Tax Court of Canada Judgments

Date: 20020131

Docket: 1999-1977-IT-G

BETWEEN:

MARVYN GURBERG,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

____________________________________________________________________

Counsel for the Appellant: Aaron Rodgers

Counsel for the Respondent: Nathalie Labbé

____________________________________________________________________

Reasons for Judgment

(Delivered orally from the Bench at

Montréal, Québec, on December 7, 2001)

McArthur J.

[1]      The issue in this appeal is whether the Appellant incurred an allowable business investment loss (ABIL) pursuant to subsections 39(1) and 50(1) of the Income Tax Act in the 1996 taxation year. The Appellant had forgiven a loan in the amount of $600,000 owing to him by 158329 Canada Inc. (the "corporation"). The most pertinent submission made by the Respondent and contained in the Reply to the Notice of Appeal was that there was no debt owing to the Appellant either at the end of 1995 or at the end of 1996 and that by agreement dated April 18, 1996[1] and effective June 30, 1995, the Appellant forgave the debt which was owed to him by the corporation.

[2]      The facts include the following. The Appellant commenced a ladies apparel manufacturing company in 1991, at which time he was the sole shareholder. By 1994, the corporation was in severe financial difficulty. The Appellant testified that the corporation was struggling during very difficult economic times and was facing bankruptcy. The Appellant was successful in having two investors advance $100,000 each to the corporation. By 1995, he had given up control of the corporation and retained only 33% of the shares and the two new investors took over control of the financing. As a result of the Banque Nationale du Canada calling in the Appellant's loan guarantees, he in effect advanced $200,000 in July 1994 and $400,000 in November 1994 to the corporation. The two new investors refused to advance further funds until the Appellant agreed to forgive the $600,000 owed to him by the corporation.

[3]      On April 18, 1996, the Appellant executed the agreement (Exhibit A-11) entered into between himself and the corporation which reads in part as follows:

            NOW THEREFORE THIS AGREEMENT WITNESSETH that on the 30th day of June, 1995 for no consideration Gurberg forgave the FIRST LOAN and the SECOND LOAN.

These loans total $600,000 and as far as the dates referred to in the agreement, with respect to the advancement of funds, they are perhaps not accurate, but the gist of it and the importance of it is that the Appellant forgave $600,000. This document, although purportedly is retroactive to June 1995 is dated April 18, 1996 and it is signed by Marie Messina on behalf of the corporation and by Marvyn Gurberg, the Appellant.

[4]      In examination-in-chief when asked when he realized the $600,000 was not recoverable, the Appellant replied, after considerable deliberation, once he executed the agreement with the corporation on April 18, 1996. In 1995, he made no effort to recover the $600,000 because any efforts to do so would have been futile and would have triggered the investors to pull out followed by possible bankruptcy of the corporation. His only hope of ever recovering any of his investment was by keeping the corporation operating with the hope that his 33% interest in the shares of the corporation would gain value over time.

[5]      The relevant parts of the legislation involved, being subsections 39(1) and 50(1) read as follows:

39(1)     For the purposes of this Act,

          

            ...

(c)         a taxpayer's business investment loss for a taxation year from the disposition of any property is the amount, if any, by which the taxpayer's capital loss for the year from a disposition after 1977

(i)          to which subsection 50(1) applies, or

(ii)         to a person with whom the taxpayer was dealing at arm's length

of any property that is

(iii)        a share of the capital stock of a small business corporation, or

(iv)        a debt owing to the taxpayer by a Canadian-controlled private corporation (other than, where the taxpayer is a corporation, a debt owing to it by a corporation with which it does not deal at arm's length) that is

...

50(1)     For the purposes of this subdivision, where

(a)         a debt owing to a taxpayer at the end of a taxation year (other than a debt owing to the taxpayer in respect of the disposition of personal-use property) is established by the taxpayer to have become a bad debt in the year, or

(b)         a share (other than a share received by a taxpayer as consideration in respect of the disposition of personal-use property) of the capital stock of a corporation is owned by the taxpayer at the end of a taxation year and

(i)          the corporation has during the year become a bankrupt (within the meaning of subsection 128(3)),

(ii)         the corporation is a corporation referred to in section 6 of the Winding-up Act that is insolvent (within the meaning of that Act) and in respect of which a winding-up order under that Act has been made in the year, or

(iii)        at the end of the year,

(A)        the corporation is insolvent,

(B)        neither the corporation nor a corporation controlled by it carries on business,

(C)        the fair market value of the share is nil, and

(D)        it is reasonable to expect that the corporation will be dissolved or wound up and will not commence to carry on business

and the taxpayer elects in the taxpayer's return of income for the year to have this subsection apply in respect of the debt or the share, as the case may be, the taxpayer shall be deemed to have disposed of the debt or the share, as the case may be, 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.

The position of the Appellant is that if he had not forgiven the loan, the corporation would have gone bankrupt. There was nothing he could do in terms of recovering the debt. Any action by him for recovery would have brought a collapse of the corporation.

[6]      In support of his position that the debt did become a bad debt during the 1995 taxation year, the Appellant referred the Court to Fritz v. M.N.R.[2] and Beaudry v. The Queen.[3] In Beaudry, Judge Rip states that it is up to the taxpayer to establish when a debt has become a bad debt. The test is not an objective test which allows the Minister of National Revenue to question the Appellant's business judgment. The Appellant also referred to Earl v. M.N.R.[4] to indicate that in denying the taxpayer's pretention that a debt has become a bad debt, the Minister had to demonstrate when, if at all, the debt became a bad debt.

[7]      The Appellant submits that there is no technical problem with the application of paragraph 50(1)(a) of the Act in light of the date of the forgiveness of the debt. The debt was forgiven in 1996 and was existing, therefore, at the end of 1995. By rendering the forgiveness of debt effective June 30, 1995, the corporation was able to take that into account in its 1995 financial statements, portraying a more attractive financial position. Without the forgiveness of debt, the corporation would have been operating with an $850,000 deficit. The Appellant further argued that although the agreement stipulates that the forgiveness of debt is effective June 30, 1995, the forgiveness of the debt was not given until the date of the signing of the contract on April 18, 1996.

[8]      The Appellant also referred to Orlando v. The Queen[5] in which case the taxpayer agreed that a debt owed to him by a corporation of which he was shareholder, be cancelled from the books of the corporation in exchange for worthless shares. Lamarre Proulx J. determined that the debt was still outstanding at the end of the taxation year and that paragraph 50(1)(a) of the Act was applicable.

[9]      The Respondent's position includes that the Appellant is not entitled to claim the business investment loss because there was no debt owing to the Appellant at the end of the 1995 taxation year, nor at the end of the 1996 taxation year. The Respondent submits that the agreement forgiving the debt (Exhibit A-11) was effective June 30, 1995 and, therefore, at the end of the year, there was no debt owing.

[10]     In support of this contention, the Respondent referred to E.C.E. Group Ltd. v. M.N.R.[6] In that case, in comparing the wording of paragraph 50(1)(a) to that of paragraph 20(1)(p) of the Act, Kempo J. stated that paragraph 50(1)(a) stipulates in clear and unambiguous language that the debt is to be owed at the end of the year. The forgiveness of debt by the Appellant constitutes a disposition of debt as that term is defined in section 54 of the Act. The Respondent maintains that the debt was disposed of as of June 30, 1995 and that there was no debt subsequent to that date.

[11]     The Respondent further distinguishes the present appeal from the Orlando case. The Appellant signed an agreement with the corporation in this case by which he forgave the $600,000. Mr. Orlando received shares for his indebtedness and the Appellant cannot argue that the debt was still in existence despite the fact that the debt was removed from the corporate records.

[12]     In the event the debt was owed to the Appellant at the end of the year, the Respondent submits that paragraph 50(1)(a) of the Act is not applicable and that the Appellant did not establish that the debt became a bad debt in that year. The Respondent refers the Court to Flexi-Coil Ltd. v. The Queen[7] and Beretti v. M.N.R.[8] The Respondent also makes reference to Hogan v. M.N.R.,[9] in which the Court adopted a list of factors that may be taken into consideration in the determination of bad debts. W.S. Fisher, Q.C. stated at page 192:

            The question of what constitutes a bad debt has been considered by the Courts on many occasions and is the subject of discussion in various books on accounting. in No. 81 v. M.N.R., 53 DTC 98, 8 Tax A.B.C. 82, the Chairman of this Board, although the case was one dealing with the determination of doubtful accounts, stated at p. 98:

            Among the factors which may be taken into consideration by a taxpayer who claims a deduction under the provisions of Section 11(1)(d) of the Act — (now s. 11(1)(e) of the Income Tax Act, R.S.C. 1952) — would be: the time element, the history of the account; the financial position of the client, the past experience of the taxpayer with the writing off of his bad debts, the general business condition in the country in a case like in the present one where the taxpayer in doing business all over Canada, the business condition in the locality where the client lives, the increase or decrease in the total sales and accounts receivable at the end of the year for which the deduction is claimed, as compared with previous years.

Analysis

[13]     The Appellant is an experienced businessman although one wonders at his motivation in commencing a business in the bleak economic times of 1991. No background was given. He apparently trusted that the economy would recover more quickly than it did. He paid a heavy price, at least $600,000, together with anguish which, I would suspect, accompanied the difficult years. He now asks this Court for the relief provided in the Act. The Respondent submits that this relief is not available and that the Appellant is thwarted by subparagraph 39(1)(c)(i) and subsection 50(1), and that no debt was due to the Appellant at the end of 1995. The Respondent's counsel relies on Exhibit A-11 as evidence of this.

[14]     Before dealing with the primary issue, I will refer to the peripheral questions which can easily be disposed of. First, prior to the Federal Court of Appeal decision in The Queen v. Byram,[10] the Minister would apparently have decided that subparagraph 40(2)(g)(ii) had not been met because the Appellant's loans to the corporation were interest free. Reference to this is made in the Reply to the Notice of Appeal at paragraph 14(j). This issue was set to rest in Byram where McDonald J.A. stated "there is no need for the income to flow directly to the taxpayer from the loan". Second, in paragraph 14(k) of the Reply to the Notice of Appeal, the Respondent states that if the debt is found not to have been forgiven at the end of 1995, the debt owing did not become a bad debt. I find as a fact that the debt was uncollectible at the end of 1995.

[15]     Marie Messina testified on behalf of the Appellant. She is the daughter of one of the two investors in the corporation. Her father was motivated to invest in that corporation because he was looking for it to occupy a space in a building he was constructing. She has been actively involved with the corporation since 1994 and attended a meeting of the then three equal shareholders shortly after her father became involved. At that time, the investors felt that they had been misled by the Appellant and that the corporation's financial position was worse then he had represented to them. The two investors insisted that the Appellant pay the National Banque in order that the bank release the corporation from the $600,000.

[16]     The Appellant stated he had no other choice. Miss Messina testified that without the Appellant's advancing the funds to the corporation which effectively reduced the corporation's indebtedness to the National Bank by $600,000, the investors would have pulled out and bankruptcy of the Corporation would have followed. Respondent's counsel made reference to the fact that the two investors were repaid some of their loans and the Appellant should have been in a position to have the corporation repay his $600,000. I do not believe this is entirely accurate. I understand that the original $100,000 invested by each of the two investors has not been repaid. What has been repaid are the revolving temporary advances made by the investors to meet crises from time to time. The evidence is clear that the $600,000 was uncollectible at the end of 1995. It would not only be unbusinesslike, but ridiculous to expect the Appellant to take action for recovery of the loan in 1995 when the corporation was insolvent. To do so, would have plunged the corporation into bankruptcy.

[17]     I understand that the corporation continues to operate. Miss Messina further testified that after five years of struggling since 1994, it is beginning to be profitable. It would appear that the Appellant permitted the corporation's accountant to reflect forgiveness of the debt in June 1995 to show a healthier position on the financial statements for the period ending June 30, 1995. Sales for that period were $4,548,620. Note 8 to the financial statements for the year ending June 30, 1995[11] states: "An amount of $600,000 was advanced to the company by shareholders and subsequently forgiven". Also, note 9 states in part: "The company has accumulated losses for income tax purposes totalling approximately $183,500 for which the tax benefits have not been recognized in the financial statements".

[18]     The Reply to the Notice of Appeal also states at paragraph 14(d) that "No change of the corporation occurred in 1994". This is incorrect and the Respondent rightly abandoned this assertion at trial. All of this leads to the thrust of the Appellant's position that because of the forgiveness reflected in the financial statement effective June 30, 1995, there was no debt owing at the year end 1995 or in 1996, as prescribed by paragraph 50(1)(a) of the Act. The Respondent argues that the agreement between the Appellant and the corporation (Exhibit A-11) clearly forgives the debt on June 30, 1995 and the Appellant allowed it to be removed from the corporate financial statement as of June 30, 1995. So, obviously, the Respondent states there was no debt at the end of the year.

[19]     While this is far from a frivolous argument, I accept the Appellant's position. The Appellant signed the forgiveness on April 18, 1996. He stated in evidence that this was the first time he realized that he was forgiving the $600,000. I find the debt was existing at the end of 1995. The Appellant permitted the corporation's accountant to reflect the forgiveness effective June 30, 1995 as an accounting entry only. The corporation was then able to present a healthier state of financial affairs to the bank and to prevent the bank calling in the remainder of their loans.

[20]     I conclude from the evidence that the loan existed at the end of 1995. It was forgiven upon the signing of the agreement on April 18, 1996. The appeal is allowed, with costs.

Signed at Ottawa, Canada, this 31st day of January, 2002.

"C.H. McArthur"

J.T.C.C.

COURT FILE NO.:                             1999-1977(IT)G

STYLE OF CAUSE:                           Marvyn Gurberg and Her Majesty the Queen

PLACE OF HEARING:                      Montréal, Québec

DATE OF HEARING:                        December 6, 2001

REASONS FOR JUDGMENT BY:     The Honourable Judge C.H. McArthur

DATE OF JUDGMENT:                     December 11, 2001

APPEARANCES:

Counsel for the Appellant:          Aaron Rodgers

Counsel for the Respondent:      Nathalie Labbé

COUNSEL OF RECORD:

For the Appellant:

Name:                 Aaron Rodgers

Firm:                  Spiegel Sohmer

For the Respondent:                  Morris Rosenberg

                                                Deputy Attorney General of Canada

                                                          Ottawa, Canada

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