation
year from the disposition of any property is,
(i) if
the property was disposed of in the year, the amount, if any, by which the
total of the adjusted cost base to the taxpayer of the property immediately
before the disposition and any outlays and expenses to the extent that they
were made or incurred by the taxpayer for the purpose of making the
disposition, exceeds the taxpayer's proceeds of disposition of the property,
and
(ii) in any other case, nil.
40 (2) Limitations −
Notwithstanding subsection 40(1),
. . .
(g) a taxpayer's loss, if any, from the
disposition of a property (other than, for the purposes of computing the exempt
surplus or exempt deficit, hybrid surplus or hybrid deficit, and taxable
surplus or taxable deficit of the taxpayer in respect of another taxpayer,
where the taxpayer or, if the taxpayer is a partnership, a member of the
taxpayer is a foreign affiliate of the other taxpayer, a property that is, or
would be, if the taxpayer were a foreign affiliate of the other taxpayer,
excluded property (within the meaning assigned by subsection 95(1)) of the
taxpayer), to the extent that it is
(i) a
superficial loss,
(ii) a
loss from the disposition of a debt or other right to receive an amount, unless
the debt or right, as the case may be, was acquired by the taxpayer for the
purpose of gaining or producing income from a business or property (other than
exempt income) or as consideration for the disposition of capital property to a
person with whom the taxpayer was dealing at arm's length.
.
. .
is
nil;
50 (1) Debts
established to be bad debts and shares of bankrupt corporation – For
the purposes of this subdivision, where
(a) a debt owing to a taxpayer at the
end of a taxation year (other than a debt owing to the taxpayer in respect of
the disposition of personal‑use property) is established by the taxpayer
to have become a bad debt in the year, or
. . .
and the taxpayer elects in the taxpayer's return of income for the
year to have this subsection apply in respect of the debt or the share, as the
case may be, the taxpayer shall be deemed to have disposed of the debt or the
share, as the case may be, at the end of the year for proceeds equal to nil and
to have reacquired it immediately after the end of the year at a cost equal to
nil.
General
230 (1) Records and books –
Every person carrying on business and every person who is required, by or
pursuant to this Act, to pay or collect taxes or other amounts shall keep
records and books of account (including an annual inventory kept in prescribed
manner) at the person's place of business or residence in Canada or at such
other place as may be designated by the Minister, in such form and containing
such information as will enable the taxes payable under this Act or the taxes
or other amounts that should have been deducted, withheld or collected to be
determined.
. . .
(4) Limitation period for keeping records, etc. – Every person required by this section to keep records and
books of account shall retain
(a) the records
and books of account referred to in this section in respect of which a period
is prescribed, together with every account and voucher necessary to verify the
information contained therein, for such period as is prescribed; and
(b) all
other records and books of account referred to in this section, together with
every account and voucher necessary to verify the information contained
therein, until the expiration of six years from the end of the last taxation
year to which the records and books of account relate.
. . .
(6) Exception where objection or appeal –
Where a person required by this section to keep records and books of account
serves a notice of objection or where that person is a party to an appeal to
the Tax Court of Canada under this Act, that person shall retain every record,
book of account, account and voucher necessary for dealing with the objection
or appeal until, in the case of the serving of a notice of objection, the time
provided by section 169 to appeal has elapsed or, in the case of an
appeal, until the appeal is disposed of and any further appeal in respect
thereof is disposed of or the time for filing any such further appeal has
expired.
Facts
[10]
It is not in dispute in these appeals that at
all material times, Gilbert Tam and his spouse, Swallow Tam, each
owned 50 percent of Hill Fai's outstanding shares. They also each held
25 percent of Chun Fai's outstanding shares, and Swallow Tam held
the remaining 50 percent of the shares in trust for Gordie Tam
(Amended Reply, paragraphs 12(a), (b) and (c)). Hill Fai and
Chun Fai are therefore affiliated persons as that term is defined in
subparagraph 251.1(1)(c)(iii) of the ITA.
[11]
In 1985, Hill Fai bought a property at 673‑679 Somerset
Street in Ottawa. The property included a building and an adjacent lot.
Gilbert Tam testified that the property was then severed so that the
vacant lot could be developed, and Chun Fai was incorporated for this
purpose in 1992.[3] The respondent disputed whether a severance actually occurred, but
what was not in dispute was that by 1994 Hill Fai owned 673‑679 Somerset
Street while Chun Fai owned 681‑685 Somerset Street, which was
the property with the vacant lot.
[12]
Chun Fai initiated construction of a building on
its property and hoped to make money by renting units to tenants. It took out a
$450,000 line of credit with Toronto-Dominion Bank (“TD”), and either Mr. and
Mrs. Tam or Mr. Tam alone personally guaranteed the line of credit.
[13]
In 1994, Hill Fai took out a $450,000 mortgage
with TD on its Somerset Street property. Hill Fai says it then loaned these
funds to Chun Fai. Mr. Tam and Mr. K. Eapen Koshy, an accountant
Hill Fai retained to prepare the corporation’s 2006 tax returns, testified
there were various reasons for the loan, including the following: Mr. Tam
wanted to settle the line of credit with TD since he had personally guaranteed
it; Chun Fai had no credit to itself borrow the funds from the bank; the funds
were needed to help finish the building; and Hill Fai could get a better
interest rate from the bank than Chun Fai since Hill Fai had a healthier
balance sheet.
[14]
The notes to Chun Fai’s financial statements for
its year ended May 31, 1995
and to Hill Fai’s financial statements for its year ended September 30,
1996 say that Hill Fai’s $450,000
loan to Chun Fai is non-interest bearing and has no specific terms of
repayment. However, Mr. Tam testified that the interest rate on that loan was
two percent higher than the rate Hill Fai was paying TD on the mortgage. Since
the mortgage interest rate was prime plus two or three percent, the interest
rate on Hill Fai’s loan to Chun Fai would have been prime plus four or five
percent.
The Respondent disputes that Hill Fai charged Chun Fai any interest on the
loan.
[15]
On top of the $450,000 loan, Hill Fai says it
also transferred land to Chun Fai in 1994 and, in connection with this
transfer, incurred a receivable from Chun Fai of $110,000. Hill Fai’s 1996
financial statements say that this loan also is non-interest bearing and has no
specific terms of repayment.
[16]
In total, Hill Fai says it loaned or advanced
$560,000 to Chun Fai in 1994.
[17]
Once Chun Fai’s building became
operational, it had difficulty finding tenants and began losing money. By 2002,
according to its financial statements for that year, it had total liabilities of
about $1.3 million against assets of about $918,000. Chun Fai had
listed its property for sale around 2000 or 2001, but a sale was only closed in
2003, the selling price being $623,442. [10]
[18]
Mr. Tam testified that, after other mortgages
registered against Chun Fai’s property were paid off, [11] Chun Fai used the net sale proceeds (amounting to about
$419,000) to repay creditors other than Hill Fai because these creditors were
charging higher rates of interest than Hill Fai.[12] Mr. Tam testified
that once Chun Fai sold its property it effectively ceased carrying on
business. According to Chun Fai’s financial statements for the year ended
2004,
Chun Fai had liabilities of about $736,000 against assets of about $2,000.
The debts owed to Hill Fai were still unpaid.
Issues
[19]
The issues in these appeals are as follows:
1. Did Hill Fai dispose of debts totalling $382,219.31
during its 2006 taxation year pursuant to subsection 50(1) of the ITA,
such that it is entitled to claim capital losses related to those debts?
2. In the alternative, did Hill Fai incur the debts for
the purpose of gaining or producing income from a business or property under
subparagraph 40(2)(g)(ii) of the ITA?
3. Pursuant to subsection 230(1), 230(4) or 230(6) of the
ITA, when was Hill Fai no longer required to keep documents relating to
the loan transactions and the capital loss claim?
Analysis
Issue 1: Disposition of debts pursuant to
subsection 50(1)
[20]
According to paragraph 50(1)(a), a
taxpayer (Hill Fai) may elect to be considered as having disposed of a
debt that it has established to have become bad in the year. Where the taxpayer
makes this election, it is deemed to have disposed of the debt for no proceeds
and to have reacquired it at no cost. The taxpayer may then claim a capital
loss pursuant to 39(1)(b), as it disposed of the debt for nil proceeds.
[21]
There appears to be no issue regarding whether the taxpayer made a
proper election. Mr. Koshy testified that he made the election,[14] and the respondent
did not dispute this.
[22]
In order to comply with subsection 50(1) and then claim a
capital loss under paragraph 39(1)(b), Hill Fai must
establish that:
a.
There were debts of
$382,219.31 owed to it by Chun Fai;
b. The debts became bad in 2006. [15]
a) Did Chun Fai owe
the amount of the debts claimed by Hill Fai?
[23]
Hill Fai must first establish what amounts it
loaned to Chun Fai. The parties fundamentally disagree over whether these debts
existed: Hill Fai says it loaned the funds to Chun Fai, while the Respondent
says no such debts were owed.
[24]
Before examining whether each of the specific
debts claimed by Hill Fai was actually owed to Hill Fai, it is worth reviewing
the general evidence Hill Fai presented at trial.
Witnesses
[25]
Hill Fai called two witnesses. The first
was Mr. Koshy, who was first retained by Hill Fai in 2007 to prepare
the corporation’s 2006 tax returns. Mr. Koshy testified that "by
implication" he was also retained by Chun Fai to prepare its returns.
In preparing these returns, Mr. Koshy had to rely on the work of two
people who had prepared Hill Fai’s and Chun Fai’s earlier returns:
Hubert Joy, now deceased, a certified general accountant who apparently
prepared the corporations' returns from 1993 to 1996, in which period the 1994
loans to Chun Fai were made; and Karl von Bloedau, an accountant
who was Mr. Koshy’s predecessor on the files. While it was unclear when
Mr. von Bloedau both began and ceased preparing the corporations’
returns, Mr. Koshy testified that before him it was
Mr. von Bloedau who had handled the files.
[26]
Mr. Koshy testified that Mr. Joy had
died by the time he became involved, and so he had no opportunity to discuss
the files with Mr. Joy. Mr. Koshy also testified that he tried to
meet with Mr. von Bloedau to obtain information on the files, but
Mr. von Bloedau refused to provide any help or documents. The only
thing Mr. von Bloedau provided was a disk containing data.
Mr. Koshy did not pursue any further contact with
Mr. von Bloedau and he testified that at best Mr. von Bloedau
did simple bookkeeping and this was all that Mr. Koshy could use from
Mr. von Bloedau.
[27]
Mr. Koshy appeared reluctant to acknowledge
that the financial statements he had prepared, which led to claiming the
capital losses, may not be reliable because of a lack of source documentation
or because the documents prepared by the previous accountants were not
themselves reliable. His position was that he interviewed Mr. and
Mrs. Tam, met with their lawyer, reviewed as many documents as possible
and did the best he could. He acknowledged, however, that there were no loan
agreements and no promissory notes. Given that Mr. Koshy was not the
accountant on the file when the 1994 transactions took place, that he had
almost no contact with the previous accountants and that his involvement with
Hill Fai only began with the 2006 returns, he is at best an interpreter of most
of the original documents and events that led to Hill Fai claiming the capital
losses in question. I would therefore assign little weight to his testimony
regarding the events that preceded the filing of the 2006 return.
[28]
Hill Fai’s other principal witness was Mr. Tam.
He was the president of both Hill Fai and Chun Fai and was also a shareholder
and director of both corporations. On several occasions, it was difficult to
assess Mr. Tam's testimony because he seemed to have difficulty either
understanding the questions put to him or communicating an answer. He testified
that his English was good enough to communicate, but there were many instances
when he either explicitly said he did not understand the questions or where he did
not seem to recognize that he was being asked to provide an answer. Simple
questions had to be repeated because he did not understand them. On other
occasions, his testimony contradicted the answers he gave at discovery. Whether
the contradictions were the result of a language barrier, faulty recollections
or other factors is difficult to say. I am therefore hesitant to assign
significant weight to Mr. Tam's testimony, particularly where there may
have been contradictions with his other oral evidence or the documentary
evidence.
Documentary evidence
[29]
It is perhaps useful, first of all, to note what
documentary evidence was not presented at trial. Mr. Koshy and Mr. Tam
testified that no loan agreements or promissory notes were prepared in connection
with the debts, and therefore none could be produced in evidence. They also
testified that they made requests to TD for copies of cancelled cheques, Hill
Fai’s mortgage application to TD and records relating to Chun Fai’s sale of property
in 2003, but that the records had been destroyed.
[30]
The primary – and practically only – documentary
evidence presented to support the debts’ existence was various financial
statements of both Hill Fai and Chun Fai. Each of these statements was prepared
by either Mr. Joy or Mr. von Bloedau. Mr. Joy's statements
were not audited but were more complete than Mr. von Bloedau’s, which were also
unaudited
and essentially consisted of a balance sheet and an income statement. Counsel
for the Respondent demonstrated that there were some discrepancies both in
Mr. von Bloedau’s documents and between those documents and Mr. Koshy’s
documents.
Mr. Koshy agreed in his testimony that there appeared to be errors in those
documents.
Mr. Koshy also agreed that Mr. von Bloedau's documents and data
were a starting point for his own work, and he stated that even though they
were a "bad starting point" they needed to be used at some point in
order to prepare the 2006 returns.
[31]
I also note that Hill Fai’s financial statements
for its year ended September 30, 1995, were not presented as evidence
despite the fact that its financial statements for 1993, 1994 and 1996 were
presented. The 1995 statements would have been useful for the sake of
continuity between Hill Fai’s preceding and subsequent statements and for the
sake of comparability with Chun Fai’s statements so that it could be seen how
each entity was recording the relevant entries.
[32]
As for the returns prepared by Mr. Koshy,
his testimony tended to show that he conducted a review of all available
records and sources of information. However, he was handicapped by not being
able to speak with Mr. Joy or in any meaningful way with
Mr. von Bloedau and by having no loan agreements, cancelled cheques,
promissory notes or other source documentation to work with. Mr. Koshy, by
his own admission, was relying on poor work done by Mr. von Bloedau.
When Mr. Koshy was asked how he came up with the claim in Hill Fai’s 2006
return for $382,219.31 in capital losses, Mr. Koshy said the figure was
based on his firm’s investigations, the financial statements of Hill Fai and
Chun Fai, and his discussions with Hill Fai’s lawyer.[20] In my view, given
the evidence regarding the documentation that was available, this is not a
solid basis for the claim.
[33]
Given all of the above, I would assign little
weight to Mr. von Bloedau's documents and Mr. Koshy’s documents.
Several errors were noted in Mr. von Bloedau’s documents, and while
Mr. Koshy appears to have been diligent in his work in preparing the
documents, he was forced to rely on poor documentation or no documentation as a
starting point. I would assign some weight to Mr. Joy’s documents since
they were prepared contemporaneously with the events in question. However,
since Mr. Joy is deceased, he was obviously unavailable to testify and
explain the figures and notes in the statements he prepared from 1993 to 1996.
Moreover, the problem with respect to Mr. Joy’s statements is the same as
that which presents itself with regard to all of the statements: there was no
source documentation provided in evidence to support the figures in the
statements.
[34]
The only other somewhat relevant document was a
corporate resolution by Hill Fai’s directors dated September 16, 1994,
allowing TD to register a $450,000 mortgage against Hill Fai’s Somerset Street property.[21]
However, this document serves only as evidence of Hill Fai’s mortgage loan from
TD; it does nothing to support the existence of any of the debts that make up
the claim for capital losses of $382,219.31.
[35]
I will now turn to determining whether each of
the specific debts claimed did in fact exist.
The claim for a debt of $110,000 − "Land"
[36]
Hill Fai claims that this debt arose from its
transfer of land to Chun Fai.[22]
However, it was never made clear what specific transfer was involved. The most
likely transfer would presumably have been the severance of Hill Fai’s property
which led to Chun Fai taking over the vacant lot portion of the property.
However, this was never explained in any detail.
[37]
Hill Fai also provided no explanation of how
this debt arose. There was therefore no evidence as to whether it was an
advance, a loan, an assumption of a mortgage or something else. The first
mention in any financial statements of Chun Fai owing a debt of $110,000 to
Hill Fai for a land transfer is in Hill Fai’s statements for its year ended
September 30, 1994.[23]
These statements record "Loans and Advances" to "Associated
Corporations" of $560,000, and a note to the statements[24] states that this
amount is made up of a $450,000 mortgage on Chun Fai’s property, which Hill Fai
is committed to pay, and a balance of $110,000 associated with a land transfer.
[38]
However, these statements are severely at odds
with Chun Fai’s financial statements for its year ended May 31, 1995, which came after Hill Fai’s
1994 statements. Those statements say that Chun Fai only owes Hill Fai
$450,000;
there is no mention of a debt to Hill Fai of $110,000. However, the notes do
say there are private loans of $110,000 owed to individuals who are not
shareholders of Chun Fai.
Since Hill Fai, although not a shareholder of Chun Fai, was not an individual
either, there was no debt of $110,000 owed to Hill Fai according to these
statements. Moreover, this recording in Chun Fai’s 1995 statements of a
$110,000 debt owed to non-shareholder individuals is a repetition of the same
entry in Chun Fai’s statements for its year ended May 31, 1994. Hill Fai’s
and Chun Fai’s statements are therefore directly at odds with each other. When
Mr. Tam was asked in cross-examination whether Hill Fai's claim of a $110,000
bad debt from Chun Fai was really the $110,000 debt that Chun Fai owed to
non-shareholder individuals, as described in Chun Fai’s statements, he answered
that he could not remember.
[39]
In none of Chun Fai’s financial statements
presented to the Court is there any specific mention of Chun Fai owing $110,000
to Hill Fai in connection with a land transfer. The $110,000 bad debt claim was
never explained in oral testimony. Its only relevant specific appearance in the
evidence is in Hill Fai’s 1994 and 1996 financial statements. In my view, these
financial statements alone do not provide sufficient evidence that Chun Fai
owed Hill Fai $110,000 in connection with a land transfer.
[40]
I am therefore not satisfied that the debt of $110,000
with respect to "Land" existed.
The claim for a debt of $3,766.88 – "Security"
[41]
Practically no information was given to support
the existence of this debt. Mr. Tam testified that Chun Fai gave no security to
Hill Fai for the $450,000 loan from Hill Fai.
The first time the financial statements record a debt owed by Chun Fai to Hill
Fai relating to “security” is in Hill Fai’s 1996 financial statements, which
say that Hill Fai had $648,149 in loans and advances receivable from Chun Fai. A note to the 1996 financial
statements states that this amount was made up of a series of special‑purpose
transactions, namely:
|
Mortgage Funding on Building
|
442,000
|
|
Land Transfer Transaction
|
110,000
|
|
Security Fees Paid
|
1,192
|
|
Interest on Mortgage
|
94,957
|
|
|
648,149
|
|
|
[Emphasis added.]
|
[42]
No further explanation for this bad debt claim
was provided, nor was any documentation presented to explain these special‑purpose
transactions. Given my earlier assessment of the financial statements and in
view of the lack of information supporting this debt, I am not satisfied that
the debt of $3,766.88 for "Security" existed.
The claim for a debt of $236,455.25 –" Interest"
[43]
Of all the bad debts claimed by Hill Fai, this
one was the most unclear. It was never apparent from the evidence whether this
debt claim represented the interest Hill Fai was supposedly charging Chun Fai
in relation to the $450,000 loan to Chun Fai, or whether the debt was simply
Hill Fai taking the costs consisting of its interest payments to TD on its
$450,000 mortgage and passing them on to Chun Fai as a loan or advance. The
evidence was contradictory.
[44]
Mr. Tam testified that on Hill Fai’s
$450,000 loan to Chun Fai, Hill Fai charged interest of prime plus four or five
percent.
This testimony directly contradicts Chun Fai’s 1995 and 2002 financial statements and Hill
Fai’s 1996 financial statements,
all of which state that Hill Fai’s $450,000 loan to Chun Fai was non-interest
bearing and had no specific terms of repayment. When counsel for the respondent
pointed out the discrepancy to Mr. Tam and suggested his earlier testimony
was wrong, his response was that this was not necessarily the case, that he may
have just misunderstood the question, that he had sent everything to his
accountant to prepare and that some accounting questions he could not answer. This does not inspire
confidence in his earlier testimony that Hill Fai was charging interest to Chun
Fai.
[45]
Counsel for Hill Fai suggested that interest was
being charged but that there was no obligation for Chun Fai to pay it. Such an
obligation, he suggested, only arose if Chun Fai was making money, a suggestion
Mr. Tam agreed with. Since Chun Fai only lost money, it never had an
obligation to pay interest.
However, this does not square with the notes to the 1995 and 1996 financial
statements indicating that the $450,000 loan to Chun Fai was non-interest
bearing. While I do have reservations about the reliability of the 1995 and
1996 financial statements given the lack of source documentation, on the matter
of whether interest was being charged I prefer them as evidence over Mr. Tam’s
evidence, for the following reasons. These statements were prepared
contemporaneously with the events; if interest was indeed being charged but not
due, the notes could have stated this. Instead, the statements consistently
said that the loans to Chun Fai were non-interest bearing. Furthermore,
Mr. Tam's testimony was contradictory and unreliable.
[46]
The first time any interest-related debt is
recorded is in Hill Fai’s 1996 statements as part of Hill Fai’s $648,149 in loans
and advances receivable from Chun Fai.
Note 4 to the statements states that the interest debt was one of the
following special‑purpose transactions:
|
Mortgage Funding on Building
|
442,000
|
|
Land Transfer Transaction
|
110,000
|
|
Security Fees Paid
|
1,192
|
|
Interest on Mortgage
|
94,957
|
|
|
648,149
|
|
|
[Emphasis
added.]
|
[47]
This would appear to suggest that the interest
debt is merely Hill Fai taking its own interest costs related to the TD
mortgage and claiming them as a loan or advance to Chun Fai. Indeed, in a
letter he sent to a Canada Revenue Agency ("CRA") appeals officer in
2011,
Mr. Koshy says that the interest balance of $236,455.25 (the interest amount being
claimed in these appeals) was the interest Hill Fai paid on the TD mortgage it
assumed on behalf of Chun Fai.
[48]
Mr. Koshy testified that Chun Fai never
paid any interest to Hill Fai
and that it appeared from the documents available to him that the computation
and reporting of interest by both Hill Fai and Chun Fai simply ceased after the
debt reached about $236,000.
He speculated that, since Chun Fai likely had no ability to pay interest
because of its financial situation, perhaps the accountant and the directors of
both corporations decided not to continue calculating the debt.
[49]
In any event, there was no documentation
provided, besides the financial statements, to support the existence of the
interest debt. There were no calculations offered and no documents related to
the TD mortgage, such as bank statements or other records, that could have
substantiated the interest figure. I am therefore not satisfied that the $236,455.25
"Interest" debt existed.
The claim for a debt of $31,997.18 – " General"
[50]
Once again, there was precious little evidence
to support the existence of this debt. This figure, or any seemingly related
debt, never appeared in any of the financial statements.
[51]
The only explanation provided for this amount
was a letter Mr. Koshy wrote to the Audit Division of the CRA in 2008 in
response to the CRA’s request for various documents, including invoices for the
$31,997.18 claim.
To support the claim, Mr. Koshy provided a copy of a cheque for $30,000.00. The handwritten notation accompanying
the cheque seems to suggest that the cheque was for legal fees and real estate
commission, but nothing more is evident. Not only does the amount of the cheque
not correspond with the claim for $31,997.18, but the cheque itself sheds no
light on the "General" claim itself or to what it related to. Counsel
for Hill Fai never presented evidence on what this debt represented.
[52]
Counsel for the respondent further noted that a
2006 trial balance prepared by Mr. Koshy
shows that the "General" amount appears to be $38,878.56. Mr. Tam agreed in
cross-examination that there was a mistake in the trial balance, which only casts further
doubt on this debt.
[53]
Given the foregoing, I am not satisfied that the
$31,997.18 "General" debt existed.
Conclusion
[54]
Hill Fai has failed to provide sufficient
evidence to support the existence of the debts totalling $382,219.31 claimed as
capital losses.
[55]
Indeed, this appears to have been the case ever since
the CRA began auditing this file. When a CRA appeals officer asked Mr. Koshy in
2011 for supporting documentation, including invoices and copies of agreements, for each of the claims, Mr.
Koshy replied that the accounts were created by the former accountant
(presumably Mr. von Bloedau), who was refusing to cooperate.
Therefore, he concluded, "details regarding these specific amounts are not
available."
[56]
Mr. Tayub Abdul, an auditor with the CRA
who eventually took over the Hill Fai file, testified that there was never any
source documentation to support the debts recorded in the financial statements.
Mr. Abdul acknowledged in cross-examination that there have been times
when he has allowed a claim for deductions without source documentation because
the claim is reasonable. But he added that Hill Fai’s claims were not
reasonable because there was no continuity in the financial statements. I agree
with that assessment. The financial statements provided as evidence never
seemed to be in alignment, and there was no other documentation presented to
support the specific debts that led to Hill Fai’s claim for capital losses.
Therefore, Hill Fai has failed to prove that Chun Fai owed it debts totalling
$382,219.31.
b) Did the
debts become bad in 2006?
[57]
Given my conclusion that Hill Fai has not
convinced me of the existence of the debts totalling $382,219.31, there is no
need to move on to the second step and determine whether the debts became bad
in 2006.
Conclusion
[58]
Hill Fai has failed to show that it disposed of
a debt under paragraph 50(1)(a) of the ITA.
Issue 2: Respondent's alternative argument
[59]
There is also no need to analyze the alternative
question of whether the alleged bad debts were incurred for the purpose of
gaining or producing income from a business or property under
subparagraph 40(2)(g)(ii). Hill Fai is therefore unable to claim a
capital loss of $382,219.31 under paragraph 39(1)(b) of the ITA.
Issue 3: Pursuant to s. 230(1), 230(4) or
230(6) of the ITA, when was Hill Fai no longer required to keep documents
relating to the loan transactions and the capital loss claim?
[60]
Subsection 230(1) of the ITA requires taxpayers
to keep records for the purpose of the administration of the ITA.
[61]
Subsection 230(4) of the ITA requires that
the books and records be kept for six years from the end of the last taxation
year to which they relate.
[62]
Finally, subsection 230(6) of the ITA says:
230. (6) Where a person required by this
section to keep records and books of account serves a notice of objection or
where that person is a party to an appeal to the Tax Court of Canada under this
Act, that person shall retain every record, book of account, account and voucher
necessary for dealing with the objection or appeal until, in the case of the
serving of a notice of objection, the time provided by section 169 to appeal
has elapsed or, in the case of an appeal, until the appeal is disposed of and
any further appeal in respect thereof is disposed of or the time for filing any
such further appeal has expired.
[63]
Subsection 248(1) of the ITA defines
"record" as including invoices and "any other thing containing
information":
248. (1) "record" includes an account, an agreement, a book,
a chart or table, a diagram, a form, an image, an invoice, a letter, a map, a
memorandum, a plan, a return, a statement, a telegram, a voucher, and any other
thing containing information, whether in writing or in any other form.
[64]
The question in this appeal is therefore to
which year do the loan transaction records "relate": 1994 as argued
by Hill Fai or 2006 as argued by the respondent?
[65]
In Tibilla v The Queen, it was held that the six-year
period starts running not on the date the event took place, but rather on the
date the taxpayer made his claim. In Tibilla, the taxpayer bought and
renovated a rental property in 2002. The taxpayer sold the property in 2007 and
was audited for capital gains in 2010. The taxpayer argued that the six-year period
during which he was required to keep the supporting documents for the
renovation expenses started running in 2002. That interpretation was held to be
incorrect and the Court ruled that the six‑year period started running on
the date the expenses were claimed. In that case, the expenses had been claimed
in 2007 for the purpose of reducing the capital gain on the sale of the rental
property. The Court's interpretation was based on the context of
subsection 230(4):
The reference to the
expiration of six years from the end of the last taxation year to which the
books and records relate is to be read in context. Here, I am of the view that,
even though the expenses were incurred in 2002, the last taxation year to which
the vouchers relate is the year in which the appellant claimed the expenses in
order to reduce his capital gain, which he realized in 2007. Therefore, the
vouchers could not be destroyed before the later of the expiration of six years
after 2007 (subsection 230(4)) and the date on which his appeal is finally
disposed of (subsection 230(6)).
[66]
Applied to these appeals, the ruling in Tibilla
means that the relevant tax event occurred in 2006 when Hill Fai claimed
the $382,219.31 in capital losses. Under subsection 230(4), Hill Fai was
therefore required to keep the relevant records for six years starting from the
end of its 2006 taxation year.
[67]
Moreover, pursuant to subsection 230(6),
Hill Fai was required to keep the relevant records until this appeal is finally
disposed of. Hill Fai therefore has no basis under the ITA for claiming that it
was not required to keep the relevant records.
Conclusion
[68]
For all of these reasons, I would dismiss the
appeals with costs.
Signed at Ottawa,
Canada, this 30th day of June 2015.
"Lucie Lamarrre"
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