Earthquake Enterprises Inc v. Minister of National Revenue, [1985] 1 CTC 2387, 85 DTC 352

Taylor, TCJ:—This is an appeal heard in Belleville, Ontario, on January 9, 1985, against an income tax assessment for the year 1980 in which the Minister of National Revenue disallowed a claim for a reserve provided for under paragraph 20(l)(n) of the Income Tax Act, SC 1970-71-72, c 63, as amended. The critical elements of the situation were portrayed in the reply to notice of appeal as follows:

— at all material times the Appellant was a corporation incorporated under the laws of the Province of Ontario which was engaged in the business of land development and construction in the Township of Marmora, Ontario;

— the Appellant’s 1980 fiscal year commences on February 2, 1979 and terminates on January 31, 1980;

— as at August 2, 1979, the Appellant owned the property;

— on August 3, 1979, the Appellant sold the property to Crowhill Estates for $250,000, realizing a profit of $220,565.26;

— as a result of the aforesaid sale, the Appellant took back a mortgage dated August 3, 1979 in the amount of $250,000, payable on demand plus a promissory note in the amount of $250,000 payable on demand plus one day;

— by an Amending Mortgage dated September 2, 1980, the principal sum of $250,000 becomes due and payable on September 2, 2000;

— that no part of the $220,565.26 profit realized by the Appellant on the sale of the property was not due after the end of the Appellant’s 1980 taxation year;

The parties agreed there had been the sale noted above, although no “sale” documents were presented. The president of the appellant did present two documents in support of his claim for the reserve as follows:

Exhibit A-1, — a mortgage dated September 2, 1980, between Crowhill Estates Ltd, (a corporation of which he was a director) and this appellant corporation, the critical portions of which read:

WHEREAS by a Mortgage dated the 3rd day of August 1979 and registered in the Land Registry Office for the Registry Division of Hastings (No 21)

on the 21st day of August, 1979 as No. 273844 CROWHILL Estates granted and mortgaged unto EARTHQUAKE ENTERPRISES INC.

to secure the payment of the principal sum of $250,000.00 with interest as therein set out upon the terms therein mentioned,

PROVIDED this mortgage to be void upon payment of TWO HUNDRED AND FIFTY THOUSAND — ($250,000.00) — DOLLARS of lawful money of Canada with interest at ten — (10%) — per centum per annum as follows:

the said principal sum of $250,000.00 shall become due and payable on demand and interest calculated daily at the said rate as well after as before maturity and both before and after default on such portion of the principal as remains from time to time unpaid in each year until the principal is fully paid; the first payment of interest to be computed from the 3rd day of August, 1979, upon the whole amount of principal hereby secured, to become due and payable on demand.

PROVIDED this mortgage to be void upon payment of TWO HUNDRED AND FIFTY THOUSAND — ($250,000.00) — DOLLARS of lawful money of Canada with interest at ten — (10%) — per centum per annum calculated and compounded yearly payable accrued interest only on the 2nd day of September in the years 1985, 1990 and 2000.

the said principal sum of $250,000.00 shall become due and payable on the 2nd day of September, 2000, and interest calculated annually at the said rate as well after as before maturity and both before and after default on such portion of the principal as remains from time to time unpaid.

Exhibit A-2, —

PROMISSORY NOTE

For value received, the undersigned hereby agrees to pay to Earthquake Enterprises Inc, a company duly incorporated under the laws of the Province of Ontario, on demand, plus one day, the sum of TWO HUNDRED AND FIFTY THOUSAND ($250,000.00) DOLLARS with interest thereon at the rate of ten percent (10%) per annum.

The undersigned may at its option prepay the whole or any part of the principal sum outstanding at any time prior to demand without notice or bonus.

DATED at Toronto this 3rd day of August, 1979

CROWHILL ESTATES

	Per: (signed) Robert Starr
Witness	President
	Per: (signed) Robert Starr
Witness	Secretary-Treasurer

It would appear from the above that Mr Starr in addition to owning and controlling the appellant corporation was also president and secretary-treasurer of Crowhill, but the Minister did not raise any issue with regard to the “nonarm’s length’’ relationship involved.

In cross-examination of Mr Starr, counsel for the Minister presented Exhibit A-3, the mortgage referenced in Exhibit A-l above, which was dated August 3, 1979, and which was different from Exhibit A-l in that the clause dealing with repayment read as follows:

Provided this Mortgage to be Void upon payment of TWO HUNDRED AND FIFTY THOUSAND —($250,000)— Dollars of lawful money of Canada with interest at ten —(10%)— per centum per annum as follows:

the said principal sum of $250,000.00 shall become due and payable on demand and interest calculated daily at the said rate as well after as before maturity and both before and after default on such portion of the principal as remains from time to time unpaid in each year until the principal is fully paid; the first payment of interest to be computed from the 3rd day of August 1979 upon the whole amount of principal hereby secured, to become due and payable on demand.

Mr Starr was unable to provide any rationale or reason for substituting Exhibit A-l for the original Exhibit A-3, although he agreed it might have been for the purpose he wished to attain at this hearing — that of deferring by use of the reserve provisions of paragraph 20(1)(n), the payment of any tax until a much later time.

It was the position and argument of Mr Starr, acting for the appellant, that the Promissory Note (Exhibit A-2) took precedence over the 1980 mortgage (Exhibit A-l) and that Exhibit A-l was in any event only a mortgage collateral to Exhibit A-2. It was his view that the Promissory Note would have been demanded before the action taken on the mortgage, and the phrase “plus one day” in the Promissory Note denoted a time later than the fiscal year 1980 determined by the Minister. It was pointed out to Mr Starr that neither the Promissory Note nor the Mortgage made any reference to the alleged sale, and that there was no indication in the mortgage of its status as allegedly “collateral”.

Counsel for the Minister took the view that the operative document was Exhibit A-3 — the 1979 mortgage, and that it was the primary security available for enforcement. Since it was ‘‘on demand” the recent Federal Court of Appeal judgment of The Queen v Donald Stanley Derbecker, [1984] CTC 606; 84 DTC 6549, must guide the Court in a determination of the issue. I would quote from that judgment:

The learned trial judge held that in the absence of a demand in the year 1977 the note in question was not “due” to the taxpayer in that year. She said:

. . . what was intended was to tax the taxpayer not at the time he was entitled to the money but at the time when it was required to be paid to him.

With respect we think that she was wrong and that the words “due to him” look only to the taxpayer’s entitlement to enforce payment and not to whether or not he has actually done so.

Here, the taxpayer, alone and at his sole option, was entitled to enforce payment of the note in 1977. From January 1, 1977, it became a present debt and could be sued on without any demand. It was owing and payable. It was, therefore, “due to him”.

Counsel for the Minister recognized that Derbecker (supra), dealt with paragraph 40(l)(a) of the Act, rather than paragraph 20(1)(n), but in my view the critical phraseology “is not due” (20(l)(n) and, ‘‘are not due to him” (40(1)(a)(iii)) are interchangeable for the purposes of this appeal. I am not impressed with any value to be attached to the Promissory Note (Exhibit A-2) after the appellant corporation had taken the further security precautions of entering into a mortgage — (originally Exhibit A-3, later Exhibit A-l). I am satisfied that the mortgage in effect in the 1980 fiscal year of the appellant corporation was Exhibit A-3, and that mortgage was simply ‘on demand”. I do not find it necessary to attempt any definition or interpretation of the relevant clause contained in the September 2, 1980 mortgage (Exhibit A-3). Finally, even though I have noted above that I place no reliance at all on the Promissory Note (Exhibit A-2), the argument of Mr Starr that in some way the words “‘plus one day” places the transaction beyond the scope of the Minister’s assessment is unacceptable. I would read Derbecker (supra), to indicate that at any time after the issuance of the Promissory Note, the appellant corporation could have demanded payment. Theoretically, had such a demand been made on January 31, 1980 (the last day of the 1980 fiscal year) the amount in issue would not have become payable until February 1, 1980 — the first day of the following fiscal year, but I fail to see what bearing that would have on the fact that it was nevertheless due immediately after issuance.

The appeal is dismissed.

Appeal dismissed.