Date: 20000919
Docket: A-500-98
CORAM: ROTHSTEIN J.A.
McDONALD J.A.
SHARLOW J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
- and -
HUANG AND DANCZKAY LTD.
Respondent
HEARD at Toronto, Ontario, on Wednesday, August 23, 2000
JUDGMENT delivered at Ottawa, Ontario, on Tuesday, September 19, 2000
REASONS FOR JUDGMENT BY: ROTHSTEIN J.A.
and SHARLOW J.A.
CONCURRED IN BY: McDONALD J.A.
Date: 20000919
Docket: A-500-98
CORAM: ROTHSTEIN J.A.
McDONALD J.A.
SHARLOW J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
- and -
HUANG AND DANCZKAY LTD.
Respondent
REASONS FOR JUDGMENT
ROTHSTEIN J.A. and SHARLOW J.A.
[1] The issue in this appeal is whether the amounts stipulated in certain debt instruments made in favour of the respondent Huang and Danczkay Ltd. (H & D) were "receivable" within the meaning of that term in paragraph 12(1)(b) of the Income Tax Act when the debt instruments were made. The decision appealed from is reported as Huang and Danczkay Ltd. v. Minister of National Revenue, [1998] 3 C.T.C. 337 (F.C.T.D.).
FACTS
[2] At all relevant times, H & D carried on the business of real estate development. In 1979, H & D entered into a development agreement with the Silver Creek - Cedarwood Partnership for the construction of multiple unit residential building (MURB) called the Silver Creek Project. In 1980, H & D entered into a development agreement the Stonehill Partnership for the construction of a MURB called the Stonehill Project. In 1981, H & D entered into a development agreement with the Burnhill Partnership for the construction of a MURB called the Burnhill Project.
[3] Each of the three development agreements had its own unique features. However, for purposes of this appeal, it is sufficient to say that in each case, H & D agreed to construct and complete the MURB project and to provide certain initial services essential to the project, including providing certain ongoing financial guarantees.
[4] In consideration for what H & D was to provide, each of the partnerships promised to pay stipulated amounts to H & D in instalments, most of which were due in future years. These obligations were evidenced by debt instruments in the form of promissory notes and, in the case of two of the three projects, wrap-around mortgages, containing the terms of payment. It is undisputed that in each case, the amounts of the promissory notes and the wrap-around mortgages (in excess of the amount of the underlying mortgages) totalled the stipulated consideration payable for everything that H & D was to provide.
[5] Each debt instrument was stated to be subject to the provisions of the related development agreement. The promissory note relating to the Silver Creek - Cedarwood partnership was typical and provided as follows:
| $3,107,300 Date: November 29, 1979 |
| FOR VALUE RECEIVED, the undersigned hereby promises to pay to or to the order of Huang & Danczkay Limited the principal sum of $3,107,300 together with interest at the rate of 11-1/2% per annum. The principal amount shall be payable on the dates and in the amounts as follows: |
| Principal Payment Date Principal Payment |
| Offering Completion Date $254,800 |
| (as defined in the Development |
| Agreement dated November 29, |
| 1979 between Silver Creek- |
| Cedarwood Partnership. Huang & |
| Danczkay Limited and Michael H. |
| Huang and Bela L. Danczkay |
| (the "Development Agreement") |
| December 15, 1980 752,500 |
| December 15, 1981 875,000 |
| December 15, 1982 350,000 |
| December 15, 1983 350,000 |
| December 15, 1984 175,000 |
| December 15, 1985 262,500 |
| Interest shall accrue from the Offering Completion Date and shall be calculated and payable yearly on each Principal Payment Date commencing December 15, 1980. |
| If any instalment of principal is not paid within 15 days of the due date, all remaining instalments of principal may, at the option of the holder, forthwith become due and payable. Interest shall be payable both before and after maturity and before and after default with interest on overdue interest at the same rate until paid. |
| This Promissory Note is given pursuant and subject to the Development Agreement and the undersigned shall be entitled to set off against any instalment of principal or interest owing under this Promissory Note such amount as Huang & Danczkay Limited may then owe to the undersigned. If transferred the transferees of this Promissory Note shall take this Promissory Note with the same rights and subject to the same liabilities as Huang & Danczkay Limited has under this Promissory Note. [Underlining added] |
[6] The wrap-around mortgage for the Stonehill project is also typical. It provided in part:
| This Charge is given pursuant to the provisions of a Development Agreement made as of June 30, 1980 (hereinafter called the "Development Agreement") and the rights, obligations and liabilities of the Mortgagor and the Mortgagee hereunder shall be subject to the provisions of the Development Agreement. |
[7] In the development agreement for each of the three projects, H & D provided a cash flow guarantee to the partnerships for a specified period of time. A typical provision describing the cash flow guarantee reads as follows:
| 10.00 From and after the Closing Date and until the Effective Date, H & D, on behalf of the Limited Partnership, shall manage the Project including the initial leasing thereof with powers and duties equivalent to those contained in Section 2.00 and 2.01 of the Management Agreement. During such period the parties agree that H & D shall indemnify the Limited Partnership against all losses incurred in operating the Project and in partial consideration for so agreeing to indemnify the Limited Partnership H & D shall be entitled to receive from the Limited Partnership any operating profits from the project during such period. |
| 10.01 From and after the Effective Date, H & D shall pay to or for the benefit of the Limited Partnership the Net Operating Deficiency during the period of four (4) years immediately following the Effective Date, provided that if the average occupancy rate for the project exceeds eight-five percent in any month prior to the effective date, such period shall terminate four (4) years after the end of such month. H & D shall at the end of each month during such period advance on account of its liabilities under this section 10.01 such amounts as may be necessary to supplement the gross receipts of the project as to keep the liabilities of the project on a current basis ... [Underlining added] |
[8] In addition, in the development agreement for the Silver Creek - Cedarwood project, H & D provided guarantees of the mortgages held by third parties. In the development agreements for the other two projects in which H & D was given wrap-around mortgages, H & D undertook to keep the underlying mortgages in good standing.
POSITIONS OF THE PARTIES
[9] H & D's position is that at the time the promissory notes and wrap-around mortgages were made, the right of H & D to receive the amounts stipulated as payable in subsequent years was conditional upon the fulfilment by H & D of certain future obligations. It is argued that the amounts were not "receivable" at the outset and did not become "receivable" until those conditions were satisfied. The conditions referred to are the cash flow and mortgage guarantees and, in the case of the projects for which there was a wrap-around mortgage, the undertaking to keep the underlying mortgages in good standing.
[10] The trial judge agreed with H & D. He said this at paragraph 22 of his decision:
| Accordingly, as a result of these ongoing obligations, the defendant did not have an immediate, absolute and unconditional right to sue for the uncollected portion of the notes and the mortgages in any of the particular taxation years: Robertson, supra, at 661; Colford, supra, at 1135. Therefore, the uncollected portion of the notes and mortgages were not "receivable" as contemplated under s. 12(1)(b) of the Act, and should not have been included in income in any of the taxation years, until such time as the conditions precedent attached to each development agreement had been satisfied. |
[11] The government argues that the trial judge erred in law in determining that the amounts in question were not "receivable" when the notes and mortgages were made. It is the government's position that they were "receivable" at the outset despite the existence of the various financial guarantees and undertakings.
[12] H & D has not asserted any entitlement to a deduction under any of the provisions in subsection 20(1) of the Income Tax Act that provide for an offset to income in the event the government's position is held to be correct (for example, the reserve for doubtful debts under paragraph 20(1)(l), the reserve for credit risks under paragraph 20(1)(l.1), the reserve for unearned amounts in paragraph 20(1)(m), the reserve for warranties in paragraph 20(1)(m.1), the deduction for repaid amounts in paragraph 20(1)(m.2), the reserve for unpaid amounts in paragraph 20(1)(o) or the reserve for bad debts under paragraph 20(1)(p)).
ANALYSIS
[13] Paragraph 12(1)(b) provides:
| 12. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable: . . . (b) any amount receivable by the taxpayer in respect of property sold or services rendered in the course of a business in the year, notwithstanding that the amount or any part thereof is not due until a subsequent year ... |
12. (1) Sont à inclure dans le calcul du revenu tiré par un contribuable d'une entreprise ou d'un bien, au cours d'une année d'imposition, celles des sommes suivantes qui sont applicables_: . . . b) les sommes à recevoir par le contribuable au titre de la vente de biens ou de la fourniture de services au cours de l'année, dans le cours des activités d'une entreprise, même si les sommes, en tout ou en partie, ne sont dues qu'au cours d'une année postérieure ... |
[14] There is no statutory definition of "receivable" in the Income Tax Act. The long-accepted definition of the term derives from Minister of National Revenue v. John Colford Contracting Company Limited, [1960] Ex.C.R. 433 (affirmed without written reasons, [1962] S.C.R. viii). In that case Kearney J. stated at page 441 :
| In the absence of a statutory definition to the contrary, I think it is not enough that the so-called recipient have a precarious right to receive an amount in question, but he must have a clearly legal, though not necessarily immediate, right to receive it. |
This test was adopted without question in Maple Leaf Mills v. M.N.R., [1977] 1 S.C.R. 558. Colford does not require that for an amount to be receivable, there be an immediate right to receive payment.
[15] In our respectful opinion, the trial judge erred in finding that the amounts in question here were not receivable because there was no immediate right to receive payment. Relying on the words of paragraph 12(1)(b) and Colford, we are of the opinion that there is no requirement that for an amount to be receivable, that there be an immediate right to payment.
[16] The other reason the trial judge found the amounts here were not receivable was that there was no absolute and unconditional right to receive payment in the years in which the notes and mortgages were made. His reference to the absolute and unconditional right to receive payment appears to come from Kenneth B.S. Robertson Limited v. The Queen, [1944] Ex. C.R. 170. In Robertson, Thorson J. stated at page 182-3:
| Did such amounts have, at the time of their receipt, or acquire, during the year of their receipt, the quality of income, to use the phrase of Mr. Justice Brandeis in Brown v. Helvering (supra). In my judgment, the language used by him, to which I have already referred, lays down an important test as to whether an amount received by a taxpayer has the quality of income. Is his right to it absolute and under no restriction, contractual or otherwise, as to its disposition, use or enjoyment? To put it another way, can an amount in a taxpayer's hands be regarded as an item of profit or gain from his business, as long as he holds it subject to specific and unfulfilled conditions and his right to retain it and apply it to his own use has not yet accrued, and may never accrue? [Underlining added] |
In IKEA Limited v. Canada, [1998] 1 S.C.R. 196, Iacobucci J., after referring to the above quotation from Robertson, stated at page 216:
| The ultimate effect of this (realization) principle is clear: amounts received or realized by a taxpayer, free of conditions or restrictions upon their use, are taxable in the year realized, subject to any contrary provision of the Act or other rule of law. |
[17] In our respectful opinion, the reliance of the trial judge on Robertson is misconceived. Neither Robertson nor IKEA dealt with the question that arises in this case, which is whether an amount is "receivable" within the meaning of paragraph 12(1)(b).
[18] Both Robertson and IKEA are cases involving the treatment of amounts actually received, and the issue was whether the amounts received had the character of income in the hands of the recipient at the time of receipt, or whether the recognition of the amount as income could be deferred. The principle that emerges from these cases is that an amount that has actually been received has the character of income at the time of receipt if the recipient has done what is required to earn it, and thus has an immediate and unrestricted right to dispose of it. By contrast, an amount received as a deposit against the fulfilment of a future obligation does not have the character of income until the obligation is fulfilled. This is explained by Thorson J. in Robertson at page 184:
| Where an amount is paid as a deposit by way of security for the performance of a contract and held as such, it cannot be regarded as profit or gain to the holder until circumstances under which it may be retained by him to his own use have arisen and, until such time, it is not taxable income in his hands, for it lacks the essential quality of income, namely, that the recipient should have an absolute right to it and be under no restriction, contractual or otherwise, as to its disposition, use or enjoyment. |
[19] In the present case, H & D was given the promissory notes and wrap-around mortgages to evidence the obligation of the partnerships to pay for the property and initial services provided by H & D. The question is whether, as H & D argues, the fact the debt instruments are stated to be "subject to" the development agreements signifies that its right to be paid does not come into existence until H & D establishes that it has fulfilled its obligations under the cash flow guarantees and other future obligations set out in the various development agreements. The problem with this argument is that there is no term in the development agreements to that effect. The words "subject to" by themselves do not necessarily imply that H & D's right to be paid did not become absolute at the time the debt instruments were made.
[20] As we interpret the debt instruments, the right of H & D to receive the amounts of the promissory notes and wrap-around mortgages arises from the partnerships making and signing the promissory notes and mortgages. With these notes and mortgages being given, the right to receive the amounts in question became absolute. True, H & D might later be called upon to make good on its cash flow guarantees or other obligations, but these are contingent liabilities of H & D. The fulfilment by H & D of its future financial obligations may affect the remedy H & D might obtain in the event the partnerships refuse to make a payment under the promissory notes or the wrap-around mortgages because a right of set off might be applicable. However, they do not preclude the indebtedness of the partnerships to H & D from coming into existence at the outset.
[21] The promissory notes give the limited partnerships the express entitlement "to set off against any installment of principal or interest owing under this Promissory Note such amounts as Huang and Danczkay Limited may then owe to the undersigned". The right of set off is consistent with the view that the partnerships' obligations to H & D are absolute but may be discharged by set off if H & D defaults on its contingent financial obligations to the partnerships. The right of set off may also be consistent with both sets of obligations initially being contingent. Of course, in such case, the right of set off will not be exercised until the mutually contingent obligations have become absolute.
[22] The important point, however, is that the existence of an express right of set off does not, by itself, indicate whether the underlying obligations are contingent or absolute. Here, as we have found, the documentation indicates that the limited partnerships' obligations to H & D are absolute as of the time the debt instruments were made. The express right of set off does not convert these absolute obligations into contingent ones.
[23] It is indicative, though not conclusive, that this interpretation of the contractual obligations is consistent with the representations made by H & D or its principals to those who were invited to invest in the various limited partnerships. The investors were told that the partnership would acquire property at a stipulated cost and incur expenses in a stipulated amount that would qualify for immediate tax relief in the form of capital cost allowance and deductions. That representation, if true, necessarily implies that the stipulated future instalments in the various debt instruments were not contingent obligations of the partnerships when the instruments were made. That in turn implies that the amounts were "receivable" by H & D at that time. If H & D is now correct in saying that as a matter of law the amounts stipulated in the debt instruments were not "receivable" when the instruments were made, the inescapable conclusion would be that they were only contingent liabilities of the partnerships, rendering false the representations made to the investors as to the tax relief available to the partnerships based on the amounts stipulated in the debt instruments.
[24] The appeal will be allowed with costs in this Court and in the Trial Division. The judgment of the Trial Division will be set aside and the Minister's assessment will be reinstated.
"Marshall Rothstein"
J.A.
"Karen Sharlow"
J.A.
"I agree
F.J. McDonald J.A."