[OFFICIAL
ENGLISH TRANSLATION]
Date: 20020730
Docket: 2001-910(IT)I
BETWEEN:
SAINT-RAYMOND PLYMOUTH CHRYSLER INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Garon, C.J.T.C.C.
[1] This is an appeal from an income
tax assessment by the Minister of National Revenue for the appellant's 1997
taxation year. By that assessment, the Minister disallowed a deduction of
$23,254. That amount was part of the $26,166 claimed by the appellant as a bad
debt following its sale of a vehicle to a related person,
Location Raybec inc.
[2] In making the assessment under
appeal, the Minister of National Revenue relied on the allegations set out in
paragraph 5 of the Reply to the Notice of Appeal, which reads as follows:
[TRANSLATION]
(a) The appellant is a vehicle retailing business;
(b) On January 23, 1997, the appellant sold an automobile to
Location Raybec inc. for $22,962 plus taxes, for a total price
of $26,166;
(c) Location Raybec inc. and the appellant are related
businesses for tax purposes. More specifically, the shareholders of
Location Raybec inc. are:
-
the appellant: 60%
-
Benoît Noreau's wife: 10%
- Benoît Noreau's son: 30%
(d) Because of financial difficulties,
Location Raybec inc. did not pay the appellant the amount owed
($26,166, including taxes);
(e) At September 30, 1997, which was the end of the appellant's
fiscal year, the appellant claimed a bad debt of $26,166;
(f) The appellant repurchased the same vehicle for $22,847
(including taxes) on July 21, 1997, and subsequently resold it to a third
party;
(g) On July 5, 2000, following an audit, the Minister issued a
notice of reassessment adding $23,254 to the appellant's income;
(h) That $23,254 corresponds to the difference between the bad debt
amount claimed by the appellant ($26,166) and the bad debt amount considered
allowable by the Minister ($2,912);
(i) The bad debt amount considered allowable by the Minister
($2,912) corresponds to the difference between the amount of the sale by the
appellant to Location Raybec inc. (excluding taxes), that is,
$22,962, and the amount of the subsequent purchase (excluding taxes), that is,
$20,050;
(j) At this point in the proceedings, the Minister is of the view
that no capital loss was incurred by the appellant on the “sale‑purchase”
transactions described above.
[3] The appellant's president,
Benoît Noreau, testified for the appellant. Jean‑Claude Girard
gave evidence for the respondent.
[4] The essential facts for the
purposes of this case can be summarized briefly. The appellant, which operates
a vehicle retailing business, sold an automobile to
Location Raybec inc. on January 23, 1997, for $22,962,
excluding taxes. Location Raybec inc. did not pay any of the purchase
price in cash because of the financial difficulties it had to deal with. It did
not provide any security to guarantee payment of the sale price. The
appellant's purchase of the automobile had been financed by Chrysler Credit
Ltd. The appellant repurchased the same vehicle from
Location Raybec inc. on July 21, 1997, by paying $20,050 in
cash, excluding taxes.
[5] Mr. Noreau testified that
Location Raybec inc. operated a car rental business. During the
period of nearly six months before the appellant repurchased the vehicle in
question on July 21, 1997, Location Raybec inc. did not pay
any of the sale price to the appellant because of its financial situation. The
appellant did not try to take back the automobile as a result of
Location Raybec inc.'s failure to pay the sale price. It preferred to
pay Location Raybec inc. $22,847 in cash, including taxes, when it
repurchased the automobile.
[6] Mr. Noreau also testified that
Location Raybec inc. began operating its business in
November 1996 and stopped in January 1998.
[7] Jean‑Claude Girard, an
auditor with the Canada Customs and Revenue Agency, explained how the bad debt
was calculated. That calculation served as the basis for the assessment.
Appellant's arguments
[8] It is worth reproducing some of
the comments made by the appellant's agent. Referring to June 1997, he
stated the following:
[TRANSLATION]
Certainly
I became disillusioned in June because things weren't improving too much, and I
always come back to the fact that I definitely owed that money to Chrysler
Credit.
. . .
That
I owed it was clear. Even though I repurchased the vehicle, there was no
connection . . . for me, it was to get back as much of my money
as possible that I . . . I told you earlier that I paid for the vehicle once
again. Because I paid for all the others and for that one too.
[Transcript,
page 67,
lines 4-8 and 11-16]
[9] To the following question asked
by the Court:
[TRANSLATION]
But
in that case, why didn't St‑Raymond decide to say to
Location Raybec: I'm buying back the car, you're having financial
difficulties. I'm buying back the car but I'm not paying you since you didn't
pay me in the first place?
[Transcript,
page 69,
lines 8-13]
[10] Mr. Noreau answered as follows:
[TRANSLATION]
Okay,
that could have been done. I don't pay Raybec and then, on the other hand, I
pay it an advance of $20,000, so it would have come to the same thing.
[Transcript,
page 69,
lines 14-17]
[11] Referring to
his accountant, Mr. Noreau testified as follows:
[TRANSLATION]
And
he also relied on the fact that a decision had been put in the books: bad debt,
well, not bad debt, account receivable. And on
September 30,
we knew there was nothing that could be collected any more.
[Transcript,
page 70,
lines 13-17]
[12] Dealing with paragraph 8 of
the Reply to the Notice of Appeal, Mr. Noreau made the following comments:
[TRANSLATION]
Paragraph
8 is the key issue for me, which I can't accept otherwise.
He argues that, in the context of a sale to an unrelated person, the
appellant would never have agreed to lay out money to buy back a vehicle from a
person to whom it had sold the vehicle without being paid.
That's
the big issue for them, for the Department. Except that, as I touched on
it a little earlier, if I hadn't repurchased the vehicle
or . . . I would still have had a loss with respect to Chrysler
Credit. I owed the money for that vehicle, which was not . . . Raybec
didn't pay me, whether . . .
[Transcript,
page 77,
line 21, to page 78,
line 4]
[13] Mr. Noreau referred to the fact
that, as he sees it, he acted reasonably and honestly, as shown by the
following comments:
[TRANSLATION]
Well,
we purchased the vehicle for $20,050 and resold it for $21,600, for a profit of
$1,550 minus the reconditioning expenses. And, kind of like I was saying
earlier, as long as it was in inventory, there was still a debt to Chrysler
Credit, regardless of whether it was in inventory at St‑Raymond Plymouth
Chrysler or Location Raybec. There was still a connection to the vehicle.
So I
think
I acted reasonably and honestly in the situation. That is more or less the
conclusion I want to make. Thank you.
[Transcript,
page 80,
lines 14-24]
Respondent's arguments
[14] In the Reply to the Notice of
Appeal, the respondent had relied not only on paragraph 20(1)(p)
but also on section 69 of the Income Tax Act (“the Act”) in
support of her assessment. At the hearing, counsel for the respondent did not
rely on section 69 of the Act since the respondent did not adduce
any evidence to show that the appellant had disposed of the vehicle in question
for a
consideration less than the fair market value thereof.
[15] Counsel for the respondent relied
particularly on the introductory portion of subsection 20(1) of the Act,
which states that, in computing income from a business or property, a taxpayer
is entitled to deduct “such of the following amounts as are wholly applicable
to that source or such part of the following amounts as may reasonably be
regarded as applicable thereto”. She emphasized the word “reasonably” used in
that portion of subsection 20(1) that was quoted. The respondent
challenged in particular the unreasonableness of the loss incurred by the
appellant.
[16] The respondent also referred to
section 67 of the Act, which provides as follows:
In
computing income, no deduction shall be made in respect of an outlay or expense
in respect of which any amount is otherwise deductible under this Act, except
to the extent that the outlay or expense was reasonable in the circumstances.
[17] Relying on subsection 20(1)
and section 67 of the Act, counsel for the respondent stated the
following:
[TRANSLATION]
So
the question that can be asked is whether, on September 30, 1997,
there was a debt that hadn't been collected. The facts tell us there was. But
is it reasonable to think that the amount of the debt or expense that the
per . . . that the taxpayer can take is what it is claiming,
$26,000? The answer would be no, because the taxpayer's chances of collecting
actually amounted to $20,000 plus taxes, $22,000, which is the amount for which
it repurchased the vehicle.
[Transcript, page 58,
lines 4-13]
[18] Further on, counsel for the
respondent added:
[TRANSLATION]
So what is
unreasonable in this is that the taxpayer, through transactions that were
specific to its circumstances, to its situation because the businesses were
related, that explain how this was dealt with. I agree with you, and I'll agree
with anyone who says to me: “yes, but 20(1)(p) doesn't impose any
restriction because of the non‑arm's length relationship.” The only
restriction in 20(1)(p) is the reasonableness of the transactions. This
may be coloured by a non‑arm's length relationship, whether factual or
legal, it doesn't matter . . .
by any other circumstance, which means that not only is a $25,000 bad debt
being claimed, but a $20,000 expense is also being claimed given that a $20,000
expense was obviously recorded when the vehicle was purchased. Which means
that, in the end, for a $25,000 vehicle, for $25,000 in income, a total expense
of $45,000 is being claimed.
[Transcript, page 59,
lines 5-23]
[19] Finally, in her rebuttal, counsel
for the respondent stated that [translation]
“in light of the transactions between the appellant and its subsidiary, the
possible recharacterization should be compensation, legal compensation.” She added
that the decision of the Supreme Court of Canada in Shell Canada Ltd. v.
Canada, [1999] 3 S.C.R. 622, [translation]
“would make it possible for the Department to apply compensation because the
appellant's transactions with its subsidiary did not properly reflect the
actual legal effect, which was compensation.”
Analysis
[20] The issue is whether, in
computing its business income for its 1997 taxation year, the appellant is
entitled to deduct a bad debt of $26,166 for the amount not paid by
Location Raybec inc. on the sale price (including taxes) of the
automobile purchased on January 23, 1997.
[21] The right to deduct an amount as
a bad debt is governed by paragraph 20(1)(p) of the Act,
which reads as follows:
Notwithstanding
paragraphs 18(1)(a), (b) and (h), in computing a
taxpayer's income for a taxation year from a business or property, there may be
deducted such of the following amounts as are wholly applicable to that source
or such part of the following amounts as may reasonably be regarded as
applicable thereto:
...
(p) the total of:
(i) all debts owing to the taxpayer that are established by
the taxpayer to have become bad debts in the year and that have been included
in computing the taxpayer's income for the year or a preceding taxation year,
and
(ii) all amounts each of which is that part of the
amortized cost to the taxpayer at the end of the year of a loan or lending
asset made or acquired in the ordinary course of business by a taxpayer who was
an insurer or whose ordinary business included the lending of money established
by the taxpayer to have become uncollectable in the year;
[22] It is not in dispute that the
appellant's debt had become a bad debt at the time it repurchased the
automobile in question on July 21, 1997.
[23] First of all, I do not agree with
counsel for the respondent regarding the interpretation of the introductory
portion of subsection 20(1) of the Act. The criterion of
reasonableness relates not to the transaction referred to in any of the
paragraphs of subsection 20(1) but rather to such part of the deduction of
an amount as is applicable to a particular source of income. This is clear from
a careful reading of the introductory portion of the subsection. I refer to the
following passage: “such of the following amounts as are wholly applicable to
that source or such part of the following amounts as may reasonably be regarded
as applicable thereto”. This wording simply takes account of the fact that in
some situations the deduction of amounts is wholly applicable to a single
source of income, whereas in other cases the deduction of an amount may be
applicable to several sources of income and only partly to one source of
income. When applicable to several sources of income, only such part of the
amount as may reasonably be regarded as applicable to that source of income is
deductible.
[24] Nor do I think that
section 67 of the Act can apply in this case. The restriction
imposed by that section applies only where the outlay or expense is not
reasonable in the circumstances, as specified by the wording of the section:
In
computing income, no deduction shall be made in respect of an outlay or expense
in respect of which any amount is otherwise deductible under this Act, except
to the extent that the outlay or expense was reasonable in the circumstances.
[25] The amount that the appellant
would like to deduct is equal to the price of the vehicle, including taxes,
specified in the contract of sale entered into by the appellant and
Location Raybec inc. The appellant did not receive any of that sale
price. It therefore claimed the full amount of the sale price, including taxes,
as a bad debt. It has not been put in evidence that the sale price was
excessive. From the standpoint of section 67, the amount of the deduction
seems reasonable to me. In reaching this conclusion, I have assumed that a bad
debt is an expense, which is doubtful. An expense is normally an outlay made to
obtain goods or services.
[26] It follows that the main
arguments made by the respondent during the hearing of this case do not seem to
me to support the validity of the assessment.
[27] Given the facts of this appeal, I
consider it necessary to begin by determining the amount of the debt owed to
the appellant by Location Raybec inc. at the end of the appellant's
1997 taxation year.
[28] To answer this question, one of
the causes of extinction of obligations, that is, compensation, must be
considered.
[29] Articles 1672 and 1673 of the Civil
Code of Québec indicate the situations in which compensation applies and
the consequences of compensation. They read as follows:
Art.
1672. Where two persons are reciprocally debtor and creditor of each other,
the debts for which they are liable are extinguished by compensation, up to the
amount of the lesser debt.
Compensation
may not be claimed from the State, but the State may claim it.
Art.
1673. Compensation is effected by operation of law upon the coexistence of
debts that are certain, liquid and exigible and the object of both of which is
a sum of money or a certain quantity of fungible property identical in kind.
A
person may apply for judicial liquidation of a debt in order to set it up for
compensation.
[30] In this case, there is no doubt
that, at the very time the repurchase contract of July 21, 1997, was
entered into and as a direct consequence of that contract, the appellant
immediately became a debtor of Location Raybec inc. for the price of
repurchasing the automobile in question and that Location Raybec inc.
became a debtor of the obligation to “deliver” the automobile in the technical
sense of that term found in the Civil Code of Québec (arts. 1716 et seq.).
Going back to the time the contract was entered into, it follows—to use the
terminology of article 1673 of the Civil Code of Québec—that the
appellant's debt to Location Raybec inc. was certain, liquid and
exigible and that its object was a sum of money. It was certain because it
could not be seriously contested. It was liquid because its amount was
determined with certainty. It was also exigible since, in the contract of sale,
payment of the price was not subject to any condition or term. Payment of the
debt could be claimed right away. In my view, it is not important that the
appellant paid the repurchase price at the time the repurchase contract was
entered into. Whether that price was paid at the time of the contract or some
time later changes nothing to the parties' legal situation.
[31] Location Raybec inc.'s
debt to the appellant under the contract of sale of January 23, 1997,
which provided for a price of $22,962, was also certain and liquid for the
reasons given earlier as regards the appellant's debt. Was that debt exigible?
[32] During the hearing of this case,
the front of the copy of the contract of sale of January 23, 1997, between
the appellant and Location Raybec inc. was filed. The back of that
contract was not filed, no doubt inadvertently.
[33] While judgment was reserved, I
noticed this omission from the evidence and decided to reopen the hearing. The
back of the contract was part of a key document given that the deduction for a
bad debt claimed by the appellant results from that contract and from the fact
that Location Raybec inc. did not pay the sale price specified
therein.
[34] The back of the contract states
the following, inter alia:
[TRANSLATION]
If
the purchaser fails to pay the sale price in full within three (3) days after
delivery, the vendor can consider that the purchaser is clearly demonstrating
its intention not to comply with its obligations hereunder, thereby putting
itself in default by operation of law, which shall enable the vendor to take
back the vehicles without legal proceedings, this sale rescinded by operation
of law.
[35] The price in the contract of sale
of January 23, 1997, was therefore exigible from
Location Raybec inc. three days at the latest after delivery of the
car in question. According to the contract of January 23, 1997,
delivery took place the same day. As well, the object of
Location Raybec inc.'s debt to the appellant was a sum of money.
[36] The debts of the appellant and of
Location Raybec inc. thus met the four conditions set out in
article 1673 of the Civil Code of Québec. It therefore follows that
both debts were extinguished by operation of law up to the amount of the lesser
debt. The debt of $22,962 owed by Location Raybec inc. to the
appellant was reduced by the debt of $20,050 owed by the appellant to
Location Raybec inc. The result is that, when the repurchase contract
was entered into on July 21, 1997, the debt owed by
Location Raybec inc. was only $2,912. The appellant's bad debt in
relation to Location Raybec inc. was therefore only $2,912 as of
July 21, 1997, and in particular at the end of the appellant's
taxation year on September 30, 1997. That is precisely the amount of
the deduction that the appellant was allowed by the Minister of National
Revenue at the time of the assessment under appeal.
[37] Before concluding, some comments
should be made on applying the Supreme Court of Canada's decision in Shell
Canada Ltd. v. Canada, supra, to the facts of this case.
[38] In my opinion, that decision does
not apply here. First of all, Shell dealt with the right to deduct
certain interest payments. In this appeal, the issue relates to the deduction
of an amount as a bad debt. Moreover, in Shell the Court held that “the economic realities of a
situation cannot be used to recharacterize a taxpayer's bona fide
legal relationships. . . . [A]bsent a specific provision
of the Act to the contrary or a finding that they are a sham, the
taxpayer's legal relationships must be respected in tax cases.” The highest
court specified that “recharacterization is only permissible if the label
attached by the taxpayer to the particular transaction does not properly
reflect its actual legal effect ....” Here, it is not a matter of
recharacterizing the appellant's legal relationships. As I have already noted,
compensation is a cause of extinction of obligations that is effected by
operation of law, regardless of the intentions of the taxpayer and the
Minister.
[39] For these reasons, the assessment
of the Minister of National Revenue is confirmed and the appeal is dismissed.
Signed
at Ottawa, Canada, this 30th day of July 2002.
C.J.T.C.C.
Translation certified true
on this 12th day of November
2003.
Sophie Debbané, Revisor
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