Mansell Nellis v. Minister of National Revenue, [1983] CTC 2480, 83 DTC 381

The Chairman:—The appeal of Mansell Nellis is from assessments of income with respect to the 1974, 1975, 1976 and 1977 taxation years.

The respondent’s assessments and the assumptions on which they were founded are best summarized by the statement of facts contained in the reply to the notice of appeal and are as follows:

2. The respondent, in computing the income of the appellant for the 1974 taxation year, included amounts of $30,000 and $25,000, a total of $55,000, not previously reported by the appellant in his return of income for 1974.

3. The respondent, in computing the income of the appellant for the 1975 taxation year, included amounts of $20,000, $16,476.68 and $225, a total of $36,701.68, not previously included by the appellant in his return of income for 1975.

4. The respondent, in computing the income of the appellant for the 1976 taxation year, included amounts of $60,544.13, $3,923.18, $8,000, $3,211.41 and $225, a total of $75,903.72, not previously included by the appellant in his return of income for 1976.

5. The respondent, in computing the income of the appellant for the 1977 taxation year, included amounts of $1,816.32 and $225, a total of $2,041.32, not previously included by the appellant in his return of income for 1977.

6. In so computing the income of the appellant for the 1974 through 1977 taxation years during a reassessment of tax to the appellant in respect of those years, the respondent made the following assumptions and findings of fact:

(a) the appellant was a 50% shareholder in a corporation known as Corners Sandstone Quarries (1966) Limited, (hereinafter referred to as “Corners”); and an almost 100% shareholder in a corporation known as Nellis Construction Limited (hereinafter referred to as “Nellis”);

(b) in the year 1974 a resolution was passed by Corners giving consent to the borrowing of funds from the appellant, in addition to funds already owed the appellant and to Nellis, in the amount of $110,000, making a total indebtedness to the appellant and to Nellis of $230,000, secured by a mortgage on two parcels of land owned by Corners;

(c) that the said $230,000, secured by the mortgage as above described, was composed of the following amounts:

(i) cash from the appellant	$110,000
(ii) previous loan repaid to the appellant and re-lent to
Corners;	50,000
(iii) a term deposit, bought by Corners with money lent by the
appellant on the security of a mortgage given as aforesaid to
the appellant in trust for Nellis;	40,000
(iv) interest owing to the appellant by Corners;	30,000
	$230,000

(d) that in the 1974 taxation year, the Appellant had interest income receivable in respect of moneys owed him by Corners of $30,000;

(e) that in the 1974 taxation year, the appellant received a security in lieu of interest income owing to him by Corners of $30,000;

(f) that the appellant borrowed $55,000 from Nellis in 1974 of which $30,000 was repaid in 1975;

(g) that Corners built a house on each of the two parcels described in subparagraph (b) above, one of which houses the appellant bought and then listed for sale, but which house the appellant at no time occupied;

(h) that in 1975 the appellant received a dividend from Nellis of $15,000 which amount was not reported by the appellant in his return of income for the taxation year 1975;

(i) that the appellant received loans from Nellis in the 1975 taxation year of $16,476.68, and in the 1976 taxation year of $3,923.18, in respect of both of which the purported repayments were a part of a series of loans and repayments;

(j) that the appellant realized a benefit in respect of his use of an automobile in

the amount of $225 for each of the taxation years 1975, 1976 and 1977;

(k) that in 1976 the appellant received security in the form of a note payable from Corners in satisfaction of an interest debt of $60,544.13;

(l) that interest on the amount of interest owing to the appellant from Corners, as described in subparagraph (k) above, was paid to the appellant by Corners in the amount of $3,211.41 in 1976 and $1,816.32 in 1977;

(m) that the appellant received a dividend of $6,000 from Corners in 1976;

(n) that Corners and Nellis were taxable Canadian corporations at all material times.

The appellant acknowledged that he received a mortgage for $230,000 which is broken down in the notice of appeal as follows:

It is acknowledged that the taxpayer received a mortgage for $230,000 which was comprised as follows:

The taxpayer property mortgage proceeds		$110,000
Advance from Nellis		40,000
Advances July 11, 1968	$10,000
October 11, 1968	5,000
November 25, 1968	10,000
January 21, 1969	5,000
July 31, 1969	10,000
October 31, 1969	3,000
December 31, 1969	5,000
March 31, 1970	2,000	50,000
		$200,000
Interest on Loans July 11/68 - March 31/70		30,000
Mortgage Principal		$230,000
		$230,000

It is admitted that the $230,000 mortgage was paid to him and the proceeds deposited in his personal bank account. However, in his notice of appeal, the appellant stated:

However it is equally true that a $60,000 note was immediately given back.

In argument, Mr R F Bott, CA, representing the appellant, stated that several of the items in the assessments are not disputed; the only issues to be decided by the Board are with respect to the larger amounts of $40,000 advanced by the appellant to Corner’s Sandstone Quarries (1966) Limited, henceforth referred to as “Corner’s”; $30,000 in interest on loans receivable which the respondent included in the appellant’s 1974 income; and $60,544.13 interest on loans which the respondent included in the appellant’s 1976 income.

With respect to the amount of $40,000, the appellant contended that “through Nellis the taxpayer received $40,000 which in turn was advanced to Corner’s and, therefore, the taxpayer simply became the conduit through which the funds flowed” (Notice of Appeal). The appellant concluded that he received no taxable benefit on the transaction under section 2 of the Income Tax Act, SC 1970-71-72, c 63 as amended. Mr. Bott also submitted that the $40,000 was included in the funds necessary to build the two houses on Corner’s property and, as such, was a bona fide business transaction between the appellant, Nellis and Corner’s and the taxing provisions of subsection 15(1) of the Act were therefore not applicable.

A third point made by Mr Bott was that if the $40,000 had not been advanced to the appellant by Nellis, then the respondent’s calculations made with respect to the appellant’s loan accounts are wrong.

As I understand it, the issue here is not whether the appellant received a taxable benefit in the amount of $40,000, nor whether the receipt by the appellant and the advance made by him to Corner’s of $40,000 constituted a bona fide business transaction. In issue is the nature of the $40,000 and the circumstances under which it was received by the appellant before he advanced the amount to Corner’s. If it is established that the $40,000 was not an advance made by Nellis to the appellant by way of a loan to a shareholder, then, as suggested by the appellant, the respondent’s assessment on that point is wrong and the $40,000 should not have been included in the appellant’s shareholder loan account for purposes of computing unrepaid loans under subsection 15(2) of the Act which is the pertinent section on this point.

In contending that the amount of $40,000 received by the appellant was not a shareholder’s loan from Nellis, reference was made to an indenture (Exhibit A-1) where at paragraph 2 of the recitals it is stated:

2. The Mortgagor is indebted to Nellis Construction Ltd.in the amount of $40,000.00 and has agreed to give this mortgage to the said Mortgagee as Trustee for the said Nellis Construction Ltd. to secure the said indebtedness.

The respondent on that point did not rely on the fact that the indenture (Exhibit A-1) is unsigned and that the date of the document, July 2, 1974, was questionable. The respondent’s position was that the $40,000 flowed from Nellis Construction Ltd by way of a shareholder’s loan to the appellant before it was advanced to Corner’s. The supporting evidence were extracts of Nellis Construction Limited’s cash disbursement book compiled into work sheets and produced as Exhibit R-1 by Mr Terry Watson, the auditor with the Department of National Revenue, who audited the appellant’s books and records.

On the second page of Exhibit R-1, there is an entry in shareholders’ account 1974-1975 of $55,000 as personal items paid by company. A breakdown of the $55,000 is found on page 2 of Exhibit R-1 and shows a loan to the appellant of $15,000 in November 1974 and a loan of $40,000 in December 1974. These entries are reflected in Exhibit A-7, a photocopy of Nellis’ loan account 84. The journal entries indicate that adjustments were made to the appellant’s loan account to reflect repayments of $30,000 of the original $55,000 which included the $40,000 in issue. The general ledger and the financial statement of Nellis Construction Limited at its year-end in 1975, 1976 and 1977 showed an unpaid balance of loans in the amount of $25,000 and that was the basis for one of the amounts that were added to the appellant’s income for 1974.

On cross-examination, the appellant was unable to recall whether the $40,000 was advanced to Corner’s in the form of a term deposit or otherwise and Mr Galbraith, the 40 per cent shareholder in Corner’s, could not remember in what form the money was received.

The evidence and the explanation of the $40,000 advance to Corner’s offered by the appellant, who must satisfy the burden of proof, was vague and unclear and he did not succeed in weakening in any way Mr Watson’s evidence on that point. More importantly, as stated by counsel for the respondent, and notwithstanding paragraph 2 of the recitals in the mortgage document, there is no evidence that a trust agreement existed between the appellant and Nellis Construction Limited and the books and records of the company do not reflect such an agreement. Moreover, nothing in the appellant’s evidence purports to establish that the $40,000 loan was made directly by Nellis Construction Limited to Corner’s.

In the absence of direct evidence, the best available evidence with respect to the $40,000 transaction is to be found in the Nellis shareholder’s loan account and the cash disbursement book. On the basis of the evidence, one cannot conclude otherwise than that the appellant personally borrowed $40,000 from Nellis Construction Limited and loaned the funds to Corner’s along with the $110,000 already advanced by him to Corner’s. Whether the transaction could have been effected differently and perhaps more advantageously for the appellant, is not, in my opinion, pertinent to the issue before me. Judgment must be rendered on the best available evidence as to what actually took place. In my opinion, the appellant did not succeed in establishing that the $40,000 received by the appellant from Nellis Construction Limited was not a shareholder’s loan made by Nellis Construction Limited to the appellant which had not been repaid within a year. The balance of the unpaid loans was properly included in the appellant’s income for 1974, in accordance with subsection 15(2) of the Act. The appeal on that point must fail.

The second point in issue is the amount of $30,000 of interest owing to the appellant by Corner’s in 1974 which was included in the $230,000 mortgage. The appellant does not dispute that fact but suggests that adding interest receivable to the mortgage principal, while it may provide security for an unsecured obligation, does not constitute payment of the debt. It is the appellant’s position that a payment can only be considered as having been received if the payment is made in an unrestricted and negotiable manner. He concludes of course that the $30,000 was not received and should not have been included in his 1974 income.

Counsel for the respondent contends that the interest owing in the amount of $30,000 is taxable under two sections of the Act: paragraph 12(1)(c) and subsection 76(1).

Dealing first with subsection 76(1) of the Act it reads as follows:

Security in satisfaction of income debt.

(1) Where a person has received a security or other right or a certificate of indebtedness or other evidence of indebtedness wholly or partially as, in lieu of payment of, or in satisfaction of, a debt that was then payable, the amount of which debt would be included in computing his income if it had been paid, the value of the security, right or indebtedness or the applicable portion thereof shall, notwithstanding the form or legal effect of the transaction, be included in computing his income for the taxation year in which it was received.

Counsel for the respondent pointed out that had the $30,000 interest owing to the appellant in 1974 then been paid, it would have been taxable. He further referred to evidence that the $30,000 interest owing was recorded in 1975 on the issuance of two cheques to the appellant in January and July of 1975, which however were not cashed and Mr Nellis’ testimony was that the moneys had never been paid.

The mortgage document Exhibit A-1, at paragraph 1 of page 4 reads as follows:

PROVIDED this mortgage to be void on payment of TWO HUNDRED AND THIRTY THOUSAND — ($230,000.00) — Dollars of lawful money of Canada with interest to be computed from the 2nd day of July 1974 at 13% per cent per annum as follows: The sum of One Hundred and Ten Thousand ($110,000.00) Dollars on account of principal money shall become due on July 2nd 1975 and the balance of the said principal money shall become due on the 2nd day of July 1979 together with interest half-yearly at the rate aforesaid payable on the second days of January and July in each year, the first of such payments of interest to be made on the 2nd day of January 1975.

There being no evidence that the cheques made payable to the appellant were a downpayment on the $230,000 mortgage, the respondent concluded that the $30,000 could only have been issued with respect to interest owing on the mortgage and was properly included in the appellant’s 1974 income. Notwithstanding Mr Bott’s cross-examination of Mr Watson, the evidence clearly supports the respondent’s position and I find that the $30,000 interest owing was properly included in the appellant’s 1974 income under subsection 76(1) of the Act.

Considering now paragraph 12(1 )(c) of the Act, it reads as follows:

12. (1) there shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:

(c) Interest — any amount received by the taxpayer in the year or receivable by him in the year (depending upon the method regularly followed by the taxpayer in computing his profit) as, on account or in lieu of payment of, or in satisfaction of, interest;

On the evidence, there can be no doubt that the $30,000 was interest receivable by the appellant in 1974. Its inclusion in income for tax purposes depends on whether the appellant was on a cash or accrual basis of accounting. Although the appellant, in stating that a payment is considered as having been made only when it is received, appeared to be referring to the cash method of accounting, the appellant did not establish that he was in fact using the cash method in computing his profit. In my opinion, that was an element of proof essential in supporting his position that the $30,000 was not to be included in income since it had not been received. In that respect also, the appellant failed to satisfy the onus and the appeal must also fail under paragraph 12(1 )(c) of the Act.

The last issue is with respect to a balance of unpaid interest in the amount of $60,544.13. The $230,000 mortgage had to be discharged before title to the two houses could be transferred to the appellant and to Mr Galbraith, the other shareholder in Corner’s. The mortgage was in fact discharged. Ina resolution of the Directors of Quarries, dated August 19, 1976, at paragraph 4, it is stated:

4. the portion of interest remaining unpaid as of August 15,1976 was $60,544.13 which the said William Mansell Nellis has agreed to waive till the Corporation is in a better financial position to pay the same.

BE IT RESOLVED that the Corporation acknowledges the said amount of $60,544.13 as owing and agrees to pay simple interest thereon at the rate of 12% per annum, payable monthly on the 15th of each month, the first of such payments of interest to become due on 15th September 1976 and calculated from 15th August 1976 on the amount of $60,544.13, and thereafter on the amount from time to time outstanding, till the said sum and interest thereon are fully paid.

In 1975 the appellant had included certain amounts of interest receivable as income but, as stated earlier, the cheques were never honoured and Corner’s debt was not extinguished. The mortgage document Exhibit A-1, paragraph 4 stipulates a 13 per cent interest on the $230,000 mortgage to be computed from July 2,1974. The interest on that amount for two years is the amount of $60,544.13 indicated in Exhibit A-5.

Although the resolution reduced the interest rate on the unpaid balance of interest from 13 per cent to 12 per cent and the appellant agreed to waive the payment of the amount until the corporation was in a better financial position, the amount of $60,544.13 of accrued interest was still owing to the appellant, even after the principal amount was repaid.

The issue here again is the inclusion in the appellant’s 1976 income of interest receivable and whether paragraph 12(1 )(c) and/or subsection 76(1) of the Act are applicable. I am satisfied on the evidence that the appellant did not receive any payment of interest in 1974. Counsel for the respondent pointed out however that the interest receivable in 1974 was recorded in the appellant’s 1975 taxation year and submitted that the appellant was, on the balance of probability, on the accrual basis of accounting and that the $60,544.13 in interest owing to the appellant by Corner’s was properly included in his 1976 income.

In the absence of any evidence on the part of the appellant that he was on a cash method of accounting, I am prepared to accept the respondent’s contention. Furthermore, I find that Corner’s resolution is valid evidence of its indebtedness to the appellant for $60,544.13 in interest and would have been taxable, had it been paid in 1976.

I conclude therefore that the amount of $60,544.13 in interest receivable was properly included in the appellant’s 1976 taxation by virtue of both paragraph 12(1 )(c) and subsection 76(1) of the Act.

For these reasons, judgment will go dismissing the appeal.

Appeal dismissed.