Arcade Construction LTD v. Minister of National Revenue, [1981] CTC 2845, 81 DTC 655

M J Bonner:—This is an appeal from an assessment of income tax for the appellant’s 1978 taxation year. The events giving rise to the assessment are somewhat unusual. The appellant had borrowed money from its bank, the Bank of Montreal. On April 22, 1977, during the appellant’s 1978 taxation year) the bank “applied” a payment of $16,000 to reduce the amount then owing to it by the appellant.* [1] The cause of this action of the bank has never been discovered. Although it appears that a payment of $16,000 was made to the bank, the identity of the payer is not known. It was admitted that no payment of the amount in question was made by the appellant and that the bank did not debit the appellant’s bank account for the amount, as was the practice of the bank in securing repayments of the loan.

Brian J Saunder, a member of the firm of accountants who acted for the appellant, testified that he first learned of the matter in the spring of 1978. At that time, during preparation of the appellant’s 1978 financial statements, he sent a confirmation form to the bank and received a response indicating that the amount of the appellant’s outstanding bank loan was $16,000 less than the figure indicated by the appellant’s financial records. Mr Saunders made enquiries and discovered that the discrepancy arose from a single $16,000 entry made on April 22, 1977. Notwithstanding conversations with officials of the bank and with his client, Mr Saunders was unable to discover the source of the payment giving rise to the entry. Based on his discussions with the bank, Mr Saunders concluded that if the “rightful owner” of the money should appear the bank would look to the appellant for repayment. Mr Saunders therefore recorded the $16,000 as a liability on the appellant’s financial statements.

Evidence was given, as well, by James M Blake, president and, I believe, principal shareholder of the appellant. He did not become aware of the entry until June of 1978 when he was advised of it by Mr Saunders. He made enquiries and was unable to discover the circumstances giving rise to the entry. He asserted that, so far as he knew, no payment was made by anyone with whom the Company did business. Mr Blake had discussions with various Officials of the bank, but was unable to discover why the entry was made. He did conclude from those discussions, however, that if ownership of the money were to become known the bank would assert a claim against the appellant.

On assessment the respondent relied upon section 80 of the Income Tax Act and reduced the non-capital loss carried forward by the appellant from 1977 by $16,000. He pleaded that in so assessing he assumed that the appellant’s indebtedness to the bank was extinguished to the extent of $16,000 and that no payment in that amount was made to the bank by the appellant.

The appellant’s counsel argued that the appellant’s liability to the bank was neither settled nor extinguished within the meaning of section 80. He submitted that a settlement required an agreement and that if a debt is to be extinguished it must be brought to an end. He argued further that the event was a “windfall”.

As to the windfall argument, counsel for the respondent asserted that the Minister did not rely on any provision of the Act other than section 80. He argued that the appellant had failed to establish that the Minister’s assumption that the debt was extinguished to the extent of $16,000 was incorrect. He argued further that under section 80 it is not necessary that the entire debt be extinguished. No authority was cited for the latter proposition.

It cannot, in my view, be said that on April 22, 1977, a debt or other obligation of the appellant was “settled” within the meaning of section 80. It seems to me that in ordinary English usage a debt or obligation is settled when creditor and debtor deliberately agree to fix or vary their existing rights and Obligations. Nothing of the sort happened here.

It is perhaps unfortunate that no one from the bank was called to give evidence. However, it seems reasonably plain from the evidence of Mr Saunders and Mr Blake that all that happened was that the bank made an entry reducing the recorded amount of the appellant’s indebtedness to it and subsequently persisted in an assertion that the indebtedness is the reduced amount. It did so quite without reference to any action taken by or on behalf of the appellant and probably as a result of some payment not in any way intended to affect or benefit the appellant.

The appellant’s obligation to pay the $16,000 to the bank might, of course, have been extinguished by the payment thereof. It could not, however, have been extinguished by an erroneous action of the bank in recording a payment not made as a payment of the debt in question. The obligation might have been extinguished by an agreement in the nature of an accord and satisfaction if supported by consideration. The evidence is inconsistent with extinguishment in this manner.

In effect the position boils down to this: The appellant says that it has not paid the bank. The bank says that someone has paid it and until that someone appears it does not intend to claim the money. In such circumstances I cannot find the debt has been extinguished. The appeal is therefore allowed and the assessment referred back to the respondent for reconsideration and reassessment on the basis that the debt or obligation of the appellant was neither settled nor extinguished during its 1978 taxation year.

Appeal allowed.