O'Blenes v. MNR, 90 DTC 1068, [1990] 1 CTC 2171 (TCC)

Garon, J.T.C.C.: — This is a case where the appellant appeals a reassessment dated December 7, 1987, in respect of the 1984 taxation year. By this reassessment, the respondent disallowed the full amount of the allowable business investment loss in the amount of $36,174 claimed by the appellant.

At all material times, the appellant's spouse Brian O'Blenes, her father-in- law, Russell O'Blenes and her brother-in-law, Peter O’Blenes, were the sole shareholders of Glenwood Developments Ltd. (“Glenwood”). The appellant's spouse owned one-third of the issued common shares of Glenwood and was vice-president of that Company. Russell O'Blenes and Peter O’Blenes were respectively president and secretary of Glenwood. The three shareholders were the sole directors of Glenwood during the relevant years. The directors of the latter company were also directors of Industrial Construction Ltd., a related company. There was also another company associated with Glenwood by the name of Industrial Excavating Ltd. but the directors of it were not the same as those of Glenwood. The appellant was neither a shareholder nor an employee of Glenwood. Glenwood was a holding company. In some of the exhibits and in the appellant's testimony reference is made to Phyllis O’Blenes who is Russell O'Blenes' wife and the appellant’s mother-in-law and to Wendy O’Blenes who is Peter O'Blenes' wife and the appellant's sister-in-law.

During 1979, the Canadian Imperial Bank of Commerce (the "Bank") requested additional security for Glenwood's operating line of credit because three individuals, who were shareholders in a company related to Glenwood, withdrew their support of Glenwood's line of credit and terminated their relationship with Glenwood and the associated company. This had the effect of freezing Glenwood's line of credit and new arrangements with the bank had to be made in order to enable Glenwood to finance its day-to-day operations.

As a consequence of the Bank's request, the appellant guaranteed payment to the Bank of the liabilities of Glenwood up to the sum of $35,000. The appellant’s guarantee dated September 12, 1979 was, at the Bank's urging, secured by a mortgage in favour of the Bank, also dated September 12,1979, on two parcels of land situate in the City of Moncton and owned by the appellant. At the time the appellant gave her guarantee in respect of Glenwood's line of credit, she did not receive from Glenwood any consideration or reward of any kind for doing so. In fact, no arrangements were worked out for compensating the appellant in respect of that undertaking before June 1981, almost two years later.

At that time, the appellant also had funds available in the form of term deposits but stated that because of some requirement of the Bank Act she could not pledge them with the Bank in respect of Glenwood's line of credit. In order to achieve the same result, the appellant, in addition to the guarantee that she had given to the Bank and the related mortgage on the two lots, withdrew at some point during 1979 those term deposits, which amounted to $68,635.73, gave that money to her husband who in turn took out term deposits in the same amount in his name and pledged them to the Bank for the purpose of assisting Glenwood in securing an appropriate line of credit with the Bank. With respect to the nature of the arrangements made by the appellant with her husband respecting the term deposits, the appellant testified that she felt that the funds made available to her husband as a result of her converting the term deposits was her money at all times. In fact, it was her uncontradicted evidence that the interest from those term deposits was deposited directly by the Bank into her own bank account.

The evidence is also clear that before June 1981, the appellant did not receive anything else from either her husband or Glenwood or any of the related companies for making available a sum of $68,635.73 in the manner set out above. It would also appear that this advance of funds by the appellant to her husband was not documented before sometime in 1981, almost two years later.

In 1981 Glenwood and related companies went through a refinancing operation with the assistance of the Federal Business Development Bank and as part of the financial arrangements the appellant asserted that the Bank gave a verbal commitment to release a debenture it held on Glenwood's assets and to release the guarantee given by the appellant and Wendy O’Blenes. Sometime later during that year the Bank refused to give up the security it had as a result of the appellant's guarantee and that of Wendy O'Blenes. The appellant then demanded of Glenwood that she be given proper documentation and security for moneys advanced through her husband to Glenwood amounting to $68,635.73 and for the guarantee in favour of Glenwood in respect of the latter company line of credit with the Bank.

As a result of these demands, a letter from Glenwood acknowledged that the advance of funds by the appellant to her husband and the pledge of those moneys to the Bank in the amount of $68,635.73 in the name of Brian O'Blenes constituted a loan to Glenwood by the appellant made with her own moneys. This letter from Glenwood to the appellant and the promissory note executed by Glenwood in favour of the appellant were not filed with the Court because the appellant was unable to locate this material. Hence the precise date of the letter and promissory note is not known but it seems clear that this documentation was issued some time in 1981, probably around June 1981. In addition, Glenwood mortgaged to the appellant and Wendy O’Blenes on June 1, 1981, five parcels of land situate in the City of Moncton in the Province of New Brunswick, together with all buildings and improvements thereon. In that indenture, it is stated that the principal money advanced on the mortgage was $190,000. The rate of interest was set out in a schedule to the agreement and was the current prime rate of the Bank plus one and one-half per cent per annum. It was also indicated in the same schedule that of the sum of $190,000 $115,000 was for the appellant's account and the remainder was for that of Wendy O'Blenes. The amount of $115,000 was arrived at, on the evidence, by adding together the $68,635.73 loan and the $35,000 guarantee and the remainder in the amount of $11,362.27 was stated to be “for the inconvenience and the provision of the loans and guarantee."

Furthermore, a couple of weeks later Glenwood issued a debenture bearing the date of June 17, 1981 in favour of the appellant and three other members of the O’Blenes family in the sum of $500,000. Clause 1 of the debenture reads as follows:

1. Glenwood Developments Ltd. (Hereinafter called "the Company") for value received, hereby acknowledges itself indebted and promises to pay to Russell O'Blenes, Phyllis O'Blenes, Judith O'Blenes and Wendy O’Blenes, as their interests may, appear, on demand, the sum of FIVE HUNDRED THOUSAND DOLLARS ($500,000.00) in lawful money of Canada, without interest.

As security for payment of the principal of the debenture, Glenwood mortgaged and charged to and in favour of the holders by way of a fixed and specific mortgage and charge “all goods, chattels and personal property situate in the Province of New Brunswick used or useful in connection with the business of the Company" listed in a schedule to the debenture and also by way of a first floating charge, “its undertaking and all its property and assets, being personal and moveable only, . . . (other than property and assets hereby validly subjected to a fixed and specific mortgage and charge)".

During 1981, the appellant received a partial payment of interest of $4,000 from Industrial Excavating Ltd. which was, in doing so, acting on behalf of Glenwood.

In early 1982, Glenwood was in a failing financial position and was not paying interest on the loans extended to the appellant. On March 18, 1982 the appellant and the three other members of the O’Blenes family, in favour of whom the debenture had been issued, after demanding payment of principal and interest on moneys owing crystallized the debenture to secure their position.

The evidence also shows that Glenwood was placed in receivership on or about March 18, 1982, in consequence of which the Bank called upon the appellant to honour her guarantee with respect to Glenwood's indebtedness to the Bank. The Bank foreclosed on the mortgage dated September 12, 1979 on the two tracts of lands owned by the appellant and sold the two lots for total proceeds of sale of $30,000. Of the amount of $68,635.73 advanced to Glenwood through her husband, as described earlier, as security against Glenwood's operating line of credit, $25,898 was applied by the Bank against Glenwood's indebtedness. As appears from the notice of appeal, the appellant computed her loss as follows:

The appellant in her written statement impliedly admitted that she was not given consideration for her guarantee provided in 1979 and that she did not acquire the debt of Glenwood for the purpose of gaining or producing income. Her reasons for taking all these steps, that is, giving a guarantee to the Bank, mortgaging for this purpose two lots that she owned and pledging, through her husband, her term deposits in support of the Glenwood's operating line of credit are well summarized in the following passage of the appellant's statement filed as Exhibit A-14:

At this point in time one might say that I was not given consideration for my guarantee and I did not acquire the debt of Glenwood for the purpose of gaining or producing income. I contend, that I did as it saved Glenwood from immediate receivership, it allowed my husband to draw a salary for approximately three more years and it allowed me time and the funds required to take my nursing reorientation so that I could go back to work if anything did happen at Glenwood and my husband could not draw a salary.

The appellant submits that she is entitled to deduct as an allowable business investment loss half of the actual loss she sustained in her efforts to support Glenwood's operative line of credit with the Bank arising out of Glenwood's failure to pay off the amount owing to the appellant.

In order to succeed, the appellant must establish that the debt owing to her by Glenwood as a result of her giving the guarantee to the Bank and her pledging the term deposits through her husband to the Bank was acquired by her for the purpose of earning or producing income from a business or property. It is not disputed that if the appellant is able to satisfy the income purpose test in respect of the acquisition of this debt, the loss sustained by the appellant would be a business investment loss within the meaning of paragraph 39(1)(c) of the Income Tax Act resulting, having regard to the particular facts of this case, from the disposition of property of a class that is described in the latter paragraph.

On the other hand, if the appellant is unable to satisfy the income purpose test with respect to the debt owing to her by Glenwood, subparagraph 40(2)(g)(ii) would be applicable with the result that the loss sustained by the appellant would be nil. Subparagraph 40(2)(g)(ii) reads as follows:

Notwithstanding subsection (1),

(g) a taxpayer's loss, if any, from the disposition of a property, to the extent that it is

(ii) a loss from the disposition of a debt or other right to receive an amount, unless the debt or right, as the case may be, was acquired by the taxpayer for the purpose of gaining or producing income from a business or property (other than exempt income) or as consideration for the disposition of capital property to a person with whom the taxpayer was dealing at arm's length,

(iii) . . .

(iv) . . .

is nil.

There is no room for doubt that when the appellant agreed in 1979 to guarantee Glenwood's line of credit with the Bank up to $35,000 no consideration or compensation was given or contemplated.

With respect to the transaction relative to her term deposits that were in the name of appellant's husband and pledged to the Bank, I agree with the position of counsel for the respondent that the proper characterization of the transaction is that the moneys representing the appellant's term deposits were given in trust to her husband who took out term deposits and applied them to Glenwood's purposes. The term deposits while in the name of the appellant's husband were always beneficially owned by the appellant. The fact that the interest on term deposits nominally held by the appellant's husband was paid directly to the appellant's account is a key factor in my view for supporting this conclusion.

With respect to the pledging of appellant's term deposits for the purpose of assisting Glenwood, the appellant again did not receive any consideration. She did not receive any reward in connection with these term deposits other than the interest to which she was entitled before giving in trust to her husband these moneys representing the proceeds resulting from her cashing in the term deposits.

On the whole of the evidence it is abundantly clear that when the appellant agreed to guarantee Glenwood's line of credit and to pledge through her husband the subject term deposits, she was not motivated by any benefit she might herself receive. Her purposes were not business purposes as far as her own situation was concerned. Family considerations played a key role. She wanted to assist Glenwood in which shareholding her husband owned a third interest. As well, that company was also at the time her husband's employer.

Subparagraph 40(1)(g)(ii) of the Act when it mentions the purpose of the acquisition of a debt refers, of course, to the creditor's purpose of earning income for her own account. The indirect advantage the appellant would derive in providing financial assistance to a company which in turn would procure a direct financial benefit to her husband is definitely too remote to meet the requirements of that subparagraph.

It has been suggested by the appellant that in 1981 as a result of the mortgage agreement dated June 1, 1981 and of the debenture of June 18, 1981, compensation was provided to the appellant. There is no question that by these two indentures the appellant would have received a significant benefit if Glenwood had been able to survive and pay off its indebtedness to the appellant. However, as pointed out by Judge Sarchuk in the case of Hugh Lowery to which case reference will be made later that the critical time at which the appellant's purpose must be examined is the time at which she gave the guarantee and pledged her term deposits. Almost two years after undertaking to assist Glenwood she moved to secure her position at the time of the refinancing of Glenwood's operations. This belated action had nothing to do with the reason why she agreed in the first place to give the guarantee and pledge her term deposits. The evidence is clear that in 1981 the appellant was not released from her guarantee given to the Bank. The mortgage and the debenture given by Glenwood were not in respect of a new guarantee provided to the Bank or a new pledge of the term deposits. There was no new injection of capital into Glenwood's business on the appellant's part.

On the whole of the evidence, I therefore come to the conclusion that the appellant has not established that when she undertook to grant the guarantee to the Bank and to pledge her term deposits she was motivated by the prospect of a financial gain or reward for herself. Her motives however commendable they are, are of a personal or private nature.

I find support for the conclusion at which I have arrived that the appellant is not entitled to deduct the capital loss in question in the approach taken by this Court in the following two cases:

Ena M. Casselman v. M.N.R., [1983] C.T.C. 2584; 83 D.T.C. 522;

Hugh Lowery v. M.N.R., [1986] 2 C.T.C. 2171; 86 D.T.C. 1649.

In the Casselman case, the facts are well summarized in the headnote of this case which reads as follows:

The taxpayer guaranteed debts owed by her son's corporation to a chartered bank. The taxpayer received only nominal consideration from the company for the loan guarantees. The taxpayer was called upon to repay the loans and she in fact did so. The taxpayer and the company then entered into written agreements whereby the company agreed to repay the taxpayer the capital portion of the loans that she had to pay plus interest at the rate of one per cent per month. The taxpayer treated her loss as a business investment loss. The Minister disallowed the deduction and the taxpayer appealed to the Tax Court of Canada.

The following passage in the judgment of Judge Tremblay shows clearly why he dismissed the taxpayer's appeal:

. . . Moreover, the risk involved in guaranteeing a debt of $50,000 can have its justification only in the quantum of the consideration when the guarantee was given. In fact, there was no quantum at all. Because of the mother-son relationship, the mother desired to help her son. That was the only motivation in this transaction. There was no business purpose, it was not done for the purpose of gaining or producing income.

Judge Sarchuk dealt with a similar situation in the case of Hugh Lowery referred to above. This was a case where the taxpayer guaranteed certain bank loans taken out by certain members of his family for the account of their business. Later on, that business failed and the taxpayer was called upon by the Bank to honour his guarantee. The following passage in the Court's judgment is of particular interest:

On the evidence adduced I am not satisfied that there was any business purpose in the granting of the guarantee. Respondent's counsel submitted, and I agree, that it is not sufficient to make a general allegation that the appellant anticipated some participation in the profits of Threads at some unstated time in the future and on that basis to argue that some consideration for the guarantee existed. There was no arrangement as to interest. There was no arrangement relative to repayment in the event of default by Threads. There was no agreement, oral or written, setting out the terms and conditions of the appellant's participation. No mechanism existed enabling the appellant to control the level of earnings to be reached by Threads before his alleged right to participate in the profits could be invoked. The appellant stated that family matters did not require written agreements. This statement however is in some measure inconsistent with the manner in which his proposed investment in Empire was secured and documented. In my view the appellant's involvement bears none of the hallmarks of a commercial or business transaction.

There is another passage in that judgment worth noting:

Although the relevant time with respect to the "purpose of earning income test" is the time at which the guarantee was given, it is proper in this case to consider as well the appellant's conduct after he was called upon to pay the debt by the bank. None of the normal commercial considerations were given to collecting the debt from the partners. Not only does this call into question the basis upon which the appellant established the debt to be a bad debt in that year but it also suggests that the risk in guaranteeing the debt had its justification only in the fact of the father/ son relationship and was not made for any business or commercial reasons.

I conclude that subparagraph 40(2)(g)(ii) of the Act is applicable in the circumstances of this case and accordingly the appeal is dismissed.

Appeal dismissed.