James Taggart v. Minister of National Revenue, [1980] CTC 2322, [1980] DTC 1296

The Assistant Chairman:—While it would appear that the appellant appealed from an assessment for income tax for each of the years 1973,1974 and 1975, it is obvious no appeal was necessary for the 1973 year as the appellant’s objection to that year’s assessment was allowed in full.

In 1973, if not earlier, the appellant became the sole shareholder, director and main officer (his wife as secretary-treasurer was the only other officer) of Frank Taggart & Sons Limited (hereinafter called “the company”) having, before that date, purchased the interest of his brother in that company. At the end of the company’s 1974 year (all years are the calendar year), the appellant was indebted to the company in the amount of $48,736 according to the books of the company. According to those same books, at the end of the company’s 1975 year there was no account receivable from the appellant. The Minister of National Revenue saw things differently. He agreed with the books of the company that it had an account receivable from the appellant at the end of 1974 in the amount of $48,736 but he took the position that, rather than that account receivable being wiped out by the end of 1975, it in fact had increased by a further $611. In addition the company had not been repaid the increase in the account receivable by the end of the 1976 year. On these facts the Minister took the position that, since the account receivable owing by the appellant to the company in the amount of $48,736 at the end of 1974 had not been repaid by the end of 1975, it was in- come to the appellant in his 1974 taxation year. He took a similar position with respect to the $611 and added it to the appellant’s income in 1975.

The appellant’s position was that the account receivable had been repaid by crediting the account with $50,000 in 1975. As the amount of $50,000 was greater than his indebtedness, there was now an account payable to the appellant which was more than the amount assessed in 1975. In fact at the end of 1975 and 1976 there was an account payable to the appellant by the company.

The appellant’s wife owned free and clear in 1975 a home outside Hamilton, Ontario, which was stated to be worth more than $50,000 in 1975. There was no suggestion it was not worth that sum. According to the books of the company (details will be given later) the property was mortgaged to the company for $50,000, which amount was applied to the appellant’s indebtedness.

The evidence disclosed that at the end of the 1971 year the company had undistributed income on hand of $57,157.49. The company, anytime after 1971, with one exception could have paid a tax of 15% on that amount (a tax of $8,573.62—which it in fact did in 1977) which would have left a tax paid undistributed surplus on hand of $48,583.87. The company then of course could have declared a dividend in 1975 which would have paid to its sole shareholders, the appellant, who could have used it to discharge virtually all of his account payable to the company of $48,736. However, one event occurred (the Anti-Inflation Act) which at least deterred action in that respect and actually prohibited the paying of that dividend until late in 1977 when it was in fact declared and paid to the appellant who apparently used it to repay his wife and she then repaid the sum borrowed on her mortgage. On or about the 13th of October 1975, it was made known that there would be such an Act with certain guidelines which would be effective the next day. The Act itself was not assented to until December 15, 1975.

The company was a small company and it was not clearly known whether or not it was covered by the Anti-Inflation Act (hereinafter called “the Al Act’’). The accountant of the company and of the appellant was aware of the approaching date of December 31, 1975, with respect to the repayment of the loan. Around mid-December he received a copy of the Al Act and, among other things, saw that it could be the company would not be able to pay dividends greater than it did the previous year (when it paid none) and if it did and it was subject to the Al Act, there would be severe penalties. Since this intended avenue of repaying the loan was apparently blocked, he directed his mind to seeing in what other manner the loan could be repaid.

He called the appellant and suggested that:

1. Mrs Taggart borrow $50,000 from the company and give an unregistered mortgage to the company.

2. Mrs Taggart loan this money to the appellant.

3. The appellant repay his loan to the company.

4. In 1976 the company (if possible) declare a dividend.

5. The appellant, on receipt of the dividend, repay his wife who would pay off her mortgage to the company.

The appellant agreed to the suggestion and stated he would take it up with his wife. The appellant later advised the accountant that his wife concurred.

As at December 31, 1975, journal entries in the books of the company showed:

It was admitted that no cheque was received and no cheque was paid by the company. It was agreed all could have been accomplished by one journal entry, namely: “Debit mortgage receivable. Credit J Taggart.’’ It was also admitted that the mortgage was not delivered to the company until June 17, 1976. The mortgage was never registered. In December 1977 the solicitor for the company advised the Department of National Revenue that, pursuant to the provisions of the Income Tax Act, the company elected to pay a dividend out of its undistributed surplus on hand. At that time it filed the requisite forms and resolutions, and paid the tax due. The dividend was apparently used to discharge the indebtedness of Mrs Taggart to the company. A discharge of mortgage form was prepared. Since the mortgage had never been registered, the discharge was not registered.

Insofar as the mortgage was concerned, other than the note the accountant made (Exhibit A-8) as to what should be done, there was no minute or memorandum of the mortgage except the journal entries until June 17, 1976. While the mortgage called for 3% interest, no interest with respect to it was accrued or paid. While the home could have been mortgaged to a third party for cash, because of the time element, insofar as the appellant was concerned, this way of giving a mortgage was the most expeditious.

The appellant’s position is of course that the amount owing at the end of 1974 was repaid before the end of 1975 and the small advance in 1975 was really never an amount owing by the appellant to the company as, at that time, the company was indebted to the appellant. The respondent’s position is that the amount the appellant owed to the company at the end of 1974 was still owing (with a slight increase in amount) at the end of 1975.

The section which must be considered to decide whether or not the appellant has been correctly assessed is subsection 15(2) of the Income Tax Act. The relevant portions of that subsection are:

Where a corporation has in a taxation year made a loan to a shareholder, the amount thereof shall be included in computing the income of the shareholder for the year unless

(b) the loan was repaid within one year from the end of the taxation year of the corporation in which it was made and it is established, by subsequent events or otherwise, that the repayment was not made as a part of a series of loans and repayments.

Insofar as this appeal is concerned, the assessments under appeal are correctly made unless the appellant has established that “the loan was repaid within one year from the end of the taxation year of the lender in which it was made.’’ The appellant says the loan was so repaid and so the appeal should be allowed. The respondent says it was not and so the ap- peal should be dismissed. The appellant submits the mortgage was in effect repayment—Mrs Taggart decided the money she was to get was to be applied to the appellant’s indebtedness to the company. While there was no delivery of the mortgage until June of 1976, there was authority to make the journal and book entries, which the accountant did make as at the end of 1975, which created a debt by Mrs Taggart to the company and wiped out the debt of the appellant to the company at that date. The respondent’s position is that, even if the giving of a mortgage would satisfy the requirements of subsection 15(2), since no mortgage was given by December 31, 1975, the assessments are valid. He says that, even if the giving of a mortgage would satisfy subsection 15(2), an oral statement to the effect that “I will loan you $50,000 on a mortgage in 1976” is not giving a mortgage in 1975.

The appellant submitted that one must look at the total picture. The company, were it not for the Al Act, was in a position to declare and pay a dividend at the end of 1975 and, on receipt of the dividend, the loan could have been repaid. Something like this happened in 1977 when the dividend was paid. It was used to repay Mrs Taggart’s indebtedness and not the appellant’s as, according to the appellant, this had been done in 1975. We have one Act of the federal government saying you must repay and another Act of the same government saying you cannot via a dividend put yourself in funds with which you could repay. What was done at the end of 1975, namely, Mrs Taggart borrowing $50,000 by way of a mortgage from the company and loaning that sum to her husband so he could repay his loan, was the expeditious thing to do. As to the date of the mortgage, counsel submitted that a verbal agreement to give the mortgage was sufficient to be a mortgage and therefore the agreement, which was reflected in the accountant’s note and journal entries and corroborated by the appellant, was sufficient to consider the mortgage to be given and to be considered before the end of 1975 as repayment of the loan. There was no suggestion that I should not accept the testimony of the appellant or the accountant as to the conversation in 1975 and the agreement of Mrs Taggart to the suggestion. However it was submitted that that agreement was not a mortgage and so there was no repayment in 1975.

Both counsel referred to the case of Estate of Thomas James Johnston v MNR, 35 Tax ABC 18; 64 DTC 204. This case also involved the giving of a mortgage to discharge a debt or part of a debt a person owed to a company of which he was a shareholder. The Board member in that case in effect said that before the mortgage was given there was a simple debt by the shareholder to the company; after the giving of the mortgage it was a severed debt. At pp 26 and 209 respectively he states:

He owed $12,000 to the said company before making the mortgage, and he owed $12,000 after making the mortgage albeit a time limit was thereby placed on the repayment of the principal money and interest at 5 /2% per annum thereafter became payable.

Another consideration the Board member mentions is the mortgage itself. He queries whether or not it was given before the 1957 year-end and then observes:

As a matter of fact, the mortgage was not registrable in December 1957 because the affidavit of execution was not sworn until July 16, 1958.

He concluded his reasons by holding that delivery of the mortgage dated December 20, 1957, was not repayment and dismissed the appeal.

The Crown made reference to the case of Roger Gauthier v MNR, 19 Tax ABC 442; 58 DTC 425. The substance of this case was, before the year was up a company to which Gauthier was indebted assigned that indebtedness to another company with which it did not deal at arm’s length, nor did Gauthier, for a promissory note of the second company. That Board member just held that those transactions were not repayment.

In the instant appeal there is no confusion as to dates. There is no doubt when the transfer was made. All these facts were clearly and frankly stated by the appellant and the accountant. There is a debt to the company which in a couple of weeks will be outstanding at the end of the year and so taxable to the appellant. We have a telephone conversation between the accountant and the appellant concerning the appellant’s wife giving a mortgage to the company and loaning the money to the appellant to repay the loan. We have the appellant stating his wife agreed. We then have journal entries the result of which, on the balance sheet of the company at the 1975 year-end, is that the company has a mortgage receivable from Mrs Taggart and there is nothing receivable from the appellant. We do not have a mortgage from Mrs Taggart delivered to the company until June 1976. The mortgage is not from the debtor as it was in the Johnston case, which in effect was only changing the debt from an unsecured to a secured debt, but from a stranger with respect to property which was Clear in title and its value in excess of $50,000 was not disputed.

In the Johnston case the giving of a mortgage by the debtor could have been held not to have been repayment and so was the reason the appeal was dismissed, and in the Gauthier case a non-arm’s length assignment and the acceptance of a promissory note was not repayment. I am of the view that the promise in 1975 to give a mortgage is not repayment even if the giving of a mortgage by a third party were. At the end of 1975 the greatest asset the company had from Mrs Taggart was her oral agreement to mortgage her property to the company. It had not been mortgaged to the company at that time. I hold that a promise to do something is not repayment.

Consequently, judgment will go dismissing the appeal for the 1974 and 1975 taxation years.

Appeal dismissed.