William M D Wright v. Minister of National Revenue, [1984] CTC 3055, 85 DTC 10

Kempo, TCJ:

Part I — Issue

This is an appeal from reassessment under which the respondent included the sum of $31,200 in the computation of the appellant’s income for his 1976 taxation year. The amount was received by him as a consequence of a sale in that year of all his shares in Dayton Wright Associates Ltd, (“Dayton”) and the nub of the issue is the characterization of that payment.

The appellant asserts that it was a tax-free repayment for the reason that it was a repayment to him of shareholder loans.

The respondent reassessed on the basis that the payment was in respect of $28,200 in accrued wages or income from employment (vide, section 5 of the Income Tax Act (the Act) plus $3,500 interest income (vide, paragraph 12(l)(c) of the Act) relative thereto or, in the alternative, that the amount paid was an appropriation of funds to the appellant, qua shareholder (vide, subsection 15(1) of the Act).

Part II — Decision

The appeal is allowed in that, on the balance of probabilities, the appellant’s receipt of $31,200 was for shareholder loans and therefore the matter is to be referred back to the respondent for reconsideration and reassessment on the basis that the amount of $31,200 is not to be included in the calculation of his income for 1976.

Part III — Reasons

The finding that the amount in issue is to be characterized as a repayment of shareholder loans, in my opinion, arises from an analysis and correlation of the totality of the evidence, with a special perspective as to the chronology of events.

The occupation and field of expertise of the appellant was in high impedence electrostatic technology and more particularly in respect of electrostatic loudspeakers.

The major incorporators of Dayton in 1970 were the appellant and a Mr H Markhoff. Mr Markhoff received 3500 shares in consideration of $12,000 cash and the appellant received 3500 shares in consideration of the assignment to the company of his interest in patent applications of an agreed value of $12,000.

The method of dealing with the appellant’s prior out-of-pocket expenses in connection with the patent matters (apparently one had already been granted and others were then in the application stage) was as set out by letter of intent dated September 27, 1970 (Exhibit Al) and another approximately one year later, October 5, 1971 (Exhibit A2). These letters are as follows:

(EXHIBIT Al)

Letter of Intent

This letter of intent covers the value of technology and development embodied in part in a pending patent applied for in the name of William M.D. Wright, and the compensation to be given, in part, for that technology, in the form of stock in a Corporation to be formed.

There has been a mutual inspection of a detailed list of development expenses including receipts, dating from March 4, 1956 to September 1, 1970 and it is agreed that the total amounts are:

In U.S. Dollars	$18,213.41
In Canadian Dollars	$15,472.35

Taking the U.S. Dollar at a par with the Canadian Dollar (which has been agreed upon for the purpose of this Letter of Intent, the total amount is .. . $33,685.76.

It is mutually agreed that a corporation is to be formed for the purpose of manufacturing Electrostatic Loudspeakers and that Mr. William M.D. Wright and Mr. Herbert Markhoff shall have equal shares at incorporation. Mr. Wright will assign the present patent pending to the company receiving in return $12,000.00 of the Common Shares of the company. The balance of the $33,685.76 shall be considered as a subordinated loan in the event that additional patents are applied for and assigned to the Corporation to be formed. Mr. William M.D. Wright specifically agrees that in this event, that the loan be subordinated to all other debts owing to suppliers, banks, secured creditors; however in the event that the company is refinanced such that his shareholdings drop below 34% this subordination shall cease, and the loan be carried on the books of the company on a par with other shareholder’s loans, if any, or on a par basis with unsecured loans.

This loan of $21,685.76 shall be interest free.

Mr. Herbert Markhoff agrees to subscribe $12,000 for his sharws [sic] in the Common Stock of the Corporation to be formed. He further represents that he has additional funds which will become available upon the sale of his portion of the lease covering La Grotta, and that in the event that this lease is sold, he will loan additional funds to the company on the same basis as the loan from Mr Wright.

It is further agreed that in the event that the company is free to and in a position to pay off either loan, that both will be paid off pro rata.

Signed this 27th day of September, 1970.
“H Markhoff’		“William M Wright”
H Markhoff		William M D Wright
(EXHIBIT A2)
	DW
	Dayton Wright
	Associates Limited
	PO Box 419
October 5th 1971	Thornhill, Ontario
LETTER OF INTENT
Between:
Wm M D, Wright
H Markhoff
Dayton Wright Associates Limited

This letter of intent is in response to Ontario Development Corporation’s requirement that all the present patent applications and/or patents save the 1964 patent be assigned to the corporation as part of the security and assets of the corporation, before they will grant the corporation a loan.

Mr Markhoff objects to the setting up of a shareholder’s Loan account based on the balance of the development costs (prior to incorporation) as noted in the 1970 Letter of Intent, as the patents themselves are not yet granted.

Mr Wright is willing to defer the setting up of this account until the patents are granted, on the provision that if the account is not explicitly paid within five years from this date, and Ontario Development Corporation’s Loan has been paid, the patents, including the one initially assigned to the corporation will revert to Mr Wright. In the event that the issuance of the patents is jepardized [sic] by failure of the coporation to pay any application costs, title to the patents shall revert to Mr Wright as soon as permission is Granted By Ontario Development Corporation.

In the event that the title to the patents are returned to Mr Wright he shall be held not-responsible for any moneys owing to the patent agents/att’y’s as of that time, those moneys to be the sole responsibility of the Corporation.

Signed and Sealed in the City of Toronto, October 5th 1971.

“Wm M D Wright”

Wm M D Wright L S

“H Markhoff’

H Markhoff L S

“Wm M D Wright” “H Markhoff’

Mr Wright & Mr Markhoff for Dayton Wright Associates Limited. POLYTECHNIC

SYSTEMS

Accordingly it had been agreed that the setting up of any shareholder loans account in respect of the aforementioned development expenses would be postponed until the patents were issued. The amount involved was $21,685.76.

On May 31, 1972 the appellant, as president, certified Dayton’s first corporate income tax return (Exhibit R2) which contained therein, inter alia, an undated opening balance sheet of Dayton indicating loan due to a director $690.27 at the commencement of business November 14, 1970, and financial statements of Dayton as at its fiscal period ended September 30, 1971, prepared by DeVries & Co., Chartered Accountants, dated May 31, 1972 and indicating loans due to directors $20,991.81 as at September 30, 1971 on the balance sheet. This amount was not explained.

The 1972 corporate tax return of Dayton (Exhibit R3) was dated January 12, 1973, was purportedly certified by a person unknown who printed the appellant’s name within quotation marks on the signature line and which return included an undated financial statement of the company as at September 30, 1972 (its author was not known or identified) showing:

Loan payable to a Director inc.

Accrued wages	$14,380.62
Deferred notes payable
(inc. $4,500.00 to a Director)	$18,450.00

According to the appellant the latter entry of $18,450 pertained to Mr Markhoff. A photocopy of the appellant’s purported shareholder loans account (Exhibit R6) commences with the opening balance figure of $14,380.62. This amount was not explained.

In 1974, and for personal reasons, Mr Markhoff was living in Florida. A Mr Klaus Behnke, whose company Benoma Metal Products (“Benoma”) was a creditor of Dayton, apparently acquired the Markhoff shares. The evidence as to the date, the terms or financial ramifications of the acquisition was unclear. Mr Behnke had capital to inject into Dayton as a loan. There were some deferred wages of the appellant on the books of the company which were to be written off or foregone to the extent that Mr Behnke was to forego any of his claims against Dayton whether by way of Benoma billings or on his acquisition of the Markhoff loans. At the same time Mr Behnke brought his brother-in-law, Gerry Olma, into the company who was also to be general manager of Dayton.

In any event, as a result of Mr Markhoff’s departure, Mr Behnke acquired voting and financial control of Dayton. The appellant stated that Mr Behnke ran the company with an iron fist. Mr Behnke had personally guaranteed bank loans; he moved the corporate bank accounts to his bank; he handled all the day-to-day banking operations and moved the company’s books and records to his own accountant, Brian Castle, who was a certified general accountant.

The appellant did most of his dealings with Mr Behnke through Mr Olma. Mr Olma died in 1976, shortly after he and Mr Behnke and the appellant had sold their shares.

On December 19 and December 20, 1974, respectively, the following letters were prepared by the appellant and given to Mr Olma:

(EXHIBIT A3)

December 19 1974

Gerry

I’ve attached the summary sheets as well as the file relating to the Letter of Intent with Herbert Markhoff. As the patents are complete and granted there is no further reason not to pick-up the balance as per the agreement as it can now be capitalized on the balance sheet. This might also require a supplemental agreement with ODC to cover subordinating the amount.

The file on the console stock purchased separately is also attached. I am quite willing to have this stock added to our stock if Brian feels it would improve the inventory picture re the bank, but as there is over $12,000 of stock on the list (some of it acquired in 1973 at prices lower than present by a substantial amount) I would like to be sure that I receive proper credit for its present value — and as some of it is the same material we are using for the preamplifiers it could be recosted using the current prices we are paying. I’ve circled the items that represent the greatest changes in process. I don’t think that this credit should be subordinated to ODC as it’s outside the area of the agreement, but you’ll have to check on that.

There are two invoices missing from the latter file, both from Electrosonic — but the numbers are on the summary — so if you want confirmation you can check Electrosonic. As you’ll also note, the only bill still outstanding is for $273.00 and is due at the end of December. As none of this stock was bought with an FST exemption or a PST exemption these amounts will have to be separated and an adjustment made, I don’t have any idea how this is done — you better check with Brian.

I also want to be sure that a list of warranty speaker repairs it typed up from the notes, and properly entered somewhere, as if you want to defer all of the replacements or even some of the replacements there’s too much chance of missing some.

ODC called re the payment Klaus promised them to have the transfer approved, they feel that it should have been made by now.

I’ve also found the file on expenses you were looking for. Some of these were put on the books, and I’ve marked them with a slip of paper stapled to the expense account summary for the week. But not all of them have — and there is some overlap — as there were bills I didn’t have when I made out each sheet that I handed in. Usually if I was missing more than one bill I held out the sheet until I could find it — and therefore as I seem to have mislaid several of these bills, there are about 13 weeks to pick up. I’ve circled the invoices missing, and if there is any feeling on these, I’m willing to drop the items to help get the books updated.

I may be able to stay over another two days if necessary, give me a call at home at 883-1386.

Otherwise if I don’t see you before Christmas, the very best.

“W W”’

(EXHIBIT A4)

	216 Essex Avenue
Dayton Wright Ass’t’s Ltd,	Richmond Hill Ontario
50 Industrial Road	December 20th 1974
Richmond Hill Ontario
Gentlemen,
This letter will be your authority to:

a/ Transfer $11,973.36 of electronic parts I have purchased and paid for myself into the inventory of the company, subject to proper credit to myself on the books of the company, and

b/ By crediting me with the balance of the amount as per the Letter of Intent (copy attached together with duplicate of the account sheets) I will waive all rights to the issued patents save for the licence granted, and

c/ Give permission for the two years of wages I could have drawn to be offset against the above items, provided an equivalent amount is dropped from the Company’s Debit to Mr Behnke as purchased from Mr Markhoff — alternately an amount of stock equal to the value of both debts to be issued to Mr Behnke and to myself in equal amounts. Note that the 4% of the Company’s Common stock must still be transferred from Mr Behnke to Mr Hewson, and

d/ Set up mutually beneficial insurance to be paid for by the Company such that in the event of the death of any of the major shareholders an amount of money is available to the other two that his share of the company may be purchased from the estate. I would like one provision added though to be provided for in such a way that in the event of any major redisposition of shares, that the insurance remain in force for a sufficient time after such redisposition or sale so that it is available to settle any warranty which might have to be given on that transaction, the term to be extended past the warranty period of the transaction, and

That the Company proceed immediately upon my return from Vacation with the proposed Shareholder’s agreement.

Trusting that this letter will fulfil the conditions required for the proposed transactions, I remain

Yours truly,

Wm M D Wright.

Signed this 20th Day of December 1974 in the City of

Richmond Hill, Ontario )

) )

) “Wm M D Wright”

) L S )

Wm M D Wright

The appellant was purportedly given a receipt (Exhibit AS) dated December 22, 1974 signed by himself and Gerry Olma for Dayton for $11,937.36 in respect of the electronics inventory which was to be credited to his shareholder loan account. The receipt was not an original, but a photocopy, with the purported signature of Mr Olma being illegible. The appellant explained that he had photocopied all the records he could get his hands on in 1976 and that Mr Olma was deceased. Given the nature of the difficulties, the document was received into evidence however in an abundance of caution it should not be given too much weight.

It is not unimportant to note that the preparation and filing of Dayton’s 1973 tax return and financial statements were late. They were prepared on February 19, 1975 (Exhibit R4) by Mr Castle who was, as stated previously, Mr Behnke’s accountant as well. He prepared Dayton’s 19 4 return and financial statements on March 4, 1975 (Exhibit RS) and the one for 1975 (which had a change of year end) on August 28, 1975 (Exhibit RIOA). The appellant’s shareholder loan ledger (Exhibit R6) shows consistent and identical handwriting commencing September 30, 1972 through to October 31, 1975.

There is therefore a reasonable inference to be drawn that the fiscal year-end amounts in the appellant’s purported shareholder loans account matched those in Dayton’s financial statements simply because their authorship was the same.

As no audit had been done, and given that the appellant was not able to explain any of the particular entries in his purported shareholder account save to note that there were loan amounts that should have been credited that had not been, we are left with records and statements that are probably reconstructions and therefore may, in themselves, be incomplete. In fairness to counsel for the appellant and counsel for the respondent, this aspect of the evidence had not been explored due, probably, to the fact that Dayton’s corporate tax returns and financial statements, supra, had just been made available and were examined during a morning break of the trial.

Apparently these records were material to the respondent’s reassessment together with the fact that the appellant, as president of Dayton, had certified the 1973, 1974 and 1975 tax returns, which included the financial statements, as being true and correct.

The appellant’s difficulties in this appeal were exacerbated by the fact that he had been given a financial statement of Dayton for its 1974 fiscal year (Exhibit A6) which differed, in respect of his shareholder loans, from that which was filed with Dayton’s 1974 corporate tax return (Exhibit R5). The one he got (albeit for banking purposes) reflected amounts in response to clauses a/ and b/ of the letter dated December 20, 1974, (supra, Exhibit A4) but the filed one did not.

The appellant was first aware that something was amiss during sale negotiations in early 1976 at which time the bank was calling the loans guaranteed by Mr Behnke who in turn therefore wanted to sell. Dayton had been in a loss position throughout. Explanations by the purchaser’s accountants were asked of and given by the appellant in respect of his shareholder loans account, one of which was dated June 21, 1976 (Exhibit Rl). Notwithstanding that the appellant’s language therein referred to some sort of apparent cancellation of wage entries (no such document or record being produced) from his shareholder loans, it is my opinion that it should not be construed as conclusive of the issue before the Court. That this should be so is the fact that the subsequent documents received into evidence were also reflective of the uncertainties in this respect.

Dayton’s operations had been stilled by Mr Behnke, corporate bankruptcy was looming and negotiations for sale were acrimonious. The purchaser withdrew its previous offer and made a take-it-or-leave-it one. On June 20, 1976 their accountant had reported to them, with financial statements of Dayton for the period August 1, 1975 to May 31, 1976 that, inter alia, the appellant’s shareholder loans account was recorded at $32,241 (Exhibit RIOB).

Following a particularly heated meeting on July 12, 1976 the appellant prepared a statement of his position (Exhibit A8), the material portions thereof being as follows:

(EXHIBIT A8)

FINAL DRAFT

To the shareholders and directors of Dayton Wright Associates.

Based on the offer tendered by Leigh Industries, I am willing to accept $31,600 (an approximation) only under specific conditions.

(a) It is not to be construed that the total shareholder’s loan from me at the time of settlement was $31,600;

(b) It is not to be construed that I am in agreement with the methods used to arrive at that total;

(c) . . .

(d) . ..

(e) That in accepting the settlement for shareholder’s loans, it is explicitly understood that this settlement is based only on monies and materials loaned by myself to Dayton Wright Associates Limited — not on interest — or any presumption of deferred — salaries;

(f) That while I believe that negotiations were begun by Leigh in good faith — I do not accept or condone the way in which shareholders and officers of Dayton Wright Associates Limited initiated and conducted them.

SIGNED this 12th day of July, 1976 in Richmond Hill, Ontario.

ACCEPTED FOR DAYTON WRIGHT ASSOCIATES

“G OLMA”
“WILLIAM WRIGHT”	“WILLIAM WRIGHT”

The appellant experienced difficulty in obtaining a complete copy of the formal agreement of sale and purchase dated July 21, 1976 but what he was able to get was entered, along with attached financial statements prepared by the purchaser’s accountant dated June 25, 1976, as Exhibit A10. There are irreconcilable inconsistencies therein in respect of the amount of shareholder’s loans.

The appellant relies on the following clauses of the agreement:

(Extract from Exhibit A10)

II. PURCHASED SECURITIES

The Vendors shall sell and the Purchaser shall purchase all but not less than all of the Issued Shares and as consideration therefor the Purchaser shall:

(a) pay to the Vendors collectively the sum of $1.00 for all of the Issued Shares.

(b) pay to the Company the sum of $37,200.00 and cause the Company to forthwith pay off the Shareholders’ Loans to the extent of $37,200.00 as follows:

Wright	—	$31,200.00
G Olma	—	$ 6,000.00
TOTAL		$37,200.00

Mr Olma died as a result of an automobile accident shortly after the aforementioned agreement had been signed.

Notwithstanding that the respondent reassessed the appellant on what could be described as a prima facie case based on the evidence he had in his possession at the time, I am satisfied that the events as viewed from a chronological perspective justify resolving the many questions raised, and inconsistencies shown, in the appellant’s favour.

On the basis of the facts and circumstances of this case I am able to accept the appellant’s assertion that, at the time of the sale, he had insisted on, bargained for and received the sum of $31,200 as satisfaction of an indebtedness of Dayton to himself for assets it had acquired from him, that is $11,973.36 for inventory and $21,685.76 in respect of patents assigned. These were corporate assets that went to the purchaser with the sale.

Accordingly this appellant has satisfied the onus on him in rebutting the factual assumptions underlying the reassessment in that, on the balance of probabilities, his 1976 receipt of $31,200 can be characterized as repayment of his shareholder loans and is thus not to be included in his income for the year.

Appeal allowed.