Date: 19980506
Docket: 96-2222-IT-G
BETWEEN:
MARCEL BEAUDRY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Rip, J.T.C.C.
[1] The issues in these appeals by Marcel Beaudry from income
tax assessments for 1982 and 1983 are whether the debt that was
bad was a business loss or a business investment loss and whether
the debt became bad in 1982 or 1983. Mr. Beaudry also appealed
from an income tax assessment for 1981 but this appeal was
withdrawn at trial and is therefore dismissed.
[2] Marcel Beaudry is a lawyer who has practised law in the
Outaouais region of Quebec for approximately 25 years. He has
also participated in numerous ventures over the years. Mr.
Beaudry recalled his involvement in at least 33 corporations
from the early 1960s to date of trial. Although some corporations
did not hold real estate - one carried on a restaurant business,
for example, - the bulk of the corporations did hold real estate.
Mr. Beaudry also holds, or held, interests in real estate in his
own name, either as a partner, or co-owner or joint venturer. Mr.
Beaudry was not in the business of lending money; he recalled
only two occasions when he made loans.
[3] Real estate owned by Mr. Beaudry in his personal capacity
or otherwise or in a corporation was held as capital (investment)
property and property for resale (inventory). For example, Mr.
Beaudry held interests in investment properties, residential and
commercial, including a hotel, in his own right as a co-owner or
partner. Most corporations in which he owned shares acquired land
for resale, including condominium development, but may have owned
investment property as well.
[4] The purchase of real estate was usually financed by money
borrowed from a bank. Mr. Beaudry personally guaranteed any loans
made to a corporation. Of course, he was personally liable for
loans made to non-corporate entities. He expected to earn income
from the corporations, no matter what their activity, by
receiving dividends, salary or bonus.
[5] On October 28, 1971 Mr. Beaudry along with three other
persons, Messrs. Maurice Marois, Roger Lachapelle and Pierre
Crevier, caused Les Investissements Mirage Inc.
(“Mirage”) to be incorporated for the purpose of
buying and selling land. In 1978 Mr. Crevier transferred his
shares in Mirage to the other three shareholders so thereafter
each of the appellant, Lachapelle and Marois held 16 2/3 of the
50 issued shares of Mirage.
[6] Mr. Beaudry took an active role in running Mirage, serving
as a director and officer. However all decisions regarding the
acquisition or sale of land by Mirage required the consent of all
the shareholders.
[7] Starting in November 1972, Mirage acquired land in about
ten transactions. Mirage purchased most of the lots as to a 100%
interest but also acquired some lots with others. The aggregate
cost of all the land was approximately $2,000,000, which was
financed by loans secured by hypothecs and bank loans from the
Bank of Montreal. The loans from the bank were guaranteed jointly
and severally by Mirage’s three shareholders.
[8] Mirage’s fiscal year terminated on October 31.
[9] Due to poor market conditions in the mid to late 1970s,
Mirage had some difficulty disposing of its land. Two parcels of
land were repossessed by hypothecary creditors. Another was
expropriated. Mirage experienced net losses on its land sales,
which were reported as business losses for tax purposes and
assessed by such by the Minister of National Revenue
("Minister"). It appears that profitable sales in
earlier years were reported as business income.
[10] By 1982, apparently due to high interest rates and a fall
in land values, Mirage was indebted to its bank in the amount of
$1,803,000. Mirage did not have sufficient assets to pay the
interest on the bank loan and the shareholders advanced funds for
this purpose.
[11] Mr. Beaudry and the two other shareholders attempted to
negotiate a settlement with the Bank of Montreal by having Mirage
surrender its land to the bank in exchange for the debt. The Bank
of Montreal rejected the proposal, insisting the shareholders
honour their guarantees. The shareholders finally settled with
the bank in 1992 as follows: Mr. Lachapelle would assume
responsibility for $450,000 of the debt and the other two
shareholders would be personally liable for the balance. In turn,
the shareholders were subrogated to the rights of the bank.
[12] In October 1982 Mirage transferred a one-third interest
in its lands to a corporation owned by Mr. Lachapelle and the
balance to Messrs. Beaudry and Marois. The land was transferred
at its then estimated fair market value, $1,870,000; the cost of
the land on the books of Mirage was $2,407,631. Mirage's loss
on the sales was $537,631. After the transfers of land took place
Mirage had no realizable assets and ceased all business
activity.
[13] Following the transfers of property to its shareholders,
Mirage was indebted to its shareholders in the amount of
$575,758.[1] Total
assets reported on Mirage’s balance sheet as at October 31,
1982 was $162,894. According to Mr. Beaudry the assets had
no real value: an amount of $21,593 due from an affiliated
company was not payable since the debtor had no assets; equity in
a partnership (sometimes referred to as the “Terre
Chevrette partnership”) having a book value of $132,457 was
similarly worthless and the partners have yet to realize anything
from the partnership. Mr. Beaudry said he knows nothing about the
third asset, a receivable from an investment.
[14] The interests in the lands transferred by Mirage to
Messrs. Beaudry and Marois were held by them as co-owners under
the style “Développment Terrains Beaudry et
Marois” (“Développement”). An income
statement for November and December 1982 was prepared to reflect
the debt and assets transferred as of October 31, 1982. The
statement shows a loss of $33,940 for the two months.
[15] The appellant says that at the end of the 1982 calendar
year it was inactive, had no realizable assets and its shares had
no value. Mirage owed its shareholders $575,758 as at October 31,
1982. Mr. Beaudry's share of the debt was $194,242. Mr.
Beaudry's view at the time was that Mirage would never be
able to repay any of the debt to its shareholders. The debt was
bad in 1982. Therefore, in computing his income for 1982, Mr.
Beaudry the amount of $194,242 as a bad debt.[2] In his view, the debt arose in
the course of business and therefore all of the debt was
deductible as a business loss. The Minister reassessed the
appellant for 1982 by disallowing the business loss. One of the
reasons the Minister considered the debt not to be bad in 1982
was that in calendar year 1983 Mirage paid dividends of $149,486.
In assessing the appellant for 1983, however, the Minister
considered the debt to have become bad in 1983 but was a capital
loss. Mr. Beaudry was permitted to deduct the amount of $97,121
(50% of the loss) as an allowable business investment loss.
[16] The Minister says Mr. Beaudry’s loans to Mirage
were of a capital nature. He did not acquire shares in Mirage for
the purpose of disposing of them at a profit. He was not in the
business of lending money or making guarantees. Mr. Beaudry
never received consideration for guaranteeing a loan for a
corporation or anyone else. The appellant intended to make money
from Mirage by receiving dividends, salaries, bonuses or other
benefits from that corporation.
[17] Mr. Gaétan Lafleur testified on behalf of the
appellant. Mr. Lafleur is an Appeals Officer with Revenue Canada
who reviewed the assessments in issue after the appellant filed
the appropriate notices of objection. Mr. Lafleur stated, among
other things, that according to the balance sheet of Mirage as at
October 31, 1982, Mirage held $160,000 of assets and
therefore the Minister's officials considered that not all of
the debt owing to the shareholders was bad on December 31,
1982.
[18] Mr. Lafleur also referred to paragraph 10 of Revenue
Canada Interpretation Bulletin No. IT-159R3[3], to defend Revenue Canada’s
position that a taxpayer may claim a capital loss on a debt owing
to that taxpayer only when all of the debt is bad.
[19] Mr. Lafleur also confirmed that Revenue Canada permitted
Mr. Lachapelle to deduct in 1982 his portion of the
shareholders' advances to Mirage since at the time Mr.
Lachapelle was no longer a shareholder, officer or director of
Mirage.[4] Mr.
Lafleur also stated that the shareholders' loan account of
Mirage for the period ending October 31, 1983 showed activity
with respect to Messrs. Marois and Beaudry.
[20] Also testifying on behalf of the appellant was Mr. Daniel
Amyotte, a chartered accountant with the accounting firm of
Levesque, Marchand. Mr. Amyotte did not prepare the
financial statements of Mirage for 1981, 1982 and 1983. They were
prepared by Mr. Ronald Belisle, C.A. who died in 1991. Mr.
Amyotte had reviewed the working papers of Mr. Belisle to make
himself knowledgeable so as to testify at the hearing of this
appeal.
[21] Mr. Amyotte testified that according to the working
papers of Mr. Belisle Mirage continued to hold its interest in
the Terre Charette partnership during November and December 1982.
During this time Mirage incurred expenses with respect to the
partnership in the amount of $8,744. (This is confirmed by
Mirage’s income statement for its 1983 fiscal year.)
[22] Mr. Amyotte was unable to determine from Mr.
Belisle’s working papers the reason Mirage continued to
show three assets, the Terre Charette partnership, advance to an
affiliated company and receivable from investment, on its books
as of October 31, 1982. He supposed it was because the assets
were not income producing. The Terre Charette partnership, he
said, could have been transferred out of Mirage “anytime
between November 1, 1982 and December 31, 1982” and thus
would still appear in an October 31, 1983 statement. Mr. Amyotte
believes that as of January 1, 1983 all assets had been
transferred from Mirage to Développement.
[23] Note 1 to the financial statements of
Développement for the two months ending December 31, 1983
described the various real estate properties acquired from Mirage
in 1982. Note 3 refers to the Bank of Montreal hypothec on lands
acquired from Mirage and assumed by Messrs. Beaudry and
Marois.
[24] Mirage did have expenses for the fiscal period ending
October 31, 1983. Some of the expenses, Mr. Amyotte explained,
were interest and bank charges and professional fees that
“could have been expenses that went over the full fiscal
year of the company, say from November 1 to October 31”. He
added “[e]ven if income stops, there are still expenses to
be incurred”. While Mr. Amyotte was of the view that as of
December 31, 1982 all properties of Mirage, except for the Terre
Charette partnership interest, and its debt had been transferred
to Développement, he was not too sure when the Terre
Charette partnership interest was transferred.
[25] In cross-examination, Mr. Amyotte, after reviewing pages
14 and 15 of Exhibit A-23, agreed with respondent’s counsel
that a journal entry dated March 1983 indicates that the
equity in the Terre Charette partnership was transferred out of
Mirage in March 1983 and at January 1, 1983 the partnership was
an asset of Mirage. Or, as he informed appellant’s counsel,
the transfer of the partnership may have been entered in his
firm’s file on March 1983.
[26] With respect to activity in the shareholders' loan
account of Mirage, Mr. Amyotte’s explanation was
simple: his review indicated that notwithstanding that
Mirage’s bank was advised to close the company’s
account as of October 31, 1982, “or somewhere before
October 31, 1982”, the bank had not followed those
instructions and transactions were recorded in the bank account.
Mr. Amyotte stated that these transactions affected only the
shareholders because there was no asset left in Mirage. All the
amounts that are shown on the Loan Account went through
Mirage’s bank account but actually belonged to the
shareholders, he concluded.
[27] The balance sheet of Mirage as of October 31, 1982
reflects a liability to shareholders in the amount of $575,758.
Appellant’s counsel led Mr. Amyotte through several
financial statements of Mirage for 1983 to explain the reduction
in the amount due to shareholders from $575,758 to nil at the end
of 1983. The amount due to an affiliated company ($21,593) and
the interest in Terre Charette partnership and other investments
in Mirage’s balance sheet as at October 31, 1982 ($141,301)
were written off. Mirage also incurred a loss of $13,358 in its
1983 fiscal year, and the loss was deducted from the total
amounts ($162,894) written off for a balance of $149,486. In the
meantime, assets had been transferred to shareholders and
compensating entries were made for balance sheet purposes.
[28] To prevent the value of any benefit being added to the
income of the shareholders due to the transfer of assets, Mr.
Amyotte said, the amount of $149,486 was included in income of
the shareholders as a dividend. The dividend was equal to the net
value of the assets transferred to the shareholders less the
expenses and the loss for the year from the Terre Charette
partnership.
[29] Rather than treating the $149,486 as a dividend Mr.
Amyotte conceded the transaction could have been structured
differently. However, he concluded that the dividend route was
“the best means of transferring the assets and charging, at
least for tax purposes, the amount equal to the value of the
assets”.
[30] In cross-examination, Mr. Amyotte agreed with
respondent’s counsel that “the way” Messrs.
Beaudry and Marois paid Mirage for the Terre Charette partnership
interest was “by declaring a dividend”. Mr. Amyotte
and respondent’s counsel agreed the dividend was
“paid” in Mirage’s 1983 fiscal year and in
calendar year 1983. Respondent’s counsel was concerned that
Mirage could not be “effectively wound down in calendar
1982” if a dividend were paid in calendar 1983. Mr. Amyotte
explained that he presumed the assets of Mirage were withdrawn
before December 31, 1982. He did not think it necessary in the
circumstances for the dividend to be paid in 1982 as well since a
dividend is not a “commercial transaction” but a
“payment to a shareholder”.
[31] In an answer to a query put by me, Mr. Amyotte agreed,
that as of October 31, 1982 Mirage had valued its assets at
the lower of cost and market value and on that day the assets may
have been realized in the amount of $162,000. Mr. Amyotte
agreed that “it is at least certain that probably the
$412,000 is not going to be paid; it’s bad”. He
agreed that $162,894[5] of the amount of $575,758 owing to shareholders was
not bad. He explained that if the loss of $575,758 had been
written off, assets would still be in Mirage “so in order
to put these assets into the hands of the shareholders, we had to
give compensation somehow, and this is the reason why the
dividend was paid because the amount of the shareholders'
loan written off is the same amount as shown on the balance as of
October 31, 1982 and has nothing to do with transactions after
that date”.
Argument
[32] Appellant’s counsel submitted that as a result of
his client’s history of personal borrowings, guaranteeing
loans, being personally liable for debt incurred by corporations
in which he was a shareholder and, finally, because Mirage was in
the business of buying and selling land for profit, Mr.
Beaudry's share of the loss of the debt Mirage owed its
shareholders was a business loss.
[33] There is a presumption that the purchase of corporate
shares constitutes a capital investment.[6] A taxpayer’s interest in a
partnership may also be presumed to be a capital asset. An
advance or outlay made by a shareholder to or on behalf of the
corporation is also generally considered to be on capital
account.[7] The
same considerations, wrote Robertson, J.A. in Easton et al. v.
The Queen et al., apply to shareholder guarantees for loans
made to corporations.[8]
[34] There are, cautioned Robertson, J.A., two recognized
exceptions to the general propositions that such losses are on
capital account:
First, the taxpayer may be able to establish that the loan was
made in the ordinary course of the taxpayer’s business. The
classic example is the taxpayer/shareholder who is in the
business of lending money or granting guarantees. ...
The second exception is ... [w]here a taxpayer holds shares in
a corporation as a trading asset and not as an investment then
any loss arising from an incidental outlay, including payment on
a guarantee, will be on income account. ...[9]
[35] A person who acquired shares in a venture in the nature
of trade may also fall in the second exception.
[36] Mr. Beaudry, it is true, has been, and continues to be,
actively involved in making investments. As a shareholder, Mr.
Beaudry may be called upon to guarantee loans undertaken by a
particular corporation. It is normal and not unusual that a
lender of money to a private corporation requires the loan be
secured, usually by the personal guarantees of the
corporation’s shareholders. A partner, of course, is liable
for liabilities of the partnership. Simply because a person makes
many investments and is required to guarantee loans made to the
investment vehicle does not turn any such investment into a
business, as appellant’s counsel suggests.
[37] The appellant was not in the business of lending money or
granting guarantees. He did not guarantee Mirage’s debt to
the bank to protect the goodwill of any business he had
undertaken. And, finally, he did not acquire Mirage’s
shares in an adventure in the nature of trade.
[38] Mr. Beaudry acquired the Mirage shares as an investment.
He guaranteed the debt in question as a shareholder of Mirage.
The guarantee was on capital account and as such the loss cannot
be deducted by the appellant in computing his income: paragraph
12(1)(b) of the Act.
[39] The appellant’s loss on the bad debt of $194,242
was a capital loss that is a business investment loss: subsection
39(1)(c).
[40] Respondent’s counsel argued that the debt of
$194,242 was not a bad debt to the appellant in 1982 because
Mirage had sufficient assets to pay a dividend in 1983. He also
submitted that since paragraph 50(1)(a) of the Act,
which provides for the deemed disposition of a bad debt for
proceeds equal to nil, refers to “a debt”, all of the
debt, and not part, must be bad in the year before it can be
recognized as bad.
[41] Paragraph 50(1)(a) provided, in part:
For the purposes of this subdivision, where
(a) a debt owing to taxpayer at the end of the taxation
year ... is established by him to have become a bad debt in the
year, ... the taxpayer shall de deemed to have disposed of the
debt ... at the end of the year ...[10]
[42] The respondent maintained that the debt referred to in
paragraph 50(1)(a) cannot be partitioned in any way and
that the whole debt must be bad before it could be recognized as
bad. Section 20 of the Act, her counsel declared, refers
to ongoing trade debts which are different in character from the
debt referred to in section 50. Section 20 also refers to
“debts”.
[43] It is clear that in 1982 the appellant would never
recover the debt as a whole. It is up to the taxpayer to
establish when a debt, whether on capital or income account, is
bad. If the taxpayer reasonably determines that he or she will
not recover the debt as a whole then it is bad at that time. The
taxpayer must objectively determine on reasonable grounds that
the debt is bad or not. The question is not an objective test
which allows the Minister to question the appellant’s
business judgment. In the case of a debt that is capital, if the
taxpayer makes an incorrect determination and all or a portion of
the debt is recovered then, since the adjusted cost base is nil,
he will pay tax in the year of recovery.
[44] In Hogan v. M.N.R., 56 DTC 183, the Tax Appeal
Board considered what is bad debt, albeit with respect to the
predecessor of paragraph 20(1)(p), at p. 193:
For the purposes of the Income Tax Act, therefore, a
bad debt may be designated as the whole or a portion of a debt
which the creditor, after having personally considered the
relevant factors mentioned above in so far as they are applicable
to each particular debt, honestly and reasonably determines to be
uncollectable at the end of the fiscal year when the
determination is required to be made, notwithstanding that
subsequent events may transpire under which the debt, or any
portion of it, may in fact be collected. The person making the
determination should be the creditor himself (or his or its
employee), who is personally thoroughly conversant with the facts
and circumstances surrounding not only each particular debt but
also, where possible, each individual debtor (although this
latter requirement would be unlikely, for example, in the case of
a mail order department debt where reliance would most likely
have to be placed on credit reports or other documentary
information or on the opinions of third parties).
As already stated, I am of the opinion that this taxpayer,
after consideration of the various factors known at that time or
foreseeable in the immediate future, did reach an honest and
reasonable conclusion that $3,190.17 of his accounts receivable
were bad debts on the date of the sale of his sole proprietorship
business to the new company.
Respondent’s counsel contended, also, that an account
receivable could not be partially bad and partially doubtful, or
even partially bad and partially collectable. I have stated above
the circumstances given by the appellant in respect of at least
one account which he felt was partially bad and partially
recoverable. Other examples were given by the appellant in the
course of his evidence, and I am satisfied that an account
receivable may be considered to be partially bad and partially
recoverable in certain circumstances, which may vary in each
case.
[45] The Board’s decision was followed recently by this
Court in Granby v. M.N.R., 89 DTC 456. Lamarre Proulx,
T.C.C.J. agreed that it is the taxpayer’s determination
that is important and also found that bad debts could be
partitioned among years under subsection 50(1). More recently the
Federal Court of Appeal approved of Archambault, T.C.C.J.’s
reliance on the passage cited in Hogan: see Flexi-Coil
Ltd. v. The Queen, 96 DTC 6350.
[46] When Mr. Lachapelle claimed his portion of the debt due
to shareholders by Mirage was bad in 1982, Revenue Canada
correctly accepted his decision. Their dispute was whether the
loss was on capital or income account.[11] It was suggested that Revenue
Canada accepted Mr. Lachapelle’s claim of bad debt in 1982
because he was no longer a shareholder of Mirage but disallowed
Mr. Beaudry’s claim for the same year since he was
still a shareholder. I do not understand the Minister’s
reasons for his decision. The nature of the debts by Mirage to
both Mr. Beaudry and Mr. Lachapelle were similar. If there were
sufficient assets in Mirage, then those assets were available to
all the creditors, including both Mr. Beaudry and
Mr. Lachapelle. There was no evidence that Mr. Beaudry
participated in a decision of directors of Mirage that he would
be paid and Mr. Lachapelle would not be paid. Also, I fail to
appreciate why, in the circumstances at bar, a
non-shareholder is in a better position to make a decision
that a debt is bad than a shareholder, in particular if the
shareholder is an officer and director of the corporation. A
director of a corporation would normally have much more
information available to him or her to make such a decision than
someone outside the corporation. It made no difference to Mirage
whether or not Mr. Beaudry was a shareholder. The debt was bad to
Mr. Lachapelle and it was also bad to Mr. Beaudry.
[47] It is for the taxpayer to determine when a debt is bad
and it was reasonable for Mr. Beaudry to have found the debt in
this case to have become bad in 1982.
[48] The appeals for 1982 and 1983 shall be allowed with costs
on the basis that in 1982 the appellant incurred a business
investment loss of $194,242; the assessment for 1983 will be
adjusted accordingly and the Minister shall, in so assessing,
apply any credits available to Mr. Beaudry that may be carried
back to 1983.
Signed at Ottawa, Canada, this 6th day of May 1998.
"Gerald J. Rip"
J.T.C.C.
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