Citation: 2013 TCC 309
Date: 20131028
Docket: 2011-1874(IT)G
BETWEEN:
MICHAEL MAST,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Angers J.
[1]
By notices dated March 8,
2010, the Minister of National Revenue (the Minister) reassessed the appellant
for his 2006, 2007 and 2008 taxation years, including in his income the amounts
of $786,828, $97,551 and $53,260 for each of those taxation years respectively
pursuant to paragraph 15(2) of the Income Tax Act (the Act).
After the filing of notices of objection with respect to the reassessments, the
Minister confirmed the reassessments on March 16, 2011. Hence these appeals.
[2]
At the beginning of the
hearing, the appellant was granted permission to file a re-amended notice of
appeal dated March 5, 2013.
[3]
The appellant was at
all relevant times an employee as well as the sole officer, director and
shareholder of Michael Mast Investments Ltd. (Mastco). It is to be noted that
the corporate name of Mastco was changed to 2038617 Canada Inc. by Articles of Amendment dated December 2, 2011. For the purpose of these
reasons, I will nonetheless still refer to that entity as Mastco.
[4]
Mastco is in the
packaging business. It operates out of the appellant's home. It has one other
employee in the appellant's wife, who has a background in design and assists
the business with regard to design in addition to exercising administrative
functions. Her salary was $39,000 a year. On occasion, their son would also
work for Mastco.
[5]
In 2004 or 2005, the
appellant decided to build his dream home. He spoke with his accountant regarding
how he could finance the construction and was told he could do it by borrowing
money from Mastco. A resolution of the board of directors of Mastco passed on
April 1, 2004 authorized Mastco to enter into a loan agreement with the
appellant and his wife so that they could borrow up to one million dollars to
enable them to acquire a dwelling for their own habitation. The loan agreement,
signed on the same day, contained the following terms:
Loan Amount: The lender will make available to the borrowers a
maximum amount of $1,000,000. Funds will be advanced as required to fund the
acquisition of land and the cost of building a new house located at 93 Rue Oxford,
Hudson, Quebec.
Loan Purpose: The purpose of the loan is to allow the lender's
president and his spouse to acquire a dwelling for their own habitation.
Loan Repayment: The loan will be repayable over a term of 10 years
commencing with the company's fiscal year ending March 31, 2008. Annual
principal repayments shall be not less than $50,000. If the property is sold
prior to complete repayment of the loan, the balance outstanding at the date of
the sale shall become immediately due and payable.
Loan Interest: This loan shall be non-interest bearing.
[6]
No other security
document was given to Mastco by the appellant. At the time the loan agreement
was signed, the appellant did not foresee any problem in paying back the loan.
The appellant, in the four years prior to the loan agreement, had had an
average yearly remuneration of $238,892. After the loan agreement, his salary
was reduced to an average of about $72,000 a year. According to Mastco's
accountant, the plan was for the appellant to repay the loan primarily out of
bonuses or dividends.
[7]
Mastco's financial statements
were prepared by Mr. Larry South and approved by the appellant on behalf of the
board of directors. The appellant would meet with his accountant on a quarterly
basis. Mr. South testified that the appellant would write cheques from Mastco
for things that were not related to the business and that they would later apportion
the amounts of the cheques between business and personal expenses. This was
particularly the case when construction of the house began. Cheques were issued
by Mastco directly to contractors and other suppliers.
[8]
The financial
statements for Mastco for the years 2000 to 2012 in Exhibit A‑19
refer to these personal advances as "loan receivable–shareholder" or "advance
to shareholder". All loans made to the appellant during a particular year
were, according to the accountant, paid back, except those that were made for
the construction of the appellant's home. The repayments were made before the
end of each year.
[9]
According to the
accountant, the "advance to shareholder" item is from a template and
should have read "advance to employees" or even "advance to
shareholder and employees", but this does not change the nature of the
loan, which is explained in a note to the financial statement. That note first
appeared in the March 31, 2010 financial statement and stated that the
company had advanced funds to the shareholder for the purpose of acquiring a
principal residence. This loan was non‑interest bearing and was repayable
in minimum annual repayments. The appellant did add to his income, as a benefit,
deemed interest at a prescribed rate.
[10]
The total cost for
building the appellant's home was 2.6 million dollars. Of that amount,
Mastco made advances totalling $999,572, of which amounts of $766,828, $97,551
and $53,260 were advanced in the 2006, 2007 and 2008 taxation years respectively
towards the building costs. Those payments were made directly to the seller of
land, the contractor, a paving company and other suppliers. The remaining costs
were paid by the appellant and his wife from personal funds and their line of
credit.
[11]
The appellant paid back
the loan to Mastco by making yearly payments starting in 2007. The balance remaining
as of February 28, 2013 was $566,000. All the yearly payments were
slightly above $50,000, except for one of $100,760 in 2008.
[12]
During the audit, the
accountant for Mastco provided the Canada Revenue Agency (CRA) with a breakdown
of Mastco’s bank transactions for the 2007 and 2008 fiscal years. All the
payments made by Mastco for the construction of the house are shown under the
heading "shareholder loan". No "housing loan" heading was
created nor was the auditor provided with any breakdown between shareholder
loan and housing loan amounts. The accountant testified that the amount
appearing as a shareholder loan at the end of a fiscal year was only the
housing loan, as all other loan amounts were repaid. That information was not
communicated to the auditor. In fact, the auditor was never advised that the
"shareholder loan" column should have been separated into two columns
or that it included a housing loan. The auditor had no way of knowing the
difference.
[13]
The issue before the
Court is whether the loan made to the appellant by Mastco falls within the
provisions of section 15(2.4) of the Act. In other words, was the
loan made by Mastco to the appellant and his wife as employees of Mastco or to
the appellant in his capacity as shareholder and to his wife as a person
connected with a shareholder?
[14]
The relevant provisions
are subsections 15(2) and 15(2.4) of the Act, which read as
follows:
15.(2) Shareholder
debt — Where a person (other than a corporation
resident in Canada) or a partnership (other than a partnership each member of
which is a corporation resident in Canada) is
(a) a shareholder
of a particular corporation,
(b) connected
with a shareholder of a particular corporation, or
(c) a member of a partnership, or a beneficiary of a trust,
that is a shareholder of a particular corporation
and the person or partnership has in a
taxation year received a loan from or become indebted to (otherwise than by way
of a pertinent loan or indebtedness) the particular corporation,
any other corporation
related to the particular corporation
or a partnership of which the particular corporation
or a corporation
related to the particular corporation
is a member, the amount
of the loan or indebtedness is included in computing the income for the year of
the person
or partnership.
(2.4)
When s. 15(2) not to apply — certain employees — Subsection
(2) does not apply to a loan made or a debt that arose
(a) in respect of an individual
who is an employee
of the lender or creditor but not a specified
employee of the lender or creditor,
(b) in respect of an individual
who is an employee
of the lender or creditor or who is the spouse or common-law partner of an employee
of the lender or creditor to enable or assist the individual
to acquire a dwelling or a share
of the capital stock of a cooperative housing corporation
acquired for the sole purpose of acquiring the right to inhabit a dwelling
owned by the corporation,
where the dwelling is for the individual's habitation,
(c) where the lender or creditor is a
particular corporation,
in respect of an employee
of the particular corporation
or of another corporation
that is related to the particular corporation,
to enable or assist the employee
to acquire from the particular corporation,
or from another corporation
related to the particular corporation,
previously unissued fully paid shares
of the capital stock of the particular corporation
or the related corporation,
as the case may be, to be held by the employee
for the employee's own benefit, or
(d) in respect of an employee
of the lender or creditor to enable or assist the employee
to acquire a motor
vehicle to be used by the employee
in the performance of the duties of the employee's office
or employment,
where
(e) it is reasonable to conclude that the employee
or the employee's spouse or common-law
partner received the loan, or became indebted, because of the
employee's employment
and not because of any person's share-holdings, and
(f) at
the time the loan was made or the debt was incurred, bona fide arrangements were
made for repayment of the loan or debt within a reasonable time.
Appellant's Submissions
[15]
Counsel for the
appellant submits that the loan was used only to acquire a dwelling house for
the appellant and his wife and that it was obtained by them in their capacity
as employees of Mastco. The agreement of April 1, 2004 between Mastco, the
appellant and his wife constitutes a bona fide arrangement.
[16]
Counsel further submits
that the loan was made at a time when Mastco's retained earnings were strong, that
it was part of an "ever-growing remuneration package", and that it
made "good business sense". The appellant had relied on professional
advice with regard to the loan arrangement.
[17]
In addition, counsel
submits that no amounts under shareholder loan were carried over from year to year
except for the housing loan and that, instead of being included as a shareholder
loan, that loan amount should have been entered as a "loan receivable –
employees and shareholder". The appellant paid tax on the "free
interest" benefit conferred on him, in accordance with section 80.4 of
the Act. According to counsel, the loan at issue is no different than such
loans found in larger corporations with established policies regarding employee
loans. Counsel submits that, in light of the evidence, it is reasonable to
conclude that the loan was received by the appellant and his wife because of
their status as Mastco's only full-time employees and not because of the
appellant's status as a shareholder.
Respondent's Submissions
[18]
Counsel for the
respondent submits that the actions taken by the appellant were consistent with
those of a shareholder and not a mere employee. He describes the loan as a
"non-interest bearing and unsecured advance". Since the loan
represented a significant portion of Mastco's retained earnings, the appellant's
actions were consistent with those of a shareholder.
[19]
Counsel further submits
that the following facts support his position:
-
the appellant simply
took money out of Mastco and used it to make progressive payments to build a
home;
-
the appellant never
paid any interest but just reported a deemed interest benefit;
-
the appellant's spouse
never repaid any of the amounts advanced nor did she report a deemed interest
benefit;
-
Mastco's balance sheet
consistently included the advances at issue as a current asset described as
either a "Loan receivable ‑ shareholder" or an "Advance
to shareholder";
-
the registers of bank
transactions provided to the auditor included a single column titled
"Shareholder Loan" and the auditor was never advised that this column
should have been segregated into two items, i.e., "Shareholder Loan"
and "Housing Loan";
-
the amounts advanced by
Mastco represented a substantial part of its assets and retained earnings for
the period in question.
[20]
The respondent's
counsel submits that, given the factual circumstances of this case, it is not
reasonable to conclude that the appellant received the loan because of his
employment and not because of his shareholdings. He further submits that, from
a subjective standpoint, it would never occur to an employee that it would be
possible to take money out of a company and to use that money to make
progressive payments to build a home.
Analysis
[21]
The determination whether
or not it is reasonable to conclude that the employee or the employee's spouse
received the loan because of the employee's employment and not because of any
person's shareholdings is a factual one.
[22]
Although the relevant
CRA Interpretation Bulletin, namely, IT-119R4 of August 7, 1998, is not
binding on this Court, it nevertheless provides assistance in making the
determination. At paragraph 11, one reads:
Whether
or not a loan made by a corporation to an individual is
considered to have been received by that individual in his or her capacity as
an employee or as a shareholder involves a finding of fact in each particular
case. When a public corporation makes a loan to a shareholder on the same terms
and conditions as to other employees who are not shareholders, the loan is
normally considered to be a loan received by virtue of that individual's office
or employment rather than his or her shareholdings. However, when the
opportunity to borrow funds is only made available to shareholders or when the
terms and conditions attached to loans to employee-shareholders are more
favourable than those attached to loans to other employees, the loan will be
considered to have been made to the employee-shareholder in his or her capacity
as a shareholder unless the facts clearly indicate otherwise.
[23]
In Views Doc. No.
2011-0406271E5, the CRA states:
Whether
the conditions set forth in paragraphs 15(2.4)(e) and (f) of the Act have been
satisfied are [sic] always questions of fact to be determined on a case
by case basis. Where a shareholder is the only employee of a corporation, the
Canada Revenue Agency will generally consider a loan to be received by virtue
of employment where a shareholder-employee can demonstrate that employees with
similar duties and responsibilities with another employer of similar size, but
who are not shareholders of that other employer-corporation, receive loans of
similar amounts under similar conditions as that granted to the
shareholder-employee.
[24]
The appellant did
establish through the evidence of an expert witness what employee‑salesmen
earn in a business similar to Mastco’s. A salesman’s yearly base salary is
$100,000 and the employer will cover the salesman’s expenses, such as laptop
computer and automobile expenses. Salesmen also receive commissions, which may result
in an average yearly income of between $150,000 and $250,000. According to the
expert, the appellant would have been at the low end of the average.
[25]
Questioned on whether
his corporation provides advances of funds to its employees, the expert answered
that if an employee's credit rating is poor, his corporation may lend money for
an automobile. He testified that money had been lent to employees for boats,
campers or a down payment for a house. Such loans are made to employees in
general and not just salesmen. The advance for a down payment on a house was made
in the 1990's and the amount was $10,000.
[26]
The business described
by the expert witness is quite different in size from Mastco. Between 2000 and
2008, that business had between 50 and 80 employees and its gross sales were
seven times greater than those of Mastco. It is therefore impossible to
conclude on that basis than an employee with another employer, similar in size
to Mastco, who has similar duties and responsibilities to those of the
shareholder‑employee herein and who is not a shareholder of that employer
would have received a similar loan to that granted to the shareholder‑employee
herein and under similar conditions. No evidence was adduced to show that this
type of loan and in similar amounts exists or is even possible for employees of
corporations in similar size to Mastco who are not shareholders.
[27]
The threshold requirement
of the subsection 15(2.4) test is reasonableness. The test requires that
the person in question, whether an employee or the employee's spouse or common
law partner, have received a loan or have become indebted and that this have occurred
because of the employee's employment and not because of any person's
shareholdings. As indicated earlier, for the purposes of the reasonableness test,
whether such a loan is made to the person qua employee or qua shareholder
can be determined by comparison with loans made to employees in other
businesses of the same kind as the business being considered (here Mastco).
[28]
The question of whether
the loan is made to an employee and not a shareholder must be decided in relation
to the time at which the loan is made. There is no doubt that at the time the
loan was made to the appellant, Mastco’s retained earnings were strong. Yet the
amount of the loan represented a very substantial part of those retained
earnings, which in turn makes it difficult to conclude that a loan of such an
amount could reasonably have been made to an employee. In my opinion, the
amount of the loan in these circumstances is far more consistent with the loan
being one made to a shareholder.
[29]
The terms and
conditions of the loan can also be an indication of whether or not such a loan is
one that is available to employees of a corporation who are not shareholders.
In our fact situation, we have a loan agreement that provides for a term of 10 years
with payments of not less than $50,000 a year with no interest. Although the
appellant did declare interest as a taxable benefit, the repayment conditions are
nonetheless very flexible. It is reasonable as well to conclude that no
employee would receive such a sizeable loan without having to give his or her lender
a lien or similar security on the house to be built.
[30]
There are other factors
in the evidence submitted that are indicative of the underlying intent of
Mastco and the appellant that the loan at issue was to be a shareholder’s loan.
The appellant was in the habit of using Mastco to pay his personal expenses,
including many related to the construction of his house; an employee would not
have had such a benefit. Moreover, the financial statements of Mastco showed
the advances under "loan receivable – shareholder" or "advance
to shareholder"; the note that first appeared in the March 31, 2010
financial statement referred to "advance to shareholder"; the bank transactions
provided to the CRA auditor indicate that all the payments made by Mastco for
the construction of the house were entered under "shareholder loan"; no
separate housing loan heading was created nor was the auditor provided with any
breakdown between shareholder loan and housing loan amounts and no such information
was ever communicated to the auditor at any time. These factors reflect a loan
made to the appellant but are nevertheless an indication that, at the time it
was made, the loan was intended to be made to the appellant in his capacity as
a shareholder.
[31]
Having concluded that
the loan is consistent with its being one made to a shareholder, I do not have
to consider, under paragraph 15(2)(f), whether, at the time the
loan was made or the debt incurred, bona fide arrangements were made for repayment
of the loan within a reasonable time. Suffice it to say that the loan agreement
between Mastco and the appellant does not establish repayment obligations sufficient
to create a bona fide repayment arrangement. A minimum payment of $50,000 a
year over a 10‑year term with no specific rate of interest on a one‑million
dollar loan does not constitute a bona fide repayment arrangement.
[32]
The appeals are
dismissed with costs.
Signed at Ottawa, Canada, this 28th day of October
2013.
"François Angers"
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