Frank I. Morrison v. Her Majesty the Queen (Informal Procedure), [1994] 1 CTC 2119, 95 DTC 269

McArthur, J.T.C.C.:—Frank I. Morrison, the appellant, appeals the reassessment by the Minister of National Revenue, ("Minister"), for the 1984, 1987 and 1988 taxation years, heard in Fredericton, New Brunswick pursuant to the informal procedure.

The issue is whether the appellant is entitled to claim an allowable business investment loss (ABIL) under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") in the 1987 taxation year.

Facts

The appellant operated an insurance agency business in Fredericton that had been in his family for many years. He and his father were the major shareholders of Frank I. Morrison & Son Ltd. ("the company"). The company was experiencing financial difficulties during the mid-1980s and the appellant purchased his father's shares.

In February 1986 the company sold most of its assets to a newly incorporated entity, Frank I. Morrison 1986 Ltd.

The appellant was one of five shareholders of the new company and eventually, with his wife, he bought out the remaining four shareholders. It was intended to be the operating company and it remains a going concern.

The former company, Frank I. Morrison & Son Ltd., which is the subject of this appeal, was stripped of most of its assets including the business good will but retained a list of accounts receivable. For practical purposes the company was dormant.

After the sale of its assets, the old company had no source of income other than the old accounts receivable and it had no intention of ever operating actively. The appellant gave evidence that he did not dissolve the company because of the cost involved and filed annual returns after persistent government demands. In its fiscal year ending October 31, 1986, the company reflected $41,302 receivable from shareholders. Frank I. Morrison Jr., the appellant, owed $40,864 and Frank I. Morrison Sr. owed $438.

In October 1987, the company borrowed $100,000 from the Royal Bank with the personal guarantees of the appellant and his father. On October 20, 1987, the company passed a resolution declaring a dividend of $100,000 payable to the shareholders on October 30, 1987. Shortly after, the shareholders loaned back the $100,000, to the company, creating a balance of $58,102, (after deducting the shareholders loans) owing and payable to the shareholders (the appellant). The appellant loaned $56,000 to the company and took an assignment of company accounts receivable that had a face value of $53,303.32. The company then paid back the bank presumably releasing the guarantors. The appellant placed a list of the accounts in evidence as Exhibit A-1 titled "Aged Accounts Receivable”, which included receivables all under the title "over 30 days" in varying amounts totalling $53,303.32. The company had not reflected most of these accounts receivable in the financial statements prior to the dividend. In February of 1988, the appellant applied himself to the collection of these accounts and quickly concluded they were uncollectible, and abandoned efforts without collecting any money. His primary objective was to operate the new corporation profitably and he, with his wife, focused all their efforts in that direction.

In computing income for the 1987 taxation year, the appellant claimed an ABIL in the amount of $29,668, calculated as follows:

The company reflected the sum of $58,102 owing to shareholders at the end of 1988 and 1989 fiscal years.

The issue is whether the appellant may claim an ABIL for capital loss in the 1987 taxation year and if the answer is affirmative, may he carry back to the 1984 taxation year and carry forward to the 1988 taxation year the amount of the resulting non-capital loss, or the amount of the capital loss as a net capital loss.

Analysis

The relevant statutory provisions of the Act applicable to the 1987 taxation year include:

38 (1) For the purposes of this Act,

(c) a taxpayer's allowable business investment loss for a taxation year from the disposition of any property is /2 of his business investment loss for the year from the disposition of that property.

39 (1) For the purposes of this Act,

(b) a taxpayer's capital loss for a taxation year from the disposition of any property is his loss for the year determined under this subdivision (to the extent of the amount thereof that would not, if section 3 were read in the manner described in paragraph (a) and without reference to the expression "or his allowable business investment loss for the year" in paragraph 3(d), be deductible in computing his income for the year or any other taxation year) from the disposition of any property of the taxpayer other than

(i) depreciable property, or

(ii) property described in subparagraph (a)(i), (ii) or (iii); and

(c) a taxpayer's business investment loss for a taxation year from the disposition of any property is the amount, if any, by which his capital loss for the year from a disposition after 1977

(i) to which subsection 50(1) applies, or

(ii) to a person with whom he was dealing at arm's length

of any property that is

(iii) a share of the capital stock of a small business corporation, or

(iv) a debt owing to the taxpayer by a small business corporation other than, where the taxpayer is a corporation, a debt owed to it by a small business corporation with which it does not deal at arm's length

exceeds the aggregate of. . . .

40 (1) Except as otherwise expressly provided in this Part

(b) a taxpayer's loss for a taxation year from the disposition of any property is,

(i) if the property was disposed of in the year, the amount, if any, by which the aggregate of the adjusted cost base to him of the property immediately before the disposition and any outlays and expenses to the extent that they were made or incurred by him for the purpose of making the disposition, exceeds his proceeds of disposition of the property, and

(ii) in any other case, nil.

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.

50 (1) For the purposes of this subdivision, where

(a) a debt owing to a taxpayer at the end of a taxation year (other than a debt owing to him in respect of the disposition of personal-use property) is established by him to have become a bad debt in the year, or

(b) a share (other than a share received by a taxpayer as consideration in respect of the disposition of personal-use property) of the capital stock of a corporation is owned by the taxpayer at the end of a taxation year and

(i) the corporation has during the year become a bankrupt (within the meaning of subsection 128(3)), or

(ii) the corporation is a corporation referred to in section 6 of the Winding- up Act, R.S.C. 1985, c. W-11, that is insolvent (within the meaning of that Act) and in respect of which a winding-up order under that Act has been made in the year,

the taxpayer shall be deemed to have disposed of the debt or the share, as the case may be, at the end of the year and to have reacquired it immediately thereafter at a cost equal to nil.

111 (1) For the purpose of computing the taxable income of a taxpayer for a taxation year, there may be deducted such portion as he may claim of

(a) his non-capital losses for the seven taxation years immediately preceding and the three taxation years immediately following the year;

(b) his net capital losses for taxation years preceding and the three taxation years immediately following the year, but no amount is deductible for the year in respect of net capital losses except to the extent of the aggregate of

(i) the amount, if any, determined under paragraph 3(b) in respect of the taxpayer for the year, and

(ii) where the taxpayer is an individual, the lesser of

(A) $2,000, and

(B) his pre-1986 capital loss balance for the year. .. .

The term "AB IL" is defined in paragraph 38(c) and “business investment loss” in paragraph 39(1)(c).

In general terms, ABILs are the taxpayer's loss from an arm's length disposition of shares in a small business corporation, or a debt owed to him by such a corporation (for shares), minus any increase in the adjusted cost base.

The scheme of the Act and ABILs was summarized by Judge Hamlyn in Nadalin v. M.N.R., [1991] 2 C.T.C. 2658, 91 D.T.C. 1451 (T.C.C.) at page 2660 (D.T.C. 1452):

Given a business investment purpose in certain circumstances a business investment loss is the loss resulting from a disposition of shares or debt of a small business corporation (paragraph 39(1)(c)).

Where a taxpayer establishes that an amount owing to him on account of a disposition of capital property has become uncollectible, he is deemed to have disposed of the debt (subsection 50(1)).

An allowable business investment loss is a certain prescribed portion of the loss resulting from the disposition of the shares or debt of a small business corporation (paragraph 38(c)).

In the case of an allowable business investment loss a taxpayer is entitled to deduct prescribed amounts from any source of income (paragraph 3(d)).

The appellant, in the present case, was not dealing at arm's length with the corporation, he owned almost all of the shares issued. He would not be allowed to deduct an ABIL if not for subsection 50(1).

To be successful, the appellant must meet the requirements of subparagraph 40(2)(g)(ii). Interpretation Bulletin IT-239R2, February 9, 1981 states that the loss is treated as nil unless the following conditions are met. These are:

(a) the corporation must have used the borrowed funds to gain income;

(b) the corporation must have made every effort to get financing through ordinary commercial means;

(c) the corporation must have permanently ceased to carry on business;

and

(d) there must be no other tax advantage to either party.

In the case at bar, the appellant does not fare favourably after applying these tests in that:

(a) the corporation used the funds to pay back the bank loan and not to gain income;

(b) the corporation, on its own, had no borrowing power, the accounts receivable being of little or no value;

(c) the corporation did not cease to carry on business; and

(d) the transaction would appear to have been manoeuvred to create a tax advantage for the appellant.

I find that there was a disposition of loss of property within the meaning of paragraph 39(1)(b) of the Act, and the debt was bad, within the meaning of subsection 50(1) of the Act.

The question remains as to whether or not subparagraph 40(2)(g)(ii) of the Act should apply. The cases have been more liberal than the Interpretation Bulletin IT-239R2.

In Ellis v. M.N.R., [1988] 1 C.T.C. 2081, 88 D.T.C. 1070 at page 2085 (D.T.C. 1072-73) Judge Brulé, JTCC, stated:

Having determined that there was a disposition of property, within the meaning of paragraph 39(1)(b) of the Act, and that the debt was bad, within the meaning of subsection 50(1) of the Act, the question remained as to whether or not subparagraph 40(2)(g)(ii) of the Act should apply to the present case. Clearly if subparagraph 40(2)(g)(ii) is to be avoided, the appellant must prove that the debt was acquired, or, in this case, that the guarantee was provided either for the purpose of gaining or producing income from a business, or for proper consideration.

It is obvious in the present case, that the debt was not acquired for the purpose of gaining or producing income from a business, or for proper consideration.

The company was inactive and used the $56,000 advanced by the appellant to pay a debt to the bank that the appellant had personally guaranteed. It must be concluded that there was no proper consideration. In return for his $56,000, the appellant received a list of aged accounts receivable totalling approximately $53,000 most of which were dated prior to 1986. He did not attempt to collect on them until 1988, when he quickly determined they were of no value whatsoever.

For the reasons set out herein, the Court is satisfied that the intent of the appellant in entering the loan of $56,000 to the company was not incurred for the purpose of gaining or producing income from business or property and that the provisions of subparagraph 40(2)(g)(ii) apply to this transaction. In view of this conclusion it becomes unnecessary to consider whether the appellant was entitled to carry forward or back the amount of the loss.

The appeals are dismissed.

Appeals dismissed.