398827 Ontario Limited and Thomas Craig Moffat v. Minister of National Revenue, [1994] 2 CTC 2047, 94 DTC 1534

Mogan, J.T.C.C.:— The appeals of Moffat v. The Queen (court file 92-1286), and 398827 Ontario Ltd. v. M.N.R. (court file 90-1253), were heard together on common evidence. In these reasons for judgment, Thomas Craig Moffat will be referred to as "the appellant” and 398827 Ontario Ltd. will be referred to as "the company”. Pursuant to a written agreement dated April 19, 1985, the appellant purchased all of the issued shares of the company. The purchase and sale transaction was concluded at Hamilton, Ontario on April 19, 1985. At the time, the appellant thought that he also purchased from the vending shareholders the right to receive certain amounts owing to them by the company with respect to shareholder loans but the terms of the written agreement did not indicate that such shareholder loans had been purchased.

In the latter part of 1985, the appellant withdrew $7,200 from the company thinking it was a partial repayment of the shareholder loans which he thought he had purchased. In January 1986, he withdrew a further $89,099 from the company on the same basis. The Minister of National Revenue issued assessments to the appellant with respect to his 1985 and 1986 taxation years adding to his reported income the amounts of $7,200 and $89,099 respectively applying the provisions of subsections 15(2) and 56(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). The Minister also issued assess- ments to the company with respect to its fiscal periods ending April 30, 1986 and 1987 applying the provisions of subsection 80(1) of the Income Tax Act on the assumption that the shareholder loans owing by the company on April 19, 1985 had been forgiven in accordance with the terms of the written agreement between the appellant and the residing shareholders. The appellant’s appeal concerns his 1985 and 1986 taxation years. The company's appeal concerns its 1986 and 1987 taxation years.

The most important document in these appeals is the written agreement (Exhibit A-7) dated April 19, 1985 between the appellant and the four vending shareholders. Set out below are the only two recitals in the agreement and the first two operative paragraphs.

WHEREAS the vendors own 40 common shares in the captial [sic] stock of 398827 Ontario Ltd. (hereinafter called the “company”), which shares constitute all of the allotted and/or issued and outstanding common shares in the capital of the company;

AND WHEREAS the vendors have agreed to sell the same to the purchasers;

NOW THEREFORE THIS AGREEMENT WITNESSETH that in consideration of the mutual covenants and agreement contained herein, the parties hereto covenant and agree with each other as follows:

ARTICLE 1 — PURCHASE OF SHARES

Subject to the terms and conditions hereof, the vendors agree to sell, and the purchaser agrees to purchase, as of the effective date, all of the allotted and/or issued and outstanding common shares in the capital of the company, which shares are owned by the vendors.

ARTICLE 2 — PURCHASE PRICE

The purchase price payable by the purchaser to the vendors for the shares shall be one dollar for each common share plus the further sum of $79,960, which shall be payable on the closing date.

The appellant claims that he paid $40 for the 40 issued shares and $79,960 for the shareholder receivables making a total purchase price of $80,000 but the respondent argues that the appellant paid $80,000 for the shares alone. In my opinion, the first two operative paragraphs are equivocal with respect to both arguments. If the appellant purchased the shareholder receivables, why are they not mentioned in paragraphs 1 and 2? And if the appellant purchased only the 40 shares, why is the price in paragraph 2 divided on the basis of one dollar “for each common share plus the further sum of $79,960"? It would have been so easy to state in plain language that the purchase price was $80,000 for the 40 shares.

The respondent relies on the following two provisions in Exhibit A-7 to support the assessments under appeal:

3. The vendors represent and warrant to the purchaser as follows:

(j) The company is the owner of all property and assets used by the company in connection with its business, free of all registered liens, charges and encumbrances except liens for current taxes and employee tax deductions referred to in paragraph (I) not yet due and except for any pledges, liens or encumbrances in favour of:

I. The shareholders;

Il. Bank of Montreal, Trenton Branch;

Il. Allind Distributors Ltd.; and,

IV. Navend Industries Co.

which pledges, liens and encumbrances the vendor will discharge prior to closing.

4. The vendors covenant and agree as follows:

(a) That on or before closing they shall cause the following creditors of the company to deliver to the purchasers releases, releasing the company from any and all claims and debts that the said creditors have against the company:

I. The shareholders;

Il. Allind Distributors Ltd.;

III. Navend Industries Co.:

IV. Howie Carr Amusements Ltd.;

V. Bank of Montreal.

In paragraph 3(j), the vendors have represented and warranted that any pledges, liens and encumbrances in their favour on the property and assets used by the company in connection with its business will be discharged prior to the closing. On a technical basis, it may be argued that those pledges, liens and encumbrances could be discharged without any debt forgiveness; but the agreement contains much sloppy language and it does not appear to have been drafted with an eye to technical detail. The covenant in paragraph 4(a) appears to have been fulfilled because Exhibit A-8 is a series of five documents each entitled "General Release of all Demands” and each purporting to release the company. Four of the releases are signed respectively by the four vending shareholders and the fifth is signed by a creditor corporation associated with some of the vending shareholders.

Having referred to the sloppy language in the agreement, I note that although the appellant as the party of the second part was the only purchaser, the word "purchaser" is plural in the second recital and in paragraph 4(a) but singular in paragraphs 1 and 2. Also, although the word "company" is defined in the first recital, it is spelled with a lower case "c" in paragraph 4(a). On a less technical basis, it may be argued that delivery of the releases to the appellant as purchaser in paragraph 4(a) is different from delivery to the company as debtor. The appellant as the new sole shareholder could hold the releases as security (like assignments) knowing that they would prevent the creditors issuing the releases from making any future claims against the company. And until the appellant surrenders those releases to the company without consideration, the amounts owing to the creditors issuing the releases may not have been forgiven but only assigned to the appellant. This is an important technical detail because, in every standard share purchase agreement, there is a covenant by the vending shareholder to deliver to the purchaser at closing a release in favour of the subject corporation.

The assessments under appeal rely upon an interpretation of the share purchase agreement (Exhibit A-7). That interpretation is reasonable on a stand alone basis but there are three subsequent events which lead me to conclude that Exhibit A-7 was poorly drafted and that the appellant did in fact purchase the shareholder loans from the vendors. Firstly, the financial statements of the company for its fiscal periods ending April 30, 1984, 1985 and 1986 (Exhibits A-6, A-11 and A-12 respectively) are consistent in showing the continued existence of the shareholder loans as liabilities of the company. It is true that the appellant as sole shareholder could probably determine the content of Exhibits A-11 and A-12 for 1985 and 1986 but, just as beauty is in the eye of the beholder, so also what a person honestly believes that he has done may very well prove to be what he has in fact done, notwithstanding sloppy language in the principal implementing document. The notes to the financial statements for 1984 and 1985 (Exhibits A-6 and A-11) explain “long term debt" as follows:

Loan from related company, Alli nd Distributors

Ltd.	—	463,422
16.7 per cent loan	—	46,199
Non-interest bearing loan	—	33,883
	$1,494,094	$1,430,625

Although Exhibit A-6 shows the company’s financial status a year before the appellant purchased the shares, and Exhibit A-11 shows the financial status 11 days after the share purchase, they are consistent in showing the continued existence of the shareholder loans. There is some doubt, however, whether they are accurate in showing the continued existence (i.e., transfer of) the company's debts to outside creditors.

The second subsequent event which helps the appellant's case is his sale of the 40 issued shares of the company to his brother-in-law, Bill Evans, in January 1986. In that transaction, the appellant was specific in testifying that he sold only the 40 shares for $40 and retained the shareholder receivables. To secure his position, there was a security agreement (Exhibit A-16) dated January 30, 1986 between the appellant and the company in which the appellant is called the "secured party" and the company is called the "debtor". Paragraph (2) of Exhibit A-16 states:

(2)The security interest granted hereby secures payment and satisfaction of the obligations, indebtedness and liability of the debtor to the secured party (including interest thereon where applicable) described in Schedule "B" hereto (hereinafter collectively called the "indebtedness").

Schedule "B" to Exhibit A-16 contained three items but only the second one is relevant:

INDEBTEDNESS

(2) ADDITIONAL SHAREHOLDER LOANS

The secured party, Thomas Craig Moffat purchased all outstanding loans and indebtedness from the previous common shareholders. These loan amounts are reflected in the corporate records of the company.

This second item in Schedule "B" indicates that in January 1986 the appellant thought that he had purchased the vending shareholders' loans receivable.

The third subsequent event which helps the appellant’s case is an amendment to the first page of the share purchase agreement (Exhibit A-7) which was circulated among the appellant and the four vending shareholders in May 1987 approximate y two years after the appellant purchased the shares of the company. The appellant's recollection was that the amendment was made before Revenue Canada Taxation had commenced the audit which resulted in these appeals. In any event, the appellant and the four vendors initialled certain changes which, for convenience, are underlined in the portion of the amended first page (Exhibit A-14) set out below:

WHEREAS the vendors own 40 common shares in the capital stock of 398827 Ontario Ltd. (hereinafter called the "company"), which shares constitute all of the allotted and/or issued and outstanding common shares in the capital of the company and have loans owing to them by the company;

AND WHEREAS the vendors have agreed to sell the same to the purchasers;

NOW THEREFORE THIS AGREEMENT WITNESSETH that in consideration of the mutual covenants and agreement contained herein, the parties hereto covenant and agree with each other as follows:

ARTICLE 1 — PURCHASE OF SHARES AND LOANS

Subject to the terms and conditions hereof, the vendors agree to sell, and the purchaser agrees to purchase, as of the effective date, all of the allotted and/or issued and outstanding common shares in the capital of the company, which shares are owned by the vendors and all outstanding loan balances owing to shareholders of the company. ARTICLE 2 — PURCHASE PRICE

The purchase price payable by the purchaser to the vendors for the shares shall be one dollar for each common share plus the further sum of $79,920 for purchase of outstanding loan balances owing to shareholders of the company which shall be payable on the closing date.

It would appear that the amount $79,920 in Exhibit A-14 is a typographical error and the amount should be $79,960 as in Exhibit A-7. In Salter v. M.N.R., [1947] C.T.C. 29, 2 D.T.C. 918 (Ex. Ct.), and in Ouellette and Brett v. M.N.R., [1971] C.T.C. 121, 71 D.T.C. 5094 (Ex. Ct.), it was decided that if an income tax assessment is based on the interpretation of an agreement in writing between the appealing taxpayer and a third party, the parole evidence rule does not prevent the appealing taxpayer from giving oral evidence to explain the agreement. Exhibit A-14 goes much farther than oral testimony of the appellant “explaining” the share purchase agreement. It is an amended first page of Exhibit A-7, initialled by all the parties two years after the event confirming in Article 2 that the shareholder receivables were sold along with the 40 shares.

On the basic issue of whether on April 19, 1985 the appellant purchased only 40 shares of the company or both 40 shares and the shareholder receivables, I find in favour of the appellant and hold that he purchased the shareholder receivables. Having reached that conclusion, I find that there was very little evidence or argument concerning the quantum of the shareholder receivables acquired by the appellant. Exhibit A-6 is the balance sheet of the company as at April 30, 1984 — almost a year prior to the share transaction. Note 4 to that balance sheet describes long term debt of the company in words which I have shortened as follows:

I am troubled by the fact that note 3 to the balance sheet of the company as at April 30, 1985 (Exhibit A-11) sweeps all of the former long term debt into one amount of $1,494,094 identified simply as “payable to shareholder". If the shareholder loans were only $611,580 at April 30, 1984 when the aggregate long term loans payable to outside parties were $819,045, what happened to those amounts owing by the company to outside parties? Were they all guaranteed by the vending shareholders? Did the vending shareholders invest another $819,045 in the company so that they could sell their shares and shareholder receivables for $80,000? Were those outside loans settled by the vending shareholders through the company or privately? Were they settled for less than the face amount owing? If they were settled through the company, were there appropriate entries in the company’s books and records to show the shareholder loans increasing as the loans to outside parties disappeared? The balance sheet at April 30,1985 (Exhibit A-11) was prepared when the appellant was the sole shareholder of the company and in complete control.

The respondent called a witness, Mr. Dixon, who proved that the $80,000 paid by the appellant on April 19, 1985 was directed by the vending shareholders to Allind Distributors Ltd., one of the outside creditors; but that evidence does not prove whether other amounts owing by the company were forgiven by Allind or whether the vending shareholders were simply purchasing the Allind receivable so that it could be sold to the appellant. The vendors may have guaranteed the Allind receivable.

These appeals were argued on the basis that the only issue was whether the appellant had purchased the shares of the company or the shares plus the shareholder receivables. Having regard to Exhibits A-6 and A-11, I should have thought that there would be a second issue concerning the quantum of those receivables if it were to be found that such receivables had in fact been purchased by the appellant. There is no evidence to prove what was the aggregate credit balance in the shareholders’ loan accounts on April 19, 1985 immediately before the appellant purchased the shares and the shareholder receivables. The parties appear to have assumed that it was $1,494,094 being the amount which appeared on the balance sheet (Exhibit-11) as at April 30, 1985. In the company’s amended notice of appeal, paragraph 7 states in part:

The Minister erred in concluding that the appellant's indebtedness in the amount $1,494,094.37 was forgiven without payment on or about April 19, 1985 pursuant to the transaction referred to in the agreement.

And in the amended reply to the notice of appeal, the Minister of National Revenue makes the following assumption in subparagraph 2(i):

2(i) the appellant’s indebtedness in the amount of $1,494,094.37 to the shareholders (vendors) was entirely forgiven on April 19, 1985;

Schedule “B” to the security agreement (Exhibit A-16) states that the appellant loaned $100,000 to the company on April 19, 1985. There is no evidence as to whether this $100,000 amount was part of the $1,494,094 referred to in the pleadings.

Because the aggregate amount of the shareholder receivables immediately before the transaction was not put in dispute by the parties, I propose to follow the assumption in their pleadings and conclude that the amount of shareholder receivables purchased by the appellant was $1,494,094.

The company's appeals are allowed on the basis that there were no debts of the company forgiven when the appellant purchased the shares of the company on April 19, 1985. The appeals of Thomas Craig Moffat are allowed on the basis that

(i) he purchased from the vending shareholders on April 19, 1985 the credit balances in their shareholder loan accounts with the company; and (ii) the amounts of $7,200 and $89,099 should not be included in computing his income for 1985 and 1986 respectively under subsections 15(2) and 56(2) of the Income Tax Act. There was no alternative argument as to whether the shareholder receivables were capital property to the appellant or whether there was partial disposition thereof in 1985 and 1986. The appellant and the company are awarded costs to be taxed as if only one appeal were litigated under the Rules of General Procedure for this Court.

Appeals allowed.