Pollock Sokoloff Holdings Corp v. Minister of National Revenue, [1973] CTC 2287

The Chairman (orally: May 30, 1973):—This is an appeal by Pollock Sokoloff Holdings Corp against the reassessment of the Minister of National Revenue for the taxation year 1968.

The reassessment arises out of the deduction made and shown in the financial statements of the appellant company of the sum of $30,000, being a portion of a loan made to one Sam Crystal over a period of years extending from 1962 to 1965.

The main witness for the appellant company, Mr Sam Sokoloff, gave evidence that there were two companies involved: the appellant company and Mysam Holdings Corporation. In or about the year 1966, their common auditor Mr Burstein, who also gave evidence, suggested that the two companies, who were controlled by the same shareholders, take advantage of a recent change in the Quebec taxation law and make Mysam a true “holding company” within the meaning of the Quebec Provincial Income Tax Act, as this would enable that company to reduce its tax liability from the existing 12% to, I think, 1/20th of 1%.

What then took place on or about January 2, 1967 was the transfer of the non-acceptable assets out of Mysam into the appellant corporation, and the transfer of the acceptable assets out of the appellant company into Mysam Corporation, so that Mysam was a true holding company within the meaning of the Quebec Provincial Income Tax Act and able to take advantage of the newly enacted amendment.

Evidence was adduced, and not contradicted, that resolutions of the boards of directors authorizing these transfers were passed and, presumably, approved by the shareholders, who were one and the same. At the time of the transfers, the appellant company had several loans outstanding. The Crystal loan had been current, in so far as interest was concerned, up until August of 1966, and the next interest payment would not be due until after the transfer of the loan from Mysam to the appellant company.

The evidence of the auditor Mr Burstein is that the said loan was not included as a bad debt in the financial statements of the appellant company because it was still considered at that time to be a current and collectable account. When questioned by me, he gave evidence that he did not set up a reserve for doubtful accounts, because the moneys that had been loaned were loaned either on the security of real estate or on the security of shares in companies that owned real estate. He therefore considered all these loans to be adequately secured and felt that it would not at that time have been good accounting practice to set up a reserve, which would unquestionably, in his mind, have been challenged by the taxation officials.

In 1968 it became apparent that the loan was in some jeopardy. Meetings were held by Sam Sokoloff with Mr Crystal. No action was taken to enforce payment of the loan but both parties were hopeful that some change in the real estate situation in the province would improve the outlook and Mr Crystal would be able, eventually, to meet his obligations. Therefore, in the year 1968, the auditors, exercising what I deem to be sound accounting principles and practice, wrote off the sum of $30,000 as a bad debt, against the total amount of $50,000 outstanding on the loan, leaving the remaining $20,000 on the books of the company. That the debt was bad to that extent at that time is unquestionable, in my mind, and, in August of 1968, Mr Crystal was forced into bankruptcy and apparently a receiving order was issued, because a trustee was appointed and action was subsequently taken to recover on the security.

The evidence of Mr Henri Verroneau, the chartered accountant from the Appeals Section of the Department of National Revenue, clearly indicates to me that the reason for disallowing this sum was that, in his opinion, the company did not qualify under subparagraph 11(1)(f)(ii) of the Income Tax Act (now subparagraph 20(1 )(p)(ii) of the amended Act, SC 1970-71-72, c 63), because it was not in the money-lending business. It is also equally clear to me that he based that decision on his calculation, set out in Exhibit R-5 I believe it was, which showed, according to his figures, that, out of total assets of $15 million, only less than 0.8% of that amount was invested by way of the lending of money.

It has been pointed out by counsel for the appellant that this $15 million included some non-liquid assets to the extent of the Fleetwood holdings which were not freely transferable, and also some $4 million in real estate. However, be that as it may, I think there is no question whatsoever, at least there is none in my mind, that it was the smallness of that percentage of the overall operation of the appellant company that is represented by moneys out on loan that led to this reassessment.

The respondent has also raised two questions concerning the right of the appellant company to object to the disallowance of this bad debt since it was not “the owner in law’’ of the Crystal debt in the year 1968. For this allegation he relies on a judgment, a writ of execution obtained by the solicitors for Mysam, whose shareholders, again I repeat, were the same as the shareholders of the appellant company. This judgment clearly shows that Mysam was ‘the judgment creditor”, such being the term used in the Province of Quebec. It is also in evidence from Mr Lipper, who obtained the judgments, that he did so on the documents available to him and was not aware that any internal transfer had taken place between Mysam and the appellant company.

It is also in evidence through Mr Lipper that this judgment could have been assigned or sold, and in fact was, I think, sold, by the resolutions between the two companies. There was a clear intention by the shareholders as to which of the two companies was the owner of the Crystal liability after the passing of those resolutions.

It is also submitted that Article 1570 and Article 1571 of the Quebec Civil Code preclude the appellant from a right before this Board by virtue of its failure to comply with the provisions of those articles. I am not expert in the Quebec Civil Code and I accept the interpretation placed on it by counsel before me, but even if not identically worded, it is not unlike the law of the Province of Ontario and, in my view, applies primarily to the giving of notice to the debtor by the transferee or assignee before the transferee or assignee of the debt may take action, and was not, and is not, intended to place the Minister of National Revenue in the position of relying on those articles in this type of situation.

lt therefore boils down to whether or not the appellant company was, pursuant to paragraph 11(1)(f), engaged in making loans and therefore entitled to deduct—and I quote from paragraph 11 (1 )(f):

(f) the aggregate of debts owing to the taxpayer

(i) that are established by him to have become bad debts in the year, and

(ii) that have (except in the case of debts arising from loans made in the ordinary course of business by a taxpayer part of whose ordinary business was the lending of money) been included in computing his income for the year, or a previous year;

As I have said, I am satisfied that the first obligation has been met. The second obligation is whether or not the debt was incurred in the ordinary course of business of the taxpayer, part of whose ordinary business was the lending of money.

The evidence is that Sokoloff was well known to have funds available for investment or for lending on real estate. It is also given in evidence that most of the people in the real estate field when it was very active in this area in the early sixties knew one another, and knew when and where funds were available. It is also in evidence that the funds were loaned to people who were acquaintances or friends of Sokoloff. To me this is not unusual, because one should not be expected to lend only to people one doesn’t know—and in fact I would seriously question the business acumen of a taxpayer who did so.

Some decisions have been cited to me by counsel. One by Mr Fordham, the last Chairman of the Tax Appeal Board, who, in 1954, in the case of George A Orban v MNR, 10 Tax ABC 178; 54 DTC 148, made a statement to the effect that the taxpayer was not holding himself out as a money-lender and that there was no continuity and that the loans were in fact small loans. I could not accept that as a proper interpretation of this section, and I am pleased to have another case cited to me by counsel for the appellant where Mr Fordham, in a later decision in, ! believe, 1971, indicated that his reasons in the Orban case were not meant to cover the situation that arises in a case such as this. (See Valutrend Management Services Limited v MNR, [1972] CTC 2170; 72 DTC 1147.)

I must give a fairly rigid interpretation to the words of the Act and, in so doing, in reading the second part of paragraph 11(1 )(f), I find no limitation, no set minimum or maximum that a taxpayer is required to meet in order to qualify as a money-lender. The provision merely states that the taxpayer must lend money in the ordinary course of his business and that part of that ordinary business must be the lending of money. It is clear that over a period of years this taxpayer has loaned money to the extent of several hundred thousand dollars, or at least in excess of $200,000, and that this is the first time that it has experienced a bad debt.

In my view, on the evidence of the witnesses and of the documents produced, I am satisfied that the appellant qualified for the exemption allowed under paragraph 11(1)(f) and the appeal will therefore be allowed and referred back to the Minister for reassessment accordingly.

Appeal allowed.