Huneault v. R., [1998] 3 CTC 2788, 98 DTC 1488

Lamarre T.C.J.:

The appellant is appealing two assessments made by the Minister of National Revenue (“the Minister”) under the Income Tax Act (“the Act”) for the 1990 and 1991 taxation years. In submitting his amended tax return for 1990 the appellant claimed inter alia a business expense of $10,000 which was disallowed by the Minister. The appellant maintained that this was salary expense incurred in the course of carrying on his profession as a notary.

Secondly, the appellant claimed a business investment loss in his tax return for 1991 under s. 39(1)(c) of the Act, on an alleged loss of $26,000, which was also disallowed by the Minister. The latter considered that the appellant had not made a loan to a small business corporation but to an individual. Consequently, in the Minister’s submission, if there was a disposition of the debt it could not result in a business investment loss. The Minister further alleged that since the loan in question bore no interest, it was not made for the purpose of gaining or producing income and so the loss sustained on disposition of the debt was deemed to be nil under s. 40(2)(g)(ii) of the Act.

The appellant contended that the loan was made to a small business corporation for the purpose of gaining or producing income.

In assessing the appellant the Minister relied on the following facts:

[TRANSLATION]

(a) on or about October 18, 1993 the Minister issued a notice of reassessment for the 1990 taxation year in which he disallowed a deduction of $10,000 by the appellant from his professional income, claimed as salary expenses paid for the purpose of gaining or producing business income;

(b) although he was requested by the Minister several times to document the $10,000 of salary expenses for the 1990 taxation year, the appellant was unable to produce any form of receipt or cheque as evidence of such expenses;

(c) the appellant knowingly, or in circumstances amounting to gross negligence in the carrying out of a duty imposed by the Income Tax Act (“the Act”), made or participated in, assented or acquiesced in the making of a false statement or omission in his tax return for the 1990 taxation year, such that the tax payable on the basis of the information provided in the appellant’s return was less than the amount that was payable under the Act;

(d) the Minister accordingly imposed a penalty on the appellant on the excess tax payable by him which was not paid as a result of the false statement or omission, pursuant to s. 163(2) of the Act, for the 1990 taxation year;

(e) on or about October 18, 1993 the Minister also issued a notice of reassessment for the 1991 taxation year in which he disallowed the deduction which the appellant had claimed as a deductible business investment loss on an alleged loss of $26,000;

(f) on or about December 7, 1989 the appellant lent the sum of $26,000 to Jean-Rhéal Gauthier in return for a promissory note;

(g) the appellant did not make this loan to a corporation, [1] but to an individual;

(h) accordingly, the disposition of this loan by the appellant cannot be a disposition of a debt owed by a small business corporation;

(i) the appellant made this loan without interest;

(j) the appellant did not make this loan for the purpose of gaining or producing income;

(k) the loss sustained by the appellant on disposition of this loan is accordingly deemed to be nil within the meaning of the Act.

At the start of the hearing counsel for the respondent mentioned that she consented to judgment regarding the penalty imposed on the appellant under s. 163(2) of the Act for the 1990 taxation year.

I also heard the testimony of Jean-Rhéal Gauthier (sole shareholder in Les Constructions Janré Ltée (“Janré Ltée”)), Claude Hachey (who acted as bookkeeper for the appellant’s employees from 1983 to 1991) and the appellant himself.

The appellant explained regarding the $10,000 salary expense that he has been a notary since 1980 and that since 1981 he has occupied space in the offices of another notary, Charles Rioux. He pays him rental which includes the use of all necessary equipment. At the start of his practice the appellant had no employees. His employees were subsequently paid through Mr. Rioux’s payroll. It was not until June 1991 that the appellant obtained his own employer number and began having his own payroll (in a sworn statement prior to the hearing, Exhibit I-4, the appellant spoke of June 1990). Accordingly, from 1983 to 1991 the appellant apparently repaid Mr. Rioux the gross salary paid to his employees.

It was not until 1990 (in the statement filed as Exhibit 1-4 the appellant spoke of July 1990, though at the hearing he mentioned towards the end of 1990 or early 1991) that the notary Rioux realized that his bookkeeper Mr. Hachey had not claimed from the appellant all the money paid by Mr. Rioux with respect to the appellant’s employees. These unclaimed amounts corresponded to the part paid by the employer for unemployment insurance, the Quebec Pension Plan, wage loss insurance and health insurance. Mr. Rioux apparently estimated the amount owed by the appellant in 1990 for the money paid in this way from 1983 to 1989 at about $10,000. The table summarizing these amounts, filed in evidence as Exhibit A-4, showed a total paid in this connection from 1983 to 1989 of $9,574.02.

As the appellant acknowledged that he owed Mr. Rioux this amount, he claimed it as a salary expense for 1990 forthwith instead of amending his tax returns for 1983 to 1989. However, the appellant admitted that he has not to date repaid Mr. Rioux.

According to the appellant’s testimony there was no formal agreement for repayment, except that from time to time Mr. Rioux would ask him about repayment of the amount. Mr. Hachey was not aware of the repayment terms and Mr. Rioux was not present to give his version of the facts.

Mr. Hachey explained in testimony that he had mistakenly failed to claim these amounts from the appellant and that as soon as Mr. Rioux told him of it he prepared the summary table (Exhibit A-4) to show exactly what amounts were owed, based on the payrolls for each year.

Concerning the loss of $26,000, this was apparently an amount loaned to Jean-Rhéal Gauthier on December 7, 1989. According to the promissory note signed by Mr. Gauthier (Exhibit I-1 ), he undertook to repay the sum of $26,000 loaned him by the appellant without interest within two weeks, that is, on December 21, 1989. On the back of this promissory note was written [TRANSLATION] “Loan Const. Janré Ltée and J.R. Gauthier”.

Mr. Gauthier testified that his business was experiencing serious financial problems at the time. A petition for the appointment of an interim receiver of the property of Janré Ltée pursuant to the Bankruptcy and Insolvency Act was made before the Superior Court, Hull District, by four creditors of Janré Ltée on November 29, 1989 (Exhibit A-l). It was alleged in that petition that Janré Ltée was four months late in its mortgage payments, totalling over $170,000. The co-petitioners were creditors of amounts totalling some $65,000.

Mr. Gauthier avoided the bankruptcy of Janré Ltée by finding the money needed to arrive at a composition with his creditors. Accordingly, he approached the appellant, with whom he had been doing business for a long time. Janré Ltée was a construction business and the appellant prepared notarial contracts relating to the sale of land and newly built houses. Mr. Gauthier mentioned that Janré Ltée might build between 200 and 300 houses a year. This client represented over 50 percent of the appellant’s turnover.

That is why when Mr. Gauthier asked the appellant to advance him the sum of $26,000, the appellant agreed as he hoped to preserve this business which was his largest source of income. The appellant explained that he put a two-week deadline on it because it corresponded to the date on which the Federal Business Development Bank (“FBDB”) was to make mortgage advances to Janré Ltée on a shopping centre in Hull, which in fact was the company’s last project. The shopping centre was not rented as expected and the FBDB refused to make the advances in question.

Mr. Gauthier explained that the FBDB subsequently retook possession of the shopping centre and held a judicial sale from which it collected the proceeds of the sale. That was the point at which Janré Ltée ceased operating its business. The appellant said this judicial sale took place some time in late 1990 or early 1991. Mr. Gauthier did not give the date of the judicial sale.

Furthermore, the appellant submitted in evidence a copy of a cheque (Exhibit A-2) which he drew on his trust account on December 7, 1989 in the amount of $48,738.39, payable to Bélec, Letellier In Trust, the lawyers acting for Janré Ltée at that time.

The appellant also filed a copy of two cheques (Exhibit A-3) drawn on the account of Bélec, Letellier, dated December 11, 1989, one in the amount of $8,500 and the other of $45,450.77, payable to Paul Fréchette, who was acting for the co-petitioners in the petition to appoint an interim receiver. According to Mr. Gauthier these two cheques were used to repay the creditors mentioned in the petition so as to avoid bankruptcy.

The appellant also submitted in evidence two copies of documents from the Bank of Nova Scotia (Exhibits A-7 and A-8) showing that he had paid $28,738.39 into his trust account on December 12, 1989. Mr. Gauthier apparently also deposited $20,000 from his personal account into the appellant’s trust account on December 7, 1989. The total of these two amounts, that is, $48,738.39, represented the amount of the cheque paid to Bélec, Letellier on December 7, 1989 (Exhibit A-2).

In support of these various amounts the appellant maintained that he made a loan to Janré Ltée, and not Mr. Gauthier personally, in order to enable the company to continue generating income.

In cross-examination the appellant admitted that he had not claimed this loss at the time he filed his tax return for 1991 (the appellant’s fiscal year for his professional income ends on July 31). He explained that at that time he was not expecting that he would be unable to recover the amount of his debt. He said it was around 1992 or 1993 that he realized Mr. Gauthier would be unable to pay. In re-examination he candidly admitted that he did not know that Janré Ltée was so much in debt at the time of the petition to appoint an interim receiver, and that it was shortly before the date of the hearing in this Court that he had learned of the content of the petition.

The appellant said that it was when Revenue Canada undertook an audit of his tax returns that he realized he had a bad debt. However, he did not know when this audit took place.

On June 1, 1994 Mr. Gauthier signed a document (Exhibit 1-2) by which he acknowledged that he was indebted to the appellant under a promissory note dated December 7, 1989 and that this loan had been made [TRANSLATION] “for the purposes of [his] company”. In the same document he indicated that [TRANSLATION] “the company [Janré Ltée] ... has not repaid the said loan”.

Analysis

The appellant has the burden of showing on a balance of probabilities that the subject assessments are incorrect.

On the $10,000 expense which the appellant claimed as an expense incurred in the course of his professional occupation, I consider that he did not succeed in showing that he was entitled to such an expense. To begin with, on the evidence I agree that this amount is attributable to money paid by Mr. Rioux in connection with salaries paid to employees. However, I draw a negative conclusion from the absence of any testimony by Mr. Rioux. I would recall here the comments contained in The Law of Evidence in Civil Cases, by Sopinka and Lederman, which were cited by Judge Sarchuk of this Court in Enns v. Minister of National Revenue (1987), 87 D.T.C. 208 (T.C.C.), at 210:

In The Law of Evidence in Civil Cases, by Sopinka and Lederman, the authors comment on the effect of failure to call a witness and I quote:

In Blatch v. Archer, (1774), 1 Cowp. 63, at p. 65, Lord Mansfield stated:

It is certainly a maxim that all evidence is to be weighed according to the proof which it was in the power of one side to have produced, and in the power of the other to have contradicted.

The application of this maxim has led to a well-recognized rule that the failure of a party or a witness to give evidence, which it was in the power of the party Or witness to give and by which the facts might have been elucidated, justifies the court in drawing the inference that the evidence of the party or witness would have been unfavourable to the party to whom the failure was attributed.

In the case of a plaintiff who has the evidentiary burden of establishing an issue, the effect of such an inference may be that the evidence led will be insufficient to discharge the burden. (Lévesque et al. v. Comeau et al. [1970] S.C.R. 1010, (1971), 16 D.L.R. (3d) 425) (emphasis added)

The appellant was very vague about the agreement he had concluded with Mr. Rioux for repayment of the money allegedly advanced by the latter. There was nothing to show the Court that Mr. Rioux had not himself already claimed in his operating expenses the amount he was now claiming from the appellant. The latter did not repay this money and submitted no evidence to show he intended to repay it. It is not enough to say that he admitted owing this amount, without providing much corroboration for his testimony. Mr. Hachey did acknowledge that he had failed to claim this amount from the appellant, but he was unable to throw any further light on the agreement made between Mr. Rioux and the appellant. I therefore conclude that the appellant provided insufficient evidence to show on a balance of probabilities that he had himself incurred an expense of $10,000 in order to gain or produce income from his profession.

For the appellant to be entitled to the business investment loss in the amount of $26,000 he has to meet the conditions set out in s. 39(1)(c) of the Act, which reads in part as follows:

39: Meaning of capital gain and capital loss.

(1) For the purposes of this Act,

(c) a taxpayer’s business investment loss for a taxation year from the disposition of any property is the amount, if any, by which the taxpayer’s capital loss for the year from a disposition after 1977

(i) to which subsection 50(1) applies, or

(ii) to a person with whom the taxpayer was dealing at arm’s length

of any property that is

(iii) a share of the capital stock of a small business corporation, or

(iv) a debt owing to the taxpayer by a Canadian-controlled private corporation (other than, where the taxpayer is a corporation, a debt owing to it by a corporation with which it does not deal at arm’s length) that is

(A) a small business corporation ...

Section 50(1) reads in part as follows, for the year in question:

50: Debts established to be bad debts and shares of bankrupt corporation.

(1) For the purposes of this subdivision, where

(a) a debt owing to a taxpayer at the end of a taxation year (other than a debt owing to him in respect of the disposition of personal-use property) is established by him to have become a bad debt in the year, or...

the taxpayer shall be deemed to have disposed of the debt or the share, as the case may be, at the end of the year and to have reacquired it immediately thereafter at a cost equal to nil.

Disregarding for the moment the question of the existence of a capital loss within the meaning of s. 40(2)(g)(ii) of the Act, the appellant first had to show that the loan was made to Janré Ltée and not to Jean-Rhéal Gauthier personally. A priori the promissory note (Exhibit 1-1) and debt acknowledgment (Exhibit I-2) established that the appellant made a loan to Mr. Gauthier personally. All the appellant’s evidence sought to show that this loan was made to offset part of the debts of Janré Ltée. [2] That may be so, but it is not enough to show that the loan was not made to Mr. Gauthier personally. As Janré Ltée was on the point of bankruptcy it is highly likely that the appellant and Mr. Gauthier deliberately agreed to make a loan to Mr. Gauthier directly so the latter could control where the money went. If the loan had been made to the company directly, in view of the fact that there was already a petition pending to appoint an interim receiver, Mr. Gauthier would have lost control of it.

Further, in tax matters form takes on some importance. In this connection I would refer to the Federal Court of Appeal judgment in Friedberg v. R. (1991), 92 D.T.C. 6031 (Fed. C.A.), at 6032:

In tax law, form matters. A mere subjective intention, here as elsewhere in the tax field, is not by itself sufficient to alter the characterization of a transaction for tax purposes. If a taxpayer arranges his affairs in certain formal ways, enormous tax advantages can be obtained, even though the main reason for these arrangements may be to save tax (see The Queen v. Irving Oil 91 DTC 5106, per Mahoney, J.A.). If a taxpayer fails to take the correct formal steps, however, the tax may have to be paid. If this were not so, Revenue Canada and the courts would be engaged in endless exercises to determine the true intentions behind certain transactions. Taxpayers and the Crown would seek to restructure dealings after the fact so as to take advantage of the tax law or to make taxpayers pay tax that they might otherwise not have to pay. While evidence of intention may be used by the Courts on occasion to clarify dealings, it is rarely determina- tive. In sum, evidence of subjective intention cannot be used to “correct” documents which clearly point in a particular direction.

Further, even if I were persuaded that the appellant loaned $26,000 to Janré Ltée, I am not persuaded that the debt became a bad debt during 1991. The appellant himself candidly admitted that he had not claimed this loss at the time he made up his 1991 tax return because at that time he did not think it would never be paid. He became certain of this at the time of the audit by Revenue Canada. However, he did not know when the audit took place.

Counsel for the appellant tried to use the petition to appoint an interim receiver (Exhibit A-l) to show that the appellant could have known as early as 1989 that Janré Ltée might find it hard to repay the loan. On the one hand, if that were so it would seem that the appellant would not have lent such a sum of money. On the other, the appellant admitted that it was not until shortly before the date of the hearing in this Court that he had learned of the content of the petition.

Counsel for the appellant also relied on the fact that the latter would no longer have expected to be repaid his debt once the FBDB retook possession of the shopping centre belonging to Janré Ltée. Once again, the evidence before the Court is insufficient to support a conclusion as to the time when this event occurred or the time when Janré Ltée ceased operating its business. Only the appellant testified on this point and his memory of dates was somewhat deficient (if we consider, for example, the discrepancy between his testimony and the earlier statement, Exhibit I-4, regarding the first amount of $10,000 at issue).

Further, it was in 1994 that the appellant had Mr. Gauthier sign a debt acknowledgment, and the assessments were issued on October 18, 1993. This suggests that it was probably not prior to 1992 or 1993, as he mentioned at one point in his testimony, that the appellant realized that his debt had really become bad.

There will be a “créance irrécouvrable” (uncollectable debt) [3] in a taxation year if the appellant can prove that using his business judgment he considered during that year that he could not collect on the debt (see Pi- cadilly Hotels Ltd. v. R. (1978), 78 D.T.C. 6444 (Fed. T.D.); Greensteel Industrial Ltd. v. Minister of National Revenue (1975), 75 D.T.C. 63 (T.R.B.)). I consider here that the appellant has not shown on a balance of probabilities that he believed his debt to be uncollectable during 1991. Consequently, the appellant has not proven that there was a deemed disposition in 1991 of a debt owed to him by a private small business corporation within the meaning of s. 50(1) of the Act.

In view of the foregoing conclusion, therefore, I do not have to rule on the question of a capital loss that might be nil under s. 40(2)(g)(ii) of the Act.

Consequently, the appeal for the 1990 taxation year is allowed and the assessment referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the Minister now agrees to cancel the penalty imposed under s. 163(2) of the Act. In all other respects the appeal from the assessment for that year is dismissed. The appeal for the 1991 taxation year is dismissed.

Appeal dismissed.