Citation: 2009 TCC 196
Date: 20090408
Docket: 2007-3508(IT)G
BETWEEN:
935475 ONTARIO LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR ORDER
Jorré J.
Order sought
[1]
The Appellant seeks an Order:
(a) striking out the Reply because it discloses
no reasonable grounds for opposing the appeal, and granting judgment
accordingly; or, in the alternative,
(b) for the determination, before hearing, of 2
questions of law or of mixed law and fact, namely, whether in light of facts
alleged in the Notice of Appeal and admitted in the Reply,
(i) the earnout amount described in subparagraph
8(3) of the Notice of Appeal was or was not includible in the Appellant’s
proceeds of disposition of its shares of Tech-Trek Ltd. in its 2002 taxation
year, or
(ii) the Appellant was or was not entitled, in
its return of income for its 2004 taxation year, to make the election described
in paragraph 20 of the Notice of Appeal;
or, in the alternative,
(c) striking the following passages from the
Reply, to wit:
(i) in paragraph 5 of the Reply, the words “except
that he denies that the Minister’s disallowance was based on the fact that a
debt of $1,052,157.00 was not owing to the Appellant.”;
(ii) in subparagraph 6(b) of the Reply, the words
“a capital asset” and “and was therefore a capital debt.”;
(iii) all of subparagraph 6(d);
(iv) in subparagraph 6(e), the words “and there
is still the possibility of a future increase in the market to make the
necessary payments to 2000228 Ontario Inc.”;
(v) in subparagraph 6(h), the words “providing
it with the ability to pay a portion of the note if it so desired;
(vi) subparagraphs 6(i), (j) and (k); and
(vii) paragraph 11;
or, in the further alternative,
(d) for such additional relief and directions as
this Honourable Court may deem just and necessary to enable the Appellant’s
appeal to proceed and to secure the just determination of the real matters in
dispute.
Order striking out the Reply
[2]
Part (a) of the motion was not
pursued at the hearing.
Accordingly, I will not deal with it.
Determination
of a question pursuant to section 58 of the Tax Court of Canada Rules
(General Procedure) (the “Rules”)
Nature
of the issues under appeal
[3]
It will be helpful at this stage
to briefly outline the nature of the dispute. The Appellant and another
corporation, 935474 Ontario Limited (“474”), each owned half of the shares of a
company, Tech-Trek Ltd. (“TTL”). Eight employees of TTL incorporated a company,
2000228 Ontario Inc., the buyer. The buyer acquired 49% of TTL’s shares.
[4]
This transaction occurred pursuant
to a share purchase and sale agreement between the Appellant, 474, the buyer or
corporation and the eight shareholders of TTL. Pursuant to the agreement the
purchase price was somewhat more than $3 million and the Appellant and 474
received $1 million plus a promissory note from the buyer for the balance
of somewhat over $2 million (the “$2 million”). The promissory note
contains various conditions relating to payment of the $2 million. In
general terms it provides for the payment of interest on the note from the buyer’s
share of TTL’s annual operating profits, net of certain payments, distributed
to the buyer corporation after the deduction of a provision for the corporate
income tax payable by the buyer corporation on the distribution. 50% of any
remaining amount of the distribution to the buyer, after the deduction for tax
and the interest payment, is to be paid on account of the principal balance of
the note.
[5]
There are also provisions for what
will happen on September 30, 201l. Specifically the note provides the
following:
4. Should any amount hereunder for principal, capitalized interest,
or interest remain unpaid as of September 30, 2011, the Lender will have the
option to repurchase from 2000228 all shares in Tech-Trek owned by 2000228 in
consideration of the forgiveness by the Lender of the balance outstanding on
this note and a release by the Lender of any other security held by the Lender
with respect to such shares and this note, and the existence of such unpaid
amount shall not represent a default by 2000228 in respect of its obligations
under this note.
It
is not clear from the promissory note what happens if the option is not
exercised.
[6]
In its tax return for the 2002
taxation year the Appellant originally reported the entire amount of its share
of the sale as a capital gain. It also claimed a capital gain reserve.
[7]
The Minister assessed the return
as filed.
[8]
Subsequently, in its 2004 taxation
year the Appellant treated its share of the unpaid balance as a bad debt
pursuant to paragraph 50(1)(a) of the Income Tax Act (the “ITA”)
and reported a capital loss which it applied against the carry-forward of its
capital gain reserve. It also asked the Minister to reassess and apply portions
of its remaining net capital loss against the capital gains reported in the
2001 and 2002 taxation years. Initially the Minister assessed 2004 as requested
and reassessed prior years as requested.
[9]
Subsequently, the Minister
reassessed the 2004 taxation year to disallow the Appellant’s paragraph 50(1)(a)
election. The Minister also made consequential reassessments to the 2001 and
2002 taxation years.
[10]
One of the Appellant’s arguments
is that $2 million of the purchase price is an earnout amount that falls
within paragraph 12(1)(g) of the ITA and, accordingly, should not
be included in the proceeds of disposition.
[11]
The Minister alleges that the
Appellant only objected to its 2002 taxation year to protect its right to carry
back a net capital loss from 2004.
Put in other terms the Reply alleges that the issue of the application of
paragraph 12(1)(g) of the ITA was first raised after the
objection stage; it is a new issue before this Court.
[12]
The motion record included a
substantial part of the share purchase and sale agreement and the schedule
thereto but not the whole agreement.
Proposed determination of the first question
[13]
The first question submitted for the
proposed determination is whether on the facts admitted the $2 million
should or should not be included in the proceeds of disposition of the TTL
shares. The Appellant says that this amount would be income falling within
paragraph 12(1)(g) of the ITA. The Appellant stated that, if it
was held that the $2 million amount fell within paragraph 12(1)(g),
it would be content to be reassessed on that basis bringing the dispute to an
end. If the Appellant failed on
the issue, that issue would be resolved leaving the subsection 50(1) issue.
[14]
For reasons which follow
immediately below I have, with some reluctance, reached the conclusion that it
would not be appropriate for me to order the determination of a question on
this issue.
[15]
Paragraphs 4 to 10 of the Notice
of Appeal have been admitted including subparagraph 8(3) of the Notice of
Appeal which reads:
[T]he Buyer
issued a promissory note to the Appellant and 474 Inc. jointly, in which the
Buyer conditionally promised to pay them up to $2,104,313 of possible earnout
amounts out of TTL’s future profit distributions, if any, to the Buyer, plus
interest at the rate of 7 % per year on the unpaid balance of the earnout
amount;
[16]
However, paragraph 11 of the Notice
of Appeal is denied in the Reply.
Paragraph 11 reads:
The Sale
Agreement and the aforementioned promissory note contemplated that if, by
September 30, 2011, the Buyer had not yet been obliged to pay the maximum
$2,104,313 possible earnout amounts to the Appellant and 474 Inc., then neither
the Buyer nor any of the shareholders of the Buyer would be obliged to pay the
shortfall, and neither the Buyer nor any of the shareholders of the Buyer would
be considered to be in default of the promissory note or the pledge agreement
or the guarantees, but the Appellant and 474 Inc. would have an option to buy
back the Buyer’s common shares in TTL for a purchase price equal to the
shortfall in the earnout payments.
[17]
Paragraphs 2.2 and 2.3 of the
share purchase and sale agreement say:
2.2 Amount
of Purchase Price The purchase price payable by the Purchaser to the
Vendors for the Purchased Shares shall be the sum of Three Million One Hundred
Four Thousand Three Hundred Thirteen and 17/100, ($3,104,313.17) Dollars to be
satisfied in the manner hereinafter set forth.
2.3 Payment
of Purchase Price Payment of the Purchase Price shall be satisfied on
Closing by the delivery to the Vendors of:
(a) a
certified cheque or bank draft in the amount of $1,000,000 subject to any
adjustments which may be agreed upon by the parties to be made on Closing which
shall be made payable to the order of the Vendors or as they may direct; and
(b) a
$2,104,313.17 Promissory Note being in the form annexed hereto as Schedule
2.3(b.1).
[18]
One question that would arise in
the course of the proposed determination is whether the amount of
$2 million is, in fact, a variable amount based on the profitability of
TTL with a maximum amount of $2 million payable or whether it is a fixed
price and the profitability of the TTL determines the timing of the payments.
[19]
Paragraph 11 asserts that if the
$2 million amount has not become payable by September 30, 2011 then
there is no obligation to pay any balance of the $2 million remaining on
that date. In denying paragraph 11, the Respondent has clearly disputed what
may be an important fact in determining the proposed question of law.
[20]
In addition, paragraph 11 of the Reply
alleges:
He says that
if the principal and interest owing under the promissory note remained unpaid
as of September 30, 2011 the Appellant and 935474 Ontario Inc. had the
option to repurchase from 2000228 Ontario Inc. all the shares of Teck‑Trek
Ltd. owned by it NOT “for a purchase price equal to the shortfall in the
earn out payments”, as is implied in paragraph 11 of the Notice of Appeal, but
the forgiveness of the balance outstanding on the note would itself constitute
the consideration for the purchase.
[Emphasis in original.]
[21]
There is a dispute as to material
facts in respect of the proposed question of law to be determined and,
accordingly, it is not appropriate to order the requested determination.
[22]
In reaching this conclusion, I
have considered the material filed with the motion record, notably the share
purchase and sale agreement and those schedules that were reproduced. I have
also considered whether the determination could be on the basis of the facts
admitted and these materials.
[23]
It may ultimately turn out that
the allegations admitted and those materials will form the evidentiary basis
for determining the paragraph 12(1)(g) issue. However, there was no
agreement that that was the case and counsel for the Respondent pointed out
that the sale agreement refers to a number of schedules not all of which are in
the material before me. The Respondent stated that it had not seen all the
schedules and that the exchange of documents and discoveries had not yet
occurred. The other schedules may be relevant to the proper characterization of
the terms.
[24]
Whether or not the rest of the
agreement turns out to be material, the Respondent is entitled to examine it.
[25]
Given this conclusion, I do not
need to consider the other factors to be considered in deciding whether or not
to order a determination of this question.
Proposed determination of a question relating to
subsection 50(1) of the ITA
[26]
In its 2004 income tax return, the
Appellant elected to have paragraph 50(1)(a) of the ITA apply on
the basis that the $2 million was a bad debt.
[27]
The determination of whether a bad
debt is established in this case depends on making reasonable judgments on the
likelihood of future events over a long period given that the promissory note
contemplates payment of the $2 million over a period of more than
10 years with no fixed schedule for payment, that at the end of fiscal
2004 there were some six years left, that there is no allegation that any
amount was due and unpaid at that time and that there is no allegation that the
business had gone bankrupt or ceased to operate.
[28]
With respect to this question, the
Respondent admitted paragraphs 16 to 18 of the Notice of Appeal:
16. After the Sale Agreement was closed, the electronics component
industry in Canada became severely depressed following the collapse of Nortel Industries,
and consequently, in TTL’s 2002 fiscal year, its revenues fell by 59 % and
its profit before management fees fell by 92 % compared to fiscal 2001.
17. In the Appellant’s 2003 and 2004 taxation years, because of the
fall in TTL’s profitability, the Buyer did not have to pay, and the Appellant
and 474 Inc. did not receive, any earnout payment.
18. In TTL’s 2004 fiscal year, TTL suffered an operating loss of
$120,995.
The
Respondent also admitted paragraph 24 of the Notice of Appeal.
[29]
The Respondent denied paragraph 19
of the Notice of Appeal which reads:
As of the end
of the Appellant’s 2004 taxation year, the Appellant determined that the Buyer
would not likely ever have to pay any earnout payment to the Appellant or 474
Inc.. When making this determination, the Appellant took pertinent facts into
account and acted honestly and reasonably.
The
Respondent did not admit paragraph 25 of the Notice of Appeal.
[30]
The facts admitted in paragraphs
16 to 18 and 24 of the Notice of Appeal are elements that are supportive of the
conclusion that there is a bad debt. However, in and of themselves, and absent
other information, it is not clear that they are sufficient to establish that
the $2 million in question had become a bad debt. Further, the Minister’s
Reply pleads a number of assumptions which contain some elements which are
supportive of the conclusion that as of the end of the 2004 taxation year the
$2 million was not established to be a bad debt. These elements are in subparagraphs
6c) to k) of the Reply:
c) the promissory note matures on September 30, 2011;
d) at the maturity of the promissory note, the shares will revert
back to the Appellant if the balance outstanding is not paid which will provide
the Appellant with some value at that time;
e) Teck-Trek Ltd. is still in operation even though the net income
has declined and there is still the possibility of a future increase in the
market to make the necessary payments to 2000228 Ontario Inc.;
f) 2000228 Ontario Inc. is still an operating legal entity and the
corporation is not bankrupt or insolvent;
g) the shares of Teck-Trek Ltd. were still owned by 2000228 Ontario
Inc. and have not reverted back to the Appellant;
h) 2000228 Ontario Inc. did have taxable income in the year ended
March 31, 2004, providing it with the ability to pay a portion of the note
if it so desired;
i) the whole amount of the debt signified by the promissory note
had not become uncollectible during the Appellant’s 2004 taxation year;
j) there were no documented attempts to collect the debt;
k) the evidence does not support that no amount will be available
for repayment in the future;
[31]
While I agree with the Appellant
that in the application of paragraph 50(1)(a) the Minister cannot second
guess the reasonable business judgment of the Appellant, there must be a
reasonable basis to the determination of a bad debt. It is clear on the
pleadings that there is a factual dispute and, accordingly, it is not
appropriate to order a determination of this question. This question is best
left for determination at trial with a full set of facts in evidence.
[32]
As with the previous proposed
determination, given this conclusion it is not necessary for me to consider the
other factors relating to the decision whether to order, or not, a determination.
The motion pursuant to section 53 of the Rules
[33]
Turning to the second part of the
motion seeking an order striking certain portions of the Reply, it is useful to
quote section 53 of the Rules:
53. The
Court may strike out or expunge all or part of a pleading or other document,
with or without leave to amend, on the ground that the pleading or other
document,
(a) may prejudice or delay the fair hearing of the action,
(b) is scandalous, frivolous or vexatious, or
(c) is an abuse of the process of the Court.
[34]
On its face, it is clear that
section 53 is not about striking out poor pleadings but rather about pleadings
that will materially harm the litigation process. It sets a high standard.
[35]
It is useful in this context to
quote from Chief Justice Bowman, as he then was, in Gould v. The Queen:
23 Generally
speaking, the striking out of portions of a pleading under section 53 of
the Rules should be reserved for only the most plain and obvious cases.
Matters of weight and relevancy are best determined by the trial judge who
will have heard all of the evidence. Frequently the significance of a piece of
evidence will not become clear until the end of a case. I repeat what was said
in Niagara Helicopters Limited v. The Queen, 2003 D.T.C. 513 at 514-515:
[6] It is in
my view premature at this stage of the proceedings to determine that facts
which counsel for the appellant considers to be a relevant and necessary part
of the appellant's case are irrelevant. The authorities are undisputed that it
is only where it is clear and obvious that a pleading is scandalous, frivolous
or vexatious or an abuse of the process of the court that it may be struck out.
(Hunt v. Carey Canada Inc., [1990] 2 S.C.R. 959 at 980; Erasmus et
al. v. The Queen, 91 D.T.C. 5415 at 5416).
[Emphasis added.]
[36]
The first part of the Reply which
the Appellant seeks to have struck is a portion of paragraph 5 which the
Appellant says denies something that was not alleged.
[37]
I agree that, on reading properly paragraph
23 of the Notice of Appeal, the Reply denies what is not alleged. I can
conceive paragraph 23 being read differently and it may be that the words in
question were put in out of an abundance of caution.
[38]
In any event, while denying what
is not alleged is not particularly helpful, I find it hard to conceive how this
would prejudice or delay a fair hearing or how it would fall within either
paragraph 53(b) or (c) of the Rules.
[39]
The Appellant next seeks to have
the words “a capital asset” and “and was therefore a capital debt” struck on
the basis that these are conclusions of law or if it is a mixed question of
fact and law then the relevant facts underlying it should be explicitly stated.
[40]
Several comments are in order.
First, this is a mixed question of fact and law and not just a question of law.
[41]
Secondly, the situation here is
rather different from the usual situation. The Appellant filed on the basis
that the shares were capital property; indeed that was still the basis on which
the Appellant’s objection relating to the bad debt was filed. Consequently,
this assumption amounts simply to the Respondent confirming the reassessment,
in respect of this aspect, on the basis of the position taken by the Appellant
in filing its tax return.
[42]
I do not think the comments in Anchor
Pointe were intended to cover such a situation and I have some difficulty
in understanding why it should be objectionable in such a situation for the
Minister to accept the taxpayer’s position. I would add that there can be no
prejudice to the taxpayer who knows why it took a particular position in filing
its return and what facts it relied upon.
[43]
The next challenged part is subparagraph
6d) of the Reply. The Appellant says it is not an assumption of fact but an
argument and a speculation about what will happen.
[44]
Leaving aside the words “which
will provide the Appellant with some value at that time”, the rest of the
statements appears to be a brief statement of a term of the transaction.
Whether or not that finding is correct,
there is nothing wrong with briefly setting out terms of an agreement. Terms of agreements are
facts; their legal effect is a conclusion of law. It would be preferable to
state that one is referring to the terms of the agreement.
[45]
In the circumstances of this case
where no one is suggesting that the debtor has ceased to exist or operate and
where payment of the debt appears to have been contemplated over a period of several
years into the future, the question of establishing a debt to be bad
necessarily involves making judgments about the likelihood of future events based
on known events as of the end of fiscal 2004.
[46]
The words “which will provide the
Appellant with some value at that time” are an argument or the reasoning for
inferring a future event, that the Appellant will get something.
[47]
Does it harm the litigation
process that the Minister states in the assumptions of facts an inference of
fact he made and something of his reasoning? Perhaps it would be better placed
elsewhere but I have some difficulty in seeing the significant harm or
prejudice. It has the merit of explaining the Minister’s reasoning in
confirming. As a practical matter, a statement of reasoning or argument does
not affect onus and its merit is only as strong or weak as its inherent logic
or lack thereof.
[48]
I cannot see how the test in
paragraphs 53(a), (b) or (c) of the Rules is met.
Accordingly, it is not appropriate for me to order that subparagraph 6d) be
struck. For the same reasons, the words in issue in subparagraphs 6e) and h)
should not be struck.
[49]
Moving on to subparagraph 6i), the
Appellant’s main thrust is that this is a conclusion of law. The Appellant also
takes the position that it is vague and ambiguous.
[50]
Even if the drafting may not be
ideal, I find its meaning clear. It is a conclusion of fact and law, not just
law. There are factual elements alleged in support of the factual conclusion in
prior paragraphs. This again does not give rise to anything meeting the tests
in paragraphs 53(a), (b) or (c) of the Rules.
[51]
The motion challenges subparagraph
6j). I would observe that in the context of this dispute, I am not sure how
relevant this particular assumption is; however, that is an issue to be dealt
with at trial.
[52]
That was not the basis for the
Appellant’s challenge. The Appellant’s argument was that it was a conclusion of
law, that it was pure argument and presupposed a legal obligation to collect.
Given that subparagraph 6j) is in paragraph 6 which is about assumptions of
fact, I am unable to read this subparagraph as argument.
[53]
The use of the word “documented”
is somewhat surprising, but if one leaves it out, the statement “there were no
attempts to collect the debt” appears to be a statement of fact. The addition
of the word “documented” raises questions but it appears to amount to no more
than “there were no attempts to collect the debt for which documentation
exists”.
It does not amount to a conclusion of law. I see no reason to strike
subparagraph 6j).
[54]
The next subparagraph challenged in
the motion is 6k). This is not ideal drafting. Clearly this cannot be a reference
to the evidence that will be heard at trial or to all evidence that may exist
on the issues; it has to be a reference to the evidence before the Minister in
assessing and confirming.
[55]
Subparagraph 6k) amounts to this: the
evidence before the Minister in assessing and confirming does not support (the
conclusion) that no amount will be available for repayment in the future. The
Appellant says this is argument and speculation, not a statement of fact. The
Respondent’s counsel acknowledged that it was a conclusion of law as phrased.
[56]
It is not easy to categorize 6k).
It may well be argument regarding the evidence seen by the Minister. Viewed in
the best possible light, it is not an allegation of fact material to the
issues. What matters is whether or not there will be amounts available to repay
the debt in the future, not whether the evidence the Minister had in assessing
and confirming supports a conclusion one way or another.
[57]
Whatever subparagraph 6k) is, it
is not an assumed fact material to the issues.
[58]
Consequently, subparagraph 6k) may
be ignored and, as a result, it is hard to see the point of striking it. It is
not evident that the criteria of paragraphs (a), (b) or (c)
of section 53 of the Rules are met and, accordingly, there will not be
an order striking subparagraph 6k) of the Reply.
[59]
It may be useful to emphasize at
this stage that if something is in the assumptions which should not be, this
does not have the effect of changing or creating an onus which would not
otherwise exist.
[60]
Finally, paragraph 11 of the Reply
is challenged as argument and stating conclusions of law.
[61]
This paragraph sets out the effect
of some of the terms of the sale agreement and denies certain words in
paragraph 11 of the Notice of Appeal. Indeed, paragraph 11 of the Reply, in
part of the last two lines, is close to the wording of paragraph 4 at the top
of page 2 of the promissory note.
[62]
There is nothing wrong with
paraphrasing terms of an agreement although it would clearly have been
preferable if paragraph 11 of the Reply had made a specific reference to the
agreement and promissory note as does paragraph 11 of the Notice of Appeal,
although such a reference is implicit in the reference to part of paragraph 11
of the Notice of Appeal. Accordingly, no order will be made with respect to
this paragraph.
[63]
Often issues relating to
pleadings, particularly the Minister’s, arise because of the impact on onus. It
is worth remembering that there are not many cases where the outcome turns on
fine points of onus. Normally the trial judge is able to make the necessary
findings of fact without recourse to questions of onus.
Conclusion
[64]
The overall result is that the
motion will be dismissed. Costs are to be in the cause.
Signed at Ottawa, Canada, this 8th day
of April 2009.
"Gaston Jorré"
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