Liampat Holdings Ltd. v. The Queen, 96 DTC 6020, [1996] 1 CTC 343 (FCTD)

Cullen J.: This is an action by the plaintiff taxpayer, Liampat Holdings Ltd. (“the plaintiff’ or “the taxpayer”), arising out of reassessments by the defendant Minister of National Revenue (“the defendant” or “the Minister”) for the 1981 and 1982 taxation years. The Minister imputed interest income to the plaintiff under subsection 17(1) of the Income Tax Act, R.S.C. 1970-71-71, c. 63, as amended (“the Income Tax Act’) and subsection 4300(5) of the Income Tax Regulations, C.R.C. 1978, c. 945, as amended (“the Regulations”). [1]

The Agreed Statement of Facts

The parties submitted an agreed statement of facts which is reproduced below:

1. The plaintiff was incorporated on December 19, 1975 pursuant to the laws of British Columbia. Its fiscal year end is September 30 in the year.

2. At all material times Liam O’Loughlin and his wife, Joya O’Loughlin, owned 100 per cent of the issued shares of the plaintiff.

3. In its 1979, 1980, 1981, and 1982 taxation years, the plaintiff loaned to Tennis World of Seattle Inc. (“Tennis World”), a corporation which had been incorporated in the State of Washington and which was not resident in Canada at any material time, various sums of money as set out in schedule “A” hereto (hereinafter the “loan”).

4. At all material times before October 1, 1981, Liam O’Loughlin owned 1,721 voting common shares of Tennis World representing 34 per cent of that company’s issued voting shares. On October 1, 1981, Liam O’Loughlin and Joya O’Loughlin owned, between the two of them, 85 per cent of the issued voting shares of Tennis World.

5. The plaintiff did not own any shares of Tennis World. Furthermore, the plaintiff did not pay any tax on the amount of the loan under Part XIII of the Income Tax Act (hereinafter the “Act”).

6. The plaintiff and Tennis World did not sign any documents setting out the terms of the loan, a repayment schedule or the rate of interest to be paid when due.

7. The oral terms of the loan (“hereinafter called the “loan agreement”) called for Tennis World to repay the principal plus interest at a “reasonable rate” (within the meaning of subsection 17(1) of the Act as that section read in 1981 and 1982) but such interest was only payable when Tennis World could afford to pay it or when Tennis World was wound up.

8. Tennis World could not afford to pay the principal or interest on the Loan in the plaintiffs 1981 and 1982 taxation years, accordingly no interest was receivable by the plaintiff under the loan agreement in its 1981 taxation year.

9. In its 1981 and 1982 taxation years, the plaintiff received no interest from Tennis World in respect of the loan.

10. In August of 1982 Tennis World was wound up without having repaid any of the principal or interest on the loan. Accordingly, the principal and the interest payable on the loan became bad debts in the plaintiff’s 1982 taxation year.

11. The plaintiff included no accrued interest in respect of the loan in computing its income in 1981 and 1982 taxation years or in any preceding taxation year.

12. The plaintiff wrote off the outstanding principal balance of the loan as a capital loss in its 1982 return. The plaintiffs 1981 and 1982 returns are contained in the gray book.

13. The plaintiffs accountant was not aware of the obligation to accrue interest on the loan in the plaintiffs 1981 and 1982 taxation years under the Act and accordingly he did not report the accrued interest and did not take an offsetting bad debt expense pursuant to subsection 20(1 )(p) of the Act in the plaintiffs 1982 taxation return.

14. The Minister of National Revenue assessed the plaintiff on tax on the assumption that the following amounts of interest were deemed to have been received by the plaintiff in its 1981 and 1982 taxation years by virtue of subsection 17(1) of the Act:

1981: $66,983

1982: $80,313

Copies of the notices of reassessment are contained in the gray book.

15. The amounts of interest that were included in the plaintiffs income in those years pursuant to subsection 12(l)(c) of the Act represent interest on the loan at the prescribed rate computed for the period during which it was outstanding in accordance with subsection 17(1) as set out in schedule “B” hereto.

I have not reproduced Schedule A; suffice to say that the plaintiff loaned money to Tennis World totalling $669,758.00 in the period from 1979 to 1982. A later correction reduced the amount loaned by $20,000.00, bring the total amount written off in 1982 to $649,758.00. I have also not reproduced Schedule B. It is a hand-written page indicating the interest calculations for the loan.

At the beginning of the hearing before me, it was my impression and that of counsel for the plaintiff, that the only argument before the Court concerned the applicability of subsection 17(1) of the Income Tax Act. However, at the conclusion of the plaintiffs submissions, it came to the attention of counsel for the Minister that the plaintiffs 1982 assessment showed zero tax owing: a nil assessment. It was her argument that this Court had no jurisdiction over an appeal from a nil assessment. Counsel for the plaintiff, while taken by surprise, was prepared to let this point be argued despite the lack of advance notice. I will address the issue of the nil assessment and this Court’s jurisdiction first.

Nil Assessment:

There is a long line of jurisprudence that no appeal lies from a nil assessment. In Okalta Oil Ltd. v. Minister of National Revenue, [1955] S.C.R. 824, [1955] C.T.C. 271, 55 D.T.C. 1176, one of the earliest cases dealing with nil assessments, Fauteux, J., writing for the Court, observed that “assessment” meant the actual amount of tax which a taxpayer was called upon to pay. If no amount was claimed, there was no assessment and, therefore, no right of appeal. This approach was adopted In Consumers’ Gas Co. v. R. (sub nom. Consumers' Gas Co. v. The Queen), [1987] 1 C.T.C. 79, 87 D.T.C. 5008 (F.C.A), a case to which counsel for the defendant made reference. In Bowater Mersey Paper Co. v. R. (sub nom. Bowater Mersey Paper Co. v. The Queen), [1987] 2 C.T.C. 159, 87 D.T.C. 5382 (F.C.A.), another case to which counsel for the defendant directed me, Pratte, J. further observed that a right of appeal does not arise from calculations done by the Minister, but from the result of those calculations. The Court found that it was simply untrue that the rule against appealing nil assessments did not apply in cases where, in spite of the assessment, the taxpayer retained an interest in the solution of an issue relating to a prior assessment.

The case law is clear and, in my view, this Court has no jurisdiction to consider the plaintiffs 1982 nil tax assessment, even if the loss would have an effect on a subsequent loss determination. However, the taxpayer is not left without alternatives. Subsection 152(1.1) provides that a taxpayer may request that the Minister determine the amount of the taxpayer’s loss. It reads as follows:

152(1.1) Where the Minister ascertains the amount is a taxpayer’s non- capital loss, net capital loss, restricted farm loss or limited partnership loss for a taxation year and the taxpayer has not reported that amount as such a loss in his return of income for that year, the Minister shall, at the request of the taxpayer, determine, with all due dispatch, the amount of such loss and shall send a notice of determination to the person by whom the return was filed.

According to Interpretation Bulletin IT-512: Determination and Redetermination of Losses, this provision was put in place specifically to deal with situations where a taxpayer has no right of appeal because of a nil assessment. I have not found any time limitations for seeking a loss determination and counsel for the plaintiff, in his written submissions did not direct me to such a provision. Accordingly, the plaintiff will not be unfairly prejudiced by the conclusion that I am without jurisdiction to consider the appeal from the 1982 assessment on its merits.

However, counsel for the plaintiff, in written submissions forwarded after the conclusion of the oral hearing, raised two arguments in favour of this Court’s jurisdiction. First, he argued that the defendant is estopped from raising the nil assessment issue at this late stage of the proceedings because the Minister had dealt with the plaintiffs objection and appeal on the merits. Respectfully, I do not accept this argument. Counsel for the defendant, in response to the plaintiff’s written submissions, directed this Court to the case of Hagedorn v. R. (sub nom. Hagedorn v. Canada), [1993] 2 C.T.C. 3141, 95 D.T.C. 288 (T.C.C.). In this case, Christie, A.C.J.T.C. concluded that while the question of jurisdiction should have been raised in the reply, the failure to do so cannot give the Court jurisdiction if, as a matter of law, jurisdiction is otherwise lacking. I am in agreement with the opinion expressed by the learned Tax Court judge and find that counsel for the Minister is not estopped from relying on the nil assessment to preclude this Court’s jurisdiction.

In the alternative, counsel for the plaintiff submitted that the Court has jurisdiction to deal with the quantum of the bad debt in 1982 so as to carry this loss back to the 1981 taxation year. In support of this proposition, counsel directed me to the case of AAllcann Wood Suppliers Inc. v. R. (sub nom. AAllcann Wood Suppliers Inc. v. Canada), [1994] 2 C.T.C. 2079, 94 D.T.C. 1475 (T.C.C.). In Aallcann, the plaintiff claimed a capital loss in the 1988 taxation year and was seeking to carry over the loss to the 1985, 1986, 1987, and 1989 taxation years. Even though 1988 was a nil assessment year, Bowman, T.C.J. found that he had jurisdiction to hear the appeals for 1985, 1986, 1987, and 1989 and to assess the loss for 1988 since this loss was a “constituent element” of the tax owing for the years on appeal. Although I do not doubt that Aallcann advocates a sound approach, I am not satisfied that its principles are applicable to the case at bar. It is clear from paragraph 12 of the agreed statement of facts that the principal amount of the loan was claimed as a capital loss in 1982; however, in 1981, there the plaintiff did not claim capital gains. The Income Tax Act provides that a capital loss can only be offset against a capital gain. Since the plaintiff did not claim a capital gain in 1981, there would be nothing against which the capital loss for 1982 could be applied. I take Aallcann to mean that this Court has jurisdiction to consider a nil assessment year where the computations from the nil assessment year have an actual impact on another taxation year; it does not give the Court jurisdiction to consider a nil assessment directly.

However, the fact that I do not accept the plaintiffs arguments on the nil assessment issue does not excuse the Minister’s unfair approach to this appeal. As counsel for the plaintiff pointed out, the assessment was sent in 1988 and the statements of claim and defence were filed in 1989. Until the day of the hearing — indeed, until the completion of counsel for the plaintiffs submissions — the nil assessment issue was not raised. I will return to this issue later in these reasons.

Based on my conclusion regarding the appeal from the 1982 assessment, the only assessment which is properly before me is the one from the 1981 assessment. I will consider the appeal from the 1981 assessment on its merits.

The 1981 Assessment:

The Minister’s decision to include in the income of the plaintiff the amount of $66,983.00 for the 1981 taxation year rests on subsection 17(1) of the Income Tax Act. [2] In 1981, the section read as follows:

17(1) Where a corporation resident in Canada has loaned money to a nonresident person and the loan has remained outstanding for one year or longer without interest at a reasonable rate having been included in computing the lender’s income, interest thereon, computed at a prescribed rate per annum for the taxation year or part of the year during which the loan was outstanding, shall, for the purpose of computing the lender’s income, be deemed to have been received by the lender on the last day of each taxation year during all or part of which the loan has been outstanding.

[Emphasis added.]

The purpose of section 17 is to prevent a corporation that is resident in Canada from lending money to a non-resident person (which, pursuant to subsection 248(1), includes a corporation) at an artificially low interest rate or for no interest. [3] The effect of making such a loan would be to “give away” income and, hence, avoid paying Canadian tax.

Subsection 17(1) provides that where a corporation resident in Canada has loaned money to a non-resident person without interest at a reasonable rate having been included in the corporation’s income, interest at a prescribed rate shall be deemed to have been received by the corporation. While subsection 17(1) deems interest to have been received by the lender, the interest is actually included in a taxpayer’s income for the year via section 12 of the Income Tax Act. Paragraph 12(l)(c), for the taxation year in question, read 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:

(c) any amount received by the taxpayer in the year or receivable by him in the year (depending on the method regularly followed by the taxpayer in computing his profit), as, on account or in lieu of payment of, or in satisfaction of, interest.

Counsel for the plaintiff and counsel for the defendant strongly disagreed about the meaning of the phrase “deemed to have been received” in subsection 17(1). Counsel for the plaintiff argued that the phrase was ambiguous, particularly in light of the facts of this case where the taxpayer had not received and was not scheduled to receive any interest. In effect, subsection 17(1) created a mandatory accrual rule; however, in the plaintiffs 1981 taxation year, it was not required to accrue interest income. [4] Since the taxpayer was not obliged to accrue interest, counsel submitted that the deeming provision in subsection 17(1) should be read as a rebuttable presumption of fact. There is a presumption that the taxpayer had received or has receivable a reasonable rate of interest in the taxation year; however, if the taxpayer has not received and does not have receivable interest, the deeming provision should not apply. If the deeming provision did apply, it would create a mandatory accrual rule, contrary to the legislative purpose of subsection 17(1).

Counsel for the defendant, on the other hand, submitted that the issue of accrual was irrelevant. Subsection 17(1) clearly states that when three conditions precedent are met — a corporation resident in Canada has, first, loaned money to a non-resident person and, second, the loan has remained outstanding for one year or longer, and third, without interest at a reasonable rate having been included in computing the lender’s income — interest is deemed to have been received. The whole issue of accrual versus receivable interest is inconsequential; the interest is deemed to have been received, period.

As to the definition of “deem”, both counsel directed me to E.A. Driedger, Construction of Statutes, 2nd edition (Toronto: Butterworths, 1983). According to the treatise, the purpose of a deeming clause is to impose a meaning, to cause something to be different from that which it might have been in the absence of the clause. However, “to deem” could be construed as raising either a conclusive or a rebuttable presumption, depending on the context in which the word is used. In St. Leon Village Consolidated School District No. 1425 v. Ronceray (1960), 31 W.W.R. 385, 23 D.L.R. (2d) 32 (Man. C.A.), a case to which counsel for the plaintiff directed the Court, Schultz, J.A. found that in determining whether the words “deem” or “deemed” raise a conclusive or rebuttable presumption, one should bear in mind the purpose to be served by the statute and the necessity of ensuring that such purpose is served. In the case at bar, the purpose of subsection 17(1) is tax avoidance. If the word “deemed” is construed as creating only a rebuttable presumption, as the plaintiff argues, the goal of tax avoidance would be impaired. Taxpayers could order their affairs so as to make interest on loans payable at the discretion of the debtor or only when the principal amount is due, avoiding all taxation if the interest is not received. Parliament clearly did not intend such an arrangement and I do not accept that subsection 17(1) raises only a rebuttable presumption.

I accept the submissions of counsel for the defendant. The language of subsection 17(1) is patently clear: if a taxpayer meets the three conditions precedent in that provision, he is deemed to have received interest, regardless of whether that interest is actually received or even receivable. In my view, there is a straight line from subsection 17(1) to paragraph 12(1)(c). It does not matter whether the taxpayer was accruing interest or not; subsection 12(3) is not in play.

I accept that by the terms of the loan agreement between the plaintiff and Tennis World, the former neither received interest in 1981 nor was the interest actually receivable in that year. The loan agreement established the legal obligations between the creditor and the debtor; however, this agreement has no effect on the Minister of National Revenue. Subsection 17(1) of the Income Tax Act, in my view, deems a certain amount of interest to be received by the taxpayer, regardless of the actual terms of the loan agreement. The Minister, in my view, was correct in including in the income of the plaintiff for 1981 the amount of $66,983.00, representing interest on the loan to Tennis World.

The effect of the defendant's late notice on the nil assessment issue:

Having found that I am without jurisdiction to consider the nil assessment for 1982 and the Minister was correct in including interest of $66,983.00 in the plaintiff’s 1981 income calculation, the plaintiff’s appeal is dismissed. However, as I mentioned earlier, I am returning to the issue of the defendant’s failure to raise the nil assessment in a timely manner. At the hearing, the plaintiff urged that, in the event that this Court found it was without jurisdiction to hear the appeal from the 1982 assessment, there should still be some sanction against the defendant, given the undue delay.

In oral argument, the plaintiff suggested that the defendant Minister could, for example, be ordered to forgo interest on the tax payable. In support of this suggestion, the plaintiff referred the court to Wargacki v. R. (sub nom. Wargacki v. Canada), [1992] 1 C.T.C. 295, 92 D.T.C. 6336 (F.C.T.D.). The case of Wargacki concerned the 1983 taxation year and was heard by Mr. Justice Joyal from December 16 to 19, 1991; judgment was rendered on February 7, 1992. However, it subsequently came to light that on June 17, 1986, the plaintiffs had made an offer of settlement. This offer, which turned out to be identical to Joyal, J.’s findings at trial, was refused by the Minister. Between the time of the offer to settle and the date of the judgment, however, a considerable amount of interest on the tax payable accumulated. In these circumstances, Mr. Justice Joyal strongly recommended that the Minister remit the interest on the tax payable from June 17, 1986 until the date of the judgment.

I not find that Wargacki dovetails with the case at bar. Furthermore, as Tremblay, T.C.J. found in Darnell v. Minister of National Revenue (March 20, 1992), 91-2572(IT) (T.C.C.), the Court has no authority either to absolve the taxpayer from liability to pay interest on unpaid taxes, or to waive interest charges when instalments are not remitted on time. Rather, I have decided to sanction the defendant by ordering that the defendant will not be awarded costs, despite its success in this appeal.

Appeals dismissed.