Les Aliments Kouri Inc. v. Minister of National Revenue, [1992] 2 CTC 2239, [1993] DTC 29, [1992] 2 CTC 2688, [1993] DTC 32

Couture, C.T.C.C.J.:—This is an appeal from an assessment for the 1983 taxation year. The relevant facts on which that assessment is based were admitted by the parties, and may be summarized as follows:

On July 18, 1980 the appellant acquired all of the shares issued by a company named Grandiose Foods Ltd. (Grandiose) for the price of $2,577.81. The contract provided for corrections to the sale price to take into account its operations for the period from January 1, 1980 to July 17, 1980. During the 1976 to 1980 taxation years, Grandiose had incurred non-capital losses in the amounts of $17,387, $23,511, $158,701 and $464,908, respectively, for a total of $664,507.

On December 31, 1980, pursuant to a resolution of the sole director of Grandiose, its board of directors authorized the sale of all its assets to the appellant, subject to the appellant assuming and discharging all the liabilities. The book value of its assets was $339,045, while its liabilities amounted to $845,187. An agreement to this effect was signed by the parties on December 31, 1980.

Also on that date, following a resolution of its one and only shareholder, its dissolution was authorized under the provisions of section 203 of the Canada Business Corporations Act.

From January 1981 to October 1984, almost all of Grandiose's liabilities were paid by the appellant. In 1981, the appellant paid $205,336 to Grandiose's creditors for the benefit of Grandiose's and in 1982 it also paid $2,912, for a total of $208,248.

For reasons which are not relevant to these proceedings, the liquidation of Grandiose was not completed until October 31, 1984.

By an assessment dated April 1, 1986, the respondent reduced by $208,248 Grandiose's non-capital losses, which it had claimed as deductions in comput ing the appellant's income under paragraph 111 (1) (a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), relying on the provisions of subsection 80(1) and subsection 88(1.1) as they applied for the taxation year under appeal. The application and result of this operation are shown on a table attached to the reply to the notice of appeal, and reproduced below:

Application of subsection 80(1):

Liabilities of "Grandiose" as of 31-12-1980		$845,187
Less: Assets of "Grandiose" as of 31-12-1980		339,045
Excess of liabilities over assets		506,142
Deduct: Unacknowledged liabilities
—Steinberg	29,495
—Karl Jung	33,000	62,495
Balance of liabilities of "Grandiose" as of 31-12-1980		443,647
Balance of liabilities of "Grandiose" other than “ Steinberg”		138,226
and Karl Jung” not settled as of 31-12-81
Liabilities settled by “ Kouri” during 1981		305,420
Reduce: Amounts owing to the parent company" Kouri”		100,084	(1)
Application of subsection 80(1) — 1981		$205,336
Liabilities settled during 1982		$ 2,912	(2)
Balance of liabilities other than "Steinberg" and "Karl Jung”		$135,314
not settled as of 31-12-1982 and 1983
		[Translation.]

This table shows that, in order to arrive at the assessment, the respondent applied the value of Grandiose's assets as of December 31, 1980 against its liabilities, thus reducing the liabilities by $339,045 ($845,187 — $339,045 = $506,142) at that date. It should be noted that this $339,045 represents the value of the assets purchased by the appellant under its agreement with Grandiose dated December 31, 1980. The other deduction, in the amount of $62,495, arises from adjustments resulting from the assessment, but which are of no consequence for the purposes of this appeal. Having established that Grandiose's liabilities amounted to $443,647 as of December 31, 1980, the respondent then deducted the amounts of the debts which the appellant paid to Grandiose's creditors in 1981 and 1982 ($205,336 and $2,912) under the terms of the agreement of December 31, 1980 between the parties. The respondent also deducted a debt owed by Grandiose to the appellant, or $100,084, thereby establishing the amount of Grandiose's liabilities as of December 31, 1982 at $135,314.

A table showing the application of Grandiose's non-capital losses as claimed by the appellant for the 1981, 1982 and 1983 taxation years was filed and shows the following:

Schedule of non-capital losses in dispute:

	as assessed by	as claimed by
	Revenue Canada	Kouri in the
		appeal at bar
Balance as of 31/12/80	664,507	664,507
Amount claimed by Kouri as of 31/12/81	175,391	175,391
Reduction of losses by M.N.R. in 1981	205,336	—
Amount claimed by Kouri as of 31/12/82	152,449	152,449
Reduction of losses by M.N.R. in 1982	2,912	—
Amount claimed by Kouri as of 31/12/83	128,419	336,667
Balance	0	0
		[Translation.]

To justify the assessment, the respondent relies on the provisions of subsection 80(1), which read as follows:

80(1) Where at any time in a taxation year a debt or other obligation of a taxpayer to pay an amount is settled or extinguished after 1971 without any payment by him or by the payment of an amount less than the principal amount of the debt or obligation, as the case may be, the amount by which the lesser of the principal amount thereof and the amount for which the obligation was issued by the taxpayer exceeds the amount so paid, shall be applied

(a) to reduce, in the following order, the taxpayer's

(i) non-capital losses,

(ii) net capital losses, and

(iii) restricted farm losses,

for preceding taxation years, to the extent of the amount of those losses that would otherwise be deductible in computing the taxpayer's taxable income for the year or a subsequent year, and

(b) to the extent that the excess exceeds the portion thereof required to be applied as provided in paragraph (a), to reduce in prescribed manner the capital cost to the taxpayer of any depreciable property and the adjusted cost base to him of any capital property,

unless

(c) the taxpayer is, at that time, a bankrupt within the meaning of section 128,

(d) the debt or obligation was such that, if interest had been paid by the taxpayer in respect of it, no deduction would have been permitted by this Part in respect of that interest in computing the taxpayer's income,

(e) section 79 is applicable in respect of the debt or obligation,

(f) the excess is otherwise required to be included in computing his income for the year or be deducted in computing the capital cost to him of any depreciable property or the adjusted cost base to him of any capital property.

The respondent also argues that subsection 88(1.1) applied, the relevant portion of which read as follows:

88(1.1) Where the winding-up of a Canadian corporation (in this subsection referred to as the “subsidiary”) commenced after March 31, 1977 and not less than 90% of the issued shares of each class of the capital stock of the subsidiary were, immediately before the winding-up, owned by another Canadian corporation (in this subsection referred to as the "parent") and all the shares of the subsidiary that were not owned by the parent immediately before the winding-up were owned at that time by a person or persons with whom the parent was dealing at arm's length, for the purpose of computing the taxable income of the parent for any taxation year commencing after the commencement of the winding-up, such portion of any non-capital loss of the subsidiary, as may reasonably be regarded as its loss from carrying on a particular business (in this subsection referred to as the "subsidiary's loss business”) and any other portion of any non-capital loss of the subsidiary from any other source for any particular taxation year of the subsidiary (in this subsection referred to as the "subsidiary's loss year"), to the extent that it

(a) was not deductible in computing the taxable income of the subsidiary for any taxation year of the subsidiary, and

(b) would have been deductible in computing the taxable income of the subsidiary for its first taxation year commencing after the commencement of the winding-up, on the assumption that it had such a taxation year and that it had sufficient income for that year,

After deducting the book value of Grandiose's assets from its deficit as established December 31, 1980, the respondent concludes, in establishing the assessment, that the $205,336 paid by the appellant in 1981 ($2,912 in 1982) to Grandiose's creditors in satisfaction of its debts indicates that Grandiose's debts to its creditors, up to that amount, have been settled or extinguished without any payment by Grandiose within the meaning of subsection 80(1), since they have been paid by the appellant.

This reasoning leads the respondent to reduce Grandiose's non-capital losses, claimed by the appellant in computing its income, by a corresponding amount ($664,507 — $208,248 $456,259) so that, as indicated by the table on page 3, Grandiose's non-capital losses as of December 31, 1983 amounted to only $128,419, and the appellant therefore could not daim the full amount of $336,667 as a deduction from its income under subsection 88(1.1).

The appellant's submission is that the provisions of subsection 80(1) do not apply in the circumstances and that it is entitled to the deduction claimed for the 1983 taxation year.

The flagrant and obvious error in the respondent's reasoning may be seen in the fact that, in his assessment, he arbitrarily ignored the factual and legal situation which arise from the agreements of December 31, 1980 between Grandiose and the appellant. The book value of Grandiose's assets, which the respondent deducts from its deficit, is the amount paid by the appellant to acquire the said assets. It is therefore wrong to argue, as does the respondent, that this book value could reduce Grandiose's deficit. That deficit was in fact reduced by the proceeds of disposition of the assets, paid by the appellant, which proceeds were paid to Grandiose's creditors under the provisions of the agreement of December 31, 1980 between the parties. The respondent simply disregarded the parties' contractual obligations under their agreements, with no apparent valid reason. If the respondent were claiming that the agreements between the appellant and Grandiose were fictitious or in the nature of a sham, he would have had to so assert, insofar as such a proposition could be argued.

Paragraphs 1 and 2 of the agreement dated December 31, 1980 between the appellant and Grandiose for the acquisition of the assets of Grandiose provides as follows:

1. The vendor hereby sells, transfers and assigns to the purchaser all of its right, title and interest in and to all its assets as of December 31, 1980, subject to the Purchaser assuming and discharging all of the liabilities of the vendor as of December 31, 1980, the whole as shall appear from the vendor's annual financial statements for the period ending December 31, 1980.

2. The purchase price shall be the book value of the said assets as shall appear from the said financial statements. The said purchase price shall be payable on demand, and the purchaser shall discharge all of the said liabilities of the vendor, to the entire exoneration of the vendor.

[Emphasis added.]

It seems to me that this passage from the agreement is unambiguous and clearly establishes the obligations of the parties.

It is therefore wrong to argue, as does the respondent, that Grandiose's debts were settled or extinguished without any payment by it. It contributed the value of its assets in return for the appellant paying its debts, up to a total of $339,045. Accordingly, and up to that amount, the provisions of subsection 80(1) of the Act do not apply in the circumstances. As submitted by counsel for the appellant, the transaction contained an indication of payment by Grandiose.

For these reasons, the appeal is allowed and the appellant is entitled to party-and-party costs.

Appeal allowed.