Hendriks v. MNR, 81 DTC 939, [1981] CTC 3029 (T.R.B.)

The Chairman:—The appeal of Mr Petrus J J Hendriks is from a tax reassessment dated August 17, 1979 by which the Minister, in computing the appellant’s income for 1975, added an amount of $28,000 received by the appellant as a loan from HVS Steel Products Limited (“HVS”) on the ground that the said amount did not qualify as a loan within the meaning of subparagraph 15(2)((a)(ii) of the Income Tax Act.

The appellant’s statement of facts reads as follows:

Statement of fact

1. The appellant is a 50% shareholder and at all material times was a shareholder and employee of HVS Steel Products Limited (“HVS”). The remaining 50% of the shares of HVS are held by Douglas McLellan of the City of Oshawa.

2. HVS carries on the business of steel fabrication and erection and has its Head Office in the City of Oshawa.

3. Bathe and McLellan Construction Limited (“Bathe”) is a company incorporated under the laws of Ontario, carries on a construction business and has its Head Office also in the City of Oshawa.

4. Simcoe Rental Limited is a company which is related to Bathe through the direct or indirect share holdings of Douglas McLellan.

5. On or about the 11th day of May, 1973, the appellant borrowed an amount of $10,400 from Bathe and used the said 10,400 to purchase 200 common shares of HVS.

6. On or about the 25th day of March, 1974, the appellant borrowed an amount of $18,000 from Simcoe Rentals to purchase a further 300 common shares of HVS.

7. On the 7th day of October, 1974, the appellant paid an amount of $1,071.63 to Bathe in respect of the loan referred to in paragraph 5 hereof.

8. On the 2nd day of April, 1975, the appellant paid to Bathe the amount of $12,686 to discharge the loan refered to in paragraph 5 hereof.

9. On the 2nd day of April, 1975, the appellant paid to Simcoe the amount of $18,900 to discharge the loan referred to in paragraph 6 hereof.

10. On the 12th day of November, 1975, the appellant borrowed from HVS the amount of $28,000 to assist the appellant to erect a dwelling house for his own occupation.

11. At the time of the loan, bona fide arrangements were made between the appellant and HVS, as represented by Douglas McLellan that the appellant would, repay the loan within a reasonable period of time by way of future declarations of dividends and/or the awarding of a periodic bonus, in favour of the appellant.

12. At the time the loan was made and based on the financial position of HVS the arrangement was made that the loan would be repaid in whole within a period of four years of the date it was made.

13. Subsequent to the making of the said arrangements the financial position of HVS altered in that it became worse.

14. As a consequence of the said change ifn the financial position of HVS, HVS was unable to provide the appellant with the wherewithal to repay the said loan pursuant to the arrangements described in paragraphs 11 and 12 hereof. The said arrangements made between HVS and the appellant were accordingly changed and the repayment of the said loan was deferred with the consent of HVS as represented by the said Douglas McLellan.

15. The appellant, as a consequence, made the following repayments of the loan to HVS.

(a) On the 31st day of December, 1978	— $4,000
(b) On the 31st day of December, 1979	— 4,000
(c) On the 31st day of March, 1980	— 4,000

16. By reassessment dated the 17th day of August, 1979, the respondent reassessed the appellant and added the said $28,000 into the computation of his income for his 1975 tax year on the basis that the said loan did not qualify as a loan described by subparagraph 15(2)((a)(ii) of the Income Tax Act 1970, 1971, 1972 SC c 63 as amended.

In his reassessment, the respondent relied on the following findings of presumptions of facts:

5. In reassessing the Appellant to include the amount of $28,000 in the computation of his income for his 1975 taxation year, the Respondent relied upon the following findings or assumptions of fact.

(a) the facts hereinbefore admitted;

(b) during the 1973 taxation year, the Appellant received the amount of $10,400 as a loan from Bathe & McLellan Construction Limited for the purchase of 200 of the issued and outstanding common shares of HVS Steel Products Limited (“HVS”);

(c) during the 1974 taxation year, the Appellant received the amount of $18,000 as a loan from Simcoe Rentals Limited for the purchase of 300 of the issued and outstanding common shares of HVS;

(d) during the 1975 taxation year, the Appellant received the amount of $28,000 as a loan from HVS to enable him to repay his outstanding loans to Bathe & McLellan Construction Limited and Simcoe Rentals Limited;

(e) by Resolution of the Board of Directors of HVS dated the 22nd day of June, 1978, HVS confirmed and ratified that it had made a loan of $28,000 to the Appellant, which loan was stated to be to enable the Appellant to purchase shares of HVS as of April 2, 1975, and which loan was stated to be repayable by equal annual instalments of $7,000 per annum without interest commencing as of the 2nd day of April, 1976;

(f) no amounts had been paid by the Appellant on account of the loan made by

HVS in its 1975 taxation year as at the end of its 1976 taxation year;

(g) bona fide arrangements were not made at the time and the loan was made

by HVS to the Appellant for repayment thereof within a reasonable time;

Findings of facts:

The evidence of the appellant and Mr McLellan can be briefly summarized as follows: The appellant and two other persons founded HVS Steel Products Limited in 1968. In 1973 Mr Douglas McLellan, the principal shareholder of Bathe and McLellan Construction Limited (“Bathe”) and Simcoe Rentals Limited (“Simcoe”) acquired a 4, share interest in HVS held by the appellant’s two former associates in HVS.

In order to arrive at a 50% ownership between the appellant and Mr McLellan, it was necessary for the appellant to acquire an additional 500 common shares of HVS. To finance the purchase, the appellant borrowed $10,000 from Bathe to acquire 100 HVS shares in May 1973 and in March 1974 he borrowed $18,000 from Simcoe to acquire 300 HVS shares.

In 1974 HVS acquired the assets of Central Steel Works Limited which was situated in Peterborough, Ontario. Though the appellant resided in Oshawa, he had a cottage in Peterborough. In December 1974 the appellant moved to Peterborough to be closer to the company’s new operations and resided at his cottage. The cottage was not a satisfactory residence and the appellant decided to sell his Oshawa home and build a residence in Peterborough. The appellant found a suitable parcel of land, the cost of which was $28,000. The appellant discussed with Mr McLellan the possibility of borrowing on the piece of land from HVS and was advised that the company’s performance was such that there should be no problem in advancing the appellant the sum of $28,000. Before the purchase of the land was closed, the appellant met with Mr McLellan and a verbal agreement was reached that the loan would be repaid out of the dividends of the company and repayment of the loan was to take place in three to four years.

The financial statements of HVS for 1973-1974 showed some profits. The financial statement as of March 31, 1975 showed sales of $1,417,457 and a profit of $86,108. In 1976 to 1978, HVS sustained losses with a substantial loss of $177,274 for 1980. The balance sheet for 1976 reflects a non-interest bearing loan to shareholder of $28,000, repayable in equal annual instalments of $7,000. The 1980 balance sheet shows a reduction from $28,000 to $15,400 under the heading of “Loan to shareholder”.

The two issues to be determined are:

(a) Was the amount of $28,000 alleged by the appellant to have been borrowed from HVS on November 12, 1975 for the purpose of erecting a dwelling for his own residence or was the money borrowed from HVS to enable the appellant to repay the loans made to him by Bathe and Simcoe for the purchase of HVS shares?

(b) Were bona fide arrangements made by the parties for repayment of the loan to HVS within a reasonable time?

To establish his contention that the loans from Bathe and Simcoe, in a total amount of $28,400 were repaid by the appellant from moneys received from the disposition of his Oshawa home, counsel for the appellant referred to a letter from the appellant’s solicitor dated February 28, 1975. The letter corroborates the appellant’s testimony that he had sold his Oshawa home in February 1975. The statement of adjustment shows a balance due on closing of $44,229.13 and after further adjustments, the appellant received a cheque for $42,206.73 on February 28, 1975 (Exhibit A-10).

Simcoe’s deposit book (Exhibit A-1) shows a deposit of $18,900 on April 2, 1975, with a notation: “P Hendriks — $18,900 (Princ $18,000, Interest $900)”; Bathe’s deposit book (Exhibit A-2) reflects a deposit of $12,686 on April 2, 1975 with a notation: “P Hendriks — $12,686 (Princ $10,400, Interest $2,286)” which is in accord with a statement prepared on Bathe’s letterhead (Exhibit A-3).

On the basis of that evidence, corroborating as it does the testimony of the appellant’s and Mr McLellan’s testimony, it would appear reasonable to conclude that the appellant had repaid both the said loans on April 2, 1975 from the proceeds of disposition of his Oshawa residence.

Having lived in a cottage since the beginning of 1975, the appellant raised with Mr McLellan the question of borrowing money from HVS in the autumn of 1975 in order to purchase land and build a house in Peterborough. Having obtained a favourable answer, the appellant signed an agreement of purchase and sale for a parcel of land for $28,000 on October 28, 1975 with a closing date of November 15, 1975 (Exhibit A-11). On November 12, 1975 HVS made out a cheque for $28,000 payable to the appellant. The purchase agreement was closed on November 15, 1975 and the bank’s stamp on the back of the cheque is dated November 14, 1975 (Exhibit A-5).

Here again, the evidence appears that the amount of $28,000 borrowed from HVS went to pay for the Peterborough land which confirms the testimony given under oath by both McLellan and the appellant.

There is however a resolution of HVS dated June 22, 1978, filed as Exhibits A-7 and R-2, which was signed by Mr McLellan and which states in part:

RESOLUTION

OF

HVS STEEL PRODUCTS LIMITED

WHEREAS the Company has lent Twenty-eight ($28,000) Thousand Dollars, on or about the 2nd day of April, 1975, to Pierre Hendriks for the purchase of shares of the Company:

AND WHEREAS the Company and Pierre Hendriks have entered into an agreement confirming the terms of the aforesaid loan;

Attached to Exhibit A-7 is Schedule “A” which is an agreement between HVS Steel Products and Pierre Hendriks, confirming the loan of $28,000 and providing among other things that the repayment of the loan be made in equal “instalments of Seven Thousand ($7,000) Dollars per annum without interest commencing as of the 2nd day of April, 1976.”.

Mr McLellan admitted having signed this resolution (Exhibit A-7) dated June 22, 1978 but claims that he had merely signed a document which had been presented to him without his having read it and which does not represent the facts.

On December 12, 1979, four months after reassessment of the appellant, a further resolution was passed by HVS in which it is stated that it has come to the attention of the corporation that the resolution passed on June 22, 1978 was incorrect in that:

(a) The purpose of the loan was to enable the appellant to purchase property to be used for his principal residence;

(b) the date of the loan was November 12, 1975 rather than April 2, 1975;

(c) the loan was to be repaid by Mr Hendriks out of bonuses or dividends received from profits of the corporation;

(d) the repayment of principal was to commence March 31, 1979 and was not to be less than $4,000 per annum (Exhibit A-8).

That there is confusion and contradiction in the two said resolutions is evident and the Board must make a judgment call as to which of the documents more accurately reflects the facts.

The evidence of the appellant and Mr McLellan is clearly in accord with the pertinent entries made on April 2, 1975 In the bank deposit books of both McLellan and Simcoe in amounts equal to loans previously made by the appellant to buy shares in HVS.

The letter of the appellant’s solicitor of February 28, 1975 with reference to the sale of the Oshawa residence and the statement of adjustments of that date are a possible and logical source of funds for the repayment of the loans used by the appellant to purchase HVS shares (Exhibit A-10).

On the basis of the agreement of purchase and sale for land in Peterborough dated October 28, 1975 (Exhibit A-11), the HVS cheque for $28,000 which corresponds exactly to the cost of the land made payable to the appellant, dated November 12, 1975, the bank’s stamp dated November 14, 1975 On the back of the said cheque, and the closing date of the purchase of the Peterborough land all took place six months after Bathe and Simcoe had been repaid.

There is no evidence of any further loans made by HVS on or about April 2, 1975 to the appellant, as suggested in the resolution (Exhibit A-7 or R-2). Nor was there evidence of any further purchases of HVS shares by the appellant after March 25, 1974.

The existence of a resolution dated June 22, 1978, (Exhibits A-7 and R-2) which refers to a $28,000 loan made to the appellant on April 2, 1975, for the acquisition of HVS shares, cannot of itself destroy the probative value of the overwhelming evidence to the contrary. It is unfortunate but very often true that little or no importance is given to the contents of company minute books and company resolutions, particularly in small enterprises. It is conceivable that Mr McLellan did sign the June 1978 resolution without having read it but having signed the resolution, it leaves the Board with two sets of contradictory evidence. I have no alternative but to decide this issue on the basis of what I consider to be the stronger evidence.

The evidence, both verbal and documentary, leads me to conclude that the subject loan of $28,000 by HVS to the appellant was to permit him under the meaning of subparagraph 15(2)(a)(ii) of the Act to purchase land on which to build a residence in Peterborough, which he in fact did.

The question now is whether bona fide arrangements were made by the parties for repayment within a reasonable period of time of the HVS loan.

Discussions were alleged to have taken place between the appellant and Mr McLellan with respect to the financial capacity of HVS to grant a $28,000 loan in 1975 and in accordance with the verbal agreement arrived at, the repayment of the loan could be made from the appellant’s share of the company’s future dividends.

There is however no promissory note to that effect and no other documentary evidence which might confirm that definite arrangements, which clearly set out the specific amounts of the payments and the time in which the loan was to be repaid, were made at the time the loan was granted.

On the contrary a serious anomaly exists in the alleged arrangements, as stated in the resolution dated December 12, 1979 Exhibit A-8, which was meant to amend the June 22, 1978 resolution Exhibit A-7, and the entries in the financial statements of HVS.

In the amending resolution, it is stated: “the repayment of principal commencing March 31, 1979 was to be not less than Four Thousand ($4,000) Dollars per annum.”.

In HVS’s balance sheet as at March 31, 1976, the note with respect to the $28,000 loan to a shareholder is described in Note 2 accompanying the financial statement as:

Loan to shareholder

The loan to a shareholder is non-interest bearing and is repayable in equal annual instalments of $7,000.

It is difficult indeed to reconcile these two contradictory statements with the requirements of subsection 15(2) of the Act that bona fide arrangements for the repayment of the loan be made at the time the loan was made.

Not only is subsection 15(2) of the Act, an exemption section which must be interpreted restrictively, but also the loan was transacted between a corporate entity and the appellant. Case law is consistent in holding that, under such circumstances, the arrangements with respect to the repayment of the loan must be more formal.

In The Queen v Peter Neudorf, [1975] CTC 192; 75 DTC 5213, cited by counsel for the respondent, Mr Justice Heald, makes the point very clearly when he stated at 196 and 5215:

It is my further view that since one of the parties to the arrangement was a corporation, there is more formality required (such as corporate resolutions, for example) than in the case of individuals and particularly where the details of a relationship are important as against third persons such as the Revenue.

The formality of the arrangements for repayment of the loan such as “corporate resolutions”, to use the example given by Heald, J, must in the context of subsection 15(2) of the Act clearly establish that a bona fide arrangement was made at the time the loan was granted. in this instance we have two ex post facto corporate resolutions: one stating that the $28,000 loan was to enable the appellant to purchase shares of HVS to be repaid from the company dividends at a rate of $7,000 per annum; the other, a correcting resolution, indicates that HVS granted the appellant a loan of $28,000 to help him erect a dwelling for his own residence, the repayment to be made from dividends at a rate of not less than $4,000 per annum. The balance sheet of HVS fiscal year, following the granting of the loan, refers to the repayment of a non-interest bearing-loan at the rate of $7,000.

Whatever else may be concluded from the glaring confusion in the documentary evidence, the appellant has failed to establish that bona fide arrangements for repayment had been made at the time the loan was granted. The subsequent attempt to incorporate in a resolution some form of arrangement for the repayment of the loan has, among other things, led to errors which make it impossible for the Board to conclude that the requirements of subsection 15(2) of the Act have been met.

I conclude therefore that bona fide arrangements were not made for the repayment of the loan at the time the loan was made and that the amount of $28,000 does not come within the exemption provided by subparagraph 15(2)(a)(ii) of the Act.

The appeal is therefore dismissed.

Appeal dismissed.