Haynes v. The Queen, 94 DTC 1906, [1995] 1 CTC 2515 (TCC)

Margeson J.T.C.C.:-

Facts

The Minister reassessed the appellant for his 1985 taxation year by adding to his income $66,587 as a shareholder’s loan pursuant to subsection 15(2) of the Income Tax Act, R.S.C. 1985 (5th Supp.), c. 1 (the "Act").

The Minister reassessed the appellant for his 1986 taxation year by adding to his income the sum of $117,728 as a shareholder’s benefit conferred upon the appellant in the year and added $37,781 to his income as a shareholder loan under subsection 15(2) of the Act. The Minister had deducted repayment on the loan of $103,115 after the sale of the first residence.

The appellant in his notice of appeal, took the position that the amount of $66,587 advanced in 1985, the $200,000 and $10,000 advanced in 1986 constituted housing loans made by the company to enable him to purchase a dwelling and were exempt under subsection 15(2) of the Act, that the $11,707 was an automobile loan from the company and the sum of $9,136 was a loan to purchase various home appliances, for which bona fide arrangements were made at the time of the loans for their repayment within a reasonable amount of time and that the said amounts should not be included in income in the years assessed.

At the time of trial, the appellant conceded that he was properly assessed with respect to the $66,587 in 1985. The appellant also conceded that he was properly assessed with respect to the $11,707 and $9,136 in 1986 and with respect to $27,781 of the $37,781 added to his income in 1986.

The appellant took the position that the remaining $10,000 of the $37,781 advance was part of his housing loan by way of the deposit paid on the purchase of his dwelling and that the $200,000 advanced to him was the remainder of the housing loan.

Appellant’s position

The appellant, Charles Haynes, testified that he was engaged in electronic research and incorporated Haynes Research Corporation in 1984. In 1985, he incorporated Fuji Overseas Marketing Inc. ("Fuji") and C.H. Architecture Shop Ltd. ("CHAS") in 1979. He was a sole shareholder, director and officer of these companies. The companies had other employees, consultants and bookkeepers and the projects were audited.

The appellant said that he borrowed the funds in question from Haynes Research Corporation to purchase a larger house. He said he heard about the possibility of taking out this housing loan from his company from lawyers and accountants. He entered into an interim agreement to buy 1125 Groveland Court in West Vancouver for $210,000. He advised his lawyer about this loan and talked to other friends, a business associate and the real estate agent as to the source of the funds. He also said that he made arrangements for repayment although they were not in writing. As he put it, ’’the arrangements were between me and me. It was the biggest thing in my life and it was not to be forgotten".

The appellant was also concerned about the loan in the event that something happened between him and his wife and so entered into an agreement with her which was referred to as a marriage contract. This agreement was signed on March 25, 1986. Title to the property was taken in both names as tenants in common, 99/ 100th as to the wife and 1/ 100th as to the husband.

The Sutherland property, so-called, was sold and $103,115 of the proceeds were paid to Haynes Research Corporation. The appellant said that he told the bookkeeper in the summer of 1986 that the proceeds of the sale were to go to the Haynes Research Corporation account and he should have been aware of all of the circumstances surrounding this transaction.

The appellant acknowledged that the withdrawal of the funds was recorded as an expense to Fuji and the repayment recorded as "income". His explanation was that the bookkeeper must have thought that the funds represented commission cheques as there were many transactions taking place at that time and the business was very active. His bookkeeper at that time was a student. The appellant became aware of the entries after discussing it with Revenue Canada.

The appellant decided to get the advice of a chartered accountant in 1986 as he was not sure his records were being kept properly. He believed he would have advised the chartered accountant that he had a loan that was repayable from the proceeds of the sale of the Sutherland property and the balance to be repaid over 25 years.

Mr. Huntley Gordon, a chartered accountant, advised the appellant that 25 years was too long a repayment term and that 15 years would be more acceptable to Revenue Canada. The repayment terms were changed to 15 years.

The balance sheet and journal entries of Haynes Research Corporation referred to the advance as a housing loan receivable and the journal entries show repayment amounts.

The appellant stated that the loan had been completely repaid at the time of the trial.

The witness admitted that there was a discrepancy in the 1986 balance sheet of Haynes Research Corporation of around $100,000 with respect to shareholders’ loans. This was attributed to an error of his bookkeeper who was a fifth year student. He said he held off filing the document until 1988.

In cross-examination, the appellant admitted that there was no evidence in writing regarding the alleged housing loan and there were no company minutes supporting it. The appellant was asked if he did not think this was important and he said, "yes, it was so important I thought it was done". He agreed that the only way to show the business of an incorporated body was through its minutes and resolutions.

The appellant could not explain the mistaken characterization of the loan repayment as income except to say that his bookkeeper made a mistake and must have felt so because of the amount of activity in the account at that time.

With respect to the discrepancy of $100,000 in the loan account, the appellant said he left it up to the accountants to do what was correct.

He said he took all the books and records to Mr. Gordon and told him the advance was supposed to be a housing loan. "Mr. Gordon suggested that we pass a resolution or something like that. This was not done as I felt it was after the fact." The appellant admitted that there was no interest payable on the advance.

Mr. Huntley Gordon was a chartered accountant who knew the appellant since 1986. In preparing his financial statements for Haynes Research Corporation, he made use of internal documents of the corporation and information provided to him. He saw no loan documents but he talked to Mr. Haynes about the alleged housing loan. This witness indicated that a mortgage was available at that time from a bank amortized over 25 years. He prepared the 1987 and 1988 financial statements.

In cross-examination, the witness said that he saw no paper work on the loans and was not told there were other shareholder loans. He relied on information given by Mr. Haynes in earlier financial statements.

Mr. Conrad Swanson was a real estate agent who dealt with the appellant with respect to the purchase of the new house. He discussed with the appellant the source of his funds to buy the new house and was told that the appellant was going to borrow the whole amount from his company and would make partial repayment from the proceeds of sale of the Sutherland property.

Mr. Richard Carrington was a commercial artist who rented an office from the appellant in North Vancouver. He discussed with the appellant the purchase of the new house and went to visit it. He was told that Mr. Haynes was going to borrow money from his company. He understood that it was to be a shareholder’s loan and that the borrower had 25 years to pay it back.

Mrs. Joanne Gaucher was the wife of Mr. Haynes at the time of the purchase of the new house. She said that they needed a bigger house. She said she was told that the new house would be mortgaged to the company. The proceeds of sale from the Sutherland house would be paid to the company and the rest would be paid back over 25 years. She felt that 25 years was a normal amortization period for a mortgage. She said she signed an agreement to make the proceeds of the Sutherland property payable against the mortgage.

In cross-examination she said that she made no agreement with Haynes Research Corporation. The mortgage on the Sutherland property was paid off from money received from Haynes Research Corporation. She said she obtained independent legal advice before signing the marriage contract. She was told that she would have nothing if the marriage broke down as the house was mortgaged.

The Minister called no evidence.

Appellant’s argument

Counsel for the appellant argued that the amounts in issue were received by the appellant as a housing loan under subparagraph 15(2)(a)(ii) of the Act and need not be included in income. He referred to the case of The Queen v. Silden, [1993] 2 C.T.C. 123, 93 D.T.C. 5362 (F.C.A.), at page 125 (D.T.C. 5364). He said further that the agreement need not be in writing under the relevant provisions of the Act.

He referred to Massey-Ferguson Ltd. v. The Queen, [1977] C.T.C. 6, 77 D.T.C. 5013 (F.C.A.), at page 11 (D.T.C. 5016) for the proposition that there need not be a formal contract but that an agreement can be inferred from evidence of conversations, letters, memoranda, accounting records, financial statements and corporate minutes.

Counsel argued that interest was not a factor in determining if there was a loan or if it was a housing loan. He referred to Cooper v. M.N.R., [1989] 1 C.T.C. 66, 88 D.T.C. 6525 (F.C.T.D.), at page 81 (D.T.C. 6535), and Perlingieri v. M.N.R., [1993] 1 C.T.C. 2137, 93 D.T.C. 158 (T.C.C.), at page 2139 (D.T.C. 160).

Counsel said that Mr. Haynes and all of the witnesses referred to the borrowing as a housing loan. The appellant’s wife referred to it as a housing loan, Mr. Richardson, Mr. Swanson and Mr. Gordon said they were told it was a housing loan, the financial statements in 1987 and 1988 referred to it as a housing loan, the journal entries referred to it as a housing loan as well as the other financial statements.

Counsel argued that arrangements were made to repay the loan within a reasonable period of time and it was being repaid.

Counsel submitted that the evidence established on a balance of probabilities that it was a loan and not an appropriation as the Minister determined in his assessment. Further, counsel argued that if I should find it was a loan then the Minister has the burden of establishing that no arrangements were made to repay it within a reasonable period of time.

Counsel submitted that no such burden has been met and that the appeal should be allowed.

Respondent's argument

Counsel for the respondent argued that the main issue was whether or not there was a loan. If there was no loan than it was a benefit or an appropriation and was properly assessed. Further, the Minister was prepared to admit that if it was a loan, it was a housing loan according to the evidence and was exempt under subsection 15(2) of the Act.

Counsel argued that there was no evidence in writing of the loan but conceded there need not be. However, if there is no evidence in writing, then there is a heavy onus on the appellant to show that there was a loan, merely making statements to other persons that there was a loan is not sufficient.

Counsel argued that the exhibits produced by the appellant did not show the existence of a loan. The appellant thought the $280,330 figure shown in Exhibit A-l owing to Fuji included the $200,000 amount. The outstanding balance of the shareholder’s loan for 1986 was shown in the documents as $104,360 which was the balance of the loan on the first residence.

When $103,115 was received from the sale of the first house it was recorded as income by Haynes Research Corporation. As of February 28, 1986, Fuji recorded the amount of $280,330 as an amount owing to Haynes Research Corporation and Haynes Research Corporation recorded the amount as a receivable from Fuji. Payments were made by Haynes Research Corporation on behalf of Fuji to Maitland & Co. for the purchase of the house and a further sum to Kin Ken Holdings for the purchase of the automobile. In 1986, CHAS and Haynes Research Corporation purchased appliances for the appellant.

Counsel argued that the loans are referred to as shareholder’s loans before 1987 and are referred to as housing loans after that period, the 1987 statements were compiled on the basis of information provided to Mr. Gordon by internal documents of the company and from the appellant. Counsel said that the appellant himself was confused as to what the statements meant.

There was over $100,000 in advances to the appellant which were unaccounted for. Counsel said that there might have been a housing loan set up in 1987 and the appellant may have intended to set up one in 1986 but he had not done so. Counsel argued that the appellant is bound by the accounting treatment given to the various items and he cannot argue that because of so-called errors that the items should be treated differently. It is not what the taxpayer might have done but what he did that is important (see Washington v. M.N.R., [1990] 1 C.T.C. 2033, 89 D.T.C. 684 (T.C.C.) and Groeneveld v. M.N.R., [1990] 1 C.T.C. 2314, 90 D.T.C. 1211 (T.C.C.), at page 2316 (D.T.C. 1213)).

Counsel cited Wright v. M.N.R., [1986] 1 C.T.C. 2581, 86 D.T.C. 1415 (T.C.C.), at page 2590 (D.T.C. 1421) as authority for the proposition that where a corporation is involved as one of the parties to a purported loan, formality must be more strictly followed. Further, counsel referred to Neudorf v. R., [1975] C.T.C. 192, 75 D.T.C. 5213 (F.C.T.D.), at page 196 (D.T.C. 5215), where Heald J. said:

It is my further view that since one of the parties to the arrangement was a corporation, there is more formality required (such as corporate resolutions, for example) than in the case of individuals and particularly where the details of a

relationship are important as against third persons such as the Revenue.

Counsel argued that where there are no resolutions covering the transaction that special circumstances must be shown as to why the resolution was not passed (see Dunlop v. M.N.R., [1991] 2 C.T.C. 2246, 91 D.T.C. 948 (T.C.C.) at page 2252 (D.T.C. 952). Counsel submitted that the appeal should be dismissed.

In reply, counsel for the appellant argued that the real issue is whether or not there was a loan. He submitted that the evidence showed there was a reasonable effort to repay the moneys.

Analysis and decision

Both parties ultimately agreed that the real issue was whether or not there was a loan, if I should find there was a loan then it was a shareholder’s loan and the burden would be on the Minister to show that bona fide arrangements were not made to repay the loan within a reasonable period of time.

This result comes about because of the fact that the Minister’s assessment was based upon facts supporting an appropriation rather than a loan. Since the Minister argues alternatively that if there was a loan then bona fide arrangements were not made to repay it within a reasonable period of time, the burden in that regard is on the Minister (see M.N.R. v. Pillsbury Holding Ltd., [1964] C.T.C. 294, 64 D.T.C. 5184 (Ex. Ct.), at page 294 (D.T.C. 5184)).

There was very little evidence submitted on the issue of "bona fide arrangements for repayment" and if I had to decide the case on that point, the party having the burden would certainly fail.

However, that issue does not arise unless I find that there was a loan in existence between the appellant and Haynes Research Corporation and between Fuji, CHAS and the appellant. The burden of proving the existence of such a loan is on the appellant. This burden has not been met.

The evidence presented before the Court is more consistent with an appropriation rather than a loan.

The appellant was an educated and sophisticated person, he was familiar with corporations, he had accounting and legal advice, he must have been familiar with the requirement to keep company minutes and resolutions so that one who needed to know would know what was going on in the corporations. The amounts involved were considerable and it is almost inconceivable that a loan of this magnitude would be taken out without more documentation than existed here.

I am satisfied that there need not be an agreement in writing but where there is not, as in this case, there must be cogent evidence presented to satisfy the Court that there was a loan and as to the terms of that loan.

It is not sufficient to merely state that there was a loan in existence and then to repeat that statement to a number of other parties. Saying it does not make it so.

An important factor here is the manner in which the various amounts were treated by the appellant and the corporations. There were not corporate resolutions setting out the loan or the terms of its repayment. There was confusion from the financial statements as to what amounts constituted the so-called "housing loan" and the other purported shareholder loans and their proper balances. The repayment of the proceeds received from the sale of the first house was recorded as income and not a loan repayment. Several payments were made on account of the appellant directly from the corporations and not to the appellant from the corporations and then from the appellant to the payee as one would expect if there was a true loan situation.

It would have been a simple matter for the appellant and the corporations to have documented the fact that there was a housing loan and what were the terms of that loan. If it was a loan it would have received the same treatment in the corporations’ financial statements from the beginning and would have been so characterized, so also would the repayments on the loan.

There were advances to the appellant to the extent of approximately $100,000 which were unaccounted for. Mr. Richard Harrington was called by the appellant and referred to the loan as a shareholder loan rather than a housing loan, and it is no answer to suggest that he used the term because he was unsophisticated. It is not sufficient to suggest that inappropriate treatment was given to the corporations’ financial records by the bookkeeper because he was a fifth year student and not a chartered accountant. None of the witnesses corroborated in any material way the declared intention of the appellant that he was arranging a housing loan with the corporations. The evidence of Mr. Gordon the chartered accountant was that most of his information about the corporations’ business came from internal corporate documents and information from the appellant himself. He did not see any source documents.

The appellant himself was aware of errors in the corporate records, or at least would have been aware of improper treatment given to the documents by his own bookkeeper, but did nothing about it.

I do not accede to the argument of counsel for the appellant that I should infer an agreement from the evidence presented and I conclude that there was no such agreement. The fact the payments are now being made or that the whole amount has been repaid does not alter this conclusion. The Court is satisfied that the amounts in question were the subject of an appropriation and not a loan. The appeal is dismissed and the Minister’s assessment confirmed.

Appeal dismissed.