Burton for Shoes Limited v. Minister of National Revenue, [1972] CTC 2419, 72 DTC 1363

The Chairman:—This appeal was brought by the taxpayer against a notice of reassessment for the taxation year 1968 wherein a deduction of $5,000 claimed in respect of a bad business debt written off in that year was disallowed by the Minister of National Revenue on the ground that it was a capital outlay within the meaning of paragraph 12(1)(b) of the Income Tax Act.

The appeal was heard at the City of Saskatoon in the Province of Saskatchewan, on October 13, 1971 by Mr J O Weldon, QC, presiding member of the sittings of the Tax Appeal Board at that time. Following the hearing of the evidence and the argument, Mr Weldon reserved judgment and, unfortunately, judgment was not delivered prior to the expiration of Mr Weldon’s term of office in March of 1972.

The parties were notified that one of three options was open to them, namely: (1) that the transcript of the evidence and argument could be reviewed by a member of the Tax Review Board (which replaced the Tax Appeal Board effective December 15, 1971), who would then render his decision; or (2), the parties could have the case determined on the transcript of the evidence with an opportunity to re-argue the case; or (3), the parties could be given an entirely new hearing before a member of the Tax Review Board.

In this case the parties have consented that the matter be disposed of under the first option, namely, a review of the evidence and argument by a member of the Tax Review Board and a decision rendered without further appearance by counsel, as the basic facts are not in themselves in dispute.

The appellant has been in the retail shoe business in Saskatoon for a great many years, and its president at the material time was a Mr Bert L Gladstone.

The evidence indicates that Mr Gladstone has been president of the company since its incorporation many years ago, and that in or about the year 1949 the company employed one Arnold J Hatton, who, at the time of his employment, seems to have been having difficulties of a personal nature. In fact, from the evidence of Mr Gladstone, it appears that Mr Hatton had been an alcoholic at the time he joined the appellant company. Apparently, with the encouragement and assistance of the president and other associates, he became a trusted and valued employee and continued as such at least until the year 1965. Over the period of years during which Mr Hatton was employed, the appellant’s president was in the habit of taking his vacation and leaving Mr Hatton in charge, and he found that Mr Hatton always acted in a very responsible manner on these occasions.

However, in the spring of 1965, the president noticed a change in the demeanour of Mr Hatton and found that the quality of his work had suffered considerably as a result. He became lax and, to use Mr Gladstone’s own words, “if I would assign him to a certain job, he would promise to do it and then it wasn’t done. I mean, it was just the opposite, all of a sudden.”

Mr Gladstone discussed the matter at home with his wife and came to the conclusion that the situation could no longer be permitted to continue. He therefore decided to have a serious talk with his employee, which he did, and he discovered that the alleged basis of Mr Hatton’s sudden lack of interest and loss of ability was the fact that he was indebted to many persons in a total amount of approximately $4,800. According to Mr Gladstone, Mr Hatton felt that, if he could find some solution which would help him to overcome this problem, he would be back to his effective and useful form to serve the company.

Mr Gladstone then decided to assist Hatton, and he requested that Hatton make out a list of all his creditors, regardless of the size of the amount involved, and submit it to Gladstone. This was done and, as I have previously indicated, the sum arrived at was about $4,800.

Mr Gladstone then decided to contact his solicitor, Mr J M Goldenberg, who had been solicitor to the company since its inception, and Mr Goldenberg informed him that this was a sizeable amount of money and should be handled in a proper and legal fashion. Accordingly, an agreement was drawn up by Mr Goldenberg on behalf of the appellant company, and was filed as Appellant’s Exhibit 1 during the hearing of this appeal. The agreement was between the appellant company and Mr and Mrs Hatton, and provided that the company would lend to the Hattons a sum of $5,000 to be repayable in the amount of $1,000 on the last day of December of each of the years 1966 through 1970, inclusive, without interest until due, and then, after the due date, interest was to be charged at 6% until paid. The agreement also provided that, in the event that Hatton’s employment with the company should for any reason come to an end, the balance of the loan was to become due and payable forthwith.

At the same time as this agreement was executed, the Hattons signed five promissory notes for $1,000 each, payable in accordance with the terms of the agreement. The agreement was signed on behalf of the company by Mr Gladstone and the corporate seal affixed, and the Hattons also signed. Mr Goldenberg had insisted that Mrs Hatton obtain independent legal advice, and the certificate of independent advice is affixed to the said exhibit.

It would appear, therefore, from the evidence, that the sum of $5,000 was advanced to Mr and Mrs Hatton in the form of a loan about the end of April 1965. Hatton continued to work for the appellant company and, in February of 1967, Mr Gladstone took his vacation, but when he returned he discovered that Mr Hatton had, as he put it, “started to drink again.” Gladstone then subsequently relieved Hatton of responsibility by taking the keys to the store away from him. Apparently the drinking problem continued and eventually — in the early summer of 1967, it would appear from the evidence — Hatton was discharged by Mr Gladstone on behalf of the company.

It would seem that Mr Gladstone has not seen Hatton since and, Mrs Hatton being without financial resources, no payments were ever made on account of the loan of $5,000 made by the company to the Hattons pursuant to the agreement (Exhibit A-1).

It should be pointed out, in passing, that although the first payment was due at the end of December 1966, Mr Hatton had informed Mr Gladstone that he had new and recurring financial problems at that time, and Mr Gladstone had agreed to postpone the first payment date until 1967, at the same time (or at approximately the same time) presenting Mr Hatton with a bonus cheque, dated December 24, 1966, in the amount of $1,000, which was filed as Appellant’s Exhibit 3 in these proceedings. Meanwhile, the loan was ‘carried on the balance sheet of the company, under the heading of “Assets”, as a loan receivable.

Eventually, after enquiries had been made by Mr Gladstone, he learned in effect that Mr Hatton had gone steadily downhill and had been seen on “Skid Row” in Vancouver and in similar districts in other Western Canadian cities. The entire debt was eventually written off in the year 1968 and becomes the subject, of course, of this appeal.

The appellant’s position is that the sum of $5,000 was necessarily laid out for the earning of income, whereas the Minister takes the position, first, that the amount was not laid out for the purpose of gaining or producing income, the expenditure having been made as an accommodation to an employee in a transaction outside the normal business of the appellant; and, secondly, that, even if it was an amount that could be considered to have been laid out for the purpose of gaining or producing income, it was laid out on capital account and the loss would constitute a capital loss.

At the hearing, the Minister indicated that he was not prepared to argue as to whether or not the year 1968 was the appropriate year in which the loss should have been written off, and so I do not direct myself to that issue in this decision.

The evidence of Mr Gladstone was that this man had been an A-1 person and a very effective employee for a number of years and so he felt that if Hatton’s financial problems were eliminated he wouild return to his productive self and again be a definite asset to the business. In cross-examination, Mr Gladstone stated that he had had a two-fold purpose in making this loan on behalf of the company. The first was to retain the services of a very competent person, and the second was to ease his own burden in operating the business. At the material time, Hatton was about 15 years younger than he and, according to Mr Gladstone, he had contemplated offering him the opportunity to become “a partner”, that is to say, a substantial shareholder, in the business. In his evidence, he says that Hatton was quite an asset to the business “when he was functioning normally”. In cross-examination (at page 25 of the transcript), when asked: “Well, I take it you hoped by doing this to continue having him in the business as an asset to the business?” he answered: “Yes, of course. No other reason.”

Mr J M Goldenberg, the company solicitor, was called and confirmed the evidence of Mr Gladstone to the effect that Hatton was so important to him that he was prepared to gamble $5,000 to keep his services. In argument, counsel for the appellant was very brief, and relied almost entirely on decisions of the Exchequer Court of Canada and, in particular, on the decision of President Jackett (as he then was) in Associated Investors of Canada Limited v MNR, [1967] 2 Ex CR 96; [1967] CTC 138; 67 DTC 5096.

In that case, the appellant company carried on the business of selling investment certificates to the public, and it employed salesmen paid on a commission basis and also employed sales managers, who organized and supervised the salesmen in particular districts and were remunerated by commissions based on the results achieved by the salesmen working for them. It is pointed out in the headnote of the Dominion Tax Cases report that, as a necessary feature of the business, the company made advances to each of its sales employees, which advances were ordinarily recovered by being set off against the commissions that from time to time became payable to the employee.

In 1954 Associated Investors of Canada Limited hired a district sales manager who had a previous record of success in a competitive business, giving him a special contract calling for large advances which, by 1960, had reached the sum of $85,000 in excess of commissions earned. The company therefore concluded that at least part of the unrepaid advances would not be recovered. The appellant in that case sought to deduct the sum of $25,000 in each of the years 1960 and 1961 by writing the amounts off to sales promotion expenses. The Minister disallowed the deductions and an appeal was taken to the Tax Appeal Board, where the Minister was upheld, and that decision was then appealed by the company to the Exchequer Court.

In his reasons for judgment, President Jackett states ([1967] CTC at 143; 67 DTC at 5099):

My first task is therefore to determine the proper treatment of the amounts in question in accordance with ordinary commercial principles. Having ascertained that, I must consider whether any different treatment is dictated by any special provisions of the statute.

He then goes on to discuss paragraphs 12(1)(a) and (b) of the Income Tax Act, citing the well-known cases connected with such sections as set out on the said pages 143, 5099 of the report. In the last paragraph on that page, he states:

No simple principle has been enunciated that serves, in all circumstances, to solve a question as to whether a transaction is a capital transaction. The general concept is that a transaction whereby an enduring asset or advantage is acquired for the business is a capital transaction;

and he cites British Insulated and Helsby Cables, Limited v Atherton, [1926] AC 205. He then goes on to say:

This is not, however, a concept that is easy to apply in all circumstances. Clearly, the acquisition of property in which to carry on the business, or of plant or equipment to be used in carrying on the business, is a capital transaction. The acquisition of less tangible assets of an enduring nature have also been held to be a capital transaction. Transactions whereby a “trading structure” is created are also capital transactions. The advances made by the appellant to its sales employees do not in my view fall in any of these categories. They were intended to provide the employees with an income during the periods while they were awaiting returns from their endeavours in the appellant’s service. They were by their very nature short term loans. They did not result in the acquisition of any asset or advantage of an enduring nature, nor did they create a “trading structure” of a permanent character. In my opinion, they were an integral part of the appellant’s Current business operations.

In my view, therein lies the distinction between the case to be determined and the Associated Investors of Canada Limited case (Supra). This was not a situation whereby funds were being advanced by the appellant company to an employee against future earnings. It was, to my way of thinking, purely and simply a loan made by the company to its employee to relieve him of the burden of debt he found himself under at the material time. The fact that the company, in so doing, felt that it would retain the services of this employee for a longer period of time does not, in my opinion, change the situation from that which existed in the cases of MNR v George H Steer, [1967] SCR 34; [1966] CTC 731; 66 DTC 5481; and C J Oliver Limited v MNR, [1970] Tax ABC 555; 70 DTC 1379. In the Steer case, it was a question of the appellant having guaranteed a loan to a company in which he was interested, and Judson, J at [1966] CTC 732; 67 DTC 5482, states, and I quote:

I have no difficulty in defining the character of this transaction. The company needed money for the drilling of three wells. The convenient way of supplying this money was by a bank loan with the respondent’s guarantee to the extent of $62,500. The guarantee means that at some time the respondent (Steer) might have to step into the bank’s shoes to this extent. This happened in 1957. He was then subrogated to the bank’s position.

Mr Justice Judson then continues on for a few more sentences before determining that this was a capital loss. Again, in the Oliver case, where a company with which the appellant had contracted ran short of money and the appellant therein made a loan against the personal note of a shareholder, which was not repaid, the loan was classified as a personal one, and it was held that the resulting loss could not in any way be construed as an operating expense: the loan did not contribute anything to the realization of the contract with C J Oliver Ltd.

I see no difference in the basic situation in the Steer case and that now before me for consideration, for whether the appellant guaranteed a bank loan for Hatton, or whether it used its own funds for the purpose of assisting him by way of a loan to reduce his indebtedness to his creditors, seems immaterial.

In this case the appellant was in the retail shoe business. It was not in the business of lending money. If the loan had been repaid in this instance, it would, in my view, have been the repayment of a capital loan and nothing more. It was not necessary to the appellant’s method of carrying on business to make advances to its employees such as was the case in the Associated Investors of Canada Limited matter. It continued to pay Hatton’s salary and, in fact, in the year 1966, as shown by Exhibit A-3, paid him a bonus of $1,000, showing, in my view, that the loan was in no way considered as prepayment for services yet to be rendered by Hatton to the company.

From the evidence contained in the transcript, the arguments recorded therein, the exhibits filed and a review of the cases cited, it is my considered opinion that the appeal must fail, and it is therefore dismissed.

Appeal dismissed.