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Citation: 2003TCC550
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Date: 20030806
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Docket: 2002-37(IT)I
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BETWEEN:
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DARRYL TAYLOR,
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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
Sarchuk J.
[1] This is an appeal by Darryl Taylor
from an assessment of tax with respect to his 1999 taxation year
by virtue of which the Minister of National Revenue (the
Minister) denied the Appellant's claim for a business
investment loss in the amount of $55,800 which would have
resulted in an allowable business investment loss (ABIL) of
$41,850.
[2] The ABIL claimed by the Appellant
pertained to an investment in IT Professional Magazine Inc. (IT
Professional), a business which was incorporated on or about June
5, 1998. Its shareholders were Michael Bessey (55%),
Louis Laskovski (25%) and the Appellant (20%). IT
Professional ceased operations and became insolvent on or about
March 31, 1999. In assessing the Appellant, the Minister does not
dispute that IT Professional was a small business corporation and
accepted that the amounts in issue were uncollectible as of
March 1999. However, the Minister does contest the assertion
that the debt was owed to the Appellant and that the loans were
advanced by him for the purpose of earning or producing income
from a business or property.
[3] Because of the nature of the
advances and the circumstances under which they were made, I
propose to deal with them separately.
(i) The Canada Trust
loan: In or about September 1998, the Appellant
borrowed $35,000 from Canada Trust which monies were advanced to
IT Professional. In return, IT Professional provided the
Appellant with a promissory note in the amount of $35,000 which
stated among other things that it would repay the Appellant for
interest "once IT Professional Magazine becomes a profitable
entity". This promissory note also provided that "in
the event that IT Professional Magazine ceased operations or
fails to reach a state of profitability, Mr. Darryl Taylor shall
be held solely responsible for the repayment of the loan and all
interest accrued to the financial institution that provisioned
the loan (Canada Trust)". Neither the promissory note nor
the partnership agreement which forms part of Exhibit A-6
contained any reference to an interest rate payable on the
principal amount advanced.
(ii) The balance of the
"business investment" amounting to $20,800 reflected
several different payments described by the Appellant as
follows:
(a) The amount of $2,500
deposited on August 7, 1998 into the bank account of IT
Professional represented a partial payment towards the $6,400
purchase price of his shares;
(b) the amount of $5,500 was obtained
from his father[1]
of which $3,900 was used to pay the balance due for the purchase
of the shares and the amount of $1,600 was "provisioned to
the magazine".[2]
(c) The amount of some $10,659.09
represented the total interest paid on the $35,000 Canada Trust
loan.[3]
[4] The evidence indicates, and the
Appellant does not dispute, that all of the foregoing amounts,
including the loans from his father, the Canada Trust loan and
the interest thereon were paid by DQuest Technologies Inc.,
(DQuest) a company of which the Appellant is the president and
sole director. The Appellant maintains that these funds were
derived from salary owing to him by DQuest and in support
referred to an undated letter from DQuest "to whom it may
concern" signed by him as president which reads as
follows:
Let it be known that all monies paid by DQUEST TECHNOLOGIES
INC. to Mr. Bevan Taylor, Canada Trust, IT Professional Magazine
etc. were taken directly from Mr. Darryl Taylor from DQUEST
TECHNOLOGIES INC. These tax paid funds were derived from salary
owing to Mr. Darryl Taylor from DQUEST TECHNOLOGIES INC. The
funds were reported on his 1999 tax return and the tax was paid
on the income. The tax paid monies drawn by Mr. Darryl
Taylor are reflected in DQUEST TECHNOLOGIES financial statement
dated July 31, 1999 under the expenses category as Management
Fees. This included checks (sic) written by DQUEST
TECHNOLOGIES INC. on behalf of Mr. Darryl Taylor.[4]
[5] The Appellant testified that he
and his partners made diligent efforts to "obtain capital
investment from outside investors, including financial
institutions, as corporate loans. Also, the Business Development
Bank of Canada was approached". They were unsuccessful and
in order to keep the project going each of the three shareholders
made loans to IT Professional. The Appellant made specific
reference to the repayment schedule which would commence only
after a "state of profitability had been established"
and noted that "we, as shareholders, did not want the
Magazine paying us back any loans until the Magazine was in a
profitable position, and in a position where it could sustain
paying us back the loans".
Analysis
[6] The Respondent's primary
position is that there was no debt owing to the Appellant by IT
Professional. This position is founded on the premise that the
loan was in fact made by DQuest, the Appellant's corporate
vehicle, and not the Appellant personally. The Respondent further
contends that if there was a debt owing to the Appellant, the
funds at issue were not invested in IT Professional for the
purpose of gaining or producing income as required by the
provisions of paragraph 39(1)(c) of the Income Tax
Act.
[7] I am unable to accept the position
advanced by the Respondent. To do so would be to ignore the
Canada Trust loan agreement, the renewal notices and an account
information document, all of which clearly support the
Appellant's position that the monies were borrowed by him
personally. Furthermore, the loan agreement indicates that the
money was deposited by Canada Trust directly into IT
Professional's Royal Bank U.S. account.[5] Further support is provided for the
Appellant's position by the promissory note from IT
Professional dated September 21, 1998 previously referred to.[6] There is no
evidence before the Court capable of supporting the
Respondent's contention that these funds were advanced to IT
Professional by the Appellant's company, DQuest. Whether the
amounts subsequently paid by DQuest to Canada Trust and to the
Appellant's father were what he described as "tax paid
income" or whether in fact they represented a shareholder
benefit is not in issue before this Court.
[8] The Respondent further argues that
the funds were not advanced to IT Professional for the purpose of
earning or producing income from a business or property. Counsel
referred to Wierbicki v. Canada[7]in support of the proposition that
funds advanced to a corporation for the purpose of keeping it
afloat do not constitute funds advanced for the purpose of
earning or producing income from a business or property. I do not
believe this decision assists the Respondent since in
Wierbicki, the Court found, inter alia, that there
was no evidence that the monies were advanced "with any
intention or expectation of creating an indebtedness
... ". That is not the case in the present appeal.
In this context, I make specific reference to the loan agreement
with IT Professional which provides that:
(i) All loans provisioned to IT
Professional Magazine Inc. by either Shareholders or Private
Investors shall be re-paid in full with interest according to the
terms set fourth (sic) in the loan agreement schedule if
an when the Corporation becomes a profitable entity;
(ii) All loans conjointly signed
by the Directors of IT Professional Magazine shall be the sole
responsibility of the investor that provisions the loans to the
Corporation; and
(iii) The re-payment schedule of all
loans provisioned to IT Professional Magazine Inc. shall commence
the first fiscal quarter after a state of profitability has been
established.
Notwithstanding the fact that this could be described as a
contingent lending arrangement, as suggested by the Respondent,
it is clear that the Appellant's motivation for advancing the
funds was to create a binding lending agreement with the
expectation that the business would in due course generate
profits.
[9] In Byramv. Canada,[8] the
issue was whether a taxpayer was entitled to claim an allowable
capital loss pursuant to subparagraph 40(2)(g)(ii) of the
Act for losses incurred on interest-free loans issued to a
corporation for the purpose of earning dividend income. The Crown
in that case argued that loans must produce an independent income
stream for the taxpayer, through interest or fees, before any
losses occasioned by such loans are deductible under subparagraph
40(2)(g)(ii) and that the potential dividend income from a
subsidiary is too remote to support the deduction under that
subparagraph.[9]
McDonald J., speaking for the Court, made the following
observations:
[13] Subparagraph
20(1)(c)(i) allows for the deduction of interest where
money is borrowed and then used for the purpose of earning income
from business or property. In Bronfman, the Court held
that the application of paragraph 20(1)(c) requires an
examination and characterization of both the use of the borrowed
money and the purpose behind such use. For a taxpayer to deduct
interest under this section, the purpose of borrowing the money
must have been to earn income and the borrowed money had to be
directly used in an eligible manner to produce this income.
[14] In contrast, subparagraph
40(2)(g)(ii) of the Act provides that any capital
loss from the disposition of a debt is deemed to be nil, unless
the debt was acquired for the purpose of gaining or producing
income from a business or property. The relevant portions of this
section read as follows:
40(2)(g)
a taxpayer's loss, if any, from the disposition of property,
to the extent that it is ...
(ii) a loss from the
disposition of a debt or other right to receive an amount, unless
the debt or right, as the case may be, was acquired for the
purpose of gaining or producing income from a business or
property (other than exempt income) or as consideration for the
disposition of capital property to a person with whom the
taxpayer was dealing at arm's length, ...
is nil.
[15] Unlike paragraph
20(1)(c) this section only requires a single stage
inquiry, namely what was the purpose for acquiring the
debt. The two stage inquiry laid down in Bronfman clearly
indicates that there is a distinction between use and purpose.
Therefore, while there are some similarities in the general
language of paragraph 20(1)(c) and subparagraph
40(2)(g)(ii), it is significant that section 40 does not
contain a "source" directed preamble nor does it refer
to use as well as purpose. Accordingly, it would be wholly
inappropriate to apply the direct/indirect use limitation imposed
in Bronfman to this section.
[16] The language of section 40
is clear. The issue is not the use of the debt, but rather the
purpose for which it was acquired. While subparagraph
40(2)(g)(ii) requires a linkage between the taxpayer (i.e.
the lender) and the income, there is no need for the income to
flow directly to the taxpayer from the loan.
[17] Such an approach is also
consistent with commercial reality. Frequently, shareholders make
such loans on an interest-free basis anticipating dividends to
flow from the activities financed by the loan. To adopt the
position of the Minister would require that this Court ignore
this reality. It would also be contrary to the comments of the
Supreme Court of Canada in Stubart Industries Ltd. v. The
Queen. Commercial reality is to be considered by the Courts
in interpreting tax provisions like subparagraph
40(2)(g)(ii) so long as it is consistent with the text and
purpose of the provision.
[18] The ultimate purpose of a
parent company or a significant shareholder providing a loan to a
corporation is, without question, to facilitate the performance
of that corporation thereby increasing the potential dividends
issued by the company. This purpose is clearly within the scope
of both the text and the purpose of subparagraph
40(2)(g)(ii), a section which is directed towards
preventing taxpayers from deducting losses that are not incurred
for the purpose of earning income from a business or
property.
[19] There is a growing body of
jurisprudence that considers current corporate reality as being
sufficient to demonstrate that the expectation of dividend income
justifies a capital loss deduction under subparagraph
40(2)(g)(ii). As articulated above, this approach is
consistent with current corporate realities and the purpose of
subparagraph 40(2)(g)(ii).
[10] The argument advanced on behalf of the
Respondent suggests that the deduction of an ABIL should be
disallowed on the basis that the funds were invested for a
purpose other than to generate income. This argument is not
supportable. It is true that the loan was advanced to a start-up
operation that had not begun generating profits but this does not
by itself mean that the business will not be successful. It is
clear that the funds were loaned to the corporation by the
Appellant for the benefit of the business with a realistic
expectation of recouping the principal with interest.[10] In my view, that is
sufficient to constitute a lending arrangement for the purpose of
sections 39 and 50 of the Act.
[11] I should specifically note that the
amount of $10,659.09 representing interest on the Canada Trust
loan does not form part of the debt owing to the Appellant by IT
Professional and accordingly cannot be included as part of his
business investment loss for that taxation year. The balance in
the amount of $1,600 which, according to the Appellant, "was
provisioned to the Magazine" has not been established to be
a debt owing to the Appellant by IT Professional.
[12] The evidence adduced by the Appellant
establishes that the amount of $6,400 reflected the purchase
price of his shares in IT Professional and that the amount of
$35,000 constitutes a debt owing to him by IT Professional for
the purposes of paragraph 39(1)(c) of the Act. Both
amounts are, in my view, this taxpayer's business investment
loss for taxation year 1999 and, therefore, he is entitled to an
allowable business investment loss calculated on that basis.
Signed at Ottawa, Canada, this 6th day of August, 2003.
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