Wilfred T. Austin v. Minister of National Revenue, [1991] 1 CTC 2533, 91 DTC 778

Mogan, T.C.J.:—In 1984, 1985 and 1986, the appellant owned all of the issued common shares of W. Austin Poultry Equipment Ltd. (the "company") and his wife owned some of the issued preference shares. The company carried on an active business with about ten employees. Relying on subsection 80.4(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), the respondent issued reassessments to the appellant and added the following amounts to his reported income for the respective taxation years:

The respondent claims that the above amounts are benefits deemed to have been received by the appellant under subsection 80.4(2) with respect to loans received from or debts incurred to the company by virtue of his shareholding in the company. The appellant claims (i) that any loans or debts should be determined only at the end of the company's fiscal period; (ii) that any deemed benefit should be reduced to the extent that amounts owing to the appellant by the company could be set off against his debts to the company; and (iii) that any deemed benefit should be allocated between the appellant and his wife.

From time to time, the company would advance funds to the appellant or to his wife or on their behalf.. The amounts so advanced were entered in the books and records of the company in an account entitled "shareholder receivable". That account normally had a debit balance indicating moneys owing by the appellant to the company. On the company's year-end balance sheet, under “Current assets", there is a heading “Due from shareholders” and it appears that the debit balance in the shareholder receivable account was included on the balance sheet under that heading.

In December 1984 and December 1985 the company paid a substantial dividend on its common shares and the dividend amounts were credited directly to the shareholder receivable account. The computation of the alleged benefit under subsection 80.4(2) has not been challenged in this case. Therefore, I assume that if the assessments under appeal were based on the debit balance from time to time in the shareholder receivable account, then the appellant was given the benefit of any reduction in those debit balances resulting from the payment of dividends referred to above.

The appellant entered in evidence as Exhibit A-1 certain documents including copies of financial statements for the company's fiscal periods ending March 31, 1984 and 1986 (with accountant's comments) and copies of certain accounts and summaries of accounts from the books and records of the company. Those documents show an almost continuous debit balance in the shareholder receivable account and certain management bonuses accrued on the last day of the company's fiscal period but not credited to the shareholder receivable account. Relying on those documents, I have no hesitation in concluding that on many occasions the appellant, by virtue of being a shareholder of the company, received a loan from or otherwise incurred a debt to the company within the meaning of subsection 80.4(2) of the Act which states in part:

80.4(2) Where a person was

(a) a shareholder of a corporation,

(b) . . ., or

(c) . . .

and by virtue of such shareholding that person received a loan from, or otherwise incurred a debt to, that corporation, the person shall be deemed to have received a benefit. . .

The appellant's first argument is that the words in subsection 80.4(2) "received a loan" and "incurred a debt" should not be applied in the middle of a corporation's fiscal period but should be applied only at the end of the fiscal period. Although every corporation needs a financial statement at year-end, there is no reason why one cannot look at the corporate books and records at any time during a fiscal period to determine if a shareholder has "received a loan from" or “incurred a debt to” the corporation as of that time. The appellant's first argument is undermined by the following words in paragraph 80.4(2)(d)". . . each such loan and debt for the period in the year during which it was outstanding. . .”.

Having found that the appellant on many occasions during the years under appeal received a loan from or incurred a debt to the company, I turn to the appellant’s second argument that any amount owing to the appellant by the company should be set off against his debts to the company. In the books and records of the company for the years under appeal, the following amounts are shown as liabilities for accrued management salaries and bonuses payable to the appellant or his wife:

On the company's balance sheet at each year end, the above amounts are not shown as an independent item but they are included as part of "Accounts payable and accrued liabilities".

Mr. E.T. Carlson, C.A., the company's outside accountant who testified as a witness for the appellant, confirmed that the amounts of accrued management salaries and bonuses (owing by the company to the appellant) were not deducted from the amounts owing by the appellant to the company in the shareholder receivable account. In keeping with a common practice, the management bonuses were accrued on the last day of the company's fiscal period (March 31) and the bonus amounts were determined to reduce the company's pre-tax profit either to nil or to the" business limit” in section 125 of the Act. Within reasonable limits, these are prudent objectives for a Canadian- controlled private corporation carrying on an active business in Canada.

If the company were to set off the accrued management bonuses against the shareholder receivable account and thereby eliminate the accrued liability and reduce the debit balance in the shareholder receivable account, I think that such conduct would, for both accounting and income tax purposes, have the effect of paying the bonuses and requiring the company to withhold and remit the appropriate amount of income tax on the bonuses. On the other hand, if the amounts were not set off and if the bonuses were only accrued and not paid, then the obligation to remit income tax on the bonuses would be deferred until they were paid. I make these comments only to indicate that the appellant and the company achieve a reasonable financial advantage (i.e., the deferring of tax) by accruing the bonuses but not paying them through a set-off of the accrued liability against the shareholder receivable account. If that financial advantage was achieved, then the accrued bonuses were not set off against the shareholder receivable account.

The appellant's position on the issue of set-off is stated in the notice of appeal as follows:

1. The assessment contains errors in that the whole amount has been charged to W. Austin and, in fact, any benefit should be allocated between W. Austin and his wife B. Austin.

2. There were other liabilities recorded on the books of the company to W. Austin and his wife B. Austin that have been disregarded.

The appellant is correct in stating that other liabilities recorded on the books of the company have been disregarded in the assessments under appeal. The question is whether the respondent should have set off any amount owing to the appellant by the company against his debts to the company. The legal concept of set-off is described in The Canadian Encyclopedic Digest (Ontario), Volume 18, 3rd ed., at page 231:

374. In an action for payment of a debt, the defendant may, by way of defence, claim the right to set off against the plaintiff's claim a debt owed by the plaintiff to the defendant. Mutual debts may be set off against each other, notwithstanding that they are of a different nature or that one debt is owed to or by a person in a personal capacity and the other debt is owed by or to the person in a capacity other than personal. Where, on a defence of set off, a larger sum is found to be due from the plaintiff to the defendant than is found to be due from the defendant to the plaintiff, the defendant is entitled to judgment for the balance.

375. The right was introduced to prevent multiplicity of actions. Before a plea of set-off can be allowed the debts must be mutual and in the same right, and a joint debt by plaintiff and another cannot be set off against a debt due from defendant to plaintiff solely.

If no action is commenced for the payment of a debt, there is nothing in law to prevent the coexistence of mutual debts. In other words, if A owes B $1,000 and B later becomes indebted to A in the amount of $1,400, the debt from A to B is not extinguished. If A or B should commence an action on one debt, the defendant would claim the right to set off the other debt by way of defence. Even if no action were commenced, A and B could agree that their mutual debts be set off leaving B owing A only $400. There would, however, have to be real evidence of such agreement.

In the circumstances of this appeal, one must ask if there was any evidence of an agreement between the appellant and the company that the accrued bonuses were to be set off against the shareholder receivable account. There was no evidence of a journal entry linking the balance in one account with the balance in the other account. There was no evidence of a long established practice setting off these respective accounts within each fiscal period. There was no evidence as to the manner in which the company recorded in its books and records the payment of the accrued bonuses when they were actually paid to satisfy the time limit in section 78 of the Act. In summary, there was no evidence of any agreement between the appellant and the company to set off these two accounts.

In this appeal, there appear to be conflicting income tax objectives. In order to defer the payment of tax, the company accrues significant management bonuses at year-end but does not pay them through a set-off against the shareholder receivable account. In order to avoid a deemed benefit under subsection 80.4(2), the appellant asks the Court to regard the accrued bonuses as having been set off against the shareholder receivable account. The accrued bonuses either were set off or they were not and, on the evidence, I am satisfied that they were not.

The appellant relied on the decision of this Court in Kates v. M.N.R., [1984] C.T.C. 2681 ; 84 D.T.C. 1605, a case concerning a series of loans and repayments within the meaning of subsection 15(2) of the Act. As I read that case, Tremblay, T.C.J. found as a fact that the loans receivable by the corporation from Mr. Kates at the end of the corporation's 1975 and 1976 fiscal periods were paid within the following year out of bonuses in the amounts of $23,800 and $145,000 respectively. The learned judge also concluded that the loans in question were not part of a series of loans and repayments. The years under appeal in Kates were 1975 and 1976, prior to the enactment of section 80.4, and the issue in that case was not a question of set-off. The appellant also relied on the decision of the Federal Court of Appeal in Massey-Ferguson Ltd. v. The Queen, [1977] C.T.C. 6; 77 D.T.C. 5013 but I find nothing in that decision which applies to this appeal.

The conclusion which I have reached on the issue of set-off is supported by the decision of this Court in Gannon v. M.N.R., [1988] 1 C.T.C. 2422; 88 D.T.C. 1282 in which Bonner, T.C.J. stated at 2425 (D.T.C. 1284):

Nothing in the evidence in the present case suggests the existence of any agreement or contract calling for the liquidation of the indebtedness on the note by means of the payments made to the appellant. An agreement between a company and its shareholder is not formed by a mere fleeting thought in the mind of the individual who controls it. The accounts in question here are not connected in any way. This is simply a case in which the company and the appellant each owe the other money. There is no authority for the proposition advanced by the appellant which is, in effect, that mutual debts cannot coexist and that in all cases where they might arise a set-off is automatically effected.

In Docherty v. M.N.R., [1991] 1 C.T.C. 2409, Brulé, T.C.J. allowed an appeal from an assessment issued under subsection 80.4(2) of the Act because he was able to conclude that the accountant's working papers showed an intention to set off certain mutual debts. The amounts paid by Mr. Docherty to his corporation through his ownership of certain apartment projects far exceeded the amounts claimed in the notices of reassessment to be owing by Mr. Docherty to his corporation. Although the financial statements did not reveal any of the transactions of lending and repayment of loans involving Mr. Docherty, Judge Brulé concluded that" the mere fact that the financial statements did not reflect the set-off is not sufficient to disallow the appeal". The decision in Docherty raises an interesting question in evidence as to whether a corporation's financial statements are of equal value to its accountant's working papers and which should prevail in the event of a conflict.

The appellant's third argument is that any deemed benefit under section 80.4 should be allocated between the appellant and his wife. The appellant owned all of the company's issued common shares. The substantial dividends paid by the company on its common shares in December 1984 and December 1985 were credited directly to the shareholder receivable account. That fact is a strong indication that the shareholder receivable account is intended primarily to reflect transactions between the appellant and the company. Some of the documents in Exhibit A-1 show how certain corporate disbursements may be allocated to the appellant and his wife but I assume that, as owner of all the issued common shares, the appellant had sole control of the company. I therefore assume that any disbursement from the company to the appellant's wife was made at his direction. The onus was on the appellant to prove that any particular loan or debt reflected in the shareholder receivable account was received or incurred by his wife. That onus was not discharged. The appeal is dismissed.

Appeal dismissed.