Guy
Tremblay:—These
cases
were
heard
on
common
evidence
in
Edmonton,
Alberta,
on
June
1,
1981.
1.
The
Point
at
Issue
The
issue
is
whether
the
appellants
are
correct
in
claiming
a
loss
for
the
1976
taxation
year
following
the
sale
of
their
business
according
to
an
agreement
made
in
January
1976,
but
retroactive
to
December
1,
1975.
According
to
the
respondent
there
was
a
profit
in
1975
and
1976.
2.
The
Burden
of
Proof
The
burden
is
on
the
appellants
to
show
that
the
respondent’s
assessments
are
incorrect.
This
burden
of
proof
results
especially
from
several
judicial
decisions,
including
the
judgment
delivered
by
the
Supreme
Court
of
Canada
in
Johnston
v
MNR,
[1948]
CTC
195;
3
DTC
1182.
3.
The
Facts
Alleged
in
the
Pleadings
3.01
The
facts
alleged
in
the
notices
of
appeal
are
as
follows:
During
the
taxation
year
1975
the
taxpayer
sold
a
property
in
the
Village
of
Man-
nville,
Alberta
to
Sixteen
Service
Mannville
Ltd
for
the
sum
of
$50,000.
The
terms
of
agreement
were
$30,000
cash
and
second
mortgage
of
$20,000.
The
mortgagor
defaulted
on
second
mortgage
payments
after
making
fifteen
monthly
instalments.
Since
then
no
further
payments
have
been
received
and
now
the
mortgage
is
in
process
of
being
foreclosed.
The
balance
of
mortgage
receivable
was
set
up
as
a
reserve,
which
under
the
circumstances
appears
reasonable
in
nature.
The
amount
set
up
as
a
reserve
for
default
on
second
mortgage
receivable
has
been
partially
disallowed
by
the
Minister
of
Taxation.
We
are
of
the
opinion
that
since
the
balance
of
the
second
mortgage
is
irrecoverable,
the
amount
unpaid
should
be
either
allowed
as
a
reserve
or
as
a
bad
debt
under
section
20(1
)(l)
and
section
20(1
)(n)
of
the
Income
Tax
Act.
We
therefore
feel
that
the
assessment
is
unjust
and
therefore
should
be
vacated.
3.02
The
replies
to
notice
of
appeal
read
as
follows:
1.
Except
as
hereinafter
expressly
admitted
he
does
not
admit
any
allegations
of
fact
or
law
contained
in
the
Notice
of
Appeal
herein.
2.
Mr
Edward
Schneider
and
Mr
George
Stevenson,
were
partners
in
a
farm
implement
and
service
station
business
which
was
incorporated
as
Joe’s
Service
(Mannville)
Ltd
on
January
1,
1972.
Ownership
was
retained
of
the
land,
buildings
and
equipment
used
by
the
company
was
retained
jointly
by
the
partners.
3.
On
or
about
December
1,
1975,
Edward
Schneider
and
George
Stevenson
disposed
of
the
above
assets
for
the
sum
of
$50,000
receiving
$30,000
in
cash
and
a
second
mortgage
of
$20,000.
The
Mortgagor
defaulted
on
the
second
mortgage
payments
after
making
15
monthly
instalments
of
$259.32,
12
in
the
1976
year
and
3
payments
in
the
1977
year;
and
steps
were
taken
to
foreclose
on
the
said
second
mortgage.
4.
By
Notices
of
Reassessment
dated
May
28,
1979,
(George
Stevenson)
and
June
5.
1979,
(Edward
Schneider)
the
Appellant
was
reassessed
in
respect
of
his
1975
taxation
year
so
as
to
calculate
the
taxable
portion
of
capital
gains
taking
into
account
the
applicable
reserve
in
the
following
manner:
Capital
Gain
on
Sale
of
Property
(
/
|
$6,012.40
|
Less:
1975
Reserve
(
Z>)
|
2,404.96
|
|
$3,607.44
|
Taxable
Portion
(50%)
50%
of
/
|
$1,803.72
|
5.
By
Notice
of
Reassessment
dated
May
28,
1979,
(George
Stevenson)
and
June
5,
1979,
(Edward
Schneider),
the
Appellant’s
1976
taxation
year
was
reassessed
to
calculate
the
applicable
reserve
in
that
year
in
the
following
manner:
Additions:
1975
Reserve
on
Property
Sale
(
Z>)
|
$2,404.96
|
1976
Reserve
(
Z>)
|
$2,261.80
|
Reduction
in
Reserve
|
143.16
|
Taxable
Portion,
50%
|
$
71.58
|
Interest
earned
on
Agreement
for
Sale
(12)
|
960.65
|
6.
On
or
about
August
23,
1979,
the
Appellant
objected
to
the
said
reassessment.
7.
In
reassessing
the
Appellant
in
respect
to
the
1975
and
1976
taxation
years,
the
Respondent
assumed,
inter
alia,
that:
(a)
The
reserve
for
both
partners
in
respect
to
the
$20,000
second
mortgage
was
correctly
calculated
in
respect
to
the
1975
taxation
year
and
calculated
in
the
following
manner:
Balance
due
on
Agreement,
December
01,
1975
|
$20,000.00
|
Reserve
|
x
12,024.81
|
4,809.92
|
50,000
|
|
Amount
to
be
included
in
1975
income
|
7,214.89
|
Balance
due
on
Agreement,
December
01,
1976
|
18,809.46
|
(b)
The
reserve
for
both
partners
in
respect
to
the
1976
year
was
correctly
calculated
in
the
following
manner:
Reserve
-
x
12,024.81
|
$4,523.60
|
50,000.00
|
|
Reduction
in
Reserve
(1976
income)
|
286.32
|
4.
Admission
and
Consent
to
File
Documents
4.01
No
witnesses
gave
evidence
before
the
Board.
The
appellants
were
not
in
Court.
4.02
During
the
trial,
many
points
of
fact
were
brought
up
by
both
counsels.
These
points
had
not
been
provided
in
the
notices
of
appeal
and
in
the
replies
to
the
notice
of
appeal.
4.03
On
the
consent
of
the
respondent’s
counsel,
the
agent
for
the
appellants
filed
as
Exhibit
A-1,
a
copy
of
a
letter
dated
March
25,
1981,
from
Mr
Walter
A
Moskal
to
the
appellant,
Mr
Howard
Stevenson.
The
following
documents
were
sent
with
the
said
letter.
They
are
part
of
Exhibit
A-1:
1.
Copy
of
agreement
for
sale
between
Sixteen
Service
Mannville
Ltd
and
Paukszto
and
Cooper
dated
January
29,
1976;
2.
Copy
of
title
to
the
subject
land
in
the
name
of
Sixteen
Service
Mannville
Ltd
showing
first
mortgage
to
Vermilion
Credit
Union
and
second
mortgage
to
George
Howard
Stevenson
and
Edward
Schneider
for
$20,000;
3.
Copy
of
statement
of
claim
by
Vitold
Paukszto
against
Sixteen
Service
Mannville
Ltd
(foreclosure
action);
4.
Copy
of
order
nisi
in
foreclosure
action
by
Paukszto;
5.
Copy
of
affidavit
of
value
obtained
in
the
foreclosure
action
by
Paukszto;
6.
Copy
of
transfer
by
Paukszto
in
favour
of
Stanley
M
Kaziechko
for
$34,000
which
transfer
is
dated
July
2,
1980.
4.04
The
agent
for
the
appellants
and
counsel
for
the
respondent
admitted
the
following
facts:
(a)
the
sale
was
made
for
$50,000;
(b)
the
capital
gain
was
in
the
amount
of
$24,049.62;
(c)
the
amount
given
in
cash
was
$30,000:
(d)
there
was
a
second
mortgage
of
$20,000:
(e)
the
debtor
paid
15
instalments
of
$259.32
from
January
1,
1976
to
March
1977
on
the
second
mortgage;
(f)
in
1977,
the
purchaser
went
bankrupt.
4.05
The
appellants
in
filing
their
1975
returns
on
April
30,
1976,
included
$2,401.75
of
capital
gain
including
recaptured
depreciation.
4.06
On
May
6,
1976,
the
appellants
filed
amended
1975
returns
on
the
basis
that
the
transaction
was
effective
only
on
January
29,
1976.
Mr
Schneider
claimed
a
refund
of
$3,033.83
and
Mr
Stevenson
claimed
a
refund
of
$2,981.34
(this
appears
from
a
letter
sent
with
the
amended
returns
and
signed
by
Vic
Letawski
and
Alta-Ed
Accounting
Services
Ltd).
5.
Law
—
Cases
at
Law
—
Analysis
5.01
Law
The
counsel
for
both
parties
referred
to
paragraphs
20(1)(I)
and
(n),
sections
38,
39,
40
and
paragraph
79(h).
5.02
Case
at
Law
The
counsel
for
the
respondent
referred
to
the
case
of
A
Godfrey
Harvey
v
MNR,
[1980]
CTC
2129;
80
DTC
1094.
5.03
Analysis
5.03.1
The
agent
for
the
appellant
contended
that
the
purchaser
in
the
transaction
“Sixteen
Service
Mannville
Ltd”
did
not
exist
legally
in
January
1976
because
the
said
company
had
not
been
incorporated.
As
an
amount
of
about
$34,000
was
received
from
the
purchaser
and
the
purchaser
in
the
agreement
is
“Sixteen
Service
Mannville
Ltd”,
the
Board
must
consider
above
all
that
the
appellants
have
received
proceeds
whether
the
purchaser
existed
as
a
corporation
or
as
a
trustee
acting
for
a
corporation
to
be
incorporated.
The
reality
is
that
Messrs
Paukszto
and
Cooper
acted
in
the
agreement
as
agents
for
a
company
to
be
incorporated
in
the
name
of
Sixteen
Service
Mannville
Ltd.
The
Board
must
presume
that
those
words
were
forgotten
in
the
agreement
and
in
the
other
documents
(Exhibit
A-1).
According
to
Mr
Dhanda,
the
company
was
indeed
incorporated
later.
The
most
important
fact
is
again
that
the
appellants
have
received
proceeds
from
a
purchaser.
5.03.2
A
second
point
was
raised
that
the
amount
of
$30,000
and
the
other
payments
were
made
only
after
1975.
Therefore,
according
to
the
appellant,
the
1975
taxation
year
cannot
be
involved
in
this
present
case
despite
the
fact
that
the
agreement
was
retroactive
to
December
1,
1975.
The
evidence
is
that
in
the
agreement
dated
January
29,
1976,
(Exhibit
A-1)
the
purchased
price
of
$50,000
should
have
been
paid
as
follows:
The
sum
of
$30,000
cash
to
be
paid
on
the
execution
of
these
presents.
As
an
affidavit
of
execution
was
signed
on
the
same
date
as
the
agreement
ie
January
29,
1976,
therefore
it
is
presumed
that
it
was
paid
on
this
date.
The
balance
of
$20,000
was
paid
by
monthly
payments
of
$259.32
from
the
first
day
of
January
1976.
It
is
admitted
that
these
payments
were
made
after
1975.
The
appellant’s
contention
is
that
they
are
not
in
the
business
of
purchasing
and
selling
properties.
Therefore,
they
must
compute
the
capital
gain
on
the
cash
basis
and
not
on
the
accrual
basis
system
of
accounting.
The
latter
system
indeed
must
be
used
only
by
taxpayers
who
are
in
business.
First,
as
it
appears
from
the
notices
of
appeal,
it
is
clear
that
the
appellants
sold
the
property
in
December
1975.
It
was
certainly
a
verbal
agreement
which
was
completed
by
a
written
agreement
on
January
29,
1976.
The
business
was
transferred
on
December
1,
1975.
It
is
the
Board’s
opinion,
that
the
profit
must
be
computed,
from
the
moment
the
business
was
transferred.
This
was
in
1975.
However,
as
no
money
was
received
in
1975,
a
reserve
equal
to
the
amount
of
profit
must
be
considered
in
the
computation
of
the
net
income
for
1975.
For
1976,
a
reserve
can
be
included
according
to
the
provision
of
the
Act.
The
accounting
system
in
itself
(cash
or
accrual)
cannot
be
taken
into
account
to
compute
the
income
of
a
capital
profit.
When
the
entire
price
indeed
is
not
paid
during
the
year
of
the
sale
there
is,
in
the
Income
Tax
Act,
a
special
subsection
40(1)
which
provides
a
reserve,
based
on
the
time
when
the
payments
are
actually
made.
In
fact,
this
section
is
based
in
part
on
the
accrual
basis
system
by
including
the
whole
profit
in
the
income
for
the
year,
and
on
the
cash
basis
system
by
allowing
a
reserve
equal
to
the
amount
which
shall
be
received
in
later
years.
Moreover,
even
if
a
taxpayer
is
in
business
(and
therefore
must
have
an
accrual
basis
system)
he
can
compute
a
Capital
gain
in
that
manner
described
in
subsection
40(1).
Paragraph
20(1
)(n)
of
the
same
Act
provides
a
reserve
of
the
same
nature
for
certain
amounts
due
in
later
years,
even
if
the
profit
of
the
transaction
is
not
a
capital
gain.
5.03.3
It
is
also
the
Board’s
opinion
that
the
interest
received
on
monthly
payments
must
be
included
tin
the
appellant’s
income.
5.03.4
The
physical
asset
was
transferred
on
December
1,
1975.
The
recapture
of
depreciation
must
therefore
be
computed
in
1975.
6.
Conclusion
The
appeal
is
allowed
in
part
and
the
matter
is
referred
back
to
the
respondent
for
reassessment
in
accordance
with
the
above
reasons
for
judgment.
Appeal
allowed
in
part.