John Strecker v. Her Majesty the Queen, [1994] 2 CTC 2341, 95 DTC 3

Sobier J.T.C.C.:—The appellant appeals from the assessment by the Minister of National Revenue (the "Minister"), for his 1991 taxation year, whereby the Minister denied the deduction by the appellant of an allowable business investment loss ("ABIL") of $33,452.73 and $481.44 interest paid to the Etobicoke Teachers' Credit Union Limited (the "interest").

The appellant's claim for a business investment loss is made as follows:

In the spring of 1987, the appellant’s son, Andrew Strecker ("Andrew"), began a residential landscaping business as a sole proprietorship known as "Andrew's Interlock".

In 1988, he decided to incorporate a corporation known as "776108 Ontario Inc.” (the "company") to carry on the business of the sole proprietorship, using the same name "Andrew's Interlock". The company continued the residential landscaping business, but in 1989 Andrew decided to change the type of business to commercial landscaping.

Four commercial jobs booked up to August 1989, totalled $491,899.97, with a projected profit of $197,319 from those four jobs. One of the customers went bankrupt and others paid less than the contract price, with the result that the business suffered set-backs, which continued until 1990, when Andrew was forced to declare personal bankruptcy and the company ceased carrying on business.

At the outset, Andrew did not have sufficient funds to start his business, therefore his father, the appellant, guaranteed loans at the Royal Bank of Canada (the "bank"). Initially the appellant guaranteed the sole proprietorship's loans and later the company's. As working capital was increasingly needed, the older guarantees for smaller amounts were replaced with guarantees for greater amounts, until when in June 1990, the appellant guaranteed loans from the bank to the company totalling $40,000.

In addition, in November 1989, the appellant borrowed $10,000 from the Etobicoke Teachers’ Credit Union Ltd. (the “credit union"). These moneys were handed over by the appellant to Andrew, who in turn deposited the funds in the company's bank account.

At all times, Andrew was the sole registered and beneficial shareholder of the company. Banking documents show that Andrew and the appellant were the directors of the company, and Andrew was its president and the appellant its vice- resident. In addition, each of them had the authority to sign the cheques on behalf of the company.

As a result of the company ceasing to carry on business, the bank demanded payment under the guarantee and a settlement was arrived at whereby the appellant paid the bank $35,000 in full satisfaction of all claims under the guarantee. In addition, the appellant repaid the balance of the loan from the credit union.

It was the appellant’s and Andrew's evidence that the appellant took part in the business. The company telephone was in his home, he provided the tools and the truck. In the summers of 1988, 1989 and 1990, the appellant helped in the business in the afternoon.

The appellant received no remuneration for working for the company, nor was in receipt of any fees or other consideration for providing the guarantees. He also received no interest on the moneys borrowed from the Credit Union and given to Andrew or the company. There was some evidence that it was Andrew's hope that the family members could all be involved in the company and that perhaps the appellant might receive shares in the future. However, none were ever issued to him and therefore he could not earn dividend income.

The issue therefore is, was part of the loss suffered by the appellant an ABIL under paragraph 38(c) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") ? Paragraph 38(c) reads as follows:

For the purpose of this Act:

(c) a taxpayer’s allowable business investment loss for a taxation year from the disposition of any property is A of his business investment loss for the year from the disposition of that property.

However, if the provisions of subparagraph 40(2)(g)(ii) of the Act come into play, then the ABIL is deemed to be nil. Subparagraph 40(2)(g)(ii) reads as follows:

Notwithstanding subsection (1),

(g) a taxpayer's loss, if any, from the disposition of a property, to the extent that it is

(ii) a loss from the disposition of a debt or other right to receive an amount, unless the debt or right, as the case may be, was acquired by the taxpayer for the purpose of gaining or producing income from a business or property (other than exempt income) or as consideration for the disposition of capital property to a person with whom the taxpayer was dealing at arm's length.

is nil.

Therefore, unless the indebtedness, including the indebtedness arising from honouring the guarantee, was acquired for the purpose of gaining or producing income from a business or a property, the ABIL will be nil.

As stated above, Andrew and the appellant gave some evidence that there was a vague plan that all the family would be involved. The appellant stated that he regarded himself as part of the company and that he saw himself as part of the future and would gain income at a later date. While this may be his evidence now, the facts surrounding the loans and the guarantee are more capable of being interpreted as a father wishing to help his son establish a business [2] . I find no evidence that there was an agreement or understanding that the appellant would become a shareholder or otherwise derive income from the company.

The agent for the appellant, referred to Fernandez v. M.N.R., [1991] 1 C.T.C. 2211, 91 D.T.C. 182 (T.C.C.). Particularly, the agent for the appellant referred to an excerpt on page 2213 (D.T.C. 183), which reads.as follows:

. . .The fact that no interest is payable with respect to a particular debt is not relevant in deciding whether the debt was acquired for the purpose of gaining or producing income. See The Queen v. Lalande, [1983] C.T.C. 311, 84 D.T.C. 6159 (F.C.T.D.), and Business Art Inc. v. M.N.R., [1987] 1 C.T.C. 2001, 86 D.T.C. 1842.

While preceding statement is correct as far as it goes, the Fernandez case is distinguishable from the case at bar, since there the appellant was the owner of shares of the corporation whose indebtedness he and the others guaranteed, as well as a part owner of the security which was sold.

At page 2213 (D.T.C. 183), Judge Mogan went on to say:

The appellant and his co-owners were committed to the Calgary company with respect to their equity in the Yorkland Property from the date when that property was pledged. The nature of that commitment is similar to the capital which is invested to acquire shares of a new corporation and also similar to the funds which a shareholder will lend without interest to his corporation. I say “similar to" because, although paid-up capital and a shareholder’s loan flow directly to the corporation whereas property which is pledged will be returned when the corporation repays its third party loans, failure to repay such loans will result in the loss of the pledged property just as much as if it were paid-up capital or a shareholder loan. [3]

The appellant and his coventurers in Fernandez pledged the Yorkland property in order to produce or gain income from the ownership of the shares of the Calgary company.

Just because the moneys received by the company, as a result of granting of guarantees and the credit union loan, were used for business purposes by the company, it does not follow that any loss on disposition of the indebtedness is an ABIL, since it is the purpose of the person advancing the funds which is paramount.

In Casselman v. M.N.R., [1983] C.T.C. 2584, 83 D.T.C. 522 (T.C.C.), the taxpayer guaranteed loans made by a bank to her son. The Court held that she did not guarantee the loans for the purpose of gaining or producing income, she guaranteed the loans to assist her son. That is the case here. The appellant's involvement in the company did not transform his reasons for giving the guarantee or making the loan from one of helping his son to one of gaining or producing income.

The facts in Lowery v. M.N.R., [1983] C.T.C. 2584, 86 D.T.C. 1649 (T.C.C.), are somewhat the same as the case at bar. Judge Sarchuk stated at pages 2174-75 (D.T.C. 1652):

On the evidence adduced I am not satisfied that there was any business purpose in the granting of the guarantee. Respondent's counsel submitted, and I agree, that it is not sufficient to make a general allegation that the appellant anticipated some participation in the profits of Threads at some unstated time in the future and on that basis to argue that some consideration for the guarantee existed. There was no arrangement as to interest. There was no arrangement relative to repayment in the event of default by Threads. There was no agreement, oral or written, setting out the terms and conditions of the appellant's participation.

Dealing with future participation of the appellant in the company, the facts before me fall squarely within the above statement of Judge Sarchuk. Similarly the borrowing from the credit union and payment of the Interest were not for the purpose of gaining or producing income, they were done to assist Andrew.

For these reasons, the appeal is dismissed.

Appeal dismissed.