Fingold v. MNR, 92 DTC 2011, [1992] 2 CTC 2393 (TCC)

Rip, T.C.C.J.:—The appellants David B. Fingold ("David") and J. Paul Fin- gold ("Raul") have appealed income tax assessments for 1985 and 1986. At commencement of the appeals, which were heard on common evidence, counsel for the appellants informed the Court his clients abandoned two of the issues in appeal, that of standby charges for automobiles included in the incomes of the appellants for 1985 and 1986 and the cost of a computer for David's personal use paid by Fobasco Ltd. ("Fobasco") in 1985. The respondent also assessed the appellants on the basis David was deemed to have received a benefit in 1985 in accordance with subsections 6(9) and 80.4(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and that Paul was deemed to have received such benefits in 1985 and 1986. The respondent also added to David's income for 1985, pursuant to subsection 15(1) of the Act, amounts paid by Fobasco in the year toward the costs of the bar mitzvah of David's son and the wedding of his stepdaughter. The issues before the Court were:

(a) whether the appellants received loans or otherwise incurred debts by virtue of their offices or employment with Fobasco as contemplated by subsection 80.4(1);

(b) with respect to Paul's appeal for 1986, assuming he is deemed to have received a benefit in 1986 in accordance with subsection 80.4(1), whether the respondent calculated the amount of the benefit correctly; and

(c) whether Fobasco conferred on David a benefit in accordance with subsection 15(1) by paying a portion of the costs of the Bar Mitzvah and wedding.

At all relevant times Fobasco was, and continues to be, a private corporation, the shares of which were, and are, owned by David, Paul and family trusts of which the appellants were, and are, the sole trustees. Both David and Paul continue to be the corporation's directors; David has been president and Paul, secretary.

Capital or Loan

Mr. James Rowley, a chartered accountant employed by Fobasco during 1985 and 1986 as vice president, finance and treasurer, testified he was responsible for all financial aspects of the corporation and was aware of the transactions in issue between the corporation and the Fingolds. These transactions consisted of Fobasco paying personal expenditures of the Fingolds and the Fingolds withdrawing money directly from Fobasco. (Either of these transactions is sometimes referred to as withdrawals”.) In the first instance David or Paul would present an invoice to Fobasco for payment, a cheque would be issued and the transaction would be coded and posted to the general ledger. In the second instance a cheque would be issued to David or Paul personally by Fobasco on request of David or Paul and the withdrawal would be posted to the general ledger. No other corporate record reflected any withdrawal and neither a promissory note nor an agreement of loan was executed. Rowley said he was not aware of any repayments of withdrawals or if there was any intent on the part of the appellants to make any repayments.

Rowley accounted for the advances to David and Paul by recording them in the David Fingold loan account and the Paul Fingold loan account, respectively. He insisted the transactions could have been reflected “in any account. . . (because it was). . . for internal accounting purposes" since the withdrawals were "advances of capital of the corporation".

Fobasco's financial statements for 1983, 1984, 1985 and 1987 were produced by Rowley to demonstrate that the Fingolds had an established history of withdrawing money from Fobasco's capital. In 1983 Fobasco purchased for cancellation 40,000 common shares for $880,000. In 1984 and 1987 the company reduced its stated capital (on common shares) by $2,048,000 and $1,400,000 respectively. Dividends out of the company's capital dividend account were declared and paid to shareholders in 1985 ($5,640,000), [1] 1987 ($5,933,742) and 1989 ($2,476,373) Rowley suggested in 1985 and 1986 the Fingolds knew returns of capital by Fobasco woul be made shortly to them as shareholders and the withdrawals were made in anticipation of such returns of capital. He indicated the making of advances to the Fingolds was part of a tax plan to reduce capital and were not loans. He said that "today", he would “not call advances shareholders' loans' but ‘payment in advance of capital reduction'". In cross- examination, he admitted that as an accountant he was aware of the significance of the term“ shareholder loan account”.

Laventhol, Horwath were the auditors of Fobasco during 1985 and 1986 and Lloyd Weiss was the partner in charge of the account and gave advice to the Fingolds. [2] Weiss testified he was familiar with the withdrawals. He said he knew the withdrawals were recorded on the shareholders’ loan account but in his view they were reductions of capital. He said as an auditor he” "deals" with the corporation's fiscal year end and is concerned only with the balances of the corporation's accounts at the end of the year. He only deals with income on a year round basis. He testified it makes no difference how an accounting item is treated during the year if the account is correct at the end of the year.

Paul Fingold confirmed that he did not consider he would have to repay to Fobasco the withdrawals. In his view the advances were reductions of equity and were bona fide since an "officer was authorizing payment". He, himself, he said, was not responsible for determining how the advances should be recorded; this was Rowley's responsibility.

David Fingold agreed with his brother and Rowley that there was no understanding any amount advanced would have to be repaid. As director of Fobasco he agreed to the payments and advances and considered he and his brother were drawing on the capital of the corporation.

Calculation of benefit (J. Paul Fingold)

Paul claims that if he is to be assessed pursuant to section 80.4, the respondent erred in calculating the interest that is to be included as a benefit in his income for 1986.

The respondent attached to his replies to notices of appeal for 1985 and 1986 an Appendix “A”, a table indicating the calculation of the deemed interest benefit. In making the calculations, the respondent took the balance of Raul's shareholder's loan account at the beginning and end of each month, averaged these two amounts and computed interest on the average amount. An error was discovered by Rowley in April, 1992.

Apparently Raul's wife purchased on July 30, 1986, shares of Slater Steel Corporation ("Slater") in trust for Fobasco. Copies of the subscription agreement to purchase the shares for $1,957,500 and the trust agreement signed by Mrs. Fingold were produced at trial. The value of the shares was reflected in note 2 to Fobasco's financial statements for 1986. On July 30, 1986 Fobasco issued a cheque for $6,307,500 as payment for the shares of Slater acquired by Mrs. Fingold and, I assume, Fobasco itself. When the cheque was posted to Fobasco's accounts, the amount of $1,957,500 was posted in December 1986 to Paul’s shareholder's loan account. The posting should have been entered on July 30, 1986, said Rowley.

During June and July, 1986, Fobasco had also made purchases of Slater shares totalling $300,000 which were charged, again incorrectly, said Rowley, to Paul’s account. The correcting entry was made in December, 1986 rather than during June and July of 1986. No evidence was tendered at trial with respect to the $300,000 of shares, but it is my understanding documentation was forwarded to the respondent immediately after trial. [3]

Counsel for the respondent has since advised the Deputy Registrar that his client has no objection to the deemed interest benefit being adjusted in accordance with the calculations of Mr. Rowley (Exhibit A-7). I agree such action by the Minister would be in accordance with the evidence. Rowley's calculations reduce the benefit from $86,714 to $3,622.

Social expenses

David's son reached the age of 13 years in 1985 and, in accordance with Hebrew tradition, was called to read the appropriate portion of the Torah as bar mitzvah. After the religious ceremony a reception was held on what I understand to be the attractive grounds of Fobasco's head office on Bayview Avenue, near Lawrence Avenue, in Toronto and part of the cost of the reception was paid by Fobasco.

In October of 1985 David's stepdaughter was married in Toronto and a reception was held at a local hotel. Part of the cost of the wedding reception was also paid by Fobasco.

At both the bar mitzvah and the wedding there were two categories of guests: first, friends and relatives of David and his wife, who I shall refer to as '^personal guests”, and second, people with whom the Fingolds and Fobasco did business, or hoped to do business, and advisors to the company, who I shall refer to as" business guests”. Invited employees of Fobasco were included in the second category.

At the wedding, for example, there were 100 couples present, of which 27 couples were business guests. Fobasco paid 27 per cent of the total cost of the wedding and David paid 73 per cent of the cost. The corporation claimed deductions in computing its income for its portions of the costs of both events and did not charge David's account. The Minister added Fobasco’s portion of the costs to David's income for 1985 on the basis Fobasco conferred a benefit to him within the meaning of subsection 15(1) of the Act. [4]

The basis on which Fobasco deducted the costs of the receptions, said Rowley, was that business associates of the Fingolds and the corporation attended these functions. When Fobasco pays for other types of entertainment, Christmas parties, for example, it is permitted to deduct their costs. People invited to the other entertainments as well as the bar mitzvah and wedding receptions, according to Rowley, include people in the financial community, such as bankers and business consultants. Fobasco is a financial corporation, Rowley insisted, and inviting these “ people enhances the company's opportunity to earn income".

Weiss, as well as Rowley, was a business guest at the wedding reception. Weiss described himself as a business associate of the Fingolds and is friendly with them. He described the Fingold's entertainment style as"lavish. . . which works for them. . .”. He invited the Fingolds and other clients to one of his daughters' wedding. Weiss described these gestures as "good business. . . [it is] nice to be friendly”.

Paul testified he did not mind Fobasco paying part of the cost of receptions since the portion the company paid was business related and allows us to earn income". The guest list included professional advisors to Fobasco such as its lawyers and auditor as well as people who could direct"deals to us”. These people, Paul explained, were also invited to Christmas parties and at a later date some "give us deals”.

David testified he determined into what category each guest fell and in case of doubt, the guest would be placed in the personal guests category. Employees were invited because "we receive services far beyond what employees usually give. . . (and we). . . prefer to work with friendly people”. Lawyers, accountants and businessmen are invited because attractive potential investments come to these people's attention. He declared" I want people to think of me as a friend” and direct these investments to him. David acknowledged that friendship is a factor in inviting people to a wedding and bar mitzvah.

Submissions

Loans or Advances

Mr. Schnier, appellants’ counsel, submitted that Fobasco had a“ pattern” of returning equity to shareholders, particularly in 1983 and 1984, and a history of “cleaning out tax accounts”. When his clients caused Fobasco to pay personal expenses or issue cheques to them, he suggested, "in their minds” the Fingolds were reducing their capital in Fobasco.

Subsection 80.4(1) [5] applies only to situations where a loan is received or a debt is incurred between a corporation and an employee. Neither Fobasco nor any of the appellants intended the payment and receipt of the advances to create, nor did they create, loans or debts, said their counsel.

Counsel stated that the reasons of this Court in A.C. Simmonds & Son Ltd. v. M.N.R., [1990] 1 C.T.C. 2087, 89 D.T.C. 707, support the appellants’ position. Christie, T.C.C.J., said, on page 2089 (D.T.C. 709):

. . . Although an advance can be associated with a loan, it can also be a payment made that is to be accounted for later by a beneficiary thereof which is not a loan.

While a number of things can be the subject of a loan, subsection 17(1) is only concerned with money loaned. Definitions of a loan of money are to be found in a number of legal publications, but to my mind this definition in Black's Law Dictionary, 5th (1979) ed. is as useful as any: “ Delivery by one party to and receipt by another party of a sum of money upon agreement, express or implied, to repay it with or without interest." This is not, in my opinion, descriptive of the transactions involving letters of credit hat are under consideration in this appeal. In M.N.R. v. T.E. McCool Ltd., [1949] C.T.C. 395, 49 D.T.C. 700 (S.C.C.), Mr. Justice Estey said at page 413 (D.T.C. 708) with reference to the relationship of lender and borrower that: “It is necessary in determining whether that relationship exists to ascertain the true nature and character of the transaction.” [6]

Black's Law Dictionary, 6th ed., 1990, defines the word "loan" to include:

The creation of debt by the lender’s payment of or agreement to pay money to the debtor or to a third party for the account of the debtor. . ...

Counsel also suggests that his clients’ actions conform to the respondent's assessing practice described in Revenue Canada Interpretation Bulletins num- ber IT-222R, dated November 22, 1976, and IT-421R, dated July 9, 1984. The first Bulletin concerns advances to employees and the second concerns benefits to individuals, corporations and shareholders from loans or debt and refers to section 80.4. Paragraph 3 of Interpretation Bulletin IT-222R states that:

An advance on account of future earnings is a payment for salary, wages, or commissions that the employee is expected to earn by his future services and, in theory, the employee is not entitled to any further payment until services of a value greater than the amount of the advance have been rendered. Normally, the employee is not required to repay such an advance as long as he continues to render the services, and the fact that the employer is entitled to recover some part of it if the employee leaves before he has earned he full amount advanced does not change the nature of the payment. A payment is usually regarded as an advance rather than a loan, when no interest is payable and the only method of repayment provided for, prior to termination of the employment, is retention by the employer of part or all of the employee's earnings.

Paragraph 14 of Interpretation Bulletin IT-421R discusses the amount of a benefit applicable to a home purchase loan in accordance with subsection 80.4(4). At the end of paragraph 14 Revenue Canada explains:

It is the Department's view that a person or partnership has received a loan or incurred a debt when the funds are advanced or the indebtedness documents executed and the person or partnership becomes legally obligated to repay the loan or discharge the debt.

All of Rowley, David and Paul declared that there was no obligation by either David or Paul to repay any portion of the advances to Fobasco. In Tremblay v. M.N.R. (1963), 31 Tax A.B.C. 69, 63 D.T.C. 136, the shareholders of a corporation decided to liquidate the corporation on the completion of a housing project then underway. The minutes of the company showed it was in the process of liquidation. In the meantime the taxpayer withdrew funds from the company, such withdrawals being referred to in the company's minutes as “loans” or "advances". The amounts withdrawn by the taxpayer were assessed as deemed dividends under the provisions of subsection 8(2) [now 15(2)] of the Act. The Tax Appeal Board agreed with the taxpayer that the advances had been received during the liquidation of the company as a recovery of capital in advance rather than loans from the company to its shareholders.

An advance recovery of the capital, therefore, according to appellants’ counsel is not a loan and section 80.4 does not apply to the facts in these appeals.

Mr. Erlichman, the respondent's counsel, replied that in Tremblay, supra, the corporation was in the course of liquidation and this was reflected in the company's minutes. No minutes of Fobasco were produced at trial.

While it is a fact that the Fingolds and Fobasco did not execute any documentation to indicate loans nevertheless, respondent's counsel said, loans may be inferred. The corporation employed a chartered accountant who, at the time, referred to the payments and withdrawals as shareholders’ loans in the books of the corporation. There is a degree, counsel stated, to which taxpayers must accept the consequences of their actions. In Wood v. M.N.R., [1988] 1 C.T.C. 2312, 88 D.T.C. 1180, the taxpayer argued that the assessment of a deemed benefit was not justified because it was the intent of both him and his accountant that the company, of which he was a shareholder, pay dividends to be set off against his indebtedness to the company. His counsel argued dividends could have been declared at the beginning of the year, rather than the end of year, and if that had been done any advances paid to the taxpayer during the year could have been offset by dividends declared, but not yet paid. Therefore the circumstances of the case did not involve the abuse that section 80.4 was intended to curb.

Bonner, T.C.C.J., did not find the argument of Mr. Wood's counsel persuasive. He said, at page 2316 (D.T.C. 1182):

Subsection 80.4(1) of the Act requires that regard be had to the period in the year during which loans or debts are outstanding. The statutory language is quite plain. At the end of any day during the year the test can be applied and the quantum of the benefit can be determined to that time subject only to reduction in respect of interest actually paid by the debtor as required by paragraph 80.4(1)(c). The length of a period during which a loan is outstanding is not affected either by the formation of an intention to cause sufficient dividends to be declared to permit a set-off or by what might have been done. . . . Dividends do not become payable unless and until an authorized organ of the company declares them. [7] It has not been shown that any resolution was, in point of fact, passed prior to January 1, 1983, and thus that any dividend was declared prior to that day. It follows that there is no basis for a finding that any dividend was owing to the appellant. . . .

See also the comments of Mogan, T.C.C.J., in Austin v. M.N.R., [1991] 1 C.T.C. 2533, 91 D.T.C. 778, at pages 2536-37 (D.T.C. 781).

Considerations

In 1983 Fobasco purchased shares for cancellation, in 1984 and 1987 the company reduced its stated capital and in 1989 Fobasco redeemed preferred shares. At no other time was the company's stated capital reduced. The company elected to pay dividends out of its capital dividend account in 1985, 1987 and 1989; in 1978 Fobasco elected to pay a dividend out of its capital surplus on hand account. Regular dividends, that is, taxable dividends requiring no election in accordance with any provision of the Act, were paid to shareholders in 1985, 1987 and 1989. I cannot find any pattern in the decisions of the directors to declare and pay taxable dividends, or to reduce its stated capital by purchasing its shares for cancellation or repaying shareholders' capital. Certainly the fact that the corporation reduced its stated capital account on two occasions prior to 1985 and paid a tax-free dividend in 1985 does not constitute a history prior to 1985 of the company returning equity to shareholders or of paying tax-free dividends, as submitted by appellants’ counsel.

I find it difficult to accept the appellants’ submission that the advances were made in contemplation of distribution of capital. Counsel argued, in distinguishing Wood, supra, that in the appeals at bar there was no retroactive passage of a dividend but advances in anticipation of reduction in capital. Counsel stressed a return of capital differs from a dividend and, if I understood him correctly, he submitted that a return of capital may be anticipated and returned to shareholders prior to any technical corporate action being made. Counsel also seemed to distinguish tax-free dividends from taxable dividends since the tax-free dividends were part of the corporation's capital surplus prior to its declaration.

Fobasco was incorporated under the laws of Ontario and is subject to the provisions of the Business Corporations Act of that province ("OBCA"), 1982, S.O. 1982, c. 4. Subsection 24(1) of the OBCA requires a corporation to maintain a separate "stated capital" [8] account in its accounting records for each class and series of shares it issues. The stated capital may be reduced without amending the articles of incorporation but a special resolution of shareholders is required and the appropriate solvency test must be satisfied under section 34 of the OBCA. [9] A special resolution of shareholders is also required when the corporation wishes to reduce its stated capital by amending its articles: paragraph 167(1)(f) OBCA.

The OBCA also permits a corporation to reduce its stated capital by purchasing its own shares for cancellation. While no resolution of shareholders is required, unless stated in the articles of the corporation, a directors" resolution authorizing such action is necessary: subsection 30(2), sections 31 and 32. Any cancellation or redemption of shares is subject to a solvency test.

At no time when the advances were made by Fobasco to the Fingolds did the directors or shareholders of Fobasco indicate by resolution or otherwise that the company was to reduce its stated capital on the class of shares owned by the appellants, purchase any of such shares for cancellation or declare a dividend, tax-free or taxable, on such shares. Simple intent in the controlling minds of a corporation that a corporate action would take place does not consummate that action. In the same way the declaration of a dividend requires a resolution of directors a reduction of capital, whether by the corporation distributing capital to the shareholders or by purchasing issued shares, requires corporate initiative. For corporate purposes a tax-free dividend is no different than any other dividend and it too must be declared by resolution of directors before it is payable. As Bonner, T.C.C.J., declared in Wood, supra, an intention of a corporation to pay dividends subsequent to forwarding funds to an employee or shareholder is not sufficient to avoid the application of section 80.4. Bonner, T.C.C.J.'s comments are not restricted to dividends only but apply to any corporate distribution of funds requiring authorization of the corporation's directors or shareholders. In Tremblay, supra, the minutes of the corporation reflected a liquidation; in the appeals at bar no minutes reflected any so-called intended actions. The withdrawals were not paid as advances of capital.

A debt is created when a lender pays money to a third party on behalf of a debtor. Fobasco paid money to creditors of each of the Fingolds on his behalf. A debt is a sum payable in respect of a liquidated money demand. It does not include an unliquidated claim for damages. [10] A debt is a sum of money owed in respect of which a plaintiff has a right to bring and maintain an action. [11] If after advancing moneys to the Fingolds, Fobasco became either insolvent or bankrupt, the corporation would have had a right of action against the Fingolds for the return of the moneys paid on their behalf. For each day before the company actually passes the necessary corporate resolutions electing to pay a dividend out of its capital dividend account or decreasing its stated capital, the moneys paid to the appellants or their creditors is a "debt" owing to Fobasco. It is not until the resolutions are passed that the Fingolds and Fobasco are in a position to set off or balance their mutual debts.

The withdrawals were not advances in contemplation of reductions in Fobasco's capital but were loans directly from Fobasco and debts incurred by Fobasco on behalf of the Fingolds in accordance with subsection 80.4(1). As such, pursuant to subsection 6(9) the benefit determined by subsection 80.4(1) is to be included in income of both the appellants for 1985 and in Paul’s income for 1986.

Social Expenses: Submissions and Considerations

Counsel for David relied on the Tax Appeal Board decision in Roebuck v. M.N.R. (1961), 26 Tax A.B.C. 11, 61 D.T.C. 72 which held that entertainment expenses incurred for the purpose of earning income from a business are deductible in computing income “subject to the exception that the expenses allowable to personal pleasure or the convenience of the taxpayer may not be deducted”. The Board held that all of the cost of Mr. Roebuck's daughter's Bar Mitzvah was his personal expense, notwithstanding that 85 per cent of the guests were clients of his law partnership.

Mr. Schnier agreed that based on Roebuck, supra, Fobasco was not entitled to deduct in computing its income any of the costs of the wedding or bar mitzvah. However, he submitted that since Fobasco incurred the expenses for the purpose of earning income from its business, that is, for the company's benefit, the expenditures were not benefits conferred on David and were incorrectly included in his income pursuant to subsection 15(1) of the Act. [12]

In my view when a taxpayer carrying on a business incurs expenses to promote the business—and counsel for appellant's argument was that these expenses were incurred by Fobasco to promote its business—the target of the expense, that is, the person who the taxpayer desires to think kindly of it, must be aware that the taxpayer, and no one else, has actually disbursed the funds for that purpose. Otherwise the whole exercise is in vain.

There was no evidence that any of the business guests were aware that they were the guests not of David and his wife but of Fobasco. Weiss described himself as a “business associate" of the Fingolds. No person invited as a business guest, other than Weiss and Rowley, who were not wholly disinterested witnesses, was called to testify that he or she knew that he or she was a guest of Fobasco. There is no evidence that the invitations sent to the business guests were any different from those sent to personal guests. I assume that Mr. and Mrs. David Fingold invited the guests to the bar mitzvah and wedding and that there was no mention of Fobasco as host on the invitations or, for that matter, at the actual bar mitzvah and wedding receptions. The business guests had no idea they were invited to these affairs as guests of Fobasco. When guests are invited to a Fobasco Christmas party they know Fobasco is the "host". I have no doubt the business guests knew they were invited because they had business dealings with the Fingolds but this is not sufficient for Fobasco to claim the guests as its own.

A very fine but definite line exists separating personal and business related expenses. It is common practice for principal shareholders of a corporation, sole proprietors of a business, professionals and others carrying on a business to invite customers and clients and others with whom business is carried on to family functions such as weddings and bar mitzvahs. The outlays or expenses made or incurred by a taxpayer or a person related to the taxpayer, for the purpose of an essentially personal function cannot be said at the same time to be made or incurred by that taxpayer for the purpose of gaining or producing income from a business. An expense is either a personal expense or a business related expense and where the expense is incurred essentially for personal purposes it cannot at the same time be incurred for the purpose of earning income from a business. [13] There may be a slight difference in fact between the two but in law the difference is clear.

McNair, J. stated in Youngman v. The Queen, [1986] 2 C.T.C. 475, 86 D.T.C. 6584, at page 479 (D.T.C. 6587) that:

There is no definition of “ benefit” or “advantage” in the Act and the words are thus capable of the broadest possible interpretation. Nor is there any simple, prescribed formula for resolving any question of shareholder benefit within the meaning of paragraph 15(1)(c) Essentially, each case must be decided on its own particular facts.

In Cakebread v. M.N.R., [1968] Tax A.B.C. 531, 68 D.T.C. 424, at page 539 (D.T.C. 429), the chairman of the Tax Appeal Board referred to the dictionary definitions of the word "benefit":

In the Oxford Dictionary" benefit" is defined as "an advantage"; and the latter word is defined as "better position or favourable circumstances”. In the Random House Dictionary" benefit” is defined as anything that is advantageous or for the good of a person".

As a result of the payments by Fobasco for the wedding and bar mitzvah, David was financially advantaged and received a benefit within the meaning of subsection 15(1) of the Act.

Conclusion

The appeals of David Fingold will be dismissed. The appeal of J. Paul Fingold for 1985 will be dismissed but his appeal from his assessment for 1986 will be allowed, without costs, and referred back to the respondent only to recalculate the interest benefit in accordance with Exhibit A-7, that is to reduce the benefit to $3,622. [14]

Appeals dismissed.