Bowman
1.C.J.:
The
appellant
appeals
from
reassessments
for
the
1987,
1988,
1989,
1990
and
1991
taxation
years.
The
issue
is
the
proper
treatment
of
interest
that
accrued
but
was
not
paid
on
certain
loans
made
by
the
appellant
in
the
years
in
question,
and
the
effect
on
the
appellant’s
income
of
the
bad
and
doubtful
debt
provisions
of
the
Income
Tax
Act.
The
appellant
was
incorporated
in
1979
under
the
Canada
Business
Corporation
Act.
Its
sole
shareholder
was,
and
continues
to
be,
Mr.
George
Windsor,
a
barrister
and
solicitor.
Its
purpose
and
apparently
sole
function
was
to
invest,
through
subscriptions
for
shares
and
the
making
of
loans,
in
a
company
Technetronic
Inc.
The
funds
for
the
investments
that
it
made
in
Technetronic
were
all
from
loans
made
to
it
by
Mr.
Windsor.
Technetronic
was
engaged
in
the
development
of
computer
software
relating
to
the
management
and
assessment
of
mainframes
and,
in
particular,
in
eliminating
bottlenecks
in
mainframes
and,
latterly,
in
networks.
The
product
which
Technetronic
was
developing
was
sophisticated
and,
to
use
Mr.
Windsor’s
word,
revolutionary.
It
also
required
large
amounts
of
money.
The
appellant
began
advancing
money,
either
by
way
of
loans
or
share
subscriptions,
to
Technetronic
in
1980.
After
the
initial
investments,
the
Toronto
Dominion
Bank
was
persuaded
to
invest
$1,000,000
in
equity
of
Technetronic
and
as
part
of
that
transaction
the
appellant
and
other
investors
converted
some
of
the
debt
owing
to
them
to
equity.
The
appellant
converted
$160,000
of
its
debt
to
equity.
Technetronic
had
25-30
shareholders.
The
appellant
ultimately
became
the
lead
and,
finally,
the
only
lender.
It
owned,
in
the
years
in
question,
about
20%
of
the
issued
shares
of
Technetronic.
Technetronic
had
little
revenue,
but
enormous
cash
needs
and
the
appellant
funded
its
day-to-day
operations
on
a
bi-weekly
basis.
Mr.
Windsor
was
well
aware
of
the
cash
needs
of
Technetronic,
since
he
was
a
director.
On
March
18,
1985,
Technetronic
entered
into
a
General
Security
Agreement
with
the
appellant
and
“Such
other
parties
as
may
make
advances
to
the
Debtor
[Technetronic]
evidenced
by
notes
that
refer
to
and
are
secured
by
this
General
Security
Agreement”.
The
Agreement
provided
in
part
as
follows:
2.
By
his
or
its
acceptance
of
a
promissory
note
issued
by
the
Debtor
and
secured
by
this
Agreement
each
Secured
Party
shall
be
deemed
conclusively
to
have
agreed
with
each
other
Secured
Party
to
co-operate
fully
and
harmoniously
with
all
Secured
Parties,
to
attend
meetings
and
respond
promptly
to
requests
to
sign
resolutions
in
writing,
and,
on
any
realization
of
the
Collateral,
in
the
event
of
any
shortfall
to
share
pro
rata
in
the
amount
realized.
Apart
from
demanding
of
the
Debtor
payment
of
the
amounts
owed
to
him
or
it,
a
Secured
Party
shall
take
no
individual
action
under
this
Agreement
or
against
the
Debtor
and,
by
his
or
its
acceptance
of
a
promissory
note
issued
by
the
Debtor
and,
by
his
or
its
acceptance
of
a
promissory
note
issued
by
the
Debtor
and
secured
by
this
Agreement,
each
Secured
Party
shall
be
deemed
conclusively
to
have
agreed
accordingly.
16.
(i)
Except
as
herein
otherwise
expressly
provided
all
moneys
arising
from
the
enforcement
of
the
provisions
of
this
Agreement
and
the
Notes
shall
be
applied,
together
with
any
other
moneys
then
in
the
hands
of
the
Secured
Parties
available
for
such
purpose,
in
the
first
place
to
pay
or
reimburse
to
the
receiver
or
receiver
and
manager
the
costs,
charges,
expenses,
advances
and
compensation
of
the
receiver
or
receiver
and
manager
in
or
about
the
execution
of
its
duties,
or
otherwise
in
relation
hereto,
with
interest
thereon
as
herein
provided,
and
in
the
second
place
to
pay
all
taxes,
assessments
and
other
charges
ranking
in
priority
to
the
Notes,
and
in
the
third
place
the
residue
of
said
moneys
shall
be
applied:
(1)
first,
in
or
towards
payment
of
the
principal
of
the
Notes
for
the
time
being
outstanding
and
second,
in
or
towards
payment
of
the
accrued
and
unpaid
interest
and
interest
on
overdue
interest
on
such
Notes,
rateably
and
proportionately
and
without
preference
or
priority
as
between
Secured
Parties
and
principal
and
interest,
provided
that
no
payment
of
which
has
been
extended,
whether
by
purchase
or
funding
or
otherwise,
(2)
the
surplus,
if
any,
of
such
moneys
shall
be
paid
to
the
Debtor
or
is
assigns.
A
promissory
note
was
signed
by
Technetronic
in
favour
of
the
appellant.
It
was
not
put
in
evidence
(having
been
lost),
but
it
was
evidently
in
approximately
the
form
of
one
that
was
given
to
another
creditor
and
read
as
follows:
Technetronic
Inc.
Secured
Promissory
Note
OTH
April
1985
ON
DEMAND
after
June
30th,
1985
the
undersigned
promises
to
pay
to
U.S.
Portfolio
Leasing
Inc.
the
sum
of
C$9,994.00
with
interest
thereon
calculated
and
payable
monthly
at
the
rate
of
15%
per
annum
until
said
sum
is
paid,
together
with
interest
on
overdue
interest
at
the
aforesaid
rate,
as
well
after
as
before
maturity,
default,
and
judgment
until
the
date
of
actual
payment.
This
Secured
Promissory
Note
evidences
a
shareholder
advance
secured
by
a
General
Security
Agreement
dated
the
18th
day
of
March
1985
made
between
the
undersigned,
92735
Canada
Limited,
and
such
other
parties
as
may
make
advances
to
the
undersigned
that
are
to
be
secured
by
the
General
Security
Agreement
and
which
created
a
security
interest
in
and
to
the
assets
of
the
undersigned
(subject
only
to
a
charge
in
favour
of
The
Royal
Bank
of
Canada
securing
a
business
improvement
loan).
VALUE
RECEIVED.
TECHNETRONIC
INC.
Per:
John
H.
Gray
President
Per:
Brian
R.
Patterson
Controller
The
difference
between
this
note
and
that
given
to
the
appellant
is
that
the
latter
was
not
for
a
fixed
amount,
but
referred
to
the
amounts
shown
on
the
books
of
Technetronic
as
owing
to
the
appellant.
Interest
under
the
note
was
payable
at
15%
and,
under
the
Security
Agreement,
was
payable
after
principal
and
in
priority
to
interest
on
overdue
interest.
Principal
was
payable
on
demand.
It
is
agreed
that
the
appellant
from
1986
to
1994
loaned
money
to
Technetronic
as
follows:
Year
|
Loan
Increase
|
Loan
Balance
|
1986
|
$1.448,860
|
$1,448,860
|
1987
|
1,179,860
|
2,628,720
|
1988
|
63,890
|
3,492,610
|
1989
|
646,010
|
4,138,620
|
1990
|
188,000
|
4,326,620
|
1991
|
343,000
|
4,669,620
|
1992
|
42,107
|
4,711,727
|
Year
|
Loan
Increase
|
Loan
Balance
|
1993
|
76.766
|
4,788,493
|
1994
|
141,682
|
4,930,175
|
No
amount
of
principal
was
ever
repaid
and
no
interest
was
paid.
Indeed
the
appellant
never
demanded
payment.
Mr.
Windsor
stated
that
he
hoped
that
ultimately
Technetronic
would
make
a
large
profit
and
be
able
to
repay
the
amounts
it
owed.
Today
the
company
is
defunct.
During
the
years
when
the
appellant
was
advancing
money
it
was
a
bottomless
money
pit
and,
while
Mr.
Windsor
stated
that
he
felt
optimistic
when
the
appellant
advanced
the
money
about
Technetronic’s
ultimate
ability
to
pay,
it
was
perfectly
obvious
that
it
kept
lending
money
in
the
hope
that
ultimately
things
would
turn
around.
If
the
appellant
stopped
lending
money
and
put
Technetronic
into
receivership,
as
it
could
obviously
have
done,
all
of
the
investment
up
to
that
point
would
be
lost.
The
interest
that
accrued
on
the
loans
was
as
follows:
Year
|
Interest
|
1987
|
$212,762
|
1988
|
390,840
|
1989
|
523,035
|
1990
|
612,948
|
199]
|
647,038
|
The
appellant
did
not
initially
file
returns,
on
the
view
that
it
had
no
income,
a
fact
that,
apart
from
the
provisions
of
the
Act,
was
inescapable
as
a
matter
of
economic
reality.
When
returns
were
demanded
the
appellant
filed
returns
showing
nil
income,
on
the
basis
that
it
was
entitled
to
use
the
cash
method
of
recording
the
interest
income.
The
Minister
assessed
originally
by
including
the
accrued
interest
income
in
the
appellant’s
income
and
also
assessed
substantial
penalties
for
gross
negligence.
These
have
since
been
dropped.
On
objection
the
Minister
allowed
reserves
for
doubtful
accounts
under
paragraph
20(1
)(/)
of
the
Act:
Year
|
Reserve
|
1989
|
$
603,602
|
1990
|
1,126,637
|
1991
2,386,623
An
analysis
of
these
figures
and
a
comparison
of
them
with
the
interest
that
accrued
as
set
out
above,
reveals
the
following:
(a)
No
reserve
was
allowed
in
1987
and
1988.
(b)
The
reserve
of
$603,602
allowed
in
1989
was
simply
the
aggregate
of
the
interest
that
had
accrued
for
1987
and
1988
($212,762
and
$390,840).
(c)
The
reserve
allowed
in
1989
of
$603,602
absorbed
the
interest
income
that
accrued
in
1989
of
$523,035,
leaving
$80,567.
This
amount
was
carried
back
to
1987,
leaving
the
appellant
with
$132,195
income
in
that
year.
(d)
In
1990,
a
reserve
of
$1,126,637
was
allowed.
This
was
simply
the
aggregate
of
the
interest
that
had
accrued
for
1987,
1988
and
1989.
However,
in
1990
there
was
included
the
interest
income
of
$612,948
that
had
accrued
in
that
year
plus
the
prior
year’s
reserve
of
$603,602
that
had
to
be
brought
back
into
income
under
paragraph
12(1)(d).
(e)
In
1991,
a
reserve
of
$2,386,623
was
allowed.
This
amount
represented
the
total
of
all
of
the
interest
that
had
accrued
in
1987,
1988,
1989,
1990
and
1991.
The
effect
of
this
was
to
eliminate
the
income
of
$647,038,
the
interest
accrued
in
that
year,
and
the
$1,126,637,
the
1990
reserve
which
had
to
be
brought
into
income
in
1991.
The
point
of
all
this
is
that
because
losses
can
be
carried
back
only
three
years
there
are
unused
capital
losses
of
$132,195
which
cannot
be
used
to
reduce
the
1987
income
to
nil
and
which
must
therefore
be
applied
to
years
subsequent
to
1991.
This
is
of
questionable
value
to
the
appellant,
considering
its
financial
condition
in
those
years.
It
will
be
observed
that
it
was
not
the
appellant
who
calculated
the
reserves.
It
was
the
Minister,
at
the
objection
level,
who
did
so.
The
calculation
of
the
reserves
was
apparently
premised
on
the
idea
that
the
1987
and
1988
accruals
did
not
become
doubtful
until
1989.
The
Minister’s
view
was
that
the
1989
accrual
became
doubtful
in
1990
and
the
1990
and
1991
accruals
became
doubtful
in
1991.
Counsel
for
the
appellant
argued
that
it
was
entitled
to
use
the
cash
method
of
accounting
for
the
interest
income
and
that
since
no
interest
was
ever
received
it
had
no
income.
In
support
of
this
position
he
relies
upon
a
decision
of
Thurlow
J.,
as
he
then
was,
in
Industrial
Mortgage
&
Trust
Co.
v.
Minister
of
National
Revenue,
[1958]
Ex.
C.R.
205,
58
D.T.C.
1060
(Can.
Ex.
Ct.),
where
the
Exchequer
Court
permitted
the
taxpayer
to
use
the
cash
method
in
respect
of
some
of
its
loans
and
the
accrual
method
in
respect
of
others.
The
correctness
of
the
decision
within
the
context
of
the
legislation
that
existed
then
has
never
been
questioned
but
it
has
been
superseded
by
subsection
12(3),
which,
in
its
original
form
was
introduced
in
1975.
In
the
years
under
appeal
it
read
as
follows:
Notwithstanding
paragraph
(1)(c),
in
computing
the
income
for
a
taxation
year
of
a
corporation,
partnership,
unit
trust
or
any
trust
of
which
a
corporation
or
a
partnership
is
a
beneficiary,
there
shall
be
included
any
interest
on
a
debt
obligation
(other
than
interest
in
respect
of
an
income
bond,
an
income
debenture,
a
small
business
development
bond,
or
a
small
business
bond)
that
accrued
to
it
to
the
end
of
the
year,
or
became
receivable
or
was
received
by
it
before
the
end
of
the
year,
to
the
extent
that
the
interest
was
not
included
in
computing
its
income
for
a
preceding
taxation
year.
I
agree
with
Ms.
Tataryn’s
submission
on
this
point.
In
my
view
subsection
12(3)
is
clear
and
unambiguous.
Where
interest
accrues
a
corporate
taxpayer
must
include
it
in
income,
even
though
it
is
neither
received
nor
receivable.
The
meaning
to
be
given
to
the
word
“accrued”
may
be
taken
from
the
decision
of
the
Supreme
Court
of
Canada
in
Morenish
Land
Development
Ltd.
v.
Metropolitan
Trust
Co.,
[1981]
1
S.C.R.
171
(S.C.C.)
at
page
179
where
Estey
J.
said:
The
problem
must,
of
course,
be
approached
as
fundamentally
one
of
contract
construction.
Where
the
term
“per
annum”
is
unqualified
by
other
expressions
in
the
mortgage,
the
cases
have
consistently
found
that
it
means
calculated
and
payable
per
annum.
However,
it
also
must
be
borne
in
mind
that
interest,
however
payable,
accrues
on
a
per
diem
basis,
as
was
stated
by
the
Vice
Chancellor
in
/n
re
Rogers’
Trusts,
at
p.
341:
In
the
present
case,
the
interest
payable
on
the
debentures,
though
payable
half-yearly,
is
not
an
entirety,
but
is
an
accumulation
of
each
day’s
interest,
which
accrues
de
die
in
diem;
and
which,
though
not
presently
payable,
is
still
due.
If
follows
that
the
interest
that
accrued
each
year
was
to
be
included
in
the
appellant’s
income.
This
does
not
of
course
end
the
matter.
The
simple
and
indisputable
economic
fact
is
the
appellant
never
received
a
penny
of
interest
income.
The
appellant’s
loans
to
Technetronic
were
in
the
nature
of
a
salvage
operation
—
a
desperate
and,
as
it
turned
out,
futile
attempt
to
keep
Technetronic
afloat.
Notwithstanding
Mr.
Windsor’s
courageous
optimism
at
no
time
in
the
entire
association
of
the
appellant
with
Technetronic
was
the
latter
in
a
position
to
pay
either
the
principal
or
the
interest.
Although
a
number
of
authorities
were
referred
to
relating
to
when
a
debt
becomes
bad
or
doubtful,
or
who
should
make
the
determination,
it
strikes
me
that
as
a
matter
of
simple
objective
fact
the
obligations
of
Technetronic
to
the
appellant
were
doubtful
from
the
outset
and
in
their
entirety.
Whether
they
were
bad
debts
or
not
within
the
meaning
of
paragraph
20(1
)(/)
(see
Flexi-Coil
Ltd.
v.
R.,
(1996),
96
D.T.C.
6350
(Fed.
C.A.)),
they
were
unquestionably
doubtful
within
the
meaning
of
paragraph
20(1)(/)
in
the
year
in
which
they
were
made.
There
was
no
basis
for
deferring
until
a
later
year
the
treatment
as
doubtful
of
the
interest
that
accrued
in
one
year.
Where
it
is
plain
that
debts
are
doubtful
there
is
no
room
for
substituting
a
taxpayer’s
subjective
views,
whether
they
be
optimistic
or
pessimistic,
for
the
objective
facts.
Here
Technetronic
had
no
revenues
and
no
means
whereby
it
could
satisfy
any
portion
of
its
obligations
and
the
only
reason
it
survived
as
long
as
it
did
was
through
the
appellant’s,
and
indirectly,
Mr.
Windsor’s
largesse.
I
have
concluded
therefore
that
the
interest
that
accrued
in
each
year
became
a
doubtful
debt
in
the
year
in
which
the
interest
accrued.
The
result
is
that
the
accruals
for
each
year
will
be
offset
by
the
amount
of
the
reserve
so
that
effectively
the
appellant’s
income
in
each
year
is
nil.
The
respondent
has
conceded
that
the
late
filing
penalty
of
$25,378
imposed
in
1989
should
be
deleted.
The
appeals
are
allowed
with
costs
and
the
assessments
are
referred
back
to
the
Minister
of
National
Revenue
for
reconsideration
and
reassessment
in
accordance
with
these
reasons.
Appeal
allowed.