Uniflor Limited v. Minister of National Revenue, [1978] CTC 2039, 78 DTC 1054

The Assistant Chairman:—Uniflor Limited (appellant) has appealed to this Board from assessments for tax for its 1972 and 1973 taxation years. The dispute between the parties is, what amount, if any, of a 1970 business loss is available to apply against the appellant’s income for its 1972 and 1973 taxation years?

In the year 1968 a corporation known as Oak Lake Builders Limited (Oak Lake) commenced building, in the City of St Catharines in the Province of Ontario, townhouses and apartment buildings. In the course of that construction it incurred liabilities to several creditors. In 1969 its five main creditors became concerned as to whether or not they would be paid in full by Oak Lake. Those five creditors were Fonthill Lumber Limited (Fonthill), Beamsville Block Limited (Beams- ville), Peninsula Ready-Mix and Supplies Limited (Peninsula), Burn- stein Brick Limited (Burnstein) and Transit Mixed Concrete & Builders Supplies Limited (Transit). In April and early May 1969, officers of the five creditors got together to consider their joint plight. It should be mentioned that all of those five corporations as well as Oak Lake dealt with each other at arm’s length as that term is used in the Income Tax Act, RSC 1952, c 148 as amended. The five creditor companies consulted with a solicitor, as a result of which a plan was designed to protect their interest. The representative of the creditors discussed their concern as to payment with representatives of Oak Lake and outlined their plan. Oak Lake concurred in their proposal. In substance the plan was that Oak Lake would convey to the creditors one apartment building for a stated consideration and the creditors would finish that apartment building—as it was not then fully constructed—and sell it, trusting they would realize enough to pay themselves the amount that was due to them by Oak Lake. As a result of the oral agreement, the five creditors with their solicitor (as trustee for a company to be incorporated—the appellant) entered into an agreement dated May 16, 1969 setting forth the terms and conditions upon which they agreed to proceed in the above-mentioned fashion to recover their indebtedness. Following that agreement the appellant was incorporated as it was to be the vehicle whereby the creditors’ goal was to be achieved. Originally the appellant was incorporated under the name of Linton Manor Apartments of St Catharines Limited, but subsequently it changed its name to Uniflor Limited. After the appellant was incorporated, Oak Lake conveyed the apartment building in question to it. In the succeeding year or two the appellant completed the apartment building and, in August 1970, sold the same. There is no dispute between the parties that the profit or loss realized was a business profit or loss (and in this case the parties agree it was a loss). The dispute however is the quantum of the loss.

The appellant’s fiscal year was the calendar year. It filed its 1970 income tax return (which is the year in which the building was sold) and it showed a loss from this transaction. Pursuant to the provisions of the Income Tax Act, it had a business loss to carry forward to apply against its income, if any, in future years, subject of course to the quantum of taxable income in those years. In 1971 such amount of the loss as was needed was used to apply against that year’s profit. The appellant, in its 1972 year, by its own computation had a taxable income, before the application of any loss, of $43,684. In the appellant’s Opinion, its loss to be carried forward at that time exceeded that amount so that for that year it had no taxable income. The appellant computed its taxable income for its 1973 taxation year, without any deduction for prior year losses, in the amount of $26,621. It then deducted its remaining prior year loss in the amount of $732.

The Minister contended that the loss was only $62,157.53, not $97,816.56 as computed by the appellant. The Minister assessed the appellant’s loss in connection with the sale of the building at a lesser figure than that computed by the appellant as the Minister was of the view that the appellant had reduced the indebtedness it owed to those five creditors, save Fonthill, at a saving to it of $35,659.03 and consequently its costs of the building did not include the full amount which had been owing to those four creditors by Oak Lake, but rather that amount less $35,659.03.

The appellant, in reply to the Minister’s assessment, took the position that it never discharged its liability to those other four creditors at that saving and it had no transactions with those other four creditors with respect to its accounts payable, rather it was Fonthill itself for itself who purchased the accounts receivable of the other four creditors at a price less than their face value by the amount of $35,659.03.

The issue then becomes, what was the cost of the goods sold by the appellant when it disposed of the building in question? It appears clear—and the parties do not dispute it—that if the appellant in the year 1969 (the year it acquired the building) discharged its obligation to those four creditors at a sum less than the face value as a result of an arrangement between the appellant and each of those creditors, then the appellant received a discount on its cost price and its real cost would only be the net amount owing to each creditor with the result that its cost was as the Minister assessed. However, should it be that the appellant had no negotiations and made no arrangement with each of those four creditors, but rather the negotiations were by Fonthill for Fonthill’s benefit, then it would appear that the cost of goods sold, in so far as the appellant is concerned, was the original contract price and there would be no reduction or discount unless of course Fonthill gave the. reduction to the appellant. It then becomes a question of determining what transpired from the time of the incorporation of the appellant to the date when the building in question was sold.

According to the agreement of May 16, 1969, each of the five creditors were to be shareholders of the appellant. While Fonthill owned over 40% of the issued stock, no one shareholder controlled the appellant. The same agreement set forth the price at which the trustee was to endeavour to buy the building from Oak Lake, the relevant portion of which reads as follows:

10. (b) As to the amount equal to the total debts owing to the respective parties of the First to the Fifth Parts inclusive by Oak Lake Builders Limited the totally owned subsidiary contracting company of the parent company Westlink Construction Limited as hereinbefore set out by the forgiveness by the company to. Oak Lake Builders Limited and/or Westlink Construction Limited of such amount.

With respect to the land the trustee hoped to buy, the parties agreed he was to act in accordance with paragraph 12 of the same agreement. Paragraph 12 in part reads as follows:

12. Upon the incorporation and organization of the company as aforesaid, the Trustee will forthwith transfer the lands and buildings comprising the twenty-six suite apartment project to the compànÿ and each of the parties agrees to assign to the company the balance owing to such party by Oak Lake Builders Limited and/or Westlink Construction Limited as hereinbefore set out and as consideration for the said assignment it is agreed that the company will issue a debenture to each party in an amount equal to the balance owing by Oak Lake Construction Limited and/or Westlink Construction Limited to such party as aforesaid; such debentures to be secured by a mortgage on the said lands and buildings.

An agreement reflecting the successful negotiations by the trustee and Oak Lake was entered into dated May 20, 1969. The parties to it were the trustee as purchaser, the parent of Oak Lake as vendor, the five creditors as creditors, and Oak Lake as the debtor. Two paragraphs of that agreement bear noting, namely, 3 and 4, as follows:

3. The “Creditors” acknowledge upon the completion of this transaction payment in full of the indebtedness of the “Vendor”, and/or of the “Debtor” and releases them from all claims in respect thereto.

4. The “Debtor” and the “Vendor” accept forgiveness of the said indebtedness by the “Creditors” as valid consideration and as payment in full of the balance. of the purchase price.

The appellant acquired the property in August 1969. All of the creditors except Peninsula, for $1 and other good and valuable consideration, gave to John Nemy an assignment dated May 23, 1969. All the assignments read exactly the same except that the persons released included all the creditors except the assignor. In November 1969 there were exactly similar assignments, except as to dates, given by the same four creditors to John Nemy. When asked about the first assignments Nemy’s statement was that they were not acted upon, and then when asked the reason for the second assignments his reply was, after a very long pause, “It was my understanding it gave me the authority to act on behalf of Fonthill”. By cheques dated November 24, 1969, Fonthill as payer paid to Burnstein, Beamsville and Transit the sums of $6,500; $5,000 and $11,590 respectively, being one-half of the amount owing to each of them by the appellant. In -Fonthill’s books these cheques were shown on the ledger in the name of the appellant as an increase in the accounts receivable from the appellant.

Notwithstanding the agreement of May 16, 1969, Peninsula remained apparently a creditor of the appellant until September 1, 1971, as its general journal showed an entry on that date debiting Peninsula with $27,734.38, and crediting Fonthill with $15,000, and the deficit account with $12,734.38. The explanation accompanying the entry was “to record payment in full of note payable—Peninsula Ready-Mix by Fonthill Lumber Ltd’’.

Fonthill at all times was controlled by John Nemy and it owned over 40% of the shares of the appellant, having been Oak Lake’s largest creditor. Mr Nemy stated he, on behalf of Fonthill, had trouble with the other shareholders so he approached them to buy them out, all on behalf of Fonthill. Fonthill bought out three in the fall of 1969 for 50 cents on the dollar, and acquired Peninsula’s receivables for 75 cents on the dollar in 1971, after the building had been sold.

It is on this basis that the appellant says it never reduced or extinguished the debts it owed to the four creditors and consequently the Minister erred in reducing the cost of goods sold as he did.

Apparently in the spring of 1975 the respondent was examining the financial statements of the appellant and, as a result of inquiries, received a memorandum on the letterhead of Smiley, Scott & Ralph, Chartered Accountants. Mr Scott, one of the partners in that firm, gave evidence on behalf of the appellant and stated the memorandum was signed by a Mr Ferguson who was a tax consultant with the accounting firm at that time paid on a per diem basis. He stated that Mr Ferguson was not a chartered accountant. The first paragraph was the only portion of the memorandum referred to and it reads as follows:

We are enclosing the photocopies of cancelled cheques by which the various Shareholders and creditors of Linton Manor Apartment Limited were paid off. We are also enclosing:a photocopy of the ledger account to which these cheques were charged on the books of Fonthill Lumber Limited. As you know, Fonthill Lumber loaned the money necessary for these transactions to Linton Manor (now Uniflor). and it was to this Loan Receivable account that these disbursements were charged.

The ledger account to which Mr Ferguson refers is the ledger account which reflected the three cheques issued to the three creditors by Fonthill. Mr Ferguson’s memorandum clearly says Fonthill “loaned the money’’. Mr Nemy and Mr Scott were clear that Fonthill bought the receivables on its own account. As to the entry on the ledger with respect to the three cheques, Mr Scott stated there was no other way to show the purchase of the accounts receivable from a third party.

There is no doubt that, just prior to the sale by Oak Lake, four of the creditors were owed a sum of money. It was quite clear that the creditors of Oak Lake intended that the appellant would forgive Oak Lake its debts to those creditors, which debts would be assigned to the appellant by those creditors (see paragraphs 10(b) and 12 of agreement of May 16, 1969, supra). The evidence was clear that the debentures referred to in paragraph 12 were not issued.

It seems to me that I am asked to conclude that the appellant’s cost of sales was reduced because of the agreement and that the cost of sales was reduced by an act of the appellant, relying of course entirely on the memorandum of Mr Ferguson. Mr Ferguson did not give evidence. Mr Scott and Mr Nemy did give evidence. Both swore Fonthill bought the assignments from the other four creditors for itself. Three original cheques were produced to show Fonthill paid off three creditors. Mr Scott stated the reflection in the ledger of those cheques was to show the purchase of those accounts receivable by Fonthill.

As to the “settlement” or reduction of the account with Peninsula, it was not contradicted that this was done in 1971, a year after the building was sold by the appellant. The appellant asserted the same contention with respect to this account as with the others and Mr Nemy also swore the settlement was on behalf of Fonthill, not the appellant. Other than the memorandum of Mr Ferguson and the agreement, no evidence was put forward to show it was the appellant who settled this account.

The result is I accept the position taken by the appellant that it had no dealings with those four creditors reducing the debt it owed to each of them and consequently, the loss of the appellant as computed by the Minister is incorrect. The cost of goods sold should not be reduced by $35,659.03 and consequently, the appeal is allowed and the assessments remitted to the Minister for variation in accordance with these reasons for judgment.

Appeal allowed.