Kanters v. MNR, 92 DTC 1508, [1992] 1 CTC 2413 (TCC)

Margeson, T.C.C.J.:—It was agreed at the outset that the evidence in this case would apply to the case of Adele Kanters, 89-2174(M).

The appeal is against reassessments for the taxation years 1986 and 1987, notices of which were sent to the appellant on September 16, 1988. The appellant was reassessed tax liability by the Minister adding to his income in the year 1986 an amount of $42,831 and in the year 1987 an amount of $17,088. These amounts represent one half of the amount allegedly loaned by The Plantation Ltd., (hereinafter called the "company") to the appellant and his spouse.

Facts

The appellant gave evidence before this Court that he was a shareholder in the "company", incorporated in Prince Edward Island and was the resident operator of that “company”. He was also a partner with his spouse in an operation in Ontario called "Delhi Farms” which was referred to as a partnership between he and his spouse. Both operations were involved in growing tobacco and the Ontario operation was actually run by a share cropper who received 50 per cent of the profits.

The appellant's evidence indicated that it was not intended to have the "company" assist "Delhi Farms” financially but there was a downturn in the tobacco industry and a loan had to be made to" Delhi Farms" to keep it afloat. It was always intended that the amount would be repaid by "Delhi Farms" to the "company" according to the appellant. When asked by his agent if arrangements were made to pay it back, he said that they had, but later said that the mortgage to secure the loan was executed at a later date. He reiterated that it was a loan, that interest was to be paid at ten per cent. He also indicated that there was another pre-existing mortgage on the property in Ontario to the Bank of Montreal.

The appellant identified a collateral mortgage made between John Kanters and Adele Kanters, carrying on business as "Delhi Farms” mortgagor to "The Plantation Ltd.”, Mortgagee, Exhibit A-1. The document is dated May 23, 1989 and refers to the indebtedness as being $300,000 and interest to be paid at 10 per cent per annum calculated from May 1, 1986. Further, it makes reference to a demand promissory note dated May 23, 1989 attached to Exhibit A-1 as evidencing the debt and referring to the same interest rate.

The appellant was asked to highlight certain parts of the mortgage by his agent, particularly the references to indebtedness interest" or such "indebtedness" and the reference in paragraph 2 which stated:

AND WHEREAS pursuant to the loan agreement and undertaking of the parties made on May 1, 1986, and the loan advances made since that time, the said demand promissory note was given by the mortgagor to the Mortgagee as security.

The appellant stated in evidence that it was his "understanding" that there was a loan agreement—verbal agreement as of May 1, 1986.

It was brought out that the "company" had the right under its constitution and in accordance with provincial legislation to make capital advances in the ordinary course of its business and this was not contested by the Minister of National Revenue.

The appellant took the position that he got no salary from "Delhi Farms", that the operation made no profit, that it pays taxes, that he received no personal gain from it and no money for his personal use, and therefore, he did not benefit from the capital advances from the "company".

The appellant and his wife owned the land, the buildings, the machinery, and the work is performed by the share cropper on the Delhi Farms” property. The share cropper does the marketing and tries to sell the crop for the best price but the appellant and his wife can override any of his decisions. “Delhi Farms” has its own bank account and the appellant and his wife have signing authority for it as well as for the "company". The appellant and his wife receive a salary from the company". The intention, according to the appellant, was to start paying back the loan immediately since the first mortgage to the Bank of Montreal has now been paid out. There was no budget for "Delhi Farms" for 1982 as of the date of this hearing.

The funds were advanced through the bank account of the "company" to the bank account of" Delhi Farms". Some of the funds were used to pay off the mortgage on the Ontario property to the Bank of Montreal.

In cross-examination the appellant agreed that the amounts in question were indeed loaned by the "company" to“ Delhi Farms” and that the amounts were included in the $300,000 referred to in Exhibit A-1, and further agreed that no document was signed with reference to the loan until May 23, 1989. He further agreed that no interest had been paid on the loans up to this time.

When the appellant was asked what dates of repayment were in his mind when the moneys were advanced in 1986, he said that no specific dates were agreed upon but they intended to pay back the loans when they could.

In the years 1986 and 1987 the appellant admitted that he and his spouse were the sole shareholders of the "company" and he was the majority shareholder. He further agreed that he and his wife were 50/50 owners of "Delhi Farms" and it was not a registered partnership in Ontario.

In redirect examination the appellant stated that there was a verbal agreement to pay the money back and that the terms of the written agreement were the same as agreed upon orally even though the written agreement in fact refers to the amount of $300,000 which is not the amount at issue in this case.

By consent of counsel for the Minister of National Revenue, the minutes of the "company" authorizing the mortgage on May 23,1989 were admitted into evidence.

Mrs. Adele Kanters also gave evidence and confirmed her status as a shareholder of the "company" and a partner in“ Delhi Farms". She is involved in the business decisions, is a signing authority and looks after the books of "Delhi Farms".

The witness indicated that she was a party to the verbal arrangement in 1986, confirmed that the loans were for business purposes and said that she did not benefit personally from the loans. She received 50 per cent of the profits from "Delhi Farms”.

Insofar as the interest rates were concerned, she said that it was a compromise, that the rate would have been approximately that in 1986 on a commercial basis or they might even have had to pay a higher rate if they borrowed from someone else. The money was used to run the operation and to make some of the payments on the Bank of Montreal mortgage.

Mrs. Kanters was asked when the loan would be paid back and she said: "Once Delhi was viable”, and that they now intend to make arrangements to pay it back. She identified her signature on Exhibits A-1 and A-2 and referred to paragraph 2 of Exhibit A-1 as evidencing the earlier oral agreement to pay back the loan. She was not sure of the amounts involved but felt that the amounts assessed to her by Revenue Canada were part of the loans from the" company" to "Delhi Farms”.

In cross-examination Mrs. Kanters was questioned about the alleged oral agreement and said it was discussed at the kitchen table but there were no directors' meetings at that time.

Appellant's position

The appellant argues that the amounts in question were advances of capital from the "company" to "Delhi Farms”. He said that the taxpayer has testified that it was necessary to have a capital infusion and there was no other party available as a source of the funds. His position is that subparagraph 15(2)(a)(i) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") applies here since the loan as made in the ordinary course of the creditor's business and the lending of the money was part of its ordinary business.

Further, it is the position of the appellant that no direct taxable benefit accrued to the appellant because the funds were loaned to the partnership for business purposes. Thirdly, he argues that bona fide arrangements were made for repayment at the time of the loan in 1986 and these were confirmed in 1989, when the mortgage and the note were executed.

The appellant refers to Wright v. M.N.R., [1986] 1 C.T.C. 2581, 86 D.T.C. 1415, and distinguishes that case from the facts in the case at bar. His position is that in the Wright case the document did not provide for any interest. In the case at bar he argues that bona fide arrangements were made for repayment and the interest rates were reasonable. Further, he says, in the case at bar there was a contemplated term for repayment, that term was on demand, that the loan was always treated as capital in nature and not as income and the requirements of subparagraph 15(2)(a)(i)had been met.

The appellant argues that as in Wright, supra, credibility is important and that here the appellant is credible as well as his spouse. He says it is not necessary to have the agreement in writing at the time of the making of a loan and that in many business transactions there is no written documentation. He asks that the appeal be allowed.

Minister's position

The Minister argues that subsection 15(2) of the Income Tax Act is the appropriate section and that in order for the appellant to be successful here he has to meet all the requirements set out therein. His argument is that the loans were made to a shareholder of the "company" namely the appellant and his spouse. There may have been an informal partnership here but that is of no consequence, since the appellant and his spouse were the 50/50 owners of “Delhi Farms".

It is the position of the Minister, that on the facts of this case, in order for the appellant to be successful, he must meet the requirements of paragraph 15(2)(a) and that requires that the appellant prove" that bona fide arrangements were made, at the time the loan was made or the indebtedness arose, for repayment thereof within a reasonable time.” It is clear from the evidence of the appellant, he says, that such arrangements were not made. They intended to repay the loans but there was no indication as to when.

The Minister refers to Wright, supra, highlighting of course, different parts of the decision than those referred to by the appellant, and says that here there is a close association between the creditor and the debtor and more formality is required in such a transaction. The situation presented here shows that the principals are merely dealing with themselves.

The Minister asked the question; what was the arrangement? He answers, there was none. No interest was ever paid, and no arrangements were made at the time of the loan for its repayment. He compares the situation to that referred to in the Wright case, supra, where it was held that no bona fide arrangements had been made to repay the loan. In that case the accountant's working papers stated that there was a loan but that alone was held to be inadequate.

It is argued that the arrangement must include payments within a reasonable period of time, or at least a fixed formula to enable one to determine when the loan would be paid, and here there is none.

The Minister is of the opinion that the executed mortgage document is irrelevant as it does not reflect any arrangement made at the time of the giving of the loan. The document was not in place until 1989. Further, he says that the mortgage does not even mention when the loan will be paid back.

It is significant also, according to the Minister, that to the date of the hearing no interest had ever been repaid and no payment had ever been made on the principal and that is another indication that no arrangements were made to pay it back.

The Minister places little significance on the appellant's argument that this was a "capital advance" as opposed to an "income advance", arguing that the purpose of the loan is not important but rather the arrangements for repayment. The Minister takes no issue with the manner in which the moneys were spent.

The Minister accepts the argument that the agreement to pay back the loans may not be in writing, but there must be a binding agreement to pay back the principal and interest within a reasonable period of time. Even if you accept the evidence as presented, he says, you have nothing more than a discussion at the kitchen table, the hope that the loans would be paid off and nothing more and that does not suffice. The Minister says the appeal should be dismissed.

In rebuttal the appellant took issue with the Minister's allegation that there was no time set for repayment, and referred to the note, which required payment on demand.

Analysis and Decision

This Court is satisfied, on the balance of probabilities, on the evidence before me that the amounts in question were loans received by the appellant in the years in question from the "company" and were taxable in the appellant's hands unless he has brought himself within the excepting provisions of subsection 15(2) of the Income Tax Act. Further, this Court is satisfied on the basis of the evidence and the arguments presented that the crux of the matter is to be found in a consideration of the following words: "and bona fide arrangements were made at the time the loan was made for repayment thereof within a reasonable period of time".

This Court cannot help but conclude that the appellant was sidetracked to a certain extent from the real issue here as he concentrated on the questions of the purpose of the loan, the use of the funds, the intention of the taxpayer and whether or not there was a benefit to the taxpayer.

It was clear from the outset that the Minister took no real issue as to why the loans were made and as to the use of the funds. I conclude without difficulty that “ Delhi Farms" needed money to survive and that the "company" loaned the money to "Delhi Farms" and that obviously some of the money was used for purchasing equipment, supplies and paying off the mortgage to the Bank of Montreal. It is not clear how all the money was used but I accept, for the purpose of this case that the funds went into the bank account of “Delhi Farms" from the "company" and were used by "Delhi Farms” in the ordinary course of its farming operations.

I am further satisfied that there was a general intention on the part of the appellant to repay the loan but that obviously depended upon the success of the operation of "Delhi Farms" and was obviously contingent upon the repayment of the loan to the Bank of Montreal first. The appellant argued throughout that he received no benefit from the loans. However, this argument is untenable because "Delhi Farms" was the appellant and his spouse, and when the funds flowed into the business, a benefit certainly accrued to them. It is not necessary for the Minister to show that part of the money went directly to the appellant’s bank account or that he took it as salary, or bought a motor vehicle or went on a vacation with it.

On the main issue as to whether or not “bona fide arrangements were made, at the time the loan was made, or the indebtedness arose, for repayment thereof within a reasonable period of time,” the evidence is very sparse.

The Court accepts the argument of the Minister that the written document, Exhibit A-1, is significantly irrelevant. It was some three years after the loans, contains within it nothing that could serve to corroborate the evidence of the witnesses as to any arrangements made for repayment at the time of the loan, it does not even refer to any repayment schedule, nor any specific amount to correspond to the amounts of the loans in issue here, makes no mention of the rate of interest and only makes vague reference to the understanding of the parties and an alleged loan agreement made on May 1, 1986.

The note attached to the mortgage refers to an interest rate of ten per cent but refers to an indebtedness of $300,000. The mere fact that it is a demand note does not make it more acceptable to establish a repayment scheme and again it was executed on May 23, 1989.

The only other evidence offered by the appellants in support of the contention that a bona fide arrangement for repayment was made at the time of the loan was the evidence of the appellant and his wife. The appellant testified that he always intended to pay back the loans and the interest rate was intended to be 10 per cent.

In essence the totality of his evidence establishes an intention to repay and at best his understanding that there was an oral agreement to pay back the money with interest. However, it is significant that no money has been paid back to date, no interest has been repaid and the appellant can point to no specific arrangements that have been made for repayment. It is obvious from the evidence of the appellant and his wife that any contemplated repayment was contingent on the other bank loan being paid back first and on the ability of "Delhi Farms" to repay the loans.

The appellant and his spouse testified that repayment was arranged in 1986 at a meeting at the kitchen table but there are no minutes of such a meeting, there were no corporate minutes of any meeting and there is little evidence as to anything else taking place at the meeting. However, Mrs. Kanters did say that they now intend to make arrangements to pay it back since it appears that ” Delhi Farms" is now viable.

Even if the Court was to accept the evidence of both witnesses I would not be satisfied that any enforceable agreement resulted from that meeting at the kitchen table. Further, even if the Court was satisfied that there was an agreement resulting from that meeting, it could have been nothing more than an agreement to pay back the money when "Delhi Farms” became viable, and when looked at from the proper time frame, that is at the time the loans are made, it is obvious that the loans might never have to be paid back. In the end result, this Court is not satisfied that the appellant has proven, on a balance of probabilities, as he is required to do, that" bona fide arrangements were made at the time the loans were made or the indebtedness arose, for repayment thereof within a reasonable time".

I find that the loans were properly included in the appellant's income in 1986 and 1987 and the appeal is dismissed and the same decision will apply to Mrs. Kanters' appeal.

Appeals dismissed.