Edwin J. Byram v. Her Majesty the Queen, [1995] 1 CTC 66, [1995] DTC 5069

Wetston J.:—This is an appeal from a reassessment of income by the Minister of National Revenue, dated June 28, 1988, in respect of the plaintiff’s 1982, 1983, 1984, 1985 and 1986 taxation years. Each court file corresponds to one taxation year; the facts are common to all files.

Facts

The following facts reflect, in part, the agreed statement of facts submitted by counsel at the outset of the hearing.

The plaintiff was at all times a resident of Canada for the purposes of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

The plaintiff left the employ of a major multi-national oil company in the early 1970s to start an oilfield consulting, maintenance and construction company, in Alberta, known as Byram Industrial Services Ltd. ("BISL”). BISL’s only shareholders and managers were, at all material times, the plaintiff and his immediate family members. The plaintiff received both a salary and dividends from BISL.

In 1978, with another shareholder, the plaintiff formed Lome’s Well Servicing Ltd. ("LWS”), an oil and gas well servicing company. At all material times, the plaintiff was a shareholder, director and officer of LWS. For direct operational services provided to LWS, the plaintiff received a salary. For managerial services provided by the plaintiff, BISL charged LWS a management fee, the plaintiff receiving BISL dividends as compensation.

In 1979, the plaintiff joined three other shareholders to form Pembina Oil Separators (1979) Ltd. ("POS"), an oilfield salvage and recycling business. At all material times, the plaintiff was a shareholder, director and officer of POS. Similar to the arrangement with LWS, the plaintiff received a salary for direct operational services and BISL dividends for managerial services provided to POS.

Also in 1979, the plaintiff incorporated Elkhound Resources Ltd. ("ERL"), a company involved in exploration and development of oil and gas in Alberta. From ERL’s incorporation until February 1984, the only shareholders were the plaintiff, his wife and BISL. In February 1984, one of the plaintiffs sons, Ken Byram, became the sole shareholder of ERL.

In 1981, following the announcement of the National Energy Program (NEP), the plaintiff looked to diversify and chose the United States. With the advent of PetroCanada, the plaintiff feared that private contractors, like the plaintiff’s companies, were no longer going to be employed. The plaintiff testified that the NEP effectively shut down exploratory drilling and seismic exploration in the Alberta oil and gas industry, and that by December 1990, virtually, all drilling rigs had moved out of Canada and into the United States. The plaintiff further testified that the overall effect on his companies, BISL, LWS, POS and ERL, was devastating. In other words, the plaintiff was apprehensive about the future of his companies in Canada.

In 1981, the plaintiff had discussions with public and private individuals regarding the oil and gas industry in east Kansas and Oklahoma regarding production volumes in the area. The plaintiff examined the possibility of acquiring property in east Kansas. The plaintiff testified that he felt that the east Kansas area was in need of skilled persons in the field of oil and gas production. Furthermore, the plaintiff had received a favourable U.S. oil price forecast, from the American Petroleum Institute and various sources contacted by the Royal Bank in Edmonton. It was expected that within five or six years the U.S. price per-barrel would rise from $35 dollars to more than $50 dollars.

In March of 1981, the plaintiff incorporated, in Kansas, Elkhound Resources Inc. ("USCO"). At all material times, the plaintiff was an officer and the director of USCO. USCO’s shareholders were:

(a) from incorporation until April 1, 1981, the plaintiff, and his son, Ken Byram, who has always been active in USCO;

(b) from April 1, 1981 to April 1, 1982, ERL; and

(c) from April 1, 1982 to date, the plaintiff, his wife and Ken Byram.

The plaintiff testified that ERL was the majority shareholder in USCO, from April 1, 1981 to April 1, 1982, for reasons dealing with U.S. immigration. During that period, USCO was considered a subsidiary of ERL. The plaintiff testified that it was his intention to operate USCO in a manner similar to the Canadian companies, namely, receiving dividends from BISL and BISL charging USCO a management fee.

On June 1, 1981, USCO acquired oil and gas rights in Kansas, known as the Greer interest. The acquisition of the Greer interest was financed by debt owed to the Kansas vendor (the Greers), $1.3 million dollars to be paid by a percentage production agreement, and the plaintiff’s Canadian bank for the remaining $1 million dollars.

It became apparent to the plaintiff that further capital would be required to develop, upgrade the facilities and operate the Kansas property. USCO was unable to borrow further funds. Accordingly, the plaintiff advanced USCO, as a USCO shareholder, $115,417.55. The plaintiff advanced USCO a further $221,381.60; however, not as a USCO shareholder. When these funds were advanced, ERL was the majority shareholder in USCO. In total, the plaintiff personally loaned USCO about $336,800 (Cdn) in the period March, 1981 to October, 1982. The loans made by the plaintiff were non-interest bearing and were not reduced to writing.

USCO suffered significant losses and resulted in the plaintiff receiving no salary or dividends emanating from USCO, nor did BISL charge USCO any management fees. By the end of 1984, it was clear to the plaintiff that USCO would not be able to repay any portion of the loans. Consequently, the plaintiff, assigned the loans and his loss, for $1 dollar, to Avalie Peck, an employee of BISL.

The plaintiff reported and claimed his loss in respect of the loans in his 1984 tax return, as a $336,800 capital loss and a $168,400 allowable capital loss (the ’’loss") per paragraph 38(b) of the Act. The plaintiff deducted the loss as follows:

(a) $109,463.50 to completely offset taxable capital gains realized in 1984;

(b) $2,000 as a deduction in 1984, pursuant to paragraph 111(1)(b);

(c) $2,000 as a deduction in 1983, pursuant to paragraphs 111(8)(a) and lll(l)(b);

(d) $13,481 as a deduction in 1982, pursuant to paragraphs 11 l(8)(a) and 111(1)(b);

(e) $2000 as a deduction in 1985, pursuant to paragraphs 111(8)(a) and 111(1 )(b); and

(f) $21,629 as a deduction in 1986, pursuant to paragraphs 111(8)(a) and 111(1)(b).

By five notices of reassessment, dated June 28, 1988, the Minister reassessed the plaintiff in respect of the 1982, 1983, 1984, 1985, and 1986 taxation years, to treat as nil, pursuant to subparagraph 40(2)(g)(ii), the allowable capital loss claimed by the plaintiff pursuant to paragraph 38(b) and denying the plaintiff any deductible capital loss for the purpose of section 3. As such, the plaintiff had no net capital loss for his 1984 taxation year for the purpose of paragraph 111 (8)(a), nor did the plaintiff have any net capital loss for the purpose of paragraph 111(1)(b) for his 1982, 1983, 1984, 1985, or 1986 taxation years.

The plaintiff objected to the reassessments by notice of objection dated September 23, 1988, notification of which was filed by the Minister on March 30, 1989.

Issues

The plaintiff’s argument is based primarily on a recent decision of the Tax Court of Canada, National Developments Ltd. v. The Queen, [1993] 2

C. T.C. 3027, 94 D.T.C. 1061. The plaintiff urges the Court to consider the oral reasons of Judge Bell, as a means of resolving, what the plaintiff submits is the issue to be determined, namely, whether the plaintiff’s loans, and subsequently acquired debt, were "for the purpose of gaining or producing income from a business or property" within the meaning of subparagraph 40(2)(g)(ii).

The defendant argued that the National Developments case has been wrongly decided in light of the Supreme Court of Canada’s decision in The Queen v. Bronfman Trust, [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059. The defendant takes the position that while the loans made by the plaintiff were made for the purpose of gaining or producing income, the income produced, in order to avoid the application of subparagraph 40(2)(g)(ii), has to be direct to the plaintiff rather than indirect income to the plaintiff by way of dividends or management fees. In the defendant’s submission the prospective income expected by the plaintiff does not meet the test established by the Court in Bronfman Trust.

The following issues arise from the parties respective submissions regarding subparagraph 40(2)(g)(ii):

1. Do the principles found in the Bronfman Trust case regarding interest deductibility under paragraph 20(1 )(c) apply with respect to allowable capital losses under subparagraph 40(2)(g)(ii)?

2. If not, were the plaintiff’s loans, and subsequently acquired debt, made “for the purpose of gaining or producing income from a business or property", within the meaning of subparagraph 40(2)(g)(ii) of the Income Tax Act?

Analysis

The first issue to be determined is whether the Bronfman use test for determining interest deductibility pursuant to paragraph 20(1 )(c), is also applicable in the interpretation of subparagraph 40(2)(g)(ii). The relevant sections read as follows:

20(1) Notwithstanding paragraphs 18( 1 )(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy)…

[Emphasis added.]

40(2) Notwithstanding subsection (1)

(g) a taxpayer’s loss, if any, from the disposition of a 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 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;

[Emphasis added.]

The defendant does not dispute that the purpose of the loans made by the plaintiff to USCO was to produce income. The defendant argues, on the basis of the Bronfman use test, that in order for the plaintiff to benefit from subparagraph 40(2)(g)(ii), the loans must be directly related to an incomeearning purpose. The defendant submits that in this case the plaintiff is using the funds to indirectly earn income in another taxpayer, USCO. Even if USCO had been successful, the plaintiff would not have received the income directly. He would have received the income indirectly by way of dividends from his shares in either USCO or BISL. Also, BISL would have charged USCO a management fee on the plaintiff’s behalf.

The defendant further contends that the purpose of subparagraph 40(2)(g)(ii), is to ensure not only that money be loaned for an incomeearning purpose, but also that the income must be earned directly by the plaintiff rather than through intermediary companies. The defendant submits that to find otherwise, would amount to ignoring the existence of the plaintiff’s corporations which would be contrary to established corporate and tax law. The defendant contends that if the words "the debt acquired" in subparagraph 40(2)(g)(ii), are read in place of the word "used" in paragraph 20(1 )(c), the plaintiff”s nexus to the income produced is too indirect or too remote to be within the statutory language of 40(2)(g)(ii). Subparagraph 20(1)(c)(1), in particular, allows a deduction of interest where money is borrowed and then used to earn income from a business or property. Absent this provision, interest expenses on loans would be prohibited from deduction under paragraph 18(1)(b). The Court in Bronfman identified the purpose of subparagraph 20(l)(c)(i) as encouraging the accumulation of capital in Canada which would produce taxable income.

For the purposes of paragraph 20(1)(c), the Court, in Bronfman, determined that not only did the use to which borrowed money was put have to be considered, as between eligible and ineligible uses, the purpose of using the borrowed money also had to be considered, since the deduction is contingent on the use for a particular income-earning purpose. In other words, in order for the taxpayer to deduct the interest, the purpose in borrowing the money had to be that the taxpayer could directly earn income from a business or property and that the borrowed money had to be used in a direct eligible manner to produce said income.

Subparagraph 40(2)(g)(ii) requires that the debt, acquired by the taxpayer, be for "the purpose of gaining or producing income from a business or property". There is no use concept in subparagraph 40(2)(g)(ii). It appears that the taxpayer’s purpose of gaining or producing income, from a business or property, only requires that it be related to the making of the loan. In my opinion, subparagraph 40(2)(g)(ii) does not require a direct link, as discussed by the Court in Bronfman, between the loan and the business or property which produces the income. In this instance, the loans were made to enable the plaintiff’s U.S. corporation to carry on business. This would have produced a future income stream to the plaintiff. While there must be a link between the lender and the shares on which dividends are expected, there is no need, as is required by paragraph 20(1)(c), that the use of borrowed money and the resulting business income be direct to the plaintiff. What if the plaintiff, instead of lending the money, had injected money into his company by means of a share purchase? Why should the tax ramifications be any different.

Paragraph 20(1)(c) of the Act deals with interest deductions while subparagraph 40(2)(g)(ii) deals with the deductibility of capital losses. As counsel for the plaintiff submits, by adopting the appellant’s argument in National Developments, supra, despite the similarity in language in the two sections, subparagraph 40(2)(g)(ii) does not include a source concept, nor a preamble that must be considered. There is a difference between use and purpose. I am of the opinion that to apply the direct or indirect use concept as found in Bronfman, is inappropriate when the issue to be determined is direct or indirect purpose. The sections do contain similar language but they are not mirror images as contended by the defendant.

The plaintiff submits that the correct approach to interpreting subparagraph 40(2)(g)(ii) is to look to commercial reality, per Stubart Industries Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305. Recently, the interpretation of taxing statutes was considered by the Supreme Court of Canada in Canada v. Antosko, [1994] 2 S.C.R. 312, [1994] 2 C.T.C. 25, 94 D.T.C. 6314.

The trend in statutory interpretation has been away from a strict interpretation in favour of a purposive approach, attempting to ascertain the true commercial and practical nature of the transaction. This is the approach taken by the Court in Stubart, supra. The Supreme Court of Canada in Antosko, supra, clarifies when the purposive approach is appropriate, by concluding that while a purposive interpretation is required to ascertain the proper meaning of an ambiguous provision, where the words of the Act are clear and unequivocal it is unnecessary for the Court to look to the results of the transaction or existing jurisprudence to assist in ascertaining the intent of Parliament. Where the words of the statute are clear and plain, it is not for the courts, but for Parliament to normatively assess the consequences of the application of a given provision. As was stated by Mr. Justice lacobucci in Antosko, supra, at page 326 (C.T.C. 31, D.T.C. 6320):

While it is true that the courts must view discrete sections of the Income Tax Act in light of the other provisions of the Act and of the purpose of the legislation, and that they must analyze a given transaction in the context of economic and commercial reality, such techniques cannot alter the result where the words of the statute are clear and plain and where the legal and practical effect of the transaction is undisputed.

With this is mind, the Court must decide whether the words of the statute are clear and plain and what is the legal and practical effect of the transaction.

The plaintiff, as a shareholder in USCO, advanced some $115,417.55 to USCO, on an interest-free basis, intending to recover income from the loaned moneys by receiving either dividends from USCO or by operating as he had in Canada, namely, providing managerial services through BISL. BISL then would charge USCO a management fee, and the plaintiff ultimately would receive dividends from BISL. To enable a closely-held corporation to earn income which could then be paid out as dividends on the shares owned by the plaintiff is certainly a debt acquired for the purpose of gaining or producing income from a business or property. While the income is not directly earned by the plaintiff, there is a clear nexus between the taxpayer and the likely future income to be earned from the acquired debt. This interpretation of subparagraph 40(2)(g)(ii) is in keeping with cases such as National Developments, supra, Business Art Inc. v. M.N.R., [1987] 1 C.T.C. 2001, 86 D.T.C. 1842 (T.C.C.), and The Queen v. Lalande, [1983] C.T.C. 311, 84 D.T.C. 6159. As Judge Rip said in Business Art at page 2009 (D.T.C. 1848):

...the fact that there may have been no interest attached to the debts in question is not relevant in deciding whether they were acquired for the purpose of gaining or producing income… It is not uncommon for a shareholder to lend money without interest and without security to a corporation since he anticipates that the loans will assist the corporation to earn income and to pay him income by way of dividends; the loan is made for the purpose of earning income from a property.... Purchasing shares and advancing money to a corporation are two ways of making an investment in a corporation. This is a sensible in terp ret at i on.... C/e^r/y the loans were made to earn income from property, that is, to place the corporation in a position where it will be successful and pay dividends.

[Emphasis added.]

Clearly, the plaintiff is entitled to the benefit of 40(2)(g)(ii) for the debt acquired from lending money, as a principal shareholder, to his small closely-held corporation.

As a shareholder, the plaintiff was directly linked to the income producing potential of USCO. Dividends could be declared in a straightforward manner should they have been available. However, can the plaintiff avoid the application of subparagraph 40(2)(g)(ii) for those loans advanced to USCO when the plaintiff was not a shareholder in USCO but rather when ERL was the shareholder in USCO, the plaintiff being another step further removed as a shareholder in ERL. Subparagraph 40(2)(g)(ii) does not require a direct link between the loan and the property or business that produces the income.

What was the taxpayer’s motivation when the loan was made. In cases, such as Lowery v. M.N.R., [1986] 2 C.T.C. 2171, 86 D.T.C. 1649 (T.C.C.), Casselman v. M.N.R., [1983] C.T.C. 2584, 83 D.T.C. 522 (T.C.C.), and O’Blenes v. M.N.R., [1990] 1 C.T.C. 2171, 90 D.T.C. 1068 (T.C.C.), where the taxpayer’s motivation in guaranteeing or lending was identified as help to a family member, not to earn income, it has been held that 40(2)(g)(ii) applies. There may have been advantage to the taxpayer, but there was no business purpose. In this case, the plaintiff’s motivation cannot be said to have been family related.

In Ellis v. M.N.R., [1988] 1 C.T.C. 2081, 88 D.T.C. 1070 (T.C.C.), where a individual taxpayer guaranteed a loan to a hotel corporation, in which his company was merely a minority shareholder, the Court found that since the taxpayer would be in no position to assume that dividends be paid from the hotel corporation the possibility of benefit was too remote and the appeal was dismissed. Unlike in Ellis, the plaintiff, as a majority shareholder in ERL at the time, had more than a mere possibility of benefiting.

Essentially, the plaintiff’s motivation was consistent; USCO required capital in order enable it to be productive. The plaintiff furnished the capital, in order to gain or produce income from the operations of USCO. Whether it be direct or indirect is immaterial. The purpose is clear and plain. It cannot be said that the plaintiffs motivation was any different as a shareholder of USCO than it was when ERL was the shareholder. I am satisfied that the plaintiff has established that the debt was acquired for "the purpose of gaining or producing income from a business or property." As such, the plaintiff should have the benefit of subparagraph 40(2)(g)(ii), and the capital losses realized in 1984 should not be treated as nil.

Accordingly, the appeal is allowed. The reassessments dated June 28, 1988, for the plaintiff’s taxation years 1982, 1983, 1984, 1985 and 1986, are set aside and the matter is remitted back to the Minister of National Revenue for reassessment in conformity with the returns filed by the plaintiff.

Appeal allowed.