Xavier V. Fernandez v. Minister of National Revenue, [1991] 1 CTC 2211, 91 DTC 182

Mogan, T.C.J.:—At the conclusion of the hearing of this appeal at Ottawa on October 9, 1990, I delivered oral reasons for judgment which, in substance, dismissed the appeal. I have reconsidered my position on one of the matters in dispute and, in these written reasons, I will amend my prior oral reasons.

The appellant owned a 4.97 per cent interest in land and building located at 265 Yorkland Boulevard, Toronto (the” Yorkland property") which was pledged or otherwise assigned to certain financial institutions as security for amounts loaned to 95827 Canada Ltd. (the"Calgary company"), a corporation engaged in the development of certain real estate in the city of Calgary, Alberta. All of the co-owners of the Yorkland property were shareholders in the Calgary company, the appellant owning 10 per cent of the shares.

When the Calgary company could not repay its loans, the financial institutions forced the sale of the Yorkland property in 1984. The selling price of approximately $1,150,000 caused the co-owners to realize an aggregate capital gain of approximately $750,000 over their 1975 cost of $435,000. The appellants share of the capital gain was $35,535 and I have already decided in my oral reasons for judgment that the appellant realized a taxable capital gain of $17,767 in 1984. I have no doubt concerning that decision.

The co-owners of the Yorkland property did not in fact receive any of the proceeds of disposition resulting from its sale because all of the available funds were paid to the financial institutions which forced the sale. In these circumstances, the appellant claims that, if he is to be taxed on his portion of the capital gain resulting from the sale of the Yorkland property, then he should be permitted to deduct a" business investment loss” with respect to his portion of the equity in the Yorkland property (at the moment of its sale) because all of that equity was invested, directly or indirectly, in the Calgary company. In my oral reasons for judgment, I dismissed the appellants claim to that business investment loss. Upon reflection, I have concluded that I was wrong in dismissing the claim.

What is really involved in the appellant's claim to a business investment loss is the effect of subparagraph 40(2)(g)(ii) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") on the special circumstances of the forced sale. When the appellant and his co-owners first pledged the Yorkland property to support third party loans to the Calgary company, they obviously expected the Calgary company to succeed. The equity in the Yorkland property was invested in the Calgary company at the time or the pledge because, as financial conditions in the Calgary company worsened, the co-owners could not withdraw their pledge of the Yorkland property any more than they could withdraw their portion of the paid-up capital of the Calgary company.

When the financial institutions forced the sale of the Yorkland property, the appellant and his co-owners could measure in dollars that portion of their investment in the Calgary company being the amount resulting from the sale which the financial institutions were able to retain to apply against their loans to the Calgary company. That amount quantified the equity of the appellant and his co-owners in the Yorkland property at the date of its sale; and in my view, the investment of that amount in the Calgary company related back in time to the date when the Yorkland property was pledged. To the extent that that amount reduced the liability of the Calgary company to the financial institutions, the appellant and his co-owners became, by subrogation, unsecured creditors of the Calgary company.

The appellant thereby acquired a debt owing by the Calgary company, the amount of which was determined only after the sale of the Yorkland property but the appellant's investment in the debt related back to the time when the Yorkland property was pledged. In other words, the amount of the Calgary company's debt to the appellant following the sale quantified the investment of his equity in the Yorkland property when it was first pledged.

A letter dated December 5, 1989 from the National Life Assurance Company of Canada to the appellant together with certain attached statements of adjustments were entered as Exhibit A-3. That exhibit indicates that the equity in the Yorkland property of the appellant and his co-owners (after providing for a first and second mortgage) was $270,644 as at the date of sale being January 17, 1984. Applying the appellant's 4.97 per cent interest in the Yorkland property to the net equity amount would give the appellant an equity of $13,451. This would be the amount of the appellant's unsecured debt owing by the Calgary company.

The Calgary company failed; it lost its property; it was unable to repay the amounts advanced by its shareholders; and it became inactive. In these circumstances and applying subsection 50(1) of the Act, the appellant in 1984 was deemed to have disposed of the debt resulting from his investment of his equity in the Yorkland property. Counsel for the respondent argued that the loss resulting from the deemed disposition of that debt was not a business investment loss within the meaning of paragraph 39(1)(c) of the Act because (a) there was no business left in the Calgary company when the forced sale occurred; and (b) the loss was deemed to be nil under subparagraph 40(2)(g)(ii) of the Act because the appellants debt owing by the Calgary company was not acquired for the purpose of gain or producing income from business or property. The relevant statutory provision is set out below:

40. (2)(g) a taxpayer's loss, if any, from the disposition of a property, to the extent that it is

(i) . . .

(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 by the taxpayer 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;

In the absence of any evidence that the equity in the Yorkland property at the time of its sale was to be regarded as a contribution of capital to the Calgary company, I assume that the appellant and his co-owners intended to become, by subrogation, unsecured creditors of the Calgary company. The appellant therefore acquired a debt owing by the Calgary company apparently without interest. The fact that no interest is payable with respect to a particular debt is not relevant in deciding whether the debt was acquired for the purpose of gaining or producing income. See The Queen v. Lalande, [1983] C.T.C. 311; 84 D.T.C. 6159 and Business Art Inc. v. M.N.R., [1987] 1 C.T.C. 2001; 86 D.T.C. 1842.

The appellant and his co-owners were committed to the Calgary company with respect to their equity in the Yorkland property from the date when that property was pledged. The nature of that commitment is similar to the capital which is invested to acquire shares of a new corporation and also similar to the funds which a shareholder will lend without interest to his corporation. I say “similar to" because, although paid-up capital and a shareholder's loan flow directly to the corporation whereas property which is pledged will be returned when the corporation repays its third party loans, failure to repay such loans will result in the loss of the pledged property just as much as if it were paid-up capital or a shareholder loan.

The commitment just referred to was made when the Yorkland property was first pledged and, at that time, there must have been a reasonable expectation of success in the Calgary company. Otherwise, the co-owners of the Yorkland property would not have put at risk their equity in that property. In other words, there was a business to invest in when the commitment was made. This answers the respondent's first argument. I would have had more difficulty in reaching this conclusion if the appellant had made a voluntary payment to one or more creditors of the Calgary company at a time when the Calgary company had become insolvent. The forced sale of the Yorkland property and the retention of the proceeds of sale by the financial institutions was not a voluntary payment by the appellant at the time of the sale.

In my oral reasons for judgment, I erred in looking at the retaining of the net proceeds of sale by the financial institutions as an investment by the appellant and his co-owners at the time of the forced sale. Instead, I should have. related the investment of those proceeds back to the date when the property was pledged. I regret that I have not had the benefit of hearing legal argument on this issue of" relating back”. There is authority for the proposition that a decision of this Court, delivered orally from the Bench, may be reversed before a formal written judgment has been issued under subsection 171(4) of the Act: Shairp v. The Queen, [1987] 1 C.T.C. 306; 87 D.T.C. 5206.

Having decided in these written reasons that the appellants acquisition of the debt owing by the Calgary company related back in time to the date when the Yorkland property was pledged, I have no difficulty in concluding that the debt was acquired for the purpose of gaining or producing income. Therefore, one of the conditions in subparagraph 40(2)(g)(ii) is satisfied; the subparagraph does not apply to the debt in issue; and the appellants loss from the deemed disposition of that debt in 1984 is not nil. This answers the respondents second argument.

The appellant is entitled to deduct a business investment loss based on the fact that his portion ($13,451) of the equity in the Yorkland property was invested in the Calgary company. The appeal will be allowed in part with costs and the reassessment for 1984 will be referred back to the respondent for reconsideration and reassessment on the basis that the appellant is entitled to deduct in computing income for 1984 the business investment loss referred to above.

Appeal allowed in part.