Dramar Investments Limited v. Minister of National Revenue, [1978] CTC 2936, [1978] DTC 1675

Delmer E Taylor:—These appeals relate to income tax assessments in which the Minister of National Revenue disallowed amounts claimed as capital losses for the years 1974 and 1975. The 1974 claim arose from the loss “carry-back” provisions of the Income Tax Act, SC 1970- 71-72, c 63, as amended, and therefore the 1975 amount represented in reality the total amount at issue. The statement of profit and loss for the appellant corporation for the year 1975 contained the following item:

The issue before the Board as whether or not, on the facts, the appellant was entitled to claim a loss of $53,331, and a determination of this would then be applicable to both years in question. The appellant relied on subsection 39(1), sections 54 and 248 of the Act; and the respondent relied, inter alia, upon sections 3, 38, 39 and 40, subsection 111(1) and paragraph 54(c) of the Income Tax Act.

Facts

The appellant (hereinafter referred to as ‘‘Dramar’’) is a corporation incorporated under Ontario law with its head office at Windsor, Ontario, and was at all relevant times a shareholder of 266591 Ontario Inc (Bavarian Inn) (hereinafter referred to as “Bavarian Inn’’), also an Ontario corporation with its head office at Windsor.

Bavarian Inn was incorporated February 16, 1973 and registered itself as trading or carrying on business under the name of The Bavarian Inn on June 6, 1973. The appellant was the beneficial owner of 5,330 common shares and 48,000 preference shares of the capital stock of Bavarian Inn, the shares being registered in the name of Charles Drakich (hereinafter referred to as “Drakich”) as Trustee for the appellant. The appellant paid $53,330 for the purchase of the said shares at the price of $1 per share. The appellant suffered loss of the whole of its investment of $53,331, which included a $1 qualifying share.

Contentions

It was the position of the appellant that the Bavarian Inn purchased from Metropole Hotel (Windsor) Ltd the business and assets of the restaurant and tavern business known as the Metropole Hotel (hereinafter referred to as “Metropole”), 917 Walker Road, Windsor, Ontario, on May 24, 1973. To facilitate the purchase of the business, the Bavarian Inn borrowed $280,000. The sum of $180,000 was borrowed from United Dominions Investments Limited (hereinafter referred to as “United”) upon security of a debenture constituting a fixed and specific charge on the chattel and real property assets purchased and a floating charge on the remaining undertaking of Bavarian Inn. The sum of $100,000 was secured by way of a purchase money second loan and chattel mortgage made by the Bavarian Inn to Metropole. The debenture to United was also guaranteed by individuals who were shareholders of Bavarian Inn and by Drakich. To facilitate the operation of the business purchased, Bavarian Inn also borrowed working capital from the Bank of Montreal (hereinafter referred to as ‘the Bank”), the aggregate amount of such borrowing reaching $45,000. The borrowing was guaranteed by the individual shareholders of Bavarian Inn and Drakich.

The Bavarian Inn operated the business and assets acquired as a restaurant and tavern business under the name of Bavarian Inn throughout the remainder of the calendar year 1973, through the calendar year 1974 and until January 1975. The business known as the Bavarian Inn was unsuccessful, became insolvent and was unable to meet its obligations as they fell due. In particular, Bavarian Inn defaulted in the payment of monies due to United, Metropole and the Bank. As a consequence of such default, United exercised the right under its security to give notice of intention to sell the charged property (the notice of Sale being dated December 5, 1974) and seized possession of the real property and chattel assets charged on January 2, 1975 and became a mortgagee in possession. In addition, United made a claim against the individuals who were shareholders of Bavarian Inn, as well as Drakich, upon the guarantee made by them of the indebtedness of Bavarian Inn. In addition, the second mortgagee commenced proceedings by way of foreclosure and sale under its second mortgage. From time to time several of the individual shareholders advanced monies to Bavarian Inn, secured the advances by way of a third mortgage and assigned the third mortgage to the Bank which, by reason of the defaults in the monies due it, also made claims against Bavarian Inn, the individual shareholders and Drakich, and this eventually led to such persons paying to the Bank the debt due upon the guarantee inasmuch as the Bank was unable to recover any money whatsoever from Bavarian Inn. Furthermore, by reason of defaults, in the payment of Bavarian’s obligations generally, actions were commenced by unsecured creditors and judgments were secured by the Ontario Ministry of Revenue in unpaid sales tax and by the Department of National Revenue of Canada for unpaid withholding tax. The insolvency of the Bavarian Inn was such that it was totally without assets, there was no equity of any kind for unsecured creditors and no equity for shareholders. In October 1975, United disposed of the seized property to Walker 917 Tavern Limited for a purchase price stated in the relevant land transfer tax affidavit of $240,000, of which $185,000 was secured by debenture given by the purchaser to the vendor. Thus, the property was disposed of by United for an amount which was less than the total sum due to United and Metropole, the aggregate of whose claims for principal were $280,000, plus accumulated interests and costs.

By reason of one or more of the events of defaults seizure and sale, and the insolvency of Bavarian Inn, Dramar suffered a capital loss and these same events of default, seizure and sale created a disposition of the appellant’s investment in Bavarian Inn, the proceeds of which were nil.

It was contended by the respondent that:

— the appellant incurred no capital loss in its 1975 taxation year;

— the amount of net capital loss available to the appellant to carry back to its 1974 taxation year was nil.

Evidence

Evidence and documentation in.support of the contentions of the appellant were given by Mr Charles Drakich and Mr Edward J Chauvin, chartered accountant.

Argument

Counsel for the appellant quoted an explanation provided by. the Department of National Revenue in connection with the assessment:

A capital loss is realized on sale of Shares, bankruptcy of the company, surrender of the charter, or cancellation of the charter by ‘the Province and as none of these events occurred during 1975, the capital Joss is not allowable for the year.

In summary, he argued that the insolvency of Dramar, which had been clearly demonstrated by the evidence presented, also should qualify for inclusion under the term “disposition” for purposes of interpretation of the Act.

Counsel for the respondent, while recognizing the difficulty which faced the taxpayer, nevertheless took the position that the definition of “disposition” had been established by earlier case law, and the situation evident in this case did not fit within the known parameters.

Reference was made to the following:

Harman v Gray-Campbell Limited, [1925] 1 WWR 1134; Victory Hotels Ltd v MNR, [1962] CTC 614; 62 DTC 1378; Lord Elgin Hotel Limited v MNR, 36 Tax ABC 268; 64 DTC 637; [1969] CTC 24; 69 DTC 5059; Rex v Ball, [1937] 1 WWR 482; William Paul Fedak v MNR, 32 Tax ABC 311 ; 63 DTC 586; Hilda M Costen v MNR, [1972] CTC 2372; 72 DTC 1311; Marlow Enterprises Limited v MNR, 42 Tax ABC 419; 67 DTC 26.

Findings

The sole point to be decided in these appeals is — notwithstanding the fact that the security in question remained in the beneficial ownership and control of the appellant — whether the worthlessness of the security was a condition allowing the taxpayer to claim “disposition” for purposes Of the Income Tax Act. In a recent decision of this Board, Fred E Coombs and Estate of Fred E Coombs v MNR, [1978] CTC 2508; 78 DTC 1370, a similar matter was reviewed in some detail, and the appeal dismissed. There is, however, a new factor in the instant case which warrants re-examination — that upon which the entire casé of the appellant is founded. This is the explanation provided by the Minister of National Revenue in reassessing the corporation and disallowing the capital loss — it is worth repeating:

A capital loss is realized on sale of shares, bankruptcy of the company, surrender of the charter. or cancellation of the charter by the Province and as none of these events occurred during 1975, the capital loss is not allowable for the year.

I have grave difficulty relating this extended definition to the precise wording of the Act relative to the matter. While the sale of shares would normally be a “. . . transaction or event entitling a taxpayer to proceeds of disposition . . .” (subparagraph 54(c)(i)), I foresee no such expectation in a bankruptcy, or the surrender or cancellation of the charter. It is less than certain that these eventualities are covered under subparagraph 54(c)(ii), in my opinion. While it is reasonable to assume that any of these events might include or lead to the cancellation of the company shares, thereby fulfilling the condition outlined in clause 54(c)(ii)(A), it would be that transaction — the cancellation, when, as, and if it developed, not embarking on a course toward that end — which would permit the applicability of the term “disposition”.

Counsel for the appellant has contended that if these three enumerated events (bankruptcy of the Company, surrender of the charter, or cancellation of the charter) fell within the ambit of the relevant provisions of the Act, the same treatment should apply in equivalent terms to the insolvency of Bavarian Inn, and the resulting total loss of value in the appellant’s share investment in that business. Having outlined above my reservations regarding the amplification of the term “disposition” provided in the explanation attached to the Minister’s reassessment, it is evident that I could not view with favour an extension of the same general hypothesis even further by the appellant.

There are perhaps two other points worthy of mention in this matter. The first is that it is difficult to visualize, except in unusual circumstances, a transaction or event other than a sale which would. meet the stringent requirements for disposition which seem evident in the Act, particularly when the property involved is an investment, in company shares. The second point is that the Board recognizes the limitations and constraints imposed by law on the individual actions of a shareholder, in particular a minority shareholder. I can conceive of a Situation in which the shareholdings of a taxpayer would be worthless to him, but he would be unable to sell them, even transfer them at no value, because they might be regarded as a liability by some other party. At the same time he might also be inhibited, even prevented by the other shareholders or by circumstances, in any attempt to seek tax relief through bankruptcy of the company, or surrender, or cancella- tion of its charter — even if such processes were deemed acceptable under the Act. Counsel for the appellant in this matter made a strong point that a “transfer” of shares under such circumstances, merely to get rid of them, could raise questions of “bona tides” from the taxing authorities, and at best would be only an artificial transaction. I can hardly quarrel with his assessment of that situation as it now stands, but I would point out that while the corporate format for business operations is recognized and acclaimed by investors and businessmen alike for its convenience and advantageous characteristics, its use for such commercial purposes carries with it the distinct obligation for the same parties to understand and accept the restrictions and parameters inherent in the corporate structure, from a taxing perspective. In the instant case, there was no disposition as defined for purposes of the Income Tax Act.

Decision

The appeals are dismissed.

Appeal dismissed.