Loans

Table of Contents

Commentary

Treatment of mortgage and other loan discounts

Where a taxpayer acquires loans with a view to such loans representing a secure source of interest income, those loans likely were acquired on capital account as investments, so that a discount between the purchase price and the principal likely will be realized as a capital gain (Wood). Before reference were made to the prescribed debt obligation rule in Regulation 7000(2)(a) deeming discounts on stripped coupons or non-interest bearing debt to be interest, a zero-coupon bond could not be considered for these purposes to have been acquired as a (capital) investment as the bond does not generate interest income (Bernick), unless the discount from the bond's principal were be characterized as interest income on general principles (see "Discounts").

However, where the taxpayer (including one not otherwise engaged in a financial business) regularly purchases mortgages or other loans at a substantial discount from their principal amount, reflecting an above-average degree of risk, the realization of those discounts on repayment of the loans generally will be on income account ( MacInnes, Lloyd Estate, Curlett); and similarly where mortgage bonuses are received on such loans (Lloyd Estate); or where the taxpayer purchased (at discounts of between 20% to 40% of the amounts owing by the purchasers) agreements that builders had entered into to sell homes for deferred sales proceeds (Scott). Although such findings have usually entailed cases where the taxpayer entered into a significant number of such transactions on a recurring basis, a single transaction of this general type can give rise to an income account gain on the grounds that it is an adventure in the nature of trade (Mandelbaum).

Loan discounts on purchases of distressed debt or venture capital investments

Where an entrepreneur acquires the shares and debt of a company in financial difficulty with a view to turning the company around, so that the debt (which was purchased at a substantial discount from the amount owing) may be repaid in his or her hands at a substantial gain, any such gain subsequently realized by him or her will be considered to have arisen from an adventure in the nature of trade, and will be taxable (Sissons, Steeves, Woods, Perkins, Meronek, Hall, Bondar). Conversely, any loss realized if the attempted restoration of the company's fortunes is unsuccessful, should be realized on income account as well (Becker). However, if the taxpayer is able to establish that the acquisition of the company's debt at a fraction of the amount owing was not part of a profit-making scheme, i.e., the potential for repayment at a gain was not a motivating factor in the acquisition of the debt, a gain subsequently realized from such repayment will be on capital account (Eidinger). (Note that a transaction of this type often will result in a grinding of losses or the tax basis of assets of the debtor under the "debt parking" rules in ss. 80.01(6) to (8).)

Similar principles apply where the taxpayer lends money to speculative start-up companies with a view to profiting from the resale of shares of the companies which are issued to the taxpayer for nominal consideration, so that the loans (in addition to the shares) may be acquired by the taxpayer on income account (Freud, Greenberg, see also Hayter). However, this principle may not apply where the taxpayer insteads lends to a holding company that lends money on an interest-bearing basis to the start-up company rather than itself being engaged in that venture (Laramee).

"Adventure" determined on commercial principles?

A transaction likely will not be an adventure in the nature of trade if it is not a transaction of a type that a trader would consider entering into (see Mandelbaum, and "Business"). Accordingly, if as a commercial matter, the transaction in question is intended to produce a loss rather than a gain, it likely is not an adventure in the nature of trade even if the provisions of the Act deem there to have been a realization of gain (Loewen, 20 March 2012 T.I. 2012-0438651E5, see also Stanley Drug, Reorganization transactions cf. Financial Collection, Smith). It also would appear that the acquisition of a debt for its face amount (e.g., from an affiliate) is not a transaction of a type that a trader would engage in, so that such debt likely will be considered to have been acquired on capital account (Pollock Sokoloff).

The claiming by a taxpayer of an income-account loss with respect to a debt in a previous year cannot convert that debt from a capital property to property held on income account so that a repayment of the written-off amount will be on income account (see Barrington).

Cases

Loewen v. The Queen, 94 DTC 6265 (FCA)

adventure must be capable of generating a commercial profit

The taxpayer, who paid $200,000 for an SRTC debenture that was redeemable by both the company and him for $140,000, realized a gain of $40,000 when the debenture was redeemed because s. 127.3(1) reduced the cost amount to him of the debenture by 50% of the $200,000 amount designated to him pursuant to s. 194(4) of the Act.

In finding that this gain was a capital gain, Hugessen J.A. stated (p. 6269) that he did "not think it can properly be said that a transaction whose sole purpose is to reduce the tax otherwise payable by a taxpayer is, for that reason alone, an adventure in the nature of trade" and (p. 6270) that although "an intention to make a profit is not essential in order for a transaction to be characterized as an adventure in the nature of trade, such transaction must be one from which it is possible to derive a profit in a commercial sense".

Eidinger v. The Queen, 86 DTC 6594, [1987] 1 CTC 36 (FCA)

The taxpayer sold shares of his family company ("Franco") to an arm's length company ("Charter") and remained as general manager of Franco. Charter and a subsidiary of Charter lent $625,000 to Franco, and when Franco subsequently fell into financial difficulty the taxpayer repurchased the shares, and was assigned Charter's loans, in consideration of for the sum of $1.00 and entering into an agreement to jointly and severally guarantee with Charter certain libilities of up to $200,000, once the liabilities of Franco had been reduced to that level.

The repayment by Franco of loan amounts now owing by it to the taxpayer did not give rise to income in his hands. Although the taxpayer received the repayments rather than being paid salary, the trial judge had found that "at the time of acquisition [of the loans], assignment of the loans to him was of little interest to him and not a primary consideration," and the taxpayer's gain should be considered to have arisen fortuitously rather than as a result of a carefully realized plan for the realization of speculative profits.

Hall v. The Queen, 86 DTC 6208, [1986] 1 CTC 399 (FCTD)

The taxpayers incorporated a Canadian corporation ("Quebec") to purchase a business (of which they were key employees) from the U.S. company owning the business ("Delaware"). In satisfaction of the purchase price, Quebec gave a promissory note to Delaware for $453,332, bearing interest at 9%, payable monthly, with the principal due in ten years' time, and the taxpayers entered into an agreement to purchase the promissory note for $250,000, $75,000 of which was payable in twenty-semi annual non-interest bearing instalments and the balance of $175,000 was due in ten years' time, also without interest. Five years later, the parties entered into transactions which resulted in the taxpayers acquiring the promissory note and (ultimately) realizing gains totaling approximately $200,000. In finding that these gains were on income account, Collier J. noted (at p. 6213) that "it is well known tax law that even a single transaction can be an adventure in the nature of trade" and that the purchase of the promissory note was not an investment.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 15 - Subsection 15(1) shareholder benefit not affected by book entry of shareholder 101

Becker v. The Queen, 83 DTC 5032, [1983] CTC 11 (FCA)

The taxpayer purchased the bulk of a lumber company's shares for $1 and subsequently loaned money to the company and guaranteed loans made to it by other parties. It was held that because the taxpayer's intention in purchasing the company was to transform it from a state of financial difficulty to profitability and then resell it (with the avowed intention of possibly repeating the operation, if successful, with other companies), the amounts which he later lost by way of loans and guarantees were fully deductible as business losses.

The Queen v. Meronek, 82 DTC 6187 (FCTD)

Gains enjoyed by the taxpayer, upon the redemption of preferred shares held by her in a company and the partial payment of company indebtedness held by her, were fully taxable because, at the times that she acquired the shares and indebtedness for nominal consideration (1) she was sufficiently involved with her husband (who became president of the company) to make his intentions her own, and (2) his intention was a speculative one of rescuing the company from insolvency and making it profitable through his own efforts.

Perkins v. The Queen, 80 DTC 6154, [1980] CTC 164 (FCA)

Non-interest bearing book debts owing by companies (the "Jones companies") in financial difficulty were found to have been acquired (at a fraction of the amounts owing) by a trust as part and parcel of the same transaction wherein the Jones companies' shares were acquired by a company of which the trust's trustee was the president and controlling shareholder. The reason for acquiring the Jones companies was that "there was a good chance they could be made successful and if so, the full value of the book debts might ultimately be reaped." The book debts accordingly were acquired as part of an adventure or concern in the nature of trade.

The Queen v. John Woods, 77 DTC 5411, [1977] CTC 597 (FCTD)

As part of the purchase by the taxpayer of a car dealership (which was determined to be a capital transaction) the taxpayer acquired a loan payable by the company to the vendor shareholder for no consideration. This loan was not part of the purchased business and was instead an asset of the vendor shareholder, and its acquisition was held to be an adventure in the nature of trade, partly in light of the apparent intention of the taxpayer to withdraw profits from the purchased business the form of a repayment of the loan's principal. All amounts received by him in this form, net of the amount of advances which he made to the company, were received on income account.

Steeves v. The Queen, 77 DTC 5230 (FCA)

After a corporation ("Paving") that was 50% owned by the taxpayers began experiencing financial difficulty, the taxpayers agreed with the other shareholders (the "Newfoundland group") to purchase the shares of the Newfoundland group for a nominal amount and to purchase book debts owing by Paving to companies controlled by the Newfoundland group (having a face amount of $620,633) for the sum of $70,000. The gains subsequently realized by them on repayment of the book debts were received on income account given that the purchase of the book debts occurred as an essential part of the overall plan to save Paving and given the potential rewards of the transaction.

Minister of National Revenue v. Sissons, 69 DTC 5152, [1969] S.C.R. 507

Following the purchase by the taxpayer of two companies on the verge of bankruptcy ("Sonograph" and "Semco"), the acquisition by him of debentures of Semco at a discount, the transfer by his company of its business to Sonograph, and the repayment by Sonograph of indebtedness owing by it to Semco after the realization by Sonograph of profits from the transferred business, the debentures owing by Semco to the taxpayer were repaid for their principal amount, giving rise to a profit to the taxpayer. This profit was found to be realized in connection with an adventure in the nature of trade given that those debentures could not be considered to have been acquired for income and given that the profit arose at least in part from his efforts as a businessman.

Wood v. M.N.R., 69 DTC 5073, [1969] S.C.R. 330

infrequent acquisitions of mortgages at a discount occurred as a sideline personal investing activity

The taxpayer, a lawyer, who acquired approximately 1 1/2 mortgages per year at a discount out of his personal savings and who made the acquisitions only after he concluded they were safe investments, realized a $700 discount on the mortgage in question for $7,100 as an accretion to capital rather than in connection with an adventure in the nature of trade. (The Crown had abandoned its contention that the amounts were interest.) Abbott J noted (in addition to the infrequency of the transactions) that income from stocks and bonds "was a relatively modest part of [the taxpayer's] gross income," his "purchases were not speculative and...made after he had inspected each property and reached a decision that each mortgage was a safe investment," and that "this pattern of appellant's activities was consistent with the making of personal investments out of his savings and not with the carrying on of a business" (pp. 5074-5).

Minister of National Revenue v. Curlett, 67 DTC 5058, [1967] CTC 62, [1967] S.C.R. 280

sale of mortgage portfolio to own company not characterized as sale of going concern

The taxpayer, who made a practice of personally advancing money, at a substantial discount, on second mortgage loans to customers of a corporation owned by him, realized a taxable gain when he disposed of all those second mortgage loans to the corporation. It was not appropriate for the trial judge to characterize the transaction as the sael at a gain of a money-lending business as a going concern gvien that the corporate purchaser was essentially wholly-owned by him and already held the first mortgages on the properties in question.

Lloyd Estate v. MNR, 63 DTC 1349 (Ex Ct), briefly aff'd 65 DTC 5031 (SCC)

A dentist, whose largest source of income was interest, discounts and bonuses received by him on mortgages which he purchased at a discount, was held to have received the bonuses and discounts as income from "speculative transactions that were adventures in the nature of trade" (p. 1357). In dealing with the submission "that the acquisition of these bonus or discount mortgages had been a mere incident in an overall investment program" (p. 1356), Noël J. noted that the dentist's mortgage holdings were "not a mere incident in his investment program, they comprise nearly the totality of his estate" (p. 1356) at the time of his death in the final taxation year in question.

Minister of National Revenue v. MacInnes, 63 DTC 1203, [1963] S.C.R. 299

highly speculative business of purchasing mortgages at discount

The taxpayer, who was a businessman engaged in the business of manufacturing soap, purchased in each year first residential mortgages with an above-average degree of risk at a discount of 15%. Judson J. held (p. 1205) that the trial judge had erred:

"in failing to find on the evidence ... that the respondent had engaged in a highly speculative business of purchasing mortgages at a discount and holding them to maturity in order to realize the maximum amount of profit out of the transaction, and in failing to find that the discounts realized were taxable income so there are profits or gains from a trade or business ..."

Scott v. Minister of National Revenue, 63 DTC 1121, [1963] S.C.R. 223

in highly speculative business of purchasing mortgages and lease-option agreements at discounts

The taxpayer, who was a senior lawyer, purchased from building contractors agreements (often in the form of lease-option agreements) for the sale of small homes outside Calgary. Notwithstanding that the deferred payments bore interest, generally at 6%, and were secured by the real estate (registered title to which was transferred to the taxpayer) the taxpayer purchased the agreement at discounts ranging from 20% to 40% in light of the risk of default. Judson J. upheld (at p. 1124) the judgment of the trial judge that:

"the appellant was in the highly speculative business of purchasing his obligations at a discount and holding them to maturity in order to realize the maximum amount of profit out of the transactions, and that the profits [were] taxable income and not a capital gain."

MNR v. Mandelbaum, 62 DTC 1093 (Ex Ct)

A Corporation ("Sunnibilt") was pressured by its bank to sell conditional sales contracts and mortgage receivables owing to it in order to pay down debt. The taxpayers purchased the mortgages and agreements for a lump sum equal to 65% of their face amount.

In finding that the resulting gains to the taxpayers when the mortgages and agreements matured were received on income account, Thorson P. found that they had purchased the mortgages and agreements in the course of their business of managing Sunnibilt (and an affiliated corporation), noted that no prudent person would have thought of purchasing the mortgages and agreements as an investment and also noted that it would have been anomalous to conclude that amounts that clearly would have been income to Sunnibilt could be received on a tax-free basis through the device of selling the mortgages and agreements to the taxpayers. Thorson P. further found that if the gains had not been realized from a business in the ordinary sense of the word, the transactions would have represented an adventure in the nature of trade given that "if a person deals with the commodity purchased by him in the same way as a dealer in it would ordinarily do such dealing is a trading adventure" and "it might reasonably be said that when the respondents purchased Sunnibilt's mortgages and agreements their transaction was similar to the kind of transactions that dealers in mortgages and agreements engaged in".

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 16 - Subsection 16(1) no-application where mortgage receivables on income account 156
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Business 109

Curlett v. MNR, 61 DTC 1210 (Ex Ct), briefly aff'd 62 DTC 1320, [1967] CTC 62, [1967] S.C.R. 280

The taxpayer regularly made mortgage loans at a 15% discount from the face amount and then, within a month of the loan, sold the mortgage loan to his company for the face amount. The discounts were received by him from his company as profits from a business carried on by him.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Illegality profits allegedly received in breach of fiduciary duty 87

See Also

Barrington Lane Developments Limited v. The Queen, 2010 TCC 388, 2010 DTC 1244 [at 3734]

The taxpayer lent money to a related company. In 1998, the taxpayer wrote off the loan as a bad debt, mistakenly reporting it as both a capital loss and an income loss. The defect in the return was not discovered until after the limitations period. The taxpayer subsequently lent more money to the related company, part of which was used to pay off the previous debt to the taxpayer.

The Minister argued that the related company's payment to the taxpayer was income under s. 12(1)(i) for repayment of a debt for which a deduction had been made in a preceding year, but Pizzitelli J. accepted the taxpayer's position that it was a capital gain under s. 40(1). Paragraph 12(1)(i) was inapplicable because its position in subdivision b of Division B of Part 1 makes it clear that the paragraph only applies to debts in the nature of "Income or Loss from a Business or Property," and the debt in question was clearly a capital asset. It was irrelevant that the taxpayer had erroneously treated the bad debt as an income loss in a previous year.

Bernick v. The Queen, 2003 DTC 839, 2003 TCC 433

A U.K. zero coupon bond purchased by a Bahamian partnership of which the taxpayer was a partner was found not to be a long-term investment but, rather, inventory to be traded in the short term.

Bondar v. The Queen, 97 DTC 517 (TCC)

The taxpayer, who was the general manager of a corporation ("HSS"), acquired debt of another corporation ("LTM") for consideration that was found by the Court to be nominal. Following the acquisition of LTM by HSS and the subsequent amalgamation of HSS and LTM, the debt owing by the amalgamated corporation ("Amalco") that the taxpayer had so acquired was set-off by book entry against debt owing by the taxpayer to Amalco.

Beaubier TCJ. found that because one of the purposes of the carefully-planned transactions was for HSS to cause LTM to become profitable, and because the taxpayer reasonably foresaw (and intended) that he would realize a profit on the loans, the gain realized by the taxpayer on the subsequent set-off of the loans was on income account.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 9 - Computation of Profit cost of shares acquired in consideration for largely worthless loan obligation was nil 144

Stanley Drug Products Ltd. v. MNR, 90 DTC 1664 (TCC)

A gain on the redemption of scientific research tax credit promissory notes was realized on capital account:

"[The transaction] had little of the indicia of an adventure in the nature of trade other than potential for profit. Merely because an investment is peculiar, has practically no risk and instantly creates a profit does not automatically turn it into an adventure in the nature of trade ..." (p. 1668)

Financial Collection Agencies (Quebec) Ltd. v. MNR, 90 DTC 1040 (TCC)

Before going on to find that the deemed gain on a redemption of an SRTC debenture was realized on income account, Rip J. distinguished Loewen on the ground that in the present case, the debenture did not yield any interest, and also stated that Finsbury Securities was "not authority for the proposition that property acquired for tax avoidance purposes cannot be the subject of an adventure or concern in the nature of trade."

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 39 - Subsection 39(4) 56

Smith v. MNR, 89 DTC 331 (TCC)

A gain on a "quick flip" of an SRTC debenture was realized on income account. "The purpose of the transaction was not to earn income from the securities, but to make a gain over the adjusted cost base on immediate realization and receive a large tax credit."

Administrative Policy

Articles

Finley, "Investment in Strip Bonds May Allow Capital Gain", Taxation of Executive Compensation and Retirement, October 1991, p. 503.

Richards, "Quick Flips: Capital Gains or Income Treatment?", Canadian Current Tax, April 1991, p. C57.