Ralph E. Tucker v. Her Majesty the Queen, [1995] 1 CTC 2101

Bell J.T.C.C.:—The issue in this appeal in respect of the appellant’s 1988 and 1989 taxation years is whether the sum of $40,000 had, in April 1988 been loaned by Campbell Investment Ltd. ("Campbell”) to the appellant or whether such loan was, in effect, made by Campbell to Keyin Technical College Ltd. ("Keyin’’).

By virtue of an agreed statement of facts signed by counsel for both parties, the following facts were set forth:

1. At all material times the appellant was a shareholder and director of Campbell Investment Ltd. ("Campbell”):

2. At all material times the appellant was a director of Keyin Technical College Ltd. (’’Keyin’’);

3. Campbell’s taxation year-end is August 31;

4. A $3,000 balance in the "due from shareholder—Ralph Tucker” account from the 1987 taxation year was carried forward to the 1988 taxation year in Campbell’s financial statements;

5. On February 11, 1988 Campbell lent or advanced funds to the appellant in the amount of $3,000 as recorded in Campbell’s books and financial statements;

6. In 1988 Keyin was indebted to the Royal bank of Canada ("bank”) under a revolving line of credit;

7. By letter dated March 25, 1988 the bank requested, among other conditions to be met by April 8, 1988 that the appellant and his wife inject a capital amount of $100,000 as additional security with respect to loans to Keyin by the bank;

8. By letter dated April 15, 1988 the bank advised that none of the conditions required by the bank in its letter dated March 25, 1988 had been met, but agreed to extend the time to meet these conditions until April 23, 1988;

9. By letter dated April 22, 1988 the bank demanded payment from the appellant with respect to loans made by the bank to Keyin and guaranteed by the appellant;

10. On April 22, 1988 Campbell lent or advanced funds to the appellant in the amount of $40,000 as recorded in Campbell’s books and financial statements;

11. By letter dated May 3, 1988 the bank advised the appellant and his wife that it would hold in abeyance its demand for payment if, inter alia, a deposit of $90,000 was placed at the bank and was either carried in the names of the appellant and his wife or in the name of Keyin;

12. The loan from or indebtedness to Campbell in the amount of $40,000 was used by the appellant to purchase a term deposit from the bank in the names of the appellant and his wife;

13. The appellant and his wife have been declaring interest income from the term deposit acquired from the bank with respect to the 1988 and 1989 taxation years;

14. As at August 31, 1988 Campbell calculated and added an interest charge of $1,901.65 on the balance of $46,000 recorded in the "due from shareholder—Ralph Tucker" account, as per Campbell’s financial statements;

15. As at August 31, 1989 Campbell calculated and added an interest charge of $4,790.17 on the balance of $47,901.65 recorded in the "due from shareholder-Ralph Tucker" account, as per Campbell’s financial statements;

16. The amounts charged to the "due from shareholder-Ralph Tucker" accounts were not repaid by the appellant within one year from the end of Campbell’s taxation year in which the loans or advances were made to the appellant;

17. The loans were not made or the indebtedness did not arise in the ordinary course of Campbell’s business and the lending of money is not part of Campbell’s ordinary business, neither did the loans or indebtedness fall within the other exclusions noted in subparagraphs 15(2)(a)(ii) to (iv) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act");

18. By separate notices of reassessment numbered 2131880 and 21381881, both dated August 22, 1991, the respondent reassessed the appellant’s income tax liability for his 1988 and 1989 taxation years by including in his income the amounts of $44,901.65 and $4,790.17 respectively and by allowing an interest deduction in the amounts of $1,435.62 and $4,143.56 for the 1988 and 1989 taxation years respectively;

19. The appellant filed notices of objection dated November 13, 1991 with respect to the 1988 and 1989 taxation years;

20. By notification dated February 11, 1992 the Minister of National Revenue (the "Minister") confirmed the reassessments dated August 22, 1991;

21. By notice of appeal dated May 11, 1992 the appellant appealed the Minister’s decision with respect to the inclusion of additional income pursuant to subsection 15(2) of the Income Tax Act for the 1988 and 1989 taxation years;

22. By reply to notice of appeal dated July 9, 1992 the respondent stated that the Minister had properly assessed the appellant for the 1988 and 1989 taxation years;

At the hearing, respondent’s counsel advised that the sum of $44,901.65 included in the appellant’s income would be reduced by the sum of $3,000 together with an appropriate interest deduction and that a consequential adjustment would be made to the interest element of $4,790.17.

The appellant testified about the relationship of Campbell, Keyin and himself with the bank and how the bank suddenly pursued the collection from, or posting of security in respect of, Keyin for its indebtedness to the bank. He stated that Campbell had a surplus of $40,000 cash (part of the $100,000 described below) which was accumulated on a monthly basis as extra rent payable. He stated that a Mr. O’Keefe, who was the guarantor of a $100,000 debt on a building built by Campbell for use by Keyin, had the authority to prepare books, write cheques, make tax payments and build up a sum of $100,000 over five years to offset his potential guarantor’s indebtedness, caused a cheque to be written to the appellant on the Campbell account in the amount of $40,000. This cheque, which was made payable to the appellant on April 2, 1988, was deposited with the bank in the name of the appellant and his wife with interest payable to them.

The appellant testified that although a letter dated May 3, 1988 from the bank addressed to the appellant and his wife stated in paragraph 1 that

The deposit may be carried in the names of Ralph & Gwen Tucker or Keyin Technical College Ltd. with the normal supporting documentation being provided.

they had no indication that the money could come from anyone but him and his wife. He further stated that the first time he was aware of the fact that this sum was set up in the books of Campbell as being a "due from shareholder-Ralph Tucker" account was when the reassessment came from the Department of National Revenue.

On cross-examination, the appellant stated that he had reviewed the books but that he had only looked at "the bottom line" and never got into detail. The respondent entered as exhibits copies of the income tax returns of Campbell for each of the years ended March 31 in 1988, 1989 and 1990. In each of the three years the financial statements included information as to the amount due from shareholders. In response to a query by respondent’s counsel as to whether he had reviewed the financial statements he replied affirmatively but said that he had never paid attention to this nor was aware of it until the reassessment. The appellant stated, in response to a question concerning same, that he had declared one- half of the interest payable by the bank on the sum of $40,000 in 1989 and 1990.

On re-examination the appellant stated that he had received a TS from the bank and he had just given it to his accountants. He stated that he knew he was receiving income but wasn’t aware of the ramifications.

Appellant’s counsel stated that it was never the intent of Campbell or of the appellant that the $40,000 would be a debt owing by him to the company but was a transaction to assist Campbell. He stated effectively that Keyin and Campbell were not two different companies because Campbell would not exist if a guarantor had not been required, that Campbell and Keyin had the same shareholders and directors and that Campbell held the realty for Keyin only. He stated that the bank demands were made to the appellant and his wife, that they had cashed RRSPs, and borrowed and "scraped together" $50,000. He stated that Campbell, in order to survive, had to support Keyin and that the $40,000 made payable by Campbell to the taxpayer "was a flow over" to the operating company, Keyin, which was a benefit to Campbell itself in that if Keyin folded, Campbell would also fail.

Counsel stated that Mr. Tucker had said that the least of his worries was how this sum would be handled from an accounting viewpoint and that this was understandable and he emphasized that the appellant was focused on the bank and keeping the company alive. He stated that he simply received the TS and gave it to his accountant and that there was no deduction to him of the interest paid by him. He urged the Court to look behind the accounting treatment in order to determine in substance whether the sum was intended to be an advance to the appellant. He stated that the sum was, without doubt, an intercorporate advance, that it was not Campbell’s money but was Keyin’s money. He also suggested that possibly there existed a constructive trust by Campbell for O’ Keefe. Finally, he urged the Court to find as a fact that this was an intercorporate advance, the accounting structure and treatment of which was not focused upon.

Respondent’s counsel stated that the books and records of Campbell reflect its financial situation and cannot be ignored. She submitted that Campbell was a separate company from Keyin and that the appellant was a shareholder of both. She said further that Campbell’s books did not reflect a loan to Keyin and stated also that it was not known what is set forth in Keyin’s books. She referred to The Queen v. Bronfman Trust, [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059. In this case, the taxpayer’s trust borrowed money in order to make capital allocations to the trust’s beneficiary. The trust had decided that it was more advantageous to borrow the money than to sell its assets in order to make the allocations. Counsel for the trust submitted (and the Crown conceded) that the trust would have obtained an interest deduction if it had sold assets to make the capital allocations and borrowed to replace them. Accordingly, it was argued that the trust ought not to be precluded from an interest deduction merely because it achieved the same effect without the formalities of a sale and repurchase of assets. At page 55 (C.T.C. 129; D.T.C. 5067-68) the Court said

It would be a sufficient answer to this submission to point to the principle that the courts must deal with what the taxpayer actually did, and not what he might have done.

In Matheson v. The Queen, [1974] C.T.C. 186, 74 D.T.C. 6176

(F.C.T.D.), from Mahoney J. said at page 189 (D.T.C. 6179):

The plaintiff further argues that, instead of making the loan, he could have liquidated other, income producing assets but that he chose instead to borrow from the bank and pay the interest in order to protect and increase his other investments.

and further,

While I may sympathize with the plaintiff inasmuch as it would likely have been possible to arrange matters in a way that could have permitted Direct, if not himself, to claim the interest expense, I must deal with the situation that in fact existed during the taxation years in question. Neither am I free to speculate on why matters were arranged as they were. The interest expense claimed by the plaintiff and disallowed by the Minister was not paid or incurred in respect of borrowed money used to earn income from the plaintiff’s business or property and the reassessments are accordingly sustained.

In The Queen v. Friedberg, [1992] 1 C.T.C. 1, 92 D.T.C. 6031 (F.C.A.), Linden J.A. at pages 2-3 (D.T.C. 6032) said

In tax law, form matters. A mere subjective intention, here as elsewhere in the tax field, is not by itself sufficient to alter the characterization of a transaction for tax purposes. If a taxpayer arranges his affairs in certain formal ways, enormous tax advantages can be obtained, even though the main reason for these arrangements may be to save tax (see Canada v. Irving Oil Ltd., [1991] 1 C.T.C. 350, 91 D.T.C. 5106, per Mahoney J.A.). If a taxpayer fails to take the correct formal steps, however, tax may have to be paid. If this were not so, Revenue Canada and the courts would be engaged in endless exercises to determine the true intentions behind certain transactions. Taxpayers and the Crown would seek to restructure dealings after the fact so as to take advantage of the tax law or to make taxpayers pay tax that they might otherwise not have to pay. While evidence of intention may be used by the courts on occasion to clarify dealings, it is rarely determinative. In sum, evidence of subjective intention cannot be used to "correct" documents which clearly point in a particular direction.

It is not only understandable but normal that someone in the appellant’s position would be more concerned with the survival of his companies than with the tax correctness of the structure respecting the use of the sum of $40,000 made available by Campbell. It is, however, vital that financial transactions be arranged with due consideration to the results thereof from a tax point of view. Although the appellant was a credible witness whom I believe was not aware of the income tax results of his actions in setting up a loan to him and his wife from Campbell, the fact is that they deposited this sum of money with the bank, received interest thereon and declared same in their income tax returns for the years in question. In addition, the appellant, when reviewing Campbell’s financial statements, did not question the fact that the sum of $40,000 was shown as due from shareholders. The appellant’s evidence was that up to the time of the demand from the bank Clarkson Gordon had been their accountants. He stated that that firm was not forthcoming with other help and they moved to Touche Ross for one year. He said that this firm "did 1988 and 1989". He stated that his operation was a small cog in a big wheel and that they received accounting work but no guidance. It is not clear who made the entries resulting in setting up the loan of $40,000 as an advance by Campbell to the taxpayer but perhaps one or both of those firms is responsible for that act.

It is regrettable that the appellant, for whatever reason, selected or endorsed the accounting treatment so employed. Neither he nor his advisers initiated a correction in the manner the transaction was handled, it having come to his attention by virtue of the reassessment by the Minister of National Revenue.

For the years in question, subsection 15(2) of the Act provided that where a person was a shareholder of a particular corporation and the person in a taxation year had received a loan from or became indebted to the corporation the amount thereof would be included in his income for the year unless the loan was made or the indebtedness arose under conditions which do not exist in the present case or unless it was repaid within one year from the end of the taxation year of the lender in which it was made.

With reluctance, I can find no assistance for the appellant, everything except a statement of his intention otherwise, pointing to the conclusion that subsection 15(2) of the Act should apply.

In light of the aforementioned statement by respondent’s counsel the assessments herein appealed are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that

A. the sum of $44,901.65 included in the appellant’s income will be reduced by the sum of $3,000 together with an appropriate interest deduction,

B. a consequential adjustment will be made to the interest element of $4,790.17, and

C. by computing the appropriate amount to be allowed as interest deduction.

The appellant is entitled to no further relief.

The appellant’s appeals are dismissed.

Appeals dismissed.