David Robinson v. Minister of National Revenue, [1993] 1 CTC 2406, 93 DTC 254

Rowe, D.T.C.C.J.:—The appellant appeals from an assessment of income tax for his 1986 taxation year whereby the respondent included into income the sum of $64,022.19 as funds or property of David Robinson Ltd. having been appropriated by the appellant and therefore taken into account in computing his income in accordance with the provisions of subsection 15(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

The parties agreed the appeal would be decided on the basis of an agreed statement of facts, filed as Exhibit A-1, which reads as follows:

1. The appellant is the sole shareholder, Director and President of David Robinson Ltd. ("the company”).

2. The company is in the business of retail antique sales and antique appraisal, with a fiscal year end of December 31.

3. In April, 1986, the appellant left Canada, and the company sold its premises in Victoria, British Columbia and transferred its inventory of antiques to England.

4. Later in 1986 the appellant chose to return to Canada and the company purchased a building to continue the antique business in Victoria, British Columbia.

5. The bulk of the inventory of antiques transported by the company to England was sold through the auction house of Tennants of Yorkshire ("tennants").

6. Tennants advanced the appellant £60,000 which was deposited to the account of the company at a value of $122,466.36 Canadian, which amount was reflected as a sale on the income statement of the company and reported in the company's Return of income for the 1986 taxation year. (Attachment "A" is the copy of the company's T2 Return for the 1986 taxation year.)

7. Total sales by Tennants was £103,565 and after the deduction of the advance and other expenses, the balance of £32,130.68 was paid to the appellant. (Attachment B" is a true copy of the Invoice from Tennants.)

8. On December 1, 1986, the appellant deposited to the company's bank account, the amount of $64,022.19 Canadian, which was the total balance paid by Tennants. As was his normal course, the appellant made no entry on the deposit slip as to the origin of the funds at the time of making the deposit.

9. In 1987, when compiling the financial statements for the company's 1986 taxation year, the company's accountants (the "accountants") queried the appellant as to the source of the $64,022.19 deposit. The appellant gave the Accountants an ambiguous response.

10. The accountants erroneously entered the $64,022.19 on the books and records of the company as a credit to the appellant's shareholder loan account, rather than as a Sale. This resulted in an understatement of revenues and an overstatement of the company's payable to the appellant. (Attachment "C" is a true copy of the analysis of the appellant's shareholder loan account in the company’s General Ledger.)

11. There was no further communication regarding this $64,022.19 between the appellant and the accountants, and there was no direction at any time from the appellant that the $64,022.19 was to be credited to his shareholder loan account.

12. At all material times, the appellant was in a credit balance with a shareholder loan account on the books of the company, even before the credit of $64,022.19.

13. The appellant never drew against the $64,022.19, however the company had sufficient underlying net assets to retire the whole amount of the company’s debt to the appellant.

14. On November 4, 1987 an auditor of the Department of National Revenue (the "auditor") advised the accountant and the appellant of the commencement of an audit of the company.

15. On November 6, 1987, the auditor examined the books and records of the company with respect to, inter alia, the shareholder loan account and the sales invoices at the accountants.

16. On November 10, 1987, the accountants advised the auditor that the $64,022.19 should be properly represented as a revenue or sales item of the company and that it was credited in error to the appellant's shareholder loan account of the company.

17. The appellant did not report the $64,022.19 on his Return of Income for his 1986 taxation year. (Attachment "D" is a copy of the appellant’s 1986 T1 Return of Income.)

The appellant's submission is that to dismiss the appeal is to permit double taxation as the corporation, of which the appellant is the sole shareholder, would be taxed as well as the appellant, on the same funds. The appellant's accountants rectified the error as soon as it was discovered, during an audit by Revenue Canada, and there is absolutely no suggestion the appellant was in any way attempting to avoid taxation or to appropriate onto himself income of the corporation.

The respondent counters with the fact that the revenues of the corporation were underreported and the shareholder's loan account of the appellant was increased so that he could have withdrawn funds from that account without paying tax. The appellant signed the tax return with the attached financial statements and ought to have noticed the error. Further, it was argued that it is not necessary for an assessment under subsection 15(1) of the Act to be based on any wilfulness on the part of a taxpayer.

The relevant portion of the provision of the Act is as follows: 15(1) Where in a taxation year

(b) funds or property of a corporation have been appropriated in any manner whatever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation,

the amount or value thereof shall . . . be included in computing the income of the shareholder for the year.

The Honourable Judge Kempo of this Court dealt with the issue of appropriation in Simons v. M.N.R., [1985] 1 C.T.C. 2116, 85 D.T.C. 105. In that case, the taxpayer was the principal shareholder of a corporation which owned and operated two service stations. As a result of an accounting error, the corporate gas purchases were overstated, the effect of which was to understate profits. The corporate accountant credited a certain sum to the taxpayer-shareholder’s loan account and the Minister included the amount of the loan into the taxpayer's income as an amount appropriated by him. In that case (as with the case at bar) it was clear the actions of the accountant were based on error and that they occurred without the advice, instructions or approval of the taxpayer. A witness for the Minister had testified that a benefit had been conferred on the taxpayer by the company by making that amount available to him to be drawn down on the loan account at any time. At page 2121 (D.T.C. 109) of the judgment, the honourable judge stated:

On the facts of this case the effect of the accounting entry did not create a debt or liability of the company to the appellant qua shareholder as the same was unquestionably an erroneous balancing entry to correct an erroneous overstatement of corporate purchases. It did not arise through any mutual dealings or transactions of any kind between the company and the appellant. It was made without corporate or shareholder knowledge, authorization or intent and without passage of even a scintilla of consideration.

No movements of funds or property of the company to or on behalf of the appellant by way of appropriation or otherwise had occurred as of July 31, 1977, or during the appellant's 1977 taxation year. I would agree with the appellant's submission that it is difficult to conceive of a liability as being funds or property that were appropriated.

On analysis of the basic substantive reality, neither party was the richer or the poorer either immediately before or after the event. On the facts of this case the error was an error and remained so for the appellant's 1977 taxation year.

For identical reasons as just recited, this erroneous balancing entry does not amount to or result in a benefit or advantage being conferred on the appellant by the company as at 31 July 1977, or during his 1977 taxation year for that matter.

In either case there was no probative evidence tendered to show that the appellant acted upon or received any measurable benefit from this erroneous balancing entry during his 1977 taxation year which is the taxation year to which this appeal is confined.

In 1990, the Honourable Judge Kempo was revisited with the problem of a shareholder's appropriation in Groeneveld v. M.N.R., [1990] 1 C.T.C. 2314, 90 D.T.C. 1211 (T.C.C.). In this case, the taxpayer deposited into his personal bank account cheques totalling over $46,000, which funds were income of a corporation of which the taxpayer was the controlling shareholder and sole manager. On the same day, $40,000 of the funds were transferred by the taxpayer from his personal account to the corporate account and the remainder was retained. Later, when queried by the accountant as to the source of the $40,000 transfer, the taxpayer advised that it was a loan to the corporation from himself and he proceeded to endorse a written explanatory notation to that effect. Counsel for the taxpayer's second submission was the whole matter arose solely by virtue of the accounting firm's error. At pages 2316-17 (D.T.C. 1213) of the judgment the learned judge stated:

I will deal with the second argument first. The case of G.D.L. Simons v. M.N.R., [1985] 1 C.T.C. 2116, 85 D.T.C. 105 (T.C.C.) was cited as authority for the proposition that an error should not be held against a taxpayer where it was created by the taxpayer's accountant. With respect, I do not agree that the decision stands for such a broadly stated proposition. The facts of that case were that a series of accounting errors resulted in an overstatement of gas purchases resulting in an understatement of profit. Solely and deliberately for purposes of balance sheet reconciliation, the accountant on his own volition made a credit entry in the shareholder loan account. All entries were erroneous, and all were made without the taxpayer's advice, knowledge, input or approval. That judgment also factually noted the absence of movement of funds or property, and that neither party was (or could have been for that matter) the richer or poorer before or after the event.

The facts of the case at bar are materially different. The effect of what transpired was that the $40,000 did not go to Dunbow in the form of an income receipt but rather went in the form of a loan. The $6,738.71 remained with the appellant.

Counsel for the respondent in written argument put the situation in the following way with which l concur:

22. It is of no help to the appellant that the company owed him more money than the amounts appropriated. Although the appellant could have shown and recorded the amounts appropriated as a repayment of shareholder loans he did not record the appropriations in this fashion.

23. In Samuel Tobis v. M.N.R., [1981] C.T.C. 2161, 81 D.T.C. 126 (T.R.B.) the failure to record amounts appropriated against shareholder loans meant those amounts were properly included in income. At page 2168 (D.T.C. 131) the Court said:

In the Board's opinion, the principal of the application of the mutual debt does not automatically apply. The mutual debt must be known by the two parties and admitted by the two parties. A company is a legal entity different from the shareholder, even if a company acts through its officers and shareholders

. . . the mutual debt a principal cannot be applied in application of the Income Tax Act except if, in each year involved, the amounts retained would have been recorded in the accounting books of the company according to the general principles of accounting.

24. If not for the respondent's auditors, the appellant would have been free to take the $40,000 out of Dunbow as a loan repayment and escape any tax liability. “After the fact” (hearing transcript page 90) attempts by the appellants accountants to adjust the records to reflect a more favourable outcome, are of no help to the appellant. The Court is not to determine the most favourable accounting treatment the appellant could have used, but it must look to what treatment the appellant in fact used. Similarly, the appellant's accountants cannot, after the respondents auditors determine the appellant failed to report income in his return of income, alter the records to reflect a more favourable treatment.

25. Clearly, in the 1979 taxation year, funds properly belonging to Dunbow were appropriated by one of Dunbow’s most prominent shareholders being the appellant, in the amount of $46,738.71. That amount is properly included in computing the income of the appellant for the 1979 taxation year. Any other finding would require rewriting history.

In the case at bar a cheque arrived from England payable to the appellant personally. Recognizing that the cheque was for payment of sales of inventory owned by the corporation, the appellant promptly deposited the cheque into the company bank account where it was converted to Canadian funds in the sum of $64,022.19. The appellant, as was his wont, did not make any special notation on the deposit slip as to the origin of the funds. A proper attention to detail when queried by the accountants would have resulted in the matter being given the proper accounting treatment. The failure in communication was, in the context of all of the facts, attributable to inadvertence. As a result, the accountants erroneously entered the $64,022.19 on the books and records of the corporation as a credit to the appellants shareholder loan account and the mistake was not corrected until an auditor of Revenue Canada announced an impending audit and a review of the books by the accountants revealed the amount should be recorded as revenue of the company and the auditor was advised accordingly. On the facts, then, there is a vast difference between the appellant and the taxpayer in Groeneveld. The question then becomes one of determinin the exact nature of an "appropriation" referred to in the subsection and whether or not the potential to have drawn down funds from the shareholder's loan account was in itself a benefit, regardless of the innocent nature of the oversight creating the opportunity. Even if the potential for benefit or advantage by drawing down on the erroneously swollen shareholder's loan account was never tapped, and no intent existed to ever have created that capacity, the key lies in attempting to ascertain whether Parliament intended, in such a situation, to include such an ethereal and contingent resource into a shareholder's income by virtue of it being seen as a benefit conferred. Is there inherent value in the static energy from water mistakenly stored in a reservoir but never the subject of any actual application for the beneficial use of the alleged appropriator?

Subsection 15(1) contemplates an appropriation for the benefit of a shareholder and/or a benefit or advantage conferred on a shareholder by a corporation. The appellant was the sole shareholder of the corporation and must either be responsible for taking unto himself or setting aside for a special purpose something of value from the corporation or, as the directing mind of the corporation, be responsible for the bestowing or granting of a benefit, and at the same time in his personal capacity agree to accept it and adapt it for his own use. Although it is the same mind operating in both instances, the appellant while wearing his shareholder's hat did nothing consistent with taking, or appropriating a benefit, and, as Director and President, when exercising control over the corporation, did not intend to have conferred anything on himself, and as a putative recipient, he was an unwilling and uninformed beneficiary. The accountants, in erroneously recording a transaction, were not acting pursuant to any direction to achieve such an end on behalf of either the corporation or the appellant as a shareholder. Clearly, the record keeping was not in accord with the facts and ran counter to the intent of the appellant at the outset when he undertook to correct an error by depositing into the corporate bank account funds which truly belonged to it. He was discharging his duty as trustee made necessary by the inadvertent act of the payor in making him the payee of the cheque. In M.N.R. v. Pillsbury Holdings Ltd., [1964] C.T.C. 294,64 D.T.C. 5184, Cattanach, J. of the Exchequer Court of Canada (as it then was) considered the application of subsection 8(1) of the Act, which for the purposes of the case at bar, is identical to the current subsection 15(1) of the Act. At page 300 (D.T.C. ) 5187, Cattanach, J. stated:

In applying paragraph (c) full weight must be given to all the words of the paragraph. There must be a "benefit or advantage” and that benefit or advantage must be “conferred” by a corporation on a “shareholder”. The word “ confer” means grant” or“ bestow”.

In the respondent's reply to notice of appeal, in paragraphs 4(n) and (o) the following assumptions of fact are made:

(n) at all material times, the appellant had appropriated the aforesaid $64,022.19 as funds or property of David Robinson Ltd;

(o) a benefit or advantage has been conferred on the appellant by David Robinson Ltd.

In order for there to have been an appropriation, the appellant must have "appropriated". Black's Law Dictionary, sixth edition, defines "appropriate" as:

To make a thing one’s own; to make a thing the subject of property; to exercise dominion over an object to the extent, and for the purpose, of making it subserve one's own proper use or pleasure.

It is apparent that the words used in subsection 15(1) refer to some form of action with a strong component of intent and certainly cannot be seen to embrace an event that is the result of mutual mistake between the parties, that is, the shareholder and the corporation, when the mistake is the result of an act or omission of a third party operating in good faith but on a faulty premise.

The question of benefit or advantage or no benefit or advantage is a question of fact to be dealt with in light of the success or otherwise of the appellant having been able to discharge the assumed facts upon which the assessment rests. (See Kennedy v. M.N.R., [1973] C.T.C. 437, 73 D.T.C. 5359, at page 440 (D.T.C. 5361).)

The appellant has met the onus and there has been no appropriation by him of a benefit from the corporation nor has the corporation conferred on him a benefit. The appeal is allowed, with costs, and the assessment is referred back to the Minister for reconsideration and reassessment to delete from income the amount of $64,022.19 for the appellant's 1986 taxation year.

Appeal allowed.