Date: 19981203
Docket: 97-3235-IT-I
BETWEEN:
OREST V. NOWAKIWSKY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Christie, A.C.J.T.C.
[1] This appeal is governed by the Informal Procedure
prescribed under section 18 and following sections of the Tax
Court of Canada Act.
[2] The issue is whether the appellant is entitled to deduct
an allowable business investment loss ("ABIL") of
$102,479.00 in computing his income tax for 1992.[1] The loss is said to have been
incurred in 1990 and carried forward to 1992. It is made up of
two categories: first, a shareholders loan to Memtek Corporation
("Memtek") in the sum of $97,262.00. Second, amounts
totalling $39,377.00 alleged to have been expended by the
appellant for the business purposes of Memtek. These are also
characterized by the appellant's agent as a shareholder loan
to Memtek. Particulars are set out in Ex. A-1-7. It reads:
1990 ALLOWABLE BUSINESS
INVESTMENT LOSS
1. Shareholder loan balance of May 31, 1984
(As Reassessed by Revenue Canada) $ 97,262.00
2. American Express
- travel paid by Orest Nowakiwsky 4,801.31
3. Mastercard
- paid by Orest Nowakiwsky $ 7,106.61
589.00 7,695.61
4. Legal and accounting fees paid
by Orest Nowakiwsky personally
on behalf of Memtek corporation. 18,447.00
5. Scotia-Line
(incurred on behalf of Memtek
corporation) 8,433.05
Business Investment Loss 136,638.97
x 75%
Allowable portion $102,479.22
[3] Memtek was incorporated in May 1980. Its purpose was
"to conduct business in the field of reverse osmosis, to
commercialize technology that was developed at N.R.C. in the
field of membrane technology and in particular reverse osmosis
and ultra filtration". The appellant was president and the
majority shareholder. There is also evidence of the incorporation
of Memcare Corporation ("Memcare") in 1982. The
appellant referred to it as a "sister corporation". It
provided technological and consultation services to Memtek. It
was also controlled by the appellant.
[4] Memtek was indebted to the Canadian Imperial Bank of
Commerce in the sum of approximately $125,000.00. In 1985 it was
in financial difficulty. Repayment of the loan was demanded and
this led to the appointment on August 9, 1985 of Thorne,
Riddell Inc. as receiver. A vice-president of that corporation,
Brian P. Doyle, C.A., dealt with this receivership.
[5] The appellant's employment was terminated on September
23, 1985 and he was denied further access to Memtek's
premises. By mid-October the employment of all employees of
Memtek had been terminated. Memtek's assets were sold. Among
the purchasers of these assets was the appellant. By bill of sale
dated November 26, 1985 he acquired specified assets "In
trust for Memcare Corporation". The assets were: an F.D.I.R.
which is an instrument that measures organic compounds, a welder,
a milling machine and an I.B.M. computer system.
[6] A statement of claim dated March 4, 1987 issued out of the
Supreme Court of Ontario. Memtek and the appellant were the
plaintiffs. The defendants were the Receiver and Doyle. Memtek
sought damages for breach of contract and future loss of profit.
In the alternative it asked for damages for breach of a fiduciary
relationship. The appellant claimed damages for breach of
contract regarding services performed by him for the defendants.
Paragraphs 4 to 8, 17 and 18 of the statement of claim read:
"4. The Plaintiff, Memtek Corporation, is a company
incorporated pursuant to the law of Canada and carries on
business in the Regional Municipality of Ottawa-Carleton.
5. The Plaintiff, Orest Nowakiwsky, resides in the Regional
Municipality of Ottawa-Carleton and was, at all material times,
the President and Chief Operating Officer of Memtek
Corporation.
6. The Defendant, Brian Doyle, is a Chartered Accountant
residing in the City of Ottawa, in the Regional Municipality of
Ottawa-Carleton and was, at all material times, a partner in the
chartered accounting firm of the Defendant, Thorne Ernst &
Whinney, the successor to the firm of Thorne Riddell.
7. The Defendant, Thorne Ernst & Whinney, is a body
corporate, carrying on a chartered accounting practice in the
City of Ottawa, in the Regional Municipality of Ottawa-Carleton,
and is the successor to the firm of Thorne Riddell.
8. The Plaintiff corporation carried on business in the
Regional Municipality of Ottawa-Carleton from July of 1990 until
August of 1985. The Company was in the process of manufacturing
reverse osmosis equipment for the filtration of liquids, and at
all material times the Plaintiff, Orest Nowakiwsky, owned
seventy-four percent (74%) of the Corporation.
17. The Defendants proceeded to carry on as Receivers pursuant
to the provision of the Security Agreement but did not proceed to
restructure the Company but seized all of the assets of the
Company, terminated the employees and wound up the Corporation
including the sale and assignment of the trade marks of the
Plaintiff Corporation.
18. As a result of the Defendants' actions, the Plaintiffs
lost all of the Sales Contracts that they had entered into, lost
the ability to continue with the research and planning, and lost
the ability to carry on business."
[7] An order issued on consent of the parties dismissing the
action without costs. The order is dated December 28, 1988. The
appellant said that the action was discontinued because of his
inability to finance it further. The statement of claim and this
order were placed in evidence by the appellant.
[8] Memtek became involved in the United States in a trade
mark dispute with a Massachusetts corporation also called Memtek
Corporation. A Washington firm of attorneys had been acting for
Memtek. It withdrew from the proceedings by application made on
April 19, 1990 to the U.S. Department of Commerce, Patent and
Trade Mark Office. This was also related to a lack of funds.
[9] Memtek was dissolved on October 4, 1993 for failure to
file annual returns. This is set out in a letter sent by Industry
Canada dated February 14, 1997.
[10] Counsel for the respondent placed in evidence the
appellant's income tax return for 1992. It shows total income
of $230,000.00. Apart from 1985 there is no evidence regarding
the appellant's income in other years.
[11] Exhibit A-1-7, which is reproduced in paragraph 2 of
these reasons, pertains to the appellant's shareholder loan
balance as of May 31, 1984 in the sum of $97,262.00. Counsel for
the respondent placed in evidence a Notice of Reassessment
addressed to the appellant. It relates to his 1985 taxation year
and it adds 50% of $97,262.00 or $48,361.00 to what may be
deducted.[2] In the
result the appellant's "Revised Taxable Income" for
that year was minus $43,240.00. Counsel placed in evidence a
further Notice of Reassessment also addressed to the appellant.
It relates to his 1992 taxation year and it allows as a deduction
a non-capital loss of $43,240.00.
[12] As will also be seen from Ex. A-1-7 the amount of
expenses alleged to have been incurred by the appellant on behalf
of Memtek totals $39,377.00. This consists of four items.
[13] First, $4,801.00 paid to American Express. Ex. A-1-8
dated December 29, 1992 shows the breakdown of this amount and
states: "During the course of the receivership,
Mr. Nowakiwsky incurred the following expenses trying to
raise financing for the company."
[14] Second, $7,696.00 paid to Mastercard. This is made up of
$7,107.00 and $589.00. A Mastercard statement for September 9,
1985 shows a new balance of $7,107.00, but this does not
establish precisely when these charges were incurred or their
purpose. The same document shows that between July 6, 1985 and
September 9, 1985 $535.00 was charged to Mastercard. The
greater part of these individual charges pertained to restaurants
in Nepean and Ottawa. The average charge was $8.25. This suggests
to me expenditures within the ambit of the phrase "personal
and living expenses" rather than outlays for the business
purposes of Memtek. In referring to this document the appellant
said:
"Most of these you will notice are restaurant bills where
we took out – we basically had lunch meetings during which
we discussed the various business matters, and in particular
towards the end of July and August they mainly centred on
refinancing the company."
As for the $589.00, all there is is a Mastercard document
indicating that payment of that amount was received on August 9,
1985.
[15] Third, there is legal and accounting fees paid on behalf
of Memtek. The amount is $18,447.00. Ex. A-1-10 shows legal
fees of $11,217.00, all of which relates to MEMTEK CORPORATION
AND OREST NOWAKIWSKY, Plaintiffs and THORNE ERNST & WHINNEY
AND BRIAN P. DOYLE, Defendants. These were billed in October
1986, September 1988 and February 1989.
[16] The accounting fees are said to have been incurred in the
sum of $6,766.00 billed by Cox, Snowdon & Merritt, Chartered
Accountants on March 15, 1988 ($3,000.00) and in December 1988
($3,736.00). Ex. A-1-10 states the accounting fees were incurred
to: "(1) Prepare May 31, 1985 financial statements and
Federal and Provincial corporate tax returns; (2) Prepare
Corporation Part VIII tax return to eliminate a part VIII
tax assessment of $1,029,968.68." The appellant's agent
said the balance of $464.00 could not be substantiated
($18,447.00 - $11,217.00 + $6,766.00 = $464.00).
[17] Fourth, there is $8,433.05 paid to Scotia-Line. The
documentary evidence in this regard is a two-page document
entitled "Memtek Corporation accounts payable as of August
9, 1985", one item of which is "Scotia Bank
$8,433.05" with a hand-written note "Paid by
Orest". The appellant said that document was prepared by the
Receiver. There is also a statement from Scotia Bank-Scotia Line
dated June 14, 1985 showing the balance due by the appellant
to be $7,663.51.
[18] The appellant placed in evidence financial statements
showing that during the period May 31, 1986 to May 31, 1992
Memcare had income of $1,389.00, $48,968.00, $11,715.00,
$55,753.00, $18,566.00, $28,650.00, $549,015.00 respectively.
[19] In the course of cross-examination this exchange took
place between counsel for the respondent and the appellant:
"Q. Yes, but in 1985, when all the assets were sold and
most of the creditors weren't able to get paid, it was
reasonable for you to assume that you weren't going to get
paid your shareholder loan if you were behind all of these other
creditors?
A. Well, of course, yes.
Q. And why wouldn't you have claimed the loss in 1985?
A. I was in such state of mind that I did not even file income
tax returns until probably I think 1988 or so.
Q. And we're talking about personal tax returns?
A. Personal tax returns. That whole idea of – like, I
was devastated by this whole operation, where all my personal
finances, my whole life energy went into restructuring this
company, and it was all destroyed and removed from me. So it took
a while for me to even get my mind around the idea of how to
proceed. And I believe it was only in '88 or so that I
started to tie up the loose ends concerning the operation, and
asked Mr. Snowdon to file tax returns both for the company
for myself."
A little later the appellant testified that the last income
tax return filed by Memtek was in respect of 1985. This was done
in 1988.
[20] Regarding the expenses said to have been incurred by the
appellant on behalf of Memtek after the Receiver was appointed,
he was asked if this had been done with the acquiescence of the
Receiver. He replied: "Some actions may have been." At
the end of cross-examination he stated that the Receiver refused
to honour those claims. It took the position that these outlays
had been made without its authority.
[21] This is said in Shkolny v. The Queen, [1996] 3
C.T.C. 2532 (T.C.C.) at 2535:
"A business investment loss for a taxation year is a
capital loss and one of the circumstances that can create such a
loss under the Income Tax Act (the 'Act')
is where an individual has lent money to a Canadian-controlled
private corporation that is a small business corporation[3] and the debt is
established by the individual to have become a bad debt in the
year: (paragraph 39(1)(c) and subsection 50(1) of the
Act).
I emphasize that the loss is capital in nature. Section 40 of
the Act states general rules applicable to taxable capital
gains and allowable capital losses. What is relevant for the
purposes of this appeal in subparagraph 40(2)(g)(ii) of
the Act provides that a taxpayer's loss from the
disposition of a debt, is nil unless the debt was acquired by the
taxpayer for the purpose of gaining or producing income from a
business or property.
An allowable business investment loss is a fraction of a
business investment loss. For 1991, the year under review, that
fraction is ¾:[4] (paragraph 38(c)). The usual rule that capital
losses can only be offset against capital gains does not apply to
an allowable business investment loss. Under paragraph 3(d) of
the Act an allowable business investment loss is treated
on the same basis as a non-capital loss from such sources as
employment, business or property, resulting in allowable business
investment losses being deductible against all sources of income
in calculating income."
[22] The appellant contends that basically it is for the
taxpayer to determine in what year a debt owing to him became a
bad debt and in this regard the Court was referred to Beaudry
v. The Queen, 98 DTC 1898 with special emphasis on what Rip,
T.C.J. said at page 1903. I agree. But these reasons for judgment
also indicate that a taxpayer is not vested with unfettered
discretion to make the determination. It must be reasonable
having regard to all of the relevant circumstances.
[23] In my opinion the evidence clearly establishes that any
debts owing by Memtek became bad debts by the end of 1985. By
that time the Receiver had put an end to the appellant's
employment by the company and he was barred from the
company's premises. All of the persons employed by Memtek
were no longer employees. The company's assets had been sold.
There is no evidence of business activity by Memtek after that
time. Paragraph 18 of the Statement of Claim states that as a
result of the Receiver's activities Memtek "lost the
ability to carry on business". The last return of income
filed by Memtek was in respect of 1985.
[24] Further, the evidence indicates that after the Receiver
was appointed on August 9, 1985 the appellant was without
authority to create the relationship of creditor and debtor
between himself and Memtek. What he did in this regard was in
defiance of the Receiver.
[25] The whole of the evidence leads to the conclusion that
this appeal cannot succeed. Accordingly judgment shall issue
dismissing it. I believe this is consonant with the decision of
this Court in Duncan v. M.N.R., 86 DTC 1549.
Signed at Ottawa, Canada, this 3rd day of December 1998.
"D.H. Christie"
A.C.J.T.C.C.
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