Citation: 2015 TCC 150
Date: 20150616
Docket: 2013-1651(IT)G
BETWEEN:
DOMENIC
DELLE DONNE,
Appellant,
and
HER
MAJESTY THE QUEEN,
Respondent.
REASONS
FOR JUDGMENT
Owen J.
I. Introduction
[1]
This is an appeal by Dr. Domenic Delle Donne of
a reassessment of his 2009 taxation year; the notice of reassessment was dated
May 19, 2011. The reassessment included in the Appellant’s income interest in
the amount of $138,633.67. This amount included $137,500 of interest payable to
the Appellant by S.A. Capital Growth Corporation (hereinafter, “SA”). Only
the amount of $137,500 payable to the Appellant by SA is in issue in this
appeal (I will refer to this amount as the “Interest”).
II. Facts
[2]
The Appellant, Mr. Davide Amato and
Mr. Kevin Yee Loong, CPA testified for the Appellant. The Respondent did
not call any witnesses.
[3]
The Appellant is a dentist who practises as a
root canal specialist. Mr. Amato is a retired dentist and the
brother-in-law of the Appellant. Mr. Yee Loong is the chartered
professional accountant who prepared the Appellant’s 2009 T1 tax return.
Mr. Yee Loong obtained the designation of chartered accountant (now
chartered professional accountant) in Ontario in 1984 and is a partner with
Sautner Austin Chartered Accountants.
[4]
SA is a Canadian-resident corporation owned by
Mr. Amato. Mr. Amato practised dentistry for 18 years before he sold
his practice in 2008 to concentrate full-time on his investments. Mr. Amato
incorporated SA in the latter part of 2007 for that purpose.
[5]
SA borrowed money from Mr. Amato and his wife
and from 40 individuals who were family and friends of Mr. Amato (the “outside investors”), including the Appellant. SA then lent that money to a second,
unrelated corporation at a higher rate of interest. It was anticipated that the
second corporation would invest the borrowed money in the market.
[6]
At first, SA made the loans to C.O. Capital Growth
Inc., which was owned by Mr. Peter Sbaraglia, another retired dentist.
Mr. Sbaraglia was a long-time friend of Mr. Amato.
[7]
In May 2008, SA stopped lending money to C.O.
Capital Growth and from that point forward instead lent money exclusively to
E.M.B. Asset Group Inc. (“EMB”), a Canadian-resident corporation solely owned by Mr. Mander.
Mr. Mander was not related to Mr. Amato or the Appellant.
[8]
Mr. Mander held himself out as a super
trader with a specialized trading strategy. Mr. Amato described the
strategy as follows:
. . . a systematic
approach using defensive mechanisms that would minimize potential losses and
would result in small incremental growth or small percentage growths on a
weekly basis. It ended up being substantial for the year, but small incremental
growth every week.
[9]
On December 11, 2008,
January 26, 2009 and February 27, 2009, the Appellant lent
SA a total of $900,000 pursuant to the terms of three loan agreements entered
into on those dates (Exhibits A-1, R-1 and A-5). The first agreement was for a
loan of $400,000 and the other two agreements were for loans of $250,000 each.
[10]
Each loan by the Appellant to SA was for a term
of three years at a simple interest rate of 25% per annum. The interest was to
be paid on the first and second anniversary dates of the agreements only if the
lender requested payment in writing at least 45 days prior to the anniversary
date. Otherwise, the interest would be added to the principal owed under
the agreement and simple interest at 25% per annum would accrue on the
additional principal. A written request to pay interest had to be made in the
form of Schedule “G” to the agreements.
[11]
Mr. Amato testified that he would not have
enforced the requirement to submit a written request to pay interest and would
have had SA pay the interest owed to the Appellant if asked by the Appellant. The
Appellant testified that he understood that he only had to ask for payment of
the interest. No written request to pay interest was tendered by the Appellant to
SA or to Mr. Amato.
[12]
The Appellant’s understanding of the strategy
was that investments would be made by SA and then would be returned to cash on
a daily basis. The Appellant was aware that Mr. Mander implemented this
strategy, but he was not aware of the loan arrangement between SA and EMB. He
believed that the money he had lent to SA was controlled by SA (or Mr. Amato)
and he did not know that the money was in fact controlled by EMB. He felt that
Mr. Amato had misled him in that regard.
[13]
Around August 2009, the Appellant invested funds
that were in his RRSP with an entity called Crystal Wealth, which was another
company controlled by Mr. Mander. The monthly RRSP statements for August
2009 and thereafter showed significant losses and this raised doubts with the
Appellant regarding the returns promised on the loans he had made to SA. He
testified that he questioned how such a high rate of interest could be earned
using the same strategy as that which lost money in his RRSP.
[14]
In the fall of 2009, Mr. Amato considered
terminating the arrangements with EMB mainly because of Mr. Mander’s
difficult personality. However, he did not take any steps to that end.
[15]
During 2009, a few amounts owed by EMB to SA
came due, some of which were left with EMB. Prior to early December 2009, EMB
did pay to SA the amounts that were not left with EMB. Mr. Amato did not
recall the total of the amounts that were paid. He did recall that SA made a
payment of $60,500 to his mother-in-law on December 7, 2009.
[16]
The payments from EMB to SA ceased in
mid-December 2009. A payment by EMB to SA in the amount of $208,000 was due on
December 14, 2009 and Mr. Mander had agreed to make the payment
at a meeting scheduled for 2 p.m. on December 11, 2009. Mr. Mander
did not show up at the meeting and EMB did not pay SA the $208,000 either on
December 11, 2009 or on December 14, 2009. Mr. Amato
was asked about his reaction to this development:
Multiple calls to
several people that were involved in his office, at which point there was some
discussion as to they hadn’t heard from him, and some feedback was that he had
a heart attack and some people in his own office went to his house to see if he
was okay. One person made contact with him and everybody claimed he had had a
heart attack.
[17]
Mr. Amato received an e-mail on
December 15, 2009 which stated that Mr. Mander had had a heart
attack six weeks earlier. Mr. Amato immediately took steps to demand payment from EMB:
Q. What did you attempt to do to collect
amounts from E.M.B. or Mr. Mander in 2009?
A. He had an automatic renewal notice on the
loan agreement with a specified date of 45 days where he was to be notified as
to whether money would be returned. So step one was to submit that. And then
step two was repeated notifications by me or somebody else that worked with us
that - - so these were the required payments that were coming due.
[18]
Mr. Mander did not admit that EMB could not
pay the amounts due to SA but instead resisted payment on the grounds that it
would disrupt his trading strategy. He asked for meetings with various people
to discuss the strategy. In hindsight, it appears that this was merely a
stalling tactic.
[19]
Because of the back-to-back loan arrangements,
the $208,000 due from EMB on December 14, 2009 was payable by SA to an outside
investor. Mr. Amato paid the amount owed to the investor from his own
funds. When again asked his reaction to EMB’s refusal or failure to pay,
Mr. Amato said:
Probably couldn’t
categorize it in one word, but it was probably panic, anger, a whole - - powerlessness.
[20]
Mr. Amato met with the Appellant and his
wife at the Appellant’s home on December 16, 2009 and advised them of
the developments with Mr. Mander. The
Appellant testified that he knew something was seriously wrong because his
brother-in-law had always been very successful financially. When asked what Mr. Amato
had told him at the meeting, the Appellant stated:
He said that Robert
had a heart attack and he’s having trouble getting in touch with him and
getting to his money. But he didn’t want us to hear anything from somebody
else, and he didn’t want us to panic and tell anybody else because he wasn’t
quite sure. But for Dave to not be sure, that is not - - something is terribly
wrong because he is always sure about money. As long as I have known him, he
has been part of our family, he has been very good with money. So that was very
upsetting to my wife and I that day. I kind of knew but I didn’t want to say
anything to my wife, “It’s gone.”
[21]
The Appellant stated that he did not make any
further inquiries of Mr. Amato in December 2009 as it was very hard to
reach him after their December meeting. The Appellant also explained that he
did not hire a lawyer because “He
is my family. It would have killed my mother.”
[22]
In January 2010, Mr. Amato retained legal
counsel, who advised him not to have any contact with Mr. Mander so as to
allow time to work up a case and gather information. Subsequently, to obtain
access to all of Mr. Mander’s assets, SA made a receivership application,
and a hearing was scheduled for March 17, 2010. Mr. Mander did
not attend the meeting and the parties received notice at the meeting that
Mr. Mander had been found dead in his home. When
asked what this meant for SA, Mr. Amato stated:
A. It was
devastating.
Q. Why is
that?
A. Well, I
felt a certain responsibility to take care of the people there, and that they
weren’t going to get their money.
[23]
The Appellant identified a letter from SA’s
counsel dated March 23, 2010 (Exhibit A-7) in which it is stated on
page 2:
We believe it is
becoming quite clear through, amongst other things, the Receiver’s
investigations that S.A. Capital and the investors it represents are but one
part of a large scheme (which we believe to be a ‘ponzi’ scheme) orchestrated
by Robert Mander.
[24]
The Appellant was asked about his reaction to
this letter:
Q. After
reading this, what did you conclude at the time?
A. It just confirmed. I knew that there was
nothing left. Again, if you know Dave - - when I saw him in December and he’s
devastated and he can’t really get to his money, I knew that things were wrong.
And we were probably, I think, somewhat misled.
Q. Misled
by whom?
A. By
Dave.
Q. About
what?
A. Well, we thought we were giving him the
money and he had control and Robert’s telling him what to do but he had control.
He had no control. He couldn’t even - - if he can’t get to his money in
December when things are due, that is not Dave, so something - - if Dave can’t
get to his money, then I knew we had lost it. If you know him, if you had been
a family member, you would have seen it too.
[25]
The Appellant recalled seeing news reports in
the newspapers, online and elsewhere about the death of Mr. Mander. Four
such reports, published during the period from March 24 to March 31, 2010,
were entered into evidence as Exhibits A-8, A-9, A-10 and A-11 not for the truth
of their contents but to provide an understanding of the circumstances that the
Appellant was facing in late March 2010.
[26]
Each report speculated about the nefarious
activities of Mr. Mander. The March 31, 2010 report by CBC News
(Exhibit A-11) stated: “Mander
committed suicide March 17 in his Freelton, Ont. home north of Hamilton,
leaving behind little evidence of the $50 million or so in loans he had taken
from investors in southern Ontario.”
[27]
The Appellant was asked about his reaction to
Exhibit A-8, which was a report by CBC News dated March 24, 2010:
Q. So you read the document at the time. What
did you conclude from having read it?
A. There is nothing. It is gone. If there was
anything, maybe there are some assets in these properties or his personal thing.
I think they were trying to, from what I understood at the time, Dave’s lawyers
or his counsel was going to try and have things seized or a receiver was
appointed. I am not sure how it works. I am not a lawyer. But I think they did
seize about $4 or $5 million of assets. And some of us were a little optimistic
that we would get something back, but apparently, the receiver went through the
whole thing for their costs. I don’t think there was anything left for not one
investor. 4 or 5 million is used up by the lawyers. That is my understanding. I
couldn’t believe it. [Lines 10 to 24 of page 58 of the Transcript.]
[28]
With respect to the news reports collectively,
the Appellant testified:
Q. Again,
what conclusions did you draw from reading these?
A. Not only did I lose everything, that
everybody I knew that was close to me lost whatever they had invested. I think
I was probably one of the larger investors because I had means, but I trusted
my family. It didn’t work out the way we wanted it to. I would have loved to
have made that income. [Lines 9 to 16 of page 60 of the Transcript.]
[29]
Mr. Amato identified a document titled “Statement of Affairs (Business Proposal)” dated April 23, 2010 and signed by Mr. Amato
(Exhibit A-2). On the first page of the Statement of Affairs, the total
liabilities of SA are stated to be $17,318,303.35 and the total assets are
stated to be $288,200, for a shortfall of $17,030,103.35.
[30]
List “A” attached to the Statement of
Affairs identifies the unsecured creditors of SA and the amounts owed to those
creditors. The List indicates that Mr. and Mrs. Amato were owed
$7,019,434.47 of a total of $17,290,103.35. With the exception of a small
amount owed to few trade creditors of SA, the balance was owed to the outside
investors.
[31]
List “H” is titled “Full Statement of Property”. In row (i) titled “Securities” are listed an amount of $8,542,000
and an amount of $8,000,000, each of which is described in the column titled “Details of property” as “Other”. Mr. Amato testified that these were the amounts owed to SA
by EMB. They are not included as assets of SA on the first page of the
Statement of Affairs.
[32]
Mr. Amato stated that he believed the
Statement of Affairs to be a fair representation of the assets and liabilities
of SA on April 23, 2010 and, in retrospect, as at
December 31, 2009. He also stated that SA has paid none of its
liabilities listed in the Statement of Affairs. The Appellant confirmed that to
the date of the hearing he had received no payments of principal or interest
from SA.
[33]
SA filed a notice of intention to make a
proposal under the Bankruptcy and Insolvency Act on April 6, 2010.
This proposal was accepted by the creditors of SA on May 10, 2010 and
by the Superior Court of Ontario on July 29, 2010. Mr. Amato
also filed a proposal to creditors under the Bankruptcy and Insolvency Act.
[34]
SA issued to the Appellant a T5 slip for his
2009 taxation year on which the Interest was included in Box 13 as interest
from a Canadian source. The issuance of the T5’s was followed by a letter from
SA’s counsel dated March 29, 2010 (Exhibit R-3) that stated, in part:
Some clients have
asked whether the amounts reported in the T5s will be paid out in cash. S.A.
Capital is currently unable to respond to that query but will be in a better
position to do so once the court-appointed receiver’s investigation concludes. That
investigation could take a number of months.
[35]
The letter also stated that SA could not reissue
the T5s as “they are currently
correct as a matter of tax law”.
[36]
The Appellant’s 2009 T1 income tax return was
prepared by Mr. Yee Loong. The Appellant’s wife delivered all of the Appellant’s
information slips to Mr. Yee Loong and told him that the interest from
SA shown on the T5 was not earned.
[37]
Mr. Yee Loong testified that initially
he was not quite sure how to deal with the Interest and that he did some
research on the point. Ultimately, Mr. Yee Loong did not include the
Interest on the T1 and provided a letter on his firm’s letterhead, addressed to
the Canada Revenue Agency (“CRA”) and dated April 21, 2010, to explain the omission. The
letter was accompanied by an extract from the Receiver’s first report to the
Superior Court and by a March 25, 2010 article in the Oakville Beaver, a
local newspaper. Mr. Yee Loong’s letter stated that the Interest was “never earned, payable nor collectible”. A copy of each of the attachments to the return was entered into
evidence by the Appellant (Exhibit A-17).
[38]
To accommodate the filing of the attachments to
the T1 return, Mr. Yee Loong prepared a paper copy of the return,
which was delivered to the Appellant with instructions on how to file the
return with the CRA. The Appellant filed the T1 return with the letter, the two
attachments to the letter and the T5 issued by SA. An unsigned copy of the T1
tax return was entered into evidence (Exhibit A-16).
[39]
In cross-examination, Mr. Yee Loong
acknowledged that he stated in the letter he had prepared that “[a]t the present time, it is not known
whether the principal amounts are recoverable”
and agreed that at the time he did not know whether SA could pay the principal
and interest owed to the Appellant.
[40]
The CRA assessed the Appellant as filed by
notice dated June 7, 2010, but subsequently, by notice dated
May 19, 2011, reassessed the Appellant to include the Interest in
income for 2009. The Appellant objected to the reassessment and the CRA
confirmed the reassessment by letter dated December 12, 2012.
III. The
Position of the Appellant
[41]
Counsel for the Appellant concedes that the
Interest is income of the Appellant earned during his 2009 taxation year but
argues that he is entitled to claim an offsetting deduction under either
subparagraph 20(1)(l)(i) or 20(1)(p)(i) of the Income Tax Act
(Canada) (the “ITA”). Counsel observes that the tests in these two provisions are
fairly simple and straightforward.
[42]
Under subparagraph 20(1)(l)(i), the
taxpayer must demonstrate that the amount claimed is reasonable, that the debt
is doubtful and that the debt has been included in the income of the taxpayer
for the year or for a previous year.
[43]
Under subparagraph 20(1)(p)(i), the
taxpayer must demonstrate that the debt has become a bad debt in the year and
that the debt has been included in the income of the taxpayer for the year or a
previous year.
[44]
Counsel observed that how the amount is to be
claimed under these provisions is not specified in the provisions. As well, he
stated that he could find no authority establishing that specific formal
reporting was required in order to claim the deduction. This may be contrasted
with other provisions in the ITA that require specific formal reporting, such
as the designation required under paragraph 55(5)(f) of the ITA.
[45]
Counsel submits that there is no requirement
that the claim under either subparagraph 20(i)(l)(i) or subparagraph
20(i)(p)(i) be made in respect of trading accounts and cites Falaise
Steamship Co. Ltd. (No. 3) v. M.N.R., 63 DTC 663, 33 Tax A.B.C. 1 in
support of that proposition.
[46]
Counsel observes that the taxpayer is required
to make a determination as to whether the debt is doubtful or bad, depending on
the provision relied upon. This raises two questions. First, at what point in
time must that determination be made. That is to say, must the determination be
made (i) by the end of the relevant taxation year, (ii) by the taxpayer’s filing-due
date for the relevant taxation year, or (iii) by a date after the taxpayer’s
filing–due date for the relevant taxation year? Second, at which of these three
points in time must the debt actually be doubtful or bad?
[47]
The Appellant submits that the cases addressing
doubtful and bad debts seem to agree that the debt must be doubtful or bad as
at the end of the relevant taxation year. However, they also seem to assume
that the determination of that status not only can but should be made after the
end of the relevant taxation year. Otherwise the creditor is left in the
position of assessing the debt on the last day of the year, which would not
work in the real world.
[48]
The question that remains is what information
may be used by the taxpayer to assess the status of the debt as at the end of
the relevant taxation year? Is the taxpayer limited to information that exists
at the end of the relevant taxation year or can the taxpayer take into account
information that comes to light after the end of that year?
[49]
The Appellant submits that the taxpayer may take
into account information that becomes available after the end of the relevant
taxation year and cites Gibraltar Mines Ltd. v. The Queen, 83 DTC 5294, 48
N.R. 188, MacDonald Engineering Projects Ltd. v. M.N.R., 87 DTC 545 and Coppley
Noyes & Randall Limited v. The Queen, 91 DTC 5291 in support of that
proposition.
[50]
With respect to the facts, counsel submits that
by April 30, 2010 it was absolutely clear that a fraud had been
perpetrated and that at best only a fraction of the principal lent by SA to EMB
would be recovered. In fact, given the information available by
April 30, 2010, it would have been fanciful to conclude that the debt
owed by SA to the Appellant was not at least doubtful by the end of 2009.
Events subsequent to April 30, 2010 only served to reinforce the
conclusion that the debt was at least doubtful at the end of 2009.
[51]
Finally, counsel submitted that, while the
letter accompanying the Appellant’s 2009 T1 income tax return does not mention
a doubtful or bad debt claim, it does generally describe a series of positions,
including the contention that the Interest was not income and was not
collectible. The reference to the Interest not being collectible identified the
concern of the Appellant that the Interest was a doubtful or bad debt at the
end of 2009.
IV. The
Position of the Respondent
[52]
Counsel for the Respondent submits that under
the terms of the three loan agreements the Appellant was required to formally
demand payment of the Interest using the form in Schedule “G” to the
agreement and that, since the Appellant did not demand payment of the Interest
in 2009, there could be no bad debt at the end of 2009.
[53]
Counsel argues that the Appellant was aware in
December 2009 that Mr. Mander had had a heart attack. However, at that
time the Interest was not owed by Mr. Mander or by his corporation, EMB. The
debt was owed to the Appellant by SA. The ability of SA to pay the Interest was
not clear, as reflected in the letters from SA’s lawyers in March and April
2010 regarding the prospects for recovery.
[54]
Counsel further submits that the Interest was
not included in the Appellant’s income in 2009 because it was not reported on
his T1 income tax return. As the Interest was not included in income, no amount
could be claimed under subparagraph 20(1)(l)(i) or 20(1)(p)(i) of
the ITA. The proper approach would have been to include the amount as income on
the return and then claim an offsetting deduction under one of those two
provisions.
V. Statutory
Provisions
[55]
The statutory provisions in issue are paragraphs
20(1)(l) and (p) of the ITA. The portions of those provisions
relevant to this appeal are as follows:
20.(1)
Deductions permitted in computing income from business or property -
Notwithstanding paragraphs 18(1)(a), (b) and (h), in
computing a taxpayer’s income for a taxation year from a business or property,
there may be deducted such of the following amounts as are wholly applicable to
that source or such part of the following amounts as may reasonably be regarded
as applicable thereto
.
. .
(l) Doubtful or impaired debts - a reserve
determined as the total of
(i) a reasonable amount in respect of doubtful
debts (other than a debt to which subparagraph (ii) applies) that have been included
in computing the taxpayer’s income for the year or a preceding taxation year,
and
. . .
(p) Bad debts - the total of
(i) all debts owing to the taxpayer that are
established by the taxpayer to have become bad debts in the year and that have
been included in computing the taxpayer’s income for the year or a preceding
taxation year, and
. . .
[56]
Paragraph 12(1)(d) of the ITA requires a
taxpayer to include in computing income from a business or property any amount
deducted under paragraph 20(1)(l) of the ITA in computing income for the
immediately preceding taxation year. Paragraph 12(1)(i) of the ITA requires a
taxpayer to include in computing income from a business or property any amount
received in the year on account of a debt for which a deduction for bad debts
has been made in computing the taxpayer’s income for a preceding taxation year.
VI. Analysis
[57]
A useful overview of the provisions in issue is
provided by Professor Tim Edgar in a 1994 paper delivered at the National Tax
Conference (footnotes omitted):
The statutory
basis for the deduction of loan losses is relatively straightforward. As
indicated above, one of the fundamental judicial principles governing the
deduction of business expenses is the non-recognition of a reserve or allowance
for expected losses. Any deduction for losses is generally deferred until the
loss is realized, which normally occurs with an outstanding loan on a
disposition by the lender arising on either a sale or a settlement. This
judicial principle is now codified, to some extent, in paragraph 18(1)(e) and
its prohibition on the deduction of an amount as a reserve or contingent
liability. In addition, paragraph 18(1)(b) prohibits the deduction of a loss or
replacement of capital, or an allowance in respect of depreciation. Paragraph
18(1)(s), added in 1988, also specifically prohibits the deduction of any loss,
depreciation, or reduction in the value of a loan or lending asset made or
acquired in the ordinary course of business of an insurer or moneylender where
the loan or lending asset is not disposed of in the year. In allowing a
deduction for the amount of a reasonable reserve in respect of doubtful loans,
paragraph 20(1)(l) operates as an exception to the judicial principle of
realization applicable to loan losses as well as the statutory prohibition on
the deductibility of a loss or depreciation allowance in respect of loans held
as capital property. The companion provision in paragraph 20(1)(p) permits a
comparable deduction for loans that have become bad.
Paragraph 20(1)(l)
was originally included in the 1948 Act as part of a gradual movement toward
the recognition of business revenue and expenses on an accrual basis. Before
that time, taxpayers could only deduct an amount for bad debts, subject to the
discretion of the minister of national revenue. For taxpayers other than
moneylenders, subparagraph 20(1)(l)(i) permits the deduction of a reasonable
amount as a reserve in respect of doubtful debts, the amount of which has been
included in computing business income. The provision thus permits the
recognition of anticipated losses on accounts receivable that have been
recognized as business revenue. For moneylenders, this general provision
applies with respect to interest on a loan to the extent that the interest has
been included in income and its collection is doubtful.
[58]
Although Professor Edgar refers to income in a
business context, it is uncontroversial that the provisions also apply to
provide a deduction against income from property.
[59]
The Respondent suggests that, because no written
demand to pay the Interest was made by the Appellant, there can be no doubtful
or bad debt. The terms of the loan agreements entered into by SA and the
Appellant stated that SA agreed to pay to the Appellant simple interest on the
principal amount of the loan at the rate of 25% per annum. The amount of
interest owed by SA to the Appellant could be determined from day to day as the
simple interest accrued on the outstanding principal.
[60]
The interest may not have been payable until a
written demand was made in the form of Schedule “G”, or the loan matured, but it was
nevertheless owed by SA to the Appellant as it accrued. This is reinforced by
the fact that, if a written demand for payment of the interest was not made 45
days before the anniversary date of the loan, the interest that had accrued to
the first or second anniversary date was added to the principal amount of the
loan, which was clearly a debt owed by SA to the Appellant. Although the precise meaning of the word “debt” may be the
subject of some debate, it certainly encompasses a contractual obligation to
pay an ascertainable sum such as the Interest, regardless of whether or not a
demand for payment had been made by the Appellant.
A. Subparagraph 20(1)(l)(i)
[61]
The potential application of subparagraph 20(1)(l)(i)
to interest on a loan was confirmed in the Department of Finance technical
notes that accompanied amendments to paragraphs 20(1)(l) and 20(1)(p)
in 1988:
Paragraph 20(1)(l)
allows a taxpayer to deduct a reasonable amount as a reserve for doubtful
debts. Subparagraph 20(1)(l)(i) provides a reserve in respect of debts
that have been included in computing the income of a taxpayer. In the case of a
loan, this subparagraph would provide a reserve in respect of interest that has
been included in a taxpayer’s income but the collection of which is doubtful.
[62]
The clear and plain words of subparagraph 20(1)(l)(i)
require the taxpayer to establish three things: (1) that the deduction is being
claimed in respect of a debt that has been included in income, (2) that the
debt is doubtful, and (3) that the amount being claimed as a deduction from
income is reasonable.
[63]
With respect to the first requirement, whether
an amount is included in a taxpayer’s income is a determination made by
applying the provisions of the ITA to the facts. The Appellant concedes that
the Interest was income to him in 2009 and the Respondent does not say that the
Interest was not taxable as such. In fact, I would not be hearing this appeal
if the Interest had not been included in the Appellant’s income for 2009. The
Respondent argues, however, that because the Appellant did not record the
Interest as income on his T1 income tax return, he cannot claim the benefit of
the deduction in subparagraph 20(1)(l) or (p) of the ITA.
[64]
The fact that the Appellant reported the Interest
in a manner that did not record it as income on a line of his 2009 T1 income
tax return does not alter the fact that the interest was included in his income
for 2009 by virtue of the application of the provisions of the ITA to the
facts. This general principle was identified by Noël A.C.J. in The Queen
v. Simard-Beaudry Inc., [1971] F.C. 396, as follows (at page 403):
As to his second
argument, namely that the debt arising from re-assessment of the taxpayer dates
only from the time that the taxpayer is assessed, and that it did not,
accordingly, exist at the time the agreement was made, it seems to me that the
answer to this is that the general scheme of the Income Tax Act
indicates that the taxpayer’s debt is created by his taxable income, not by an
assessment or re-assessment. In fact, the taxpayer’s liability results from the
Act and not from the assessment. In principle, the debt comes into existence
the moment the income is earned, and even if the assessment is made one or more
years after the taxable income is earned, the debt is supposed to originate at
that point. . . .
[65]
As the Interest was included in the Appellant’s
income for 2009 pursuant to the terms of the ITA applicable to interest income,
the first requirement of subparagraph 20(1)(l)(i) is satisfied.
[66]
The second requirement in subparagraph 20(1)(l)(i)
is that the debt must be doubtful. The Appellant concedes that the debt must be
doubtful as of the end of the relevant taxation year (in this case, December
31, 2009), which accords with the jurisprudence and with the fact that a
taxpayer’s liability under the ITA is determined on a
taxation-year-by-taxation-year basis. It would simply make no sense if a
deduction for a taxation year were to be dependent on a state of affairs that
came into existence after the end of that taxation year, unless the ITA
expressly so provided as is the case, for example, with loss carry-backs.
[67]
The more pertinent question is whether the
taxpayer may rely on information that comes into existence after the end of the
taxation year to make a determination of fact as at the end of that taxation
year. In my view, that is precisely how the scheme of the ITA works, within
specified time limits. Let me explain.
[68]
A taxpayer who is required to file an income tax
return for a taxation year is required to file that return by the filing-due
date for the year. In the case of an individual, the filing-due date is either April
30 or June 15 of the immediately following year. By
signing the return, the taxpayer certifies that the return is correct and
complete and that it fully discloses all of the taxpayer’s income for the year.
[69]
A taxpayer must, therefore, determine his, her
or its income for the year by the filing-due date. If, in making this
determination, the taxpayer was limited to the information available at the end
of the taxation year, it would prove to be a very difficult, if not impossible,
task. Instead, the taxpayer may rely on information that comes into existence
after the end of the year, but before the filing-due date, to fulfill his, her
or its obligation to report all income earned in the year. This information
includes the amounts reported on information slips such as T3s, T4s and T5s,
which are expressly not due until after the end of the taxation year.
[70]
In practical terms, the determination of whether
a debt is doubtful for the purposes of paragraph 20(1)(l) must also be
made, in respect of a taxation year, by the filing-due date for that year so
that the deduction can be reflected in the net income reported for the year in
the taxpayer’s income tax return. I can see no valid reason why, in making that
determination, a taxpayer should be precluded from relying on all information
available up to the filing-due date. That is not to say that the debt need only
be doubtful by the filing-due date. Rather, the taxpayer must determine whether
or not the debt was doubtful at the end of the taxation year, taking into
account all information available up to the filing-due date for that year. Similarly,
any assessment of the taxpayer’s determination regarding the debt should be
based on all information available up to the filing-due date. The review of the
taxpayer’s decision should not be an exercise in second-guessing the taxpayer’s
judgment as of the filing-due date, using hindsight rather than the facts
available up to that date.
[71]
In this case, the filing-due date for the
Appellant’s 2009 taxation year was April 30, 2010. The Appellant was entitled
to take into account all information available up to April 30, 2010 in filing
his 2009 T1 income tax return, so that he could certify that his return for the
year was correct and complete and that it fully disclosed all of his income for
the 2009 taxation year.
[72]
This leads to the question of what is a doubtful
debt. In Coppley Noyes & Randall, supra, the Federal
Court-Trial Division described the requirements for finding a doubtful debt as
follows (at page 5297):
It is conceded that in order for an amount to be included as a
reserve for doubtful debts there has to be more than just some doubt that the
account might not be paid: Picadilly Hotels Ltd. v. The Queen, 78 DTC
6444 (F.C.T.D.). The decision in No. 81 v. M.N.R., (supra)
rejected the assertion that every debt which is overdue is a doubtful one
against which a reserve must be set up; see also Brignall v. M.N.R., 61
DTC 488 (T.A.B.). There must be good and substantial reason to question the
likelihood that the account will be paid. The Interpretation Bulletin issued by
the Minister of National Revenue (No. IT-442, paragraph 22) describes the test
as follows:
. . . For a debt to be classed as a bad debt there must be evidence
that it has in fact become uncollectible. For a debt to be included in a
reserve for doubtful debts it is sufficient that there be reasonable doubt about
the collectibility of it. . . .
In Highfield
Corporation Ltd. v. M.N.R., 82 DTC 1835 (T.A.B.) at 1847, it was said:
. . . A “Reserve for doubtful debts” established under section
20(1)(l) of the Act would seem to leave with the taxpayer a much greater
degree of flexibility in using business judgment with regard to the inclusion
of amounts in such a reserve that [sic] is permitted to a taxpayer in
claiming a deduction under section 20(1)(p) of the Act for a “bad debt”.
The term “doubtful debt” in itself can mean only what it says — the debt is
owing and possible of collection, but that possibility is not sufficiently
certain in the mind of the taxpayer that he wishes to be placed in the
disadvantageous position of having to pay income tax thereon before that
possibility has become more of a certainty.
[73]
The information available to the Appellant by
April 30, 2010, including the suggestion by SA’s lawyers in late March 2010 that
a Ponzi scheme was involved (Exhibit A-7) and newspaper and other media reports
suggesting the same (Exhibits A-8 to A-11), casts serious doubt on the collectibility
at the end of 2009 not just of the Interest but also of the principal owed by
SA to the Appellant. In my view, any reasonable person would have reached the
conclusion that at the end of 2009 the payment of the Interest was at the very
least doubtful given the strong indication that SA had been the victim of fraud
and had no independent means of paying the amounts owed to the Appellant.
[74]
The tenuous financial position of SA at the end
of 2009 was further confirmed by the fact that SA had filed on
April 6, 2010 a notice of intention to make a proposal under the Bankruptcy
and Insolvency Act. The “Statement
of Affairs (Business Proposal)” dated
April 23, 2010 made clear the fact that SA had no financial resources
other than the amounts owed to it by EMB, which, because of the circumstances,
were not recorded as an asset of the corporation. Mr. Amato testified that
the Statement also fairly reflected the financial position of SA at the end of
2009, which simply recognizes that SA’s financial condition resulted from the
fraud perpetrated by Mr. Mander from the outset, and not from
circumstances that arose after 2009.
[75]
To be clear, the circumstances of SA that were
revealed by April 30, 2010 also existed at the end of 2009. This is
not a case where the financial condition of SA deteriorated after 2009. This is
a case where the true circumstances of SA at the end of 2009 were revealed by
facts that came to light both in December 2009 and after 2009 but before the
Appellant’s filing-due date for the year. As already stated, the Appellant was
entitled to rely on all these facts in assessing the status of the debt owed by
SA at the end of 2009.
[76]
Although not relevant to the analysis of the
Appellant’s judgment on the filing-due date, events subsequent to April 30,
2010 only serve to confirm that the money lent by SA to EMB was fraudulently
appropriated by Mr.
Mander and that SA could not have paid any of its debts
at the end of 2009 as the money it had lent to EMB had been stolen.
[77]
The final requirement that must be satisfied is
that the amount claimed must be reasonable. Given that it was apparent by
April 30, 2010 that SA and the Appellant were very likely the victims
of a Ponzi scheme that held out the illusory promise of high interest rates,
that the whereabouts of the principal lent to EMB was unknown and that the
prospects for recovery of the principal invested were uncertain, it was
reasonable for the Appellant to claim a deduction under subparagraph 20(1)(l)(i)
equal to the full amount of the Interest. As stated in Coppley Noyes &
Randall, supra (at page 5297):
If there is a
reasonable doubt that an account is not collectible, the degree of doubt is
expressed as a proportion of the total debt taken as a reserve. In that sense
the amount included in a reserve with respect to any given account is an
estimate of the risk that the account will not ultimately be paid.
[78]
Here, the Appellant had reasonably concluded
that there was little, if any, prospect of recovering the principal lent to SA
and no prospect of recovering the Interest. Accordingly, a deduction under
subparagraph 20(1)(l)(i) of the ITA equal to the full amount of the
Interest was reasonable.
B. Subparagraph 20(1)(p)(i)
[79]
Subparagraph 20(1)(p)(i) has only two
requirements. First, the debt in issue must have been included in the
taxpayer’s income for the year the deduction is claimed or for a previous year.
For the reasons given above in the context of the analysis of subparagraph
20(1)(l)(i) of the ITA, this requirement has been satisfied by the
Appellant.
[80]
Second, the taxpayer must establish that the
debt has become a bad debt in the year. The generally accepted approach to
determining whether a debt is bad is identified by the Federal Court of Appeal
in Flexi-Coil Ltd. v. The Queen, 96 DTC 6350, 199 N.R. 120 as follows
(at page 6351 DTC, 122 N.R.):
The parties are
also agreed as to the learned Tax Court Judge’s statement of the case law
interpreting this provision (Appeal Book V, 942):
The question of when a debt becomes bad is a question of fact to be
determined according to the circumstances of each case. Primarily, a debt is
recognized to be bad when it has been proved uncollectible in the year. In Roy
v. M.N.R., 58 DTC 676, Mr. Boisvert of the Tax Appeal Board stated at
page 680:
As the Act does not define a bad debt, it is necessary to turn to
recognized accounting principles of business practice. A debt is recognized to
be bad when it has been proved uncollectible in the year.
The question of when a debt is to be considered uncollectible is a
matter of the taxpayer’s own judgment as a prudent businessman. In Hogan v.
M.N.R., 56 DTC 183 at page 193, Mr. Fisher described how this
determination should be made:
For the purposes of the Income Tax Act, therefore, a bad debt
may be designated as the whole or a portion of a debt which the creditor, after
having personally considered the relevant factors mentioned above in so far as
they are applicable to each particular debt, honestly and reasonably
determines to be uncollectable at the end of the fiscal year when the
determination is required to be made, notwithstanding that subsequent events
may transpire under which the debt, or any portion of it, may in fact, be
collected. The person making the determination should be the creditor himself
(or his or its employee), who is personally thoroughly conversant with the
facts and circumstances surrounding not only each particular debt but also,
where possibly, [sic] each individual debtor . . . (Emphasis is mine)
This approach has been followed in numerous judgments, including Anjalie
Enterprises Ltd. v. The Queen, 95 DTC 216 (TCC), and Berretti v. M.N.R.,
86 DTC 1719 (TCC). In summary, to decide whether a taxpayer is entitled to a
deduction for bad debts, the Court must be satisfied that the taxpayer itself
made the determination that the debts had become uncollectible and that in
making such determination, it acted reasonably and in a pragmatic business-like
manner, applying the proper factors.
[81]
The decision in Flexi-Coil indicates that
a debt is a bad debt when the taxpayer determines that the debt is
uncollectible and, in making this determination, has acted reasonably and in a
pragmatic, business-like manner, applying the proper factors. The excerpt from
the decision of the Income Tax Appeal Board decision in Hogan also
confirms that subsequent events do not alter a properly made determination. To
this I would add that there is a difference between events that transpire by
the filing-due date that reveal the true state of affairs as of the end of the relevant
taxation year and events that transpire after the end of that taxation year
that alter the circumstances of the debt in the subsequent taxation year. Only
the former are relevant to the status of the debt as at the end of the relevant
taxation year.
[82]
As for the proper factors, the Federal Court of
Appeal in Rich v. Canada, 2003 FCA 38, [2003] 3 F.C. 493 provided the
following guidelines for determining when a debt is a bad debt (at paragraph
13):
I would summarize
factors that I think usually should be taken into account in determining
whether a debt has become bad as:
1. the history and age of the debt;
2. the financial position of the debtor, its revenues and
expenses, whether it is earning income or incurring losses, its cash flow and
its assets, liabilities and liquidity;
3. changes in total sales as compared with prior years;
4. the debtor’s cash, accounts receivable and other current
assets at the relevant time and as compared with prior years;
5. the debtor’s accounts payable and other current
liabilities at the relevant time and as compared with prior years;
6. the general business conditions in the country, the
community of the debtor, and in the debtor’s line of business; and
7. the past experience of the taxpayer with writing off bad
debts.
This list is not
exhaustive and, in different circumstances, one factor or another may be more
important.
[83]
The circumstances in this case are unusual in
that the inability of SA to pay its debt to the Appellant arises because SA was
the victim of fraud. The CRA states in Income Tax Folio S3-F9-C1: Lottery
Winnings, Miscellaneous Receipts, and Income (and Losses) from Crime, under the
heading “Fraudulent investment
schemes”:
1.43 A taxpayer may
claim a deduction for a bad debt pursuant to paragraph 20(1)(p) in the
year the fraud is discovered to the extent that investment income purportedly
earned from a scheme, that was not considered to have been received or
withdrawn by the taxpayer, was previously included in the taxpayer’s income.
Generally, the year the fraud is discovered is considered to be the year during
which the Crown lays charges against the perpetrator of the fraud. Any amounts
received by the taxpayer or paid to a third party for the benefit of the
taxpayer cannot be claimed as a bad debt deduction.
[84]
The CRA position does not address a circumstance
such as that existing here where the perpetrator of the fraud has committed
suicide and therefore will never be subject to charges. In my view, the proper
question to ask here is whether, in the circumstances as they were known by
April 30, 2010, a person acting reasonably and in a pragmatic,
business-like manner would have concluded that the Interest was uncollectible
at the end of 2009 because the existence and the result of the fraud perpetrated
against SA had been sufficiently well established to draw that conclusion.
[85]
The information available to the Appellant as at
April 30, 2010 indicated that as of December 31, 2009 SA had no resources to pay
its debts other than what it might collect from EMB under the receivership. Although
the amount that might be recovered by SA was not known (as suggested in some of
the correspondence highlighted by the Respondent), it would have been perfectly
reasonable for the Appellant to conclude that only a portion of the principal
owed was likely to be recovered and that the Interest was illusory and would
not be recovered.
[86]
After all, it was apparent by April 30, 2010
that the whole investment scheme was very likely a fabrication by Mr. Mander
(a Ponzi scheme, as it was described by SA’s lawyers in March 2010). As well,
by all indications, the whereabouts of the money that had been loaned to EMB
was unknown, even though lawyers had been retained by Mr. Amato to investigate
as early as January 2010. Although it was still possible that the receiver
would recover some of the debt owed to SA so that SA could pass that money on to
the outside investors, a reasonable person may well have concluded that the
probability that the Interest would be recovered was zero.
[87]
As stated above in the context of the analysis
of subparagraph 20(1)(l)(i) of the ITA, SA’s financial condition did not
deteriorate after 2009. The facts that came to light after 2009 and before the
Appellant’s filing-due date revealed that SA did not have the ability to pay
the Interest at the end of 2009 because Mr. Mander had stolen the funds
EMB had borrowed from SA using the promise of a 25% annual return.
[88]
In the unusual circumstances of this case, I am
of the view that the only reasonable conclusion for the Appellant to reach on
April 30, 2010 was that the Interest, which was owed by SA to the
Appellant at the end of 2009, was a bad debt at the end of 2009. Consequently, the
Appellant was entitled to claim under subparagraph 20(1)(p)(i) of the
ITA a deduction in the amount of the Interest in computing his income for the
2009 taxation year.
C. Other Issues
[89]
The Respondent suggested that in order to claim
a deduction under either subparagraph 20(1)(l)(i) or subparagraph 20(1)(p)(i)
of the ITA, the Appellant should have recorded the Interest as income and then
claimed the deduction. However, the Respondent was not able to identify exactly
how the deduction under either of these subparagraphs is claimed on the return.
One possibility, not identified by either party, is that the amount would have
to be entered on line 232 of the return under “Other deductions”, with a description
of what was being claimed.
[90]
The Appellant sought expert advice on how to
file his 2009 T1 income tax return from a chartered professional accountant and
followed that advice. The letter attached to the return amply described and
explained the Appellant’s filing position. Although the letter did not make
specific reference to paragraph 20(1)(l) or 20(1)(p), it did
state that the Interest was not included on the return because, among other
things, it was not collectible. The jurisprudence makes clear that the
essential characteristic of a bad debt is that it is uncollectible.
[91]
In any event, even if the Appellant did not
specify that he was claiming a deduction under subparagraph 20(1)(l)(i)
or (20(1)(p)(i) of the ITA, it is well established that it is open to a
taxpayer to amend his return through the appeal process. In The Queen v.
Imperial Oil Limited et al., 2003 FCA 289, 2003 DTC 5485, the Court stated
(at paragraph 10):
The administrative difficulties arising from the complex affairs of
two large corporations have driven the Crown to propose statutory
interpretations that are not only incorrect, but that have the potential to
cause inordinate difficulties for taxpayers whose affairs are not complex. For
example, it is reasonably common for taxpayers to file objections to
assessments based on their own returns. This is routinely done, for example,
if a taxpayer wishes to preserve the potential right of appeal while the
Minister deals with a request to allow a deduction that the taxpayer simply
forgot to claim. Alternatively, a taxpayer might choose to assert a
controversial claim for the first time in a notice of objection because a
negative outcome at that stage will not result in tax liability. Many such
claims could be considered fairly without a complete audit.
[Emphasis added.]
[92]
Here, the Appellant is using the appeal process
to claim a deduction under subparagraph 20(1)(l)(i) or 20(1)(p)(i)
of the ITA that was implicitly reflected in his filing position as explained in
the letter accompanying his 2009 T1 income tax return. If, as stated in Imperial
Oil Limited, a taxpayer can use the appeal process to claim a deduction not
initially claimed, then it must be that the Appellant can use the appeal
process to clarify a filing position that was identified in general terms when
he filed the return.
[93]
For the foregoing reasons, the Appeal is allowed
with costs to the Appellant and the reassessment is referred back to the
Minister of National Revenue for reconsideration and reassessment on the basis
that the Appellant is entitled to deduct $137,500.00 under subparagraph 20(1)(p)(i)
of the ITA in computing his income for the 2009 taxation year.
Signed at Ottawa, Canada, this 16th day of June 2015.
“J.R. Owen”
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