Francis Louis Wright v. Minister of National Revenue, [1986] 1 CTC 2581, 86 DTC 1415

Tremblay, T.C.J.:—This appeal was heard on August 28, 1985 at the City of Victoria, British Columbia.

1. The Point at Issue

Pursuant to the notice of appeal, the point to determine is whether the appellant is correct in the computation of his income with regard to his 1979 and 1980 taxation years, not to include $9,818.54 amd $81,048.08 respectively.

In assessing the appellant, the respondent included the said amounts in the appellant’s income for the said years on the basis that they were shareholders loan advances by Wright Enterprises Ltd. (the "Company"), a company owned by the appellant, and they were not reimbursed within the time limit provided in section 15 of the Income Tax Act.

The appellant contends that loans were mainly made to enable him to purchase a piece of land and build a dwelling house for his own occupation and therefore that the loan is exempt from taxation under subparagraph 15((2)(a)(ii) of the Act.

2. The Burden of Proof

2.01 The burden of proof is on the appellant to show that the respondent's assessment is incorrect. This burden of proof results particularly from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v. M.N.R., [1948] S.C.R. 486; [1948] C.T.C. 195; 3 D.T.C. 1182.

2.02 In the same judgment, the Court decided that the assumed facts on which the respondent based his assessment or reassessment are also deemed to be correct. In the present case, the assumed facts are described in the reply to notice of appeal as follows:

7. In assessing the Appellant’s income for 1979 and 1980 . . . the Respondent assumed, inter alia, as follows:

(a) the Appellant did not, during the taxation years involved or thereafter, purchase or erect a dwelling house for his own occupation on the land purchased;

(b) the terms of repayment of the loan to the Appellant from Wright Enterprises Ltd. required repayment within 10 years from August 29, 1979, or upon subdivision of the land in question, whichever occurred earlier, and such a term of repayment for the loan did not require it to be repaid within a reasonable time;

(c) that the loans referred to in the Notice of Appeal made by Wright Enterprises Ltd. to the Appellant in 1979 and 1980 are required to be included in the Appellant’s income.

3. The Facts

3.01 The appellant is a businessman and resides in Victoria, British Columbia. He lives on his boat near the purchased property involved in this appeal.

3.02 At all material times, the appellant was the president, one of two directors, an employee and 90 per cent shareholder of Wright Enterprises Ltd. At all material times, the appellant’s wife held the remaining 10 per cent of the issued and outstanding shares of the Company.

The taxation year of the company is from July 1st to June 30th.

3.03 On or about August 1, 1979, the appellant, Peter Myles White, Sheila Lynn White and Douglas Dirk Barron (collectively the “Purchasers”) entered into an agreement with Mary Yerxa (the “Vendor”) to purchase for the sum of $250,000 a parcel of undeveloped land comprising approximately three acres located at Canoe Cove, North Saanich, British Columbia and being more particularly known and described as (District of North Saanich), Lot 1, Section 20, Range 3 East, North Saanich District, Plan 9814 (the “Land”)(Exhibit A-5).

3.04 On or about August 29, 1979, the Company advanced the sum of $83,829.96 to the appellant to enable or assist the appellant to acquire an undivided one-third interest in the land.

3.05 When entering into the purchase agreement with the Vendor, the appellant’s only intention was to purchase an undivided one-third interest in the land to erect a dwelling house thereon for his own occupation.

3.06 At all material times, the appellant knew that the land was unsubdivided and that, unless and until the land was subdivided, a building permit could not be obtained for the construction of a dwelling house thereon.

A letter dated June 6, 1979 which was sent by the Municipal Office of the District of North Saanich to Mr. Barron, one of the purchasers, reads as follows:

I have now reviewed your application respecting a bare land strata plan for lands described as Lot 1, Section 20, Range 3 East, Plan 7086 which had been forwarded to me by way of letter dated May 22, 1979.

As we discussed in subsequent meetings, Municipal policy is to discourage bare land strata plan proposals where conventional subdivisions are feasible, however, due to the configuration and location of the referenced lands, a bare land strata plan will be considered in this instance. Approval is therefore granted in principle to the proposal as amended.

Requirements for the lot and road configuration shall be as follows.

There was in fact a problem of subdivision concerning this property. The acreage was 3.89. However, pursuant to municipal regulation, the minimum acreage required for the construction of a house was 1.5. None of the purchasers had the minimum. However, the above letter explains the requirements to meet in this special case. The then municipal engineer, Mr. den Boer, had agreed in substance with the letter of the approving officer. He even made a plan to explain the proposed subdivision (Exhibit A-2).

3.07 Also at that time, in June 1979, the appellant had discussed, with the accountant of the company Mr. Winterbottom, the possibility and the way to borrow money from the company to purchase the said land.

In his testimony the accountant said it was then anticipated that the subdivision of the property would be settled within two years.

3.08 The appellant filed the promissory note, issued and signed by him (Exhibit A-1 (3)). It reads as follows:

3.09 Minutes of a Meeting of Directors of the Company dated November 17, 1980 confirm the loan made on August 29, 1979 (Exhibit A-1(4)). The resolution reads as follows:

There being no further business the meeting adjourned.

[signed]

[FRANK WRIGHT]

It appears from the wording of this document , . . and to be evidenced by a promissory note” that Exhibits A-1(3) and A-1(4) were made the same day, November 17, 1980. This was admitted by the appellant and his accountant Mr. Winterbottom.

3.10 The appellant’s intention as well as his accountant's was to reimburse the company, when a loan would be made from the bank to build the home, after the subdivision of the property i.e., within two years from August 29, 1979.

3.11 In the fall of 1979, the appellant bought four truck loads of building materials (bricks, plywood, etc.) to build the house.

3.12 In January 1981, after the return of the partners from an 18-month trip, all the partners tried to have the subdivision from the Municipal Office. Engineer den Boer had left; the new engineer was opposed to the request, therefore the subdivision was not issued. Despite the efforts by the partners, the Municipal Office refused to be bound by the earlier letter to permit the subdivision.

3.13 The appellant’s accountant Mr. Winterbottom confirmed the veracity of different working papers (Exhibits R-2, R-3, R-4, R-5, R-6) he made in view of preparing the financial statements of Wright Enterprises Ltd. on June 30, 1979 and on June 30, 1980. Those documents confirmed that a -cheque of $83,825.96 was issued by Wright Enterprises Ltd. to the order of vendor of the piece of land on behalf of the appellant. In Exhibit R-4 dated July 17, 1980, it is underlined that a “Legal document . . . to come" to confirm the loan of $83, 825.96 to the appellant by Wright Enterprises Ltd.

3.14 Mr. Brian David Allan, the respondent's witness, filed Exhibit R-7: a summary of the different transactions of the shareholders loan account of Wright Enterprises Ltd. from 1978 to 1980. The computation of the two amounts involved in this case clearly appears as being $9,818.54 for 1979 and $81,048.08 for 1980. The Exhibit R-7 reads as follows:

Wright Enterprises Ltd.

Mr. Frank Wright Shareholders Loan Account

1978-1980

			Fiscal Year-	Allowable to
Date	Balance	Balance	End Change	Mr. Wright
					1978
30 June 78		NIL		$ 2,300.00
31 Dec. 78		$ 2,300.00	$10,518.54
					1979
30 June 79		10,518.54		$ 8,218.54
					1,600.00
31 Dec. 79		12,118.50	82,048.08	$9,818.54
					1980
30 June 80		92,566.62		$80,448.08
					600.00
31 Dec. 80		93,166.62	1,118.06	$81,048.08
					1981
30 June 81		93,684.68		$	518.06
		Amounts added to income under
		Subsection 15(2) are as follows:
		1979 — $ 9,818.54
		1980 — $81,048.08

For both years, the reassessment was issued on January 24, 1983.

3.15 Pursuant to the respondent's policy explained in paragraph 34 of Interpretation Bulletin IT-119R2, a second reassessment was issued in January 1984 concerning the 1980 taxation year, reducing the amount assessed by $18,757.98. Mr. Allan filed as Exhibit R-8 a document giving the computation of the income for the initial assessment and the two reassessments. It reads as follows:

Frank Wright

Schedule of Total Income 1980

	Initial	Jan. 24 1983	Jan. 9 1984
	Assessment	Reassessment	Reassessment
1980
Net Employment Earnings	$11,640.00	$11,640.00	$11,640.00
Interest Income	116.00	116.00	116.00
Shareholder Benefit
under 15(1)(c)	NIL	4,646.00	4,646.00
Shareholder Loan 15(2)	NIL	81,048.08	62,290.10
Total Income	$11,756.00	$97,450.08	$78,692.10

The amount assessed under Subsection 15(2) was reduced by $18,757.98 between the January 24, 1983 to January 9, 1984 reassessments due to a repayment of this amount during 1981 being applied directly to the 1980 15(2) amount pursuant to policy in paragraph 34 of IT-119R2 (now paragraph 31 of IT-119R3).

Paragraph 34 of IT-119R2 reads as follows:

Application of Subsection 15(2) and Paragraph 20(1 )(j) Where “A Series"

34. Where there is a series of loans and repayments . . . paragraph 15(2)(b) does not apply. Assuming that the loans . . . do not come within the excepting provisions of paragraph 15(2)(a), they are includable in income pursuant to the opening words of subsection 15(2) without allowing one year for possible repayment. Although there is a series of loans and repayments, a repayment . . . is allowed as a deduction if it otherwise qualifies under paragraph 20(1)(j). If a taxpayer requests that a decrease (or part of it) be applied to reduce any amount that may be subject to tax in the immediately preceding taxation year, the Department will accede to that request but will not also allow a deduction under paragraph 20(1 )(j) for that amount.

3.16 If the loan, however, occurred in 1979 and not in 1980, then the amounts assessed must be changed as it appears from Exhibit R-9 prepared by Mr. Allan:

Wright Enterprises Ltd.

Mr. Frank Wright Shareholders Loan Account

			Fiscal Year-	Allowable to
Date	Balance	Balance	End Change	Mr. Wright
					1978
30 June 78		NIL		$ 2,300.00
31 Dec. 78		$ 2,300.00	$10,518.54
					1979
30 June 79		10,518.54		$ 8,218.54
				82,048.08
31 Dec. 79		95,944.46	82,048.08	$90,266.62
					1980
30 June 80		92,566.62			NIL
					600.00
31 Dec. 80		93,166.62	1,118.06	$	600
					1981
30 June 81		93,684.68		$	518.06

If the $83,825.96 loan occurred in 1979 and not 1980, the amounts to be added to income under Subsection 15(2) would be as follows:

1979 — $90,266.62 1980 — 600.00

4. Law — Cases at law — Analysis

4.01 Law

The main provisions of the Income Tax Act involved in the instant case are sections 15(2)(a)(ii), (b), 20(1)(j).

15. . . .

(2) Where a particular corporation, a corporation to which the particular corporation is related or a partnership of which either or both of the corporations is a member has in a taxation year made a loan to a person (other than a corporation resident in Canada) who is a shareholder of the particular corporation or who is connected with a shareholder of the particular corporation, the amount thereof shall be included in computing the income for the year of the person to whom the loan was made unless

(a) the loan was made

(i) in the ordinary course of the lender’s business and the lending of money was part of its ordinary business,

(ii) to an employee of the lender or to the spouse of an employee of the lender to enable or assist the employee or his spouse to acquire a dwelling for his habitation,

(iii) where the lender is a corporation, to an employee of the corporation to enable or assist the employee to acquire from the corporation fully paid shares of the capital stock of the corporation, or to acquire from a corporation related to the corporation fully paid shares of the capital stock of the related corporation, to be held by him for his own benefit, or

(iv) to an employee of the lender to enable or assist the employee to acquire an automobile to be used by him in the performance of the duties of his office or employment,

and bona fide arrangements were made at the time the loan was made for repayment thereof within a reasonable time; or

(b) the loan was repaid within one year from the end of the taxation year of the lender in which it was made and it is established, by subsequent events or otherwise, that the repayment was not made as a part of a series of loans and repayments.

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 or such part of the following amounts as may reasonably be regarded as applicable thereto:

(j) such part of any loan repaid by the taxpayer in the year as was by subsection 15(2) required to be included in computing the income of the taxpayer for a previous year (except to the extent that the amount of the loan was deductible from the taxpayer’s income for the purpose of computing his taxable income for that previous year), if it is established by subsequent events or otherwise that the repayment was not made as part of a series of loans and repayments;

4.02 Cases at Law

Counsel for the parties referred the Court to the following cases:

1. Ocean View Development Limited v. M.N.R., 15 Tax A.B.C. 204; 56 D.T.C. 286, (T.A.B.);

2. Irving Brown v. M.N.R., 35 Tax A.B.C. 197; 64 D.T.C. 316, (T.A.B.);

3. Bonavista Investment Corporation v. M.N.R., 37 Tax A.B.C. 398; 65 D.T.C. 183, (T.A.B.);

4. Coleman C. Abrahams [No. 1] v. M.N.R., [1967] 1 Ex. C.R. 333; [1966] C.T.C. 690; 66 D.T.C. 5451;

5. Mary E. Walkem v. M.N.R., [1971] C.T.C. 513; 71 D.T.C. 5288, (F.C.T.D.);

6. Emile Morin v. M.N.R., 26 Tax A.B.C. 161; 61 D.T.C. 161, ((T.A.B.);

7. J.A. Layden v. M.N.R., 28 Tax A.B.C. 33; 61 D.T.C. 623, (T.A.B.);

8. Peter Reekie v. M.N.R., [1980] C.T.C. 2502; 80 D.T.C. 1447, (T.R.B.);

9. Petrus J.J. Hendriks v. M.N.R., [1981] C.T.C. 3029; 81 D.T.C. 939, (T.R.B.);

10. Joseph Deckelbaum v. M.N.R., [1982] C.T.C. 2659; 82 D.T.C. 1636, (T.R.B.);

11. Shirley Butterfield v. M.N.R., [1984] C.T.C. 2228; 84 D.T.C. 1185, (T.C.C.);

12. Clayton’s Case (1816), 35 E.R. 781; [1814-23] All E.R. Rep.1;

13. Gene A. Nowegijick v. The Queen and Others, [1983] 1 S.C.R. 29; [1983] C.T.C. 20; 83 D.T.C. 5041;

14. Amelia Rose v. M.N.R., [1973] 1 F.C. 65; [1973] C.T.C. 74; 73 D.T.C. 5083, (C.A.);

15. John Altenhof v. M.N.R., [1973] C.T.C. 2303; 73 D.T.C. 239, (T.R.B.);

16. The Queen v. Peter Neudorf, [1975] C.T.C. 192; 75 D.T.C. 5213, (F.C.T.D.);

17. Kenneth E. Heal v. M.N.R., [1980] C.T.C. 2199; 80 D.T.C. 1169, (T.R.B.);

18. R. Fontana v. M.N.R., [1981] C.T.C. 2896; 81 D.T.C. 803, (T.R.B.).

4.03 Analysis

4.03.1 The crux of the matter is whether:

(a) “bona fide arrangements were made at the time the loan was

made for repayment thereof within a reasonable time" and

(b) “the appellant meets the requirement of 15(2)(a)(ii) because he did not erect the dwelling house during the taxation years involved and after".

4.03.2 Concerning the latter point, the Court thinks that the decision of the Municipal Office of the district of North Saanich in 1981 to refuse to issue the subdivision permit of the subject property (para. 3.12) despite the letter issued on June 6, 1979 (para. 3.06) cannot be reproached to the appellant. As in the Emile Morin case (para. 4.02(6)), it was beyond the appellant’s control. This was the actual cause for not erecting the dwelling house. The appellant was in good faith, when he based his decision to purchase the land on the letter dated June 6, 1979 of the Municipal Office. The piece of land was required before building a house.

4.03.3 The remaining point whether there are bona fide arrangements seems more complicated. Counsel for the appellant contends that the decision concerning the loan was made in the summer of 1979. The cheque was actually made out on August 29, 1979 (para. 3.09) and by the working papers of the accountant (Exhibits R-2, R-3, R-4, R-5, R-6) (para. 3.13). Moreover, as it was provided in 1979 that the permit of subdivision of the land (para. 3.07) and that loan would be reimbursed to the company within two years (para. 3.10); therefore the repayment was within a reasonable time, counsel for the appellant contends.

4.03.4 Counsel for the respondent, however, contends that as the promissory note and the resolution of the lender were passed only on November 17, 1980 and as no interest on the loan is provided in these documents, therefore the appellant did not make bona fide arrangements at the time the loan was made for repayment thereof within a reasonable time. Counsel for the respondent also contends that paragraph 15(2)(a) must be strictly interpreted because it is really a diversion of corporate funds for other than normal corporate purposes.

The verbal agreement in August 1979 does not meet the wording of the exemption provision.

4.03.5 It is well known that most of the transactions in the business world do not always depend on written documentation but rather on verbal agreements particularly when the relationships between parties are close (Massey Ferguson Limited v. The Queen, [1977] 1. F.C. 760 at 767; [1977] C.T.C. 6 at 13; 77 D.T.C. 5013 at 5017, (C.A.)).

This occurs more often between the sole or the main shareholder of a company and the said company, as in the instant appeal (the appellant owns 90 per cent of Wright Enterprises Ltd.). However, the dispute does not exist between the appellant and the company. The letter indeed officially confirmed, in November 1980, the loan made by cheque in August 1979. The dispute exists between the appellant and a third party, the Department of National Revenue, administrator of the Income Tax Act which contains paragraph 15(2)(a) requiring bona fide arrangements at the time the loan was made.

4.03.6 Counsel for the appellant stressed in the Emile Morin case (para. 4.02(6)) the facts which are quoted as follows from the headnote in the Dominion Tax Cases:

The appellant was the president and principal shareholder of a private company in the road contracting business. The company carried on operations in the eastern part of Quebec, most of its contracts being obtained from the provincial government. Following an election in 1956, the government stopped granting contracts to contractors in the area. In order to keep the company's machines busy, the appellant decided to move, with his wife and six children, to Montreal and to carry on operations in that district. The company granted him a loan of $15,000 for the purchase of a house in Montreal. Late in 1956, the appellant bought a small duplex in Montreal which he planned to convert to a single-family dwelling to house the eight members of his family. The two apartments were temporarily rented to tenants, but the appellant improved the premises for his own use and had an office fitted up in the basement, which he occupied for some time. About a year later, the appellant’s company was awarded a large government contract for building a road in its original territory. The appellant, although he had been successful in obtaining some contracts in the Montreal area, decided to abandon his plans to move to Montreal. Wishing to repay the money he had borrowed from his company, the appellant tried to sell the duplex but without success. In assessing for 1956, the Minister added to the appellant's declared income the $15,000 lent to him by his company. The Minister relied on section 8(2) which provides that, unless certain conditions are met money lent by a corporation to a shareholder shall be deemed to have been received by the shareholder as a dividend.

Held: The appeal was allowed. The $15,000 loan granted to the appellant by his company was not taxable under section 8(2). The evidence established that the loan was made to enable the appellant to purchase a dwelling house for his own occupation, that arrangements were made at the time for repayment of the loan within a reasonable time, and that the appellant used the money to purchase a house with the intention of occupying it with his family and not with the intention of deriving income from rent. It was only because of subsequent events which the appellant could not foresee that his plans were not carried out.

In the said case, however, it was adduced in evidence, that a loan of $15,000 was made after a resolution was passed on November 3, 1956 at a special meeting of the directors of the company providing an interest of four per cent per annum and repayment in instalments of $2,000 per year. The fact that Mr. Morin did not actually live with his family in the purchased house, and that the mortgage was not signed until January 3, 1959, was beyond Mr. Morin's control as the evidence showed. In the instant case, as underlined above (para. 4.03.2), it was beyond Mr. Wright's control that subdivision of the subject land was not made. However, this is not the point at issue. The point is that no resolution was passed by the company in August 1979 at the time of the loan.

4.03.7 Both counsel referred to the John Altenhof case (para. 4.02(15)) which is quoted as follows from the headnote in the Dominion Tax Cases:

The appellant and his brother were the only two beneficiary shareholders of a tool company, their solicitor also owning a single share. Having incurred various expenses, the appellant needed a loan of $30,000 which the company duly advanced to him in 1968. No promissory note or document confirming repayment arrangements was signed at this time. When the Minister included the $30,000 in the appellant’s income for that year, he objected, contending that section 8(2) applied and the money should not have been considered taxable in his hands.

Held: The appeal was dismissed. The Minister acted correctly in adding the amount in question to the appellant's income. Evidence revealed that there was no bona fide agreement, written or otherwise, between the company and the appellant stipulating that he should repay the loan at some future time. In view of this, section 8(2) clearly was not applicable and the appellant was liable for the amount in question.

Judge Cardin, then a member of the Tax Review Board, said at C.T.C. 2305 (D.T.C. 240):

(Arrangements for repayment bona fide or not)

The point in issue in this appeal is whether or not bona fide arrangements for the repayment of the loan were made at the time the loan was made pursuant to subsection 8(2) of the Income Tax Act. Even if one were to admit, as counsel for the appellant contends, that the Act does not require that the bona fide arrangements for the repayment of the loan be in writing, there must be sufficient proof to satisfy the Board that arrangements for the repayment did, in fact, exist at the time the loan was made.

In the absence of a written document, the Board must rely on the facts and the credibility of the appellant. The facts of this appeal pose more questions than they answer. Admitting that the meeting took place in February 1968, and that advances were made to the appellant for the purpose of building a house how, under the circumstances of this case, can the Board determine whether or not arrangements for repayment were made at the time the loan was made? From Mr. Kulyk’s notes which were lost and had to be reconstructed from memory? From the company’s minute book which dated the loan as at May 13, 19712 From the promissory notes dated February 12, 1968, and May 13, 1971 both of which were signed by the appellant knowing he had not given a promissory note in February 19682 From the facts of the case, just how credible has the appellant proven to be?

4.03.8 In many cases referred to by counsel for the parties, there were no arrangements at all (R. Fontana case (para. 4.02(18)), Peter Reekie case (para. 4.02(8)), Kenneth E. Heal case (para. 4.02(17)) or there were ex post facto corporate resolutions (Petrus J.J. Hendriks case (para. 4.02(9)), Amelia Rose case (para. 4.02(14)), J.A. Layden case (para. 4.02(7)) or there was no interest provided in the resolution of the company (Joseph Deckelbaum case (para. 4.02(10))).

4.03.9 In my opinion, Mr. Justice Heald in the Peter Neudorf case (para. 4.02(16)) touches the actual point when he stated at C.T.C. 196 (D.T.C. 5215):

It is my further view that since one of the parties to the arrangement was a corporation, there is more formality required (such as corporate resolutions, for example) than in the case of individuals and particularly where the details of a relationship are important as against third persons such as the Revenue.

The formality must be more strictly followed when the result is an advantage received by the main shareholder of the corporation because when the lack of a formality in the application is the mistake of the said shareholder, he has no excuse. Already, in June 1979, after the meeting with the accountant's company, Mr. Winterbottom, the appellant was aware of the resolution the company had to pass.

No evidence was shown explaining special circumstances which were beyond the appellant’s control as to why the resolution was not passed in August 1979. A corporation is a legal entity, a different person from the shareholder. How may a third person know a decision of a corporation? It is only by the resolution passed by the corporation.

The resolution passed November 1980 may justify the appellant to pay the company on a ten-year basis because this concerns only the relation involved between the appellant and the company.

From the moment, however, a third person such as the respondent, becomes involved because of the application of paragraph 15(2)(a) of the Income Tax Act, which is an exemption provision, then the formality provided in the said Act must be applied.

In my opinion, in August 1979, there is no evidence that bona fide arrangements then existed because there was no arrangement at all.

It is true that the notes in the working papers of the accountant stated that there is a loan. However, this is not an arrangement in the sense of the Act. Moreover, the main note simply stated that on July 17, 1980 there was not yet a legal document passed to confirm the loan (para. 3.13). This is an admission that the required arrangement had not been passed at the time that the loan was made.

4.03.10 Moreover, if the corporate resolution had been passed in August 1979 as it was in November 1980, namely without providing interest, I doubt that it would have been a bona fide arrangement unless it could have been proven that in the actual repayments reasonable interest was included.

4.03.11 The advantage received by the appellant must apply in 1979 because, it is the year the shareholder received the amount of $83,825.96 with the consequences described in paragraph 3.16 above.

5. Conclusion

For these reasons, the appeal is allowed in part and the matter is referred back to the respondent for reassessment.

Appeal allowed in part.