Citation: 2005TCC35
Date: 20050107
Docket: 2001-2751(IT)G
BETWEEN:
AILEEN ELLIOTT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
[1] Aileen Elliott appeals an income tax assessment for 1998
in which the Minister of National Revenue denied her an allowable business
investment loss ("ABIL") within the meaning of section 38 and
subsection 248(1) of the Income Tax Act ("Act").
[2] Ms. Elliott, a dental surgeon, is married to Donald Elliott.
Donald Elliott and his brother Michael Elliott were the sole shareholders
and directors of Michael & Donald Elliott Construction Limited
("Construction"). Construction was a small business corporation
within the meaning of subsection 248(1) of the Act and carried on the
business of general construction, mainly carpentry. As most small businesses,
the corporation had good and not so good years. In January 1993 the brothers
were working on a roof of a building. The scaffolding broke and both brothers
were seriously injured and could not work. Donald Elliott recalled that
Construction "burned up a lot of money that year".
[3] At the end of 1993, the corporation's credit was
"maxed out", according to Donald Elliott, and the company was in bad
shape. In 1993 Construction borrowed $20,000 from Ms. Elliott to pay bills and
"keep things running".
[4] Construction obtained some contracts in 1994 but the
profits were negligible. After the accident the bank ceased to be friendly,
said Donald Elliott.
[5] In 1996 Ms. Elliott made two loans to Construction, one
for $2,000 and another for $5,000. The company had a profit of $10,869 in 1996
but Donald Elliott commented that the company hired a "large
crew" that year and, in retrospect, the company should have shut down in
1993.
[6] Ms. Elliott made six more loans to Construction in 1997,
in May of $2,000, in June of $5,000, in November of $5,000 and $1,000, in
December of $10,000. Construction repaid her $2,000 in July.
[7] Construction had a line of credit with the National Bank
of Canada which was personally guaranteed by
Ms. Elliott. An interest rate of approximately 12 per cent was being
charged to Construction for the monies obtained on the line of credit. In
order to reduce the interest rate Ms. Elliott paid off Construction’s debt of
$40,245.61 to the National Bank. This took place in November, 1997.
Construction was not in default to the bank and the bank had not demanded that
Ms. Elliott made good on her guarantee. Ms. Elliott obtained the funds to pay the
bank by personally borrowing $40,000 from the Bank of Nova Scotia at an interest
rate of between 5 to 6 per cent; the loan was secured by a hypothec on the
family home owned by Ms. Elliott. Ms. Elliott paid the interest on the loan.
Construction was to reimburse her for any interest she paid on the loan and to
repay her the $40,000. Unfortunately, at the end of 1997 the company was
“running out of money”. By the end of 1997 the company was “cash poor”, stated
Mr. Elliott.
[8] Ms. Elliott agreed that she advanced money to
Construction for it to stay in business. She corroborated her husband’s
evidences that Construction agreed to repay her for the money she advanced and
to repay her for the money she borrowed from the Bank of Nova Scotia, plus the
interest she paid on the loan. She paid the money so that her husband could
make a living. She described her husband and brother‑in‑law as hard
working people and she thought that they would get through the difficulty and
pay her back.
[9] Mr. Elliott said that Construction paid no interest to
Ms. Elliott and that she was not entitled to any interest on the money she advanced.
There was, he declared, an understanding with his wife that if she had to
borrow money to pay interest on money borrowed to advance to Construction,
Construction would pay, or reimburse, her the interest she paid.
[10] Some of the funds advanced by Ms. Elliott to Construction
came out of a joint bank account she had with her sister-in-law, Michael
Elliott's wife. Donald and Michael also advanced money to Construction.
[11] In early 1998, the brothers met with Construction's
accountant, Michel Roussin, and decided to close down the company. At the
time the company owed $94,000 to Ms. Elliott. Ms. Elliott was not paid; the
debt was bad.
[12] Mr. Roussin had prepared Construction's financial
statements since 1978. The company's minute books were maintained, Mr. Elliott
stated, until 1995 by D. Kisilenko, a lawyer in Pointe Claire, Quebec. Mr. Kisilenko sent the minute
books to Construction for signature sometime in 1995 and then
"disappeared".
[13] A note to Construction's unaudited balance sheet as at
December 31, 1997 advises that "During the year ended December 31, 1997, 5,000
common shares were issued and fully paid in the amount of $50,000". Mr. Réjean
Gauthier, Mr. Roussin's former partner, testified $25,000 was converted
from loans to shares in each of 1996 and 1997. Apparently, according to Mr.
Elliott, Mr. Roussin advised him that Ms. Elliott should be a
shareholder. While Mr. Elliott could not speak to the truth of the
financial statements, he did acknowledge that his wife was not a shareholder of
Construction; the paperwork (i.e. the directors' resolution) was not completed until
2001 and no share certificate had been issued to her. Mr. Gauthier stated that
he thought that he saw a subscription for shares by Ms. Elliott. Ms. Elliott
testified that she never received a share certificate and did not consider
herself a shareholder of Construction.
[14] According to Construction's balance sheet as at December
31, 1997, the corporation had a deficit of $165,036.
[15] I accept every word of the testimony of the Elliotts. They
are good and honest people. Their evidence was a breath of fresh air in a dry,
warm courtroom. Their answers to questions posed to them were clear and unambiguous.
They told the truth even when the truth may have been contrary to
Ms. Elliott’s interests in her appeal.
[16] Appellant's counsel submitted that his client advanced
money to Construction, a small business corporation, over the years for the
purpose of earning income and incurred a loss when Construction was unable to
repay the loans; she was deemed to dispose of the debt in 1998 when it became a
bad debt: paragraph 39(1)(c), subparagraph 40(2)(g)(ii) and
paragraph 50(1)(a) of the Act.
[17] Counsel for the appellant agreed
that between 1993 and 1998 Ms. Elliott financed activities of a family business
operated through Construction of which her husband was a shareholder. She
should be entitled to an ABIL arising from the deemed disposition of her loans
to Construction regardless of whether she was technically a shareholder of the
company. She had a beneficial interest in her spouse's shares of Construction
and an indirect expectation to earn income. The only distinction between
claiming an ABIL, he submitted, on the disposition of loans rather than on
disposition of shares is that subparagraph 40(2)(g)(ii) of the Act
must be satisfied in the case of an ABIL arising from a loan. He declared that
the loans to Construction were made for the purpose of earning income and
therefore satisfy the requirements of subparagraph 40(2)(g)(ii) of the Act.
[18] The lending of money by Ms.
Elliott to Construction even without interest, counsel stated, resulted in the
creation of a potential source of income for her in light of the attribution
rules provided in the Act with respect to loans made directly or
indirectly to, or for, the benefit of a spouse. The payment by the appellant to
the National Bank to satisfy Construction's line of credit gave rise to an
indebtedness bearing interest in favour of the appellant, by the operation of
legal subrogation of rights.
[19] I cannot agree with appellant's
counsel that the appellant had a beneficial interest in her husband's shares of
Construction and an indirect expectation to earn income so that one could find
that she advanced money to Construction so as to earn income. I have no doubt
that Ms. Elliott did advance the funds to Construction and paid the National
Bank for the reason she said she did, for her husband to continue to make a
living from Construction, that is, for the family to earn income. If
Construction were successful it could pay salary and dividends to Mr. Elliott,
not the appellant.
[20] Paragraph 39(1)(c) of the Act
refers to a "taxpayer's business investment loss" and to a "debt
owing to a taxpayer". Subsection 248(1) defines the word
"taxpayer" to include "any person whether or not liable to pay
tax". A family is not a taxpayer, although an individual member of a family
is a taxpayer.
[21] Ms. Elliott's problem is not unusual, unfortunately. There
are many people who lend money and guarantee loans to small businesses to
corporations in which their spouses own shares but they do not. Many of these
people are not sophisticated in tax matters. They do what they feel is
important for the economic well‑being of the family. They do not do
consult lawyers or accountants who may advise how to structure the loan or
guarantee so, if something goes wrong, then, for tax purposes, they could
deduct at least a portion of the money they may lose. Many of these people and
their spouses are hard‑working people of modest means. They do what they
think is right; they are optimistic. They do not foresee possible failure. When
failure does come, they lose everything. On the other hand, a more
sophisticated person may impose a rate of interest on the loan to the spouse's
corporation or acquire shares in that company and in the case of a loan
guarantee, charge the corporation for the guarantee. In the latter cases, if
the loan goes bad or the person must honour the guarantee, because income was a
consideration for the loan or guarantee, the person would be eligible to deduct
a portion of the amount lost as an ABIL. Our senior courts have told us there
is no equity in a taxing statute and as the Act is written, there is not
much I can do to help Ms. Elliott. Parliament may well wish to consider the
unique situation of family controlled small business corporations and the
possibility of permitting family members to deduct a portion of the amount of
loans and guarantees made by a shareholder's spouse for the benefit of such a
corporation when the loans go bad or guarantees are exercised. As the law now
stands, such taxpayers are not even entitled to claim a capital loss on such
misadventure.
[22] The loans made by Ms. Elliott to Construction were not
made by her for purpose of earning income for herself as a taxpayer. Her
counsel's submission that she was the beneficial owner of her husband's shares
of Construction is not tenable on the evidence. The facts in Buhler v. The
Queen
bear no resemblance to those at bar and are of no assistance to the appellant.
[23] On the other hand, when Ms. Elliott voluntarily paid
$40,000 to the National Bank to satisfy Construction’s debt from its line of
credit, Ms. Elliott became legally subrogated in the rights of the bank.
As such, Ms. Elliott obtained recourse against Construction of the amount she
paid to the bank, plus interest. Article 2346 of the Civil Code of Québec reads
as follows:
|
2356. A surety who
has bound himself with the consent of the debtor may claim from him what he
has paid in capital, interest and costs, in addition to damages for any
injury he has suffered by reason of the suretyship; he may also charge
interest on any sum he has had to pay to the creditor, even if the principal
debt was not producing interest.
A surety who has bound himself without
the consent of the debtor may only recover from him what the debtor would
have been bound to pay, including damages, if there had been no suretyship;
however, costs subsequent to indication of the payment are payable by the
debtor.
|
2356. La
caution qui s'est obligée avec le consentement du débiteur peut lui réclamer
ce qu'elle a payé en capital, intérêts et frais, outre les dommages-intérêts
pour la réparation de tout préjudice qu'elle a subi en raison du
cautionnement; elle peut aussi exiger des intérêts sur toute somme qu'elle a
dû verser au créancier, même si la dette principale ne produisait pas
d'intérêts.
Celle qui s'est obligée sans le
consentement du débiteur ne peut recouvrer de ce dernier que ce qu'il aurait
été tenu de payer, y compris les dommages-intérêts, si le cautionnement
n'avait pas eu lieu, sauf les frais subséquents à la dénonciation du
paiement, lesquels sont à la charge du débiteur.
|
[24] In the case at bar, while there is no evidence one way
or the other, because Ms. Elliott and Construction do not deal at arm’s length,
I infer that Construction had consented to the guarantee. Indeed, without the
guarantee, it is doubtful that the bank would have given Construction a line of
credit.
[25] Respondent does not dispute that Ms. Elliott was
subrogated in the rights of the bank. Respondent’s counsel simply submits that
in order to give rise to an ABIL the guarantee given or the payment made under
the guarantee must have been made for the purpose of gaining income.
[26] The evidence is clear: the guarantee itself was not
made for the purpose of gaining income. However, when Ms. Elliott paid the
money to the National Bank, she stood in the shoes of the bank who did advance
the money for the purpose of earning income and she was entitled to interest
from Construction on the same terms as the bank.
[27] In income tax, persons often become liable for tax as a
result of a transaction or legal result that they did not intend. For example,
what a person intends to be a capital transaction may turn out to be a
transaction on income account, or what a person intends to be a tax free event is
held to be a taxable event. While Ms. Elliott’s purpose in paying off the bank
was not to earn income ‑ she may not have even been aware of
her rights to be subrogated in the rights of the bank - the result of paying
the bank entitled her to claim interest from the bank’s debtor, Construction. The
purpose of the loan she inherited from the bank was for an income earning
purpose. When Ms. Elliott took over the bank’s loan to Construction, she was
entitled to claim interest; she became a creditor of a potential income‑producing
loan. Had Construction paid her interest on the subrogated loan amount, the
interest would be included in her income; once the loan became bad in 1998, she
incurred a capital loss that is a business investment loss, and she ought to be
entitled to claim an ABIL on the amount she paid to the National Bank.
[28] The appeal is therefore allowed to permit the appellant to
deduct in computing income for 1998 an allowable business investment loss equal
to three‑quarters of the amount she paid to the National Bank. The
appellant is entitled to costs.
Signed at Ottawa, Canada, this 7th day of January 2005.
"Gerald J. Rip"
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