Clifford Olson, Phyllis Olson v. Minister of National Revenue, [1984] CTC 3029, 84 DTC 1826

Taylor, TCJ:—These are appeals heard on common evidence in Regina, Saskatchewan, on August 23, 1984 against certain income tax assessments viewed by the taxpayers (from notices of appeal prepared by G Dillon & Co, Certified General Accountants) in the following way:

Our client has been taxed under subsection 15(2) of the Income Tax Act in respect to amounts paid to a third party on behalf of the shareholders T4 as a taxable benefit. Our client’s bookkeeper erred in the entries that were made in the company’s records but the addition of the amounts to the Shareholders T4 was intended to repay the company for the third party payments that the corporation had made on behalf of the shareholder. However Revenue Canada is not willing to accept that reasoning and have assessed our client on the basis of subsection 15(2) of the Income Tax Act.

As I understand the basic situation, the two appellants purchased, from a third party, the share capital of the business known as One Stop Organ Shop Ltd, in the year 1978. To do so they took out bank loans and arrangements for monthly payments out of the company bank account to the bank were made for these personal bank loans. During the years in question, these monthly payments were understood by the office accountant Mr Morris to be considered as personal loans by the corporation to the shareholders, and the amounts were accumulated in ledger accounts entitled “Shareholders Loans”. These amounts were not credited with any repayments or indication of repayments to the corporation, by the shareholders. With the understanding of the appellants, Mr Morris, when preparing the annual T4 wage slips for the two shareholders for the years 1979 and 1980, added to the regular salaries of the appellants, amounts which he believed would be subject to the provisions of section 15 of the Income Tax Act, SC 1970-71-72, c 63 as amended — in 1979 the amounts of $7,840 (Clifford), and $2,280 (Phyllis); and in 1980, $23,520 (Clifford). Mr Morris, according to his interpretation of section 15 of the Act, did not consider that any such “benefit” for the year 1978, needed to be shown separately (as it was for 1979 and 1980) for inclusion ir income of that year.

After reviewing the fiscal year ends involved, and examining the payments to the bank, the Minister reassessed the appellants by adding to income the following — 1978, $21,560 (Clifford), 1979, $15,680 (Clifford) and $6,840 (Phyllis). In so doing the Minister relied, inter alia, upon sections 3, 4 and subsection 15(2), paragraph 20(1)(j) and section 248 of the Income Tax Act, RSC 1952, c 148, as amended, by section 1 of SC 1970-71-72, c 63 applicable to the taxation years in issue herein.

The Minister gave as explanation in each case:

— that the loans were part of a series of loans and repayments made by the Company to the Appellant, shareholder, during the years in issue herein;

— that the amounts included in the Plaintiffs income were not repaid within one year from the end of the taxation year of the Company.

The end result (according to the Minister) is that the appellants, although they have paid income tax on the amounts on the basis determined by Mr Morris, did not have the alternative or privilege, if you will, of doing so in the manner that they did. The amounts so calculated by Mr Morris were based on (for example), the bank loan repayments made in the 1978 fiscal year of the company being charged as a benefit to each appellant in his (or her) 1979 personal tax year. Mr Morris did not make any journal entries in the corporation records which would have had the effect of providing the company with a deduction as “salaries and wages”, or anything else for these “benefit” amounts — again, and I repeat, even though the appellants paid personal tax on them voluntarily, as determined by Mr Morris. He believed that since the two appellants had not made specific restitution to the corporation for the “loans” (that is the monthly amounts paid to the bank and charged to “shareholder’s loans”) within a year after the end of the fiscal year of the corporation, that such amounts were automatically taxable under subsection 15(2) of the Act in the hands of the appellant. He apparently gave no consideration to the prospect that the repetitive method of such repayments could lead to the assertion of the Minister, (supra), that there was a “series” involved. Before proceeding, I note for the record, there is no indication of impropriety in the conduct of either Mr Morris, or that of the appellants — and the Minister has not so asserted — it is simply a question of whether their interpretation and application of the Act can be sustained.

As I see it, Mr Morris did have certain options, but they may not have been the ones he believed he had. At the end of the 1978 fiscal year of the corporation, Mr Morris could have prepared a simple journal entry — crediting shareholders loan, and debiting salaries and wages, for the amounts accumulated to that point, and provided for the appellants to pay personal tax on these amounts in the 1978 taxation year. Whether the monthly bank repayment amounts then might have been more properly described as “advances” or “bonuses” or anything else becomes irrelevant for the purposes of this appeal — proper personal tax would have been paid in the proper year, and a legitimate corporate deduction taken. Without examining the point in detail, I would also think it possible that up to and including December 31, 1978 (the end of the calendar year) some such “bonus” might have been charged through the corporation’s accounts to clear up (probably right up until December 31, 1978) the accumulated amounts in “Shareholders Loans”. In effect that is what the Minister has done, for example, by increasing Clifford’s income by $21,560 for 1978, since these were the respective totals that accumulated during calendar year 1978, from the eleven monthly repayment amounts.

However, Mr Morris did not utilize either of the possible options noted above for the corporation or the taxpayers, and as I see it, after January 1, 1979, there existed only the avenue of repaying (in real terms), the shareholder’s loans before the year end of the corporation — May 31, 1979. It was asserted at the hearing, that this is what Mr Morris accomplished, and he thereby fulfilled the prime condition in subsection 15(2) of the Act — “the loan or indebtedness was repaid wihin one year from the end of the taxation year of the lender —’’. In the instant case, taking the appeal of Clifford for the year 1979, the amount he declared as a “benefit” (when filing his 1979 income tax return in April 1980) was $7,840 which must be regarded as his version of “repayment”, of the four amounts of $1,960 each “loaned” to him between February 1978 and May, 1978. In fact, all he accomplished was to report that the loans were still outstanding and subject to inclusion in income. I am unable to accept as a “repayment” on or before May 31, 1979 (the latest possible date) the amount of $7,840 (Clifford) first noted on the T4 slips probably prepared in February 1980 and reported in the tax return probably filed in April 1980.

While the Minister’s second line of reasoning (“made as a part of a series —”) might well hold up on its own, I do not find it necessary to examine it in detail. The prerequisite that “the loan or indebtedness was repaid within one year from the end of the taxation year of the lender” has not been met.

The appellants in this matter find themselves caught in the web of the provisions of subsection 15(2) of the Act, and required to pay personal income tax on the amounts withdrawn in the taxation years within which those amounts were withdrawn. The basic fact is that the taxpayers used corporation funds in order to acquire personal assets, and subsection 15(2) of the Act essentially prohibits, rather than provides, for such diversion. I would cite from page 2201 and page 1171 of Kenneth Heal v MNR, [1980] CTC 2199; 80 DTC 1169:

The sections of the Act (15(1) and 15(2)) at issue here were obviously placed therein at least in part for the purpose of dissuading taxpayers from using the funds of corporations in which they were shareholders for purposes and in ways materially different from those to which such funds would be put by them in the regular business operations of the corporation. The risk in perceiving a closely-held private corporation as a mere business extension or alter ego of a shareholder taxpayer personally must be avoided, or the penalty paid. There are only a limited number of mechanisms by which a shareholder may legitimately put himself personally in control of funds of a corporation — salary, dividends, and interest primarily. Any other procedures must be carefully scrutinized by the shareholder to ensure that he is not also assuming an income tax liability personally. The lack of proper advice, or a lack of understanding, by the taxpayer does not absolve him of the results however unfortunate or oppressive.

The Board is not insensitive to the plight of this taxpayer, as he portrays it — owing some $30,000 on a loan of $50,645.00 to build a house he has lost, in addition to having repaid some $16,522 of the amount. There is little in the way of explanation which can be provided to this taxpayer to assuage his displeasure at such a situation, but a comment to be found in a decision of the Board (Dramar Investments Limited v The Minister of National Revenue, [1978] CTC 2936), more particularly at pages 1678 and 2940 respectively, would bear repeating:

“. . . I would point out that while the corporate format for business operations is recognized and acclaimed by investors and businessmen alike for its convenience and advantageous characteristics, its use for such commercial purposes carries with it the distinct obligation for the same parties to understand and accept the restrictions and parameters inherent in the corporate structure, from a taxing perspective.

The appeals are dismissed.

Appeals dismissed.