Beck v. MNR, 92 DTC 1784, [1992] 2 CTC 2085 (TCC)

Lamarre Proulx, T.C.C.J.:—The appellant appeals an income tax reassessment made by the respondent, the Minister of National Revenue (the"Minister") for the 1984 taxation year.

The question at issue is whether the appellant received payment of a debt owed to him by a corporation, Brenloc Canada Ltd. ("Brenloc"), in the 1984 taxation year, debt that the appellant had deducted as a bad debt in the calculation of his income for the 1983 taxation year.

At the end of the year 1983 and beginning of 1984, Brenloc had creditors for a total amount of $392,958. These creditors agreed to invest in Brenloc by taking advantage of the Ontario Small Business Development Corporations Program. This is an incentive program which repays 30 per cent of the amount invested in a small business.

In accordance with an agreement (Exhibit A-1, tab D), dated August 23, 1984 and signed by Brenloc, each of Brenloc's creditors and 561312 Ontario Ltd. (the "Corporation"), the creation of which was for the purpose of the program, the following transactions were entered into: the appellant and the other creditors borrowed money for the total amounts of the debts, that is $392,958. With these funds and some other funds which appear to be the anticipated funds from the grants, the creditors purchased 417,958 newly issued equity shares of the Corporation, for the amount of $417,958. The appellant acquired 30,731 shares for a consideration of $30,731. The Corporation subscribed 417,958 shares of Brenloc at a purchase price of $417,958. Brenloc settled the debts of each creditor at their face value and the creditors agreed that they had no claims in respect of such debts. Upon the receipt of funds from Brenloc in settlement of their debts and upon receipt of the funds paid by the Government of Ontario pursuant to the Small Business Devlopment Corporation Act, on September 5, 1984, the creditors applied such funds toward the repayment of the loans. All this generated for Brenloc, from the Small Business Development Corporations Program, liquidity in the approximate amount of $125,000.

The agreement makes it clear, at clauses 6 and 7, that there were funds received by the creditors in settlement of their debts in the amount of the face value of their debts against Brenloc. These clauses read as follows:

6. Forthwith upon and contemporaneonsly with the subscription for and payment by 561312 of the shares in BRENLOC as set forth in paragraph 5 hereof BRENLOC agrees to settle the debts set forth in Schedule “A” annexed hereto at their face value without further interest. The CREDITORS for themselves, their respective heirs, executors, successors and assigns doth by these presents, and in consideration of the allotment to them of shares in 561312 remise and release BRENLOC of and from all suits, actions, claims and demands that they have had or may have in respect of such debts.

7. Forthwith upon the receipt by the CREDITORS of funds from BRENLOC in settlement of their debts in such manner as herein provided, the CREDITORS jointly and severally agree to pay and apply such funds toward the repayment of such amounts as have been borrowed in accordance with the provisions of paragraph 3 hereof. The CREDITORS further covenant and agree that, with respect to any funds that they shall receive from the Government of Ontario pursuant to the Small Business Development Corporations Act such funds shall be paid and applied by them in repayment of such loan in such manner as herein provided.

In the year 1989, the appellant disposed of the shares of the Corporation acquired in 1984. The proceeds of dispositions were nil. The appellant, in the calculation of his income for the 1989 taxation year, included a deduction for an allowable business investment loss for the disposition of these shares.

Counsel for the appellant submits that the appellant did not receive a true payment for the debt owed to him by Brenloc. The plan followed by the creditors did not have for effect a payment of their debt but a conversion of their debt into worthless equity shares.

Counsel for the respondent submits that the payment of the debt by Brenloc should be included in the calculation of the appellant’s income pursuant to subparagraph 12(1)(i) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act") This subparagraph reads as follows:

12(1)There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:

i) Any amount received in the year on account of a debt in respect of which a deduction for bad debts had been made in computing the taxpayer's income for a previous year;

The respondent made also an alternative plea on the basis of subsection 56(2) of the Act, about which there is no need to elaborate in view of the outcome of this matter.

Both parties informed the Court that Judge Beaubier, of this Court, rendered a judgment December 3, 1990, dismissing the appeal of one of the creditors signatory to the above-mentioned agreement, in the matter of Richard M. Doris v. M.N.R.. The question at issue was the same as the one that is before the Court and Judge Beaubier concluded as follows at page 2084 (D.T.C. 289):

In the instant case, the taxpayer entered into the Agreement filed as Exhibit A-4 of his own free will and at that point, agreed to the various forms of consideration embodied in the agreement mutually with the parties. The result is that this Court finds that the bad debt declared in 1983 was paid in full satifaction to the appellant by the transaction in 1984. In particular the payment by Brenloc described in paragraph 6 of the Agreement filed as Exhibit A-4 constitutes payment of the debt to the appellant.

Counsel for the appellant argued that the decision may be distinguished on the grounds that in the Doris case, the appellant was the president of the company, had interest in its future benefits and was aware of the full meaning of the agreement, which was not the case of the appellant. He reiterated that Brenloc was on the verge of bankruptcy, there was no way that there was in it sufficient cash to pay the creditors, that the agreement was a means to keep Brenloc afloat and inject some liquidity into it, and that most of the transactions were only book entries.

I cannot agree with the argument that the agreement of August 23, 1984 should be put aside as the fact is, that, it is an agreement that is a binding agreement between the parties. It has not been denounced or repudiated by the appellant. On the contrary, in 1989, the appellant acted pursuant to the agreement and accepted it when he claimed an allowable business investment loss with respect to the disposition of shares of the corporation. He accepted that with the funds received in payment of his debt, he had reimbursed a loan that had allowed him to purchase the said shares. By this agreement the creditors agreed to participate as investors in a plan that would keep Brenloc alive and inject liquidity into it. They agreed to transform themselves from creditors to investors. They agreed that their debts against Brenloc had been fully paid and thus extinguished pursuant to clauses 6 and 7 of the agreement.

I believe that the agreement says clearly that the parties agree that the debt that the appellant had against Brenloc was paid at its face value pursuant to the agreement and that the debts were to be extinguished by payments made by Brenloc in accordance with the agreement. Though it is sad that the investment plan the parties had agreed to did not turn out well, I find appropriate the words of Mr. Justice Le Dain of the Supreme Court of Canada in Perrault v. The Queen, [1978] C.T.C. 395, 78 D.T.C. 6272, at page 403 (D.T.C. 6278):

The incidence of taxation depends on the manner in which a taxpayer arranges his affairs. Just as he may arrange them to attract as little taxation as possible, so he may unfortunately arrange them in such a manner as to attract more than is necessary.

The appeal is dismissed.

Appeal dismissed.