Norman Kenneth Ans v. Minister of National Revenue, [1977] CTC 2572, 77 DTC 396

Delmer E Taylor:—This is an appeal from income tax reassessments for the year 1973 in which the Minister of National Revenue increased the taxpayer’s reported taxable income by a total of $28,999.80, repre- senting a bonus of $16,500 credited to the shareholder’s loan account of the appellant, and $12,499.80, a balance remaining in the same shareholder’s loan account on December 31, 1974. The appellant relied upon subsections 15(2) and 78(3) of the Income Tax Act, SC 1970-71-72, c 63 as amended, while the respondent relied, inter alia, upon subsection 15(2) of the said Act.

Facts

The appellant, at all times material, was a shareholder and officer of Continental Bedding and Furniture Co Ltd (hereinafter referred to as “Continental” or “the company”) of the City of Saskatoon, in the Province of Saskatchewan. In or about December 1972 he entered into an agreement with one Stewart Duncalfe to purchase Duncalfe’s shares in Continental. An amount of $50,000 was borrowed from the Canadian Imperial Bank of Commerce (hereinafter called “the bank”) in connection with the sale agreement between the appellant and Duncalfe. Continental, in 1973, declared a bonus in favour of the taxpayer.

Contentions

The position of the appellant was that

—Continental borrowed the $50,000 from the bank for the express purpose of transferring the said money to the taxpayer to purchase the shares of Stewart Duncalfe, and that the company was acting as a conduit pipe for the money between the bank and the taxpayer;

—because the loan from the bank was made on the taxpayer’s personal security and because the shareholder’s loan from the company to the taxpayer contained no element of fraud, deceit Or connivance and was not made for the purpose of distributing surplus profit of the company to the shareholders, there existed between the taxpayer and the company a principal-agent relationship as opposed to a borrower-lender relationship;

—as the bonus was never utilized by him and as it was applied without his knowledge or consent to the shareholder’s loan account, the bonus, by virtue of subsection 78(3) of the Income Tax Act, becomes income in the hands of the company and not the taxpayer.

In assessing the appellant, the respondent assumed that

—the capital loan of $50,000 was repaid together with interest with company funds generated by the company and was not repaid by the appellant;

—the sum of $16,500 was recorded by Continental as a bonus payable to the appellant and the company reduced the appellant’s Outstanding shareholder’s loan account by the same amount;

—from January 1, 1973 to December 31, 1973 Continental had loaned to the appellant $12,499.80 which was not repaid before the end of the 1974 taxation year.

Evidence

Norman K Ans submitted in support of his appeal a copy of his shareholder’s loan account in Continental for the years 1973 and 1974 (Exhibit A-1), and a copy of a demand note for $50,000 from Continental to the bank, dated January 12, 1973 (Exhibit A-2). The appellant and Duncalfe had agreed in late 1972 that Duncalfe should purchase the interest of Ans in Continental, but when Duncalfe had been unable to meet the terms for such a purchase, the option to do so reverted to Ans. He had arranged to borrow the funds required ($50,000) personally from the bank, but had been given advice that it would be more advantageous to have the loan made to the company instead. For security he had pledged his personal insurance, the company shares he acquired and given his personal guarantee, even though the loan was made to the company. Payments to the bank were made by the company at the rate of $1,000 per month. Operations had continued to be successful for a while but, in 1974, Continental had financial difficulty and went into bankruptcy. The appellant lost all his investment, retaining only his home, but had not received any demand from the trustees for the company for any amounts claimed as indebtedness from him to Continental.

Regarding the bonus in question, the appellant had been informed by the accountants when it was declared that this action could benefit the company from an income tax viewpoint. He had been unaware that the amount was credited to his shareholder’s loan account, he had not received the bonus because the company had lacked the funds, no T4 wage return had been prepared for it and, accordingly, he had not reported it as taxable income.

During cross-examination the appellant identified the following:

Exhibit R-1—Letter dated December 19, 1972 from Touche Ross

& Co, Chartered Accountants, to the appellant, dealing with the proposed purchase of the interest in Continental held by Duncalfe;

Exhibit R-2—Offer to purchase relating to the above for $50,000

which, in addition to Duncalfe’s interest in Continental, also settled the financial arrangements between the two parties in several other businesses;

Exhibit R-3—Notes to the financial statements for the year ended

December 31, 1973;

Exhibit R-4—Report by the bank on Continental’s application for

credit dated January 16, 1973;

Exhibit R-5—Two pages of journal entries for the year 1973 from

the accounting records of Continental, and a copy of a cheque from Continental to the appellant dated January 12, 1973.

In connection with these documents, the appellant agreed that he had not repaid the company at the rate of $1,000 per month but he had made periodic payments during 1973 and 1974; that his purchase from Duncalfe had given him all the shares in Continental; and that the accountants for the company had also been his personal accountants.

Argument

Counsel for the appellant referred the Board to certain cases, notably Loughran v MNR, 13 Tax ABC 154; 55 DTC 361; Zatzman v MNR, 23 Tax ABC 193; 59 DTC 635, and J W Ramsay v MNR, 26 Tax ABC 193; 61 DTC 191, and asserted that the circumstances could be related to the evidence brought forward in the instant appeal to consider not only the original $50,000 loan but, if necessary, the further $16,500 bonus payable, as all part of a “conduit pipe’’ form of transaction. There was however no basis for considering the $16,500 as taxable to the appellant in any way, according to counsel.

Counsel for the respondent argued there was no doubt the appellant had benefited from the $12,499.80 loan balance remaining unpaid in his shareholder’s loan account at December 31, 1974; that at the minimum the $16,500 must be added to this amount as a benefit in the event that the Board found it should not be regarded as salary or wages; and that the appellant had “received’’ the bonus payable by virtue of his control of the company and credit to the loan account in the records of the company. Counsel submitted for the Board’s consideration the cases of Massey-Ferguson Limited v Her Majesty the Queen, [1974] CTC 671; 74 DTC 6529 and [1977] CTC 6; 77 DTC 5013; S Hart Green v MNR, 2 Tax ABC 218; 4 DTC 6; Prazoff v MNR, 10 Tax ABC 145; 54 DTC 141, and Jean-Pau! Morin v Her Majesty the Queen, [1975] CTC 106; 75 DTC 5061.

Findings

Counsel for the appellant urged upon the Board that the company acted only as a “conduit pipe’’ for the bank to loan to the appellant the $50,000 necessary for him to purchase the shareholder’s equity of Duncalfe. In simpler terms, there was really not a loan from the bank to the company, and a separate loan, in turn, from the company to the appellant—that in fact the bank loaned the funds to the appellant directly—using the company only as a convenient means through which to pass the funds.

The two main reasons put forward in support of the ‘‘conduit pipe’’ theory were that the appellant had originally arranged to borrow the money personally and not through the company, and that when money had been borrowed by the company, he had put up personal security. On the first reason, the appellant’s explanation was that he had been advised that it would be of tax advantage to have the company rather than himself make the loan from the bank, and he proceeded accordingly. No indication was given what might be this tax advantage or to whom, but if it was intended for the company, then it is difficult to accept that it should now be subverted to the taxpayer; and if originally the tax advantage was for him, then it remains to be seen on the merits of the case whether it was real or imagined. The merits, therefore, for the appellant’s argument come down to his second reason—the security involved to support the amount and terms of the loan granted by the bank.

For the appellant’s proposition to be accepted in my opinion would require clear evidence that the terms, conditions and obligations undertaken by the appellant remained virtually unchanged—certainly undiminished—from those assumed by the company in the loan from the bank. However, there is considerable evidence in Exhibit R-4 that the security for the company loans, regarded by the bank as of primary importance, was that security available under the general assignments of the company’s accounts receivable, inventory and fire insurance, not under the personal guarantees, etc, of the appellant. Indeed, the oral testimony of the appellant indicated that the insurance policies on his own life, premiums for which were paid from company funds, were probably the only additional personal security available to him with which to support the bank loan. This is a business practice sufficiently common (the deposit of executive life insurance policies in conjunction with granting corporate loans) that I would fail to see how, on its own merits, it would constitute the major factor in the granting of banking accommodation. Further, the bank loan to the company called for payments of $1,000 per month plus interest at the rate of 8 /2% per annum. There is no evidence that either of these conditions was carried forward into the loan by the appellant from the company, that even any note payable from the appellant was prepared, or that he either paid or was charged with the interest which the company paid to the bank.

There would appear to be little support for the conclusion that, under the circumstances cited in this case, the loan from the company to the appellant should be regarded as the same loan made to the company by the bank. The company may be viewed as having been a mechanism through which the appellant was provided the funds he required, but that mechanism did not take the form of a conduit pipe, it was in fact more akin to an exchange platform. The judicial cases cited by counsel, in my opinion, differ in all major aspects from the instant case and provide the appellant with scant comfort. Any balance from the $50,000 loan to the appellant remaining unpaid and coming within the terms of subsection 15(2) of the Act should be taxable in his hands. This would include the $12,499.80, so treated by the respondent.

Turning to the bonus of $16,500 at issue, the case law submitted by counsel for the respondent did not appear to the Board to be particularly significant to the point at issue in this matter. In fact, the respondent in the pleadings and at the hearing dealt in only general terms with the manner in which the recording of the bonus and its credit to the appellant’s loan account might be defined as “received by him in the year’’, which is required under section 5 of the Income Tax Act when taxing an amount as ‘salary, wages or other remuneration”. An examination of Exhibit A-1 shows that the taxpayer did not physically receive a cheque or cash specifically dedicated to the payment of that amount, concurrent with or immediately subsequent to the crediting of the $16,500 to his shareholder’s account (the accounting entry was made on December 31, 1973). It had served only to reduce his liability to the company shown in that account as of that date. As pointed out by counsel for the appellant, a prima facie case therefore can be made that he did not receive the amount in question. It is just as obvious, however, that during the year 1973, preceding the declaration of the bonus, the company had made several payments to or on behalf of the appellant and debited these amounts to his account.

Although not reviewed in great detail at the hearing, this is one important aspect of the issue—do the payments made to or on behalf of the appellant prior to the declaration of the bonus take on the character of a “receipt”, only formalized by the all-encompassing year-end journal entry? Or do these amounts, separately or totally, deserve the treatment as only further loans or advances made by the company to the appellant during that year? In my opinion, to relate one (the series of advances in 1973) to the other (the journal entry recording the bonus) would require an agreement, actual or determinable from the events, that the appellant was to receive amounts on account of salary during the year, and that the accounting treatment for these advances on salary would be made at the end of the year. There is no evidence that such an understanding existed in any form during 1973.

The accounting entry for the $16,500, as shown on Exhibit R-5, was:

The effect of the above is to set up a liability of the company (the bonus payable) to the appellant. It was apparently entered in the shareholder’s loan account because the appellant was already indebted to the company but it was not to record salaries already paid, it was for salaries payable.

A similar journal entry on the same accounting page reads as follows:

The Board has no knowledge of the basis for this second entry but there is no reason to assume the intent was any different than the entry which is significant in this case—to establish salaries payable for some income tax benefit to the company. Whether or not the $12,190 amount was paid in 1973 or at any other time the Board is not aware, but there is no evidence the $16,500 was paid. While recordkeeping procedures of this type may be perfectly appropriate from a corporate accounting viewpoint, I am unable to conclude that they would have any merit in determining the income tax liability of the individual affected unless the amount was determined as having been received by the taxpayer in the year under review. It is my opinion that since there is no corporate evidence that the $16,500 was paid in 1973, and all the evidence supports the appellant’s position that he did not receive it, it should not be taxable in his hands as salary or wages. The Board expresses no opinion on the effect this could or should have on the taxable position of the company, and the applicability of subsection 78(2) of the Act does not come into question in this appeal.

The subsidiary argument, on the bonus payable, made by counsel for the respondent—that in the event the amount was held not to be salary or wages, this would only serve to increase the unpaid balance in the shareholder’s loan account by $16,500 and therefore the appellant would be taxable on the greater amount under subsection 15(2)—is untenable in this appeal. Such a proposition, while perhaps having some validity in theory, presumes the reversal of the bonus payable journal entry in the accounting records of the company, and the Board’s responsibility does not include any such direction to Continental. The explanation provided in the Minister’s notice of reassessment dealing with the $16,500 was as follows:

Tax on this amount was not assessed under subsection 15(2) of the Act and I am unaware of any basis upon which counsel may so extend it at this time.

Decision

The appeal is allowed in part, in order that the taxable income of the appellant be reduced by an amount of $16,500. In all other respects the appeal is dismissed. The matter is referred back to the respondent for reassessment accordingly.

Appeal allowed in part.