Hrga v. R., 97 DTC 5165, [1997] 2 CTC 172 (FCTD)

Jerome A.CJ.:

This appeal by the plaintiff came on for hearing before me at London, Ontario on April 18, 1996 and November 27, 1996. At issue is whether the plaintiff appropriated, to his benefit, the property of Interconserv Inc. and, if so, whether the value of that benefit should have been included in the computation of his income for the 1986 and 1987 taxation years by the Minister of National Revenue pursuant to subsection 15(1) of the Income Tax Act, R.S.C. 1952, c. 148, as amended. At trial, the parties withdrew as an issue the entitlement of the plaintiff, Interconserv Inc. (“Interconserv”) to claim a capital loss and to benefit from the “small business deduction”.

BACKGROUND

The plaintiff, Mr. Hrga, is a resident of Lambeth, Ontario and has carried on business in the automotive parts industry. He is the sole beneficial shareholder of Interconserv. Interconserv owned sixty per cent of the issued and outstanding shares in the capital stock of Concept Marketing Services Inc. (“Concept”). Under a debenture, Concept convenanted to pay Victoria & Grey Trust Company $350,000.00, which Victoria & Grey had loaned to Concept. The plaintiff signed this debenture as guarantor. In 1986, the plaintiff was called upon to honour the guarantee.

The plaintiff’s tax returns did not include the transaction in the calculation of income. The plaintiff received a notice of re-assessment, dated August 8, 1989, for the taxation years 1986 and 1987 indicating that the money paid by Interconserv to Mr. Hrga was considered to be funds or property that was appropriated to a taxpayer in those years and which, by virtue of paragraph 15(l)(b) of the Income Tax Act, should have been included in computing his income. As a result, the Minister of National Revenue included in the plaintiff’s income the sum of $145,698.00 (being related to the guarantee) and $3,813.00 (being the amount paid in legal fees in relation to the guarantee). The plaintiff filed a Notice of Objection on September 21, 1989 on the basis that it was factually incorrect for the Minister to attribute the money as being appropriated by the taxpayer given the true nature of the transaction. The Minister confirmed the re-assessment by Notification dated May 17, 1990.

The plaintiff now appeals the decision of the Minister on the basis that he did not receive any personal benefit from the transaction and that the Minister misapplied section 15 of the Income Tax Act given the pith and substance of the transaction.

The plaintiff submits that he had an indemnity agreement with Intercon- serv whereby he would be compensated and saved harmless in respect of any liability which he incurred under the guarantee. The plaintiff states that Mr. Hrga acted in his personal capacity to secure the operating capital requirements of Concept and thereby benefit his corporation Interconserv. It is stated that the plaintiff stood to lose personally by providing the guarantee, but for the fact that the true beneficiary, Interconserv, agreed to indemnify him. The plaintiff submits that my reasoning in Toma v. Her Majesty the Queen (1994), 93 F.T.R. 177 (T.D.) [appeal to the Federal Court of Appeal discontinued] should be applied to the circumstances of this case as in substance, similar to the situation in Toma, the funds had not been received by the plaintiff in such a manner as to benefit him personally.

The defendant submits that the payments to the plaintiff constituted an appropriation of funds or property of Interconserv to or for the plaintiff’s benefit and that a benefit or advantage was conferred on the plaintiff within the meaning of subsection 15(1). The defendant states that the debenture was signed by Mr. Hrga without qualification and that there was no resolution by the board of directors of Interconserv pertaining to Mr. Hrga acting as an agent for Interconserv or being indemnified by it. The defendant submits that Toma is distinguishable on a factual basis as in that case there was no indication that the lender would only provide funds to the operating mind of the company in his personal capacity. Here, Victoria & Grey clearly required Mr. Hrga’s personal guarantee in order to advance the funds to Concept.

ANALYSIS

The relevant portions of subsection 15(1) of the Income Tax Act state: s. 15(1) Where in a taxation year

(b) funds or property of a corporation have been appropriated in any manner whatever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation,

the amount or value thereof shall, except to the extent that it is deemed to be a dividend by section 84, be included in computing the income of the shareholder for the year.

My reasons in Toma provide the general framework for approaching a case pertaining to subsection 15(1):

The Supreme Court of Canada in decisions such as Stubart Investments Ltd. v. Minister of National Revenue, [1984] 1 S.C.R. 536; 53 N.R. 241; Johns- Manville Canada Inc. v. Minister of National Revenue, [1985] 2 S.C.R. 46; 60 N.R. 244 and Bronfman (Phyllis Barbara) Trust v. Minister of National Revenue, [1987] 1 S.C.R. 32; 71 N.R. 134; 87 D.T.C. 5059, makes it clear that the Court may ascertain the true commercial and practical nature of the taxpayer’s transaction to avoid a slavish application of the text of the law in a way that defies common sense and logic.

In a recent decision (Penny v. Minister of National Revenue, (1994), 89 F.T.R. 66 (T.D.)), Madame Justice Simpson, when commenting on the interpretation of s. 15(l)(b) of the Act stated that while the word “appropriate” does not necessarily require a formal documented taking, it does require intention on behalf of the taxpayer and cannot be inadvertent, (at 180)

It is clear that section 15 requires two things: a benefit to the taxpayer and an intentional taking. In Toma, the taxpayer personally looked after a situation where his companies were in peril and, once produce from his business had been delivered to Allstate, he considered the matter to be closed and forgot about it. As often happens, it was his accountants, one year later, who discovered the transaction and required more detailed information in order to file returns on behalf of both limited companies.

The similarity between Mr. Hrga’s case and that of Toma arises from the fact that the Concept loan could not have been arranged without Mr. Hrga’s personal guarantee. The difference between the two cases is that Mr. Hrga took one further step, to put in place an indemnity from Interconserv, a corporation which he also controlled. Since Mr. Hrga gave his personal guarantee, but if called upon was to be indemnified by Interconserv, his exposure was different from that of Mr. Toma. In my view, Mr. Hrga could do no worse than break even. But, I cannot find that he stood to make a benefit. Therefore, the principle of my reasoning in Toma remains the same and is applicable.

I find the explanation of Mr. Hrga to be reasonable and credible. It was the intention of the plaintiff that while he would be personally liable as guarantor for the Concept loan, he had an independent right to be indemnified on the basis of an agreement with Interconserv. As the sole director and operating mind of Interconserv, the plaintiff was authorized to make a decision on behalf of Interconserv pertaining to the indemnity agreement. The plaintiff was acting in the best interests of the corporate bodies with which he was involved by providing his personal guarantee for the benefit of and on behalf of Interconserv.

The appeal is allowed with costs. The re-assessment is referred back to the Minister of National Revenue for reconsideration and re-assessment on the basis that the amounts of $145,698.00 and $3,813.00 should not be included in computing the appellant’s income for the 1986 and 1987 taxation years.

Appeal allowed.