George H Stevenson, Edward Schneider v. Minister of National Revenue, [1981] CTC 2901, 81 DTC 817

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.