Jonathan Cloud v. Her Majesty the Queen, [1995] 1 CTC 2726

Garon J.T.C.C.:-This is an appeal from a reassessment dated January 2, 1990 for the 1985 taxation year. By his reassessment the Minister of National Revenue imposed, inter alia, penalties in the amount of $11,569.15 and arrears interest to the date of the reassessment in the amount of $29,974.70.

At the outset, I might perhaps point out that the appeal relates exclusively to the imposition of penalties and interest. The appellant did not challenge the addition to the appellant’s income of the amount of $208,400, pursuant to subsection 15(2) of the Income Tax Act, R.S.C. 1985 (5th Supp.), c. 1 (the "Act"). I mention this because the imposition of penalties and interest at issue in this appeal depends in part on the correctness of the inclusion in the appellant’s income of the foregoing amount for the 1985 taxation year.

The facts set out in paragraph 7 of the amended reply to the notice of appeal were admitted by the appellant. This paragraph reads as follows:

7. In so reassessing the appellant by notice of reassessment dated January 2, 1990, the Minister proceeded on the basis that:

(a) the appellant was a director and principal shareholder of Sunwrights Multinational Inc. ("Sunwrights");

(b) in the 1985 taxation year, the appellant received a loan or became indebted to Sunwrights in the amount of $208,400 for the purpose of purchasing from Sunwrights, royalty contracts issued to investors;

(c) the loan or debt was not made or did not arise in the ordinary course of Sunwrights’ business nor was the lending of money part of its ordinary business;

(d) the loan or debt does not fall within the exclusions noted in subparagraphs 15(2)(a)(ii) to (iv) of the Income Tax Act’,

(e) on November 22, 1987, the appellant transferred the royalty contracts back to Sunwrights and Sunwrights reduced the loan or the debt to $ nil. Accordingly, the Minister reassessed the appellant in the 1987 taxation year, and allowed a deduction in the amount of $208,400 pursuant to paragraph 20(1)(j) of the Income Tax Act;

(f) the loan or debt was not repaid within one year from the end of the taxation year of Sunwrights in which the loan or debt was incurred;

(g) the appellant filed his 1985 taxation return on November 26, 1986 and it was assessed on January 20, 1987.

The appellant, in his testimony, mentioned other facts which relate to the Sunwrights Multinational Inc. (the "company") and to the research work that had been done in the area of the development of technologies relative to the use of solar energy. For the purposes of this litigation, it is of interest to mention that by an agreement dated November 22, 1987, the appellant sold to the company "Royalty Rights for a purchase price of $208,000"!. By paragraph numbered 2 of this agreement, it was provided that "The company shall pay the purchase price by reducing the indebtedness of Cloud to the company by the amount of $208,000". The Court was also informed that the Minister of National Revenue by his assessment in respect of the appellant’s income for the 1987 taxation year granted a deduction pursuant to paragraph 20(1 )(j) of the Income Tax Act in respect of the "payment" contemplated by the above numbered paragraph 2 of the agreement of November 22, 1987.

Appellant’s position

The appellant submits in his notice of appeal that as a result of the non-capital loss in the amount of $197,419 from a subsequent year being applied to the 1985 taxation year, the interest and penalty should also be reduced. Presumably this position is based on the premise that the late- filing penalty and interest, being calculated as a percentage of income tax payable, should be reduced as the amount of tax payable is reduced.

The appellant makes a second argument with respect to section 80.5 in his notice of appeal. The following excerpt from his notice of appeal contains the appellant’s reasoning on this point. It reads as follows:

A.2 The grounds for the appeal are that section 80.5 of the Act provides for a deduction, corresponding to the amount of income attributed to me, due to the

’It is to be noted that in this agreement, reference is made to an amount of $208,000 and not to an amount of $208,400, as mentioned in the pleadings.

use to which the funds were put, i.e., the purchase of investment contracts on which a profit could reasonably be expected to be made.

However, at the hearing of this appeal, the appellant made no comment on the application of section 80.5 of the Act.

Furthermore, he added in argument at the hearing of this appeal that by the last day he was required to file his return of income, that is on April 30, 1986, in respect of the 1985 taxation year, he did not owe the Government of Canada anything in respect of tax for the 1985 taxation year, and that it is only subsequently after the expiration of the period referred to in paragraph 15(2)(b), that he became indebted to the Government of Canada in respect of the 1985 taxation year.

Respondent’s position

Counsel for the Minister submits that the loan was included in income by virtue of subsection 15(2) as it remained unpaid within one year of receiving it. Consequently, the calculation of the late-filing penalty and interest is correct and should not be reduced despite the subsequent application of a non-capital loss.

Analysis

I shall first deal with the imposition of penalty by the reassessment in issue. Subsection 162(1) in its application to the 1985 taxation year reads as follows:

162(1) Every person who has failed to file a return as and when required by subsection 150(1) is liable to a penalty equal to the aggregate of

(a) an amount equal to five per cent of the tax that was unpaid when the return was required to be filed; and

(b) the product obtained when one per cent of the tax that was unpaid when the return was required to be filed is multiplied by the number of complete months, not exceeding twelve, in the period between the date on which the return was required to be filed and the date on which the return was filed.

As appears from the wording of the above subsection, the crux of the matter is the determination of the point in time at which the tax that was unpaid must be ascertained in the present case for the purposes of calculating the penalty that may be applicable in respect of the 1985 taxation year. The leading case in this area is Leach Bros. Stores Ltd. v. M.N.R., [1985] 1 C.T.C. 2067, 85 D.T.C. 94 (T.C.C.). In that case, the appellant argued that even though its tax return was filed late, there was no tax payable in the year in respect of which the return was filed late upon which a penalty could be calculated as a result of the taxpayer carrying back a non-capital loss. In that case. Associate Chief Judge Christie stated at page 2068 (D.T.C. 95) that:

The only relevance that unpaid tax has is to provide the basis for a formula for the calculation of the quantum of the penalty.

He went on to say (at page 2069 (D.T.C. 95)):

Whatever the date may be when a penalty is levied pursuant to subsection 162(1), these three steps must be taken. First, the time when the return was required to be filed is determined. Second, the amount of tax that was unpaid at that time is calculated. Third, the amount of the penalty is settled upon by adding five per cent of the amount arrived at in the second step and the product obtained when one per cent of the tax that was unpaid when the return was required to be filed is multiplied by the number of complete months, not exceeding 12, between the date on which the return was required to be filed and the date on which it was filed. I can find no place in this legislative scheme for taking into account non-capital losses which arose after the time when the return was required to be filed.

This decision of Associate Chief Judge Christie in the above case was followed by Judge Beaubier of this Court in Reemark Chelsea Terraces Project Ltd. v. Canada, [1993] 1 C.T.C. 2727, 93 D.T.C. 469 (T.C.C.).

In my view, the period in 1986 terminating on April 30, is the time with reference to which the unpaid tax must be ascertained for the computation of the penalty. At that time, the amount of $208,400 representing the amount of the loan made to the appellant by the company had to be taken into account for the purposes of determining the tax payable by the appellant in respect of the 1985 taxation year. In this respect, subsection 15(2) of the Income Tax Act provides that "the amount of the loan or indebtedness shall be included in computing the income for the year of the person...unless, (b) the loan or indebtedness was repaid within one year from the end of the taxation year of the lender or creditor in which it was made or incurred..." [emphasis added].

Applying the wording of subsection 15(2) of the Act to the facts of this case, there was a clear requirement for the appellant to add the amount of the loan, being $208,400, to his income for the 1985 taxation year for the purpose of computing the tax that was unpaid in respect of the same taxation year. Subsection 15(2) clearly provides for the inclusion of the total amount of the loan unless the amount is repaid within the time frame specified in paragraph 15(2)(b). Should there be a repayment of the loan within one year from the end of the taxation year of the corporation in which the loan was made there would be no requirement to include the amount of a loan made by corporation to a shareholder in his income for the year in which the loan is made. Since this particular circumstance does not exist in the present case, it follows that the amount of the loan had to be included in the appellant’s income for the 1985 taxation year.

I shall comment briefly on the application of section 80.5 of the Income Tax Act since reference to this section is made in the notice of appeal, as mentioned earlier.

Section 80.5 applies only when a benefit is deemed to have been received by a taxpayer under section 80.4. A benefit is deemed to have been received under section 80.4, if the amount of interest actually paid in a taxation year in respect of a loan or debt is less than the amount of interest that would correspond to the rates of interest prescribed by Part XLIII of the Income Tax Regulations. Here there was no benefit deemed to have been received by the appellant under section 80.4 hence section 80.5 can have no application.

I am therefore of the view that the penalty for late filing was properly levied on the appellant in respect of the 1985 taxation year.

I shall now deal with the matter of interest.

Section 161 establishes liability for interest.

The appellant, in the course of his examination in Court of an auditor of Revenue Canada, put to him a number of questions regarding the matter of interest and appeared to be satisfied with the explanations given in respect of the basis on which interest was calculated on the tax and the penalty owing during the relevant period. In any event, the appellant was not able to establish that the interest levied by the reassessment of January 2, 1990, was wrongly calculated mathematically speaking or computed by reference to erroneous principles.

For these reasons, the appeal is dismissed, with costs.

Appeal dismissed.