Sahota v. R., [1999] 3 CTC 2355, 99 DTC 900

O’Connor T.C.J.:

This appeal was heard at Vancouver, British Columbia on April 26, 1999 pursuant to the General Procedure of this Court. Testimony was given by the Appellant herself and by the Appellant’s chartered accountant, Brian Shpak. Also, a Statement of Agreed Facts and Documents (36 in number) was submitted. The document at Tab 18 was missing but this was not critical.

The Statement of Agreed Facts reads as follows:

Statement of Agreed Facts and Documents

The Parties hereby agree that for purposes only of this Appeal and any appeal therefrom or any other proceeding taken in this matter, the facts set out herein are true. Either party may adduce other evidence not inconsistent with these facts. The parties also agree that the documents referred to herein are true copies of the documents they represent. Either party may adduce other documents, not inconsistent with these documents.

1. The Appellant resides in the City of Vancouver, in the Province of British Columbia.

2. Yang-Myung Holdings Ltd. (“Holdings”) and Yang-Myung Hotel Management Ltd. (“Management”) are corporations duly incorporated under the laws of the Province of British Columbia. (Together, Holdings and Management shall be referred to as the “Companies”.)

3. Holdings is the registered owner of certain lands and premises located in Vancouver, British Columbia, commonly known as the Astoria Hotel, and legally described as detailed in Tab 1 (the “Subject Properties”). Management operates the Astoria Hotel.

4. The Companies’ each have a fiscal year end of July 31.

5. Copies of the corporate income tax returns for Holdings for the years ending July 31, 1992 to July 31, 1996, inclusive, are attached hereto at Tabs 2 to 6.

6. Copies of the corporate income tax returns for Management for the years ending July 31, 1993 to July 31, 1996, inclusive, are attached hereto at Tabs 7 to 10.

7. On or about February 6, 1991, the Appellant’s spouse, Gudy Singh Sahota, also known as Gurdyal Sahota, entered into an Agreement of Purchase and Sale (the “Purchase Agreement”) whereby he offered to purchase all of the issued shares and shareholders’ loan accounts, if any, of the Companies. The completion date was March 18, 1991. A copy of the Purchase Agreement is attached hereto at Tab 11.

8. On or about March 6, 1991, the Appellant’s spouse executed an assignment of his rights title and interest under the Purchase Agreement to the Appellant for “good and valuable consideration”. A copy of the assignment is attached hereto at Tab 12.

9. At the time of the share purchase, there was an outstanding loan in the Companies’ names, being a loan with the Toronto Dominion Bank as lender (the “TD Loan”). The TD Loan was secured by a Joint Debenture, which included a mortgage granted by Holdings over the Subject Properties (the “TD Mortgage”). The original amount of the TD Loan was $1.7 million, and the balance of the TD Loan at the time of the share purchase was $1,459,374.95. A copy of the Joint Debenture is attached hereto at Tab 13.

10. To assist in the purchase, $1.8 million was borrowed from the Banca Commerciale Italiana of Canada (the bank shall be referred to as the “Italian Bank” and the $1.8 million loan shall be referred to as the “First Italian Bank Loan’’). A copy of the Commitment Letter setting out the terms of that loan is attached hereto at Tab 14.

11. As part of the security required by the Italian Bank for the $1.8 million loan, the Companies provided a Promissory Note, and the Appellant and 4 other family members executed guarantees to the Italian Bank. Copies of the Promissory Note and the guarantees are attached hereto at Tabs 15 and 16, respectively.

12. On completion of the share purchase, the TD Mortgage under the Joint Debenture remained on the Subject Properties, with some modifications. A copy of the Modification of Mortgage is attached hereto at Tab

17. Copies of the Statement of Adjustments and Supplementary Statement of Adjustments are attached hereto at Tab 17A.

13. The Appellant has been the sole shareholder and sole director, as well as the president and secretary, for both Holdings and Management since March 18, 1991.

14. In June and July, 1993, the following events took place:

a) the Italian Bank granted a loan, in the Companies’ names, in the amount of $3.2 million. The Commitment Letter setting out the terms of that loan is attached hereto at Tab 18;

b) as part of the security for the $3.2 million loan, Holdings granted a mortgage to the Italian Bank over the Subject Properties, for the principal amount of $3.2 million (the “Subject Mortgage”). A copy of the Subject Mortgage is attached hereto at Tab 19;

C) as additional security, the Appellant and 4 other family members each executed guarantees to the Italian Bank. A copy of the Appellant’s guarantee (the “Guarantee”) is attached hereto at Tab 20. The guarantees of the other family members were similar to the Appellant’s Guarantee;

d) Holdings and Management executed Directors’ Resolutions and the Appellant executed Officers’ Certificates for both Companies with respect to, inter alia, the borrowing of the $3.2 million loan. Copies of the Directors’ Resolutions and Officers’ Certificates are attached hereto at Tabs 21 to 24;

e) Holdings and Management executed an Acknowledgment of Borrower re: PPSA, a copy of which is attached hereto at Tab 25;

f) Holdings and Management executed a Security Agreement (Real and Personal Property), a copy of which is attached hereto at Tab 26;

g) Holdings and Management executed an Order to Pay to the Italian Bank, a copy of which is attached hereto at Tab 27;

h) Holdings, Management, and all the family members who had given guarantees, executed a Letter of Undertaking not to further encumber the Subject Property, a copy of which is attached hereto at Tab 28;

i) a Loan Indemnification Agreement was executed between the Appellant and Holdings. A copy of the Loan Indemnification Agreement is attached hereto as Tab 29.

15. The $3.2 million Italian Bank loan was sought in order to obtain new financing in the form of a lower rate first mortgage sufficient to repay both the TD Loan and the First Italian Bank Loan and to provide additional working capital.

16. Of the $3.2 million borrowed, $1,747,026 (or 54.6%) was used to pay out the remaining balance on the First Italian Bank Loan.

17. Working papers for Holdings for the years ended July 31, 1994 and July 31, 1995 are attached hereto at Tabs 30 and 31, respectively.

18. The Subject Mortgage required Holdings, as the mortgagor, to make monthly periodic payments of principal and interest in the amount of $29,447.38 (the “Mortgage Payments”).

19. At all material times, Management paid the monthly Mortgage Payments by cheques written on its own bank account. A copy of a sample cheque is attached hereto at Tab 32.

20. At year end, adjusting journal entries were made between the Companies to reflect rent owned by Management to Holdings and mortgage payments made by Management. Holdings also charged an amount representing 54.6% of the Mortgage Payments to the Appellant by reducing the balance of the Appellant’s shareholder’s loan account accordingly. The remaining 45.4% of the Mortgage Payments were reflected in Holdings financial statements.

21. The Italian Bank did not make a demand for payment on the Appellant under either the Appellant’s guarantee for the $1.8 million loan or the Appellant’s guarantee for the $3.2 million loan.

22. In filing her income tax return for the 1994 taxation year, the Appellant reported total income before deductions in the amount of $183,840, calculated as follows:

Employment Income	$ 65,000
Interest and other investment income	28,840
Business Income	90,000
	$183,840

The business income of $90,000 represented a management fee paid to the Appellant by Holdings. A copy of the Appellant’s 1994 income tax return is attached hereto at Tab 33.

23. In computing income for the 1994 taxation year, the Appellant claimed an interest expense in the amount of $160,214 as a deduction from income. The amount of $160,214 represents 54.6% of the total interest paid on the Subject Mortgage in the calendar year 1994.

24. The Minister of National Revenue (the “Minister”) initially assessed the Appellant for the 1994 taxation year by Notice dated September 5, 1995. In so assessing, the Minister disallowed the claimed interest expense. A copy of the Notice of Assessment is attached hereto at Tab 34.

25. The Appellant objected to the September 4, 1995 assessment by Notice dated January 12, 1996. The Minister confirmed the assessment by Notice of Confirmation dated May 30, 1997. Copies of the Notice of Objection and Notice of Confirmation are attached hereto at Tabs 35 and 36, respectively.

The Appellant’s testimony was essentially to the effect that everything had been arranged by Mr. Shpak, the chartered accountant, and that she followed his advice in all respects. Mr. Shpak testified that he made the arrangements with the banks as to the loans, that the true borrower of the First Italian Bank Loan and of the 54.6% of the $3.2 million loan was the Appellant. However, the bank required that the $3.2 million loan be placed in the name of the Companies, i.e., the Companies were the borrowers with the Appellant and others being guarantors. He testified further that the bank was reluctant to lend money secured merely against shares in the Companies but demanded security directly on the hotel and its contents and this was the reason the Companies were shown as borrowers. Although the Companies were shown as borrowers in the loan documentation, the true borrower or the de facto borrower was the Appellant and that this is supported by the financial statements and working papers of the Companies. Mr. Shpak also testified to the effect that it was part of the tradition of the Appellant’s extended family that each member should acquire real estate and most commonly, hotels and that since the Appellant was the only member of the family who did not have such an investment, it was decided that the Appellant would acquire real estate comprising the Astoria Hotel through her acquisition of the shares of the Companies.

Mr. Shpak also stated that the bank, although not a party to the Loan Indemnification Agreement, was certainly aware of the agency situation, that the bank knew the purpose of the First Italian Bank Loan was to enable the Appellant to purchase the shares of the Companies and 54.6% of the $3.2 million loan was used to pay of the First Italian Bank Loan.

Issue

The issue in this appeal is whether the Appellant is entitled to a deduction for interest paid in 1994 on 54.6% of the $3.2 million loan.

Appellant’s submission

The Appellant’s basic submission is that the de facto borrower of 54.6% of the $3.2 million loan was the Appellant and the proceeds representing the said 54.6% was used to pay out the First Italian Bank Loan, the proceeds of which had been used to purchase the shares of the Companies. He refers in particular to the Loan Indemnification Agreement at Tab 29.

To quote from the Appellant’s written submissions:

Appellant as de facto borrower

18. The first issue is whether the Appellant is entitled to this deduction even though the loans were in the Companies’ names. The Appellant submits that the Appellant is the de facto borrower in this loan, even if the loan is in the Companies names. The loan was obtained for the specific purpose of purchasing shares and shareholder’s loans accounts for the Appellant. The shares are in the name of the Appellant. It is respectfully submitted that while the loan may have been in the name of the Companies, the loan was obtained on behalf of the Appellant, and accordingly, there was an agency type relationship between the Appellant and the Companies with respect to this loan.

19. With respect to this issue, the Appellant relies upon the Tax Appeal Board decision in Zatzman v. Minister of National Revenue (1959), 59 D.T.C. 635 (Can. Tax App. Bd.). In this decision, two transactions were asserted by the Minister to be loans from the company to the primary shareholder, and as such taxable as dividend income. The taxpayer argued that the loans were actually made by a third party through the company to him, and that the company merely acted as an agent to facilitate the loan. With respect to the first loan considered in the judg- ment, the Appellant approached a friend, and asked the friend to discount a $12,000 note. The friend signed the note as president of Dominion Metal Co., and signed it over to the Appellant’s company, Dartmouth Scrapyards Ltd. The Appellant’s company then forwarded $12,000 to the Appellant on account of the note. With respect to this advance, the court held that it was a loan obtained by the Appellant from his friend (or his friend’s company), and that the Appellant’s company merely acted as an agent. Similarly, we say that in this case, the First Italian Bank Loan was a loan obtained by the Appellant herein from the Italian Bank, and the company merely acted as an agent in facilitating the transaction.

Consolidation of loan

21. The second issue is whether the consolidation of the two loans precludes the Appellant from claiming this deduction. The Appellant relies upon the decision in Riddell v. Minister of National Revenue [(1986), 86 D.T.C. 1374 (Fed. T.D.)] in support of its proposition that the Appellant is not precluded from claiming the interest paid as a deduction.

22. In Riddell, the Appellant obtained a loan to purchase shares in the coAppellant company. In 1976, he obtained an opportunity to consolidate this loan with a loan of the company’s, and did so. In 1978, he obtained a personal loan, and a company loan, to pay out the consolidation loan. The personal loan was to pay out his portion of the consolidation loan. At all material times, the company made both the principle [sic] and interes payments on the loan on behalf of Mr. Riddell, expensing the payments as either wages or as deductions to the shareholder’s loans account. He declared his proportionate share of the interest on the consolidation loan, and at appeal it was held by this court that he should be entitled to the deduction.

23. The court specifically allowed the appeal on the issue of the interest deductions, holding (at page 5533):

I take an entirely different view however, with respect to whether Mr. Riddell should be permitted to deduct the interest payments in computing his personal income tax returns for the years in question. On this issue, I am satisfied the plaintiff s appeal should be allowed. The evidence demonstrates that the Minister of National Revenue had a policy in effect, which under these circumstances, permitted taxpayers to make the deductions Mr. Riddell was seeking to make.

24. The appellant’s position, simply put, is two-fold:

a. This decision is evidence of the Minister’s policy, which is corroborated by Mr. Shpak’s testimony, that the Ministry allows taxpayers, such as Ms. Sahota, to make deductions for interest paid on account of loans to purchase shares in companies, regardless of whether the loan was in the taxpayer’s name or not, and specifically even after consolidation with a loan of the company’s. Under the authority of this decision, the Minister is bound by that policy; and

b. This court is bound by the doctrine of stare decisis to hold that this Appellant should be entitled to the same treatment before the law as was Mr. Riddell; and as such, should be entitled to make deductions for loans obtained on account of the purchase of shares, regardless of whose name the loan is in.

Conclusion

25. It is respectfully submitted that the Appellant ought to be entitled to the deduction claimed, namely an interest expense of $160,214 in the 1994 taxation year. The Appellant seeks an order directing the Ministry to allow the deduction, plus costs of this Appeal.

Counsel also referred to the decision of the Supreme Court of Canada in Bronfman Trust v. R. (1987), 87 D.T.C. 5059 (S.C.C.) and concluded that one must look at the commercial and economic reality of the situation and that in this appeal that reality was that the Appellant was the borrower and that the Companies merely acted as agent.

Respondent’s submissions

Respondent submitted that there was no borrower/lender relationship between the bank and the Appellant, that the Appellant was merely a guarantor and that no demand for payment had ever been made upon her by the bank.

She also accentuated that the bank was not a party to the Loan Indemnification Agreement. Further, that because of the Appellant’s personal financial conditions the bank would not have loaned to her. Consequently the true borrowers were the Companies as indicated in the loan documentation.

She adds that the cases relied upon by the Appellant are distinguishable. She adds further that the onus is on the Appellant to establish the borrower/lender relationship and that in case of doubt one should find that the Appellant has not discharged that onus.

No agency agreement was presented to support the allegation that the Companies acted as agents for the Appellant.

Counsel pointed out that, based upon the Appellant’s apparent unawareness (from her testimony) of what was going on she could hardly be considered a principal in a principal agency agreement.

Counsel referred to several cases, including those discussed below.

In Denison Mines Ltd. v. Minister of National Revenue (1971), 71 D.T.C. 5375 (Fed. T.D.), the Federal Court decided that no agency relationship, expressed or implied, existed between a company and its wholly owned subsidiary and denied the parent certain deductions of expenses actually incurred by the subsidiary.

In certain other decisions, notably a decision of the Federal Court of Appeal in À. v. MerBan Capital Corp. (1989), 89 D.T.C. 5404 (Fed. C.A.), it was held that paragraph 20(1)(c) requires that for interest to be deductible, it must be paid on money borrowed by the taxpayer and not by someone else such as subsidiary companies.

Counsel argues further that the quotation from the Riddell case referred to above is bad law. The Minister is not bound by policy decisions taken at earlier times and she states that that is clear from the decision of the Federal Court of Appeal in Ludco Enterprises Ltd./Entreprises Ludco Ltée v. R. (1994), 95 D.T.C. 5311 (Eng.) (Fed. C.A.).

Analysis and Decision

It is clear that the basic loan documentation clearly indicates that the borrowers were the Companies and not the Appellant. However, in my opinion, the evidence establishes that with respect to 54.6% of the $3.2 million borrowed in 1993 the true borrower was the Appellant. This is borne out by the testimony of Mr. Shpak, the history of the loans, the financial statements of the companies, in particular those of Holdings, which showed that Holdings did not deduct interest on the said 54.6% of that loan. Reference is also made to the resolution of Holdings at Tab 24 of Exhibit A-1, the Loan Indemnification Agreement at Tab 29, the ledgers of the Companies at Tabs 30 and 31 of Exhibit A-1 and the working papers of Holdings. All these documents support the testimony of Mr. Shpak and lead to the conclusion that the true borrower of 54.6% of the $3.2 million loan was the Appellant.

The reason why the Companies were shown as borrowers of record was to satisfy the Italian Bank’s demands that it needed to have direct security on the assets of the companies and not simply security on the shares owned by the Appellant.

54.6% of the $3.2 million loan went to pay off the First Italian Bank Loan which had provided the Appellant with the necessary funds to purchase the shares and the loans receivable. These assets comprise prop- erty which became the major source of income for the Appellant and in my opinion the conditions of subsection 20(1)(c) of the Income Tax Act are met.

Even if one was to accept the Respondent’s contention that no agency existed, which I do not, the Loan Indemnification Agreement makes it clear that at the very least the Appellant was indebted to Holdings for 54.6% of the $3.2 million loan. In other words, if a debtor/creditor relationship did not exist with the Bank it did between the Appellant and Holdings.

I should add that I am not relying on the Riddell decision. In other words, the Minister was not bound by policy decisions of her employees.

For all of the above reasons, the appeal is allowed, with costs.

Appeal allowed.