Date: 20030122
Docket: 2002-1506(IT)I
BETWEEN:
JOE COSENTINO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
(Delivered orally from the Bench at
Toronto, Ontario on September 18, 2002)
Miller J.
[1] Joe Cosentino claimed an allowable
business investment loss for his 2000 taxation year of $25,000 on
a business investment loss of $37,500. The Minister denied
Mr. Cosentino's allowable business investment loss and
Mr. Cosentino appeals that assessment.
[2] Mr. Cosentino and his brother
and two cousins worked for Cosentino Wholesale Fruit Limited
throughout most of the 1990s. Cosentino Fruit was owned by the
cousins' respective fathers Joe Cosentino Senior, and
Frank Cosentino, each with a 50 per cent interest in the
company. In 1991, the family determined the company needed an
injection of capital to continue. It turned to the four cousins.
They loaned the company $37,500 each for a total of $150,000.
Mr. Cosentino had to take out a collateral mortgage against
his property to get the funds necessary to invest in the family
company. There was no loan agreement for the $150,000, although
Mr. Cosentino explained that the interest rate was prime
plus two per cent and for several years he received his monthly
interest from the company. He duly reported the interest income
on his tax returns.
[3] In the late 1990s the family
situation was such that Mr. Cosentino left the company. His
brother had left prior to this. Mr. Cosentino did not feel
he could continue to work with his cousins. As well, another
financial crisis was brewing, and Mr. Cosentino decided it
was time to get out. This was in March of 1998. His father,
however, remained involved with the company as a 50 per cent
owner, although matters did not appear to be copacetic amongst
the family.
[4] After March 1998,
Mr. Cosentino recalls receiving only a couple of months
interest. When he raised this matter with his cousins he was told
they were restricted by the bank. He indicated that he found it
very difficult to deal with his cousins on this.
[5] By 1999, the finances of the
company had deteriorated, as had family relations, to the point
that Mr. Cosentino and his father sought legal advice.
Mr. Cosentino's father had more at stake, according to
Mr. Cosentino, as he had provided the bank with personal
guarantees. In September 1999, Mr. Cosentino and his
father's lawyer attempted to resolve their financial concerns
by proposing a settlement which would remove Mr. Cosentino
and his father from any further involvement with the company,
including payment of half of Mr. Cosentino's $37,500
loan and a release of Mr. Cosentino's father's
guarantees. It was clear from the tone of this correspondence
that Mr. Cosentino and his father were extremely concerned
about the "security of the family assets". They
received no favourable response to this proposal. They were
rebuffed.
[6] By early 2000, Mr. Cosentino
had the impression the company was facing bankruptcy and needed a
white knight to salvage the business. The salvation appeared in
the form of the Toronto Wholesale Produce Association. That
organization was prepared to take over the Royal Bank's
position as the company's major creditor, although there were
strings attached. The company was to be transferred to
Mr. Cosentino's cousins, the Royal Bank was to be paid
several hundreds of thousands of dollars, the Royal Bank was to
release Mr. Cosentino and his father from any obligations,
and Mr. Cosentino was to forego any right to his loan.
Unless these conditions were met there would have been no
restructuring and salvaging of the business. Mr. Cosentino
agreed and signed the appropriate release on April 28, 2000. He
believed this was the only way to get his father out from under
any ongoing financial burden. Given his cousins' behaviour
over the previous eighteen months he knew by the end of 1999 his
investment was likely lost in any event. If he had not agreed to
this restructuring he believed the company would have gone
bankrupt. As well as wanting to ensure his father would not be
hurt financially he also retained some pride in the family name
attached to a family company, and if the company could
restructure to survive he was clear that was his preference. As
he says, there was lots of emotion there.
[7] In this case, to claim an
allowable business investment loss in accordance with paragraph
39(1)(c) of the Income Tax Act, it is first
necessary to review subsection 50(1). I will just read that
section:
50(1) For the purposes of this subdivision,
where
(a) a debt owing to
a taxpayer at the end of a taxation year (other than a debt owing
to the taxpayer in respect of the disposition of personal-use
property) is established by the taxpayer to have become a bad
debt in the year ...
...
and the taxpayer elects in the taxpayer's return of income
for the year to have this subsection apply in respect of the debt
... the taxpayer shall be deemed to have disposed of the debt ...
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.
So there are two conditions from this provision: there must be
a debt, and it must have gone bad. There is no question there was
a debt of $37,500. The Respondent's position is, however,
that the debt was extinguished in April 2000 at the time that
Mr. Cosentino signed the release and therefore the debt did
not exist at the end of the year. She further argues that even if
there was a debt, the Appellant has not proven it became a bad
debt in the year. He had not, according to the Respondent, taken
sufficient reasonable businesslike steps to recover his debt. It
can, therefore, not be said to have become uncollectible.
[8] The Respondent relied on the
principles set out in the Federal Court of Appeal case of
Flexi-Coil Ltd. v. Canada[1] where Mr. Justice MacGuigan
stated:
...In summary, to decide whether a taxpayer is entitled to a
deduction for bad debts, the Court must be satisfied that the
taxpayer itself made the determination that the debts had become
uncollectible and that in making such determination, it acted
reasonably and in a pragmatic business-like manner, applying the
proper factors.
In applying this principle I reach a different conclusion from
the Respondent. What was Mr. Cosentino facing when he agreed
to effectively write off his investment in April 2000? He had
received no interest on his loan for the better part of two
years. He had attempted to deal with his cousins on this but
without success. The company continued to struggle
financially. He and his father had sought legal advice in
1999. They had made a proposal but had been rebuffed. By the end
of 1999 he believed his investment was lost. The company was
facing bankruptcy and could only be saved by complying with the
new financier's conditions. His father's guarantee could
only be cancelled if he wrote off his investment. He had some
lingering family feeling to the ongoing viability of the
company.
[9] Looking at all of those factors I
believe Mr. Cosentino did indeed act in a reasonable
businesslike manner. Businesslike behaviour does not necessarily
have to mean acting spitefully or in a way which will bankrupt a
company just to prove you have made every effort to collect your
own debt. I would like to think that businesslike behaviour could
encompass a more humane approach. In this case the writing was
clearly on the wall; Mr. Cosentino was not getting his money
back. Why force the issue any further when there are sound
reasons not to?
[10] I am satisfied Mr. Cosentino's
debt of $37,500 has been proven to have become uncollectible in
2000 and indeed what better proof that a debt has become
uncollectible than the creditor's preparedness to release any
right to the debt for nothing, or in this case for one dollar.
That was a formalization of what Mr. Cosentino already
realized. The difficulty that the Respondent argues this creates
for Mr. Cosentino is that because he disposed of the debt,
there was no longer a debt owing at the end of 2000, which the
Respondent claims there must be for subsection 50(1) to
apply.
[11] There is no doubt Mr. Cosentino
invested in a small business corporation. There is no doubt that
investment turned sour, as did some family relations. It is my
understanding that the purpose of the rules with respect to
allowable business investment losses is to encourage investment
in small businesses by providing a more favourable tax treatment
than ordinary capital losses in the event the investment does not
prove successful. Mr. Cosentino is someone to whom these
rules should apply, yet they are worded in such a way as to, at
first blush, deny him their application because he gave up any
right to the debt receivable. He truly wrote it off as bad. This
result seems contrary to the very intent of the allowable
business investment loss rules. Had he sold his position to
Toronto Wholesale for a dollar he would have qualified for an
allowable business investment loss pursuant to subparagraph
39(1)(c)(ii). Instead he wrote off the debt by forgiving
it for a dollar. If he had claimed his allowable business
investment loss in 1999 I find he would have been entitled to it.
There was still a debt owing at the end of 1999. Was it bad? Yes.
The final nail in the form of Mr. Cosentino's release of
the debt in April 2000 did not have to be hammered home to
satisfy me there is justification for Mr. Cosentino to treat
the debt as bad in 1999.
[12] The correspondence from BDO Dunwoody
outlining Toronto Wholesaler's requirements, including a
requirement for filing a proposal under the Bankruptcy &
Insolvency Act, was dated January 4, 2000. I am satisfied
Mr. Cosentino knew by the end of 1999 that any further
efforts to collect would be futile, and he was correct. The 1999
taxation year is not before me, but I raise 1999 to alert the
Respondent that had this issue been for 1999 I would have allowed
Mr. Cosentino an allowable business investment loss as all
conditions of paragraph 39(1)(c) and subsection 50(1)
would have been met. Should I, Ms. Edinboro, dismiss his
appeal, suggest he file an amended 1999 return, suggest the
Minister look favourably on the 1999 allowable business
investment loss and run the risk that does not unfold as it
should and be back here in two years time dealing with the same
issue and giving Mr. Cosentino a favourable result at that
point? Or can I legitimately reach a practical conclusion in this
informal procedure of allowing this appeal for 2000? I believe I
can.
[13] In support of this conclusion I refer
to the recent decision of Judge McArthur in Gurberg v.
The Queen[2] In Gurberg the Appellant similarly
forgave a debt in April 1996. Judge McArthur found that as the
debt was owed at the end of 1995 the provisions of subsection
50(1) were met and the allowable business investment loss was
allowed. I am prepared to follow such an interpretation of the
interplay between subsection 50(1) and
paragraph 39(1)(c) in this case and likewise find
that Mr. Cosentino is entitled to his allowable business
investment loss in 2000.
[14] The appeal is allowed and the matter is
referred back to the Minister for reassessment and
reconsideration on the basis that Mr. Cosentino is entitled
to his allowable business investment loss flowing from his
$37,500 loss in his investment. I believe the Income Tax
Act in force in 2000 would require that the allowable
business investment loss is half of the $37,500.
Signed at Ottawa, Canada, this 22nd day of January, 2003.
J.T.C.C.
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