Frederic G. Gannon v. Minister of National Revenue, [1988] 1 CTC 2422, 88 DTC 1282

Bonner, T.C.J.:—The appellant appeals from assessments of income tax for the 1982 and 1983 taxation years. On assessment the respondent, in reliance on subsection 80.4(2) of the Income Tax Act, added to declared income interest deemed to have been received by the appellant on his indebtedness to Gannon Bros. Energy Ltd. (the company). The sole issue to be decided is whether the appellant is right in contending that the debt to the company was, by reason of set-off, less than the respondent found it to be.

At all material times the appellant owned 65 per cent of the common shares and 100 per cent of the preferred shares of the company. Pursuant to agreement dated November 1, 1980, the appellant sold certain property to the company. The agreement provided that the purchase price:

. . . shall be paid by the Purchaser to the Vendor as follows:

(a) as to an amount which is equal to the tax cost (as hereinafter defined) of the assigned property by the delivery of its promissory note for such amount, payable on demand, without interest, to the order of the Vendor; . . .

From time to time during the years in question the appellant drew money from the company and entries were made in the books and records of the company debiting the appellant's shareholder's loan account. It was not until June of 1983 that a journal entry was made in the books of the company offsetting the company's indebtedness to the appellant evidenced by the note, against the indebtedness owing by the appellant to the company in respect of the funds withdrawn.

The position of the respondent in relation to the assessment is set forth in the following passage from Exhibit A-6, a letter written by a Revenue official to the appellant’s accountant:

As previously discussed in our telephone conversation of January 7, 1985 the Department's policy according to IT-421 Paragraph 10 is to recognize cancellation of liability when adjustments are actually made to the accounting records. In view of this policy, we do not feel that the Note Payable should be allowed as a credit prior to June 30, 1983. Furthermore, the financial statements of Gannon Bros. Energy Ltd. (1981-1982) show this Note Payable as distinct and separate from any other amounts due to/from the taxpayer since there was a separate agreement drawn in respect of this amount. We feel strongly that the nature of this loan was different from that of the other loans i.e. shareholder's drawings, due from shareholder, Accounts Receivable and Accounts Payable - Fred Gannon. Therefore, we are prepared to confirm this part of the assessment. We understand that you do not agree completely with our view on this matter.

The respondent pleaded that on assessment he assumed:

. . . the loans and indebtedness of the Appellant upon which the deemed benefit was based were admitted in the books of account maintained on his behalf.

This assumption was incorrect. The books to which reference was made were the books of the company, not the books of the appellant. Furthermore, Mr. Gannon explained that at the time there had been difficulty in obtaining proper accounting services and as a result accounting records were inadequate.

It is difficult to conceive how a simple bookkeeping error whether of commission or of omission can be a foundation for taxation. Generally speaking taxation rests on what happened and not on an oversight in making a financial record of what happened. The appellant's liability here depends on whether he ". . . received a loan or otherwise incurred a debt . . ." within the meaning of subsection 80.4(1) of the Act and not whether the books were properly kept. That however, is not the end of the matter.

The appellant was asked whether there was any express agreement, whether written or oral, between himself and the company calling for a setoff. His answer was that he was the sole operating officer of the company, that he owned shares as previously mentioned and that it was "the intention" that the indebtedness of the company to him be paid before drawings could be considered to be a debt from the appellant to the company. He added that he was only one person, that the "prevailing intention” was as just set out and that he had thought in those terms at all times. He said that he considered that the company owed him about $65,000 (on the note) and that he had the right to draw that money from the company.

In argument, counsel for the respondent produced paragraph 10 of his client's Bulletin IT-421R which reads in part as follows:

10. Where a shareholder or employee owes money to a corporation, a benefit may be calculated during the time the debt is outstanding. No netting or offsetting of any accounts "due to" or "due from” the shareholder or employee will be deemed or considered to have taken place in order to eliminate the calculation of a benefit during a particular period. It will only be after the actual cancellation of the liability by a payment or adjustment in the accounting records that such amount will no longer be subject to the calculation of a benefit under section 80.4 . . . .

Bulletins of this sort may be of use where the meaning of legislation is in doubt. In Gene A. Nowegijick v. The Queen, [1983] C.T.C. 20; 83 D.T.C. 5041) Dickson J. (as he then was) said the following at page 24 (D.T.C. 5044):

Administrative policy and interpretation are not determinative but are entitled to weight and can be an “important factor” in case of doubt about the meaning of legislation: per de Grandpré J. Harel v. The Deputy Minister of Revenue of the Province of Quebec, [1978] 1 S.C.R. 851 at 859.

However, counsel for the respondent did not point to any legislative language of uncertain meaning which could conceivably have application. It is therefore difficult to see how the bulletin can be of any use in arriving at a solution in this case.

The appellant argued that the respondent erred in failing to recognize the indebtedness of the company to him ”. . . for it is fundamental both in common law and under the tax law that the principal of set-off be honoured". In this regard the appellant referred to the following passage from the Canadian Encyclopaedic Digest (Western), 3rd ed., Debtor and Creditor, section 130 as follows:

Both at law and equity, and without reference to statute or the tribunal in which the cause is depending, the principle prevails that in the case of connected accounts of debit and credit on the balance of the accounts is recoverable, which is a virtual adjustment and set-off between the parties.

Reference is made to Bank of Montreal v. Tudhope, Anderson & Company (1911), 21 Man. R. 380. The authority cited by the appellant does not support his position. In Bank of Montreal v. Tudhope, Robson, J. referred at page 386 to Watson v. Mid-Wales Railway Company, 36 L.J. C.P. 285, and said:

Willes, J., points out that mere cross-claims do not necessarily give an equity to set off, much less so when they are in futuro. He says: “It is necessary to shew mutual credit: I do not mean in the sense of mutual credit under the statutory provisions of the Bankrupt Law, but in the sense of there being an agreement or contract made or to be inferred that one debt was to liquidate the other. Where the balance only is to be the debt, there is a clear equity that one of the parties is not to have any detriment by the act of the other. But here the debts are payable at different times. There is nothing from which we can infer that one liability was to liquidate the other, or that the balance only was to be considered due".

Nothing in the evidence in the present case suggests the existence of any agreement or contract calling for the liquidation of the indebtedness on the note by means of the payments made to the appellant. An agreement between a company and its shareholder is not formed by a mere fleeting thought in the mind of the individual who controls it. The accounts in question here are not connected in any way. This is simply a case in which the company and the appellant each owe the other money. There is no authority for the proposition advanced by the appellant which is, in effect, that mutual debts cannot coexist and that in all cases where they might arise a set-off is automatically effected.

Counsel also made reference to the decision of this Court in Stan Kates v. M.N.R., [1984] C.T.C. 2681; 84 D.T.C. 1605. I cannot find in that case any principle having application in the present circumstances.

For the foregoing reasons, the appeals will be dismissed.

Appeals dismissed.