Shirley Butterfield v. Minister of National Revenue, [1984] CTC 2228, 84 DTC 1185

St-Onge, TCJ [ORALLY]:—The appeals of Mrs Shirley Butterfield were heard on June 22, 23 and 24, 1982, at the City of Vancouver, British Columbia, by the assistant chairman of the Tax Review Board, but he was unable to render judgment before his death which occurred on March 13, 1983. The parties hereto agreed that judgment should be rendered, on the transcript of the evidence and subsmission, by a judge of the Tax Court of Canada.

Before his death, Mr Dubrule had alread summarized the facts and submissions which read as follows:

“The appellant (sometimes called ‘Shirley’) appeals from an assessment of taxes for each of the years 1974 and 1975 with respect to those amounts added to her income by the respondent, which amounts the respondent has assumed were loans to her by Butterfield Imports Ltd (‘Imports’) as a shareholder of Imports which were not repaid by her within the time limited by subsection 15(2) of the Income Tax Act (after tax reform). That section reads as follows:

15(2) Where a corporation has in a taxation year made a loan to a shareholder, the amount thereof shall be included in computing the income of the shareholder for the year unless . . .

(b) the loan was repaid within one year from the end of the taxation year of the corporation 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,

and, where the shareholder is a corporation, the amount so included in computing its income for the year shall be deemed to have been received by it as a dividend.’’

In the course of these reasons reference will likely be made to many companies of a group called “The Butterfield Group”.

The husband of Shirley was John Butterfield (“John”). Butterfield Machinery Ltd. (“Machinery”) was a corporation and John was its sole shareholder. John was its president and Shirley its secretary. Imports was a corporation with Shirley as its sole shareholder. She was its president and John its secretary. Butterfield Machinery Erectors Ltd. (“Erectors”) was a corporation whose shares were owned equally by Machinery and Imports. John was its president and Shirley its secretary. It had a wholly-owned subsidiary, Butterfield Sawmill Construction Ltd (“Sawmill”). The evidence is not clear as to who the president and secretary were. Another corporation was Butterfield Machinery (Prince George) Ltd. (“Prince George”), whose shares were owned 90 per cent by John and 10 per cent by Shirley, with John the president and Shirley the secretary. The last corporation was Que Sera Charters Ltd. (“Charters”). All shares were owned by John and he was the president. It could be that both John and Shirley had signing authority for all companies, but, in any event, both John and Shirley had signing authority (especially noted, cheque signing authority) for Imports.

Prior to the 1971 calendar year, both Imports and Machinery had been reasonably successful. In about 1971, a hull for what ended up becoming a yacht (called “Que Sera”) was ordered by one of the above companies or John. It was delivered to John’s residence in 1971, together with two propulsion engines at a total cost of about $30,000. These costs were paid for by Machinery, presumably by cheque

In the summer of 1972, and again around September of 1972, Machinery entered into two contracts to do its usual work, but there was an unusual feature. Both were out of the Vancouver area: one was near Prince George, BC, and the other at Fort Nelson, BC. Erectors and Sawmill were to perform the contracts. Because of very unexpected difficulties (the details are unimportant), Machinery efectively ended up with no cash flow and pressing creditors. There were many creditors of Machinery, Erectors and Sawmill and the crediors petitioned them into bankruptcy. Those companies through John, acting on advice of advisers, made a proposal which, after modification, was accepted. Two terms of the acceptance were that John was on a restricted pay schedule and, secondly, since his net worth was about $40,000, he was to give a mortgage on the yacht assigned to the trustee under the proposal. The petition was made in mid-March of 1973 and, while orally the proposal was accepted a few months later, all terms legally were not complied with until at least June 30, 1976.

Since the early spring of 1973, John had limited, if any, funds and finishing the boat cost money. The source of the money to do that was Imports, which advances were charged to Shirley’s loan account. In the calendar year 1974, Shirley’s debt to Imports increased to $58,793.78 and in the 1975 calendar year it increased by a further $33,764.26, mainly because of costs of the yacht. The respondent says these amounts were not repaid as required by subsection 15(2) of the Act and so were added to the appellant’s income.

Since Imports had a fiscal year ending September 30 and the appellant contends the loans (paid or unpaid) should be computed on a fiscal year basis, the loans on this basis (assuming the respondent’s position in law is correct) would be in the amount of $26,846.86 in 1974 and $66.912.92 in 1975.

John stated that he owned the Que Sera and gave a mortgage on it to Imports in the amount of $80,000. This mortgage was registered on September 24, 1974. The mortgage to the trustee was registered on June 30, 1976, and, immediately following that, a further mortgage was registered in the amount of $60,000 to Imports. Concurrent with the giving of the mortgages to Imports, Imports was given a “Collateral Marine Agreement” and a “Promissory Note” in the same amount as the mortgage and they called for monthly payments and interest and became due and payable on January 1, 1977. While the notes carry a date of January 1, 1974, or September 30, 1975, and the mortgages were registered on September 24, 1974, and September 30, 1976, the collateral agreements clearly show “as of” the dates of the notes. They also show, in the same sentence, “executed on” August 29, 1974, or June 1, 1976.

There are two points to be resolved in this appeal: “What year — calendar of the individual or fiscal of Imports — is the year in section 15(2)?” and, “Was the giving of the mortgages payments?” The appellant took the position, from a value point of view, that the value of the $80,000 mortgage, because of facts, was established in any event and the $60,000 was still payment as it was accepted by Imports. The respondent says that, since the respondent is taxing an individual, the calendar year must be used and, all things considered, the mortgages are not payment. He raised no questions as to value of the mortgages.

As I view the appeals, unless I hold that the mortgages were not repayment, there is no need to decide the year. In the result the first question to be answered is, “Were the mortgages repayment?”

In principle, since value was not (for these reasons) a question, the appellant’s position was relying on the case of Oswald H New et al v MNR, [1975] CTC 2257; 75 DTC 206. In short, this case states that a loan payable by an individual is paid by the assignment to the company of an account receivable from a “nonarm’s length” company. The debtor and the company to which he owed the money, as well as the company to which the debt was assigned, with respect to each other did not deal at arm’s length. I quote from those reasons at 209:

It seems to me that the assignment of a debt from one company to another without the debtor giving up anything in satisfaction of the debt, though perhaps legal and accepted in accounting practice, does not for the purposes of section 8(2) of the Income Tax Act, necessarily constitute the repayment of a loan. However, it depends on the circumstances under which the assignment took place and the bona fide nature of the receivable and its acceptance in payment by the assignee. The assignment of receivables from a financially sound company to which receivables the borrowers gave up their rights and which were indeed transferred to the lender as legal consideration for the loans, is not only legal and in accordance with accepted accounting practices but can, in my opinion, be considered as a repayment of the loans within the meaning of section 8 of the Act.

Those reasons stated at 210 and 211 are as follows:

I do not believe that the respondent can have it both ways. According to case law and the Department of National Revenue’s interpretation bulletin, and as counsel for the respondent himself admitted, for purposes of section 8, money’s worth can be considered as a valid repayment of a loan. If that is so, then whether or not, in the absence of fraud or sham, the companies are related and controlled by one person, and whether or not the recipient chooses to convert his “money’s worth” into cash, the money’s worth, once accepted by its creditor, must in my opinion be considered as a valid repayment of the loan within the meaning of section 8(2) of the Act.

Counsel then referred to novation and suggested, by this principle, the debt was repaid and quoted from Cheshire and Fifoot on Law of Contract, 9th ed (1976) at 508 as follows:

Novation is a transaction by which, with the consent of all the parties concerned, a new contract is substituted for one that has already been made. The new contract may be between the original parties, eg, where a written agreement is later incorporated in a deed; or between different parties, eg, where a new person is subsituted for the original debtor or creditor. It is this last form, the substitution of one creditor for another, that concerns us at the moment. The effectiveness of such a substitution was concisely illustrated by Buller, J.

“Suppose A owes B £100, and the three meet, and it is agreed between them that A shall pay C the £100; B’s debt is extinguished, and C may recover the sum against A.”

Counsel for the Minister submitted that, in considering the New case, (supra), one must look at the entire reasons and the findings of the Chairman in reaching his conclusion:

On reviewing the evidence in this case, I am satisfied that the entire set of circumstances concerning these appeals, namely, Oswald New’s decision to keep his operations going through his son and associates instead of liquidating his assets on the open market in contemplation of his retirement; the sale by New & Co. of 100,000 common shares of Coastal Towing to Andy’s Bay as an important step leading up to Oswald New’s retirement; the assignment to Coastal Towing of $25,000 in receivables to repay within the prescribed time limit, loans that had been made by Coastal Towing to Oswald New personally and to the personal corporation, all were carried out in good faith and in the genuine belief that such a consolidation of funds and accounts between the companies would constitute a valid repayment of the loans made to Oswald New and New & Co. by Coastal Towing. I am also satisfied, as indeed is the respondent, that the sum paid for the 100,000 shares of Coastal Towing was a reasonable price to pay in the circumstances and that their value could conceivably have been greater than the amount paid.

I have no trouble, from the evidence, in accepting the economic viability of Andy’s Bay and its capability of paying, although it did not in fact do so, the amount of $25,000 to Coastal Towing, with the result that the issue in this appeal, stripped of any extenuating facts or circumstances, is simply whether the assignment by New & Co of $25,000 of its bona fide receivables to Coastal Towing can be considered as a repayment of loans or advances made by the assignee within the meaning of section 8(2) of the Act.

His submission was that really the giving of the mortgage (or mortgages) was not repayment of the loan as John, the mortgagor, while not bankrupt personally, was the owner of all the shares of a limited company which had made a proposal under the Bankruptcy Act which had been accepted at the time he gave the mortgage. Also he repeated what counsel for the appellant stated at the opening of the hearing, namely, that John was involved in all major decisions of the Butterfield Group and, of course, he had cheque signing authority for Imports in addition to being its secretary. His submission was that it would be inconceivable for Imports to foreclose on John for failure to pay the mortgage. In that respect he pointed out that no amounts were paid by John on the mortgage and that by book entry they were charged to Shirley. In addition, both mortgages were due on January 1, 1977, and yet they were not repaid on that date.

According to the evidence adduced, Mrs Shirley Butterfield owes money to Imports.

Counsel for the appellant argued that the giving of mortgages by John to Imports operates novation. This proposition cannot be accepted for three reasons:

1. Because the creditor (Imports) did not discharge the debtor (Shirley);

2. No transaction indicates that novation was to take place;

3. The giving of a mortgage is only the giving of collateral and does not extinguish the debt.

Furthermore, there is no evidence to show that the loans were repaid by Mrs Shirley Butterfield within the time limited by subsection 15(2) of the Income Tax Act.

As to the argument with respect to the company fiscal year and the appellant calendar year, the Court believes that the amount of the loans to be added in a shareholder’s income is the one not repaid at the end of the company fiscal year.

This period is used only to fix the amount of the loan. But when it comes to taxing the shareholder, it is the individual and not the company which is going to be taxed and consequently, if this individual is on a calendar year, he should be taxed on that period.

Reference is made to the last part of subsection 15(2) of the Income Tax Act which reads as follows:

Sec. 15(2)

(2) Loan to a shareholder . . . the amount thereof shall be included in computing the income of the shareholder for the year . . .

(italics are mine)

In his amended reply to the notice of appeal at paragraph 14, the respondent made the following allegation:

14. He says that a subsequent review of the Notices of Reassessment dated December 4, 1980 and October 5, 1979 with respect to the Appellant’s 1975 taxation year disclosed that the amount of $6,015.00 was erroneously included in income of the Appellant in that same pertained to advances made by Butterfield Imports Ltd in its 1975 and 1976 taxation year repaid before the end of its 1976 taxation year and that the proper amount to be assessed as being included in income of the Appellant should consequently be $33,764.26.

For these reasons, the appeals are allowed in part and the matter is referred back to the respondent to recalculate the amounts of the unpaid loans and to reassess the appellant according to the reasons of this judgment.

Appeal allowed in part.