Citation: 2011 TCC 386
Date: August 18, 2011
Docket: 2007-4061(IT)G
BETWEEN:
SRI HOMES INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Little J.
A. FACTS
[1]
SRI Homes Inc. (“SRI”)
is a company incorporated under the laws of the Province of Alberta, with its head office located in Edmonton, Alberta.
[2]
SRI is in the business
of producing and selling manufactured homes.
[3]
Prior to May 1, 2001,
Norterra Inc. (“Norterra”) owned 100 per cent of the issued and outstanding
shares of SRI.
[4]
Effective May 1, 2001, R&M
Frontier Holdings Corporation (“R&M”) purchased 100 per cent of the shares
of SRI from Norterra.
[5]
The purchase of the
shares of SRI by R&M triggered a deemed year-end for SRI of April 30, 2001.
[6]
Prior to the purchase
of the shares of SRI by R&M, SRI owned 50 per cent of the common
shares of Valley Vista Seniors Park Inc. (“Valley Vista”) and 33 per cent
of the common shares of Lakeside Pines Development Inc. (“Lakeside Pines”).
[7]
SRI advanced money to
Valley Vista and Lakeside Pines to finance their general business operations,
i.e., to pay for capital and current expenses (the “Shareholder Loans”).
[8]
The Shareholder Loans
were interest-bearing and SRI reported the accrued interest.
[9]
Effective April 30,
2001, SRI sold certain assets (the “Assets”) including the Valley Vista shares
and the Lakeside Pines shares and the Shareholder Loans to 3556514 Canada Inc.
(“3556514”). 3556514 is a corporation in the Norterra Group of companies.
[10]
At all material times,
Norterra controlled 3556514.
[11]
At the time of the
Assets sale referred to in paragraph [9] above, SRI and 3556514 were related
companies.
[12]
The total purchase
price paid for the Assets was $4,430,366.
[13]
SRI paid $4,430,366 for
the Assets and allocated proceeds of disposition to the Shareholder Loans of
$1,332,796.
[14]
The Minister of
National Revenue (the “Minister”) maintained that the fair market value of the
Shareholder Loans was $1,744,626.
[15]
The Minister also
maintained that SRI made no attempt to collect on the Shareholder Loans and
took no legal action to collect the said loans.
[16]
The Minister maintained
that the principal and accrued interest on the Shareholder Loans were fully
collectable at the time of the disposition to 3556514.
[17]
The Minister maintained
that SRI expected the Shareholder Loans to be fully repaid.
[18]
The Minister maintained
that no Section 22 Election was executed by SRI or 3556514 with respect to the
sale of the Shareholder Loans by SRI to 3556514.
[19]
The Minister maintained
that SRI reported a portion of the amount owing on the Shareholder Loans as
interest income on its tax returns.
[20]
The Minister maintained
that the interest was expensed by Valley Vista and Lakeside Pines.
[21]
The Minister maintained
that SRI did not forgive any portion of the Shareholder Loans owed by Valley
Vista and Lakeside Pines.
[22]
The Minister maintained
that, after the sale of the Assets, Valley Vista and Lakeside Pines owed
3556514 both the principal and accrued interest outstanding on the Shareholder
Loans.
[23]
The Minister maintained
that the fair market value of the Shareholder Loans on April 30, 2001 included
both the principal and the interest thereon.
[24]
The Minister maintained
that there was no income loss or capital loss on the disposition of the
Shareholder Loans to 3556514.
[25]
The Minister maintained
that there was no income loss or capital loss on the disposition of the shares
of Valley Vista and the shares of Lakeside Pines to 3556514.
[26]
The Minister maintained
that the receivable on the Shareholder Loans was a shareholder loan and not a
trade receivable.
[27]
The Minister maintained
that SRI is not in the business of lending money.
[28]
The Minister maintained
that Valley Vista repaid its Shareholder Loans to 3556514 in full on October
21, 2002.
[29]
The Minister maintained
that the allocation of the proceeds of disposition for the remaining assets,
excluding the Shareholder Loans, was reasonable.
[30]
The Minister maintained
that the proceeds of disposition allocated for the remaining assets, excluding
the Shareholder Loans, was equal to their fair market value.
[31]
The Minister maintained
that, in its April 30, 2001 tax return, SRI expensed the negative retained
earnings of its investment in Valley Vista and Lakeside Pines (i.e., its
portion of those companies’ cumulative equity losses) in the amount of
$411,830.
[32]
The Minister maintained
that SRI had a non-capital loss of $605,527 for its taxation year ending April
30, 2001.
B. ISSUES
[33]
The issues are whether,
for its taxation year ending April 30, 2001, SRI:
a)
is entitled to expense
the negative retained earnings of its investment in Valley Vista and Lakeside
Pines (i.e., its portion of those companies’ cumulative equity losses) in the
amount of $411,830; and
b)
had an additional
non-capital loss of $411,830 available for carry back to its taxation year
ending December 31, 2000.
C. ANALYSIS AND DECISION
[34]
In his opening remarks,
Counsel for the Appellant said:
MR.
IHAS: … Just by way of background, the evidence will show -- and this is brief
background, Justice, obviously the evidence will tell this, but in or about
May, 2001 there was a transaction between a company by the name of R&M
Frontier Holdings Corporation whereby it purchased the shares of the appellant,
SRI Homes, from NorTerra Inc. As part of that transaction, certain assets --
and these were related to manufactured home parks, were transferred from SRI to
a numbered company, that's 3556514 Canada [Inc.], immediately prior to the transfer of
the shares. So these were assets to be excluded part and parcel with the share
transaction.
The
primary issues on the appeal will be whether the disposition of these
receivables by the taxpayer was at fair market value, and whether the losses
suffered upon the disposition were capital or non-capital. Of course, if
they're in the latter, the deduction is allowed, and I know my learned friend
will argue that if they're in the former, the deduction is not allowed.
(Transcript, page 3, line 22 to page 4, line 15)
[35]
In his opening remarks,
Counsel for the Minister said:
MR.
SENKPIEL: Your Honour, it's the respondent's position that this isn't a
case about valuation at all. This is a case about a company that had some
assets that were removed from it. That's SRI Home[s] Inc. At that time, it's
owned a hundred percent by NorTerra Inc.
When
those assets are removed, they're sold to a sister subsidiary. They're both
related parties. Two of the items on the appendix to the agreement for that
transfer are for shareholder receivables. The shareholder receivables indicate
that there is an allowance for doubtful accounts.
But
what really happened is on the books of SRI Home[s] Inc. They simply expensed
their proportionate share of the negative retained earnings of two companies
that were owned by SRI Inc. to a certain degree. So, Lakeside Pines, which is
owned 50 percent by SRI Homes Inc., and Valley Vista Seniors Park Inc. is owned
33 and a third percent, as those companies would have income, or loss, they
would obviously on their own income statements for tax purposes indicate
whether they had income or loss. They had had losses for a number of years, and
if you total up those losses, they were the $411,830.
When
they do the consolidated statement for SRI Home[s] Inc., they consolidate those
numbers, just for book purposes, not for tax purposes. And so they had done
that, and they had taken their proportionate share of these negative retained
earnings, and it amounted to $411,830. When the transaction arises where those
assets, those shares and those shareholder loans, are transferred over to the
sister subsidiary –
(Transcript, page 8, line 11 to page 9, line 15)
[36]
Mr. Senkpiel continued:
When
that amount -- when those assets are transferred over to the sister subsidiary,
that's done in preparation for the purchase by an independent third party,
R&M. They are going to buy SRI Homes Inc., but they don't want these
assets. So what they did is, on their books they expensed the negative retained
earnings in these investments. They're not entitled to do that. That's -- and
that is what this case is about in its simplest. They weren't entitled to expense
the negative retained earnings of their investments in these companies.
(Transcript, page 9, line 23 to page 10, line 8)
[37]
In his argument,
Counsel for the Appellant said:
MR.
IHAS: Now, Your Honour, it's my submission that this is a simple case.
Ultimately, there is a decision to be made about whether the assets that were
transferred from SRI to the numbered company, 514, as I'll refer to it, were at
fair market value, the particular assets in question, which are namely the
loans.
(Transcript, page 359, lines 10 to 15)
And
then my friend will respond to that, and say, "Well, even if it was, the
losses were capital." So the second question will be whether they are
capital or non-capital. It will be my submission that they are clearly
non-capital in light of the decisions stemming from the Easton decision
and others which I have in my brief of authorities, which I will submit clearly
show that in this circumstance, viewing the facts that we have before the
court, they're non-capital in nature.
In
which case, the expenses claimed by the appellant were entirely appropriate and
in which case the appeal should be allowed.
(Transcript, page 360, lines 6 to 17)
[38]
In his argument,
Counsel for the Respondent said:
MR.
SENKPIEL: At this point, the respondent would like to hand up the
respondent's book of authorities. And it's the respondent's submission that,
despite the -- as was suggested by my friend, despite the complexity in the
transactions themselves, the law and the facts that we're going to be dealing
with today are quite simple.
(Transcript, page 405, lines 4 to 10)
With
respect, no expert has testified that in determining the collectability of
shareholder loans, we look at the liquidation value of a company. Neither
Valley Vista [n]or Lakeside Pines, as I've mentioned, was valued by a qualified
business valuator. The approach in determining the collectability of
shareholder loans is not supported by expert evidence. We have a real estate
appraisal and liquidation of assets approach which is misguided, and we have no
testimony by a qualified expert that suggests it's appropriate.
Moreover,
Lakeside Pines wasn't even appraised.
JUSTICE: So
you're suggesting, Mr. Senkpiel, there was, in your view, no basis for the
suggestion that these loans were non-collectable.
MR.
SENKPIEL: I'm suggesting there is no expert evidence that suggests that
it's appropriate to try to attempt to calculate a liquidation value for a
company selling its real estate assets, and then have that related to the
collectability. All we have is a real estate appraisal, and obviously that's
something that somebody would want to consider. But is a liquidation value the
appropriate approach? Is an ongoing value the appropriate approach? We need a
business valuator to make a proper expert -- give proper expert evidence in
this appeal, and we haven't had that.
And
in addition, it gets more complicated, because we have somebody who's looking
at the real estate value who is independent and a third party, but then the
rest of the details are by Mr. Robert Adria and Brian Holterhus, who obviously
have an interest in the litigation.
(Transcript, page 406, line 7 to page 407, line 13)
[39]
Mr. Senkpiel said:
MR.
SENKPIEL: I'd like to suggest that the particular amount of $411,830 is
not deductible for six reasons. And right now I'll just give the reasons and
then I'll give the details.
The
first reason is on page 6, paragraph (ee). In its April 30th, 2001
tax return, SRI expensed the negative retained earnings of its investments in
Valley Vista and Lakeside Pines; that is to say, its portion of those
companies' cumulative equity losses in the amount of $411,830. That's the first
reason. The Act doesn't permit that deduction.
The
second reason is the shareholder loans were fully collectable. That's set out
on page 7, paragraph 21 of the reply.
The
third reason –
JUSTICE: Just
bear with me for one second.
MR.
SENKPIEL: Sure.
The
last one is on page 7, paragraph 21. The shareholder loans were fully
collectable.
JUSTICE: And
that's paragraph 21. Okay.
MR.
SENKPIEL: The next one is related to paragraph 22. But I'll just phrase
it slightly differently. In order to take a doubtful account on a loan
receivable, the debt must still be owned. On April 30th, 2001, the
debt was no longer owned by SRI Homes Inc. They couldn't take an allowance for
doubtful accounts pursuant to the Act. That's my third argument.
JUSTICE: Okay,
just follow through with that a bit more. Tell me what you're saying there.
MR.
SENKPIEL: Pursuant to the particular way the provision works, under
Section 22 it's really a reserve. During the year, you take an allowance for a
doubtful account, based on the fact that you have a receivable, whether it's an
account receivable for inventory in retail or if it's an account receivable on
a loan receivable. You take a reserve, an allowance for doubtful accounts.
JUSTICE: I
know how that works.
MR.
SENKPIEL: And then the next year you take it back into income, and if
it's still doubtful you take an allowance for doubtful accounts.
JUSTICE: And
SRI had sold the park at this time?
MR.
SENKPIEL: Yes.
JUSTICE: OK.
MR.
SENKPIEL: They can't take an allowance for doubtful accounts. So the
next question is, this is number four: Can they take a bad debt expense? Okay,
we've got a receivable, whether it's an account receivable or it's a loan
receivable if we accept that it's on income account. The debt had to be bad --
has to be a bad debt. It means it has to be uncollectable. There is no possible
way that this debt was uncollectable. And we'll see -- I'll go into that. But
it had to be bad. It's trite law.
And
so they can't take that deduction. So then they don't have any basis to take a
deduction. The fair market value is the value, then, of the face amount of the
debt, pursuant to the Income Tax Act. And so, my fifth argument, it's
sort of found on page 7 of the reply, paragraph 26, we've got related parties.
The fair market value is the full amount of the shareholder loans assigned. No
way that they're allowed to take a deduction in the Act. And there are
numerous -- and we'll go into the provisions that would allow them to do it,
but they have to do it a certain way.
The
last argument, argument 6, if we turn to page 8, paragraph 31, if SRI had an
offer –
JUSTICE: Just
before you go to that next one --.
MR.
SENKPIEL: Sure.
JUSTICE: What
do you say about SRI in number 27? SRI is not in the business of lending money.
MR.
SENKPIEL: It's our position that SRI clearly was in the business of
lending money to dealers and that sort of thing. What we're saying is, this
particular loan was not made in that business of lending money, which is a
requirement under the particular provision. That's what we were just about to
get to.
JUSTICE: OK.
MR.
SENKPIEL: Which is –
JUSTICE: I'm
just telling you that -- I heard the evidence, and I heard Mr. Ihas's argument.
I don't think it's a stretch to recognize that SRI is in the business of
lending money. They were assisting, financially, dealers. They were providing
financial facilities in the same way that GMAC, or whatever they are called,
did for General Motors, or companies of that nature. So it's not a stretch,
it's not beyond the evidence that I hear that that was part of SRI's business.
MR.
SENKPIEL: It would be the respondent's position that it's not a stretch
at all. We would accept that they obviously lend money to dealers.
JUSTICE: Yes.
MR.
SENKPIEL: The question then is: Is this particular loan one of those
loans? Right? Because you can't -- even if you are in the business of lending
money, the particular loan itself has to be in that business, as we'll see
pursuant to the case law. And pursuant to the provisions. And it's going to be
our position that in this particular case it wasn't, because of the originating
document that we've looked at, the 1992 letter agreement between the three
parties.
We
have there three parties. We don't just have a dealer, we have SRI homes, we
have a dealer, and the individual who owned the land. Basically, they've got
together for an investment dealing with a particular project. And we would say
therefore that -- and we do agree with the argument, the case that's cited by
the respondent, particularly the Federal Court of Appeal decision in Easton
at paragraph 15 and 16. We do agree with the law, and so we will be dealing
with that. And as you note, that's my sixth argument.
So,
it's my position logically that should have been our first argument, if it was
our strongest, because that ends everything. …
(Transcript, page 412, line 25 to page 417, line 22)
[40]
Mr. Senkpiel continued:
MR. SENKPIEL: In terms of a Section 22
election, I don't have included in my book of authorities -- it's not something
that could have been done in the circumstances. The reason is, you have to have
the sale of 90 percent of the assets of a company that are being sold, and the
other business has to carry it on. And that's not what happened here. It was a
sale of just simply receivables and shares.
So
they couldn't have actually done Section 22, but they could have done, as I
have indicated -- forgiven the debt and '514 wouldn't have been able to collect
the amount. And Section 80 would have applied to have the amounts included in
the income of the subsidiary company.
(Transcript, page 424, line 20 to page 425, line 8)
[41]
I agree with the
reasoning outlined by Mr. Senkpiel in his argument.
[42]
The appeals are
dismissed, with costs.
Signed at Vancouver, British
Columbia, this 18th day of August
2011.
“L.M. Little”
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