Georgia Medical-Dental Building Limited v. Minister of National Revenue, [1972] CTC 2359, 72 DTC 1316

A J Frost:—This is an appeal from an income tax reassessment dated August 10, 1967 in respect of the appellant’s 1963 taxation year, wherein the amount assessed was increased from 89¢ to $40,004.28. This appeal was heard at Vancouver, BC on May 19 and 21 and continued on June 2, 1971 by the Tax Appeal Board as it was then constituted. By mutual consent written arguments were submitted on June 29 and 30, 1971, respectively.

In the said reassessment the Minister of National Revenue made the following adjustments to declared income:

Upon Notice of Objection duly signed and filed the Minister confirmed the assessment on the ground (a) that bank interest of $76,344.31 was not interest on borrowed money used for the purpose of earning income, and (b) that professional fees of $2,460 claimed as a deduction from income were not incurred in the course of borrowing money used for the purpose of earning income.

The appellant’s profit and loss statement for the year ended June 30, 1963, which includes only seven months of operations, contained in summary and amended form the following:

The appellant company owned and operated an office building in Vancouver and, during June 1962, became engaged in a series of financial transactions, pursuant to which it assumed certain legal obligations to pay interest to money-lenders. A major part of this interest ($76,344.31) had been disallowed as a deductible expense for appellant’s 1963 taxation year. Another expense of $2,460 incurred for professional services in arranging the said transactions was also disallowed. Appellant contended that the respondent erroneously disallowed these expenses in accordance with the provisions of paragraph 11 (1 )(c) and subparagraph 11 (1 )(cb)(ii) of the Income Tax Act.

The respondent in his reply contended that the assessment had been properly made because the said expenses were not incurred for business purposes, but rather to assist three persons, namely, Doctors A K Mathisen, H G Weaver and J W Cluff (hereinafter referred to as the “Doctors”) in acquiring for their private benefit the outstanding shares in the appellant company.

From the evidence adduced at the hearing, the pleadings and oral statements made by the parties, the following relevant facts were established. On May 4, 1962 the Doctors instructed Canada Permanent Toronto Genera! Trust Company at Vancouver to purchase on their behalf all outstanding shares in the appellant company at the price of $500 each. The price was apparently based on the verified financial position of the company as at June 30, 1961 and it has been stipulated that nothing should be done to change that position.

The share certificates had to be deposited on or before June 1, 1962 and the transfer would become effective within 30 days thereafter. It is obvious that whatever financial transactions were completed, especially those involving large sums of money and/or pledging the company’s assets, during the last week of June 1962 these transactions were made by or at the instructions or approval of the new owners (the Doctors) who constituted the new board of directors. On June 27, 1962 the board decided to borrow from the Bank of Montreal $500,000 at an annual interest rate of 6%, This loan was followed by another one from the same source in the amount of $1,500,000. In addition, the company received from seven shareholders, including the Doctors, 6% interest bearing advances totalling $200,000.

These loans and advances were reflected on the appellant company’s current bank account with the Bank of Montreal as follows:

These borrowings were to pay off certain existing indebtedness and thereby make fully available certain unencumbered assets as security for the new loans. Insofar as the money was borrowed for this purpose, interest was allowed as a deductible expense. However, an amount of not less than $1,995,000 was lent to the Doctors who turned it over to Canada Permanent Trust Company to pay for the shares purchased from and deposited by the former shareholders. The amount of $1,500,000 initially borrowed from the Bank of Montreal was replaced by a loan from Great West Life Assurance Company, secured by a mortgage on the appellant company’s assets and registered on July 10, 1962.

Even if the Doctors had paid interest on the said $1,995,000 used for the purchase of the above-mentioned shares, which interest is not shown on the books of the appellant company as revenue for its 1963 taxation year, the Board would still have to assume that this borrowed capital was not used for the purpose of earning income from a business or property, but solely for that of enabling the Doctors to acquire the shares issued and outstanding in the appellant company. To what extent these transactions may or should have affected the personal income tax liabilities of the Doctors is beyond the scope of this appeal, which deals with the deductibility of interest paid to the Bank of Montreal and Great West Life by the appellant company, a deduction which the respondent had correctly disallowed. There is, however, a discrepancy between the amount of interest actually paid over a period of seven months from June 30, 1962 to February 28, 1963, date whereon another corporation controlled by the Doctors took over all the assets and liabilities of the appellant company calculated at an interest rate of 6% per annum. It appears that only an interest amount of Goo X 742 X $1,995,000 or $69,825 can be attributed to the moneys borrowed and used for the acquisition of the shares, and not $76,344.31. The disallowance of $2,460 paid for professional fees should stand as it would not be possible to properly apportion these charges without further evidence.

Appellant objects to the rate of tax applied by the respondent. It appears that the latter was fully justified in making the distribution of the low income tax rate as he saw fit to do and the Board cannot see any malice in the Minister’s action since the appellant company was clearly in default by not answering to the respondent’s properly executed invitations to make the choice. The appeal on this point must be rejected as unfounded.

Finally, I must deal with the matter of the late filing penalty. The fact that the return was filed late has been established beyond any reasonable doubt while the appellant has done nothing to refute the evidence. The Board has no jurisdiction to reduce the amount of a penalty of this kind or to deny it to the respondent who administered the applicable provisions of the Income Tax Act in the only way open to him. In view of these considerations and findings, it is not necessary to deal with the respondent’s contention that issues not raised in the Notice of Objection cannot be brought up in the Notice of Appeal or even orally at the hearing.

For the above reasons the appeal is hereby allowed in part and the matter referred back to the Minister for reconsideration and rassess- ment accordingly.

Appeal allowed in part.