Date: 20020131
Docket: 1999-1977-IT-G
BETWEEN:
MARVYN GURBERG,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Counsel for the Appellant: Aaron
Rodgers
Counsel for the Respondent: Nathalie
Labbé
____________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at
Montréal, Québec, on December
7, 2001)
McArthur J.
[1] The issue in this appeal is
whether the Appellant incurred an allowable business investment
loss (ABIL) pursuant to subsections 39(1) and 50(1) of the
Income Tax Act in the 1996 taxation year. The Appellant
had forgiven a loan in the amount of $600,000 owing to him by
158329 Canada Inc. (the "corporation"). The most
pertinent submission made by the Respondent and contained in the
Reply to the Notice of Appeal was that there was no debt owing to
the Appellant either at the end of 1995 or at the end of 1996 and
that by agreement dated April 18, 1996[1] and effective June 30, 1995, the
Appellant forgave the debt which was owed to him by the
corporation.
[2] The facts include the following.
The Appellant commenced a ladies apparel manufacturing company in
1991, at which time he was the sole shareholder. By 1994, the
corporation was in severe financial difficulty. The Appellant
testified that the corporation was struggling during very
difficult economic times and was facing bankruptcy. The Appellant
was successful in having two investors advance $100,000 each to
the corporation. By 1995, he had given up control of the
corporation and retained only 33% of the shares and the two new
investors took over control of the financing. As a result of the
Banque Nationale du Canada calling in the Appellant's loan
guarantees, he in effect advanced $200,000 in July 1994 and
$400,000 in November 1994 to the corporation. The two new
investors refused to advance further funds until the Appellant
agreed to forgive the $600,000 owed to him by the
corporation.
[3] On April 18, 1996, the Appellant
executed the agreement (Exhibit A-11) entered into between
himself and the corporation which reads in part as follows:
NOW THEREFORE THIS AGREEMENT WITNESSETH that on the 30th day of
June, 1995 for no consideration Gurberg forgave the FIRST LOAN
and the SECOND LOAN.
These loans total $600,000 and as far as the dates referred to
in the agreement, with respect to the advancement of funds, they
are perhaps not accurate, but the gist of it and the importance
of it is that the Appellant forgave $600,000. This document,
although purportedly is retroactive to June 1995 is dated April
18, 1996 and it is signed by Marie Messina on behalf of the
corporation and by Marvyn Gurberg, the Appellant.
[4] In examination-in-chief when asked
when he realized the $600,000 was not recoverable, the Appellant
replied, after considerable deliberation, once he executed the
agreement with the corporation on April 18, 1996. In 1995, he
made no effort to recover the $600,000 because any efforts to do
so would have been futile and would have triggered the investors
to pull out followed by possible bankruptcy of the corporation.
His only hope of ever recovering any of his investment was by
keeping the corporation operating with the hope that his 33%
interest in the shares of the corporation would gain value over
time.
[5] The relevant parts of the
legislation involved, being subsections 39(1) and 50(1) read as
follows:
39(1) For the purposes of this
Act,
...
(c) a
taxpayer's business investment loss for a taxation year from
the disposition of any property is the amount, if any, by which
the taxpayer's capital loss for the year from a disposition
after 1977
(i) to which
subsection 50(1) applies, or
(ii) to a person
with whom the taxpayer was dealing at arm's length
of any property that is
(iii) a share of the
capital stock of a small business corporation, or
(iv) a debt owing to the
taxpayer by a Canadian-controlled private corporation (other
than, where the taxpayer is a corporation, a debt owing to it by
a corporation with which it does not deal at arm's length)
that is
...
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, or
(b) a share
(other than a share received by a taxpayer as consideration in
respect of the disposition of personal-use property) of the
capital stock of a corporation is owned by the taxpayer at the
end of a taxation year and
(i) the
corporation has during the year become a bankrupt (within the
meaning of subsection 128(3)),
(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
(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.
The position of the Appellant is that if he had not forgiven
the loan, the corporation would have gone bankrupt. There was
nothing he could do in terms of recovering the debt. Any action
by him for recovery would have brought a collapse of the
corporation.
[6] In support of his position that
the debt did become a bad debt during the 1995 taxation year, the
Appellant referred the Court to Fritz v.
M.N.R.[2]
and Beaudry v. The Queen.[3] In Beaudry, Judge Rip states that it is
up to the taxpayer to establish when a debt has become a bad
debt. The test is not an objective test which allows the Minister
of National Revenue to question the Appellant's business
judgment. The Appellant also referred to Earl v.
M.N.R.[4] to
indicate that in denying the taxpayer's pretention that a
debt has become a bad debt, the Minister had to demonstrate when,
if at all, the debt became a bad debt.
[7] The Appellant submits that there
is no technical problem with the application of paragraph
50(1)(a) of the Act in light of the date of the
forgiveness of the debt. The debt was forgiven in 1996 and was
existing, therefore, at the end of 1995. By rendering the
forgiveness of debt effective June 30, 1995, the corporation was
able to take that into account in its 1995 financial statements,
portraying a more attractive financial position. Without the
forgiveness of debt, the corporation would have been operating
with an $850,000 deficit. The Appellant further argued that
although the agreement stipulates that the forgiveness of debt is
effective June 30, 1995, the forgiveness of the debt was not
given until the date of the signing of the contract on April 18,
1996.
[8] The Appellant also referred to
Orlando v. The Queen[5] in which case the taxpayer agreed
that a debt owed to him by a corporation of which he was
shareholder, be cancelled from the books of the corporation in
exchange for worthless shares. Lamarre Proulx J. determined that
the debt was still outstanding at the end of the taxation year
and that paragraph 50(1)(a) of the Act was
applicable.
[9] The Respondent's position
includes that the Appellant is not entitled to claim the business
investment loss because there was no debt owing to the Appellant
at the end of the 1995 taxation year, nor at the end of the 1996
taxation year. The Respondent submits that the agreement
forgiving the debt (Exhibit A-11) was effective June 30, 1995
and, therefore, at the end of the year, there was no debt
owing.
[10] In support of this contention, the
Respondent referred to E.C.E. Group Ltd. v.
M.N.R.[6] In
that case, in comparing the wording of paragraph 50(1)(a)
to that of paragraph 20(1)(p) of the Act, Kempo J.
stated that paragraph 50(1)(a) stipulates in clear and
unambiguous language that the debt is to be owed at the end of
the year. The forgiveness of debt by the Appellant constitutes a
disposition of debt as that term is defined in section 54 of the
Act. The Respondent maintains that the debt was disposed
of as of June 30, 1995 and that there was no debt subsequent to
that date.
[11] The Respondent further distinguishes
the present appeal from the Orlando case. The Appellant
signed an agreement with the corporation in this case by which he
forgave the $600,000. Mr. Orlando received shares for his
indebtedness and the Appellant cannot argue that the debt was
still in existence despite the fact that the debt was removed
from the corporate records.
[12] In the event the debt was owed to the
Appellant at the end of the year, the Respondent submits that
paragraph 50(1)(a) of the Act is not applicable and
that the Appellant did not establish that the debt became a bad
debt in that year. The Respondent refers the Court to
Flexi-Coil Ltd. v. The Queen[7] and Beretti v. M.N.R.[8] The Respondent
also makes reference to Hogan v. M.N.R.,[9] in which the Court adopted a
list of factors that may be taken into consideration in the
determination of bad debts. W.S. Fisher, Q.C. stated at page
192:
The question of what constitutes a bad debt has been considered
by the Courts on many occasions and is the subject of discussion
in various books on accounting. in No. 81 v. M.N.R., 53
DTC 98, 8 Tax A.B.C. 82, the Chairman of this Board, although the
case was one dealing with the determination of doubtful accounts,
stated at p. 98:
Among the factors which may be taken into consideration by a
taxpayer who claims a deduction under the provisions of Section
11(1)(d) of the Act — (now s.
11(1)(e) of the Income Tax Act, R.S.C. 1952)
— would be: the time element, the history of the
account; the financial position of the client, the past
experience of the taxpayer with the writing off of his bad debts,
the general business condition in the country in a case like in
the present one where the taxpayer in doing business all over
Canada, the business condition in the locality where the client
lives, the increase or decrease in the total sales and accounts
receivable at the end of the year for which the deduction is
claimed, as compared with previous years.
Analysis
[13] The Appellant is an experienced
businessman although one wonders at his motivation in commencing
a business in the bleak economic times of 1991. No background was
given. He apparently trusted that the economy would recover more
quickly than it did. He paid a heavy price, at least $600,000,
together with anguish which, I would suspect, accompanied the
difficult years. He now asks this Court for the relief provided
in the Act. The Respondent submits that this relief is not
available and that the Appellant is thwarted by subparagraph
39(1)(c)(i) and subsection 50(1), and that no debt was due
to the Appellant at the end of 1995. The Respondent's counsel
relies on Exhibit A-11 as evidence of this.
[14] Before dealing with the primary issue,
I will refer to the peripheral questions which can easily be
disposed of. First, prior to the Federal Court of Appeal decision
in The Queen v. Byram,[10] the Minister would apparently have
decided that subparagraph 40(2)(g)(ii) had not been met
because the Appellant's loans to the corporation were
interest free. Reference to this is made in the Reply to the
Notice of Appeal at paragraph 14(j). This issue was set to rest
in Byram where McDonald J.A. stated "there is no
need for the income to flow directly to the taxpayer from the
loan". Second, in paragraph 14(k) of the Reply to the Notice
of Appeal, the Respondent states that if the debt is found not to
have been forgiven at the end of 1995, the debt owing did not
become a bad debt. I find as a fact that the debt was
uncollectible at the end of 1995.
[15] Marie Messina testified on behalf of
the Appellant. She is the daughter of one of the two investors in
the corporation. Her father was motivated to invest in that
corporation because he was looking for it to occupy a space in a
building he was constructing. She has been actively involved with
the corporation since 1994 and attended a meeting of the then
three equal shareholders shortly after her father became
involved. At that time, the investors felt that they had been
misled by the Appellant and that the corporation's financial
position was worse then he had represented to them. The two
investors insisted that the Appellant pay the National Banque in
order that the bank release the corporation from the
$600,000.
[16] The Appellant stated he had no other
choice. Miss Messina testified that without the Appellant's
advancing the funds to the corporation which effectively reduced
the corporation's indebtedness to the National Bank by
$600,000, the investors would have pulled out and bankruptcy of
the Corporation would have followed. Respondent's counsel
made reference to the fact that the two investors were repaid
some of their loans and the Appellant should have been in a
position to have the corporation repay his $600,000. I do not
believe this is entirely accurate. I understand that the original
$100,000 invested by each of the two investors has not been
repaid. What has been repaid are the revolving temporary advances
made by the investors to meet crises from time to time. The
evidence is clear that the $600,000 was uncollectible at the end
of 1995. It would not only be unbusinesslike, but ridiculous to
expect the Appellant to take action for recovery of the loan in
1995 when the corporation was insolvent. To do so, would have
plunged the corporation into bankruptcy.
[17] I understand that the corporation
continues to operate. Miss Messina further testified that after
five years of struggling since 1994, it is beginning to be
profitable. It would appear that the Appellant permitted the
corporation's accountant to reflect forgiveness of the debt
in June 1995 to show a healthier position on the financial
statements for the period ending June 30, 1995. Sales for that
period were $4,548,620. Note 8 to the financial statements for
the year ending June 30, 1995[11] states: "An amount of $600,000 was
advanced to the company by shareholders and subsequently
forgiven". Also, note 9 states in part: "The company
has accumulated losses for income tax purposes totalling
approximately $183,500 for which the tax benefits have not been
recognized in the financial statements".
[18] The Reply to the Notice of Appeal also
states at paragraph 14(d) that "No change of the corporation
occurred in 1994". This is incorrect and the
Respondent rightly abandoned this assertion at trial. All of this
leads to the thrust of the Appellant's position that because
of the forgiveness reflected in the financial statement effective
June 30, 1995, there was no debt owing at the year end 1995 or in
1996, as prescribed by paragraph 50(1)(a) of the
Act. The Respondent argues that the agreement between the
Appellant and the corporation (Exhibit A-11) clearly forgives the
debt on June 30, 1995 and the Appellant allowed it to be removed
from the corporate financial statement as of June 30, 1995. So,
obviously, the Respondent states there was no debt at the end of
the year.
[19] While this is far from a frivolous
argument, I accept the Appellant's position. The Appellant
signed the forgiveness on April 18, 1996. He stated in evidence
that this was the first time he realized that he was forgiving
the $600,000. I find the debt was existing at the end of 1995.
The Appellant permitted the corporation's accountant to
reflect the forgiveness effective June 30, 1995 as an accounting
entry only. The corporation was then able to present a healthier
state of financial affairs to the bank and to prevent the bank
calling in the remainder of their loans.
[20] I conclude from the evidence that the
loan existed at the end of 1995. It was forgiven upon the signing
of the agreement on April 18, 1996. The appeal is allowed, with
costs.
Signed at Ottawa, Canada, this 31st day of January, 2002.
J.T.C.C.
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