Denthor Developments Ltd. v. The Queen, 97 DTC 667, [1997] 1 CTC 2075 (TCC)

Beaubier J.T.C.C.: - At the opening of the hearing counsel for both parties agreed that all matters in these appeals had been settled except that contained in an Agreed Statement of Facts which they filed. They also agreed that the Court is to determine the issue remaining in respect to the appeal of Denthor Developments Ltd. and the appeal of Nilsson Livestock Ltd. will be settled based upon that.

The Agreed Statement of Facts reads:

The parties hereto, admit the following facts provided that such admission is made for the purpose of this Appeal only and may not be used against either party on any other occasion or by any other party.

1. At all times material to these appeals, Denthor Developments Ltd. (“Denthor”) and Nilsson Livestock Ltd. (“Nilsson”) were corporations duly incorporated according to the laws for the time being in force in Alberta.

2. At all times material to these appeals, Denthor was carrying on the business of purchasing land and developing same and selling the land at a profit as its main source of income.

3. In the course of its business activities, Denthor borrowed funds from the Toronto Dominion Bank (“TD Bank”). The use and applications of the funds aforesaid were as set out in the document marked as Exhibit A hereto.

4. At all times material to this appeal, Denthor was in debt to the TD Bank in respect of money borrowed by it from time to time for the purposes of its business of purchasing land, developing it and selling it at a profit.

5. The land purchased as aforesaid constituted the inventory of land held by Denthor for development and sale as aforesaid.

6. The TD Bank had from time to time loaned money to Nilsson.

7. The money borrowed from time to time by Denthor was secured in the manner set out in the document styled “Schedule of Securities in Detail” dated February 2, 1981 and issued by the TD Bank and attached hereto as Exhibit B.

8. From 1988 to 1990 the shareholders of Denthor were as follows:

As at March 31, 1988: Bill Nilsson & Allan Gerlach: 50% each

As at June 30, 1988: Bill Nilsson & Allan Gerlach: 50% each

As at March 31, 1989: Bill Nilsson & Nilsson Livestock Ltd.: 50% each

As at March 31, 1990: Nilsson Livestock Ltd.: 100%

9. Denthor and Nilsson were unable to pay TD Bank the debt owed by each of them to it. TD Bank demanded payment of the said loans on June 6, 1983. Being desirous of avoiding legal actions by the TD Bank in respect of their respective borrowings, they entered into a joint Settlement Agreement dated March 31, 1987. The lands of Denthor, subject to the aforesaid mortgages to the TD Bank at the time of the aforesaid Settlement, are set out in the Schedule “A” of Exhibit C hereto.

10. By the aforesaid Settlement Agreement it was, inter alia, agreed that on the payment of the sum of $2,000,000.00, the TD Bank would release and discharge Denthor and Nilsson and Mr. Bill Nilsson in respect of all amounts due and owing to it at that time and discharge the respective mortgages and other securities. The aforesaid Settlement Agreement, dated March 31, 1987, is attached hereto as Exhibit C.

11. Of the settlement sum of $2,000,000.00, the sum of $1,000,000.00 was in respect of the borrowing of Denthor and the balance in respect of the borrowing of Nilsson.

12. The amount due and owing to the TD Bank from Denthor as at March 31, 1987, as principal and interest, in respect of the aforesaid mortgages was $2,194,152.00.

13. Pursuant to the aforesaid Settlement Agreement, Denthor paid the TD Bank the total sum of 1,000,000.00 and the Bank forgave and released Denthor in respect of the sum of $ 1,194,152.00.

14. Denthor treated the gain of $1,195,152.00 pursuant to section 80 of the Income Tax Act (the “Act”) (being the total of the debt forgiven by the TD Bank of $1,194,152.00 and the debt forgiven by Nilsson of $1,000.00) and allocated it in respect of the year ended 31.3.1988 as follows:

Loans forgiven in the year by the TD Bank: $1,195,152.00 Allocated as follows:

Reduce Non capital Loss carried forward: $ 579,451.00

Reduce ACB of investments in affiliated companies: $ 81,633.00 Not allocated and therefore lost: $ 534,068.00

TOTAL: $1,195,152.00

15. Denthor also applied the provisions of section 80 of the Act in calculating its non- capital losses and cost amount of assets in computing its income for its taxation year ended March 31, 1987, with respect to the settlement of the debt of $1,000.00 owed by it to Nilsson.

16. Denthor was wound-up into its shareholder corporation, Nilsson, on or about June 30, 1990, and non-capital losses and net capital losses carried forward by Denthor were transferred to Nilsson pursuant to the provisions of the Act.

17. The Corporate Registry of Alberta issued a Certificate of Intent to dissolve in respect of Denthor dated June 14, 1990. On June 30, 1990 a Special Resolution of the Directors and the Shareholders of Denthor was unanimously passed causing the voluntary winding up of Denthor pursuant to the provisions of section 204 of the erta Business Corporations Act The Special Resolution further directed that the assets of the company be distributed in accordance with the plan of distribution attached to the Resolution. The Special Resolution aforementioned further directed that the property of Denthor be distributed to Nilsson. Denthor was accordingly dissolved and the property distributed to Nilsson.

DENTHOR DEVELOPMENTS LTD.
ID BANK ortgages
			—		Operating Line…					Clyde ortgage —			—
DATE			Advances			Int	Balance	Land		Dey Costs Int	Sales		Balance
	7/29/82						132,964						9,000	18,288
	3/29/83						132,964					14,000		4,288
	3/29						132,964							4,288
	10/4						132,964							4,288
	10/5						132,964							4,288
	4/15						132,964			(4,000)				288
	9/6/84						132,964							288
							132,964							288
	unreconciled
	Subtotal		1,000,00			32,964	132,964		0	93,323	10,965	104,000		288
	3/82					17,428	150,392				5,229			5,516
	3/83					16,697	167,090				3,173			8,689
	3/84					0	167,090				2,437			11,125
	3/85
	3/86					12,488	179,577
	3/87
			100,00			19,571	179.577		Q	93.323	21.803	104,000		5
							Banhead Mortgage
						Dey Costs Int		Sales
					Land				Balance
										9,000	1,016,333
										9,000	1,007,333
										'5,000	1,002,333
							(9,000)			9,000	984,333
								14,000			998,333
											998,333
								68,000		1,066,333
										1.066,333
										471	1,065,862
						366,569597,474206,611			104,792	1,065,862
									170,452	1,236,314
									180,130	1,416,444
									147,975	1,564,419
									162,549	1,726,968
									137,248		1,864,216
									140,233	2,004,449
						366,569597,4741,145,198			104,792 2.004.449
Summary of TD Bank Mortgages
								Notes
			Dev.					1 )	3 separate debts @ TD Bank; operating, Clyde A Barrhead projects
	aad		Costs		int	Sales	Balance	2)	Separate morigage security was registered for each debt by TD Bank.
								Personal and corporate guarantees of Nilsson Livestock Ltd & Denthor
Line of								were also given.
Credit	100,000	79,577					179,577	3)	As mortgage loan approvals were exceeded new blanket mortgages
								were registered by TD Bank.
								4)	TD bank mortgage balances increased by payments for land purchases,
Clyde	0	93,323		21,803		104,000	11,125	developments costs and Interest related to projects.
								5)	TD Bank mortage balances were reduced by proceeds from sales of lots.
								6)	Funds were not advanced from Nilsson Livestock Ltd. to Denthor because
Barrhead 366.569		597.474 1145198				104.792	2.004.449	it was a 50% joint venture project with A. Gertach, an unrelated third party.
								7)	Denthor's only business (1979-1987) was real estate sales A development
								and related activities.
Balance per Accounting Records - General Ledger							2,195,152
Settlement Amount								1.000.000
								1.000.000
Debt Forgiven								1.195.152
								1.195-152

As can be seen from Exhibit A to the Agreed Statement of Facts, over $1,000,000 of the $2,195,152 was interest. Much of that interest was arrears which, under normal lending agreements, becomes principal which is added to the then outstanding principal, whereupon interest in the succeeding period is calculated on the total sum. Exhibit C to the Agreed Statement of Facts, the “Settlement Agreement”, did not break the

“Settlement Funds” down into principal or interest or into any other amounts. It was a lump sum settlement and the amount extinguished or forgiven was also treated as a lump sum without any breakdown. Indeed, the “Final Release” (Schedule G to Exhibit C) does not even refer to any amount released; it merely describes the consideration paid for the release.

Appellants’ counsel stated that the issue before the Court is: Whether section 80 of the Income Tax Act applies to the release of liability in an arm’s length lender-borrower relationship (not being a trade creditor relationship and with no prior deduction of an amount relating to the borrowed funds settled)?

Respondent’s counsel stated that the issue is: Whether there is a profit under section 9 of the Income Tax Act if money is borrowed and used in an income activity and any amount of it is forgiven?

Section 80 of the Income Tax Act describes particular circumstances in which it is to apply. In filing its income tax returns and claiming as it did, the Appellant followed the order set out in subsection 80(1), which read in part as follows for the year in question:

80(1) Where at any time in a taxation year a debt or other obligation of a taxpayer to pay an amount is settled or extinguished after 1971 without any payment by him or by the payment of an amount less than the principal amount of the debt or obligation, as the case may be, the amount by which the lesser of the principal amount thereof and the amount for which the obligation was issued by the taxpayer exceeds the amount so paid, if any, shall be applied

(a) to reduce, in the following order, the taxpayer’s

(i) non-capital losses,

(i.l)farm losses,

(ii) net capital losses, and

(iii) restricted farm losses,

for preceding taxation years, to the extent of the amount of those losses that would otherwise be deductible in computing the taxpayer’s taxable income for the year or a subsequent year, and

(b) to the extent that the excess exceeds the portion thereof required to be applied as provided in paragraph (a) to reduce in prescribed manner the capital coast to the taxpayer of any depreciable property and the adjusted cost base to him of any capital property,

unless

(f) the excess is otherwise required to be included in computing his income for the year or a preceding taxation year or to be deducted in computing the capital cost to him of any depreciable property, the adjusted cost base to him of any capital property or the cost amount to him of any other property,

The $1,195,152 is the excess described in paragraph 80(l)(f). On the evidence before the Court the only source Denthor had from which it could obtain income was land. Subsection 80(1) specifically makes the amount of Denthor’s debt in excess of the $1,000,000 it paid apply to reduce the losses enumerated in paragraph (a). Any amount remaining must be used to reduce the items of capital cost described in paragraph (b).

Paragraph 80(1 )(f) overrides paragraphs 80(1 )(a) and (b) only if, to paraphrase paragraph 80(1 )(f), the $1,195,152 is otherwise required (that is, required by some other provision of the Income Tax Act):

(a) to be included in Denthor’s income for 1987 or the preceding taxation year, or

(b) to be deducted in computing -

(i) the capital cost to Denthor of any depreciable property,

(ii) the adjusted cost base to Denthor of any capital property, or

(iii) the cost amount to Denthor of any other property.

At the material time Denthor’s debt related exclusively to its business of acquiring, developing and selling land. In this regard, subsection 18(2) of the Income Tax Act provides that in circumstances where land is held primarily for development or resale, the amount of any interest expense relating to the acquisition of land which can be claimed for tax purposes in a year cannot exceed the revenue obtained from the property for that year.

Denthor’s business consisted of the acquiring, developing and reselling of land. There are no proceeds from the sale of land and no business profit within the terms of subsection 9(1) of the Act can occur unless and until land is sold. Denthor could not use any interest expense, except upon making sales of land. Paragraph 80(1 )(f) did not apply to the Appellant in 1987 because the excess was not required to be included in Denthor’s income by any provision of the Income Tax Act. The excess would only have to be included in income if the forgiveness of the debt was in respect of an expense that was deductible in computing income for tax purposes that year. That was not the case in this instance.

The appeal is allowed.

The parties are to appear before the Court at 9:15 a.m. on October 11, 1996, at Edmonton, Alberta to speak to the matter of Nilsson Livestock Ltd.

V. R..

Denthor is awarded its party and party costs.

Appeal allowed.

1997-01-30