Citation: 2006TCC530
Date: 20061002
Docket: 2003-3762(IT)G
BETWEEN:
MARIA MACKAY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
O'Connor, J.
[1] The only issue in
this appeal is whether in the 2001 taxation year the Appellant had a business
investment loss ("BIL") as defined in paragraph 39(1)(c)
of the Income Tax Act ("Act") and thus be entitled to
claim as a deduction from income an allowable business investment loss
("ABIL") (50% of the BIL) pursuant to paragraph 38(c) of the Act.
[2] The Reply to the
Notice of Appeal also refers to a claim by the Appellant to deduct legal fees in
the amount of $6,667 but, as indicated by both parties at the hearing of this appeal,
this was no longer an issue.
[3] The amount of the
ABIL in question is $26,324.97. It results from a loan made by the Appellant in
1990. It is not necessary to review the exact amount of the loan and the
amounts repaid prior to the debt becoming bad, as it is common ground that the
actual amount of the ABIL claimed was $26,324.97. Calculations are submitted
later in these Reasons which appear to support this number.
[4] Nor is it necessary
to review several of the conditions required for the deduction of an ABIL pursuant
to Section 3, paragraphs 38(c), 39(1)(c) and subsection 50(1)
of the Act. The only question requiring analysis is whether the loan by
the Appellant was made to an individual or to a corporation, because each of
the two corporations involved that might be considered as the possible borrower
of the loan in question are assumed to qualify as a Canadian-controlled private
corporation ("CCPC") and all other required conditions are assumed to
have been met. So, was the loan made to an individual or to one or both of the
two corporations?
Facts
[5] An Agreement (the
1990 Agreement) executed April 23, 1990 between the Appellant
("Maria") and Tibor Zoltan Barath ("Tibor"), filed at Tab
"D" of Exhibit A-1 states, inter alia, that Maria and Tibor
had cohabited in a relationship resembling that of husband and wife since 1987,
that they were each financially responsible for themselves, that there were no
matrimonial rights vis‑a‑vis their respective properties and
that neither party would be entitled to property rights arising from their
cohabitation arrangement. The 1990 Agreement provided further as follows on page 7:
(4) Maria and Tibor each
acknowledge that Tibor is the owner of all the issued shares in 892076 Ontario
Limited and 890276 Ontario Limited has a 49% interest in Molnar Food Service
Ltd. The parties acknowledge that Maria has no interest whatsoever in 892076
Ontario Limited or Molnar Food Service Ltd.
(5) Maria and Tibor acknowledge
that to facilitate the acquisition of Tibor in the corporations referred to
above, Maria and Tibor have agreed to the following:
(a) Maria has placed
a new first mortgage on the family residence for the principal sum of
$145,000.00, replacing a previous employee mortgage loan in the sum of
$60,000.00;
(b) Maria shall
lend to Tibor the sum of $85,000.00 for the purchase of his shares in the above-mentioned
corporations, in consideration for which Tibor has agreed to guaranty payment
on the said mortgage;
(c) Maria shall be
responsible for the sum of $600.00 per month on the said mortgage and Tibor
shall be responsible for the difference plus all related legal and other
expenses associated with negotiation and registration of the said mortgage;
(d) Tibor agrees to
pay the principal sum of $85,000.00 together with accrued interest within ten
(10) years of the date of his acquisition of an interest in the corporations
referred to above. He shall have the option to make prepayments on the mortgage
pursuant to its terms and such payments shall be credited against his liability
for the principal sum of the said loan from Maria;
(e) Until full
repayment of the said loan, Maria shall have a lien on the shares of Tibor in
892076 Ontario Limited on the following terms;
(1) Maria shall
receive the equivalent of 50% of the net profits, including income and
dividends, received by Tibor or 892076 Ontario Limited by virtue of their
interest in Molnar Food Service Ltd.;
(2) Tibor shall
indemnify and save Maria harmless from all claims arising out of the mortgage
on the family residence to the extent of his obligations set out above;
(3) After repayment
of the principal sum and accrued interest aforesaid, Maria shall release all
claims against the said shares or corporations.
[6] The Direction (Tab
E of Exhibit A-1) to the attorney in charge of the transaction instructed said
attorney, inter alia, to pay to 892076 the sum of $75,000.
[7] Thus, although the
loan is to Tibor and the two corporations are not parties, Maria is granted by
Tibor a type of lien on the shares of 892076 and $75,000 of the loan proceeds
are directed to be paid to 892076. These facts and the imprecise wording of the
1990 Agreement contribute to the difficulties in interpreting that Agreement.
The Agreement, however, makes it clear that Tibor, by making payments under the
new first mortgage ("mortgage") will be discharging his liability
under the "said loan from Maria".
[8] From 1990 until
1997 Tibor made payments under the 1990 Agreement. After the relationship between
Maria and Tibor broke down (sometime in 1995) a further agreement (the "Amending
Agreement") was entered into on January 7, 1997 between Maria
and Tibor. It appears at "P.5" and following of Tab K of Exhibit A-1.
It referred to the 1990 Agreement and amended its terms to alter the amounts
and details concerning the respective repayments of the mortgage by the
parties. It specifically details the exact amounts of the mortgage for which
Tibor remains liable. It also provided that until Tibor had repaid his share of
the mortgage in full Maria would be entitled to one-half of Tibor's share in
the year end profits before income tax realized by Tibor from Molnar. This Amending
Agreement further provided as follows:
4. Tibor will
enter into a Pledge Agreement in the form annexed hereto as Schedule
"A" whereby Maria's solicitor, Michael Woods, shall hold as
escrow agent the share certificates representing all shares owned by Tibor in
892076, and all shares owned by 892076 in Molnar, as security for repayment of
Tibor's share of the Mortgage.
5. Tibor shall
further cause 892076 to execute a guarantee of the obligation of Tibor
hereunder, in the form annexed hereto as Schedule "B", and Tibor
shall cause Molnar to execute and deliver an Acknowledgment and Covenant in the
form annexed hereto as Schedule "C".
[9] Although the
Amending Agreement refers to a guarantee by 892076 as Schedule "B" and
an Acknowledgement and Covenant by Molnar as Schedule "C", those
documents were not filed. The Pledge Agreement however, referred to as Schedule
"A", was filed at Tab G of Exhibit A-1. It is also dated January 7,
1997 and the Parties are Maria, Tibor and 892076; it refers to Maria as "Pledgee"; Tibor as
"Pledgor" and 892076 as "892076". Its' principal provisions
are as follows:
...
WHEREAS the Pledgor is as of the date hereof the
registered and beneficial owner of One Hundred (100) common shares in the
capital of 892076 (hereinafter referred to as the "892076 Shares"),
and 892076 is as of the date hereof the registered and beneficial owner of
Forty-Nine (49) common shares in the capital of MOLNAR FOOD SERVICE LTD.
(hereinafter referred to as the "Molnar Shares");
and
AND WHEREAS the Pledgor has agreed to pledge the 892076
Shares, and 892076 has agreed to pledge the Molnar Shares, to the Pledgee as
general and continuing collateral security for the Obligations (as hereinafter
defined);
...
1. Definitions:
...
(g) "Obligations" means the
obligation to repay the loan of $85,000.00 made by the Pledgee to Pledgor on or
about April, 1990, of which $80,288.90 remains outstanding as of May 1, 1995,
as well as any other amount that is now or becomes payable by the Pledgor to
the Pledgee pursuant to either Cohabitation/Marriage Contracted dated April 23,
1990, or an Amending Agreement dated the even date hereto which Agreement amend
the terms of this Cohabitation/Marriage Contract;
...
(i) "Pledged Collateral" means
collectively,
i. the 892076 Shares and all Shares
hereafter owned or acquired by the Pledgor in 892076, as well as the Molnar
Shares and all Shares hereafter owned or acquired by 892076 in Molnar Food
Service Ltd.;
...
[ii, iii, iv – irrelevant]
[10] The Pledge Agreement further provides as
follows:
2. PLEDGE OF SHARES
(a) Pledge of collateral. As general
and continuing collateral security for the due payment and performance of the Obligations,
each of the Pledgor and 892076 hereby assign, hypothecate and pledge to and in
favour of the Pledgee, and grants the Pledgee a security interest in, all of
the Pledged Collateral.
(b) Acknowledgement of receipt. The
Pledgee acknowledges receipt from the Pledgor of Share Certificate No.
___________ issued ___________, 199__ representing the 892076 Shares, and
receipt from 892076 of Share Certificate No. ___________ issued
_______________, 199_ representing the Molnar Shares, duly endorsed in blank
for transfer, or accompanied by a duly signed power of attorney for transfer in
blank.
...
4. DEFAULT AND ENFORCEMENT
(a) Remedies. In the event of any
default in the due performance or payment of any of the Obligations (an
"Event of Default"), the security hereby constituted shall become
immediately enforceable and the Pledgee may, in its sole discretion, do any or
all of the following:
i. effect the registration of, and obtain
from either 892076 or Molnar Food Service Ltd. a certificate or certificates
for any of the Pledged Shares in the name of the Pledgee or its nominee(s), and
for such purpose the Pledgee is hereby irrevocably appointed the attorney of
the Pledgor and 892076 with full power of substitution to endorse and/or
transfer any of the Pledged shares to the Pledgee or its nominee(s);
ii. vote any or all of the Pledged Shares
(whether or not transferred into the name of the Pledgee) and exercise all
other rights and powers and perform all acts of ownership in respect thereof as
the Pledgor or 892076 might do;
[11] Tibor made an
assignment in bankruptcy January 30, 1998. Up to that time he had made his
required payments on the mortgage. The bankruptcy proceedings lasted until
sometime in 2001. Maria had filed a Proof of Claim in the bankruptcy
proceedings for $83,282.22. On or about January 31, 2001 certain assets of
Molnar were sold. The Pledge of Molnar shares in favor of Maria was recognized
in the bankruptcy proceedings. Forty-nine percent of the proceeds of the sale
of the Molnar assets amounted to $30,632.28. This was apparently paid to Maria
leaving the balance of her claim at $52,649.94. This is the BIL amount, 1/2 of
which is $26,324.97 which is the amount of the ABIL claimed by Maria in the
2001 taxation year. There is no doubt that the debt, which in 2001 had been
reduced to $52,649.94, became bad in 2001. Also filed at Tab H of Exhibit A-1
is an unaudited Balance Sheet of 892076 as of March 31, 1997 indicating a
liability of "Mortgage Loan Payable - $77,181.73".
Submission of
the Appellant
[12] The submission of
Maria is essentially that she always believed that because the monies advanced
found their way into one or both of the corporations that she became the owner
of a debt of a CCPC and when the debt went bad she was entitled to claim an
ABIL. She also believed that the agreements referred to above, in particular
the Amending Agreement and the Pledge Agreement executed in 1997 plus the fact
that through the bankruptcy proceedings she received 49% of the sale proceeds
of Molnar assets, must indicate that one or both of the corporations was the
debtor.
Submissions of the
Respondent
[13] The submissions of counsel
for the Respondent are seen in the following extracts from the transcript of
the hearing:
...
In this case it is the Minister's submission that in the 2001 year or
at any material time prior to that neither the Ontario corporation, 892076, nor
Molnar Food were indebted to the Appellant and that the Appellant did not have
a shareholder/creditor relationship to 892076.
...
We have an agreement in 1990 between the Appellant and her common-law
spouse at the time. In clause 4 at page 7 of that agreement, which is at tab D
of Exhibit A-1, it states that Tibor, who was the Appellant's common-law spouse
at the time, was the owner of the shares in 892076 Ontario and that 892076 had
a 49 per cent interest in Molnar Food Service Ltd. There is an acknowledgment
that the Appellant has no interest whatsoever in the numbered company or
Molnar.
...
We have an agreement between the Appellant and her common-law spouse.
There was no debt obligation owing by the numbered company or Molnar to the
Appellant. There was no additional agreement beyond this 1990 agreement at the
time that would create any other obligations, and neither the numbered company
nor Molnar were parties to this agreement.
...
From 1990 until 1997 Tibor made payments. It is her evidence that
Tibor made the payments every month. In 1997, as result of the breakdown of
the relationship in 1995, there was an Amending Agreement written up, once
again between the Appellant and Tibor which once again required Tibor to make
payments on the mortgage and to make certain payments in respect of the
numbered company's profits. It also created a security interest for the
Appellant. Should Tibor default on his obligations, it would give the
Appellant access to the shares of both Molnar and the numbered company as
security.
When Mr. Barath went bankrupt in 1998, the Appellant exercised the
security to control the shares of the numbered company and Molnar. Ultimately,
Molnar's assets were sold in 2001, and the Appellant realized roughly $38,000
from that transaction.
For the purpose of the appeal the Appellant has to demonstrate that she
had a capital loss either from the disposition of shares of a small business
corporation or from the disposition of a debt owed by a CCPC to her during the
year. If the loan went to Tibor and not to the numbered company, it is our
submission that she is not able to make out that she is entitled to an
allowable business investment loss.
It is the Minister's submission that the documentation that has been
provided, the agreement and the Amending Agreement, are signed by the
Appellant. The agreements are between the Appellant and Tibor Barath, not
between the Appellant and the numbered company. The obligation to pay, as
stated in those agreements, was Tibor's obligation.
The stated purpose of the loan in the first agreement, the April 1990
agreement, is to facilitate the acquisition of Tibor in the numbered
corporation and Molnar. There is no obligation to the corporations or to the
Appellant. The only time that a corporation was referred to or became involved
in any of those agreements was in the schedule to the Amending Agreement
regarding the pledging of shares, and that, we submit, was just to guarantee
that, if there was a default by Tibor, the shares go to the Appellant.
When you look at the agreements, the debt was Tibor's. He had the
obligation to pay. He was the one who was going to lose his shares in the
company if he defaulted. The investment in the numbered company and in Molnar
was Tibor's; it was not the Appellant's investment.
The only agreement that we have is the 1990 one where she agrees to
give money to Tibor, not to the numbered company. The subsequent transfer of
the shares upon Tibor's default and the subsequent sale of those shares, I
would submit, was in furtherance on her collection of the debt owing to her by
Tibor. She is trying to recover the amount that he borrowed and did not pay
back. It is not an investment in the company and the company goes bad. The debt
that goes bad is when Tibor goes bankrupt and stops making his payments. There
is a default, and she exercises her rights under the agreement that she has
with Tibor to take over those shares.
Analysis
[14] In a decision of the
Federal Court of Appeal, namely Rich v. The Queen, 2003 D.T.C. 5117,
Rothstein, JA gave an overview of the ABIL rules.
THE ABIL RULES
[4] In Fundamentals of Canadian Income Tax,
6th ed, (Toronto: Carswell,
2000) at page 423, Professor Krishna explains that an ABIL is a special type of
capital loss that receives preferential treatment for income tax purposes. An
ABIL arises on the disposition of shares or a debt of a small business
corporation. A small business corporation is a Canadian-controlled private
corporation that uses all or substantially all of its assets in an active
business in Canada ...
[5] Unless a lender is in the money-lending
business, a bad debt would normally be treated as a capital loss. However,
unlike ordinary capital losses, which may be deducted only against capital
gains, an ABIL may be deducted against income from any source.
...
[7] Counsel for the appellant explained that the
purpose of the ABIL rules was to encourage investments in small business
corporations. A bad debt from a small business corporation could be deducted
from the lender's income from any source, although the amount of the deduction
was limited ...
[15] I am sympathetic to
the position of the Appellant but I am satisfied that the submission of counsel
for the Respondent is correct. The Appellant may have received bad legal advice
and the Amending Agreement and Pledge Agreement executed in 1997, coupled with
the fact that 49% of the sale proceeds of Molnar assets came to her in the
bankruptcy proceedings may have led her to believe her debtor really was one or
both the corporations. However, the documents speak for themselves. It is clear
that the debt was owed by Tibor and not by either one of the corporations. There
is absolutely no doubt that from 1990 to 1997 that statement was correct. The
corporations had nothing to do with the loan, other than the fact it was made
to Tibor to provide him with funds to acquire the shares of 892076. It is
acknowledged that $75,000 of the loan proceeds were paid by the lawyer to
892076 but the 1990 Agreement makes it clear that this was payment for the
shares in 892076 which Tibor acquired.
[16] The only real connection
with the corporations arises in 1997 when the Amending Agreement was executed
and the shares of the corporations were pledged. This was subsequently followed
by the Appellant realizing on that security. The Amending Agreement and the Pledge
Agreement did not operate to change the original debt from a debt owing by
Tibor to a debt owing by the corporations. The loan monies were not an
investment in a CCPC. They were loaned to Tibor to enable him to acquire the
shares in 892076. They were not given to Tibor as a trustee for Maria to invest
in the corporations. It is also clear that Maria never became a shareholder in
either of the corporations. The unfortunate but relatively clear conclusion is
that the debt was a debt of Tibor's and not of the corporations. Consequently,
the Appellant is not entitled to the ABIL claimed.
[17] As this appeal is
not concerned with whether the Appellant may be entitled to a net capital loss
(as opposed to an ABIL) which might be available as a deduction against capital
gains in one or more taxation years, I am not obliged to decide this issue.
[18] In conclusion for all
of the above reasons the appeal is dismissed. There shall be no costs.
Signed at Ottawa, Canada, this 2nd day of October, 2006.
"T. O'Connor"
Email this Content