Dale Kwong, Donna Kwong and Janet Kwong v. Her Majesty the Queen, [1993] 2 CTC 2056, 93 DTC 588

Bonner, T.C.C.J.:—The appellants appeal from assessments of income tax made on the basis that they, as persons connected with Jack Kwong, sole shareholder of Jajan Holdings Ltd. (" Jajan") became indebted to Jajan and that, by virtue of subsection 15(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), the amounts of their respective indebtednesses were to be included in their incomes.

The language of subsection 15(2) which ensnared the appellants is as follows:

Where a person . . . is connected with a shareholder of a particular corporation . . . and the person . . . has become indebted to the particular corporation .. . . the amount of the loan or the indebtedness shall be included in computing the income for the year of the person. . . .

Jack Kwong is the father of Dale and Donna Kwong and husband of Janet Kwong. He held 300 shares of a corporation called either Food-Vale Stores (1984) Ltd. or 303566 Alberta Ltd. [1] In 1986 he sold 180 shares of Food-Vale to Janet Kwong and 60 shares of that corporation to each of Dale and Donna Kwong. Dale, Donna and Janet Kwong each agreed to issue a promissory note to Jack Kwong in payment of the purchase price. In the case of Dale and Donna Kwong the promissory notes were non-interest bearing, payable on demand and in the principal amount of either $33,600 or $36,600. [2] In the case of Janet Kwong the principal amount of the promissory note issued to Jack Kwong was $100,800. That sum was payable on demand with interest at the rate of 11 per cent per annum.

On January 30, 1986, Jack Kwong assigned to Jajan the note which he had received from Janet Kwong. On April 10, 1987, Jack Kwong assigned to Jajan the notes which he had received from Dale and Donna Kwong. Following the assignments the amounts of the promissory notes were recorded on the books of Jajan as credits to Jack Kwong's shareholder’s loan account. Payments were made on the promissory notes in 1987 and 1988 by Dale and Donna Kwong and in 1987, 1988 and 1989 by Janet Kwong. Those payments were applied by Jajan to reduce the amounts recorded as owing to Jack Kwong.

Evidence was given at the hearing by Kurt Madsen, a chartered accountant. He testified that the notes were assigned to Jajan to assist in keeping track of the payments made thereon and to aid in the computation of interest. He produced a summary of the balance sheets of Jajan for the fiscal periods ending September 30, 1985 to 1987 inclusive in order to demonstrate that no moneys were paid out by Jajan as a result of the transactions and that at all times at least to the end of 1987 substantial amounts of money were owed by the corporation to Jack Kwong. That evidence was not seriously challenged but I am not totally convinced that the explanation for the assignment of the notes is complete. The reason given does seem flimsy and I observe that no member of the Kwong family was called to testify. On the other hand nothing in the evidence demonstrates that the sales of the shares and assignments of the notes forms part of a scheme intended to strip Jajan of assets and leave worthless notes in their place.

There is no doubt that the appellants were, by virtue of subsection 15(2.1) and section 251 of the Act ”. . . personfs] . . . connected with. . . ." Jack Kwong within the meaning of subsection 15(2) of the Act. Equally there is no doubt that as a result of the assignments of the notes the appellants became indebted to Jajan. There remains however the question whether counsel for the appellants was correct in contending that the transactions fall outside the object and spirit of the subsection and in consequence are not caught by it.

Counsel for the appellants submitted that subsection 15(2) must be applied not blindly but rather with an eye to the commercial and economic realities of the transaction and to the text and purpose of the statute. He invoked the approach laid down by Dickson, C.J.C., in The Queen v. Bronfman Trust, [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059 at C.T.C. 128-29 (D.T.C. 5066-67). He submitted that strict construction is no longer appropriate and he relied on the following passage from the reasons of Estey, J., in The Queen v. Golden, [1986] 1 S.C.R. 209, [1986] 1 C.T.C. 274, 86 D.T.C. 6138 at pages 214-15 (C.T.C. 277, D.T.C. 6140):

In Stubart Investments Ltd. v. The Queen, [1984] 1S.C.R. 536, [1984] C.T.C. 294, (84 D.T.C. 6305] at pages 573-79 (C.T.C. 313-17, D.T.C. 6321-24), the Court recognized that in the construction of taxation statutes the law is not confined to a literal and virtually meaningless interpretation of the Act where the words will support on a broader construction a conclusion which is workable and in harmony with the evident purposes of the Act in question. Strict construction in the historic sense no longer finds a place in the canons of interpretation applicable to taxation statutes in an era such as the present, where taxation serves many purposes in addition to the old and traditional object of raising the cost of government from a somewhat unenthusiastic public.

He submitted that the purpose of subsection 15(2) is to prevent the distribution of corporate assets to shareholders by means of loans to shareholders rather than by means of straightforward dividends which would be subject to tax. Counsel traced the development of the subsection from one which originally addressed loans by corporations to their shareholders to one which now covers not only loans to persons connected with the shareholders but also indebtednesses which cannot be accurately described as loans. He submitted that the transactions now under review fall outside the subsection because

(a) it was not intended that money leave Jajan's treasury as a result of the transactions, and,

(b) the appellants did not become indebted to Jajan as a consequence of transactions between themselves and the corporation.

Counsel for the respondent relied primarily on the plain language of the subsection. She argued that in balancing the manifest purpose of the legisla- tion and the language of the provision in question a Court should, as noted by the Federal Court of Appeal in British Columbia Telephone Co. v. The Queen, [1992] 1 C.T.C. 26, 92 D.T.C. 6129 at page 31 (D.T.C. 6132) ”. . . give greater weight to clear words supported by their immediate context than to larger assertions of parliamentary intention, particularly those based on extrinsic evidence She submitted further that any limitation of subsection 15(2) to indebtednesses arising from transactions between the connected persons and the corporation would permit tax avoidance but she did not attempt to support or develop this submission in any way.

Section 15 of the Act focuses on outflows of corporate money and assets and on the urge of those who own corporations to get their hands on such money and assets without incurring liability to tax. In 1964, in M.N.R. v. Pillsbury Holdings Ltd., [1964] C.T.C. 294, 64 D.T.C. 5184, the Exchequer Court had occasion to consider the purpose of subsection 8(1) of the former Act, predecessor of the present subsection 15(1). At page 299 (D.T.C. 5186), Cat- tanach, J. said:

Provisions in the Income Tax Act, other than section 8, govern the taxability of such payments and distributions when made in the orthodox way. In the remainder of this judgment, when referring to dividends, I intend to refer to any of these payments or distributions referred to in this paragraph.

Subsection (1) of section 8 is aimed at payments, distributions, benefits and advantages flowing from a corporation to a shareholder other than those referred to in the immediately preceding paragraph. While the subsection does not say so explicitly, it is fair to infer that Parliament intended, by section 8, to sweep in payments, distributions, benefits and advantages that flow from a corporation to a shareholder by some route other than the dividend route and that might be expected to reach the shareholder by the more orthodox dividend route if the corporation and the shareholder were dealing at arm's length.

Subsection 15(2) is aimed at analogous transactions whereby assets are removed from the corporate treasury and are replaced by debt the repayment of which is not enforced. A useful review of the evolution of subsection 15(2) may be found in John W. Durnford's article Loans to Shareholders" [3] . At page 1415 of the article Durnford notes:

Further developments involved spreading the net (1) to include certain borrowers who are not themselves shareholders of the company making the loans, and (2) to include lenders over and above the corporation of which the borrower is a shareholder. The coverage was also extended to indebtedness as well as loans. Evidently taxation leakages were occurring from the interposition of persons other than immediate shareholders and the corporations in which they held shares, as well as from the use of transactions that did not strictly constitute loans.

Thus a shareholder, whether or not intending to avoid taxation on funds received from a corporation, is obliged to include in his income the amount of any loan made to him by the company, or indebtedness incurred in its favour.

Returning to the argument of counsel for the appellant and to the submission that strict construction is to be avoided, it may be noted that the problem created for the appellant by subsection 15(2) does not stem from any sort of “literal and virtually meaningless” interpretation of the subsection. What counsel for the appellant seeks is not some sort of broad construction of the subsection but rather the imposition of limitations on its operation. In relying on the fact that the events which have taken place so far involving Jajan on the one hand and the Kwong family on the other do not point to the existence of the scheme of the sort that subsection 15(2) was intended to prevent, counsel suggests in effect that the subsection applies only to cases in which such a scheme is present. In relying on the absence of any direct dealings between the appellants and Jajan, counsel suggests in effect that subsection 15(2) applies only when indebtedness arises from direct dealings between the corporation and the persons connected with the shareholder.

In my view, the argument advanced in favour of such limitations on the operation of the subsection lacks an essential element. It fails to point to any repugnancy or conflict between an interpretation which accords to the words of subsection 15(2) their ordinary meaning and any other provision of the Act. In the absence of such an inconsistency there is no basis for departing from the ordinary meaning of the statutory language.

In Stubart Investments Ltd. v. The Queen [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305 at page 578 (C.T.C. 316, D.T.C. 6323), Estey, J. refers to the modern rule of statutory construction in the following passage:

While not directing his observations exclusively to taxing statutes, the learned author of Construction of Statutes, (1983), 2nd ed., at page 87, E.A. Driedger, put the modern rule succinctly:

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

At page 86 of Driedger’s work, immediately before the passage to which Estey, J., refers, the learned author states:

If the meaning is clear, the consequences of the application of the words to specific facts are immaterial. Yet, in reading the statute one cannot help thinking about the practical application of the statute. Thus in Escoigne Properties Ltd. v. Inland Revenue Commissioners, [1958] 1 All E.R. 406, Lord Denning said that in understanding a statute he considered specific instances. And in considering consequences a judge may well be "startled". But mere disbelief that Parliament meant what it said is no justification for straining or mutilating the language of the statute in order to escape the plain meaning. It is submitted that the proper role of the judge at this stage, if he finds the words “unbelievable”, is to take another look and see if the legislature actually said what it appears to have said. Only when there is an ambiguity, obscurity or inconsistency that cannot be resolved by objective standards is it permissible to resort to subjective standards or reasonableness in order to avoid unreasonable consequences. In these circumstances consequences may legitimately be regarded in making a choice between two reasonable alternatives; but it is not legitimate to use consequences as an excuse to place an unreasonable construction on words that can have only one reasonable grammatical construction.

Although it is obvious that the scope of subsection 15(2) is very broad and that it may form a trap for the unwary, Parliament has made provision for escape from the trap. In this regard I refer to paragraph 15(2)(b) which [allows] avoidance of the inclusion in income by repayment of the loan within the stated period. As well, paragraph 20(1)(j) of the Act allows deduction in respect of repayment made after the expiry of the escape period provided for in subsection 15(2).

For the foregoing reasons, the appeals will be dismissed, with costs.

Appeals dismissed.