Date: 19981016
Docket: 97-2694-IT-I
BETWEEN:
JOHN DAVID COOPER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
BOWIE J.T.C.C.
[1] These appeals are brought from reassessments made under the Income Tax Act (the Act) for the taxation years 1991, 1992, 1993 and 1994. Three issues are involved. The first is whether certain amounts are properly included in computing the allowable business investment loss (ABIL) to which the Appellant is admittedly entitled for the year 1991. The second concerns the imposition of a penalty under subsection 163(2) of the Act. The third issue relates to the right of the Minister of National Revenue (the Minister) to reassess the Appellant for the taxation years 1991 and 1992, although more than three years had passed since the initial assessments for those years were made. The years 1992, 1993 and 1994 were reassessed only to reduce the losses carried forward from 1991 in consequence of the reduction in the ABIL for the 1991 year.
Facts
[2] The Appellant and his friend and partner, Mr. Locke, decided to go into business together in 1987, supplying a variety of products to retail outlets. Their line included toiletry items of all kinds, but a major item was electrical personal care appliances such as hairdryers, which they purchased from suppliers in the Orient. Their business needed substantial operating capital, as they were required to pay for shipments of these items before delivery. They therefore arranged with the National Bank of Canada (the bank) for a line of credit in the amount of $300,000. The business was incorporated under the name Cooper Locke Group Inc. (CLGI), and it was to that company that the bank extended the line of credit. Before doing so, however, it required guarantees, secured by mortgages on their residences, from the Appellant, Mr. Locke, and their wives. Each of them provided a guarantee in the amount of $250,000. The Appellant and his wife executed a collateral mortgage in favour of the bank in the amount of $250,000, and Locke and his wife did so in the amount of $100,000. By a separate instrument (the equalization agreement), the Coopers and the Lockes agreed that if either of them were called upon to honour these guarantees then they would share equally the debts of CLGI, and they would share equally the amounts that either was required to pay under the guarantees.
[3] For reasons that are not relevant here, the business did not succeed. The debt to the bank climbed at one point to about $600,000. In April 1991, it stood at $314,273.66, at which time the bank demanded payment, and thereby effectively ended any hope that the business could be saved. Mr. Cooper and Mr. Locke persevered to ensure that all the creditors were paid, but ultimately they were both required to sell their homes to satisfy the demands of the bank for payment under the guarantees. I am satisfied that the Appellant had no other source of funds from which he could have honoured his guarantee, and that he sold his home only after it had become clear to him that the bank would do so if he did not.
[4] Upon the incorporation of CLGI, the Appellant and Locke, the only shareholders and directors, passed a directors’ resolution providing that the company would indemnify them and their wives in respect of their guarantees. The operative provisions of that indemnity reads as follows:
NOW THEREFORE BE IT RESOLVED THAT:
1. In consideration of their providing the Guarantees, the Corporation is hereby authorized to provide the following assurances to the Guarantors:
(a) The Corporation shall agree to pay all of the costs of the Guarantors in connection with their entering into the Guarantees;
(b) The Corporation shall agree to indemnify and save the Guarantors harmless from any claim, liability or loss arising in respect of the Guarantees, from time to time, including, without limiting the generality of the foregoing, any claims, liabilities or losses arising as a result of the Guarantors having to honour their obligations under the Guarantee; and
(c) in the event that any of the Guarantors are required to pay any amount in respect of the Guarantees, then to the extent of such payment, the Corporation acknowledges and agrees that the Guarantors will be entitled to an assignment of the Loan as if the Guarantors had been original parties thereto, and for the purposes of this provision, any amounts owing by the Corporation to the Guarantors, and unpaid, including amounts owing by the Corporation to the Guarantors under paragraph (a) or (b) above, shall be considered payments made by the Guarantors.
[5] The Appellant’s contention is that by operation of this indemnity provision CLGI became indebted to him for the amount which he was required to pay to the bank under his guarantee, and also for all the incidental costs arising out of the sale of the family home and the purchase of a replacement.
[6] The sale price of the Appellant’s house was $633,000.00. Of this, he paid $213,949.18 to the bank under the guarantee. He also paid the bank $29,342.80 from the proceeds to discharge a personal loan for a car purchase. The Appellant paid more under his guarantee to the bank than Mr. Locke did to discharge the debt of CLGI, and as a result he was entitled to receive $48,463.50 from Locke under the equalization agreement. Locke paid this in two instalments of $40,800.00 and $7,663.50, both of which were paid in 1991. I shall refer to these amounts collectively as the equalization payment. Having sold their home, the Coopers required a place to live, so they bought a less expensive house, and for one week between the closing dates the family lived in a hotel. The expenses resulting from the sale of one home, the purchase of another, and the relocation of the family were the subject of some confusion, both in filing the Appellant’s income tax return for 1991, and at the trial. I find that these amounts were accurately recorded in Exhibit R-8 as follow:
Real estate commission on sale $37,252.05
Bank service charge 85.00
Legal fees 2,460.11
Land transfer tax on purchase 4,432.94
Temporary accommodation 585.17
Moving costs 6,242.38
Hook up of hydro, telephone etc 1,835.19
Total $52,892.84
I shall refer to this amount as the removal expenses.
[7] The Appellant, as was his practice, had his accountant, a Mr. MacDonald, prepare his income tax return for the 1991 taxation year. Mr. MacDonald realized that the Appellant was entitled to claim an ABIL, but he did not consider himself qualified to compute the amount of it. He therefore asked Mr. Brian McGee, C.A., the accountant for CLGI, who claims expertise in tax matters, to do the computation. Mr. McGee was of the opinion that the legal result of the indemnity resolution was to make both the amount paid to the bank, net of the equalization payment, and the removal expenses, a debt owing by CLGI to the Appellant. He testified that he had made an entry in the books of the company to reflect that. He therefore computed the business investment loss on that basis, using numbers which he obtained from the Appellant over the telephone. This computation became an exhibit at the trial, and is reproduced here in its entirety.
Exhibit A-5
Dave Cooper
Schedule of loss
Cooper Locke Group Inc.
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Common shares |
100.00 |
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Paid to National Bank |
213,904.00 |
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Paid by Locke to Cooper re: shortfall |
40,000.00 |
173,904.00 |
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Service charge |
235.00 |
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|
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Locke/Cooper equalization |
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Paid by Cooper |
173,904.00 |
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Paid by Locke |
156,977.00 |
16,927.00 |
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/2 |
(8,463.50) |
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Legals |
3,410.11 |
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Disposal costs Real Estate Temporary accommodation Moving Land Transfer Hook ups & other costs |
37,252.00 786.00 6,542.00 4,432.00 1,197.39 |
50,209.39 219,395.00 |
|
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[8] Mr. McGee gave this information to Mr. MacDonald by telephone on or about April 30, 1992, and, at Mr. MacDonald’s request, also faxed a copy of Exhibit A-5 to him the same day. Mr. MacDonald in turn inserted it in the T-1 general return which he prepared, and the Appellant signed.
[9] Mr. McGee’s computation of the ABIL contained some errors. The amounts of the payment to the bank, the bank service charge, the legal fees, the moving expense, the hydro hook-up and the temporary accommodation were all inaccurately stated. Of the total business loss, $100.00 was described as being the acquisition cost of the shares, and the balance was simply described as “Shareholder loan”. There was no indication that the debt arose out of the operation of the indemnity resolution, the guarantee, and the removal costs. The return was prepared by the accountants, signed by the Appellant, and filed during the last week of April 1992. It was apparently done in some haste, and none too carefully.
Assessment – audit – reassessment
[10] The Appellant was assessed for the 1991 taxation year on the basis that he was entitled to a deduction for the ABIL as claimed in his return. However, in September 1994, his 1991 return was the subject of an audit by Revenue Canada, apparently as a result of an audit of CLIG. The auditor, Ms. Nadine Clarke, spoke at various times with the Appellant, Mr. MacDonald, and Mr. McGee in her attempts to obtain documents to substantiate the amount of the ABIL claimed. Mr. McGee stated in his evidence that he had faxed Exhibit A-5 to her to show the calculation underlying the ABIL claim; she does not appear to have received it. She did, however, receive from the Appellant a copy of the reporting letter sent to him by his lawyer following the closing of the sale of his house. From this document she learned that two separate payments had been made to the National Bank of Canada from the proceeds of the sale. One was the $213,949.18, paid under the loan guarantee; the other was the $29,342.80 paid to discharge the Appellant’s personal loan balance.
[11] Following her conversations with the two accountants and the Appellant, and her review of the reporting letter, Ms. Clarke was apparently left under the misapprehension that the ABIL claimed by the Appellant in his return had been made up of the $213,949.18, plus other shareholder loan amounts totalling $5,490.00, for which no substantiating evidence had been produced to her. Certainly she knew nothing of the equalization payment from Locke, although it had been netted out of the amount claimed by the Appellant. She therefore proposed to reassess the Appellant for the 1991 taxation year on the basis of a total business loss of $213,949.00, which would yield an ABIL of $160,462.00. There was no suggestion at that time of imposing a penalty. The Appellant, on the advice of Mr. McGee, agreed to accept a reassessment on that basis, rather than continue to dispute the relatively small amount that would be deducted from his loss available to be carried forward. The reassessment was made on February 27, 1995, on the basis proposed by Ms. Clarke.
[12] The Appellant’s return for 1991 again came under scrutiny by Revenue Canada in November 1995. Ms. Barbara Schofield had been performing an audit of Mr. Locke’s return, and in the course of it she had learned of the equalization payment that had been made by him to the Appellant. Upon examining the Appellant’s file she, understandably, concluded that the Appellant had failed to account for this payment in the computation of his claim, and that he had not revealed it to Ms. Clarke when she performed her audit. It had formed no part of the adjustments made by Ms. Clarke when she had reassessed the Appellant in February of that year.
[13] Ms. Schofield wrote to the Appellant on November 3, 1995, stating that she was proposing to reassess him. The proposed reassessment would reduce his business investment loss by the $48,463.00, thereby reducing his ABIL by $36,347.25. It would also make consequential reductions in the amounts carried forward to future years, and impose a penalty under subsection 163(2) of the Act. Upon receipt of this letter, the Appellant consulted with Mr. McGee, who drafted a response that the Appellant signed and sent to Ms. Schofield on December 2, 1995. The second paragraph of that letter reads as follows:
The amount of my losses in respect of Cooper Locke Group Inc. were reduced by the amounts received by Mr. Locke. The losses occurred many years ago and I am unable, at this time, to locate all of the original documentation in support of the claim. I do have some documentation from the lawyers, including a direction regarding the funds disbursed from their trust account to the National Bank of Canada (the Bank) in settlement of their loan. The $243,291.98 disbursed to the bank, plus other amounts due to me from the company, less the amounts paid to me by Locke represented my losses of $213,949.00.
.
This statement was correct in asserting that the original claim had been reduced to take into account the payments from Locke. It was incorrect so far as it stated that the payment to the bank of $243,291.98, less the payments from Locke, plus “other amounts due to me from the company” represented losses of $213,949.00. In fact the letter should have stated that the payment to the bank of $213,949.18, minus the $48,463.50 paid to him by Locke, plus the removal expenses, together with the $100.00 paid for his shares, represented the total loss of $219,395.00 claimed in his 1991 tax return.
[14] Ms. Schofield replied to this letter on December 13, 1995. Not surprisingly, she was still under the impression that the Appellant had included the payment of his personal loan in his business loss claim, and that he had not deducted the amounts received by him from Locke. She again proposed the same reassessment and penalties.
[15] Mr. McGee responded to this letter on behalf of the Appellant. His reply ran to two full pages, but it made only the most oblique reference to the real estate commissions, the legal fees and the moving costs which made up some $53,854.00 of the claim. They were, however, set out in an accompanying schedule[1] prepared by his assistant, which for the first time indicated to Revenue Canada the real basis on which the ABIL was claimed. Unmoved by this letter, Ms. Schofield proceeded with the reassessment on the basis that she had proposed in her November 3rd letter. The penalty imposed was $2,932.87. Notices of reassessment for the years 1991, 1992 1993 and 1994 were mailed to the Appellant on May 9, 1996. The dates of the original notices of assessment for the taxation years 1991 and 1992 were June 23, 1992 and May 6, 1993, respectively.
Analysis
[16] As I said at the outset, there are three issues. What is the amount of the ABIL to which the Appellant is entitled? Is the Appellant subject to the penalty imposed? Was the Minister entitled to reassess the Appellant for the 1991 and 1992 taxation years in May 1996, more that 3 years after the date of the original assessments for those years?
[17] The relevant provisions of the Act read as follows:
The amount of the ABIL
38 For the purposes of this Act,
...
(c) a taxpayer's allowable business investment loss for a taxation year from the disposition of any property is 3/4 of his business investment loss for the year from the disposition of that property.
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 his capital loss for the year from a disposition after 1977
(i) to which subsection 50(1) applies, or
(ii) to a person with whom he 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 owed to it by a corporation with which it does not deal at arm's length) that is
(A) a small business corporation,
(B) a bankrupt (within the meaning assigned by subsection 128(3)) that was a small business corporation at the time it last became a bankrupt, or
(C) a corporation referred to in section 6 of the Winding-up Act that was insolvent (within the meaning of that Act) and was a small business corporation at the time a winding-up order under that Act was made in respect of the corporation,
exceeds the aggregate of
...
39(12) For the purposes of paragraph 39(1)(c), where
(a) an amount has been paid by a taxpayer in respect of a debt of a corporation pursuant to an arrangement under which the taxpayer guaranteed the debt,
(b) the amount was paid to a person with whom the taxpayer was dealing at arm's length, and
(c) the corporation was a small business corporation
(i) at the time the debt was incurred, and
(ii) at any time in the 12 months before the time an amount first became payable by the taxpayer under the arrangement in respect of a debt of the corporation,
that part of the amount that is owing to the taxpayer by the corporation shall be deemed to be a debt owing to the taxpayer by a small business corporation.
...
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 him in respect of the disposition of personal-use property) is established by him to have become a bad debt in the year, or
...
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 penalty
163(2) Every person who, knowingly, or under circumstances amounting to gross negligence in the carrying out of any duty or obligation imposed by or under this Act, has made or has participated in, assented to or acquiesced in the making of, a false statement or omission in a return, form, certificate, statement or answer (in this section referred to as a “return”) filed or made in respect of a taxation year as required by or under this Act or a regulation, is liable to a penalty of ...
...
163(3) Where, in any appeal under this Act, any penalty assessed by the Minister under this section is in issue, the burden of establishing the facts justifying the assessment of the penalty is on the Minister.
The 1996 reassessment
152(4) Subject to subsection (5), the Minister may at any time assess tax for a taxation year, interest or penalties, if any, payable under this Part by a taxpayer or notify in writing any person by whom a return of income for a taxation year has been filed that no tax is payable for the year, and may
(a) at any time, if the taxpayer or person filing the return
(i) has made any misrepresentation that is attributable to neglect, carelessness or wilful default or has committed any fraud in filing the return or in supplying any information under this Act, or
reassess or make additional assessments, or assess tax, interest or penalties under this Part, as the circumstances require ...
The amount of the ABIL
[18] It is not disputed that the Appellant is entitled to an ABIL in the 1991 taxation year. What is in dispute is the amount of it, and more specifically whether he is entitled to include the removal expenses as part of it. The answer to this depends upon whether the indemnity resolution makes them a debt owing by CLGI to the Appellant. That resolution provides the guarantors with a complete indemnity for
... any claim, liability or loss arising in respect of the Guarantees, from time to time, including, without limiting the generality of the foregoing, any claims, liabilities or losses arising as a result of the Guarantors having to honour their obligations under the Guarantee; ...
(emphasis added)
[19] In my opinion, the removal expenses are a loss arising as a result of the Appellant having to honour his obligations under the guarantee. It is quite clear that, but for the guarantee, he would not have been required to sell his family home, nor would he have done so. The purchase of a less expensive home was a direct and unavoidable result of the sale. As Dickson J., as he then was, said in Nowegijick v. The Queen,[2]
The phrase "in respect of" is probably the widest of any expression intended to convey some connection between two related subject matters.
Certainly it is wide enough to embrace the sale of the Appellant's house, and the purchase of a replacement for it, within the scope of the indemnity. This was the view taken by both shareholders, and by their accountant. Mr. McGee said in his evidence that he had made the entries in the books of the company to reflect this liability to the Appellant in his shareholder loan account. It is not disputed that the company had ceased operation and was unable to meet its obligations by the end of 1991.
[20] This does not quite end the matter of the amount of the ABIL, however. Mr. McGee's original computation, which formed the basis of the claim made by the Appellant in his income tax return, was inaccurate in a number of respects. The actual removal expenses were, as I have found above, overstated. The amount established at trial is $52,892.84, not the amount of $54,809.32 used by Mr. McGee to compute the claim. The ABIL to which the Appellant is entitled, therefore, is properly computed as:
100 shares at $1.00 each $100.00
paid to the bank $213,949.18
less recovered from Locke 48,463.50 165,485.68
removal expenses 52,892.84
total 218,478.52
ABIL = 0.75 x $218,478.52 = $163,858.89
This is $689.11 less than the amount claimed by the Appellant.
The penalty
[21] The basis upon which the Minister imposed the penalty in this case is set out in some detail as one of the Minister's assumptions pleaded in the Reply. I quote it verbatim:
22(z) in failing to deduct the reimbursement received from Locke in the amount $48,463.50 in computing his BIL in the 1991 taxation year, as above mentioned in this paragraph, the Appellant knowingly, or under circumstances amounting to gross negligence, in carrying out a duty or obligation imposed under the Act, made or participated in, assented to or acquiesced in the making of false statements or omissions in his income tax return for the 1991 taxation year, as a result of which the tax that would have been payable assessed on the information provided in the Appellant's income tax return filed for that year, was less than the tax in fact payable by the amount of $5,865.74;
[22] Clearly, the Appellant did not, as is alleged, fail to deduct the amount that he recovered from Locke when claiming his ABIL. The penalty assessed therefore cannot stand.
The 1996 reassessment
[23] The Minister's right to reassess the Appellant for the 1991 and 1992 taxation years more than three years after the initial assessments were made depends upon the Appellant having made a misrepresentation that is attributable to neglect, carelessness or wilful default, or having committed fraud in filing his return, or in supplying information under the Act. The Appellant's return certainly misstated the amount of the business investment loss. This was due to carelessness on the part of the Appellant, who apparently furnished Mr. McGee with inaccurate data for the removal expenses claimed.
[24] Quite apart from the error in the return, the Appellant furnished misinformation when he sent his letter of December 2, 1995 to Ms. Schofield. As I have already found, that letter misstated the basis of the claim. Mr. McGee, who drafted the letter, said quite candidly in his evidence that he was attempting to prevent Ms. Schofield from learning the true basis on which he had computed the ABIL. The Appellant, if he had given the letter any thought at all before he signed it, would have realized that what it said was simply not correct.
[25] By the time this letter was sent, the three-year period for reassessment had already expired. It is argued that it therefore cannot form the basis for a reassessment under subparagraph 152(4)(a)(i). I do not accept this. To interpret the provision that way would be to add limiting words which are not found in the Act. One of the purposes of this paragraph is to encourage candour in taxpayers; that purpose would not be well served by the narrow construction proposed by counsel for the Appellant.
[26] For both these reasons, I find that it was open to the Minister to reassess the Appellant for the taxation years 1991 and 1992 on May 9, 1996.
[27] The appeals are allowed. The assessments are referred back to the Minister for reconsideration and reassessment on the basis that the Appellant is entitled to an ABIL in the amount of $163,858.89 in the 1991 taxation year, and to the appropriate carry forward in the 1992, 1993, and 1994 taxation years. He is not subject to the penalty assessed.
Costs
[28] The Appellant has achieved substantial success in the appeals, and so I may award costs, in accordance with section 18.26 of the Tax Court of Canada Act.
[29] The hearing of this appeal took an entire day. This is due in large measure to the fact that the Appellant and Mr. McGee had deliberately avoided disclosing the true facts to Ms. Clarke, and later to Ms. Schofield. As Mr. McGee put it in his evidence, he did not give Exhibit A-5 to Ms. Schofield, as he knew that she would disallow the claim to include the removal expenses in the loss. For this reason, I have considerable doubt about the veracity of his evidence that he faxed this document to Ms. Clarke. He said in his evidence that he was deliberately vague, in the hope that he would get lucky. He could only mean by this that the assessors would not find out the true facts, because he knew that at least Ms. Schofield disagreed with his interpretation. It goes without saying that this is not appropriate conduct for a professional advisor. More important for present purposes, it caused what should have been a simple dispute as to whether the removal expenses were properly included to become a full-day hearing, most of which was devoted to determining the real facts. The Appellant shall have costs, but with a counsel fee for one-half day of trial only.
Signed at Ottawa, Canada, this 16th day of October, 1998.
"E.A. Bowie"
J.T.C.C.