Date: 20020502
Docket: 2001-3141
BETWEEN:
DONALD G. BARKER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor
Judgment
(Edited from the transcript of Reasons for
Judgment delivered orally from the Bench on March 15, 2002 at
Toronto, Ontario)
Hershfield, J.T.C.C.
[1]
This is an appeal in respect of a reassessment of the
Appellant's 1997 taxation year in which he claimed a
loss arising from the retirement of what was documented as a loan
to a company, Barker Terp Gibson Limited (which I will refer to
as "Barker Limited"). In 1997, $41,480.00 was advanced
to the company. The loan was forgiven as part of the same series
of transactions that documented it as a loan.
[2]
That amount was asserted to be a capital loss that met the
requirements of paragraph 39(1)(c) of the Income Tax
Act (the "Act"), which defines a business
investment loss from the disposition of any property. While that
paragraph goes on to narrow its application to the loss from the
disposition of certain types of capital property, namely a
certain type of share or certain type of debt, the loss so
defined must first be a capital loss as otherwise determined in
respect of the disposition of any property regardless of whether
or not it is a share or a debt. Further, for the capital loss
otherwise determined to constitute a business investment loss,
the disposition must be one to which subsection 50(1) applies
unless it is a disposition to a non-arm's length person. In
the case at bar it is not necessary to find that subsection 50(1)
applies as the disposition in question in the subject year is to
an arm's length person[1].
[3]
As to the type of property that can give rise to a business
investment loss, subparagraphs 39(1)(c)(iii) and (iv)
require that the property disposed of be a share in the capital
stock of a small business corporation or be a debt owing to the
taxpayer by a Canadian-controlled private corporation. The
further requirements relating to the bankruptcy or winding-up of
the debtor do not apply where the property disposed of is a debt
owed to the taxpayer by a Canadian-controlled private
corporation that is a small business corporation.
[4]
These are the relevant aspects of the definition of business
investment loss as prescribed by paragraph 39(1)(c) which
reads as follows:
39(1) For the purposes of this Act,
...
(c) a taxpayer's business investment
loss for a taxation year from the disposition of any property is
the amount, if any, by which the taxpayer's capital loss for
the year from a disposition after 1977
(i) to which subsection 50(1) applies, or
(ii) to a person with whom the taxpayer was
dealing at arm's length
of any property that is
(iii) a share of the capital stock of a small business
corporation, or
(iv) a debt owing to the taxpayer by a
Canadian-controlled private corporation (other than, where the
taxpayer is a corporation, a debt owing to it by a corporation
with which it does not deal at arm's length) that is
(A) a small business corporation,
(B) a bankrupt (within the meaning assigned by
subsection 128(3)) that was a small business corporation at the
time it last became a bankrupt, or
(C) a corporation referred to in section 6 of the
Winding-up Act that was insolvent (within the
meaning of that Act) and was a small business corporation at the
time a winding-up order under that Act was made in respect of the
corporation,
...
[5]
The corporation, Barker Limited, is a Canadian-controlled
private corporation, that is a small business corporation. That
Barker Limited meets the requirements of these defined terms
was not disputed by the Respondent. The issues identified by the
assumptions in the Reply are whether there was a debt owing and
if there was whether it was made for the purposes of gaining or
producing income. The principal issue was acknowledged to be the
purpose of the advance of the funds and the application of
subparagraph 40(2)(g)(ii). That sub-paragraph provides
that the taxpayer's loss will be treated as nil to the extent
that the loss arises from the disposition of a debt or other
right to receive an amount unless it was acquired for the purpose
of gaining or producing income. If the property disposed of in
the case at hand, is in fact a debt or other right to receive an
amount acquired for a non-income earning purpose,
subparagraph 40(2)(g)(ii) would be fatal to the
Appellant's claim for either a capital loss or a business
investment loss. In respect of the question as to whether the
property disposed of was a debt or right, subject to this stop
loss rule, I note that paragraph 7(h) of the Reply states an
assumption as follows:
(h)
there was no debt owing to the Appellant by a Canadian controlled
private corporation;
[6]
Since it is not an issue that Barker Limited was a
Canadian-controlled private corporation, this assumption in
the Reply confirms the Respondent's position that there was
no debt in existence that could be disposed of at a loss.
However, that there is no debt, a finding of fact that I will
deal with later in these Reasons, does not necessarily mean that
a capital loss, albeit not a business investment loss, has not
been incurred. Notwithstanding this possibility, for the
Respondent confirmed at the trial that it was the
Respondent's position that neither a capital loss nor
business investment loss had been incurred in the subject year in
respect of any disposition of any property of the Appellant. In
my view, a capital loss has been incurred and recognition of it
is required.
[7]
The Appellant was a 50% shareholder in Barker Limited. Each
shareholder guaranteed the company's line of credit and bore
unlimited liability in respect of the indebtedness to the bank,
although the Appellant's guarantee was only secured by a
collateral mortgage for $25,000.00. The company was running into
difficulty and was incurring losses. The bank line was not in
immediate jeopardy but the Appellant, who was employed by the
company, decided to call it quits. He needed out of his guarantee
and wanted to dispose of his shares. It was acknowledged that the
guarantee at this point in time had not been called.
[8]
The Appellant and the other 50% shareholder in Barker Limited
entered into a purchase and sale agreement pursuant to which the
Appellant sold his shares in Barker Limited for $1.00 and
pursuant to which the Appellant contributed his share of the
company's deficiency as a loan and forgiveness.
[9]
The accountant for Barker Limited, who testified along with
the Appellant in this matter, did year-end financial
statements for February 28, 1997, which would be the
company's year-end on the sale of the
Appellant's shares to the other 50% shareholder in this
case. The previous year-end had been April 30 but the share
sale effected a change of control on February 28 the effective
date of the purchase of shares by the other 50% shareholder and
that resulted in a change in year-end to
February 28.
[10] The
financial statements were not prepared until the end of May, and
the buyout price was determined in consultation with the
accountants at that time. The purchase and sale agreement was not
prepared until May although it was executed as of February 28,
1997. There was a deficiency or negative value attributable to
the Appellant's interest of $41,480.00 calculated in respect
of this buyout due to liabilities of the company and a deficiency
of assets. The most substantial liability (about 85% of the total
liability of the company) was the outstanding bank loan
guaranteed by the Appellant. The parties agreed that the
deficiency or negative value had to be accounted for. While there
was no evidence that the Unanimous Shareholder's Agreement
(terminated under the purchase and sale agreement) provided for
this or that there was any other pre-existing written
shareholder's agreement requiring such accounting, I accept
that same was the implicit agreement of the parties as
co-shareholders. It was an agreement between them
necessitated by the departing shareholder's obligation under
the guarantee and his need to be released from it. I accept that
this was a mutual agreement.
[11] While the
written agreement documenting the sale of the shares did not
refer to the release, there was correspondence from the bank in
March and April of the subject year that confirms that the
release had already been obtained before the agreement was
written up in May. The bank provided the release in reliance on
other guarantors (namely the other shareholder whose agreement
was required by the bank before it would release the Appellant).
I accept that the release was a precondition of the Appellant
advancing and forgiving repayment of the subject $41,480.00 which
he contributed to the company under the purchase and sale
agreement. I further accept that the release would not have been
given had not the Appellant accounted to Barker Limited for the
negative value determined by its accountant. The release was
conditional on the other shareholder's consent that was, in
turn, conditional on the Appellant accounting for the deficiency.
The guarantee pierced the corporate veil in favour of the bank
and obtaining the release effectively pierced the veil in favour
of the Appellant's co-shareholder. I accept that the mutual
agreement that effectively pierced the veil as between
shareholders created a deferred liability which was coupled to
the deferred liability arising from the personal guarantees
provided to the bank.
[12] It seems
clear then that the Appellant bought his full release from all
deferred liabilities by contributing to the company his share of
the negative value of the company. That is, he bought his release
by contributing 50% of the deficiency which share was
$41,480.00.[2]
[13] While it
is clear that the payment here was on account of a deferred
liability or loan, it was described in the purchase and sale
agreement as a loan or current advance to Barker Limited
with an immediate forgiveness, presumably in the hope of getting
the business investment loss treatment on its disposition.
However, if the transaction was in fact a current advance (loan)
then it could not be said to have been made for the purpose of
gaining or producing income which in turn would mean that the
disposition occurring on the forgiveness would be subject to the
stop loss rule in subparagraph 40(2)(g)(iii).
[14] As to
whether or not there was a current debt owing to the Appellant as
a result of the transaction as documented, I agree with the
assumption in the Reply. There was no debt created.[3]
[15] If there
was no debt, the nature of the payment has to be ascertained. It
is clear that the amount was paid by the Appellant to obtain the
release under the guarantee. It was a payment arising primarily
in respect of that deferred liability which was incurred by the
Appellant in a prior year when an income earning purpose was not
in question. A loss incurred in respect of such a deferred
liability is a capital loss but not one included within the type
of loss that qualifies for business investment loss
treatment.
[16] During
argument in this matter, the Respondent's counsel referred me
to the case of Easton v. R., 97 DTC 5464 (FCA). While the
reason for her is providing me this case is unclear, I note that
it makes reference to the case of M.N.R. v. Steer (1966),
[1967] S.C.R. 34 (S.C.C.), wherein it was held that a
guarantee given to a bank for a company's indebtedness by the
taxpayer in consideration for shares in the company was to be
treated as a deferred loan to the company and that monies paid to
discharge the indebtedness were to be treated as a capital loss.
Further, the general tenure of the Easton decision seems
to me to be clear. Unreimbursed payments by shareholders in
respect of payments arising from a guarantee, even voluntary
payments, are presumed to be on capital account unless rebutted
by facts that compel income treatment as opposed to capital
treatment. A shareholder's guarantee of the corporation's
liability is made to secure an enduring benefit in the form of
dividends or an increase in value of the share. While the benefit
relates to the shares, it is not sufficiently related to
constitute a cost of the shares. The benefit is a distinct
capital asset, and as underlined in the case at bar, has attached
rights and liabilities that go beyond those attached to the
shares themselves. Shares are a non-assessable interests.
In the case at bar, the shareholders, aside from their interests
in the shares, and in addition to the bank guarantees, have
agreed to be assessable as between the two of them. Accordingly,
there are rights and obligations between them that go beyond the
rights that attach simply to their shares. The benefit derived
from the guarantee and the assessable interest in the company
might be reflected in rights assured under a Unanimous
Shareholder's Agreement or otherwise. [4] In the case at bar, the purchase and
sale agreement, pursuant to which the $41,480.00 was contributed,
contains mutual releases of all such rights and obligations and
from all manner of actions, causes, debts, claims and the like.
There are indemnity and save harmless provisions that are
redundant in the shareholder context alone. This, together with
the termination of the Unanimous Shareholder's Agreement,
evidences that there was another intangible property, a
chose-in-action if you will, embodied in the co-shareholder
arrangement in this case in respect of which consideration was
required to be paid on its disposition. That bundle of mutual
rights and obligations is "property" having, in this
case, a negative value to each of the parties that have an
interest in it. The shareholders have, as between them, looked
through the corporate veil and created an interest, distinct from
the shares, capable of alienation between them. The contribution
to a deficit or to satisfy a deferred or contingent liability
(arising primarily from the personal guarantees to the bank) is a
cost of the disposition of this intangible property that gives
rise to a loss pursuant to the calculations set out in
subparagraph 40(1)(b)(i). That is, there is a disposition
in this case of a capital property that requires a payment that
gives rise to a loss under the Act. A building needing to
be demolished can be sold by the vendor paying the purchaser to
take it over. These are costs or outlays made for the purpose of
making the disposition and form part of the loss calculated in
subparagraph 40(1)(b)(i) which provides that the loss from
the disposition of any property includes "any outlays and
expenses incurred by the taxpayer for the purpose of making the
disposition".
[17] The
Appellant was retiring from active involvement with
Barker Limited. He was resigning as an employee and officer
and director and sold his shares. He was obliged to pay the
subject amount in order to walk from commitments that he made in
a commercial context on capital account. These commitments
constituted a deferred liability which had to be dealt with on
withdrawing from all his interests in the company including
disposing of his shares and related contractual interests. His
related contractual interests are capital property and to the
extent they have a negative value paid on disposition, such
payment is a cost of sale. The negative value was a contingent
liability that ceased to be contingent on the disassociation of
the Appellant from Barker Limited. The cost of such a
disassociation is on capital account and in this case gives rise
to a capital loss of $41,480.00. To find otherwise, not to allow
this capital loss, would be to say that this expenditure falls
into the category of a "nothing" not recognized at all
in our tax system. Yet, it is clearly not a personal expenditure.
It is a cost clearly associated with the capital side of his
investment in this company and as such he should not be denied
recognition of a loss actually incurred.
[18] I will
make a few additional comments relating to one of the other cases
referred to by Respondent's counsel, namely, The Cadillac
Fairview Corporation Limited v. The Queen, 99 DTC 5121
(F.C.A.). In that case, a parent company made payments to the
bank pursuant to a guarantee of its subsidiary's debt before
there was a demand. As I understand the case, the bank required
these payments as it would not consent to various proposals that
would leave the loan balance unpaid and secured by other parties
acquiring the subsidiary. This would suggest that the share
purchase price would have been deflated to recognize the
existence of the debt had the bank agreed to such proposals.
Instead, it seems the bank required the loans to be retired which
the parent did and the buyer then required the parent to waive or
release any subrogated claims it had against the subsidiary
arising from its payment of such liabilities of its subsidiary.
The parent claimed a capital loss in respect of the amount paid
to the bank and the Federal Court of Appeal found that no such
loss existed. It seems that that finding was based on the finding
in that case that the debt owing by the subsidiary to the parent
arising from the parent's payment of the subsidiary's
debts was not disposed of but rather enforcement rights were
waived for valuable consideration. The extrication from a
financial fiasco was the consideration and no loss should be
recognized.
[19] While
Cadillac Fairview does stand for denying losses created by
termination payments on account of contingent liabilities,
caution should, in my view, be exercised in applying it where
doing so denies recognition of actual outlays that enable the
sale of a capital asset. Recognizing capital losses created by
such outlays is a theoretically acceptable result and one
permitted by subparagraph 40(1)(b)(i) which was not
considered in Cadillac Fairview. On the facts of
Cadillac Fairview, the sections of the Act relied
on to claim the loss were found to not apply on their own terms.
Further, Cadillac Fairview is distinguishable from the
case at bar. In the case at bar, there is a distinct capital
asset existent between two shareholders who as between them had
set up a regime of rights and liabilities which were required to
be disposed of on the sale of shares by one of them. This
distinct capital asset was disposed of and the disposition
required the incurrence of expenses which gave rise to a loss
under subparagraph 40(1)(b)(i). In Cadillac
Fairview there was a finding that there was unaccounted for
consideration that offset any loss. In the case at bar, we have
an existent contractual relationship between
co-shareholders each with a contingent liability. There was
consideration that passed between them on the termination of
their contractual arrangements that offset except to the
extent of the deficiency which was accounted for and was a cost
of sale over and above the other consideration that flowed from
the termination of the Appellant's interests in these
contractual arrangements.
[20]
Accordingly, the appeal is allowed and is referred back to the
Minister on the basis that a capital property has been disposed
of and that outlays and expenses in the amount of $41,480.00, are
to be recognized as outlays and expenses made or incurred by the
Appellant for the purpose of making that disposition for the
purposes of subparagraph 40(1)(b)(i). For greater
certainty, I note that the loss so determined is not a business
investment loss.
Signed at Ottawa, Canada, this 2nd day of May 2002.
"J.E. Hershfield"
J.T.C.C.
COURT FILE
NO.:
2001-3141(IT)I
STYLE OF
CAUSE:
Donald G. Barker and
Her Majesty the Queen
PLACE OF
HEARING:
Toronto, Ontario
DATE OF
HEARING:
March 15, 2002
REASONS FOR JUDGMENT BY: The
Honourable Judge J.E. Hershfield
DATE OF
JUDGMENT:
May 2, 2002
APPEARANCES:
Agent for the
Appellant:
Cary N. Selby
Counsel for the
Respondent:
Andrea Jackett
COUNSEL OF RECORD:
For the
Appellant:
Name:
Firm:
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2001-3141(IT)I
BETWEEN:
DONALD G. BARKER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on March 15, 2002 at Toronto,
Ontario, by
the Honourable Judge J.E. Hershfield
Appearances
Agent for the
Appellant:
Cary N. Selby
Counsel for the
Respondent:
Andrea Jackett
JUDGMENT
The
appeal from the assessment made under the Income Tax Act
for the 1997 taxation year is allowed, with costs, and the
assessment is referred back to the Minister of National Revenue
for reconsideration and reassessment in accordance with the
attached Reasons for Judgment.
Signed at Ottawa, Canada, this 2nd day of May 2002.
J.T.C.C.
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