Klassen v. R., [1997] 3 C.T.C. 2497

Hamlyn T.C.C.:

1 These are appeals for the 1989, 1990, 1991, 1992, 1993 and 1994 taxation years. They were heard under the informal procedure.

2 The Appellant was initially assessed for the respective taxation years as follows:

3 In computing his income for the taxation years in issue, the Appellant claimed the following deductions:

4 In reassessing the Appellant for the taxation years in issue, the Minister of National Revenue (the “Minister”) disallowed the deductions outlined above.

Facts

5 An Agreed Statement of Fact was filed. It reads as follows:

1. The appellant, Ted Klassen, mortgaged his home, at 3403 Breton Close N.W. in the city of Calgary, Province of Alberta on or about April 2, 1990. The Certificate of Title #881 - 195 - 585 discloses that a mortgage in the amount of $113,600 was registered against the property on April 9, 1990. Ultimately this mortgage was transferred to the Scotia Mortgage Corporation. Attached hereto as Exhibits 5 and 6 in the Exhibit binder of the appellant. [identified as exhibit A-1]

2. The mortgage referred to in paragraph 1, in respect of the Bank of Nova Scotia (Scotiabank), was originally held by the Province of Alberta Treasury Branch. Attached hereto as Exhibit 9 in the Exhibit binder is a copy of the original mortgage agreement.

3. The appellant married Barbara Jean Markin in December, 1989. Barbara Jean Markin (o/a Klassen) was director of 404165 Alberta Ltd., on July 13, 1989 at which time she signed a Debenture in respect of 404165 Alberta Ltd. (to be known as Village Gardens), located at #183 - 8060 Silversprings Boulevard N.W. in the city of Calgary. Attached hereto as Exhibit 15, in the Exhibit binder are the two debenture documents.

4. A search at Alberta Corporate Registry discloses that the sole director of 404165 Alberta Ltd., was Barbara Jean Markin. The company was noted in default of filing for the years 1990 and 1991. Attached hereto as Exhibit 17 to the Exhibit binder is a computer printout from the business records of Corporate Registry.

5. A search of the Alberta Personal Property Registry on October 17, 1990 disclosed that 404165 Alberta Ltd. had one secured creditor, the Toronto Dominion Bank located at 500 - 58 Avenue S.E. in the city of Calgary, with collateral consisting of equipment and stock. Attached hereto as Exhibit 16 if that document.

6. Ronald Leo Anderson prepared the T1 income tax returns for the appellant/taxpayer, Ted Klassen. He prepared the returns for the years 1989 to the present. He has had over 26 years experience in tax matters, including 12 years as an auditor with the auditor general of Alberta, 3 years in bankruptcy administration, 7 years as the financial reporting officer for the University of Alberta, and as of 1979 he was involved in the preparation of personal income tax returns with a1/5of that involvement being in relation to small business corporations.

The Appellant's Position

6 The motivation for the investment in Village Gardens by the Appellant was based upon the following: a guaranteed repayment with replacement security as confirmed by the Alberta Treasury Branch; direct payment from the profits were to be earned from the company by way of salary, fee, and ultimately shares in the company; and the benefit of the interest in the shares as matrimonial property pursuant to Alberta legislative provisions.

7 Thus, the Appellant concludes the investment of the taxpayer in Village Gardens was made for the purpose of gaining or producing income.

The Respondent's Position

8 In the 1992 taxation year the Appellant was not entitled to a deduction for a business investment loss of $133,099 with respect to Village Gardens.

9 In the 1993 taxation year the Appellant was not entitled to a deduction of interest as the amount was not incurred for the purpose of earning income from business and property[FN1: <p>On this issue, at trial no substantive evidence was tendered.</p>] .

10 And, in the 1989, 1990, 1991, 1993 and 1994 taxation years the Appellant was not entitled to a deduction in respect of non-capital losses.

Significant Evidence

11 In 1990, the Appellant at the behest of his wife was asked to invest in Village Gardens. This investment was to be by way of a loan. The funds were to be raised through the placing of a mortgage on a property that was formerly the Appellant's home. The loan was to assist Village Gardens to secure from the Alberta Treasury Branch monies to allow a better cash flow, to acquire more product from lower priced suppliers and to do advertising. The period of the loan was to be three to six weeks. The costs of the mortgage and the payments on the mortgage would be covered by Village Gardens. From the investment with the anticipated growth of Village Gardens, the Appellant expected to receive an income (from a promised salary and from promised shares and dividends). The agreement between the Appellant and his spouse was verbal.

12 The Appellant believed from his own assessment that Village Gardens was a good business but needed a larger cash flow.

13 It is also of note the Appellant had been through a previous divorce and the Appellant believed, under the circumstances, any investment in his spouse's business upon marriage dissolution would make that property matrimonial property.

14 The testimony of the personal loans officer who had dealt with the Appellant for many years and had assisted him in advice and loans on other projects, advised him the investment was for a short term and was sound. She stated the Appellant's wife had other property that would take over the mortgage security in the next three to six weeks releasing his property back to him.

15 The personal loans officer was not truthful with the Appellant, she had loaned the Appellant's wife more funds than she should have, she knew that Village Gardens had serious financial problems and she was seeking to find ways to cover the Appellant's wife's debt. She further knew that the Appellant historically relied on her for financial advice and investments. Thus, she advised him falsely that the placing of the short term mortgage on his property was a good investment. The mortgage was placed on the property and the funds were advanced to Village Gardens. Two months later, the Appellant discovered several startling events: his credit cards had been misused by his wife and the credit lines were extended beyond the limits; further, the Appellant's wife did not have the equity that she purported to have as her other properties were fully encumbered and she was deeply in debt. Shortly thereafter, upon being confronted, the personal loans officer admitted her deceit to the Appellant that things were not as she represented.

16 Thereafter, the Appellant's matrimonial life with his wife disintegrated resulting in divorce. The personal loans officer was eventually discharged for her misdeeds in relation to the Appellant. Village Gardens went into receivership and the Appellant's wife also went into personal bankruptcy. The final result for the Appellant was that he was liable for the amount advanced to Village Gardens on account of the mortgage with no realistic recourse against his wife or Village Gardens.

Analysis

17 The issue is whether the Appellant is entitled to a business investment loss with respect to the money he submits he invested in Village Gardens. Pursuant to paragraph 50(1)(a) where a taxpayer is owed a debt that is established to be a bad debt, there is a deemed disposition of the debt which triggers a capital loss under paragraph 39(1)(c). Pursuant to paragraph 39(1)(c) the debt must have been owed to the taxpayer by a Canadian-controlled private corporation (“CCPC”) which is a small business corporation. A small business corporation is defined in subsection 248(1) as a CCPC in which all or substantially all of the fair market value of the assets are used principally in an active business carried on primarily in Canada. A CCPC is defined in subsection 125(7) as a private corporation that is a Canadian corporation that is not controlled by non-residents or a public corporation. The other applicable restriction in order for the taxpayer to claim a business investment loss is in subparagraph 40(2)(g)(ii) which states that the debt must have been acquired by the taxpayer for the purpose of earning income.

18 Through the operation of the Act a loss on the deemed disposition of a debt of a small business corporation which has become uncollectible will be deemed to be nil unless the debt has been acquired by the taxpayer for the purpose of gaining or producing income from a business or property.

19 Once this finding is established, the allowable business investment losses (3/4of the business investment loss) are given special treatment such that the Appellant can deduct the losses from any source of income in the year in which they arise. Further, the losses may be applied to the extent Act provides.

Conclusion

20 In this case, the monies were advanced by the Appellant through the bank to Village Gardens. The Appellant was promised that he would, with the success of Village Gardens, receive a salary and ultimately receive shares and dividends. The mortgage was to be discharged within three to six weeks when his wife would give the bank her own replacement securities.

21 Village Gardens was a Canadian controlled private corporation that owed a debt to the Appellant and he has established the debt was a bad debt in 1992, that is, was uncollectible.

22 In this case, I conclude the Appellant had formed the intention and had the purpose of gaining and producing income from the making of the loan. The business investment loss through the operation of the Act and the facts in this case is an allowable business investment loss.

Decision

23 The appeals are allowed and the matter is referred back to the Minister for reconsideration and reassessment on the basis that the Appellant had a business investment loss of $133,099 for the 1992 taxation year with respect to a loan made to Village Gardens and is entitled to an allowable business investment loss and tax treatment in conformity with the Act.

24 There will be no order as to costs.