Date: 19990125
Docket: A-282-96
CORAM: STONE J.A.
McDONALD J.A.
SEXTON J.A.
BETWEEN:
THE CADILLAC FAIRVIEW CORPORATION LIMITED
Appellant
-and-
HER MAJESTY THE QUEEN
Respondent
Heard at Toronto, Ontario, on November 18 and 19, 1998.
Judgment delivered at Ottawa, Ontario, on January 25, 1999.
REASONS FOR JUDGMENT BY: McDONALD J.A.
CONCURRED IN BY: STONE J.A.
SEXTON J.A.
Date:19990125
Docket: A-282-96
CORAM: STONE J.A.
McDONALD J.A.
SEXTON J.A.
BETWEEN:
THE CADILLAC FAIRVIEW CORPORATION LIMITED
Appellant
-and-
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
McDONALD J.A.
[1] The issue to be decided in this case is whether a taxpayer can claim an allowable capital loss pursuant to subparagraph 40(2)(g)(ii) of the Income Tax Act (the "Act") for losses incurred on guarantees made in respect of loans made to a subsidiary corporation for the purpose of earning dividend income from that subsidiary.
Facts
[2] The Appellant is a large Canadian public company whose principal business was the purchase, development, leasing and management of commercial, retail, industrial and residential real property and the sale of residential real property. This business is carried on by the Appellant both directly and through its subsidiaries, many of which are located in Canada or the United States. Indeed, part of the Appellant"s business is to provide management and financial support to its subsidiaries. These services are generally provided free of charge; however, the Appellant does anticipate earning dividend income from its subsidiaries.
[3] This appeal is principally concerned with the Appellant"s dealings with five of its fifth tier subsidiaries in the United States, namely: CF Parkside Inc., CF Cleveland Inc., CF Jocelyn Inc., CF Prospect Inc. and CF Society Hill Inc. (collectively, the "CF subsidiaries"). The CF subsidiaries were related to the Appellant as follows:
| (a) The Appellant owned CFI Properties B.V. ("CFI"), a Netherlands Antilles company; |
(b) CFI owned Cadillac Fairview U.S. Inc. ("CFUS");
| (c) CFUS owned Cadillac Fairview Residential Holdings Inc. ("CF Holdings"); |
| (d) CF Holdings owned Cadillac Fairview Residential Properties Inc. ("CF Properties"); and |
| (e) CF Properties owned the CF subsidiaries. |
a. The Dealings of the CF subsidiaries
| 1. CF Society Hill |
[4] In December 1979, CF Society Hill formed a general partnership with Greenwood Properties Inc. ('Greenwood') called Independence Place Associates ('IPA') to construct, develop and sell two residential condominium apartments in Philadelphia. IPA borrowed US$53,000,000 from the Bank of Montreal (New York Agency). The Appellant provided an unconditional and continuing guarantee of the loan both as guarantor and as a principal obligor. Greenwood provided a similar guarantee.
[5] On March 1, 1983, CF Society Hill entered into an agreement with the other parties allowing it to withdraw from IPA. Essentially, the agreement required the restructuring of IPA"s financing arrangements. Under the terms of the restructuring agreement CF Society Hill was required to contribute $3,266,324 to IPA. This amount was to be applied against the principal owing on the Bank of Montreal loan. The restructuring agreement stipulated that the loan would not go into default. On July 19, 1983, the Appellant paid $3,266,324, on behalf of CF Society Hill, and the following day the Bank of Montreal released the Appellant from its guarantee.
| 2. CF Prospect, CF Parkside, CF Jocelyn and CF Cleveland |
[6] In December 1979, CF Parkside, CF Jocelyn and CF Cleveland formed separate partnerships with Chateau Corporation ("Chateau") to acquire buildings in the Washington D.C. area for conversion into condominiums for sale. These partnerships were Parkside Associates ("PA"), Jocelyn House Associates ("JHA") and Cleveland Terrace Associates ("CTA") respectively. Each partnership borrowed the following capital amounts from the First National Bank of Chicago ('FNBC') to finance their real estate ventures:
| (a) PA -- US $ 48,512,600; |
| (b) JHA -- US $2,387,400; and |
| (c) CTA -- US $ 3,200,000. |
[7] As a condition of each loan, the Appellant and the principal shareholders of Chateau (the "Chateau shareholders") jointly and severally guaranteed the loans. On June 25, 1982, PA was converted into a joint venture between CF Parkside and Chateau. CF Parkside then assumed and became solely liable for 50% of the amount owing on the loan formerly held by PA. The Appellant became the sole guarantor of this loan.
[8] On January 22, 1980, CF Prospect formed a general partnership with Chateau called Prospect House Associates ("PHA") for the purpose of acquiring a building in Virginia for conversion into condominiums for sale. PHA borrowed US $26,600,000 from the Bank of Nova Scotia. The Chateau shareholders and the Appellant each guaranteed 50% of this loan.
[9] Each of these real estate ventures ultimately encountered serious financial problems. To minimize their losses, the Appellant"s Board of Directors voted to divest their interest in these projects. To accomplish this goal CF Properties, the immediate parent of the CF subsidiaries, was to sell all of its shares in these companies to the Chateau shareholders.
[10] With respect to the loans to PA, JHA, and CTA, a default would occur under the loan if all of the issued and outstanding shares of the capital stock of CF Parkside, CF Jocelyn, or CF Cleveland ceased to be owned by the Appellant, or by a wholly owned subsidiary of the Appellant, unless the bank consented to the sale. The Bank did not consent and the parties were forced to negotiate new arrangements to effect the withdrawal of the Appellant"s economic interest from the ventures.
[11] Originally, the Chateau shareholders were to pay $10,500,000 for all of the shares in CF Parkside. CF Properties was to pay the full outstanding balance owed by PA on the loan that the Appellant had guaranteed. When the bank refused to consent to this transaction, the agreement was amended. Under the new terms, Chateau was to pay $1,000 to CF Properties for the shares, and $10,499,000 to the lender as partial satisfaction of the outstanding balance of the loan. The Appellant was to pay any other amounts that remained outstanding in satisfaction of the loan. The Appellant ultimately paid $4,994,500.86 to satisfy the loan to PA.
[12] All the shares of CF Cleveland and CF Jocelyn were sold to the Chateau shareholders for $1.00. CF Properties was to pay $1,700,000 of the amount owing to the bank under the loan that the Appellant had guaranteed. The Chateau shareholders were responsible for any other outstanding amounts on the loan. After the Bank refused to consent, this agreement was amended to the effect that the purchase price of the shares was $1,000, and the Appellant was to pay the lender $1,701,000 as partial satisfaction of the outstanding amount of the loan. The Chateau shareholders were to pay any remaining balance on the loan. On March 23, 1983, the appellant paid a total of $1,701,000 -- $1,194,400 in respect of CTA, and $506,600 in respect of JA.
[13] Under the terms of each of the share purchase transactions, the Appellant waived any claims, by way of subrogation or otherwise, which it may have had against CF Parkside, CF Jocelyn and CF Cleveland immediately after making payment to the Bank.
[14] Under a proposed agreement, the Chateau shareholders were to purchase the shares of CF Prospect for $1 and to pay the outstanding balance owed to the lenders less an agreed upon amount to be paid by CF Properties. On April 19, 1983, the Bank of Nova Scotia indicated that it would not consent to the purchase agreement as structured and was seeking full repayment of the loan from the guarantors. In response, the share purchase agreement was amended to include other parties, including the Appellant.
[15] The shares of CF Prospect were eventually sold to SEEF Corp. (CF Parkside was changed to SEEF Corp. when it was bought by Chateau). The Appellant paid $3,797,177.57 to the Bank, to be applied against the loan. Under the terms of the agreement, the Appellant waived any claims it may have had against CF Prospect immediately after making this payment. CF Properties was also to pay $3,756,000, but evidently it did not do so.
[16] At the time that the Appellant made the payments in respect of each venture, none of the subsidiaries had the resources to pay their respective loans. At trial, the Appellant did not adduce any evidence as to how the various negotiated amounts were determined.
b. The Appellant"s Claim
[17] The Appellant deducted $7,926,000 as an allowable capital loss in its 1984 taxation year. This represented 50% of the $15,852,000 in payments made by the Appellant in order to extricate its interest in the failed real estate ventures of the CF subsidiaries. The Appellant argued that these payments were made pursuant to the terms of the loan guarantees that it had given in respect of these subsidiaries. The Minister of National Revenue (the "Minister") disallowed this deduction on the basis that the guarantees were not issued for the purpose of gaining or producing income from a business or property and that accordingly, the loss suffered was deemed to be nil under subparagraph 40(2)(g)(ii) of the Act. Subparagraph 40(2)(g)(ii) reads:
| 40.(2) (g) a taxpayer"s loss, if any, from the disposition of property, to the extent that it is ... |
| (ii) a loss from the disposition of a debt or other right to receive an amount, unless the debt or right, as the case may be, was acquired for the purpose of gaining or producing income from a business or property (other than exempt income) or as consideration for the disposition of capital property to a person with whom the taxpayer was dealing at arm"s length, ... |
is nil.
[18] The Appellant appealed to the Tax Court of Canada. The judge who heard the case retired before rendering judgment. The case was assigned to another judge who dismissed the Appellant"s appeal on the basis of the transcript of the evidence and argument.1
[19] The learned Tax Court Judge was of the view that it was not sufficient that the capital amounts were expended for the purpose of gaining or producing income from a business. The question, as he saw it, was whether the Appellant disposed of property or was deemed to have disposed of property in circumstances giving rise to a capital loss. He answered this question in the negative with respect to CF Prospect, CF Parkside, CF Jocelyn and CF Cleveland when he stated:
| ... I do not think that [the Appellant] became the owner of a debt from Jocelyn, Cleveland, Parkside or Prospect. As part of the agreement under which it participated in the sale by Properties of the shares of these companies to Chateau it had to pay amounts that could be related to the guarantees. The payments were however attributable to the much more complex arrangements under which the appellant assisted its subsidiary Properties to extricate itself from the various real estate ventures in which its subsidiaries had become involved. The payment of the guaranteed amounts did not result from any default by the partnerships. It was related to a condition in the agreement with the Bank that an event of default would be deemed to occur if the shares of the subsidiaries were sold without the Bank's consent but this fact was incidental to the entire transaction. The triggering of the deemed default, the payment of the negotiated amounts and the simultaneous waiver of any rights of subrogation (if indeed any could otherwise have come into existence considering that the event of default was occasioned by the act of Properties, a subsidiary of the guarantor, a transaction in which the appellant itself was intimately involved) were part of an interrelated series of transactions which achieved the overall economic goal of extricating the Cadillac Fairview organization from the U.S. ventures. They did not result in the appellant's acquiring by way of subrogation any debt that could be disposed of under section 50 or otherwise. The waiver of any rights of subrogation by the appellant as an integral part of the overall transaction prevented such a debt from coming into existence. I do not accept the appellant's argument that it acquired by subrogation debts of the subsidiaries when it paid the agreed amounts under the amended share purchase agreements, and that it then disposed of those debts by reason of its waiver. The words 'hereby waives any claims, by way of subrogation, or otherwise, which it may have against CF' constituted an anticipatory waiver that prevented, and was intended to prevent, any right of subrogation from coming into existence. It is clear that the entire transaction was structured to ensure that the appellant, by reason of the payment, would acquire no enforceable subrogated rights against any of the subsidiaries whose shares were being sold. It is inaccurate and unduly simplistic to see this as a garden-variety payment by a guarantor of a principal debtor's obligation, followed by a subsequent waiver, for no consideration, of the subrogated debt. The waiver was an essential ingredient in the entire transaction, and even if I accepted the appellant's analysis (which I do not) that it acquired a debt which it waived, the consideration for that waiver cannot, either as a matter of law or as a matter of commercial common sense, be regarded as nil. The price paid for the appellant's role in the matter, including the payment to the bank and the waiver, was Chateau's participation in enabling the Cadillac Fairview organization to disengage itself from the fiasco.2 |
[emphasis added]
[20] The Appellant appeals to this Court.
Analysis
[21] It is clear from the terms of sections 38 [Taxable capital gain and allowable capital loss] and 39 [Meaning of capital gain and capital loss] of the Act that a capital loss may only be claimed where there was an actual or deemed disposition of property. As found by the Tax Court Judge, the mere fact that a capital payment was made is not sufficient, in and of itself, to give rise to a capital loss.
[22] Under the law of subrogation, a guarantor is normally subrogated to the position of the creditor where a guarantee has been given in respect a primary debtor"s obligation and the guarantor is required to, and does in fact, make payment under that guarantee. Where these subrogation rights have not been expressly or implicitly waived the primary debtor becomes obligated to the guarantor for the full amount that was paid under the guarantee.3
[23] Where a debtor cannot repay its subrogated debt to the guarantor, the debt may be regarded as "bad". The relevant portions of section 50 of the Act read as follows:
| 50.(1) For the purposes of this subdivision, where |
| (a) a debt owing to a taxpayer at the end of a taxation year ... is established by the taxpayer to have become bad debt in the year, or ... |
and the taxpayer elects in the taxpayer"s return of income for that year to have this subsection apply in respect of the debt ... the taxpayer shall be deemed to have disposed of the debt ... at the end of the year for proceeds equal to nil and to have reacquired it immediately after the end of the year at a cost equal to nil.
If the guarantor makes an election under section 50 the "bad" subrogated debt will be deemed to have been disposed of at the end of the taxation year and acquired immediately thereafter at no cost. In this manner, the law of subrogation operates in conjunction with section 50 of the Act to create the disposition required to support a claim for capital loss. The question is whether the circumstances of this case are sufficient to establish that the Appellant acquired subrogated debt and disposed of it under section 50 or otherwise. For the reasons articulated below, I am of the opinion that the Appellant did not do so.
[24] The Tax Court judge held that the following questions must be answered in the affirmative to conclude that the Appellant incurred an eligible capital loss under the Act:
| (a) Were the subsidiaries" obligations to the banks guaranteed by the Appellant? |
| (b) Did the Appellant make payment pursuant to the guarantees? |
| (c) Did the Appellant acquire, through subrogation, the debt owing by the CF subsidiaries? |
| (d) Was the debt disposed of within the year (for nil proceeds)? |
| (e) Was the debt acquired for the purpose of gaining or producing income from a business or property of the Appellant? Or, in other words, were the guarantees given to gain or produce income from a business or property? |
It is not disputed that the Appellant guaranteed the loans made to the CF subsidiaries, accordingly only the last four questions are relevant to this appeal.
a. Were the payments made pursuant to the Guarantees?
[25] This Court has held that in determining the proper characterization of a transaction which allegedly gives rise to a loss from a loan or guarantee the transaction is to be examined "from a practical business point of view to determine the intent with which the money was provided."4 This is a factual determination.
[26] In the circumstances of this appeal, the Appellant had guaranteed loans made to its subsidiaries in respect of five real estate ventures in the U.S.. When the real estate ventures collapsed, the Appellant sought to extricate the subsidiaries thereby limiting its liability. To this end, the Appellant (or its subsidiaries) made arrangements which required certain payments to be made by the Appellant. In the case of the share transfers, the Agreements expressly stated that these payments were to be applied in satisfaction of its guarantees. In the case of CF Society Hill, the Appellant paid monies on behalf of its subsidiary and the Bank accepted such payments in fulfilment of the Appellant"s obligations under the guarantee.
[27] It is clear from the evidence that the complex share transfer arrangements negotiated by CF Prospect, CF Parkside, CF Jocelyn and CF Cleveland addressed many issues other than the guarantees provided by the Appellant. The real estate ventures for which the loans had been obtained were experiencing economic difficulties. Although default had not yet occurred, the maturity date of each of the loans were approaching. In each case the maturity date had been extended to accommodate the needs of the parties. The CF subsidiaries did not have sufficient assets to make payment on the loans. It is reasonable that in these circumstances the Appellant would foresee the possibility of default or demand and seek to reach agreements that would limit its obligations under the guarantees. The agreements in question achieved this result.
[28] If the transactions are examined in their entirety, it is equally clear that the payments made by the Appellant were in response to these guarantees. Simply put, the payments made by the Appellant were not solely in response to its obligations under the guarantees. The guarantees are clearly the principal motivator for the amendments to the share purchase agreements that were made after the Bank refused to grant its consent. Although the Appellant failed to adduce evidence as to how the negotiated payments were fixed, there is sufficient evidence to establish that the payments were made pursuant to the guarantees and the Appellant"s obligations thereunder. I am satisfied that each payment was made to satisfy some obligation under the terms of the guarantees.
[29] In respect of CF Society Hill, the Tax Court Judge assessed the relevant viva voce and documentary evidence and found that the evidence failed to establish that the payment had been made pursuant to an obligation under its guarantee to the Bank. Of significance was the fact that the refinancing agreement clearly stated that the payment was made on behalf of CF Society Hill, in fulfilment of CF Society Hill"s obligations. In reaching this conclusion, the Tax Court Judge made the following findings:
| ... I do not think that the fact that the appellant paid Society Hill"s obligation under the March 1, 983 agreement constituted a fulfilment of the appellant"s obligation under its guarantee to the Bank. Moreover, there is no evidence in the record to show that the appellant ever treated Society Hill as its debtor by subrogation of the amount so paid, or that Society Hill ever regarded itself as having any liability to the appellant. Mr. Wood testified that at the end of the 1984 taxation year the appellant did not show on its financial statements any amounts owing by any person on account of the amounts paid to the Bank of Montreal. The $3,266,324 paid by the appellant was a payment made by it on behalf of Society Hill as the price of Society Hill"s being allowed to extricate itself from the IPA partnership. |
Nothing in the record indicated that the appellant thereby acquired a debt to itself from Society Hill that was capable of becoming bad within the meaning of section 50 of the Income Tax Act or of being otherwise disposed of by the appellant.5
I can find no error which would justify interfering with these findings.
b. Did the Appellant acquire debt claims against the CF subsidiaries?
[30] As noted above, where a guarantor pays the debt to the creditor, he is entitled to be subrogated to the rights of the creditor. The amount that the guarantor is entitled to recover is limited to the amounts actually paid pursuant to the guarantee.6 In the case at bar, the Appellant made payment pursuant to its guarantees before the amounts were actually due on demand from the lenders but this does not necessarily invalidate its claims of subrogation.7 The question becomes whether or not the Appellant forfeited its rights of subrogation through waiver or otherwise.
[31] In respect of CF Prospect, CF Parkside, CF Cleveland and CF Jocelyn the central issue is whether or not the Appellant has lost its rights of subrogation under the waiver provisions of the share purchase agreements. The Tax Court judge found that the waiver provisions resulted in "simultaneous waiver of any rights or subrogation" and constituted "an anticipatory waiver, that prevented ... any right of subrogation from coming into existence." With respect, I cannot agree.
[32] Waiver "presupposes the existence of a right to be relinquished."8 Accordingly, waiver could not be effected until the payments were made and the debt had been subrogated to the Appellant. The Appellant"s rights of subrogation arose at the time payment was made.9 Furthermore, the provision is clear. "Immediately following the payment," the Appellant waived any claims against its subsidiaries, arising by subrogation or otherwise. The Appellant"s waiver occurred after the subrogated debt arose and constituted a release of the right to enforce these subrogated claims. Accordingly, the waiver provision disposed of the Appellant"s subrogation rights, but it was not a peremptory waiver of these rights. The waiver provision in each of the share purchase agreements does not prevent the debt held by the lender from accruing to the Appellant through subrogation. These provisions establish that the Appellant cannot enforce any of the debt claims it acquired by virtue of its payments under those agreements.
c. Were the debt claims disposed of within the taxation year (for nil proceeds)?
[33] While the Appellant clearly disposed of the debt acquired under the share purchase agreements through the operation of the waiver provisions, this is not determinative of the issue. As noted above, the Appellant clearly guaranteed loans for its subsidiaries. The sale of the shares of these subsidiaries by CF Properties was an attempt to cap the Appellant"s liability under these guarantees as it extricated itself from the failed real estate transactions. As conditions to the sale of its subsidiaries to the Chateau shareholders, the Appellant agreed to make payments to discharge its obligations under the guarantees and to waive all claims against its subsidiaries for the amounts paid. Under the terms of the agreements, Chateau would effectively purchase these companies, i.e. the subsidiaries, free from debt.
[34] It is clear that without the waiver provision, Chateau would never have entered into this transaction. Without the waiver, the Appellant could have sought repayment from its subsidiaries (now owned by Chateau) of the entire amounts it paid to the lenders under the purchase agreements. It is worth repeating here what was stated by the Tax Court Judge:
| It is inaccurate and unduly simplistic to see this as a garden variety payment by a guarantor of a principal debtor"s obligation, followed by a subsequent waiver, for no consideration, of the subrogated debt. The waiver was an essential ingredient in the entire transaction, ... , the consideration for the waiver cannot, either as a matter of law or as a matter of commercial common sense, be regarded as nil. The price paid for the appellant"s role in the matter, including the payment to the bank and the waiver, was Chateau"s participation in enabling the Cadillac Fairview organization to disengage itself from the fiasco.10 |
[emphasis added]
[35] As the Appellant disposed of its rights of subrogation for valuable consideration, it cannot then avail itself of the potential tax benefits conferred by subparagraph 40(2)(g)(ii). The advance of money in exchange for valuable consideration, namely enabling a subsidiary to extricate itself from an unsatisfactory partnership, does not constitute a capital loss for income tax purposes.11
d. Were the debt claims acquired for the purpose of earning income?
[36] In light of my earlier conclusions, it is not necessary to determine this issue in the case at bar.
Conclusion
[37] The Appellant guaranteed loans for subsidiaries involved in real estate transactions in the United States. When these transactions began to fail, the Appellant attempted to extricate itself and its corporate family from these transactions and to limit its liability under the guarantees. Complex arrangements were negotiated by the parties to facilitate the removal of the Appellant"s interest in the failed transactions. These agreements ultimately resulted in the Appellant making several payments to pay down the debt obligations of the CF subsidiaries as well as the sale of four of the subsidiaries to Chateau. The nature of these transactions was such that the Appellant did not acquire any debt by subrogation or otherwise which could have been disposed of within the year as required by subparagraph 40(2)(g)(ii) of the Act. The Appellant"s rights of subrogation were precluded by either: (a) the structure of the transaction itself; or (b) the express waiver of these rights by the Appellant for valuable consideration. Accordingly, this appeal cannot succeed.
Disposition
[38] I would dismiss the appeal with costs.
"F.J. McDonald"
J.A.
"I agree
A.J. Stone J.A."
"I agree
J. Edgar Sexton J.A."
__________________
1 See The Cadillac Fairview Corporation Limited v. Her Majesty the Queen , 97 D.T.C. 405 (T.C.C.) [hereinafter, Cadillac Fairview]
3 See K. McGuinness, The Law of Guarantee (Toronto: Carswell, 1996) at 146.
4 Bosa Bros. Construction Ltd. v. Her Majesty the Queen, 96 D.T.C. 6193 (F.C.T.D.) at 6209. See also Easton v. Her Majesty the Queen, 92 D.T.C. 6218 (F.C.T.D.) at 6221.
5 Cadillac Fairview, supra note 1 at 409.
6 McHale v. M.N.R., 92 D.T.C. 1781 (T.C.C.) at 1783.
7 Drager v. Allison, (1959) D.L.R. 431 (S.C.C.) at 435-36.
8 See Turney v. Zhilka , [1959] S.C.R. 578 at 584.