Smith v. The Queen, 93 DTC 5351, [1993] 2 CTC 257 (FCA)

Mahoney, J.A. (Stone and McDonald, JJ.A. concurring):— This is an appeal from a reported decision of the Trial Division arising out of the assessment of the appellant's 1980 income tax return ([1986] 1 C.T.C. 418, 86 D.T.C. 6196). It is concerned with funds or property assumed by the Minister to have been diverted from one company to another to the benefit of the appellant or the second company and with a bad debt claimed and disallowed.

The background facts

From some time in 1978, the appellant had been an officer, director and owner of 49 per cent of the shares of a franchised Ford automobile dealership, Holiday Ford Sales (1977) Inc., hereafter" Holiday 77". He and the owner of the remaining 51 per cent were both active in its management. It was a fairly large dealership with an average of about 60 employees, 700 vehicles on lease, and sales during its two operating years of $11.5 and $12.7 millions. During 1980, the co-owner decided to withdraw and the appellant wished to continue in the business. Holiday Ford Sales (1980) Ltd., hereafter"Holiday 80”, was incorporated. The appellant became president and general manager and owned 20 per cent of its shares. Ford Motor Company of Canada, hereafter Ford", owned the remaining 80 per cent. The appellant invested $110,000 and Ford $440,000 in preferred shares. The appellant’s shares were subordinated to Ford's.

Holiday 77 sold Holiday 80 almost all of its assets and undertaking except its accounts receivable and its portfolio of leased vehicles. The transaction was expressed to close July 13 but was actually completed July 24. The interval was required to finalize details, including compliance by Holiday 77 with the Ontario Bulk Sales Act. To obtain Bulk Sales Act waivers from Holiday 77's creditors, the appellant loaned it $49,000. That is the subject of the bad debt claimed.

To facilitate the transaction, a separate bank account, the" interim account”, was opened. All moneys arising out of the operation of the dealership during the period July 13 to 24, the “interim period”, were to be deposited to the interim account. If the sale were not to close, the moneys were to be transferred to Holiday 77. If it closed, they were to be credited to Holiday 80.

From July 13 to 24 inclusive, the appellant was active in the management of Holiday 77. From July 25 to August 11 inclusive, Holiday 77 was exclusively managed by Ford Credit Canada Ltd., hereafter FCC". FCC appointed a receiver of Holiday 77 on August 11.

From July 13 to August 5, the appellant was active in the management of Holiday 80. The appellant was relieved of his duties as general manager of Holiday 80 and his signing authority on August 5. He was fired on August 14.

Holiday 77 sued FCC and the receiver. The action was unsuccessful. It was settled before an appeal was heard. The appellant received no moneys out of the settlement nor from the receiver or Holiday 77 after the appointment of the receiver.

The appellant sued Holiday 80 for wrongful dismissal and Ford to recover his investment in Holiday 80. Holiday 80 counterclaimed alleging misappropriation of funds. Both actions were settled. The terms of settlement are not in evidence.

The particular transactions

Aside from the bad debt claim, this appeal is concerned with four transactions involving a total of $33,623.45 which occurred during the period July 13 to August 5.

A. The payment by Holiday 80 to FCC

The Minister’s assumption in respect of this payment was:

(i) the plaintiff signed a cheque issued on the bank account of Holiday Ford 80 bearing #44 dated July 28, 1980, in the amount of $3,063.33 to pay an outstanding liability between Holiday Ford 1977 and FCC.

The appellant, testifying in February 1986, simply did not remember anything about the payment and was unable to refresh his memory from the cancelled cheque. [1] The trial judge found that the appellant had not discharged the onus of rebutting the Minister's assumption.

B. The Lawson deposit

The purchase price to Holiday 77 of some leased vehicles had been financed by FCC by their sale to FCC with a repurchase obligation at the end of the lease term. Vehicles so financed were referred to as "red carpet leases”. This transaction involved a returned red carpet lease.

The Minister's assumptions were:

(g) at the time of the sale between Holiday Ford 1977 and Holiday Ford 1980, there was an understanding that FCC could offer the previously leased car to either Holiday Ford 1977 or Holiday Ford 1980 and that the designated company would have to buy the car even though these red carpet leases were all property of Holiday Ford 1977 since these leases were not part of the above-mentioned sale.

(l) one Mr. Lawson purchased from Holiday Ford 1977 a former Holiday Ford 1977 red carpet leased car, namely an 1980 Corvette on July 21, 1980 for $14,000 and proceeds of the sale were later deposited in the bank account of Holiday Ford 1977.

(m) the liability to FCC in respect of this vehicle was paid by Holiday Ford 1980 as more precisely described in paragraph 9(g) above.

The learned trial judge found (C.T.C. 421, D.T.C. 6199):

There is no actual evidence that the liability for the car to Ford Credit was paid by Holiday 77 but common sense would appear to indicate that it was paid by Holiday

80. There is no evidence either way. The Minister . . . in effect, assumed that the total sum of $14,000 was in fact received by Holiday 77 to its benefit. That company was obviously not entitled to the moneys. The plaintiff failed to establish that it did not, in effect, receive a $14,000 benefit arising from that sale. The amount is therefore assessable.

The documentary evidence established that initial $14,000 cheque was deposited to Holiday 77's account, not the interim account, on July 21. It bounced. A debit advice was issued by the bank July 30. The replacement cheque was deposited to Holiday 77's account on or about August 1.

C. The Wildman payment

The assumptions pleaded here are:

(p) Holiday Ford 1977 sold a 1980 Ford Fairmont to one Mr. Russel Wildman on July 9, 1980 for $8,080.

(q) Holiday Ford 1980 made the payout to FCC on this vehicle on July 25, 1980, in the amount of $7,560, being a portion of an amount of $22,843.43 remitted to FCC by Holiday Ford 1980.

The trial judge found those assumptions established by the evidence, and also (C.T.C. 422, D.T.C. 6199-6200):

The [$22,843.43] cheque covered five separate amounts detailed on the back of the cheque. Among those amounts one finds the sum of $7,560.12 besides which one also finds the notation “old company”.

The evidence clearly indicates that the above-mentioned sum was in fact due by Holiday 77 to Ford Credit but was paid by Holiday 80. There is no evidence that Holiday 80 was reimbursed.

D. The Dunk sale

The Minister’s assumptions were:

(j) Holiday Ford 1980 purchased from Holiday Ford 1977 a 1979 Ford Bronco (licence #EN9794) for $6,800 on July 13, 1980 as it appears from Schedule F of the agreement for sale made as of July 24, 1980.

(k) one Edith Dunk purchased this Ford Bronco car on July 22, 1980 for $9,000 from Holiday Ford 1980, but such proceeds of sale were deposited to the bank account of Holiday Ford 1977.

The trial judge found:

The sum of $9,000 in respect of a Ford Bronco sold to one Edith Dunk of [sic] July 22, 1980 was received by Holiday 77. The car had been sold by that company to Holiday 80 and the plaintiff admitted that Holiday 80 had paid for it.

This payment was received during the interim period. It appears that it was not deposited to the interim account.

The legislation

Both subsections 15(1) and 56(2) of the Income Tax Act had been pleaded and were found to apply to the particular transactions by the learned Tax Court judge. [2] The learned trial judge dealt only with subsection 56(2) and that was the only provision relied on by the respondent in its memorandum and on hearing of the appeal. The respondent's position implies recognition that it is not arguable that the transactions resulted in a benefit to or for the appellant but that they benefited only Holiday 77. That recognition is well founded. I, therefore, propose to refer only to subsection 56(2) in dealing with the four particular transactions.

56 (2) A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.

For purposes of subsection 56(2), the appellant is the taxpayer, Holiday 77 is the other person upon whom benefit was conferred, and Holiday 80 is the source of the benefit. Initially, $54,659 was attributed to the appellant; that was reduced to $38,358.87 by the Tax Court ([1984] 1 C.T.C. 2524, 84 D.T.C. 1502), and to the present balance of $33,623.45 by the trial judge.

Analysis

The parties are in agreement and the trial judge accepted that, to engage subsection 56(2), the four conditions defined by Cattanach, J. in Fraser Companies Ltd. v. The Queen, [1981] C.T.C. 61, 81 D.T.C. 5051, at page 71 (D.T.C. 5058) must be met. The payment or transfer of property:

1. must have been to a person other than the taxpayer;

2. must have been at the direction or with the concurrence of the taxpayer;

3. must be for the taxpayer's own benefit or for the benefit of some other person on whom the taxpayer desired to have the benefit conferred; and

4. would have been included in computing the taxpayer's income if it had been received by the taxpayer instead of the other person.

Conditions 1 and 3 are clearly met and, in my opinion, so is condition 2.

It is understandable that the appellant not remember the details of individual transactions which occurred during an obviously turbulent period. That said, in my opinion, the learned trial judge correctly concluded that:

The concurrence or participation of the taxpayer to the conferring of the benefit need not be active. It may well be passive or implicit and can be inferred from all the circumstances, not the least of which being the degree of control which the taxpayer is entitled to exercise over the firm or corporation conferring the benefit.

The taxpayer's entitlement to exercise control is to be stressed. [3] Holiday 80 is the corporation from which funds or property were transferred. The first three transactions occurred while the appellant was managing Holiday 80. The fourth occurred during the interim period while he was managing both companies. The management of Holiday 80, the company that made the payments or transferred the property, engages condition 2.

It is not so clear as to condition 3. The taxpayer's motive to benefit the payee or transferee has been obvious in the reported cases to which we were referred. For example, in Champ v. The Queen, [1983] C.T.C. 1, 83 D.T.C. 5029 (F.C.T.D.), dividends were paid to the controlling shareholder's wife but not to him on shares of the same class. In Guay Estate v. The Queen, [1975] C.T.C. 150, 75 D.T.C. 5090 (F.C.T.D.), a minority shareholder, director and actual manager diverted moneys payable to the company into his own pocket. In M.N.R. v. Bronfman, the directors, four brothers and a brother-in-law, had caused the company to make gifts to their relatives and to former employees. In New v. M.N.R., [1970] Tax A.B.C. 700, 70 D.T.C. 1415, the company had rented a residence to its sole shareholder's son for less than its fair rental. In Perrault v. The Queen, [1978] C.T.C. 395, 78 D.T.C. 6272 (F.C.A.), the taxpayer, an individual majority shareholder, agreed to buy out a corporate minority shareholder and, before the purchase took effect, had the company declare a dividend, which he renounced as to his own shares, which paid the selling shareholder a tax-free amount equal to the agreed purchase price. In Outerbridge Estate v. Canada, [1991] 1 C.T.C. 113, 90 D.T.C. 6681 (F.C.A.), the taxpayer had caused his personal holding company to transfer securities to his daughter and son-in-law at prices below their fair market value.

The interest or motive of the appellant to benefit Holiday 77 or the benefit to him of doing so is not at all apparent, given the commercial and economic realities that probably existed. [4] It is inviting, in the abstract, to doubt that he benefited or desired to benefit it. There is, however, an absence of evidence to remove the matter from doubt in the abstract to a conclusion on a balance of probabilities. Exceptionally, neither the relevant tax return nor notice of assessment are on the record; while neither may have been helpful in resolving the issues, their absence is symptomatic of the paucity of evidence as to the surrounding circumstances made available in this case. We simply do not have the complete story. The trial judge did not expressly address this problem but the Tax Court judge did and, the problem still exists in the terms he described it ([1984] C.T.C. 2524, 84 D.T.C. 1502, at page 2532 (D.T.C. 1508)):

The parties have not stripped naked the assessment for a full examination of the facts; after the trial some facts are still in hiding. My task therefore is to determine the appeal on a balance of probabilities.

That was also the task of the learned trial judge.

It seems to me that if there had been no rationale for the direction of funds from Holiday 80 to Holiday 77 and it had simply been an explicable result of the chaos that may well have existed at the dealership during the period July 13 to August 5, that was evidence relatively easy to obtain. Instead, the appellant relied on his understandable ignorance of the minutiae of his subordinates' actions and his separation from the dealership to profess ignorance as to why the transactions had been handled as they were and whether corrective action had been taken later.

The learned trial judge cannot be found to have erred in concluding that, on a balance of probabilities, the appellant had not disproved the assumptions upon which the Minister had reassessed as regards the four particular transactions. That, however, is not an end to the matter. This Court's decision in Outerbridge Estate was rendered after the trial judgment herein. It has added another precondition to the application of subsection 56(2), which seems to me to be relevant in the circumstances.

It was held in Outerbridge, supra, at pages 117-18 (D.T.C. 6684),

that the validity of an assessment under subsection 56(2) of the Act when the taxpayer had himself no entitlement to the payment made or the property transferred is subject to an implied condition, namely that the payee not be subject to tax on the benefit received.

That conclusion, obiter in the result, was based on the analysis by Marceau, J.A. that preceded it (C.T.C. 117, D.T.C. 6684).

It is generally accepted that the provision of subsection 56(2) is rooted in the doctrine of "constructive receipt” and was meant to cover principally cases where a taxpayer seeks to avoid receipt of what in his hands would be income by arranging to have the amount paid to some other person either for his own benefit (for example the extinction of a liability) or for the benefit of that other person [citations omitted]. There is no doubt, however that the wording of the provision does not allow to its being confined to such clear cases of tax-avoidance. The Bronfman judgment, which upheld the assessment, under the predecessor of subsection 56(2), of a shareholder of a closely held private company, for corporate gifts made over a number of years to family members, is usually cited as authority for the proposition that it is not a pre-condition to the application of the rule that the individual being taxed have some right or interest in the payment made or the property transferred. The precedent does not appear to me quite compelling, since gifts by a corporation come out of profits to which the shareholders have a prospective right. But the fact is that the language of the provision does not require, for its application, that the taxpayer be initially entitled to the payment or transfer of property made to the third party, only that he would be subject to tax had the payment or transfer been made to him. It seems to me however, that when the doctrine of constructive receipt is not clearly involved, because the taxpayer had no entitlement to the payment being made or the property being transferred, it is fair to infer that subsection 56(2) may receive application only if the benefit conferred is not directly taxable in the hands of the transferee. Indeed, as I see it, a tax-avoidance provision is subsidiary in nature; it exists to prevent the avoidance of a tax payable on a particular transaction, not simply to double the tax normally due nor to give the taxing authorities an administrative discretion to choose between possible taxpayers.

[Emphasis added.]

While I might have distinguished Bronfman on further or other grounds, since the benefit to the shareholders of having personal gifts paid for by the company with pre-tax dollars over the shareholders themselves paying for them with after-tax dollars seems transparently clear, I agree with that analysis. Being "subject to tax on the benefit received" means that it is required to be included in the calculation of the recipient's taxable income.

The appellant had no entitlement to any of the payments made to or for the benefit of Holiday 77 described above. They were clearly subject to tax in Holiday 77's hands. In my opinion, as a matter of law, subsection 56(2) was wrongly invoked by the Minister in reassessing the appellant. I would allow the appeal as it relates to that issue.

The bad debt

The learned trial judge made no relevant findings of fact. He identified the $49,000 in his recitation of the facts but he did not deal with the issue of the bad debt claim except implicitly in the result. Counsel agreed that there is no reason that would preclude us from making the necessary findings of fact on the basis of the record.

By paragraph 50(1)(a) of the Act, a bad debt owing to a taxpayer is deemed to have been disposed of at the end of a taxation year. The Act provides:

40 (2)(g) a taxpayer's loss, if any, from the disposition of a property, to the extent that it is

(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 . . .

is nil. . . .

On appeal, the bad debt claim was presented in the appellant's memorandum, replied to by the respondent's memorandum, and argued as a discrete issue, independent of the subsection 56(2) attributions, yet it was pleaded in the statement of claim only as follows.

13. The plaintiff further states that if any of the aforesaid amounts were properly included in the income of the plaintiff for the 1980 taxation year, then the plaintiff is entitled to deduct therefrom the loan of $49,000 which the plaintiff made to Holiday Ford 1977 on July 24, 1980 and which became a bad debt in the same year.

It was not specifically mentioned in the prayer for relief.

In the absence of the relevant tax return, notice of assessment and notice of objection, it may, nevertheless, be inferred that the appellant did not report the attributed amounts as taxable income nor claim the bad debt as a deduction in his return, that the attribution was made on assessment and the bad debt first claimed as a result of that in the notice of objection or, perhaps, by the statement of claim as an alternative way to relief from what was regarded as an improper assessment. In other words, I infer that the statement of claim accurately represents the basis upon which the deduction of the $49,000 as a bad debt was claimed. What little evidence we have, and I refer particularly to the existence, on August 11, of conditions that led and allowed FCC to put Holiday 77 into receivership, leads me to infer that the loan was uncollectible when it was made on July 24. It would require some proof of an initial expectation that Holiday 77 would be able to repay it to qualify it as a loan potentially amenable to deductibility as a bad debt. There is a long, and by now irreversible, line of decisions flowing from Canada Safeway v. M.N.R., [1957] S.C.R. 717, [1957] C.T.C. 335, 57 D.T.C. 1239, which preclude a finding that the expectation of income from Holiday 80 would so qualify a loan to Holiday 77.

Whether or not any amounts were properly attributed under subsection 56(2) could, in my opinion, have no possible relevance to whether the bad debt had been properly claimed. I do not think it arguable that such amounts, even if properly attributed, were "income from a business or property" in the hands of the appellant so as somehow to qualify the loan as having been made "for the purpose of gaining or producing income from a business or property", a sine qua non of an allowable bad debt.

That said, the issue is one which is quintessentially to be defined by the pleadings. The appellant has sought to redefine the issue and, whatever the reason, the respondent has not demurred. Since, in the result of the trial and this appeal, I would find none of "aforesaid amounts” to have been properly included in the calculation of the appellant's 1980 taxable income, the entitlement to deduct the $49,000 as a bad debt, as pleaded, is clearly moot. I would dismiss the appeal as to the bad debt claim.

Conclusion

I would allow the appeal to the extent of referring the appellant's 1980 income tax assessment back to the Minister for reconsideration and reassessment on the basis that none of the $33,623.45 dealt with in these reasons for judgment was properly included in the appellant’s taxable income pursuant to subsection 56(2) of the Income Tax Act. I would allow the appellant his costs here and in the Trial Division. I would otherwise dismiss the appeal.

Appeal allowed in part.