Muttart Industries Ltd. v. Minister of National Revenue, [1986] 1 CTC 2373, 86 DTC 1301

Taylor, T.C.J.:—This is an appeal heard in Edmonton, Alberta, on November 26, 1985, against an income tax assessment for the year 1979, in which the Minister of National Revenue disallowed an amount of $71,000 charged against income for that year as a “bad debt.” As portrayed in the notice of appeal, the appellant’s situation was:

— The Taxpayer includes as part of its ordinary business, the lending of money.

— As part of this business, a loan was made to one James Mroch and a note taken as security for such loan.

— After careful investigation, the Taxpayer concluded that there is no reasonable possibility of collecting this loan and therefore wrote this loan off as a bad debt.

— Because this was simply one of a series of loans made in the ordinary course of its business, the Taxpayer is entitled to the bad debt write-off in its 1979 taxation year.

The Minister’s reply to notice of appeal stated:

With further reference to the allegations . . . the Notice of Appeal says that on or about September 27, 1978 the Appellant lent to James A. Mroch a sum of $40,000, the principal amount of which was due on July 31, 1979 and interest being payable at a rate of 14% per annum. On or about June 15, 1979, a further loan of $31,000 was made by the appellant to Mr. James

A. Mroch on terms that the loan would be repaid on July 31, 1979 and bore interest at the rate of 14% per annum.

— James A. Mroch was a former employee of the Appellant and at all relevant times to this appeal the credit manager of Muttart Builders Supplies Ltd. a company associated with the Appellant;

— the said sums could not be deducted under the provisions of paragraph 20(1)(p) of the Income Tax Act, R.S.C. 1952, c. 148 as amended by S.C. 1970- 71-72, c. 63, s. 1 in that the “debts" at issue.

— were not established by the Appellant to have become bad debts in the year, and

— had not been included in computing the Appellant’s income for the year or a previous year;

— The Appellant’s ordinary business during the relevant period was not the lending of money.

— In the alternative the Respondent respectfully submits that if the Appellant’s ordinary business was the lending of money (which is not admitted but is expressly denied) then the loans made by the Appellant to James A. Mroch were not made in the ordinary course of business but were rather payments made as an accommodation to an officer of an associated company with the consequence that the said sums cannot be deducted under the provisions of paragraph 20(1)(p) of the Act.

— He (the respondent) relies, inter alia, upon sections 18(1)(a), 18(1)(e), and 20(1 )(p) of the Income Tax Act.

— He (the respondent) submits, that the amounts of $71,000 claimed as a deduction from income, does not come within the ambit of paragraph 20(1)(p) of the Income Tax Act and therefore cannot be deducted.

— The Respondent further submits that the Appellant has not shown that an outlay or expense was during the 1979 taxation year incurred by the taxpayer for the purpose of gaining or producing income with the consequence that any deduction is prohibited by virtue of the provisions of paragraph 18(1)(a) of the Income Tax Act.

At the start I should like to note that some discussion was held with the parties dealing with the question of whether paragraph 20(1 )(p) of the Act should be regarded as the appropriate vehicle for the claim made. It was not necessary for the Court to make any decision on this point since the parties agreed that the issue was now to be litigated under paragraph 20(1 )(l) of the Act. Reference can be made to the analysis of this point provided in Highfield Corporation Limited v. M.N.R., [1982] C.T.C. 2812; 82 D.T.C. 1835; and CG. I. Norbraten Architect Limited v. M.N.R., [1983] C.T.C. 2145; 83 D.T.C. 121. If one can properly read paragraph 20(1)(p) so that the sole condition to be fulfilled is subparagraph 20(1)(p)(i), and that subparagraph 20(1)(p)(ii) is quite irrelevant when ""loans” are at issue, then that section might have some value in the deduction of loans which have become uncollectible. As noted above, no final determination of that point was required here, the Court being completely in agreement that there was no question of the potential for relief for this taxpayer under paragraph 20(1)(I) of the Act. To whatever degree there is common ground between the requirements of paragraph 20(1 )(l) of the Act, and the pleadings of the Minister (supra) relating to paragraph 20(1)(p) of the Act, I would also note that I find no merit in the proposition that there is something about a loan ""to an officer of an associated company” which in itself prohibits the deductions sought, and the respondent did not bring forward case law which in my view would support such a bar.

A question was also raised by counsel for the appellant (based on Kit-Win Holdings (1973) Ltd. v. The Queen, [1981] C.T.C. 43; 81 D.T.C. 5030 (F.C.T.D.)) regarding the following phrase from the reply to notice of appeal:

— In reassessing the Appellant with respect to its 1979 taxation year the Respondent proceeded on the basis that . . . [Emphasis mine.]

It was with some difficulty that counsel for the respondent rationalized the use of this term as compared with the more regular “facts and assumptions” or “assumed” which counsel for the appellant suggested were in keeping with the law. The Court was not prepared to discontinue the hearing based solely on this technicality, and indeed it should be said with appreciation that counsel for the appellant did not pursue the point unreasonably, just enough to once more impress on the Minister’s representative the responsibility for clarity and certainty in notifying the taxpayer of the onus placed upon him.

In essence the testimony provided to the Court was that up to about the year 1977, the appellant corporation had been engaged in the construction and building supply business. The current president of the corporation, Mr. Herbert Edward Mildon had also been president and chief executive officer during that period. After the sale of the business (construction and building supplies) the appellant found itself in 1978 with a very substantial sum of money — more than $3 million which according to Mr. Mildon it wished to use in the “money-lending” business, and he actively sought out placements for these funds. In addition the appellant retained the real estate property on which the construction and building supplies business continued to operate, and the appellant rented the premises to the purchasers

— the new operators and owners of that business. A major facet of the sale of the construction and building supplies business had been that the appellant took back as part of the purchase price, and held during the times relevant to this appeal, a ten per cent debenture in the amount of $700,000. The business had been sold to former employees, of which Mr. Mroch was one. There are certain corporate name changes to accommodate these transactions, but they did not materially affect the matter before the Court. A very major item of evidence, entered as Exhibit A-1, was the following:

MUTTART INDUSTRIES LTD.

SUMMARY OF LOANS, NOTES AND OTHER RECEIVABLES AND RELATED INTEREST INCOME

In addition to the Mroch “loan” at issue, and the $700,000 debenture, to both of which I shall return later, there will be reference made to the par- ticulars of some of the other amounts noted above, given in testimony, which I consider directly relevant to the determination of this appeal.

Before venturing to examine the specific arguments put forward by counsel for the appellant, Mr. F. D. Jones, I should like to review the two paragraphs relied upon by the appellant — requiring different arguments, paragraph 18(1)(a) and subparagraph 20(1)(l)(ii) of the Act. In summary the argument for allowing the amounts in question — under paragraph 18(1 )(a) is (and I quote counsel for the appellant):

. . . where you have a commercial enterprise and you have something that is expended for the purpose of gaining or producing income, unless there is a prohibition in the Act, basically that is allowable as an expense under 18(1)(a).

. . . Section 18(1)(a) allows the expense as a business deduction .. . 18(1)(a)’s purpose is, (as Royal Trust case indicates), from a business connotation, in arriving at the profits of a business, only profits are taxable, of course, in business income.

You have a business, you have the loans made in the course of that business, you have loans uncollectible. Therefore, I suggest to you, sir, that they should be able to be written off in ascertaining the profits of that particular business.

Section 20 allows a deduction, because the first part of the section says, notwithstanding paragraph 18(1)(a), (b) and (h), so therefore, this section would, even if you felt 18(1)(a) wasn’t applicable, this section would be applicable.

. . . the facts . . . certainly lead to no other conclusion than the loans were made as part of the ordinary business of Muttart Industries.

The other part, of course, were the rental incomes. The prime tenant, of course, of whom were the employees, or the company to which Mr. Mildon sold his company previously. So, as far as that goes, I suggest to you, sir, that the facts are almost overwhelming to show that there was a loan made by a taxpayer as part of its ordinary business.

As I comprehend Mr. Jones, he is saying that in the event that for some reason, the Court does not find this amount at issue deductible under paragraph 18(1)(a) of the Act as an ordinary business or property expense, then it would be deductible under subparagraph 20(1 )(l)(ii), as a loan made in the ordinary course of business. That is a perfectly good approach for Mr. Jones to take — simply that if it can be shown that the amounts meet the criteria under section 18 for all deductions, it should be so treated. After that effort failing (if it does) any deductions sought under the provisions of section 20 of the Act must be an exception to that normal deduction procedure under section 18 of the Act. But section 20 of the Act only comes into play — as I see it, when the deduction sought is excluded from such treatment under section 18 by virtue of specific clauses (a), (b), or (h) of the Act. So first a review of section 18. That section does not provide for deductions in the abstract sense of the word. The view that “paragraph 18(1)(a) provides for deductions”, is not one to which I subscribe. The rule from section 18 is no deduction unless, not a deduction unless. I accept that an expense or outlay "made or incurred .. . for the purpose of gaining income” comes under the terms of paragraph 18(1 )(a) (See B.C. Electric Railway Company Limited v. M.N.R., [1958] C.T.C. 21; 58 D.T.C. 1022). However, while B.C. Electric Railway Company Limited (supra) is often quoted as standing for the proposition that "Ioans” should be deductible under section 18 of the Act, I would think it to be a most unusual situation when "loans” could be so treated. “Loans” almost exclusively by definition are capital outlays — the purpose of the outlay is to earn income from it. A loan would rarely, if ever (I cannot quickly think of an exception) be included as a “current” cost of doing business in a particular year — even under circumstances where the frequency and characteristics of the lending operation were such that the interest income therefrom would be termed from “business” rather than from “property”. I hasten to add that I am not prescribing that there is necessarily any clearly defined line separating lending money in a “business” from lending money as “property” — but wherever that line of demarcation may be (if it exists) it would not affect the recording of the loan in the first instance — that outlay would be capital! So accordingly, while cases such as B.C. Electric Railway Company Limited (supra); M.N.R. v. Algoma Central Railway, [1968] C.T.C. 161; 68 D.T.C. 5096; and Associated Investors of Canada Limited v. M.N.R., [1967] C.T.C. 138; 67 D.T.C. 5096 etc. may provide some comfort to taxpayers, in that allegedly “capital” amounts were not considered as capital by the Courts, and therefore allowed under paragraph 18(1)(a), they do not, in my view, provide the basis for the proposition advanced in this appeal that “loans” are deductible under that paragraph. Therefore I do not subscribe to the proposition of counsel for the appellant, made in these words:

So, my first proposition basically is that pursuant to the 18(1)(a) argument, if we have, under the facts of this particular case, a business operation and if you find that these loans were made for the purpose of gaining or producing income, then the expenditures made pursuant to those loans, i.e. uncollectible loans, should be deductible under section 18(1)(a).

As I see it, where the amounts at issue arise out of “loans”, unless there is relevant jurisprudence to which I have not been referred, a taxpayer should look to section 20 of the Act not to section 18 for relief. In Highfield (supra) upon which counsel for the appellant also relied, this Court determined that issue in favour of the taxpayer based on section 20 of the Act not section 18.

Here, we face quite a different situation — also reviewed in detail in Highfield (supra). I re-emphasize the thrust of the comments made therein dealing with the line of cases commencing with George A. Orban v. M.N.R., 10 Tax A.B.C. 178; 54 D.T.C. 148. Highfield (supra) rejects the mathematical “basis for determining a loan'”, and in George Robinson v. M.N.R., [1985] 1 C.T.C. 2054; 85 D.T.C. 84 the Court reviewed the “technical” arguments sometimes raised by the Crown in appeals of this kind, and concluded on page 2057 (D.T.C. 87) of Robinson (supra):

. . . No jurisprudence was provided to the Court by the respondent which would serve to invalidate a demand note merely on those grounds . . .

In the instant appeal, certain technical features — (related or associated parties or corporations, minimal interest rates, etc.) were raised by the respondent, but in my view the thrust of the Minister's basis for the assessments comes down to the proposition that the requirement:

Section 20(1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source of such part of the following amounts as may reasonably be regarded as applicable thereto:

(I) a reasonable amount as a reserve for

(ii) doubtful debts arising from loans made in the ordinary course of business by a taxpayer part of whose ordinary business was the lending of money;

had not been met by the appellant in the circumstances.

There would be little purpose served by a review of the further details provided in Highfield (supra), other than to note that the reliance placed upon it, and its use in this appeal was related in a certain fashion to the fact that the original appeal to the Federal Court, against the decision by this Court favourable to the taxpayer, lodged by the respondent has apparently been withdrawn,* [1] and therefore that particular taxpayer's appeal will not be further debated in the Courts. The critical phrase in Highfield (supra) relevant to this appeal, as I see it, is to be found on page 2824 (D.T.C. 1843) :

. .. The constant and consistent procedures adopted and followed by Highfield when making its investments make the particular loans in question “ordinary” in every aspect.

That comment simply makes the point, that whereas a “loan” may be made

— (and I am prepared to accept that in this appeal, certain “loans” were made) — that particular form of “lending money” may not of itself qualify the amount at issue for the deduction sought under subparagraph 20(1 )(l)(ii) of the Act, because of the requirements contained therein. First, (while under section 18 of the Act, one could argue “business” or “property”, there is no reference to “property” under subparagraph 20(1 )(l)(ii), indeed there is not even a reference to “income”, in subparagraph 20(1 )(l)(ii). It would appear to me that the general provision in the opening clause of section 20 which covers both business and property, is reduced under subparagraph 20(1)(l)(ii) to simply “business”. It is here that the “minimum” level of activity and appropriate operational characteristics must demonstrate a “business” source as opposed to a “property” source to activate the deductions permitted in the section (see Highfield (supra)). While not totally impossible, it seems to me highly improbable that a single loan made, which becomes doubtful of collection, would qualify as a “business”, and it would have even greater difficulty being accepted for the taxpayer as proof that the “ordinary business was the lending of money” (emphasis mine). The argument advanced in this appeal to overcome this difficulty was essentially that after the sale by the appellant of the construction and building supplies part of the original business, it (the corporation) was left with two major assets — a real property, where its original construction and building supplies business was conducted, and which it then in turn rented to the purchasers of that business; and money, which it proceeded to loan out as a money-lender. The two arms of this business venture (rents and interest) formed the new business of Muttart — according to the appellant. I believe this proposition fails. I am not convinced that the rental activity — which consisted almost exclusively of renting the one real property to the purchaser of the construction and building supplies business, qualifies as a “business” or part of a “business”, as contrasted with its role as simply a source of investment income. That could be enough in itself to dispose of this matter, but if it were not, one turns to the second reason — the loans.

The particular loans at issue in this appeal to Mr. Mroch for $71,000 (actually two loans) have been surrounded in Exhibit A-1, (supra) by various other amounts alleged to be “loans” of different source and to different parties, in order to demonstrate the "lending of money” business of the appellant. These data do not accomplish that objective. I do not regard the term deposits of some $2,600,000, as contributing to the framework of the business of lending of money. I am not saying that it could not be part of such a business, but taken in isolation, (as if it were the one and only financial activity at issue), it would be a pure ""investment”. The same is true for the ten per cent debenture of $700,000 — it was merely the balance of the sale price of the construction and building supplies business, which the vendor (this appellant) agreed to finance. That is not even ""lending of money”, in my view. The same holds true for the ""Bremner Land & Cattle Co. Ltd. loan of $200,217.00”. It is essentially a withdrawal of company funds by or on behalf of the president of the appellant corporation, Mr. Mildon, for use in acquiring and holding some real estate owned with other parties, some family, some not. I see no real basis for asserting that that activity represents a corporation engaged in the ""business of lending of money”. The Kaufman, Heron and Baldwin amounts are loans — and do add some little weight to the appellant’s contention. Turning then to the ""short-term matured loans and notes”, while there is no balance outstanding at November 30, 1979, it is clear that interest ($105,901) was earned on them during that year. However again they were largely — perhaps exclusively — short-term investments, rotated or changed regularly to take maximum advantage of the beneficial fluctuation in interest rates. The record and history of Smolcic, Morrison, Cashe Mountain Developments and First National Homes are varied and to some degree complex. They represent either loans provided to ex-employees or persons closely associated with the company, or the use of funds for personal or family ventures by the president. In summary therefore (with respect to the fiscal year 1979 as demonstrated by Exhibit A-1) one should view the appellant, as far as the money-lending is concerned, as a very healthy holding company (financially at least) having as its prime assets a $700,000 debenture and $2,600,000 in term deposits. The business of the corporation during that year in a major sense consisted of holding and securing these two investments. In addition the company had made available on rather nebulous terms to the company president at least a further $200,217 and perhaps considerably more. I do not agree that the use of rather relatively small amounts of available cash for a variety of purposes (some of which Kaufman, Heron Baldwin, and yes the one at issue Mroch, might well qualify as “loans’’) serves to put this appellant in the category that its ""ordinary business was the lending of money”, and that within such a framework the Mroch loan was made in the ""ordinary course of business”. In my view except for the particular reasons or rationalizations (personal commitments, assisting friends or corporations) which created the ""loans” anomalies, this corporation would have proceeded to invest its surplus funds in safe term deposits or short-term notes. I do not doubt the assertion of the company president at the hearing that on behalf of the appellant he was searching around for loans and investments for the portfolio. He may even have been willing to invest more in such loans — but he certainly was not prepared to do so at the risk of prejudicing the already certain return from such things as short-term notes and term deposits. Clearly neither the $700,000, ten per cent debenture nor the $200,217 Bremner land and Cattle Co. Ltd. amount were available to him for other investing, let alone to use as the capital in a ""business of lending of money”. I am quite satisfied that under certain circumstances such items as the ten per cent debenture and the term deposits could be a part of a portfolio held by an operator engaged in the “business of lending of money”. There is nothing in my mind significantly different in debentures or term deposits as such, which would disqualify them as "loans”. This $700,000 because of its origin is not a loan — it is merely security for an unpaid debt and is at best an investment, not part of a business of lending money. The ""term deposits” in this matter do represent a form of loans to banks, trust companies or credit unions, but these loans are investments, not part of a business.

What kind of metamorphosis must take place and the level of activity which must be reached in a given set of circumstances arising out of ""investments” in order to qualify the loans therein as forming a ""business” may not be possible of mathematical determination, but that level of acceptability, whatever it is, has not been demonstrated in this appeal. The ordinary operation of Muttart during the year in question was the investing of surplus funds, not the business of lending of money. It could well be that during subsequent years that situation changed, but that question is not before the Court.

The appeal is dismissed.

Appeal dismissed.