As a condition to receiving a loan to fund the renovation of a property of the two registrants (the Castros), the Castros were required to transfer the property to a corporation of which they were equal shareholders (using the services of a notary appointed by the lender) and to pledge the voting shares of the corporation to the lender. Such transfer was made by the Castros for the sum of $1.00, and the transfer documents certified that the property was an exempt residential property. Later, in settlement of a dispute, the shares of the corporation were transferred to the lender. The Castros were subsequently assessed for failure to charge GST on the fair market value of the property on the basis that the transfer was a taxable supply. The Castros unsuccessfully tried to recover such tax from the corporation, and then claimed a bad debt deduction pursuant to ETA s. 231 equal to such tax assessment of them.
In confirming the denial of such claim, Smith J found that the share pledge did not remove the right of the Castros to elect the board of the corporation, so that the corporation and they were related persons pursuant to ITA s. 251(2)(b)(ii) and, thus, did not deal with each other at arm’s length pursuant to ETA ss. 126(1) and (2). Furthermore, in addition to thus not satisfying the requirement of s. 231(1) that the recipient was dealing at arm’s length with the supplier, the Castros had not satisfied the requirement in s. 231(1.1) that they had declared and remitted the tax on the supply. Smith J stated (at para. 47, TaxInterpretations translation):
It would be altogether too easy to avoid paying the tax if there was simply a failure to include it in the return, followed by a wait of several years for the tax authorities to assess it, only to claim a deduction at that point because the passage of years had rendered the claim uncollectible.