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Citation: 2005TCC205
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Date: 20050411
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Docket: 2004-2943(IT)I
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BETWEEN:
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DAVID JOHNSON,
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Appellant,
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And
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
CampbellJ.
Introduction:
[1]This appeal is in respect to the Appellant's 1999
taxation year. In his tax return for that year, the Appellant
deducted an interest expense of $2,603.00 and an allowable
business investment loss ("ABIL") of $13,350.00. The
Minister reassessed the Appellant on March 31, 2003 disallowing
the ABIL in the amount of $13,350.00 and disallowing the
deduction of the interest expense in an amount of $2,560.00.
[2] The Minister confirmed the
Appellant's reassessment for the 1999 taxation year based on
the following assumptions of fact found at paragraph 19 of the
Reply to the Notice of Appeal:
19. In confirming the
Appellant for his taxation year 1999, the Minister assumed the
following facts:
(a) the Corporation
(the "Corporation" as defined in paragraph 4 of
this Reply) was incorporated under the Business Corporations
Act (Ontario) on March 11, 1988;
(b) the Appellant did
not substantiate that he invested the amount of $17,800 in the
Corporation;
(c) financial
statements of the Corporation for the fiscal year ending February
28, 1999 list $28,472 in cash, total assets of $1,187,155,
liquidities in an amount of $28,472, revenues of $181,739 and a
net profit of $2,834;
(d) the cheques
numbered 4 and 5 dated May 4, 1988 and June 9, 1988
respectively in the amounts of $4,590 and $4,080 made by the
Appellant to the Corporation were applied to the Appellant's
shareholder's loan account; and
(e) the Appellant did
not substantiate that he incurred interest expenses in excess of
an amount of $43 for the 1999 taxation year.
The assumption of facts outlined in paragraph c was first
made by the Minister in confirming the reassessment.
[Emphasis is mine]
Section B of the Reply, under the heading "Other Material
Facts", went on to list the following at paragraphs 20,
21 and 22:
20. The Appellant has not
proven that Corporation was a Small Business Corporation during
the 1998 and 1999 taxation years.
21. The Appellant did not
demonstrate that the Corporation was neither bankrupted nor
insolvent during the 1999 taxation year.
22. The Appellant did not
demonstrate that the Corporation permanently ceased to carry its
activities during the 1999 taxation year.
[3] The issues to be decided and as
listed in paragraph 23 of the Reply to the Notice of Appeal are
as follows:
23. The issues to be
decided are whether:
(a) the Corporation was
a Small Business Corporation;
(b) the Appellant is
entitled to a Business Investment Loss in the amount of $17,300
for his 1999 taxation year; and
(c) the Appellant is
entitled to a deduction of interest expense of an amount of
$2,560.
[4] As a preliminary matter, the
Respondent advised me that the parties had agreed that paragraph
20, listed under "Other Material Facts", was no longer
in issue and as a result paragraph 23(a) was no longer an
issue. The two remaining issues as contained at
paragraph 23(b) and (c) are therefore before me for
decision.
The Appellant's Evidence:
[5] Edward Securities Inc. was
incorporated on March 11, 1988 to carry on the business of
development of limited partnerships, particularly with respect to
Egyptian Arabian horses. These limited partnerships offered
investors farm loss deductions. David Edwards was the owner of
this company and he also owned six or eight other corporations.
One of these corporations was Edwards Arabians which owned a farm
property where the horses resided. In addition to its involvement
with limited partnerships, Edward Securities Inc. also registered
in 1988 with the Ontario Securities Commission to operate a full
securities company. According to the Appellant's evidence,
Mr. Edwards asked him to become a part owner of Edward Securities
Inc. He subscribed for 153 Class A preferred shares and paid
$15,300.00, as well as 25 Class A shares for which he paid
$2,500.00, together with 51 common shares at $1.00 per share. He
used personal lines of credit to purchase the shares. He stated
that this money went into a shareholder loan account to be
applied against the purchase of these shares because at the time
he put the money into the company the share structure had to be
first approved by the Ontario Securities Commission as part of
the licensing of the company as a securities dealer. Edward
Securities Inc. was required, by securities legislation, to
maintain as a reserve at all times $25,000.00 in net free capital
and $10,000.00 for a contingency bond. The corporation provided
this $35,000.00 amount through the purchase by the Appellant of
the 178 Class A preferred shares in the amount of $17,800.00 and
51 common shares in the amount of $51.00. The balance of the
$35,000.00 was paid through share subscription by David
Edwards.
[6] Eventually in 1996 and 1997, the
CRA successfully challenged the farm loss deductions which were
offered to investors through the limited partnerships and as a
result that revenue source ceased. In 1999 David Edwards held an
auction at the horse farm in Addison, Ontario where horses worth
from $30,000.00 to $60,000.00 were sold for as little as $300.00.
The farm property, which consisted of the farmhouse and two large
barns, was repossessed by the Business Development Bank.
[7] As a result of the horse auction
by Edwards, the Appellant stated that there was a great deal of
"bad press in the newspapers" where Edwards was
referred to as a horse thief, a crook and someone who was evading
taxes. This type of publicity occurred in July 1999. According to
the Appellant, Edwards Securities had no source of income
respecting these limited partnerships and its only other source
of income, the sale of mutual funds, also became non-existent. He
stated that David Edwards' credibility was so severely
affected by the media coverage that there were simply no more
clients and without clients there were no sources of income for
the company. David Edwards informed the Appellant that the
company no longer existed. Edwards was eventually prohibited from
ever having an investment license again within the Province of
Ontario. The Appellant had his license suspended for a two-year
period. The Appellant testified that the company basically ceased
to exist in December 1999. He expected that the company would
eventually be wound up. However the Appellant stated that
David Edwards simply destroyed all the records and books of
the company, without pursuing a formal dissolution, and walked
away. Edwards went through personal bankruptcy around 2001 and
listed all of his companies.
[8] There were no employees of Edward
Securities at the end of 1999. A part-time bookkeeper who
was trying to assist the few remaining clients in finding other
investment companies, was employed until August 1999. Most of the
investors of Edwards Securities owed money in respect to these
limited partnerships, but because they had been challenged by the
CRA, they were not paying their accounts to the company. Because
of all the negative publicity surrounding the limited
partnerships the mutual fund clients were leaving to go with
other brokers. He explained that the receivables listed on the
company's December 31, 1999 balance sheet had no value
because they were in respect to the other companies owned by
David Edwards and therefore they had no fair market value. In
respect to all of the companies, in which Edwards was involved,
the Appellant stated that they had no assets and no income.
According to the Appellant, the only asset of Edwards Securities
was "... the receivables from investors and there was no way
investors were going to pay up on investments that had gone down
the drain, basically." (Transcript, page 18.)
[9] On cross-examination, the
Appellant stated that, according to the Ontario Securities
Commission, the $35,000.00 reserve in Edwards Securities was to
be maintained and not be used. However David Edwards did
access some of this money in violation of the Securities
Commission Regulations. Once the part-time bookkeeper was
discharged in August 1999, very few entries were made on the
corporate balance sheet for the period ending December 31,
1999 and therefore the books were not up to date. The "Due
from Shareholders" entries were correct, he stated, but went
on to explain that they were due from related companies of David
Edwards which were insolvent. He also stated that any money
coming into Edwards Securities was being paid out to help fund
these other related companies. These amounts were all due on
demand plus interest bearing but they were all due from the
related companies owned by David Edwards. He also confirmed
that he did request payment of the loans receivable in respect of
the limited partnerships but those investors had walked away
after the CRA challenge and there was no hope of collecting. He
identified amounts on cross-examination that came into the
company under the heading "Due from Affiliates" and
re-routed to help the other related companies. He admitted
that the company had some revenue but that the revenue in 1999
was used to pay legal fees and expenses.
Respondent's Position:
[10] The Respondent's position is that
the Appellant is not entitled to an ABIL in the amount of
$13,350.00 since he has not satisfied the conditions set out in
subparagraph 50(1)(b)(iii) of the Income Tax
Act (the "Act"). In addition the Appellant
is not entitled to deduct the interest expense of $2,560.00.
[11] In respect to the claim for an ABIL,
the Respondent placed the most emphasis on the first condition in
subparagraph 50(1)(b)(iii). To support the contention
that Edwards Securities at the relevant time was not in a state
of insolvency, a number of arguments were relied upon which are
dealt with in detail in my analysis.
[12] In respect to the last three conditions
of subparagraph 50(1)(b)(iii), the Respondent argued
that the Appellant had not presented sufficient evidence to
satisfy these three conditions.
[13] With respect to the second issue, the
deductibility of the interest expense, the Respondent again
argued the lack of supporting documentation.
Analysis:
Issue #1:
[14] Is the Appellant entitled to an ABIL
for the 1999 taxation year? With respect to the ABIL, the only
remaining issue is whether or not the Appellant can meet the four
criteria listed in subparagraph 50(1)(b)(iii) of the
Act which states:
50. (1) For the purposes of this subdivision, where
...
(b) ...
(iii) at the end of the
year,
(A) the corporation is
insolvent,
(B) neither the
corporation nor a corporation controlled by it carries on
business,
(C) the fair market value
of the share is nil, and
(D) it is reasonable to
expect that the corporation will be dissolved or wound up and
will not commence to carry on business
and the taxpayer elects in the taxpayer's return of income
for the year to have this subsection apply in respect of the debt
or the share, as the case may be, the taxpayer shall be deemed to
have disposed of the debt or the share, as the case may be, at
the end of the year for proceeds equal to nil and to have
reacquired it immediately after the end of the year at a cost
equal to nil.
[15] The Reply to the Notice of Appeal does
not contain assumptions of fact relating to the last three
conditions found in subparagraph 50(1)(b)(iii) and except
for the Crown's allegations, no facts would have been assumed
respecting the first condition. While the file was in the
Minister's hands, the only assumed fact with respect to the
ABIL was that the investment of $17,800.00 was not substantiated.
(See the Assumptions of Fact and other Material Fact reproduced
at pages 2 and 3 of this judgment.)
[16] It therefore follows that the onus of
proof, with respect to these four conditions in subparagraph
50(1)(b)(iii) should lie with the Respondent and not with
the Appellant as it usually does in such appeals. In support of
this, I refer to the case of Canada v. Loewen, [2004]
F.C.A. 146 where Justice Sharlow, at paragraphs 10 and 11,
summarizes the rule as follows:
[10] Nor is it open to the Crown
to plead that the Minister made a certain assumption when making
the assessment, if in fact that assumption was not made until
later, for example, when the Minister confirmed the assessment
following a notice of objection. The Crown may, however, plead
that the Minister assumed, when confirming an assessment,
something that was not assumed when the assessment was first
made: Anchor Pointe Energy Ltd. v. Canada, 2003 DTC 5512
(F.C.A.).
[11] The constraints on the
Minister that apply to the pleading of assumptions do not
preclude the Crown from asserting, elsewhere in the reply,
factual allegations and legal arguments that are not consistent
with the basis of the assessment. If the Crown alleges a fact
that is not among the facts assumed by the Minister, the onus of
proof lies with the Crown. This is well explained in Schultz
v. Canada, [1996] 1 F.C. 423 (C.A.) leave to appeal to the
S.C.C. refused, [1996] S.C.C.A. No. 4.
[17] At paragraph 40 of Jacques St-Onge
Inc. v. The Queen, 2003 DTC 153, Justice Archambault
stated the following:
[40] However, this question was
never raised either in the Respondent's pleadings or at the
hearing. The facts set out in the Reply to the Notice of Appeal,
which the Minister relied on in making his assessment, make no
reference to Salvage's solvency status. No application was
made to amend the Reply to the Notice of Appeal. The argument
related only to the issue of whether it was reasonable to expect
on April 30, 1994, that Salvage would be dissolved or wound up.
According to the case law concerning the burden of proof, what a
taxpayer must do is demolish the facts on which the Minister
relied in making his assessment. If the Minister did not state a
relevant fact in his Reply to the Notice of Appeal, it is
difficult to criticize the taxpayer for not having demolished it.
It would therefore be totally inappropriate to dismiss
Management's appeal on the basis of its solvency.
This rational applies to my conclusions on the last three
conditions of subparagraph 50(1)(b)(iii) and I could
dispose of these three conditions on this basis alone. Even if I
do not rely on the decision in the case of Jacques St-Onge
Inc., I remain unconvinced by the Respondent's arguments
on these last three conditions of subparagraph
50(1)(b)(iii)
[18] The Respondent's arguments, made in
summation, regarding these last three conditions, are as
follows:
As for the second condition found in section 50(1)(b)(iii),
that neither the corporation or a corporation controlled by it
carries on business -
Whether or not a business has ceased is a question of
fact.
The evidence revealed that Edwards Securities, in December of
1999, as well as the Appellant and Mr. Edwards, the other
shareholder, were still registered with the Securities
Commission.
The Financial Statement of February of 1999, Exhibit R-1,
indicated a net income of $2,839. As well, the Balance Sheet of
December of 1999, Exhibit R-2, showed that the Accounts Payable
had increased in the amount of $1,923 since February, this
indicating a certain activity. Therefore, it is submitted that
the Appellant had not demonstrated that Edwards Securities had
ceased to carry on business.
As for the third condition, which is that the value of the
share is nil, the Appellant did not present direct evidence on
this point. However, the Financial Statement, Exhibit R-1, and
the Balance Sheet, Exhibit R-2, do show that the shareholder
equity did increase from February to December of 1999; therefore,
on their face, those two documents establish that as of December
of 1999, the value of the share was not nil.
As for the final condition, which is found at Section
50(1)(b)(iii), it is reasonable to expect that the
Corporation will be dissolved or wound up and will not commence
to carry on business.
There again the Appellant testified that he thought the
Corporation would be dissolved or wound up at some point. He did
not present any other evidence.
(Transcript, pages 90-91.)
[19] The short answer to the
Respondent's arguments respecting these last three conditions
at subparagraph 50(1)(b)(iii) is that at the end of the
1999 taxation year, Edwards Securities Inc. was simply worth
nothing and had no prospect of commencing business operations
anytime in the future. The evidence of the Appellant sets out the
state of affairs of Edwards Securities in 1999. Because of the
CRA challenge, limited partnerships in farm loss deductions could
no longer be offered and as a result the horses had been
auctioned off at sacrifice prices, the farmland and barns had
been repossessed, Edwards' investment license was taken from
him permanently and the Appellant had his license suspended for a
period of two years. Because of the bad publicity and media
coverage surrounding the horse auction, Edwards was construed as
a thief and crook. With all credibility gone, investors in the
mutual funds aspect of the company exited, as the Appellant put
it, "in droves". With no clientele and no prospect of
any, how could there by any value to this company or its shares
or any prospect of it continuing or re-commencing business.
[20] From this evidence, and from the
evidence as a whole, it is clear that at the end of the 1999
taxation year:
(a) The corporation was not
carrying on business and the Respondent did not question whether
"a corporation controlled by it carries on business"
under clause 50(1)(b)(iii)(B);
(b) The fair market value of the
corporation's shares were nil; and
(c) It was "reasonable to
expect", with reference to both the subjective and objective
test of reasonable (as dealt with by Justice Archambault at
paragraphs 25-36 of Jacques St-Onge Inc.) that the
corporation would be dissolved or wound up and would not commence
to carry on business. In fact here the evidence supports that the
corporation has not carried on business since 1999.
[21] With respect to these last three
conditions of subparagraph 50(1)(b)(iii), I conclude
that the Respondent has not met this burden respecting the ABIL.
Even if the burden had not shifted and remained with the
Appellant, I would have come to the same conclusion because I
found the Appellant a credible and straightforward witness. I am
therefore prepared to accept his version of the facts in response
to the Respondent's arguments.
[22] I turn next to the first condition of
subparagraph 50(1)(b)(iii), that is, was the
corporation insolvent at the end of the 1999 taxation year, which
is the condition where the Respondent placed the most emphasis
and reliance.
[23] The Respondent initially addressed the
definition of the term "insolvent". Although it is not
defined in the Act, the Respondent stated that "...
it is reasonable to expect that the usual meaning of
"insolvency" - namely, the inability to pay liabilities
as they come due - is the meaning that should be given to the
word". (Transcript, page 86.) The first question which
arises from the definition offered by the Respondent is whether
this meaning of "insolvency" is the one to be used for
the purpose of subparagraph 50(1)(b)(iii). According
to several passages contained in the decision of Will-Kare
Paving & Contracting Ltd. v. Canada, [2000] 1 S.C.R. 915,
it is pertinent to first consider whether the word
"insolvency" has an "established and accepted
legal meaning (paragraph 33 of Will-Kare). According
to the Supreme Court decision in Robinson v. Countrywide
Factors Ltd., [1978] 1 S.C.R. 753, there should be both a
"technical and a general sense" attached to the word
"insolvency". Laskin C.J.C., dissenting in this
decision, summarized the two as follows at page 760:
The view taken by the Privy Council and by this
Court as to the meaning of "insolvency", as well after
as before the abolition of Privy Council appeals, has been a
uniform one. Lord Thankerton, speaking for the Privy Council
in the Farmers' Creditors Arrangement Act reference,
supra, at p. 402, expressed it as follows:
In a general sense, insolvency means inability to
meet one's debts or obligations; in a technical sense, it
means the condition or standard of inability to meet debts or
obligations, upon the occurrence of which the statutory law
enables a creditor to intervene with the assistance of a Court,
to stop individual action by creditors and to secure
administration of the debtor's assets in the general interest
of creditors; the law also generally allows the debtor to apply
for the same administration.
[24] Subparagraph 50(1)(b)(ii), which
is located in this provision just prior to the relevant section I
am dealing with here, states:
(ii) the corporation
is a corporation referred to in section 6 of the
Winding-up Act that is insolvent (within the meaning of
that Act) and in respect of which a winding-up order under that
Act has been made in the year, or ...
Section 3 of the Winding-up and Restructuring Act,
R.S.C. 1985, c. w-11, as amended by 1992, c. 26, s. 19, deems a
company insolvent in six different instances, one of which is
"if it is unable to pay its debts as they become due"
(paragraph 3(a)). This Act seems to extend the general meaning of
"insolvency" by deeming, for example, acknowledgement
by the company of its insolvency (para. 3(d)). Should this
be applied in like fashion to subparagraph 50(1)(b)(iii)?
I believe that since Parliament explicitly included a reference
to this Act in subparagraph 50(1)(b)(ii) but
not in subparagraph 50(1)(b)(iii), then Parliament clearly
intended that the general definition of "insolvency"
would apply in subparagraph 50(1)(b)(iii). Since the
definition proposed by the Respondent is similar to the general
definition found in the case of Robinson, I propose to use
the Respondent's general definition in my analysis of the
first condition of subparagraph 50(1)(b)(iii), that
is, whether the corporation is insolvent at year end. I also base
this on the fact that I would arrive at the same conclusion
whether I relied on the general definition or the technical
definition.
[25] The Respondent offered a number of
arguments as to why the corporation was insolvent at the end of
the 1999 taxation year. Firstly, the Respondent argued that the
documents offered by the Appellant, the financial statement and
the balance sheet, did not clearly establish that the corporation
was insolvent. (Transcript, pages 85-86.) This summary by the
Respondent of the Appellant's position respecting these
documents is not entirely accurate. During his testimony, the
Appellant made the following clarification regarding the
corporation's balance sheet for the period ending December
31, 1999:
This came from the internal accounting records of the
"New Views Accounting Programme" of Edwards Securities
and although it says "Dec. 31, 1999", the bank was only
reconciled up until August 31st. So very few entries
actually were in there from August 31st to the end of
December. (Transcript, page 38.)
In addition the other main shareholder of the corporation,
David Edwards, destroyed all of the books and records of the
corporation before he "walked away", according to the
Appellant's testimony. This fact brings into question the
reliability of the corporation's balance sheet in its
totality. However, I accept the Appellant's evidence
concerning those entries in the balance sheet where the Appellant
could justify them. The corporation's part-time bookkeeper
was employed only until August 1999 and at that time the
Appellant stated very few entries were made subsequent to this.
The Appellant here had to depend on the few records he could
collect and his recollections respecting the financial position
of the corporation during this period. Since I accept the
Appellant's evidence as credible, I reject the
Respondent's submissions in respect to these documents.
[26] Secondly, the Respondent argued
that:
The Appellant testified that $25,000 of this amount could not
be used, as it was a reserve requirement of the Securities
Commission. In the Balance Sheet, Exhibit R-2, dated
December 31, 1999, the amount appearing on that document was
$10,922. The Appellant explained that it was his feeling that
Mr. Edwards was probably the one that took the money out of
the account. (Transcript, pages 86-87.)
[27] Although there was no direct evidence
on this point, the implication was that this reserve was to be a
constant if the corporation was to retain its license and good
standing with the Ontario Securities Commission. When the balance
sheet shows a reduction in the reserve at December 1999 then I
conclude the reduction is attributable to Mr. Edwards' use of
this money, as the Appellant alleged, even though he would have
been prohibited from using it. I therefore do not believe that
these amounts were available to pay liabilities as they became
due. In addition, the Appellant testified that Edwards would have
withdrawn the funds in issue for purposes other than those
relating to corporate business. The Appellant's own testimony
on cross-examination best describes the circumstances respecting
the use of this money:
Q. ... The cash,
now, is in the amount of $10,922.12; therefore, you will agree
with me that there is less than $25,000?
A. Absolutely. He
chewed up some of that. And that again is a violation of OSC
Rules.
So, yes, that is correct, that figure.
Q. Therefore, on
December 31, 1999, Edwards Securities was still registered with
the Securities Commission?
A. It was still
registered, but had not - the Filing was supposed to be for
February 28th. The normal Filing would have been
February 28, 2000. He thought he could put the money back -
I'm assuming he thought he could put the money back before
there was any violation. But --- (Transcript, page 40.)
[28] Based on the Appellant's evidence,
which I accept as credible, the money was therefore not available
to pay the corporation's liabilities as they became due and
in any event it would be entirely insufficient.
[29] Thirdly, the Respondent's arguments
in respect to the corporation's assets were as follows:
As for Accounts Receivable, in February of 1999 the amount was
$16,971. The Appellant explained that this amount represented
commissions that were owed to Edwards Securities. He acknowledged
the fact that in December of 1999, as shown in Exhibit R-2,
Edwards Securities did receive this payment. However, he could
not explain what was done with this amount.
Another asset that figured on the Financial Statement
consisted of the Loans Receivable, in the amount of $15,000.
The Appellant testified that these loans were made to
investors. He acknowledged the fact that they were payable on
demand. He also stated that he tried to collect the amounts, but
could not produce any letters, and he did not take any actions
against these investors.
As for the "Due from Affiliates", in February of
1999, as shown in Exhibit R-1, the amount of $4,479 was owed to
Edwards Securities. The Appellant acknowledged the fact that he
did receive payment, but once again could not say what was done
with that money.
. . .
Finally, for the "Due from Shareholders", which was
the biggest asset shown in Edwards Securities Financial
Statement, in February of 1999 the amount was $1,094,283. The
Appellant testified that this amount was owed by a corporation,
622291 Ontario Ltd. The Appellant did not ask 622291 Ontario Ltd.
to repay this amount. Not even a small portion of it. He
acknowledged the fact that this amount was payable on demand, as
shown in Note 2 of the Financial Statement, Exhibit R-1.
Further, as shown by the Balance Sheet, Exhibit R-2, an amount
of close to $90,000 was loaned to 622291 Ontario Ltd. between
February of 1999 and December of 1999.
The Appellant testified that since 1998, Edwards Securities
was troubled financially.
This fact is clearly not substantiated by the Balance Sheet
and the Financial Statement, which showed that Edwards
Securities, in this period, was able to find $90,000.00 to
loan.
(Transcript, pages 87-89.)
[30] The Appellant stated that all or
substantially all of the amounts receivable by the corporation
were used to pay either the legal bills relating to the
Securities Commission's investigation of the corporation or
to assist other related companies controlled by Edwards. As for
amounts that were identified as "accounts receivable"
or "Due from Shareholders", according to the
Appellant's evidence, they contained for the most part,
amounts due from the other companies which Edwards controlled and
which were insolvent. In fact, in response to the question on
cross-examination: "Isn't it true that this 'Due
from Shareholders loan' ... in the amount of over
$1 million was payable on demand?" The Appellant
responded:
It was due on demand and interest-bearing, which is clearly
stated in the Notes. But they were all Companies owned by David
Edwards.
So, he could demand the money from himself. Big Deal!
It's in the Notes, but it doesn't really mean
anything.
(Transcript, page 47.)
His evidence was that some receivables had been sold on terms
to investors and were therefore owed by investors in respect to
the limited partnership projects but that there was no
expectation that they would pay "... on investments that had
gone down the drain, basically." (Transcript, page 18.) He
testified that he requested repayment of these loans but the
response was
A lot of laughter ... David Edwards handled pretty much
all of that. But the investors weren't going to pay for
something where they had lost all of their investment and all of
their deductions."
(Transcript, page 50.)
[31] Fourthly, in respect to the
corporation's equity, the Respondent argued as follows:
The Appellant also acknowledged the fact that between February
of 1999 and December of 1999, the amount of re-paid earnings
increased by $44,239. As a result, the Shareholder's Equity
also increased between February of 1999 and December of 1999,
from $495,644 to $540,883. (Transcript, page 88.)
[32] First, even if the equity could be
applied to pay liabilities as they became due, there would still
be more than $100,000.00 in the difference between the
$682,000.00 in liabilities and the $540,883.00 in equity. Second,
before the equity could be applied to the liabilities, there
would need to be shareholder approval. Third, transforming one
source of financing (equity) to another source of financing
(liability) does not improve, in theory, the corporation's
financial position. I therefore do not believe that the
Respondent's fourth argument respecting the first condition
of subparagraph 50(1)(b)(iii) is of much help in the facts
of this case.
[33] The Respondent's final argument
respecting clause 50(1)(b)(iii)(A) related to the
corporation's liabilities and went as follows:
Finally, for the liabilities of Edwards Securities, Exhibit
R-1, the Financial Statements and Exhibit R-2, the Balance Sheet,
both show that a Note was payable, and the Appellant referred to
a Subordinated Note of the amount of $682,000.
The Appellant testified that this Note was due to an
affiliated corporation. The Appellant also testified that there
were no actions pending to recover this amount. (Transcript, page
89.)
In addition the Respondent referred to the fact that between
February 1999 and December 1999 according to these documents, the
assets of the corporation had increased by $55,079.00 while the
liabilities had only increased by approximately $10,000.00.
[34] During 1999, most of the money received
by the corporation was not retained but was paid to David
Edwards' related companies. It is logical to assume here that
if further funds had been available to the corporation, the
appropriate legal avenues would have been pursued against the
corporation to recover the $682,000.00. Therefore at the end of
1999, this liability was still a heavy burden on the
corporation's finances. Had this not been the case, it may
have been possible to attribute a nil value to the corporate
liabilities. In that case I may have been inclined to follow the
reasoning expressed by the CRA in Technical Interpretation
9802347 (June 15, 1998) where it states:
... the word 'insolvent' should be given its ordinary
meaning since the term is not defined in the Act. The dictionary
defines 'insolvent' as follows: 'unable to pay its
debts'. Accordingly it is our opinion that a corporation
possessing neither assets nor liabilities at the end of the
taxation year could not as a general rule be considered insolvent
for the purposes of subparagraph 50(1)(b)(iii) of the
Act.
[35] Again I would have come to the same
conclusion respecting clause 50(1)(iii)(b)(A) even if
the burden had not shifted to the Respondent because I found the
Appellant's testimony credible.
[36] In summary, the Respondent has not met
the burden respecting the four conditions of the Act set
out in subparagraph 50(1)(b)(iii) and the Appellant is
therefore entitled to the ABIL for the 1999 taxation year.
Issue 2:
[37] In respect to the deductibility of the
interest expenses, the Respondent took issue with the lack of
supporting documentation.
[38] The Appellant's evidence respecting
these interest expenses was that he used lines of credit to
provide the money to the corporation in 1988 to become a part
owner. The money went into a shareholder loan account and was
eventually used to purchase shares. The investments, some of
which belonged to his wife, were in the vicinity of $80,000.00.
After using lines of credit to finance this amount he rolled it
into a mortgage against his residence. He testified that he was
unable to obtain supporting banking information for the Canada
Trust line of credit as the Toronto Dominion Bank had taken over
this trust company and all records relating to the relevant
period had been destroyed. Neither could he provide information
on his Scotia line of credit because he was informed that there
were no records, not even on microfiche, prior to 1990.
[39] Since some of the corporate investments
belonged to his wife, when asked how he calculated the interest
expense deduction for the CRA, he stated:
I forget what the breakdown is ... But the interest portion is
my percentage of that $80,000."
(Transcript, page 24.)
[40] Although the Appellant was a credible
witness, it is not sufficient, when there is no supporting
documentation and the Appellant is simply unable to provide any
satisfactory figures to support his claim, to be successful. The
Appellant needed to prove that:
(1) he borrowed money for the
"purpose of gaining or producing income from the business or
property";
(2) he was charged interest on the loan;
and
(3) he paid that interest.
[41] The Minister's position is summed
up in the testimony of Robert Dupont, an auditor with the
CRA, who stated in this regard:
Respondent counsel:
Q. Can you explain
to the Court why you disallowed the interest expense?
Mr. Dupont:
A. The interest
expense that Mr. Johnson claimed ---
He didn't give me
any documentation to show that the expense was incurred or that
it had been incurred for investment purposes.
(Transcript, page 72.)
. . .
A. He had stated,
also, that he had transferred that amount on to his mortgage and
that he had bought a house in 1987.
. . .
What we would have liked to have seen would have been the
mortgage documents from the Registry Office to show how much the
mortgage was at that time and then how much he would have
increased his line of credit; or how much he paid for the shares.
But I didn't get any of that information.
Justice Campbell:
Q. Did you ask for
that and it just wasn't provided?
A. Yes. It
wasn't provided.
(Transcript, page 75.)
[42] After hearing the evidence of the
Appellant and Mr. Dupont, I still have absolutely nothing
concrete before me that would permit me to attempt a breakdown of
the capital and interest charges. The Appellant did not supply
the necessary documents to the auditor nor did he provide me with
any explanation as to why a copy of his mortgage document from
the Registry Office could not be obtained. He had to know it
could be relevant as the auditor had requested it. The Appellant
made no attempt to provide this basic information nor did he
attempt to give me a reliable breakdown of the $80,000.00 as
between he and his wife. He simply stated that he forgot what the
breakdown was. The burden here is on the Appellant and he has
simply provided nothing in the way of documentary evidence or
corroboration from other witnesses. I consider it extremely
detrimental to an Appellant's case when they cannot
personally provide me with their own formulation of a breakdown
that they supposedly used in support of their claim. In addition
it would have been very easy for the Appellant to obtain a
duplicate registered copy of his mortgage documentation. I
therefore dismiss the Appellant's claim for a deduction of
interest expenses.
[43] The appeal is therefore allowed,
without costs, to the extent that the Appellant will be permitted
to claim the ABIL in the amount of $13,350.00.
Signed at Ottawa, Canada, this 11th day of April 2005.
Campbell J.
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