Byke Estate v. The Queen, 74 DTC 6585, [1974] CTC 763 (FCTD)

Mahoney, J:—The questions raised in this appeal are the attribution to the late Jacob Byke of certain sums as income under subsection 8(1) of the Income Tax Act for the years 1963 to 1967 inclusive and the disallowance of the deduction of such amounts, or a portion thereof, from his income for those years claimed under paragraph 11(1)(c) of the Act. Similar issues arise in respect of Mitchell and Stella Byke for the same years. By order, the three appeals were heard on common evidence. With respect to Jacob Byke only, it is alternatively pleaded that a portion of the amount attributed, if income at all, was income of his wife, Mary Byke, and wrongly attributed to him. Mitchell Byke is the son of Jacob and Mary Byke. Stella Byke is Mitchell Byke’s wife.

Pursuant to an offer in writing, made by them. May 16 and accepted May 22, 1962, the Bykes became owners of all of the outstanding shares of Tecumseh Hotel (Chatham) Limited (“the Company”), a private company incorporated under the laws of Ontario. The transfer of shares to the Bykes was recorded July 27, 1962. The election of Jacob, Mitchell and Stella Byke as directors and officers was recorded July 30, 1962. Mary Byke did not become a director until after the number of directors was increased from three to four on January 2, 1967. She appears not to have been an officer of the Company at any material time.

Dividends in the aggregate of $4,572.21 declared at a. meeting of the retiring directors dated July 30, 1962 were assessed to the plaintiffs, for their 1963 tax years, as follows:

Counsel for the defendant, at the beginning of the trial, acknowledged that the Crown is satisfied that these dividends were actually received by the vendors and he consented to the appeals being allowed in part on the basis that the above amounts be deleted from the computation of the plaintiffs’ incomes for 1963. Otherwise the appeals are opposed.

Shareholdings, following the purchase, were, at all material times, as follows:

The offer provided a purchase price totalling $210,000, subject to adjustments at closing, payable by a $5,000 deposit; $55,000, subject to adjustment, on closing and a deferred balance of $150,000. Adjustments on closing resulted in that payment being $57,065.12. The deposit and some $7,000 of the payment on closing were derived from family resources, $8,000 of which are said to have been the personal resources of Mary Byke. The balance was derived from a $45, 000 bank loan to Jacob and Mitchell Byke.

There are three separate issues to be considered in these appeals:

1. Mary Byke’s assets:

2. the interest on the bank loan;

3. the interest on the deferred balance.

I will deal with them in that order.

1. Mary Byke’s assets

Unfortunately Mary Byke’s health did not permit her to testify at the trial and no acceptable proposal to get her evidence was forthcoming. Her son, Mitchell Byke, testified to events that may have been common knowledge in the family but which, to a large extent, transpired while he was very young and, indeed, to some extent, before he was born. Jacob Byke, prior to his death, destroyed numerous relevant documents which Mitchell Byke testified would have established his mother’s independent means.

Jacob and Mary Byke both immigrated to Canada in 1925; they were married in 1927. Mary Byke worked in Canada from 1925 through 1928. Mitchell Byke was born in February 1929; his mother did not work again until 1933. She worked, on and off, in a factory from 1933 to 1937; in 1937, 1938 and 1939 she worked, seasonally, on tobacco farms. The family tobacco farm was acquired in 1939; thereafter she worked on the family farm and, seasonally, for other farmers.

The first documentary evidence as to Mary Byke’s independent resources is a bank book, purporting to have been hers, issued in respect of Savings Account No 647 at The Royal Bank of Canada, Scotland, Ontario. It covers transactions between January 1, 1962 and March 16, 1967. There are 24 transactions entered, none of which are initialled by the recording teller. It also bears a printed legend: “Form 5115(8-69)” There is nothing on its face to identify the account as that of Mary Byke. I am not satisfied that it is an original document nor a complete copy. It is of no probative value.

The documentary evidence which I do accept shows that Mary Byke did open an account, Savings Account No 6027, at The Royal Bank of Canada, Chatham, Ontario with an $8,000 deposit on July 18, 1962. That $8,000 was transferred on August 1, 1962 to the current account of Mitchell Byke at the same bank which was used exclusively as the vehicle for the assembly and disbursement of the down-payment and payment on closing on acquisition of the Company’s shares. The only other transactions through Account No 6027, until it was closed on March 14, 1967, were the interest on the $8,000 while it was so deposited and the interest on that interest. There is no evidence that, prior to July 18, 1962, Mary Byke filed income tax returns or that Jacob Byke reduced the exemption he claimed in respect of her as his dependant. She filed no returns in respect of the years 1963 to 1967 inclusive; of those years, it was only for 1967 that Jacob Byke reported any income of Mary Byke’s in reduction of the exemption he claimed for her. Her income in 1967 was reported to be $536.95. She was registered owner of an interest in the tobacco farm; however, during the years in question, Jacob Byke reported the entire income from the farm as his own and also included in his income his wife’s share of the interest from the sale of an apartment building in Burlington of which they had been owners along with Mitchell and Stella Byke.

On the evidence, I am not satisfied that the $8,000 deposited to Mary Byke’s account No 6027 at The Royal Bank of Canada, Chatham, Ontario was her own money rather than her husband’s. The assessment of income to Jacob Byke cannot be disturbed on this ground.

2. The interest on the bank loan

$45,000 was borrowed, on the note of Jacob and Mitchell Byke made July 19, 1962, from The Royal Bank of Canada, Scotland, Ontario. Interest on that loan was charged by the Scotland branch to the Chatham branch and was paid by the Company. The loan was reduced by principal payments of $10,000 on April 19, 1963; $8,000 on May 22, 1964; $10,000 on January 21, 1965; $10,200 on February 15, 1965 and $5,000 on March 1, 1965. On May 7, 1965 a further $1,900 was borrowed increasing the principal balance to $3,700. This was fully paid on August 27, 1965..

v This final payment of $3,700 appears to have been the only principal payment on the bank loan made by the Company. It was charged to the shareholders’ accounts rateably and was repaid by them from dividends. This and other charges to the shareholders’ accounts, as well as ‘all payments of dividends referred to herein, was achieved by journal entry made, in each case, on the last day of the Company’s fiscal year. The interest payments were not charged to the shareholders and were not reimbursed to the Company by them.

The plaintiffs concede that the interest on the bank loan was properly attributed as income pursuant to subsection 8(1) of the Act but argue that they should be permitted offsetting deductions under paragraph 11(1)(c):

11. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 12, the following amounts may be deducted in computing the income of the taxpayer for a taxation year:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income. from which would be exempt or to acquire an interest in a life insurance policy),

(ii) an amount payable for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance

policy),

or a reasonable amount in respect thereof, whichever is the lesser;

In the case of the bank interest, it is subparagraph 11 (1)(c)(i) that is in play.

There is no question that the money was borrowed to acquire property the income from which would be taxable to the plaintiffs. Interest was, in fact, paid and its reasonableness is not questioned. The actual treatment of the $3,700 principal payment, as well as the treatment of principal payments. under the mortgage which will be dealt with. later on, satisfies me that, although Mitchell and Jacob Byke were the only ones legally obligated to the Royal Bank, Stella Byke was legally obliged to them to contribute her rateable share. The problem is that they did not pay the interest. The Company, which was not legally obliged to do so, did and they did not reimburse the Company.

Subparagraph 11(1)(c)(i) is not complete in itself; rather, subparagraph 11(1)(c)(i) must be read and construed as a whole. Arranged ina grammatically conventional order and edited of the alternatives not applicable in the circumstances, the section provides:

An amount paid in the year pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning. income from property may be deducted in computing the income of a taxpayer in a taxation year.

The basic scheme of the Income Tax Act as it bears on a Canadian resident is to impose tax on that taxpayer’s income and not on anyone else’s income. Clearly the provisions of the Act that permit a deduction in the computation of that income are to be applied in the context of:the basic scheme. Subparagraph 11(1)(c)(i) permits a deduction by the taxpayer who paid the interest and not by some other taxpayer. There are numerous ways in which a person can “pay” a sum but, in this case, the plaintiffs did not, in any way, pay. the interest to the bank.

3. The interest on the deferred balance

, It is convenient to deal first with the plaintiffs’: contention that if this interest. was properly attributed to them as income, they are entitled to an offsetting deduction under subparagraph 11 (1 )(c)(ii). Again, it is helpful to strip that provision of inapplicable alternatives and to arrange it in a conventional order.

An amount paid. in the year pursuant to a legal obligation to pay interest on an amount payable for property acquired for the purpose of gaining or producing income therefrom may be deducted in computing the income of a taxpayer for a taxation year.

Taken in the context of the basic scheme of the Act, it is clear that the deduction permitted by this section is also permitted only to the taxpayer who actually paid the interest. Again the plaintiffs did not; the Company paid this interest as well.

The plaintiffs argue that the mortgage interest is not attributable to them under subsection 8(1). The bases of this position are two: that the interest payments were not, in substance, equivalent to payment of dividends to the plaintiff shareholders and, secondly, that the mortgages were illegal and, hence, there was no obligation to pay the interest and, so, no “benefit” conferred by its payment.

The material provisions of the offer were:

WE, THE UNDERSIGNED, Mitchell Byke, Stella Byke, Jacob Byke and Mary Byke, hereinafter called the “Purchasers” having inspected the following described property, schedules and documents, hereby agree to and with Joseph Alaica, Simica Alaica and Nada Milosevich, hereafter called the Vendors, to purchase all of the outstanding shares both preferred and common of Tecumseh Hotel (Chatham) Limited for the sum of $210,000 . . . payable as follows:

$5,000 of lawful money of Canada, by cheque paid to the Vendors as a deposit to be held pending completion and/or other termination of this Agreement and to be credited on account of purchase money on closing; $55,000 in cash or cheque on closing, subject to adjustments of any and every nature connected with or in any way concerning the assets of Tecumseh Hotel (Chatham) Limited;

$150,000 by Tecumseh Hotel (Chatham) Limited giving back to the Vendors a first mortgage on the realty, and collateral security by a Chattel Mortgage on the chattel assets, with interest at Six Percent per annum, payable $400.00, or more at the option of the Purchasers, principal and interest in addition computed monthly, said mortgage to run for a period of 25 years, with the privilege to the Mortgagors, to pay any amount at any time, without notice or bonus, and such Mortgage to be made in favour of the Vendors or their nominee or nominees.

This offer is subject to the following warranties, provisos and conditions:

THE VENDORS WARRANT

7. That all of the present Directors and officers will submit their resignation in favour of the purchasers and have same available at the time of

closing. The company will by its new directors and Shareholders pass a by-law validating the mortgage to be given back for balance of purchase price.* [1]

THIS OFFER IS CONDITIONAL UPON

1. That this contract of purchase and sale shall be closed on or before the 1st day of July, 1962 or within 10 days after approval of the transfer of the licenses of the Liquor Control Board of Ontario shall have been notified to the Purchasers, or their Solicitor, whichever date shall be the latter, on which date vacant possession of the lands and premises shall be given to the Purchasers.

. . . Deed or transfer to be prepared at the expense of the Vendor [and said Deed or transfer shall contain covenant on the part of the Purchasers to pay off said assumed mortgage], and mortgage to be prepared at the expense of the Purchasers.! [2]

The by-law validating the mortgage was never passed.

The relevant statutory provisions in subsection 8(1) follow. Neither paragraph (a) nor the exceptions apply in the circumstances.

8. (1) Where, in a taxation year,

(b) funds or property of a corporation have been appropriated in any manner whatsoever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation . . .

the amount or value thereof shall be included in computing the income of the shareholder for the year.

The land mortgage was dated July 26, 1962, executed by Mitchell Byke as president and Stella Byke as secretary of the Company and was registered in the Kent County Registry Office on August 1, 1962. The collateral chattel mortgage was similarly dated and executed and was filed August 2, 1962. There are no affidavits attached to the land mortgage; however, in an affidavit of execution attached to the chattel mortgage, John Benjamin Watson, a solicitor of Chatham, deposed that it was executed in his presence on July 30, 1962 by Mitchell and Stella Byke, personally known to him to be the Company’s president and secretary respectively.

Every month, the required $400 principal payment plus interest was paid to the vendors by the Company. Annually in arrears the aggregate principal payments were charged rateably to the shareholders and the liability satisfied by the offsetting dividend. Nothing was done about the interest.

The plaintiffs’ argument that the payments of interest were not, in substance, equivalent to payments of dividends to the plaintiffs turns on the factual proposition that the Company had granted the mortgages and, with it, the right to receive interest, to the vendors prior to the plaintiffs acquiring their shares and, so, the moneys required to meet that obligation could never have been available to them as dividends. That argument must, if for no other reason, fail on the facts.

There is a remarkable confusion as to the date of closing in the documentary evidence. Mitchell Byke’s recollection of events is of no assistance. On the one hand, the vendors are recorded in the minute book as transferring the shares to the purchasers on July 27; on the other hand, they are also recorded as meeting as directors and paying themselves dividends, as shareholders, on July 30. The purchasers are shown as executing the mortgages, as officers, on July 26 but the minute book records their election as officers on July 30. In the circumstances, I find Mr Watson’s affidavit the most reliable documentation on the point and that the mortgages were executed on July 30 after the purchasers had met as shareholders to elect directors and after those elected directors had met to elect officers. The mortgages were not granted prior to the purchasers becoming shareholders.

The plaintiffs argue that the same result flows where the property necessary to meet the obligation had, in effect, been appropriated by the vendors prior to the sale and where, in executing and delivering the mortgages, the purchasers were fulfilling an obligation imposed by the vendors. In such a case, it is argued, the moneys required to discharge the obligation could never be available to pay dividends to the purchasers and, so, since they could never reach the plaintiff shareholders by one of the “orthodox dividend routes”, subsection 8(1) of the Income Tax Act is not applicable.

The very comprehensive analysis of subsection 8(1) by Cattanach, J in MNR v Pillsbury Holdings Limited, [1965] 1 Ex CR 676 at 682 ff: [1964] CTC 294 at 299 ff; 64 DTC 5184 at 5186 ff, is cited as authority for this position. With all due respect, that is not the ratio of that decision; quite the contrary. Any appropriation of resources for one purpose obviously restricts or eliminates their availability for some other purpose depending on the nature of the appropriation. What the Pillsbury case decided was that where it is found that a benefit had been conferred by a company on a shareholder, subsection 8(1) still requires a determination that the benefit was conferred because the beneficiary was a shareholder and not because of another, bona fide, relationship between the company and its shareholder.

Finally, the plaintiffs argue that since they were never personally liable to pay the interest on the mortgages, its payment by the Company cannot be construed as a benefit to them. It is a fact that under neither the offer nor the mortgages did the plaintiffs assume a personal liability to pay the deferred balance of the purchase price or the interest on it. The plaintiffs further submit that the mortgages were illegal by virtue of subsection 23(1) of The Corporations Act, RSO 1960, c 71,* [3] of Ontario as it stood when they were created. I am inclined to agree with this submission but, since it is irrelevant, do not find it necessary to reach a conclusion on it. If a benefit was conferred on the plaintiffs within the meaning of subsection 8(1), the taxability of that benefit is in no way affected by its having been conferred illegally.! [4]

lt is a fact that the purchasers agreed to buy the Company’s shares from the vendors for a certain price and that it was contemplated that part of that price would be paid by the Company granting the mortgages. When the Company fulfilled the commitment that the purchasers had made in respect of that portion of the purchase price it conferred a benefit on them. When, periodically, the Company carried out the terms of its commitment the benefit was quantified and the Company’s funds appropriated for their benefit. The benefit did not accrue to them as the result of any bona fide relationship with the Company except as shareholders. They are taxable in respect of it.

The appeals are allowed to the extent previously indicated and are otherwise dismissed. Each of the plaintiffs commenced a separate action in respect of each year’s assessment. Each action was separately defended and then, on motion by the plaintiffs, the five actions commenced by each were ordered joined. Subsequently, on application by the defendant with the consent of the plaintiffs, it was ordered that the three continuing actions be tried together on common issues of fact and law. The defendant is entitled to her costs to be taxed on the following basis: her disbursements under item 2(2) of Tariff B plus a counsel fee under item 2(1)(a) for each of the 15 original actions plus a counsel fee under items 2(1)(b), (c), (d), (e) and (f) on the basis of the three joined appeals having been a single Class III action.