Dale Maccala v. Her Majesty the Queen, [1995] 1 CTC 2215, 95 DTC 398

Lamarre J.T.C.C.:-This is an appeal from an assessment of tax made by the Minister of National Revenue (the "Minister”) in respect of the appellant’s 1986 taxation year. In assessing the appellant, the Minister added an amount of $170,987.55 to the appellant’s total income as a taxable deemed dividend received pursuant to subsection 84(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the ’’Act”). In doing so, the Minister relied on the fact that upon the winding-up or discontinuance of Roadrunner Farms Ltd. ("Roadrunner") of which the appellant was a shareholder, funds or property amounting to $114,092.70 were distributed or otherwise appropriated to the appellant, as follows:

The paid-up capital in respect of the shares of the appellant being $101 at the time of the winding-up of Roadrunner, the Minister established that the appellant received a deemed dividend from Roadrunner amounting to the value of the funds or property of Roadrunner distributed to the appellant in excess of the paid-up capital in respect of the shares. This value is $113,991.70.

The appellant admits that he received the property mentioned above to the exception of the class 6 item, referred to during the hearing as the Quonset, which he denies having received, and even denies the fair market value attributed to it. The Minister claims that the appellant appropriated the Quonset and that the fair market value is $30,000 while the appellant argues that there is a nil value. Furthermore, the appellant contends that the amounts and property received were repayments of a loan made to Roadrunner and as such were not to be considered as appropriations of funds from Roadrunner giving rise to a deemed dividend under subsection 84(2) of the Act.

Facts

The appellant, Dale Maccala, operated a family farm in the rural municipality of Calder, Saskatchewan. He was engaged exclusively in grain farming. By the late 1970s, the farming enterprise consisted of approximately 1,600 acres. In the early 1980s, he incorporated Roadrunner and through this corporate entity expanded operations to approximately 10,000 acres.

Expansion was financed by a loan ("loan") from a branch of the Royal Bank of Canada ("bank") in Kamsack, Saskatchewan, received on October 21, 1981 in the amount of $1,000,000. The loan was secured by a debenture ("debenture") covering the property of Roadrunner with the appellant providing a personal guarantee ("guarantee") for the loan. The guarantee was supported by a pledge of the appellant’s personal property. The debenture and guarantee were duly registered and entered in the appropriate registries.

The year 1981 was a difficult one for grain farmers. A severe frost prevented seeding until late May. This was compounded in August of that year when another frost set in which entirely wiped out the crop. Failure of the 1981 crop, combined with high interest rates at the time placed considerable financial strain on the appellant’s operations. The situation was similar for 1982 and 1983. The result was that the appellant, at best, was only able to meet interest payments on the loan. In an attempt to continue farming, increasing reliance was placed upon the bank for working capital.

In 1984 the situation came to a head. The bank wished to realize on its security under the debenture and guarantee. Pursuant to an indenture dated May 3, 1984 ("indenture"), Roadrunner transferred its property to the bank, as well, the bank called on the appellant to make good on his guarantee. In honouring the guarantee the appellant in the indenture transferred three parcels of land, identified as Southeast Quarter 7-27-31-W1, Southeast Quarter 13- 27-32-W1 and Northeast Quarter 7-27-31-W1 (collectively called "property") to the bank. In addition to the transfer of the property, the appellant, under the indenture, assumed a $200,000 debt pursuant to his guarantee on Roadrunner s behalf.

On July 31, 1986 Roadrunner terminated business and voluntarily wound up. On the winding-up the appellant, as sole shareholder of Roadrunner, received the remaining property of the company.

Appellant’s position

Counsel for the appellant maintains that, by virtue of the guarantee, the value of the property transferred to the bank plus the amount of the debt assumed by the appellant increases the amount of the loan to Roadrunner. From this proposition he advances the position that the fair market value of the land transferred is $252.000. [1] Similarly, counsel submits that the appellant personally assumed a debt of $200,000 which should further increase the shareholder’s loan account to Roadrunner. Consequently, the property received by the appellant on winding-up should reduce the loan to Roadrunner. Finally, the appellant contests the inclusion in income of the value of the Quonset alleging that he never received it and that, in any case, it has no value.

Minister’s position

The Minister’s counsel did not contest the principle that payments made and debts assumed on behalf of a company pursuant to a guarantee are the equivalent of loans to the company on whose behalf the debts were assumed or the payments were made. Rather he puts in issue the valuation of these amounts. The Minister submits that when the property was transferred to the bank, affidavits of value were attached to the transfers sworn by the appellant which state the value of the property, in aggregate, to be $120,000 and that this amount has been credited to the loan account. [2] Counsel for the Minister contends that the appellant cannot stray from that valuation.

In relation to the assumption of the $200,000 debt, the Minister alleges that the debt was not assumed by virtue of the guarantee but is merely a promise to pay upon the occurrence of certain events. In the alternative, he argues that even if it were the result of the guarantee, there can be no increase in the shareholder’s loan account until the guarantee is honoured and payments are actually made.

Finally, with respect to the Quonset, the Minister maintains that as a result of the winding-up, the Quonset was part of the assets of the company transferred to the appellant, and was treated as such in the financial statements of the company in the year of dissolution in 1986. The Minister contends that the value is $30,000 being the value established by the appellant’s accountant.

Analysis

Transferred property

Counsel for the appellant adduced expert evidence from Mr. Cliff Durnford, an accredited member of the Appraisal Institute of Canada. According to that evidence, the value of the property on May 3, 1984, the time of the transfer to the bank, was $252,000. At the time the property was transferred to the bank, affidavits of value (as required by section 234 of the Land Titles Act, Revised Statutes of Saskatchewan 1978, c. L-5), sworn by the appellant, were filed with the transfer. Section 234 of that Act reads,

(1) The value shall be ascertained by the oath or affirmation of the applicant, owner or person acquiring the land or of such other person as the registrar believes to be acquainted with its value and whose oath or affirmation he is willing to accept.

(2) If the registrar is not satisfied as to the correctness of the value so sworn to or affirmed, he may require the applicant, owner or person acquiring the land to produce a certificate of the value under the hand of a sworn valuator appointed by the registrar or a judge, which certificate shall be received as conclusive evidence of the value.

This section requires the value of transferred land to be established by affidavit for registration purposes and for the purpose of calculating land transfer fees. The appellant, in his affidavits of value, swore that the value of the property was as follows. With respect to the South East Quarter 7-27-31-WI he swore,

1. That the within piece of land, together with all buildings and other improvements thereon in my opinion of the value of $30,000.00 dollars and no more.

With respect to the South East Quarter 13-27-32-W1 he swore,

1. That the within piece of land, together with all buildings and other improvements thereon in my opinion of the value of $60,000 and no more.

With respect to the North East Quarter 7-27-31-WI he swore,

1. That the within piece of land, together with all buildings and other improvements thereon in my opinion of the value of $30,000 and no more.

When asked by his counsel why he had placed the value of South East Quarter 13-27-32-W1 at $60,000, he testified that,

A. My understanding of that figure at that time was the value of that land that it cost us to acquire the land, the $60,000 value in 1981.

Q. Was that land in your opinion worth more than $60,000 in May of 1984?

A. Yes very much so, more than $60,000.

With respect to the other parcels of land that made up the property, his testimony was similar. He testified that the value he swore to in the affidavits of value represented nothing more than the cost of the land plus the improvements. The original certificates of title were filed with the Court as exhibits and they support the appellant’s claim that the values he ascribed to the property in the affidavits of value were cost plus improvements.

The appellant testified that he considered the transfer to the bank differently than a sale. He was not receiving proceeds of disposition and consequently, the value placed on the property was cost plus improvements. When this issue was put to him by counsel for the Minister in cross-examination, the appellant responded,

Q. Well it is not what you could have done, it is what you actually did.

A. And I explained the reason that 1 did that, it was based-I explained the reason I did that. It was based on—when 1 was sitting in the chair signing those pieces of paper, I was thinking about value that those pieces of property cost me.

These affidavits of value amount to admissions by the appellant and may be used against him. The Minister is entitled to confront any witness who has sworn an affidavit and put to him the contents. The witness is free to adopt what has been sworn in the affidavit or to testify differently. If he chooses to alter what he has previously sworn to, it reduces to an evidentiary issue that is resolved on the weight attached to that later testimony. In the present case, the affidavits of value were prepared for a different purpose than that before the Court, without a full appreciation by the deponent of what was required. The appellant is a credible witness and I am convinced he did not intend to put forth values in the affidavits of value that were representative of the market value.

The value to affix to the property remains to be determined. The Court is not bound by the value advanced by one of the parties but is free to establish a value of its own. Mr. Justice Walsh expressed this principle in Bibby v. The Queen, [1983] C.T.C. 121, 83 D.T.C. 5148 (F.C.T.D.), at page 131 (D.T.C. 5157), where he said,

While it has frequently been held that a Court should not, after considering all the expert and other evidence merely adopt a figure somewhere between the figure sought by the contending parties, it has also been held that the Court may, when it does not find the evidence of any expert completely satisfying or conclusive, nor any comparable especially apt, form its own opinion of valuation, provided this is always based on the careful consideration of all the conflicting evidence. The figure so arrived at need [sic] not be that suggested by any expert or contended for by the parties.

The appellant’s expert placed a value on the property, as of May 4, 1984, of $232,000 plus a contributory value of $20,000 for improvements, yielding a total value of $252,000. The evidence was that the method of appraisal used was the direct sales approach which involved comparing sales made in the immediate area at the appraisal date to determine a comparable value. In pursuing this approach six sales were examined and an aggregate price of $252,000 was established.

There are no defects in the expert’s chosen method nor are there any frailties in the information upon which the opinion is based. Nothing has come to light during examination-in-chief or cross- examination that would cast doubt on the appraised value. The conclusion is supported by data gathered from similar sales that have taken place in the immediate area, at the relevant time. The appellant’s appraisal was not refuted by the Minister who opted not to call any expert witness. Nor was there any evidence presented that would put into question the value of the property reached by the appellant’s expert. I heed the warning of Adrian Keane in The Modern Law of Evidence wherein he comments at page 377,

The danger is particularly acute in the case of opinions expressed by expert witnesses, of whom it has been said, not without some sarcasm, "it is often quite surprising to see with what facility and to what extent, their views can be made to correspond with the wishes or the interests of the parties who call them....

Nonetheless, in view of the evidence, I accept that the value of the property is $252,000. For the purpose of increasing the value of the shareholder’s loan account owed by Roadrunner to the appellant this amount must be reduced by $62,000, representing the amount owed on the property. The increase to the shareholder’s loan account is $190,000? [3]

Assumed debt

On May 3, 1984, pursuant to the indenture the appellant assumed a debt of $200,000 as a result of his guarantee. The appellant contends that this amount should increase the loan account. The liability of a guarantor is contingent upon the default of the principal, however, when this occurs the liability becomes real. The Minister advances the position that until the amount of the assumed debt had been paid no amount is available to increase the loan account. In support of this proposition he relies upon Interpretation Bulletin IT-239R2 which states, at paragraph 4,

A taxpayer who is required to honour a guarantee is considered to have acquired a debt at the time the guarantee is honoured equal to the amount of payment(s) made pursuant to the guarantee.

Interpretation bulletins do not have the force of law and are not binding upon the Court; however they may be useful, in cases of ambiguity, as an interpretive guide (Harel v. D./M.R. (Quebec), [1978] 1 S.C.R. 851, [1977] C.T.C. 441, 77 D.T.C. 5438). The right of a guarantor against a principal is a right to be indemnified in respect of the amounts that he has paid by reason of the guarantee obligation. A guarantor who makes a payment under a guarantee has a right of action against the principal debtor to recover the amount of that payment (Douglas v. Maritime United Farmers Co-op Ltd., [1928] 3 D.L.R. 166 (N.B.C.A.); In Re a Debtor, [1937] Ch. 156 (C.A.)). In Re Mitchell, [1913] 1 Ch. 201 at page 206, Parker J. commented,

... 1 may say at once that it appears to me that, until the surety is called upon to pay and does pay something under his guarantee, there is no debt or right at law at all; until then, a surety’s right is confined to a right to come into equity in order to get an indemnity against his liability to the creditor.

Similarly, Halsbury’s Laws of England, Vol. 20, Guarantee and Indemnity, paragraph 237 (and the cases cited thereto) states,

Until the guarantor has paid the creditor, the guarantor’s right of indemnification against the principal debtor does not constitute a debt owed to the guarantor by the principal debtor.

The obligation to pay was assumed on May 3, 1984. The evidence was that no payments were made until 1988. In the light of the above principles and the facts, the assumed debt does not increase the shareholder's loan account as no payments were made under the assumed debt in the 1986 taxation year.

Quonset

This item was received upon winding-up. The evidence does not deny it. The accountant testified that all assets and liabilities of Roadrunner to July 31, 1986 were reflected as being disposed of in its financial statements, and the shareholder (the appellant) was charged with all the remaining assets of Roadrunner. I understand that the Quonset was part of the remaining assets. The issue is, therefore, one of valuation. The appellant contends that the Quonset is without value, whereas the Minister contends that the value of the Quonset is $30,000. The Minister advances the argument that the appellant in his notice of objection indicated that the value of the Quonset was no more than $30,000. Indeed the notice of objection reads,

1. It is estimated that the fair market value of the remaining Class 6 asset [Quonset] of Roadrunner Farms Ltd. would be no more than $30,000.

In a letter to the Department of National Revenue by the appellant’s accountant the Quonset is valued at $30,000. It states,

Mr. Maccala estimates that the fair market value at present cannot be greater than $30,000.

Counsel for the appellant argues that the Quonset is worthless but if it does have value it was pledged as security to the bank and they are entitled to it. I cannot accept this latter submission, title to the Quonset was in the name of Roadrunner and on winding- up it passed to the appellant.

During the dealings between the Department of National Revenue and the appellant, there was much negotiations on the value of the Quonset. The Quonset was purchased in 1983 for $70,544. The Department of National Revenue initially assessed the value of the Quonset in 1986 as being $65,673. The appellant later countered that the value of the Quonset was no more than $30,000. The Minister accepted this amount and assessed accordingly. This value was reached as the result of negotiation and bargaining between two parties with clearly differing interests. I can see no reason for departing from the valuation they reached and accept $30,000 as the value of the Quonset.

Conclusion

For the 1986 taxation year, the value of the shareholder’s loan account will be increased by the amount of $130,000, representing the value of the property transferred to the bank. This amount is in addition to the $60,000 previously credited by the Minister. The assumed debt of $200,000 has no effect upon the 1986 taxation year as no payment was made under that obligation. Finally, the value of the Quonset is $30,000 as contended by the Minister with the result that the value of the property received on winding- up remains unchanged. Merely receiving property on the dissolution of a company does not constitute an appropriation of capital unless there is something more. In this case, the values of the property received from Roadrunner on winding-up were not appropriations of assets but were repayments of a loan.

For these reasons, the appeal is allowed with costs.

Appeal allowed.