Citation: 2009 TCC 337
Date: 20090908
Docket: 2003-4006(IT)G
BETWEEN:
HERON BAY INVESTMENTS LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
I.
Introduction
[1] Heron Bay
Investments Ltd. (“Heron Bay”) loaned money to a related company in its 1994 fiscal
year. For its 1995 taxation year, Heron Bay deducted the entire loan as a write-off for a
doubtful debt under subparagraph 20(1)(l)(ii) or a bad debt under
subparagraph 20(l)(p)(ii). That write-off is contested by the Minister.
II.
Issues for Determination
[2] The issues for
determination have to do with whether the three conditions prescribed in either
subparagraph 20(1)(l)(ii) or subparagraph 20(1)(p)(ii) of the Income
Tax Act (the “ITA”) have been met and are as follows:
(a) Does the Appellant’s ordinary
business include the lending of money?
(b) Was the loan made in the ordinary
course of the Appellant’s moneylending business? and
(c) Was the loan established to be
doubtful under subparagraph 20(1)(l)(ii) or uncollectible under
subparagraph 20(1)(p)(ii)?
The Appellant contends that all of the conditions have
been satisfied. Not surprisingly, the Respondent alleges the opposite.
III.
Factual Background
A. Background and General
Business Practices of the Conservatory Group of Companies
[3] The late Ted Libfeld was a holocaust
survivor who immigrated to Canada at the end of the war with nothing more
than his personal belongings. He went on to build a very successful real estate
firm, first with partners and later with his four sons. For the last 50 years,
the Conservatory Group of Companies has carried on the business of real estate
development, from commercial buildings to condominiums and residential housing
in the Greater Toronto Area. In addition, in later years the Conservatory Group
provided mortgages to third-party purchasers in connection with its real estate
business and invested large amounts of surplus funds in commercial paper.
[4] The Conservatory Group is now run by Ted’s
four sons: Sheldon, Jay, Mark and Corey.
[5] Heron Bay is one of the oldest corporations in the Conservatory
Group. Heron Bay’s business activities include the purchase and
development and subsequent sale of real property. It also loans money to
related entities. Heron Bay builds residential homes on its own and in
partnership or through joint ventures with other corporations within the Group.
In the taxation years under review, it operated its business as a merchant real
estate developer, performing sales, marketing and design functions. It left the
risky business of home building to third‑party builders. The common
shares of Heron Bay are owned equally
by the four brothers. Sheldon Libfeld is, and was during the relevant
years, the president and secretary of Heron Bay.
IV. The Acquisition of the Frost Farm
A. Runnymede Development Corporation Ltd.
[6] Runnymede Development Corporation Ltd. (“Runnymede
Development”) carries on the business of real estate development in the Greater
Toronto Area.
B. First Right of Purchase
[7] By memorandum of agreement dated
April 14, 1988, Runnymede Development granted Ted Libfeld in
Trust a first right to purchase any future residential building lots owned by
Runnymede in the town of Ajax.
[8] In the early 1990s, Runnymede announced that it was ready to sell certain land
known as the “Frost Farm”, Group I and Group II lots. Potential purchasers,
including Rosehue Downs Development Inc. and Burlmarie Developments Inc., both members
of the Conservatory Group, expressed interest in the Group I and Group II lots.
[9] There was some disagreement as to the
interpretation of the “first right to purchase” enjoyed by Ted Libfeld in trust.
Mr. Libfeld understood that he enjoyed a “right of first refusal” such
that Runnymede would have to present an executed offer, whereupon Mr. Libfeld
would have the right to match the offer and purchase the lots. Runnymede
understood the term to mean that it could present an offer to Mr. Libfeld for
acceptance within a reasonable time (“right of first purchase”), failing which Runnymede could sell the lots at an equal or better price. A right
of first refusal would have greater value to the Conservatory Group than a
right of first purchase as, in the long run, it would dissuade third parties
from bidding for the properties.
[10] During the dispute over the interpretation
of the term “first right of purchase”, Runnymede presented offers to Libfeld’s
lawyer, who was to confirm that these offers were made by bona fide
third parties. Neither Mr. Libfeld nor Jack Feintuch, the executive vice‑president
of Runnymede, could recall the outcome of the referral
to Libfeld’s lawyer.
[11] Despite Runnymede’s denial that there was a
binding agreement of purchase and sale with respect to the Group I lots, Mr. Libfeld
took the position that there was a binding agreement and threatened legal
action on the basis of a right of first refusal.
[12] With the agreement of both parties, the
issue of the scope of the right of first purchase and other unrelated issues
were taken to arbitration. At a cost of $5 million, Runnymede, obtained, inter
alia, a release with respect to Libfeld’s right of first purchase and related
right of joint venture. Mr. Feintuch testified that the release and the
payment of the $5 million had nothing to do with the purchase price or the
fair market value of the Frost Farm lots. The reduction in price was merely a
mechanism for the payment of the $5 million for the release with respect to
Libfeld’s right of first purchase and the settlement of other, non-relevant, issues.
Mr. Libfeld took the contrary view and alleged that part of the
$5 million settlement award related to a rebate on the purchase price of
the Frost Farm. Mr. Libfeld felt that they had overpaid for the Frost
Farm.
[13] The following members of the Conservatory
Group executed agreements to purchase the Frost Farm lands from Runnymede as
follows:
• 147 building lots for
$11,764,000 by Rosehue Downs Development Inc. by agreement executed
August 10 and 12, 1994;
• 142 building lots for
$12,202,800 by Burlmarie Developments Inc. by agreement executed August 10
and 12, 1994.
[14] The transactions were structured using a long-form
agreement of purchase and sale. Under such an arrangement, title does not pass
until a sale to the ultimate homeowner occurs and payment has been made on a
lot-by-lot basis. Only then, would the deed to the lot held by Runnymede be
put directly in the homeowner’s name. When a deposit is made for the property, there
is no security given for the funds being advanced. The developer who puts the
deposit down only obtains the right to build on and develop the lots.
[15] Contemporaneously with the above
transactions, Marlo Developments Inc. (“Marlo”), another member of the
Conservatory Group, acted as trustee for the Marlo joint venture in which
Viewmark Homes Ltd. (“Viewmark Homes”) holds a 95% interest and Shellfran
Investments Ltd. holds the remaining 5% interest. Marlo agreed to purchase:
• 147 building lots for
$12,000,000 from Rosehue Downs Development Inc. by agreement dated
August 10, 1994;
• 142 building lots for
$12,500,000 from Burlmarie Developments Inc. by agreement dated
August 10, 1994.
[16] Heron Bay
loaned Viewmark Homes a total of $3,770,000 from Heron Bay’s investment in other real estate joint ventures [i.e. Viewmark Homes
Ltd. (trustee)] during October to November 1994. This loan was to enable Marlo,
on behalf of the joint venture, to acquire the property. The $3,770,000
represented nearly 100% of the deposit required for the leveraged acquisition
of the Frost Farm lands from Burlmarie and Rosehue. The two properties
purchased consist of an aggregate of 289 building lots (the “Property”).
[17] By agreement dated November 30, 1994,
Heron Bay confirmed advances totalling $3,770,000 to
Viewmark Homes. The $3,770,000 debt was secured by a promissory note to Heron Bay and by a pledge to Heron Bay of Viewmark Homes’
investment interest in the Marlo joint venture. The terms of the loan were as
follows:
• The principal balance
and interest were repayable on demand.
• The loan was without
recourse, which means that Heron
Bay’s sole recourse under the loan was against Viewmark
Homes’ interest in the Property (i.e. its 95% interest in the Marlo joint
venture).
• The loan bore interest
at 8% per annum.
V. Heron Bay’s Tax Position
[18] By November 1994, Sheldon Libfeld
was alleging that the fair market value (“FMV”) of Viewmark Homes’ interest in
the Property had been determined to be less than its cost of the Property. In
the course of dealing with the appraiser hired by the Appellant to value the
properties, Sheldon Libfeld gave that appraiser information respecting property
transactions in Whitby. Appraisals obtained at the request of Heron Bay put the FMV of the Property as at November 30,
1994 at no more than $17,235,000. That coupled with other encumbrances on the
Property totalling $20,636,000, which ranked ahead of Heron
Bay’s claim, led to Heron Bay’s determination that the value of the loan was nil.
It should be noted that this occurred within a short period after the funds
were first advanced.
[19] In computing its income tax for its 1995
taxation year, the Appellant claimed a deduction from income of the entire
amount of the $3,770,000 loan on the basis that the loan had become a doubtful
or bad debt at that time. No adjustment was made in the T2S(1) for tax purposes
as, for accounting purposes, the deduction was entered on Heron Bay’s profit and loss statement. It is Heron Bay’s
position that the loan was made in the ordinary course of its business, which included
the lending of money, both of which are essential conditions to be met in order
for a taxpayer to claim a deduction for a doubtful loan or bad debt.
VI. The Minister’s Position
[20] The Minister suggests that at all material
times the major business activity of Heron Bay was real estate and that the
lending of money was not an integral part of its business operations, but
merely part of an occasional investment of surplus funds, generally in the form
of term deposits.
[21] The Minister also submits that the loan
made by Heron Bay was outside the ordinary course of any
moneylending business and was not consistent with Heron Bay’s related-party transactions. In brief, Heron Bay made only two non-recourse loans and claimed a
doubtful or bad debt deduction in respect of each of those two loans.
[22] Finally, the Minister contends that the
evidence does not show that the loan was doubtful, uncollectible or bad.
VII. Rezoning Expenses
[23] Heron Bay incurred an
expense of $89,799 for the rezoning of a parking lot on its 90 Dundas Street West property in Toronto so that the construction of a condominium building
would be permitted. The parking lot portion of that property was treated by Heron Bay as part of its inventory. Heron Bay
claims that the condominium sales did not take place, though, due to a decline
in the condominium market. As a result, Heron
Bay
obtained an appraisal with respect to the property and on the basis of this
appraisal, determined that the FMV attributable to the parking lot was less
than the actual purchase price of the parking lot. While Heron Bay did
not increase the portion of the Dundas
Street property which it regarded as
inventory by the amount of the expense incurred for the rezoning, it did deduct
the $89,799 in computing its income for its 1995 taxation year. Heron Bay submits that claiming the expense in this fashion was
the same as if the amount had been included in its inventory and a deduction
taken in accordance with subsection 10(1) of the ITA since the fair
market value of the inventory item was less than its cost.
[24] The Minister
argues that no evidence was provided to substantiate the decline in value and
submits that the parking lot was not inventory of Heron Bay and that Heron Bay accordingly
had no basis for writing down its inventory under section 10(1) of the ITA.
Rather, the Minister submits, the rezoning expense was an expenditure on
account of capital, since it was a one-time expenditure for the purpose of
bringing into existence an asset of permanent and enduring advantage, and thus the
deduction thereof is prohibited by paragraph 18(1)(b) of the ITA.
VIII. Analysis
[25] Paragraph 20(1)(l) of the ITA as it
applies to Heron Bay’s 1995 taxation year reads as follows:
20.(1)
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:
. . .
(l) a
reserve determined as the total of
(i) a
reasonable amount in respect of doubtful debts that have been included in computing
the income of the taxpayer for that year or a preceding taxation year, and
(ii) where
the taxpayer is a financial institution (as defined in subsection 142.2(1)) in
the year or a taxpayer whose ordinary business includes the lending of money,
an amount in respect of properties (other than mark-to-market properties, as
defined in that subsection) that are doubtful loans or lending assets
that were made or acquired by the taxpayer in the ordinary course of the
taxpayer’s business of insurance or the lending of money or that
were specified debt obligations (as defined in that subsection) of the
taxpayer, equal to the total of
(A) the
prescribed reserve amount for the taxpayer for the year, and
(B) in respect
of doubtful loans or lending assets for which an amount was not deducted for
the year by reason of clause (A) (in this clause referred to as the “loans”,
the lesser of
(I) a
reasonable amount as a reserve for the loans in respect of the amortized cost
of the loans to the taxpayer at the end of the year, and
(II) the
product obtained when the total of
1. the part of the reserve for the loans reported in the financial
statements of the taxpayer for the year that is in respect of the amortized
cost to the taxpayer at the end of the year of the loans, and
2. the total
of all amounts included under subsection 12(3) or paragraph 142.3(1)(a)
in computing the taxpayer’s income for the year on a preceding taxation year to
the extent that those amounts reduced the part of the reserve referred to in
sub-subclause 1.
is multiplied
by one minus the prescribed recovery rate,
or such
lesser amount as the taxpayer may claim where the lesser amount is the total of
a percentage of the amount determined under clause (A) and the same percentage
of the amount determined under clause (B);
[Emphasis added.]
[26] Subparagraph 20(1)(l)(i) is inapplicable in the
present appeal. It allows the deduction of a reasonable reserve in respect of
doubtful debts which have been included in computing income. The loan made to
Viewmark Homes was made with after-tax funds and was not included by Heron Bay in the determination of its
income.
[27] Subparagraph 20(1)(l)(ii) is relevant to the
present appeal. The part that concerns us applies to doubtful loans or lending
assets of taxpayers whose ordinary business includes the lending of money,
where such doubtful loan were made or acquired in the ordinary course of the
taxpayer’s business of the lending of money.
[28] Clause 20(1)(l)(ii)(A) applies only to certain
types of loans made by banks and is not applicable in the present appeal.
Clause 20(1)(l)(ii)(B) provides for a general reserve and is relevant to
the present appeal. This reserve is equal to the lesser of a reasonable reserve
in respect of doubtful loans and the reserve amount entered on the financial
statements. The Appellant relies on clause 20(1)(l)(ii)(B) to claim a
deduction for the loan made to Viewmark Homes. It argues that the loan was
doubtful at the end of its 1995 taxation year and that it meets all of the
above conditions.
[29] The Appellant also relies on paragraph 20(1)(p).
This provision allows a taxpayer to deduct the full amount of a loan that has
been made where:
(a) the ordinary
business of the taxpayer includes the lending of money;
(b) the taxpayer
made the loan in the ordinary course of its business of lending money; and
(c) it has been
established in the year by the taxpayer that the loan has become uncollectible.
[30] The conditions described in paragraphs (a) and (b) above
are identical to those set out in paragraph 20(1)(l). The condition described
in paragraph (c) above is different. Paragraph 20(1)(l) requires only
that the debt be established as doubtful. Paragraph 20(1)(p) requires
the debt to have become uncollectible in the year. This, obviously, is a more stringent
standard. If the Appellant fails to establish that its loan to Viewmark Homes
satisfies the two conditions in paragraph 20(1)(l) that are the
same as those under paragraph 20(1)(p), it will also fail under paragraph
20(1)(p). The Appellant’s counsel, Mr. Innes, directed his arguments at
trial to the Appellant’s case under paragraph 20(1)(l) in acknowledgment
of the fact that this was the easier of the two provisions to rely on to
justify the Appellant’s deduction of the Viewmark Homes loan.
A.
Whether Ordinary Business
Includes Moneylending
[31] The Minister
submits that Heron Bay does not
carry on the business of moneylending. The Minister argues that even though
Heron Bay made loans, it did not act as a moneylender as that term is commonly understood,
since Heron Bay did not seek to profit at all from the loans it made, because it
either charged no interest or did not enforce the debt.
[32] Determining
whether or not a moneylending business exists is a question of fact. If it can
be shown, after considering as a whole all the facts of the case, that there is
a degree of system and continuity about the transactions, the existence of a
moneylending business will be established.
[33] Case law which
establishes the test set out above can be found in Orban v. M.N.R., 54 DTC
148 (ITAB), a decision in which Mr. Fordham quoted old English cases on
moneylending at pages 149-50:
. . . In
Litchfield v. Dreyfus, (1906) 1 K.B. 584, at p. 589, Farwell J., said:
But not every man who lends money at interest carries on the business of
money‑lending. Speaking generally, a man who carries on a money‑lending
business is one who is ready and willing to lend to all and sundry, provided
that they are from his point of view eligible . . . it is a
question of fact in each case.
. . . In Newton v. Pyke,
(1908) T.L.R. 127, at p. 128, Walton, J. states:
Whether a man
was carrying on business as a money-lender must be, as was pointed out in Litchfield
v. Dreyfus, a question of fact in each case. It seems impossible to lay
down any definition or description which would be of much assistance, but I
feel that it is not enough merely to shew that a man has on several occasions
lent money at remunerative rates of interest; there must be a certain degree
of system and continuity about the transactions.
In Nash v. Layton, (1911) 2 Ch.
71, at p. 82, Buckley, L.J., said:
Whether a man
is a money-lender or not is an investigation whether he has done such a
succession of acts as that upon the facts proved by establishing that those
acts were done the Court arrives at the conclusion as matter of law that he
falls within the definition of a money-lender.
[Emphasis added.]
[34] It is true that
in all three cases the effect of the British Money-lenders Act, 1900 was
under consideration, but in each of them the court concerned had, in addition,
to deal with the subject of moneylending generally.
[35] In R.S. Jackson
Promotions Ltd. v. M.N.R., 85 DTC 145 (TCC), Sarchuk J. added the
following at page 149:
The presence
or absence of any single factor referred to does not by itself establish
whether that the appellant was not carrying on the business of money-lending. It
is the cumulative effect of this evidence that leads the Court to that
conclusion . . .
[Emphasis added.]
[36] Furthermore, the
Federal Court of Appeal stated in footnote 2 of Loman Warehousing Ltd. v.
Canada, [2000] F.C.J. No. 1717 (QL):
. . . the
business of lending money under the Act extends not only to one who lends money
to all who qualify in the conventional sense (see Litchfield v. Dreyfus
(1906) 1 K.B. 584 at 589), but would also include one who lends money on a
regular and continuous basis over time to a limited group of borrowers for an
arm’s length consideration . . .
[Emphasis added.]
[37] The Minister
submits that it is not sufficient to have interest income to prove that a
moneylending business exists. The Minister argues that receiving interest from
mortgages associated with the sale of property is not carrying on the business
of a moneylender. Rather, it is the receiving of payment of the unpaid purchase
price of property.
Furthermore, the Minister suggests that the lending activity is not being
carried on with a view to profit because it involves a number of related‑party
transactions in which the Appellant borrows at 15% and lends at a lower rate,
for example, 8%.
[38] Dealing with the
first argument, I find it difficult to accept the suggestion that the receipt
of interest relates only to the unpaid purchase price of property. The receipt
of interest payments with respect to the mortgages associated with the sale of
property implies that a loan was made to the purchaser in order to assist the
purchaser in completing the purchase of the property. The loan is a separate transaction
from the sale. Accordingly, when payments are made on the purchase price of a home,
interest is charged on the portion of the loan that is outstanding.
[39] Regarding the
second argument made by the Minister, it was suggested that Heron Bay did not act
as a typical moneylender would since it did not lend with a view to profit, as Heron Bay
borrowed at 15% but made loans on which it charged a lower percentage. This implies
that a typical moneylender would borrow at a lower rate and lend out at a
higher rate, thereby earning a profit in the form of the interest income from
the spread between the two rates. While this is generally true, it is useful to
point out that the 15% rate at which Heron Bay borrowed funds was on shareholder loans. It is also important to
note that a business can make loans from profits earned and retained in the
business.
[40] Turning to the evidence appearing in the financial statements, it can
be observed that interest income is broken down into several components on the
Non‑Consolidated Statement of Income
as follows:
|
Interest Earned from:
|
Year Ended: Aug 31/96
|
% of Total Interest
|
Year Ended: Aug 31/95
|
% of Total Interest
|
|
Mortgage
|
54,571
|
5.9%
|
64,607
|
6.1%
|
|
Term Deposits & T-Bills
|
55,885
|
6.0%
|
64,576
|
6.1%
|
|
Loans Receivable
|
822,040
|
88.1%
|
933,029
|
87.8%
|
|
Total Interest:
|
932,496
|
100%
|
1,062,212
|
100%
|
[41] From the above
table, it is clear that for the fiscal years ended August 31, 1995 and 1996, interest
income from mortgages and loans receivable made up a substantial portion of the
interest income received. The interest on the loans receivable is explained in
notes 4 and 5 to the financial statements dealing with interest earned on loans
made to related parties.
[42] Mr. Libfeld
stated that internal funds were used for lending within the group instead of relying
on bank financing.
The funds were lent out to help other entities cover construction costs or cash
requirements as necessary from time to time.
Eventually, when surplus funds become available, they are used to repay Heron Bay. From 1992 onward, interest
was normally charged on all loans.
Furthermore, there was evidence presented that showed the history of numerous
loan transactions with individuals and related parties, including the amounts
loaned, the interest rates charged over different periods of time, the payments
made and the outstanding balances.
Along with the results reflected in the income statement, all these factors
support the notion that there is a capacity to make a profit from such loans through
the earning of interest income. While there may have been a few loans that bore
no interest,
interest rates and the timing of interest payments are really terms of the loan
that is negotiated between the parties. The fact remains that loans are
commonly made by Heron Bay. Accordingly,
after considering the factors above, it can be said that a certain degree of
system and continuity does exist with respect to the transactions in question.
This is similar to the situation in Langhammer v. The Queen, 2001 DTC 45
(TCC), a case in which Judge Rip (as he then was) found that loans were made
for the purpose of earning interest income as opposed to income from property. Judge
Rip found that continuity or system in the lending activities was established
due to the fact that the loans were made for specific terms (in that case,
three years or shorter) and the lender kept track of interest payment due dates
and outstanding balances.
[43] In Saltzman v.
M.N.R., 64 DTC 259 (TAB), Mr. Saltzman provided money to a law firm that made
mortgage loans on his behalf. After receiving interest, Mr. Saltzman
proceeded to claim a reserve for doubtful debts in the same amount. Mr. Davis,
Q.C. found that Mr. Saltzman was not in the business of moneylending because he
lacked continuity or system in lending out his money. Mr. Saltzman just
put in the money, but did not know who the borrowers were, what the exact
nature and terms of the mortgages being issued were, or whether he had gotten
any money back and knew little of how his money was invested. This can be
contrasted to Heron Bay’s case.
[44] Whether the loans
are made to related parties or not, Heron
Bay
is not precluded from being a moneylender. In 576315 Alberta Ltd. v. Canada,
[2001] T.C.J. No. 510 (QL), the corporate taxpayer made two loans to two
different corporate entities. The first loan of $1.7 million was to
finance four restaurants while the second loan of $325,000 was to enable a
debtor to pay its bills. The Minister argued that the taxpayer had not
established a systematic and continuous pattern of lending money, did not
always collect interest on loans, did not hold itself out to the public as a
moneylender, and made a number of loans to related persons or business
associates. Nonetheless, Judge Bonner allowed the appeal in part by allowing a
deduction related to the first loan since financing was part of the taxpayer’s
ordinary business and the lending done was part of that financing activity. The
inference is that the fact that a loan is made to a related party does not
preclude the related-party lender from being a moneylender.
[45] In Rich v. The
Queen, 2003 DTC 5115 (FCA) (hereinafter “Rich”), Rothstein J.A. stated
at paragraph 16 that while a non-arm’s length relationship may justify closer
scrutiny than arm’s-length situations, a non-arm’s length relationship alone,
without more, cannot lead to a finding that the creditor did not act honestly
and reasonably in determining the debt to be bad.
[46] I find that Heron Bay is in
the business of moneylending since making loans is an integral part of its
business and, as established above, there were both system and continuity in the
making of the loans. Hence the purpose of the loans was not just the occasional
investment of surplus funds. The factors indicating the existence of a
moneylending business far outweigh any factors that suggest otherwise.
B.
Whether the Loan Was Made in
the Ordinary Course of Business
[47] In determining the treatment of the deduction
under examination, the next question is whether the loan to Viewmark Homes was
made by Heron Bay in the ordinary course of its business. As part of
the Conservatory Group system, Heron Bay loaned money to related parties and did
so on a rather regular basis. One might be tempted, at first blush, to conclude
that because the loan to Viewmark Homes was made on income account, it follows
that this loan was made in the ordinary course of the Appellant’s moneylending
activities. In my opinion, such an approach would confuse the proper fact-finding
test of the first condition with the fact-finding enquiry needed to determine
the second issue. By adding the word “ordinary” to the second condition, namely
that the loan be made “in the ordinary course of the taxpayer’s business . . .
of lending . . . money”, the legislator has indicated that the
taxpayer must demonstrate not only that the loan was made in the course of the
taxpayer’s business, but also that it was made in the normal or regular (“ordinary”)
course of the taxpayer’s business of lending money. In my opinion, the non‑recourse
feature of the Viewmark Homes loan makes this loan stand out as an extraordinary
transaction when compared to the other types of loans that are commonly made by
the Appellant.
[48] The argument put forward by Heron Bay in this regard is based on the “normalcy”
of the loan in question. It submits that the loan was made in connection with its overall profit-making scheme
and was of a class of loan arrangement usually entered into by it. Heron Bay
asserts as well that the loan was prompted by the ordinary business
considerations that governed its making of loans.
[49] For a loan to
fail this test, it would need to be extraordinary or “extracurricular” in some
distinct fashion and different from activities carried on in the day-to-day
operation of the business as an entity. The loan would need to appear as an
aberration or an abnormality of some kind.
[50] As a preliminary
noteworthy point, the wording used in paragraph 20(1)(l) is not
“ordinary course of business”, but “ordinary course of the taxpayer’s business
of . . . lending . . . money”. I will, accordingly,
consider Heron Bay’s business
and the types of loans it typically makes in order to determine whether the
loan it made to Viewmark Homes was made in the ordinary course of its business.
[51] An instructive
point of departure for the purpose analysis is to delineate the meaning and
scope of the phrase “in the ordinary course of the taxpayer’s business”. This phrase
is found in other provisions of the ITA, and has also been judicially
considered in different contexts.
[52] Activity falling within “the ordinary course
of business” involves repetition and continuity. Factors considered in distinguishing between
transactions on account of capital and transactions on income account are
useful but not necessarily determinative.
Moreover, “[i]t is trite law that there is a rebuttable presumption that the
income earned from anything that a corporation does within the limits of its
corporate objects or enabling legislation is business income.” But this is not to suggest
that anything done by a corporation under the umbrella of its corporate objects
or enabling legislation is done in the ordinary course of business or in the
ordinary course of that corporation’s business “because Parliament has used the
word ‘ordinary’. The addition of the word ‘ordinary’ to the expression ‘course
of business’ must have been intended to capture particular transactions and not
just anything done by the corporation in its business.”
[53] The phrase was
canvassed by Judge Rip (as he then was) in British Columbia Telephone Company
v. M.N.R., 86 DTC 1286 (TCC) in the context of former paragraph
20(1)(gg) dealing with inventory allowances. At page 1290, Judge Rip commented
as follows, relying on international decisions:
In a
bankruptcy matter before the High Court of [Australia], Rich, J. wrote that for
transactions to be considered in the ordinary course of business supposes “that
according to the ordinary and common flow of transactions in affairs of
business there is a course, an ordinary course. It means that the
transaction must fall into place as part of the undistinguished common flow of
business done; that it should form part of the ordinary business as carried
on, calling for no remark and arising out of no special or particular
situation”: Downs Distributing Co. Pty., Ltd. v. Associated Blue Star
Stores Pty., Ltd. (In Liquidation), (1948), 76 C.L.R. 463, at page 477.
Street, J., of the Supreme Court of New South Wales stated that “the
transaction must be one of the ordinary day-to-day business activities,
having no unusual or special features, and being such as a manager of a
business might reasonably be expected to be permitted to carry out on his own
initiative without making prior reference back or subsequent report to his
superior authorities, such as, for example, to his board of directors.”: Re
Bradford Roofing Industries Pty., Ltd., (1966) 84 W.N. (Pt. 1) (N.S.W.) 276
at page 285 . . . .
[Emphasis added.]
[54] To similar effect
is the discussion in Highfield Corporation Ltd. v. M.N.R., 82 DTC 1835
(TRB), at page 1843, of the phrase “in the ordinary course of [the taxpayer’s]
business” in the moneylending context:
. . .
Since making a loan is the lending of money, it would seem to me that a loan
made in the "ordinary course of business" would identify that transaction
as part of the "ordinary business" of the taxpayer. For a loan to
fall short of those parameters, it would need to be extraordinary or
extracurricular in some distinct fashion and clearly different from the
day-to-day operation of the business as an entity. It would appear as an
aberration or an abnormality of some kind. Perhaps there is a bottom line
consisting of a certain required frequency, or similarity of
"loan" transactions below which it could not be said that they
formed part of the ordinary business of the taxpayer. However, I am not faced
with the problem of locating that "bottom line" in this appeal. The
constant and consistent procedures adopted and followed by Highfield
when making its investments make the particular loans in question "ordinary"
in every aspect.
[Emphasis added.]
[55] The phrase “in
the ordinary course of the taxpayer’s business” covers “the amalgam of
day-to-day activities carried out with regularity and a degree of frequency by
the management of the taxpayer in conducting the taxpayer’s business, which may
be contrasted with isolated transactions infrequently engaged in, including
significant asset acquisitions or dispositions that are extraordinary events.”
[56] The “appropriate
approach of interpretation should be the one that considers the specific
characteristics and operating history of the particular business that included
an impugned transaction.”
Support for this approach is found in Royal Bank v. Tower Aircraft Hardware (1991),
3 CBR (3d) 60 (Alta. Q.B.), a decision in which the nature of past advances to
shareholders was found by the court to be relevant in determining whether a
subsequent shareholder advance was made in the ordinary course of business. Similarly,
in Can. Commercial Bank, etc. (1986), 49 Alta. L.R. (2d) 58 (Alta.
Q.B.) at 62, the court considered “what is ordinary in light of all the
circumstances” in delineating the scope of ordinary course of trade. Both of
these cases demonstrate that courts take into account the specific relationship
of the parties in order to determine whether an impugned transaction was carried
out in the ordinary course of business.
[57] In Industrial
Investments Ltd. v. M.N.R., 73 DTC 118 (TRB), the appellant company loaned
money to an affiliated company. No security or collateral was obtained and no
interest was charged. The shareholders stated that the reason for proceeding in
this manner was that they controlled the American company and the money would
be repaid as soon as the funds became available from that company’s business
operations. The Board found that the loan was not made “in the ordinary course
of business” by the Appellant and that it was more in the nature of an
accommodation for an associate, or a capital investment.
[58] Against this
background, the determination of what falls within the scope of “ordinary”,
whether in terms of business generally or in the taxpayer’s business
specifically, becomes an exercise that is highly fact-specific. “Authorities
generally agree that the expression [“in the ordinary course of business”]
cannot be defined with any precision in the abstract and that its proper
interpretation will depend on the facts specific to each case.” The Supreme Court of
Canada, for bankruptcy law purposes, in Robitaille v. American Biltrite
(Canada), [1985] 1 S.C.R. 290, at 291 stated that “it is best to consider
the circumstances of each case and to take into account the type of business
carried on between the debtor and creditor” when determining what constitutes the
ordinary course of the taxpayer’s business.
[59] The Supreme Court
approved the following passage from the Quebec Court of Appeal’s majority
decision in Pacific Mobile Corp. (In re): American Biltrite (Canada) Ltée c.
Robitaille, [1982] C.A. 501 at 506:
It is apparent
from these authorities, it seems to me, that the concept we are concerned with
is an abstract one and that it is the function of the courts to consider the
circumstances of each case in order to determine how to characterize a given
transaction. This in effect reflects the constant interplay between law and
fact.
[60] Some of the
judicial statements referred to above related to provisions of the ITA that
are inapplicable in the instant appeal or to provisions of other statutes. This
does not necessarily render inapplicable the judicial treatment of those
provisions. Legislative drafters are understood to abide by the principle of
uniformity of expression, so that each term has one and only one meaning. Therefore, the same words appearing
in a statute are to be given the same meaning.
[I]t is a
basic principle of statutory interpretation that where the same words are used
in a statute, they are to be given the same meaning.
In Ainsworth
Lumber Co. Ltd. v. The Queen,
the court considered the issue of how to interpret the words used in the
Act and adopted the following commentary:
[T]he third
edition of Driedger on the Construction of Statutes at page 163 . . .
says:
It is
presumed that the legislature uses language carefully and consistently so that
within a statute or other legislative instrument the same words have the same
meaning.
. . .
In R. v.
Zeolkowski, (1989) 61 D.L.R. (4th) 725, at 732 (S.C.C.),
Sopinka, J. wrote:
Giving the
same words the same meaning throughout a statute is a basic principle of
statutory interpretation.
Driedger at
page 475 reads:
In preparing
an enactment, the legislature is presumed to be aware of existing case law and
to take that case law into account in drafting its provisions. Where words
have been given a particular meaning in a case or series of cases, and those
words are then used in legislation, the obvious inference is that the
legislature intended to give the words the same established meaning.
[61] The concept of
“ordinary course” has also been addressed, in the term preferred share context,
in relation to the provisions denying the intercorporate dividend deduction to
specified financial institutions. The exception carved out of these denial
provisions permits the intercorporate dividend deduction in connection with
term preferred shares acquired outside the “ordinary course of [the] business”
carried on by the taxpayer.
[62] The only reported
case discussing the phrase “ordinary course of business” as used in subsection
112(2.1) of the ITA is Société d’investissement Desjardins v. M.N.R.,
91 DTC 393 (en.), 91 DTC 373 (fr.) (TCC). The Appellant in that case,
a subsidiary of a financial institution (therefore a specified financial
institution for the purposes of the said subsection), was established with a
view to investing in Quebec businesses. In the course of a reorganization
designed to give employees greater share ownership, the Appellant converted
certain debentures of the Sico company into a separate class of shares. Shortly
thereafter, one half of these shares were redeemed, giving rise to a deemed
dividend that was deducted by the Appellant in accordance with subsection 112(1).
The Minister in turn denied the deduction pursuant to subsection 112(2.1)
of the ITA. The Appellant conceded that the shares in question
constituted term preferred shares, but argued that subsection 112(2.1) did
not apply given that the shares were not acquired in the ordinary course of its
business.
[63] This Court
allowed the appeal. Its findings were twofold. Firstly, it held that in
determining if a term preferred share was acquired in the ordinary course of the
business carried on by a specified financial institution, all of the
circumstances surrounding the acquisition must be examined. It was found in
this regard that the Appellant’s acquisition of the particular shares did not take
place in the ordinary course of its investment business, but instead occurred only
in response to outside pressures to carry out the reorganization.
[64] Secondly, the
acquisition fell outside the Appellant’s ordinary course of business because
the short-term nature of the particular shares did not accord with the Appellant’s
general investment policy, which was to invest in medium- to long‑term
investments. In this respect, the Court adopted a narrow reading of the
taxpayer’s ordinary course of business, restricting it to those actions which the
taxpayer customarily carries on. Rather than finding that the taxpayer’s
ordinary course of business was making investments, or even investing in Quebec
businesses, it narrowed the focus even further, finding that the taxpayer’s
ordinary course of business was to hold medium- to long-term investments.
[65] The purpose of
the “ordinary course” condition appears clear to me in the context of both the
term preferred share rules and the provisions under consideration in the
present case. In the context of the term preferred share rules, provision was made
to allow a specified financial institution (“SFI”) the benefit of an
intercorporate dividend deduction that otherwise would be denied with respect
to dividends received on “term preferred shares”. To be eligible for this
treatment the SFI must establish that the shares were not acquired in the
ordinary course of its business.
[66] An SFI may be in
the business of lending money to third parties. In this context it could
subscribe for preferred shares that are, in substance, identical to unsecured
debt issued by its client. The prohibition found in subsection 112(2.1) would
then operate to deny a deduction for intercorporate dividends paid on such
shares and the dividend paid on the shares would be taxed much in the same way
as the interest would have been had the funds been loaned instead. On the other
hand, if the same financial institution wanted to capitalize a subsidiary
through an investment in preferred shares for a reason other than for its
general business purpose of money lending or investing in shares of third
parties, the shares might not be acquired in the “ordinary course of business” thus
paving the way for an intercorporate dividend deduction. To benefit from the
exception, the SFI must demonstrate that the investment in the preferred shares
of its subsidiary is different from the third‑party transactions that it
enters into as part of its general business activities.
[67] The “ordinary
course” condition found in paragraphs 20(1)(l) and (p) operates a
little differently. Unlike the case of term preferred shares, where the
condition operates as an exception to the general rule that disallows a
deduction for the preferred share dividends, here the conditions must be met in
order for a reserve or deduction for a doubtful loan or bad debt to be allowed.
[68] Those provisions
recognize that although a taxpayer’s ordinary business may include moneylending
activities, in certain cases a loan may be made outside the taxpayer’s ordinary
course of business while still being a transaction on income and not capital
account.
[69] I therefore turn now
to the application of the foregoing interpretive principles and guidelines to
the facts in the instant appeal. Heron Bay acted as “banker”
for Conservatory Group member companies.
A taxpayer can be a moneylender or have moneylending activities as part of its
ordinary business but make loans without this being done in the ordinary course
of business. While Heron Bay regularly loaned money from its retained earnings
to Conservatory Group member companies, often on non-commercial terms, such
loans were not typically made on a non-recourse basis. The appellant company apparently
made and received hundreds of loans between 1988 and 1995. Only two such loans made by Heron Bay, however, were without recourse: namely, the loan in
dispute in the instant appeal and another one to Shellfran Investments, a
Conservatory Group member company. Ultimately, both loans were written off as
doubtful or bad debts on the strength of an appraisal obtained by Heron Bay. This
fact is reflected in the question-answer sequence below from the
cross-examination of Mr. Libfeld, found at page 135 of the trial transcripts,
commencing at line 9:
Q. . . . If you look at
Tab 23 in the same Book of Documents, you will see a promissory note from
Shelfran Investments?
A. Yes.
Q. And this promissory note was
made without recourse?
A. Yes.
Q. If we look to every promissory
note you have produced in these volumes, this is the only other note that was
made without recourse. You understand that?
A. Yes.
Q. In this case, the taxpayer
again obtained an appraisal, and again claimed a bad debt in respect of this
particular transaction; is that not so, Mr. Libfeld?
A. If you tell me so. . . .
Q. You understood, I would
suggest, that there was a benefit in writing down your inventory, to defer the
taxation in respect to the borrowing company, and to claim a bad debt in the
lending company.
And you could accomplish both of
the things through the use of a non-recourse promissory note.
You understood that, didn’t you,
Mr. Libfeld?
A. Yes.
[70] Mr. Libfeld’s
answers to the above questions are revealing when considered in the context of
his overall testimony. He testified that he believed Runnymede was
not living up to the terms of the transaction negotiated with his late father.
In his eyes, the Conservatory Group enjoyed a right of first refusal rather
than a right of first purchase. A right of first refusal had greater value for
the Conservatory Group as it required Runnymede to solicit bona fide
offers from third parties. The Conservatory Group would have the opportunity to
scrutinize the offers in deciding whether or not to exercise the right of first
refusal. In brief, because Runnymede acted on the basis that its obligation was one
resulting from the granting of a right of first purchase, Mr. Libfeld felt that
the group may have been placed in the circumstance of having overpaid for the
property.
[71] In that context,
it is not unreasonable to believe that the related-party financing transactions
were structured to allow of a double deduction if the Conservatory Group was to
develop the land and incur a loss in the process. Mr. Libfeld acknowledges
that he is familiar with the tax aspects of the transactions. First, the joint
venturers, as the owners of the land, are entitled to write its value down to
fair market value and claim a business loss, assuming they can demonstrate that
the land had decreased in value. Second, by making the loan by Heron Bay to
Viewmark Homes a non-recourse loan, Heron Bay increased the chances that it
would be able to claim a reserve for a doubtful debt as Heron Bay would not
have access to Viewmark Homes’ other assets and investments.
[72] As noted earlier,
Mr. Libfeld failed to persuade me that the loan was made non-recourse for
commercial purposes. None of the other related-party loans made by Heron Bay had
this limitation save for the other loan, to Shellfran Investments, in respect
of which a doubtful debt deduction was also claimed.
[73] I do not find the
mere fact that the Conservatory Group could benefit from a double deduction to
be particularly offensive. Heron Bay would be entitled to a deduction provided that it met
all of the conditions laid out in paragraphs 20(1)(l) or (p),
which I do not believe it has done. In the present case, the specific terms and
features of the non-recourse debt made it extraordinary and put it outside Heron Bay’s
ordinary course of business. This, in tandem with the non-arm’s length
relationship between Heron Bay and Viewmark Homes, as well as the fact that
both non‑recourse loans were written off by Heron Bay as bad or doubtful
debts, all suggests to me that something was going on, something outside the
ordinary course of the taxpayer’s business.
[74] Mr. Libfeld was
given the opportunity during cross-examination to explain the underlying reason
for making the loan to Viewmark Homes non‑recourse. He stated, commencing
at line 12 of page 134 of the trial transcript, that “to protect the interests
of all the companies involved, we made it non‑recourse . . .”.
To similar effect is the following question-answer sequence from the examination-in-chief
of Mr. Libfeld, commencing at line 6 of page 67 of the trial transcript:
Q. Could you tell us what
security, if any, Heron Bay took with respect to this loan?
A. Heron Bay took Viewmark’s
interest in Marlo as security for this loan.
Q. Was there any other form
of recourse?
A. No.
THE COURT: I would
like to ask the witness a question.
We are dealing with related
companies at this point. Without questioning your judgment, why would you make
a non-recourse loan? What difference did it make, from a business or
commercial standpoint?
THE WITNESS: We wanted to
protect corporations within the system.
It would be beneficial to make it
non-recourse, so if there was a problem with one of the other corporations, it
wouldn’t end up affecting it.
. . .
THE WITNESS: The
commercial reason is to protect. If something happened, we wouldn’t want
people to be able to go through one company to another, to be able to realize
on that loan.
We didn’t want to put Viewmark at
risk, if something happened to Heron Bay.
. . .
THE WITNESS: . . .
it is structured in a way that we protect the interest of the system, so to
speak, in terms of not allowing one corporation to end up triggering a domino
effect throughout the rest of the system.
[75] While a borrower
may request that a loan be non-recourse for bona fide commercial
reasons, I do not find Mr. Libfeld’s explanation —
namely the protection of Viewmark Homes’ assets from Heron Bay — to be credible. Heron
Bay often borrowed on a full recourse
basis from corporations within the group and loaned on a full recourse basis. This included a loan from
Viewmark Homes to Heron Bay in excess of $5 million. The inference could thus
be made that, but for the without a recourse restriction on the promissory
note, Viewmark Homes would have had the capacity to satisfy the debt. That is,
rather than loan the money, Heron Bay could, in my view, have instead repaid the loan
it received. Heron Bay could have
offset one loan against the other, were it not for the without-recourse element
of the loan.
[76] Additionally, it
does not appear from the evidence that Runnymede, the entity to which was owed a
balance of sale price secured by the land, requested that the loan be made
non-recourse. There is also no evidence that the banks lending to the
Conservatory Group requested this feature. Generally speaking, unrelated
creditors may demand subordination of related-party indebtedness to provide
better security for their loans.
[77] In the end, I
find that the loan was extraordinary and abnormal. It deviated from the types
of loans that Heron Bay would generally make in the course of its business.
This is particularly true if one bears in mind the interpretation to be given
to the concept “ordinary course” pursuant to the decision of this Court in Société
d’investissement Desjardins, above. The loan fails to fall into place as
part of the undistinguished common flow of Heron Bay’s business. It is clearly different from Heron Bay’s day-to-day business and its practice of making full
recourse loans. In the absence of any credible and convincing evidence to the
contrary, I draw a negative inference from the circumstances presented to me:
that is, the loan was made non-recourse to facilitate its earlier write-off.
[78] Considering the
other with-recourse loans made back and forth between the related entities and the
almost immediate bad debt claim with respect to the without‑recourse loan,
the assertion that the without-recourse feature was designed to protect the
interests of Heron Bay from third parties is difficult to accept as an
accurate and realistic portrayal of what was really occurring. The “ordinary
course” requirement in paragraph 20(1)(l) serves to prohibit the
doubtful debt reserve even in the case of persons that loan money as part of
their business, unless the loan is made in the ordinary course of the
taxpayer’s business.
C. Whether the Debt Was
Doubtful or Bad
[79] The test for bad
debts and doubtful debts was stated by Justice Reed in the decision Coppley
Noyes & Randall Ltd. v. Canada (M.N.R.), [1991] F.C.J. No. 347 (QL)
(FCTD), in which she quoted paragraph 22 of Interpretation Bulletin IT-442 –
Bad Debts and Reserve for Doubtful Debts, as follows:
. . .
For a debt to be classed as a bad debt there must be evidence that it
has in fact become uncollectible. For a debt to be included in a reserve
for doubtful debts it is sufficient that there be reasonable doubt about
the collectibility of it. . . .
[Emphasis added.]
[80] The question of
when a debt is to be considered uncollectible is a matter of the taxpayer’s own
judgment as a prudent businessman (Flexi-Coil Ltd. v. R., 1995
CarswellNat 1380, [1996] 1 C.T.C. 2941, at paragraph 22).
[81] In the case of doubtful
debts on the other hand, “doubtful” means there must be some reasonable doubt
as to the collectibility of the principal amount of the debt obligation. It is
sufficient if there is some reasonable doubt as to the timeliness of payments.
(Ryan Keey, Carol Klein Beernink and Joscelyn Affonso, eds., Canada Tax
Service, vol. 4 (Toronto: Thomson Reuters Canada Limited, 2009), at 20‑1406).
[82] Accordingly, the
test appears to be more flexible for doubtful debts than for uncollectible
debts. In Highfield Corporation Ltd., above, Mr. Taylor confirms
this by stating the following in his decision (paragraphs 34 and 35
CarswellNat, page 1847 DTC):
. . .
A “Reserve for doubtful debts” established under section 20(1)(l) of the Act
would seem to leave with the taxpayer a much greater degree of flexibility
in using business judgment with regard to the inclusion of amounts in such a
reserve than is permitted to a taxpayer in claiming a deduction under section
20(1)(p) of the Act for a “bad debt”. The term “doubtful debt” in
itself can mean only what it says – the debt is owing and possible of
collection, but that possibility is not sufficiently certain in the mind of the
taxpayer that he wishes to be placed in the disadvantageous position of
having to pay income tax thereon before that possibility has become more of a
certainty.
In effect, a
taxpayer may be given a year’s grace with the application of section 12(1)(d)
of the Act serving to bring the reserve back into income in the following year,
at which point he is presumably required or permitted to re-examine the
situation and reserve against the amount again, or not do so depending on his
business judgment then, and the situation at that time. Obviously if his
original concern regarding collectibility has been ill-founded and the amount
collected in the interim, it would be credited as income. Conversely, under
section 20(1)(p) of the Act, it is necessary for the taxpayer to
establish that the amount at issue is a “bad debt” – in simple language
uncollectible. It has gone beyond any reasonable hope of recovery and is
effectively worthless (not merely doubtful) as an asset. That, as I see
it, requires considerably greater support for the claim than may be required
under section 20(1)(l).
[Emphasis added.]
[83] An honest and
reasonable determination is needed in order to establish that the loan was bad
(Rich, above, at paragraph 28). A reasonable determination will be based
on a contextual review of all of the factors that come into play in the
particular situation.
[84] Rothstein J.A. summarized
the factors — similarly to those adopted in Hogan v. M.N.R., 56
DTC 183 (ITAB) — that should be taken into account in determining
whether a debt has become bad, at paragraph 13 of Rich:
1.
the history and age of the debt;
2.
the financial position of the debtor, its revenues and expenses,
whether it is earning income or incurring losses, its cash flow and its assets,
liabilities and liquidity;
3.
changes in total sales as compared with prior years;
4.
the debtor’s cash, accounts receivable and other current assets
at the relevant time and as compared with prior years;
5.
the debtor’s accounts payable and other current liabilities at
the relevant time and as compared with prior years;
6.
the general business conditions in the country, the community of
the debtor, and in the debtor’s line of business; and
7.
the past experience of the taxpayer with writing off bad debts.
This list is
not exhaustive and, in different circumstances, one factor or another may be
more important.
[85] At paragraph 14 of Rich, Rothstein J.A. went on to state:
While future prospects of the debtor company may be relevant in some
cases, the predominant considerations would normally be past and present. If
there is some evidence of an event that will probably occur in the future that
would suggest that the debt is collectible on the happening of the event, the
future event should be considered. If future considerations are only
speculative, they would not be material in an assessment of whether a past due
debt is collectible.
[86] Rothstein J.A. confirms
that there is no one specific factor that must be present for a debt to be
classified as a bad debt. The uncollectibility of a debt is determined on the
basis of the consideration of many factors. While Rich is a case that
deals with bad debts, the factors considered for bad debts also apply to
determining whether debts are doubtful; it is simply a matter of adapting them to
take into account the fact that for doubtful debts the threshold is lower, as
the collectibility of the debt need only to be doubtful. (Interpretation
Bulletin IT-442R at paragraphs 23 and 24).
[87] Heron Bay argues that the decision to write off the
$3,770,000 loan receivable in its 1995 taxation year was a business judgment
and as such should not be questioned as it was honestly and reasonably made on the basis of the facts
and the valuation of the asset at that point in time. In the alternative, Heron Bay suggests that the write-off was valid because the
loan was uncollectible.
[88] Dealing with the
doubtfulness issue first, I agree that a taxpayer is generally in the best
position to determine whether a receivable from a client is doubtful or not.
In this case, however, there are some questions that arise after consideration
of the factors relevant to the situation.
[89] This is what emerges from the application of some of the factors listed in the Rich decision
above:
D. History and Age of
the Debt
[90] In considering
the history of the debt written off, the time period between the date the loan
was made (late in the 1994 fiscal year) and its write-off by Heron Bay in its
year ended August 31, 1995, was short. During cross-examination, Mr. Libfeld
confirmed that Heron Bay never made
any demands on Viewmark Homes for repayment of the whole or any part of the
debt.
[91] It is important
to note that it is unnecessary for a creditor to exhaust all possible recourses
for collection. All that is required is an honest and reasonable assessment (Rich,
above, at paragraph 15). Nonetheless, considering the fact that Heron Bay owns
Viewmark Homes, the two entities were not dealing at arm’s length, and accordingly,
the write-off warrants closer scrutiny. As Justice Rothstein stated in the Rich
decision at paragraph 16:
. . .
The non-arm’s length relationship may justify closer scrutiny than in [arm’s]
length situations. But a non-arm’s length relationship alone, without more,
cannot lead to a finding that the creditor did not honestly and reasonably
determine the debt to be bad.
[92] The additional
factors that follow will reveal why closer scrutiny is warranted in this case.
E. The Financial
Position of the Debtor
[93] There was no
indication that Viewmark Homes was in financial difficulty. One example is that
Viewmark Homes had sufficient funds to lend a substantial sum to Heron Bay. The Minister argued that the balance sheet for the
year ended August 31, 1995 reflected a loan of $4,055,765 made by Viewmark
Homes to Heron Bay during the year.
Another example shows that Viewmark Homes had $15,000,000 in current net assets
for the 1996-1997 period of the joint venture, and that, in the 1997-1998
fiscal period of the joint venture, Viewmark Homes withdrew that same amount
from its capital account.
F. Valuation Reports
on the Value of the Land
[94] Mr. David Atlin,
the expert real estate appraiser for Heron
Bay,
determined the fair market value (FMV) of the 289 residential lots as at
November 30, 1994 to be $19,000,000
and the value of the favourable financing terms that helped finance the
purchase to be $3,563,255 for the buyer.
[95] Mr. John Davies,
the expert appraiser for the Minister, valued the lots in separate parcels (one
of 142 lots and the other of 147 lots). He confirmed that there would be no
difference in the result of his appraisal if the lots were determined together
(i.e. 289 lots).
Mr. Davies determined the fair market value of the land to be $22,160,000 in
his January 21, 2009 amended report.
[96] Both Mr. Atlin
and Mr. Davies used similar approaches in their valuation of the land, namely a
direct comparative approach, which compares market evidence with the subject
property using some standard unit of comparison. Mr. Atlin used price “per
front foot”, while Mr. Davies used price “per lot”. Mr. Atlin testified
that this particular difference, however, does not result in any material
differences in the value of the land.
Also, neither appraiser disputed the facts themselves with respect to the
property, that is, facts such as drainage issues, soil conditions, planning and
zoning status, etc.
Furthermore, both appraisers agreed on the general performance of the market.
[97] During the trial,
Mr. Atlin stated that the material differences between the two reports arise with
respect to:
(a) financing and
(b) the size of the development as it affected
absorption.
[98] With respect to
the financing element, Mr. Atlin noted that the subject property includes
non-arm’s length financing consisting of a one-year interest-free period and a relatively low
interest rate (prime + 1%) in relation to the loan‑to‑value ratio. Mr. Atlin stated the
loan-to-value ratio (i.e. the percentage of the purchase price which was
financed) to be 85% for parcel 1 and 82.5% for parcel 2. Mr. Atlin testified that
favourable financing would drive up the price, but not the value. He noted that
there is an important distinction between price and value. The total price for the
transaction was $24,400,000, which factored in the value of the interest-free
period and the favourable interest rates. Mr. Atlin then assigned a total value
of $3,536,255 to the favourable financing, which figure was made up of
$1,762,144 for the smaller parcel and $1,774,111 for the other parcel.
Subtracting the $3,536,255 (i.e. removing the impact of the financing) from the
$24,400,000 provides the cash sale equivalent.
During cross‑examination, Mr. Atlin agreed that there was no
significant change in value between August and November 1994.
[99] At this point it
should be noted that Heron Bay’s recourse to the joint venture’s assets extended
to both the land and the value of the favourable financing terms. Therefore,
the disagreement between Mr. Davies and Mr. Atlin over how much of the value
should be allocated to the favourable financing terms is irrelevant to the
issue being considered as, whichever way the value is allocated, both assets
support the loan debt owed by Viewmark Homes to Heron Bay. What separates the two experts is that, on the one
hand, Mr. Atlin says that what was acquired by Viewmark Homes was worth $1.4 million
less at year-end because of the absorption cost, while Mr. Davies disputes this
finding.
[100] With respect to the
size of the development, Mr. Atlin testified that there is a significant
downward adjustment for purchasing in bulk as compared to buying small lots. Mr. Atlin explained that in
a purchase of 289 lots, one would benefit from economies of scale and thus the
price would be reduced. Subtracting from the $20,400,000 purchase price a value
of $1,400,000 for the absorption cost gives a cash equivalent fair market value
of $19,000,000.
Mr. Atlin further stated that the intrinsic value of the land does not
change.
[101] Mr. Davies, on the
other hand, arrived at a final figure of $23,966,800 in his June 18, 2008
report. Mr. Davies relied mainly on the purchase and sale agreements entered
into between Runnymede and Burlmarie and Rosehue since, he testified, the
actual prices paid for property best represent its market value. Mr. Davies further
confirmed that there was no discernable change in market conditions between
August 1994, when the purchase and sale agreements were entered into, and
November 1994.
His initial figure of $26,425,275 for the 289 lots in the same report, arrived
at without the benefit of having the purchase and sale agreements available,
was based on comparable properties for which interest-free periods of varying lengths
were factored in.
Mr. Davies noted that all the comparables were inclusive of vendor take-back
mortgages at similar rates of interest (9%), and very similar time periods,
with the exception of the interest-free period. Mr. Davies stated that
the comparables were used to verify the price paid.
[102] The difference
between Mr. Davies’ initial report and his amended report dated January 21,
2009 was due to the fact that the interest-free periods of varying lengths were
taken out
of the calculation in order to reduce all sales to a common basis. This was
done because the transaction in Heron Bay’s case had
an interest‑free period of one year only. After the interest
adjustment, Mr. Davies testified, the total of $23,966,000 was allocated
as follows: $22,160,000 for the land and $1,806,004 for the interest benefit. Also, another report,
dated January 22, 2009, was made by Mr. Davies concerning
offers he was asked to consider. Mr. Davies confirmed that these offers — from Coughlan, Fram, and a numbered company — gave further credibility to the opinion that the
purchase and sale agreements were at market value.
[103] With respect to
adjustments for absorption, Mr. Davies testified that he understood Mr. Atlin
to say that there was considerably more risk in purchasing a larger‑sized
property than a smaller one because of the length of time it took to absorb (or
resell) the lots.
Mr. Davies stated that there was no attempt to sell the property as one
parcel, rather, it was divided into two separate parcels. He further testified
that an absorption adjustment was not warranted because larger builders were
able to obtain significant cost saving benefits from purchasing a large number
of lots, namely benefits, in terms of the bulk ordering of materials,
sequentially moving from house to house, professional fees (e.g. design,
legal), brokerage fees, and spreading the cost of a model home over a larger
number of houses (cost and the fewer number of model homes needed).
[104] Both appraisers
agreed that there was no overall change in the market from August 1, 1994
to the date the write off was claimed by Heron
Bay. Therefore, I find Mr. Davies’
approach to be preferable because he relies on the actual arm’s length sale in concluding
that the value of Viewmark Homes’ joint venture assets had not declined by the time
Heron Bay claimed its write-off.
[105] If I was to accept Mr. Atlin’s
view, I believe a reasonable conclusion could be drawn that Heron Bay’s cost of
the loan was overstated at the outset and should be reduced pursuant to
paragraph 69(1)(a) of the ITA.
[106] Paragraph 69(1)(a)
provides that where a taxpayer acquires property from a person with whom that taxpayer
was not dealing at arm’s at an amount in excess of its fair market value at the
time, the taxpayer’s cost shall be deemed to be that fair market value. Heron Bay gave
cash to Viewmark Homes, a non-arm’s length party, in exchange for intangible
property in the form of a loan receivable. On the face of it, paragraph 69(1)(a)
could accordingly apply, resulting in no deduction as the cost of the non-recourse
loan would be nil for Heron Bay. As Mr. Atlin testified that nothing had changed
in the real estate market over the period in question, presumably the
absorption costs that he used to justify a decline in the value of the land likewise
existed at the time of purchase. I recognize that the Respondent did not seek
to pursue this point when I raised it at trial. However, I simply cannot ignore
it if it is otherwise applicable.
[107] Soon after the loan
was made, a valuation was performed, and then the entire write-off occurred. In
fact, as noted earlier, the Appellant hired a valuator within 60 days of
the first advance of funds. In the past, a similar loan by Heron Bay to
Shellfran, a related entity, had been made, also on a non-recourse basis. After
that loan was made, an appraisal was obtained and the loan was written off. The non‑recourse
feature of the loan appears to have been added to facilitate the write‑off.
[108] In any event, I
find that Heron Bay is not entitled to the deduction claimed for all of
the other the reasons noted earlier.
G. The General
Business Conditions in the Community
[109] The expert
appraisers for Heron Bay and the Minister both agreed on the performance of
the general real estate market. In the late 1980s, the real estate market
experienced very good economic performance. Then there was a downturn in the
early 1990s, but by 1994 there were signs of recovery.
H. The Past
Experience of the Taxpayer with Writing off Doubtful Debts
[110] It is interesting
to note that the loan from Heron Bay to Viewmark Homes was made on a non-recourse basis.
Mr. Libfeld explained that the reason for this was protection: if something
happened to Heron Bay, they did not want creditors to be able to go through
Heron
Bay to Viewmark Homes.
I did not find this explanation to be very credible. While there were many
loans made by Heron Bay, only one
other was made on a non-recourse basis, also to a related party.
[111] Overall, there are
limits to how far deference will be given to business judgment. One case in
which those limits would apply is where the business judgment was clearly
unreasonable. As explained earlier, transactions between related parties may be
subject to closer scrutiny. In Flexi-Coil Ltd. v. R., above, affirmed
[1996] 3 C.T.C. 57 (FCA), it was noted at paragraph 20:
. . .
the supplier of goods is also the owner, financial backer and controller of the
customer: it is in a position to influence how the business of the customer
subsidiary is to be carried on, . . .
[112] And at paragraph 25
the following was stated:
To my
knowledge, the Act does not provide special rules for the determination when
the debts owing by related parties are bad. Therefore, the rules applicable to
arm’s length traders should apply to those not dealing at arm’s length. This
does not mean that courts should not be vigilant in ensuring that the related
creditor acted properly in determining that some debts had become
uncollectible.
[113] In Rich, above,
the taxpayer lent money to his son’s corporation, which could not repay the loan.
The taxpayer in Rich only held a 25% interest in his son’s corporation.
Both Heron Bay and Viewmark Homes were controlled by the Libfelds. Heron Bay also
held an equitable interest in Viewmark Homes and thus Heron Bay owned both the debt and the equity, thereby making it
easy to manipulate the terms of the loan. Accordingly, closer scrutiny is
warranted. Considering all the above factors, I believe that Heron Bay took
an early opportunity to write off this debt, a step that was not justifiable in
the circumstances. Among the primary factors that stand out is the fact that
little time elapsed between the loan and its write-off. There was no evidence
provided that showed a change in circumstances between the time the loan was
contracted and the date the write-off was claimed. In addition, the valuations
provided at trial revealed that the difference between them as regards the
value of the underlying property of the joint venture was small. Mr. Atlin, who
testified on Heron Bay’s behalf,
split the value between land and favourable financing. The only decline in
value was attributed to absorption. Mr. Davies, who testified for the Minister,
relied mainly on the purchase and sale agreements to determine the value, as these
provide the arm’s length price. He relied on prices and offers for comparable
properties to confirm that the recent arm’s length price should be preferred.
[114] With respect to the
alternative argument that the write-off was a bad debt, the criterion to be
met, as established above, is that the debt has become uncollectible. The
factors described earlier can also be used to assess the collectibility of the
debt. Looking at all the factors as a whole, one must conclude that Heron Bay has
not established that the loan was uncollectible. There is no evidence that the loan
amount or part thereof, was uncollectible. Accordingly, the requirements of subparagraph
20(1)(p)(ii) have not been met either.
I. Reasons
re: Rezoning Expenses
[115] The Respondent’s
position was that the rezoning expenses were capital in nature as they were a
one-time expenditure incurred to clear the way for the development of a high-rise
condominium that could be resold at a profit.
[116] Since no evidence on
submissions were provided by Heron Bay on this matter, the appeal can be dismissed with
regard to this issue. It would be useful nonetheless to just comment on the
general principles related to the analysis of such an issue.
[117] The first question
to be asked is whether an expenditure of this type is a current expense or a
capital expense. The distinction is not necessarily clear. If it is determined
to be a current expenditure, it is deductible in the year incurred. If it is
determined to be a capital expense, the next question to answer is whether it
is subject to capital cost allowance rules or whether it is an eligible capital
expense. If the answer is neither, then it is considered “nothing” and no
deduction is permitted on the amount of the expenditure (Tim Edgar & Daniel
Sandler, Materials on Canadian Income Tax (Toronto:
Carswell, 2005) at 486).
[118] The basic test for
determining whether an expenditure is capital in nature or not is the enduring
benefit test. The leading case on this had traditionally been the decision of
the House of Lords in British Insulated and Helsby Cables v. Atherton [1926]
A.C. 205 (HL), in which Viscount Cave held that (at pages 213-214):
when an
expenditure is made, not only once and for all, but with a view
to bringing into existence an asset or an advantage for the enduring
benefit of a trade, I think that there is a very good reason (in the
absence of special circumstances leaning to an opposite conclusion) for
treating such an expenditure as properly attributable not to revenue but to
capital
[Emphasis added.]
[119] This standard rule
was dealt a blow by the Supreme Court of Canada in a unanimous judgment
rendered by Estey J. in Johns-Manville Canada Inc. v. The Queen, [1985]
2 C.T.C. 111, at 119, who quoted Hallstroms Pty. Ltd. v. Federal
Commissioner of Taxation (1946) 72 C.L.R. 634, 648:
The
solution to the problem is not to be found by any rigid test or description.
It has to be derived from many aspects of the whole set of circumstances some
of which may point in one direction, some in the other. One consideration may
point so clearly that it dominates other and vaguer indications in the contrary
direction. It is a commonsense appreciation of all the guiding features
which must provide the ultimate answer. Although the categories of capital
and income expenditure are distinct and easily ascertainable in obvious cases
that lie far from the boundary, the line of distinction is often hard to draw
in border line cases; and conflicting considerations may produce a situation where
the answer turns on questions of emphasis and degree. That answer: “depends on
what the expenditure is calculated to effect from a practical and business
point of view rather than upon the juristic classification of the legal rights,
if any, secured, employed or exhausted in the process”.
[Emphasis added.]
[120] In essence, there
is no hard and fast rule in determining whether as expenditure is income or
capital in nature. Rather, a common-sense assessment of all the relevant facts is
required.
[121] With respect to
rezoning expenditures, The Cadillac Fairview Corporation Limited v. The
Queen, 97 DTC 405 (TCC), provides some guidance on how zoning costs should
be dealt with. In Cadillac Fairview, the corporate taxpayer incurred
substantial expenses to obtain density rights (air space rights) in respect of
a proposed building. The issue was whether the cost of obtaining zoning changes
permitting a higher density in buildings which the Appellant proposed to build
on land it owned in Toronto formed part of the cost of the land or of the
buildings, or was an eligible capital expenditure. Judge Bowman (as he then
was) stated the following at pages 413 and 414:
. . .
We may start from the proposition that in the absence of legislative or
other legal restrictions a landowner is free do to what it wants on its land.
It can farm it, build highrise apartments or office buildings, or build the Tower
of Babel. Its rights inhere in the ownership of the land. The exercise of
those rights can, however, be restricted, regulated or prohibited by legislation.
In this case the authority having that jurisdiction is the province and it
delegates the power to the municipal authorities.
The power of
municipal zoning is conferred upon the municipality by the Planning Act.
Section 34 of the Planning Act of Ontario R.S.O. 1990, c. P-13 reads in
part as follows:
(1) Zoning by-laws may be passed by the councils of local municipalities:
1.
For prohibiting the use of land, for or except for such purposes
as may be set out in the by-law within the municipality or within any defined
area or areas or abutting on any defined highway or part of a highway.
2.
For prohibiting the erecting, locating or using of buildings or
structures for or except for such purposes as may be set out in the by-law
within the municipality or within any defined area or areas or upon land
abutting on any defined highway or part of a highway.
3.
For prohibiting the erection of any class or classes of buildings
or structures on land that is subject to flooding or on land with steep slopes,
or that is rocky, low-lying, marshy or unstable.
4.
For regulating the type of construction and the height, bulk,
location, size, floor area, spacing, character and use of buildings or
structures to be erected or located within the municipality or within any
defined area or areas or upon land abutting on any defined highway or part of a
highway, and the minimum frontage and depth of the parcel of land and the
proportion of the area thereof that any building or structure may occupy.
. . .
(3) The authority to regulate provided in paragraph 4 of subsection (1)
includes and, despite the decision of any court, shall be deemed always to have
included the authority to regulate the minimum area of the parcel of land mentioned
therein and to regulate the density of development in the municipality or in
the area or areas defined in the by-law.
The origin of
that section is S.O. 1983, c. 1.
Presumably the
zoning by-laws of Toronto were enacted by it under the authority of a predecessor
to that section, possibly section 39 of the Planning Act, R.S.O. 1980,
c. 379 which is substantially the same as that contained in R.S.O. 1990. It
is important to recognize that zoning does not constitute a conferral of a
right but rather a restriction of the otherwise unlimited right of a landowner
to do what it wishes with its land. It is less accurate to describe a change in
zoning to allow a further use of land as the conferral of a right than to
describe it as a lifting or relaxation of a restriction on the otherwise
unrestricted use of the property. It follows that the right to use
property, whether restricted by zoning by-laws or not, is a right that inheres
in the ownership of the property. It is part of the bundle of rights that a
landowner has by reason of ownership of property. The cost of a
modification of the restrictions of the rights that a landowner has with
respect to the use of land is a part of the cost of the land. The cost of
lifting restrictions on the exercise of those rights clearly relates to the
cost of the bundle of rights that ownership entails. Density rights
have to do with what the owner can do with the land. If a landowner is
successful in improving the zoning of a parcel of land, and then sells it, it
is inconceivable that the revenue authorities could demur at the inclusion of
the cost of that rezoning in the cost of the land sold.
. . .
. . .
The cost of modifying rights relating to what one can do with land are [sic]
in my view a cost attributable to the land. They inhere in the land, whether or
not a structure is erected on the land. In this case the proposed Phase II has
not been erected. It requires something of a leap of faith to claim capital
cost allowance under Class 3 on a building that does not exist and may never
exist. The land however does exist, along with all of the rights that inhere in
it. The rights do not exist independently of the ownership of the land. If the
ownership of the land is transferred, the rights follow it.
[Emphasis added.]
[122] In the present case,
the property purchased by the Appellant consisted of an office building and
surface parking lot. Rezoning was obtained with respect to the parking lot in
order to permit the construction of a high-rise residential condominium
building whose condominium units were to be sold. Unfortunately the condominium
market declined and the sales contracts were terminated. At that point, Heron
Bay obtained an appraisal with respect to the Dundas Street property and, on the
basis of this appraisal, it was determined that the value of the portion of the
property attributable to the parking lot was less than the actual purchase
price of that portion of the land. Heron Bay submits in its notice of appeal
that deducting the $89,799 rezoning cost as an expense was equivalent to that
amount being added to its inventory and then a deduction being claimed pursuant
to subsection 10(1) of the ITA, since the fair market value of that
inventory item was less than its cost. Other than this statement, there were no
submissions or evidence presented on this issue.
[123] The Respondent, in
its written submissions, argued that the amount in question was a once-and-for-all
expenditure which would bring into existence an asset of permanent and enduring
advantage. The parking lot was capital property to the Appellant, and was
operated as rental property. It was not inventory, nor was it treated as such
by the Appellant. In any event, the case law referred to below will suggest
that the rezoning expenses should be added to the cost of the land. As Judge Bowman
(as he then was) stated in Sun Life Assurance Co. of Canada v. Canada,
[1997] T.C.J. No. 446 (QL):
16 Counsel
for the appellant contended that the acquisition of the density rights bore
directly on the economics of the operation in the sense that a larger building
could be constructed and increased rents would be received. This is, I
think, evident from the memorandum quoted above. Counsel also contended that
density rights and zoning by-laws have to do essentially with buildings. In support
of this he pointed to the City of Toronto Official Plan in which a number of
the definitions of density appear to focus on the size of building that may be
put on a lot.
17 I do
not necessarily disagree with these observations but, notwithstanding Mr.
van Banning's very able argument, I do not think that they are determinative
of the issue. In analyzing the question one must determine the true nature of
zoning. While I have no reluctance about reconsidering my own judgment in
Cadillac Fairview, or in distinguishing it, I am not persuaded that I reached
the wrong conclusion in that case. Nor can I see any rational basis for
reaching a different conclusion depending on whether a building is constructed
on the land.
18 I
continue to be of the view that since zoning determines what a landowner can do
with land it is an attribute of the land and that costs associated with
obtaining a change in zoning are part of the cost of land. Density rights have
to do with what an owner can do with land. They are, therefore, an integral
component in the value of land. They exist independently of their exercise and
independently of any present or future building. They would continue to exist
even if the building were demolished and the land were left vacant or another
building erected. In light of this, it cannot be said that they form part of
the cost of this particular building. The obtaining of higher zoning, or increased
density rights, may well affect the economics of the intended commercial
operation but this results from the fact that the landowner has obtained the
right to do more with the land. On one view of the matter one could say that
the cost of purchasing the land is an integral part of the economics of the
proposed commercial operation yet one could not include the cost of the land in
the cost of the building. Possibly one way of testing the conclusion would be
to envision the situation where the previous owner, before selling the land to
Sun Life, had negotiated with the church and, for a price, obtained a higher
density or more favourable zoning and as a result charged a higher price for
the land. The increased price for the land could not be attributed to the
building even though, in a sense, it relates to the type of building that can
be constructed on the land.
[Emphasis added.]
[124] While we have not
been provided with evidence as to the nature of the rezoning expenses incurred,
it would follow from the Respondent’s argument that no deduction is permitted
because the expenditure was a payment on account of capital and therefore
prohibited by paragraph 18(1)(b). Although the Respondent submits that the
rezoning expenses should be included as part of the cost of the parking lot, it
could be argued that the cost incurred for the rezoning should be added to the
land, in light of the case law mentioned earlier. Since no arguments or
evidence were presented by the Appellant in this regard, the appeal on this
issue is dismissed.
VIII. Conclusion
[125] The appeal is
dismissed. Under subparagraph 20(1)(l)(ii), Heron Bay
qualifies as a moneylender as there is an established system and continuity to
the loans it makes. It fails, however, to meet the ordinary-course-of-business condition
because non‑recourse loans are not the typical loans that Heron Bay makes. Finally, Heron Bay did not exercise informed judgment in the
circumstances and as a consequence failed to meet the reasonableness
requirement of the provision. The debt had not been outstanding for long, and
it has not been established that there were changes in circumstances that gave Heron Bay cause to doubt the collectibility of the debt.
Furthermore, the valuation evidence provided revealed that the difference in
the value of the property was small. Thus, in the absence of more cogent
evidence, there is nothing to establish that the write-off was reasonable. The
requirements under subparagraph 20(1)(p)(ii) have not been met
either, as there was no evidence provided that the debt was uncollectible.
[126] The cases considered by the Court are cited in
the Appendix.
Signed at Ottawa, Canada, this 8th day of September 2009.
"Robert J. Hogan"
Email this Content