Wolf v. MNR, 92 DTC 1858, [1992] 2 CTC 2231 (TCC)

Rip, T.C.C.J.:—George M. Wolf ("Wolf") appealed his income tax assessments for 1983 and 1984 on the basis the Minister of National Revenue ("Minister"), the respondent, erred in including in his income for each of 1983 and 1984 the amounts of $491.22 and $3,667 respectively as a benefit pursuant to section 80.4 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the "Act"). At the opening of trial the respondent's counsel advised the parties agreed that if I find Wolf is deemed to have received a benefit in 1984, the amount of the benefit be reduced to $2,098.

During the years in appeal the appellant Wolf was the sole shareholder of Wolf Leather Goods Ltd. ("Holdco") and Holdco owned all the common shares of Ottawa Leather Goods Ltd. ("Ottawa"). Wolf owned all the issued preferred shares of Ottawa.

The appellant was, and is, an officer and employee of Ottawa and an officer of Holdco. He received a salary from Ottawa. From time to time Wolf would withdraw funds from the two corporations. Most of the money Wolf withdrew was from Ottawa. In the years at issue, when the funds were advanced by Ottawa to Wolf, Holdco was indebted to Wolf, Ottawa was indebted to Holdco and, as a result of the withdrawals, Wolf became indebted to Ottawa.

Wolf testified that the funds he withdrew were "part and parcel of money" owed to him. He said he considered the funds in Holdco and Ottawa as "the same pot”. He assumed that if he withdrew money from either corporation there would be an offsetting of loans between him and the corporations.

The appellant stated that in 1983 and 1984, if one considers the corporate loans to and from shareholders as a single unit, he owed nothing to the companies as a group. In his view his withdrawals from Ottawa were to be recorded in the relevant corporation's books as a reduction of amount Ottawa owed Holdco and correspondingly, a reduction in the amount Holdco owed Wolf.

Wolf testified that the bulk of the amounts for which funds were withdrawn was to pay personal expenses charged on his credit card. Advances were taken out of Ottawa because that corporation had cash at the time”. Holdco's assets were invested.

The corporations' auditor, E. Deans Berry ("Berry"), described the various amounts owing to Wolf by Holdco at the end of its 1983 to 1986 fiscal years inclusive, and to Holdco by Ottawa at the end of Ottawa's 1982 to 1985 fiscal ears inclusive. He also produced copies of several pages of Ottawa's general ledger recording the amounts withdrawn by Wolf during 1982 to 1987. According to the general ledger a credit balance existed in Wolf's account at the end of 1981 and 1982 but the account was in a debit position at December 1983, the end of Ottawa's 1983 fiscal period, and again at the end of Ottawa's 1984 fiscal period.

The general ledger reflected all withdrawals by Wolf from Ottawa, except for salary. Usually at the end of each year, Berry explained, journal entries would be made to credit Wolf's account with Ottawa and debit the amount Ottawa owed to Holdco. In Holdco's books, Wolf's account was debited and Ottawa's account was credited. In Berry's words, entries were "prepared each year to set off amounts in the group”.

No adjustments were made in Wolf's loan account with Ottawa for the end of 1983, Berry declared. However the adjustments were shown in the financial statements of Ottawa for its 1983 fiscal period and Holdco for its 1984 fiscal period. The omission in 1983 was corrected in Ottawa's books on December 31, 1984.

In other words, Wolf's drawings, not including salary, from Ottawa in 1983 totalled $15,610.86 and in 1984 totalled $26,078.07. At the end of its 1983 and 1984 fiscal years Ottawa was in debt to Holdco. At the end of Holdco's 1984 and 1985 fiscal years, it was in debt to Wolf. The financial statements of both corporations (that of 1983 for Ottawa and 1984 for Holdco) reflect that the amount of Ottawa's debt to Holdco, and Holdco's debt to Wolf was reduced by $15,610.86, the amount of Wolf's advances from Ottawa in 1983. However, as stated previously, Wolf's drawings account in Ottawa was not adjusted at the end of 1983. The adjustment was made as of December 31, 1984 when his drawings account in Ottawa was debited by the aggregate of his drawings for 1984 and 1983. The accounts between Holdco and Ottawa and Wolf and Holdco were adjusted also to reflect his drawings in 1983 and 1984. The assets and liabilities in the financial statements of Ottawa, for 1984, and Holdco, for 1985, reflect the adjustments between the companies, themselves and Wolf, as they did for the previous years.

Berry testified that"as duties of accountant my duty is to make sure books should be kept properly . . . to make sure . . . Wolf could withdraw money when he wants it . . . .” Berry declared he could have charged each draw to Holdco and have Holdco charge the withdrawal against Wolf's account. In fact, Berry insisted, he was doing the same thing. He said he did not consider it necessary to do a“ gyration" of transfers between Holdco and Ottawa.

Revenue Canada assessed Wolf under section 80.4 for the period of time moneys, other than salary, were advanced to him or on his behalf by Ottawa up to the time adjustments were made on December 31, 1984. In other words, Revenue Canada assessed interest for the time the drawings account was in a debit balance for a period in each year. Revenue Canada did not recognize any adjustment to the account in 1983, although a reader of the financial statements would assume such adjustments had been made. The debit account at the end of 1983 was carried over by Revenue Canada to 1984.

The appellant's agent, Mr. Donald Scott, C.A., a partner of Mr. Berry, submitted, as I understand it, that since there was only one individual shareholder in the corporate group, no restrictions should be put on withdrawals to Wolf so long as his accounts in the corporate group do not show a debit balance. He suggested that accounts between the two corporations themselves and between each of them and Wolf are subject to continuous "set-off" without the necessity of reducing to writing the agreement to set-off the debts. He relied on the Tax Court decision of Docherty v. M.N.R., [1991] 1 C.T.C. 2409, 91 D.T.C. 537, where, at page 2412 (D.T.C. 539), Brulé, T.C.C.J. analyzed case law on set-off and added that [l]n the administration of a small corporation, it often occurs that decisions be [sic] made without registration of any records. Often, like in business, no written agreement between parties occurs .. .” Brulé, T.C.C.J. referred to Massey-Ferguson Ltd. v. The Queen, [1977] C.T.C. 6, 77 D.T.C. 5013, at page 13 (D.T.C. 5017).

Brulé, T.C.C.J. emphasized that where a third party, such as the respondent, is concerned more formality may be required.

The respondent's position is that Wolf received the advances from Ottawa by virtue of his office or employment and is therefore deemed by subsection 80.4(1) to have received a benefit in 1983 and 1984 in an amount equal to the interest on the advances computed at the prescribed rate on each such advance for the period in each year durin which the advance was outstanding. No interest was paid by Wolf on the advances.

Halsbury's Laws of England (4th ed., Vol. 42, page 240, paragraph 405) offers the following example of set-off:

Where A has a claim for a sum of money against B and B has a cross-claim for a sum of money against A such that B is, to the extent of his cross-claim, entitled to be absolved from payment of A's claim, and to plead his cross-claim as a defence to an action by A for the enforcement of his claim, then B is said to have a right of set-off against A to the extent of his cross-claim.

A right of set-off applies only against cross demands which are connected with each other. There must be mutual debts due between the same parties and in the same right: Richards v. Bank of B.N.A. (1901), 8 B.C.R. 209 at page 213.

There is no question that if one consolidates the accounts of Holdco and Ottawa, Wolf is a creditor and not a borrower. However, the accounts are those of three distinct parties, Holdco, Ottawa and Wolf, and each party has a different legal relationship with the other. Wolf is creditor of Holdco but debtor of Ottawa, Ottawa is creditor of Wolf but debtor of Holdco. There were no mutual debts due between any two of these parties which could be said to cause set-off to apply. In Gannon v. M.N.R., [1988] 1 C.T.C. 2422, 88 D.T.C. 1282, it was held that automatic set-off between two parties will prevail only when the accounts of debit and credit are connected. Bonner, T.C.C.J. held there was no authority to support the appellant's position that mutual debts could not coexist ana that in all cases where they arose a set-off was automatically effected. Some independent action was required to adjust the accounts to the extent of the advances made by Ottawa to Wolf.

The Federal Court-Trial Division considered the appeal of Tick v. M.N.R., [1972] C.T.C. 137, 72 D.T.C. 6135. The appellant owned five corporations. He was indebted to four corporations but the fifth corporation owed the appellant an amount greater than the aggregate he owed the other corporations. Thus, he claimed, he was an overall creditor rather than a debtor and the loans he owed to the four corporations should not be included in his income as deemed dividends: [subsection 8(2), now subsection 15(2)].

Heald, J., at page 141 (D.T.C. 6139), stated:

I cannot agree with this submission. I have to look at the relationship between the appellant and each of the four corporations whom, the respondent alleges, “loaned” money to him. I cannot look at a fifth corporation to whom he may have loaned money. Nor can I treat these transactions as only involving one company or "one pot" as the appellant seeks to do.

In the case at bar, debts were not due between the same parties, specifically Wolf and Ottawa. There is no right of set-off with respect to the advances by Ottawa to Wolf and any amount Holdco may owe Wolf.

Subsection 80.4(1) declares interest on a loan or debt shall be computed on each such loan or debt for the period in the year during which it was outstanding. Any adjustment of debt or loan in the books of account at the end of a financial period does not make disappear the existence of the debt or loan for the time during which it was outstanding, that is, from the date of the advance to the date of adjustment. An accountant's end of year adjusting entry is not a magic potion that eliminates previous events. An adjustment may be in order but only takes effect from the time it is made. A transaction may have legal consequences and no accountant's handiwork can nullify, ab initio, either the transaction or its legal consequences. Thus an officer or employee of a corporation is deemed to have received a benefit during the period in the year the debt or loan was outstanding, notwithstanding any subsequent adjustment in the books of the corporation to nullify the debt or loan.

On the facts of this appeal, there was no set-off at any time. Ottawa advanced funds to Wolf either directly or indirectly, making payments on his behalf, and once an advance was made a debt was outstanding from Wolf to Ottawa. No adjustment was made in 1983; the only adjustment made was on December 31, 1984 when Wolf's indebtedness for advances in 1983 and 1984 was reduced to nil. The financial statements of Ottawa for 1983 and Holdco for 1984 reflected an informal arrangement that in reality had not taken place.

The appeal for 1983 is dismissed and the appeal for 1984 is allowed only to reduce the benefit to $2,098, the amount agreed by the parties.

Appeal dismissed.