Anjalie Enterprises Limited, C/O Teichrob Unger & Co. v. Her Majesty the Queen, [1995] 1 CTC 2802

Lamarre J.T.C.C.:-This is an appeal from an assessment issued against the appellant corporation for its 1989 taxation year, whereby the Minister of National Revenue, (hereinafter the Minister), disallowed the carryforward of a non-capital loss of $293,511 incurred by its predecessor corporation, Andrich Enterprises Ltd., (hereinafter Andrich), on the basis that the said non-capital loss originated in 1982 and was no longer available for carryforward in 1989.

The Minister relied on subsection 87(2.1) and paragraphs 20(1 )(p) and 111(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), as applicable during the years in issue.

Facts

Mr. Andrew Martin, principal shareholder in Andrich, was the only witness at trial. In March 1981, Andrich sold, to Forecastle Holdings Ltd. (hereinafter Forecastle), for $1,600,000, some real property it had acquired in late 1979 for $745,000. Forecastle granted a first mortgage to Ram Mortgage Corporation from which it borrowed an amount of $800,000 of which $600,000 was paid to Andrich.

In addition, the purchaser granted Andrich a second mortgage in the principal amount of $1,000,000. The second mortgage provided for a payment in reduction of principal of $75,000 on June 1, 1981, which Forecastle failed to make.

On July 30, 1981, Forecastle was legally advised by Andrich’s lawyer of its failure and was asked to pay the full outstanding principal balance of $1,000,000 together with interest by September 8, 1981. Again, Forecastle did not execute the payment.

On November 6, 1981, Andrich instituted a petition for foreclosure seeking relief against Forecastle and the guarantors. On March 17, 1982, Andrich obtained an order from the Supreme Court of British Columbia granting it the conduct of sale of the property in the foreclosure action by Ram Mortgage Corporation.

On May 17, 1982, a modification of mortgage was signed between Andrich, Forecastle and guarantors whereby Andrich agreed to reduce the outstanding balance of principal and interest from $1,084,100 to $475,000 upon certain conditions. Again, Forecastle defaulted on the first payment, and on July 12, 1982, the Supreme Court of British Columbia granted an order nisi of foreclosure to Andrich. The redemption period was set at three months.

Andrich then listed the property for sale on September 1982 for $1,900,000 and in April 1983, for $1,750,000. No evidence was provided by the appellant to establish that these values were the result of a certified appraisal.

Andrich received no offer, and Forecastle never paid the outstanding debt. Mr. Martin was also advised on December 16, 1982 by his lawyer that an appraisal had been conducted on the property, and the market value was established at $700,000 on August 26, 1982, by a certified appraiser hired by Forecastle.

The first mortgage payable to Ram Mortgage Corporation attached to the property was in excess of $1,000,000 in September 1982. In addition, there were other creditors with additional claims that exceeded another $1,000,000 against the subject property that had to be paid before Andrich at that time. It was, therefore, not economically viable for Andrich as was said in a letter signed by Andrich’s accountant to Revenue Canada in 1992, to repossess the subject property as it had been so severely encumbered by the purchase. According to the said letter, the purchaser filed for bankruptcy, and the asset values were insufficient to fully repay the first priority claim of Ram Mortgage. The date of bankruptcy is not indicated.

Andrich via its accountant filed its tax return for the year ended March 31, 1982 on December 31, 1982. By that time, it was apparent that there was no prospect of collecting the debt as mentioned in paragraph 10 of the notice of appeal. As a result, Andrich claimed a deduction for a bad debt in computing its 1982 taxable income. Part of the loss, $132,177.64 was carried back in 1981. Andrich has not had any taxable income since.

On April 22, 1988, Andrich’s accountant advised Revenue Canada in writing that Andrich erred in claiming a loss resulting from the above debt in its 1982 taxation year. The loss should have been claimed in the 1983 taxation year. On December 31, 1988, Anjalie Enterprises Ltd. and Andrich amalgamated to become the appellant company. Subsequent to that amalgamation, the appellant company deducted the loss in computing its income for the 1989 taxation year.

The Minister denied the deduction on the basis that the loss was incurred in Andrich’s 1982 taxation year, and, therefore, could not be deducted in its 1989 taxation year as 1989 was past the five year carryforward period for 1982 losses.

Appellant's position

Notwithstanding its treatment of its 1982 taxation year, it is the appellant’s position that Andrich continued to seek recovery of the amount outstanding under the second mortgage from Forecastle and the guarantors until 1984 at least. As a result, Andrich erred in claiming the bad debt in its 1982 taxation year. Because it had prematurely treated the debt as bad, the appellant is arguing that the loss arising from the bad debt should be properly recognized in Andrich’s 1983 taxation year.

Respondent's position

The respondent’s position is that the debt owing was established by Andrich to have become bad in the 1982 taxation year. Counsel for respondent relies on a decision of the Federal Court of Appeal in Wilchar Construction v. The Queen, [1981] C.T.C. 415, 81 D.T.C. 5318, to say that the taxpayer was estopped from changing the year in which it established the debt was bad.

The respondent raised another issue. At the time in 1988 when the appellant requested that the bad debt be deducted in 1983 rather than 1982, both 1982 and 1983 were statute-barred pursuant to subsection 152(4) of the Act, and the non-capital loss claimed for the 1982 taxation year was no longer deductible in computing taxable income.

Counsel for the appellant answered in saying that it was not necessary to re-open the years 1982 and 1983 to establish the quantum of the loss in 1989. He based his argument primarily on the decision of the Exchequer Court of Canada in New St. James v. M.N.R., [1966] C.T.C. 305, 66 D.T.C. 5241.

Analysis

I will first deal with the issue relating to the determination of the bad debts.

The relevant legislation is paragraph 20(1 )(p) of the Act, which reads:

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 deducted all debts owing to the taxpayer that are established by him to have become bad debts in the year and that have been included in computing his income for the year or a preceding taxation year.

In general the question of when a debt becomes bad is a question of fact to be determined according to the circumstances of each case. Primarily a debt is recognized to be bad when it has been proved uncollectible in the year. The question of when a debt is to be considered uncollectible is a matter of the taxpayer’s own judgment as a prudent businessman. This has been stated by the Federal Court-Trial Division in Picadilly Hotels Ltd. v. The Queen, [1978] C.T.C. 658, 78 D.T.C. 6444.

In Stikeman Canada Tax Service, Volume 4, 1994 edition, page 20-1610, it is said that normally the debt should be written off as soon as but not before all normal collection procedures have been carried out without success. However, the taxpayer’s own knowledge of the debtor’s financial situation might dictate a deduction in an earlier or later year, depending on the circumstances.

The taxpayer should be in a position to satisfy the Minister not only that the debt was bad, but that it did not become bad in some earlier year. In Bowyer-Boag Ltd. v. M.N.R. (1950), 2 Tax A.B.C. 202, 50 D.T.C. 311, Mr. Fisher from the Tax Appeal Board stated at page 208(D.T.C. 314):

I am of the opinion that a taxpayer should not expect that he would be allowed to postpone the writing-off of what are in fact bad debts, for years after the date when in fact such debts became bad, and then to write them off in a year in which taxes happen to be imposed at high rate. All the surrounding circumstances, therefore, have to be taken into consideration in dealing with a claim such as has been put forward on behalf of this appellant.

Then, in trying to determine what constitutes a bad debt, Mr. Fisher stated in Hogan v. M.N.R. (1956), 15 Tax A.B.C. 1, 56 D.T.C. 183, that the issue of whether a debt becomes uncollectible in a given year must be based on the facts existing in that taxation year.

Moreover the determination of the bad debt cannot be revised in light of facts which only became apparent at a later date. Mr. Fisher stated at page

7 (D.T.C. 192), and I quote:

As already indicated, paragraph 11(1 )(f) states that the bad debts must be established to be bad in the year and not 18 months or two years afterwards. I am of the opinion, therefore, that the explicit provisions of the legislation in respect of this particular item preclude taking into consideration facts which have not become known until many months afterwards and which could not have been foreseen by the taxpayer at the time of his determination.

In addition, Mr. Fisher relied on Anderton & Halstead Ltd. v. Birrell, 16 T.C. 200, in which Rowlatt J. stated at pages 208 and 209, and I quote:

What the statute requires, therefore, is an estimate to what extent a debt is bad, and this is for the purpose of profit and loss account. Such an estimate is not a prophecy to be judged as to its truth by after events, but the valuation of an asset de praesenti upon an uncertain future to be judged as to its soundness as an estimate upon the then facts and probabilities.

In Roy v. M.N.R. (1958), 20 Tax A.B.C. 385, 58 D.T.C. 676, Mr. Boisvert for the Tax Appeal Board, adopted the views of Mr. Fisher in Hogan, supra, and added the following comment at page 391 (D.T.C. 680), and I quote:

As the Act does not define a bad debt, it is necessary to turn to recognized accounting principles of business practice. A debt is recognized to be bad when it has been proved uncollectable in the year.

In the more recent Tax Court of Canada case of Berretti v. M.N.R., [1986] 2 C.T.C. 2293, 86 D.T.C. 1719 (T.C.C.), Sarchuk J. adopted the views of these previous cases at pages 2297-98 (D.T.C. 1722-23). And I quote:

Certain principles can be excerpted from these decisions. There is for example no necessity that a debt be absolutely irrecoverable...and that possible recovery in the future is not per se a bar to a determination of uncollectability.... These judgments also confirm the proposition that the determination of uncollectability is to be made by the appellant and not by an official of the respondent or some other person.

In the present case, as the case law demonstrates, the determination of when the second mortgage was uncollectible was to be made by the mortgagee, Andrich. The 1982 year-end financial statements reflected this bad debt. I assume the taxpayer and its auditors used generally accepted accounting principles in making this determination. Indeed, the appellant who relied on his accountant’s judgment, did not call him as a witness, which testimony would have been helpful in dealing with the present case. It is therefore difficult for the appellant to argue that the realization of the mortgage loss in the 1982 taxation year was in error. The letter from the accountant on behalf of the appellant in 1992 to Revenue Canada confirmed that point, as he considered himself that the value of the property had declined to $700,000 by September 1982, and that there was an outstanding debt of $2,000,000 on the property on September 1982, before the appellant could be paid. In December 1982, at the time of filing the 1982 income tax return of Andrich, the decision was made by the appellant and its accountant to declare the bad debt in the year 1982.

If I follow the reasoning of Judge Collier in Picadilly Hotels, cited supra, I find that the appellant did not discharge his burden of proving that the debt was not uncollectible in the year 1982 on the balance of probabilities. On this point no evidence was adduced on the assets of the debtor company and on the date of its bankruptcy, and no evidence was adduced that the appellant did not consider in his business judgment the debt uncollectible in 1982.

In the Picadilly case, the plaintiff had the right to foreclose the property and could have forced the return of the asset, which he didn’t. In the present case, Andrich obtained an order giving it the right to conduct the sale of the property and started the foreclosure procedure during the 1982 taxation year.

In the case of Greensteel Industries v. M.N.R., [1975] C.T.C. 2099, 75 D.T.C. 63, Judge Cardin of the Tax Review Board said that the decision to treat the debt as bad or not rested entirely with the company. The Minister could not afterwards substitute his own judgment for that of the principal shareholder.

In the present case, the appellant used its business judgment at the end of 1982 and declared a loss on the bad debt in the 1982 taxation year. I do not believe that six years later it can change its business judgment in order to benefit from the changes in the Act.

The fact that Andrich continued to seek recovery of the amount outstanding under the mortgage until 1984, and that the Supreme Court of British Columbia did not grant the order nisi until after the 1982 taxation year had ended must have been considered at the time the tax return for 1983 was filed. In fact, the 1983 financial statements show that there were no more accounts receivable from Forecastle and no amendment was made at that time to change the year the debt should have been considered bad.

Furthermore, in the case of Berretti cited before, Sarchuk J. concluded that there is no requirement that the debt be absolutely irrecoverable in the future for there to be a determination of irrecoverable in the present.

If I add to that the fact that the law was changed in 1983 so as to permit the carryback of non-capital losses for three years instead of one and a carryforward of seven years instead of five, which the appellant could not reasonably foresee in 1982, and the fact that by declaring the loss in 1982, it took the opportunity of carrying back the loss in 1981, I am more inclined to believe that the appellant’s argument cannot prevail.

I therefore conclude that the Minister rightly denied the loss in the appellant’s 1989 taxation year on the basis that the loss was incurred in Andrich’s 1982 taxation year and, therefore, 1989 was past the five-year carryforward period for 1982 losses. Considering my conclusion on the first issue, I will not have to deal with the second issue raised by the Minister. For all these reasons, the appeal is dismissed with costs for the Minister.

Appeal dismissed.