Date: 19980715
Docket: 95-3417-IT-G
BETWEEN:
eROBERGE & FILS INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Lamarre Proulx, J.T.C.C.
[1] The appellant is appealing a reassessment by the Minister of National Revenue ("the Minister") for its 1989 taxation year.
[2] The issues are:
(1) whether, within the meaning of s. 12(1)(i) of the Income Tax Act ("the Act"), the appellant received an amount in 1989 on account of a debt in respect of which a deduction for bad debts had been made in 1988. The appellant maintains that the amount was received in 1990 while the respondent contends that it was received in 1989. The respondent relies on the fact that in 1989, as the result of a giving in payment, the appellant acquired ownership of an immovable given as security and that the debt was thereby extinguished. The appellant submits that the debt was not extinguished by the giving in payment because the giving in payment was not yet effective. The transfer of ownership was finalized only in the following year when the immovable in question, which was acquired by means of a giving in payment of uncertain validity, was sold in accordance with a plan adopted by the appellant;
(2) and whether the aforesaid giving in payment also barred the appellant from deducting interest on the principal debt in 1989.
[3] The facts in support of the appeal are set out in paragraphs 4 to 12 of the Notice of Appeal:
[TRANSLATION]
4. THAT on or about December 4, 1987 Courtage Plus Abitibi Inc. ("Courtage") by notarial contract gave a hypothecary security in the amount of $250,000 to the APPELLANT in respect of certain purchases of building materials supplied or to be supplied to COURTAGE by the APPELLANT;
5. THAT on or about February 8, 1988 COURTAGE sold to Pierre Dubuc the immovable hypothecated to the APPELLANT;
6. THAT on or about November 22, 1988 a 60-day notice was served by bailiff on COURTAGE and Pierre Dubuc as a consequence of their failure to perform their obligations to the APPELLANT under the hypothecary security;
7. THAT on or about October 2, 1989 the APPELLANT made a proposal in writing to the other creditors of COURTAGE and Pierre Dubuc who had security interests in the hypothecated immovable;
8. THAT by that proposal:
(a) the APPELLANT would bring an action for giving in payment against COURTAGE and Pierre Dubuc;
(b) the APPELLANT would sell the immovable to a company to be incorporated with as its shareholders certain creditors of COURTAGE and Pierre Dubuc;
(c) the purchase price would be financed by means of a hypothecary loan of $656,000 from a financial institution and of shares to be issued in the new corporation;
(d) $330,050 in debts owed to the creditors would accordingly be paid and 315,000 shares in the new corporation would be issued to eight creditors including the APPELLANT, who was to receive $205,000 and 58,475 shares; and
(e) each of the creditors would stand surety for the hypothecary loan for up to the amount corresponding to the shares they held in the new corporation;
9. THAT on or about November 22, 1989 COURTAGE and Pierre Dubuc conveyed the immovable to the APPELLANT under the giving in payment;
10. THAT according to a deed of sale dated March 27, 1990 the new corporation was named 2745-8017 Québec Inc. and had been incorporated on January 4, 1990;
11. THAT on March 27, 1990 the APPELLANT sold the immovable to 2745-8017 Québec Inc. for an amount equal to its adjusted cost base, or $263,475, payable by means of $205,000 in cash and $58,475 in the form of 58,475 shares in the purchaser's capital stock;
12. THAT by the contract of March 27, 1990 2745-8017 Québec Inc. would pay certain debts to 18 other creditors in the following manner:
(a) cash payments to 16 creditors: $198,430
(b) issuing of shares to 7 creditors: $256,525
The total cost of the immovable thus came to $718,430 . . . .
[4] Of the facts on which the Minister relied in arriving at his reassessment, I will reproduce only those set out in paragraphs 6 and 7 of the Reply to the Notice of Appeal ("the Reply"). The facts set out elsewhere in the Reply are not really different from those presented by the appellant.
[TRANSLATION]
6. for its 1988 taxation year the appellant claimed as a deduction for bad debts certain amounts owed by Logements RPG 2 Inc., Maison Gobeil Inc., Dion Philippe Géo Lab Ltée and Pierre Dubuc totalling $188,517.80;
7. for its 1989 taxation year it also claimed as a deduction for bad debts an amount of $42,634.57 owed to it by the same five debtors although these debts were not even doubtful and had been extinguished by the exercise of the giving in payment clause . . . .
[5] The assessment referred to the recovery of a bad debt of $131,106 claimed as a deduction in 1988. This therefore is the amount at issue, not the amount of $188,517.80 mentioned in paragraph 6 of the Reply.
[6] Jean-Guy Roberge has been the appellant's president since 1964. In 1987 one Pierre Dubuc was a debtor of the appellant. Pierre Dubuc was the principal shareholder in several businesses which on various accounts had purchased building materials from the appellant. These businesses and Pierre Dubuc himself owed the appellant a large sum of money. In order to protect the appellant's debt Mr. Roberge obtained from Courtage Plus Abitibi Inc. ("Courtage Plus"), in which Mr. Dubuc was the sole shareholder, a hypothecary security of $250,000 on an immovable owned by Courtage Plus.
[7] This hypothecary security was dated December 4, 1987 and registered on December 9, 1987. The debtor undertook to repay the sum loaned on request and the agreement contained a giving in payment clause. The document was filed as Exhibit A-1.
[8] The hypothecary security contained inter alia the following clauses at pp. 1-2:
[TRANSLATION]
The debtor acknowledges that it owes the creditor the sum of $250,000 on a loan in that amount made to it by the creditor, of which the debtor acknowledges receipt to its complete satisfaction and gives release therefor.
. . .
The parties herein appearing do depose and agree that this hypothecary security is given only to secure accounts payable for the purchase of materials, total existing and future accounts, up to the amount of the said hypothecary security, which the parties declare that they are fully acquainted with and accept as such.
[9] According to Mr. Roberge and Mr. Doré (Jean-Claude Doré is a chartered accountant who has been the appellant's auditor since 1976), these allegations raised concerns for counsel for the appellant, who wondered whether the security could be valid for debts other than those of Courtage Plus and whether this corporation's other creditors might not object to it.
[10] In an effort to resolve this problem a document was signed by Courtage Plus and Pierre Dubuc in September 1988 acknowledging that the security had been given to secure the debts of five other corporations and his own personal debts. It was filed as Exhibit I-1. Dated August 20, 1988, the document acknowledged that the total amount owed by Pierre Dubuc and his businesses came to $229,549.52. It was agreed between the parties by the same document that the 60-day notice would not be registered before October 21, 1988.
[11] The 60-day notice was signed on November 14, 1988 and registered on the 16th of that month. At that point, according to clause 10 of the notice, the debtor's debt was $242,994.63. This document was filed as Exhibit A-2.
[12] Mr. Roberge and Mr. Doré explained that around that time Mr. Dubuc had drawn up and proposed a plan to retain part ownership of the immovable given as security. The plan provided that the creditors would become owners of the building by agreeing to exchange part of their debt for shares in a corporation that would hold the immovable. This corporation would obtain a hypothecary loan which would enable it to repay the other part of the debt.
[13] Mr. Roberge did not believe that this proposal could be carried through to completion by Mr. Dubuc. He accordingly took over the proposal himself and undertook to negotiate with the lending institution and the creditors either personally or through his accountant Mr. Doré.
[14] On June 22, 1989 La Financière submitted a financing offer. This document was filed as Exhibit A-3. The amount of the loan would be $656,500. The security would be a first hypothec on the building, the personal but not joint and several guarantees of all the shareholders for the amounts stated in the document and a withdrawal of $100,000 to cover the monthly payments. Before the lending institution made any disbursements, the privileges and hypothecs would have to be cancelled and the shareholders would have to submit their financial statements. There was also a list of other conditions, such as a firm quotation by a bidder for repairs and an option to withdraw the financing offer if the financial statements were not to the satisfaction of the lending institution.
[15] Exhibit A-4 is the agreement negotiated between the creditors registered for the immovable in question and the appellant. The agreement was dated October 2, 1989 and the latest date for acceptance was October 19, 1989. This agreement, the purpose of which was to avoid a judicial sale, involved several stages. The appellant would use the giving in payment clause to become owner of the immovable. The immovable would then be conveyed to a new company which would borrow $656,500. The new company would pay the appellant and seven creditors, either in cash or in shares. The appellant, for its part, would receive $205,000 in cash and $58,475 in shares. An amount of $109,100 would be set aside for repair work, $6,500 for loan charges and $30,000 for professional fees. In addition, $100,000 would be deposited in a trust account to secure payments on the hypothec.
[16] Exhibit A-5 is the document by which the giving in payment clause was exercised. It was dated November 22, 1989 and registered the same day. The appellant became the owner as of December 4, 1987. Certain passages from the document must be reproduced here:
[TRANSLATION]
4. The creditor has caused the 60-day notice to be registered against the said immovable . . . .
. . .
6. As it does not wish to incur court costs or other costs, the debtor hereby acknowledges that the giving in payment clause is now effective . . . .
THESE FACTS HAVING BEEN STATED, the creditor declares that it is exercising the option of becoming owner of the immovable . . . .
. . .
This giving in payment is made in consideration for the full and final release by the creditor of the debtor for all sums owed to it in principal, interest, costs and incidentals, under the following deeds:
. . .
AMOUNT OF CONSIDERATION: $250,000
[17] Exhibit A-6 is the bid for repair work. It is not dated but its date of acceptance does appear on it. It was accepted on February 7, 1990 by 2745-8017 Québec Inc., a company incorporated on January 4, 1990 as attested to by Exhibit A-11.
[18] Exhibit A-7 is an extract from the land register applicable to the immovable in question. It can be seen that as of December 9, 1987, the date the hypothecary security was registered, several privileges for substantial amounts were registered against the immovable.
[19] Exhibit A-8 is a motion dated December 18, 1989, probably made ex parte, to cancel the January 18, 1989 registration against the immovable of a judgment. That judgment directed Pierre Dubuc to pay Mines Assay Supplies the sum of $19,989.77. Exhibit A-9 is a certificate attesting that the judgment to cancel rendered on February 19, 1990 would not be appealed. The certificate is dated March 21, 1990.
[20] Exhibit A-10, dated March 27, 1990, is the contract of sale of the immovable by the appellant to 2745-8017 Québec Inc. The sale price was $263,475, of which $205,000 was payable out of a loan yet to be obtained and $58,475 was payable in shares in the purchaser. Additionally, the purchaser assumed responsibility for and paid certain registered creditors, partly in cash and partly in shares. Other creditors were paid only in cash.
[21] Exhibit A-11 is the deed of hypothec dated March 27, 1990 between La Financière Prêts-Épargne Inc. and 2745-8017 Québec Inc. The amount of the loan was $656,500. The witnesses pointed out that the deed clearly stipulated that the amount of each advance and the date on which it would be made were left to the lender's discretion. The personal guarantees of the purchasers in the amounts they had already committed themselves to pay were attached to this deed. The lending company's initial disbursements began in May 1990 and ended in August 1990, as can be seen from Exhibit A-12.
[22] Exhibit A-13 is a deed of sale of the immovable in question by the lending institution, dated January 15, 1994. The price is $65,000. The lending institution had become the owner as the result of a giving in payment judgment dated June 8, 1993.
[23] Exhibit A-15 is a letter of explanation sent to the Minister's auditors by the appellant's accountant. In it he indicated that there was an appraisal report which had been prepared at the time of the proposed agreement between the creditors (Exhibit A-4). The value was $900,000 if the building was completed and had a 100 percent occupancy rate. However, the building had not been completed at the time and was not rented. On the 1989 deduction for the bad debt, this is what the accountant said:
[TRANSLATION]
Recovery of bad debt
Roberge & Fils Inc. entered a bad debt of $188,517.80 in its books in 1988.
No recovery was entered in the books in 1989 following the giving in payment. Instead it was registered in 1990 when the amount was actually received.
The giving in payment was only one stage in the process of eventually obtaining the money owed, and the building had no value per se as it had not been completed and rented.
Roberge & Fils acted only as a "vehicle" for the eventual transfer to 2745-8017 Québec Inc.
What is more, the hypothec held by Roberge & Fils Inc. could have been challenged, as therefore could the giving in payment.
That is why the recovery was entered in 1990 at the time the file was closed and the money actually received.
[24] Mr. Roberge stated that recovery of the immovable was not the objective: a judicial sale of it would have brought in nothing, as its value was questionable. A number of privileges involving substantial amounts had been registered and in the opinion of the appellant's counsel its very title to the immovable was not very clear. Only the performance of the agreement and obtaining of the hypothecary loan had any meaning.
[25] As to the additional amount deducted as a bad debt in 1989, Mr. Doré, the appellant's accountant, explained that this was interest on the principal debt and that since the principal debt had been deducted as a bad debt in 1988 it was, in his opinion, logical to deduct interest and incidental costs amounting to $42,635 in 1989.
Arguments and conclusions
[26] Counsel for the appellant submitted that the validity of the hypothecary security was uncertain, because it could have been challenged by the other privileged or hypothecary creditors. Because of this uncertainty assuming ownership of the immovable was an integral part of a plan to resell it to a corporation in which the appellant and the debtor's other creditors would be shareholders. The plan also involved financing from a financial institution. It was a complex plan and was not finalized until 1990.
[27] Counsel for the appellant therefore submitted that in 1989 the appellant did not have beneficial ownership of the immovable within the meaning of s. 79 of the Act. Section 248(3) of the Act defines what the term beneficial ownership must be understood to mean in the Quebec context. He argued that the appellant had not acquired full ownership of the immovable in question because it could not dispose of the immovable as it saw fit, in view of the uncertainty of title which had compelled it to reach agreement with the debtor's other real creditors. In this connection he referred to the decision of Judge Tremblay of this Court in Larose v. M.N.R., 92 DTC 2055, in particular at p. 2064.
[28] He also noted that the immovable did not have the value of the debt of approximately $250,000, and that it would have no value unless it was purchased by the company that was to be incorporated, in which the creditors were to be shareholders.
[29] Counsel for the respondent maintained that s. 79 of the Act applied in 1989 since the appellant, which was a hypothecary creditor, had acquired beneficial ownership of the immovable in that year by means of the giving in payment. He also referred to s. 248(3) of the Act, which states that the meaning of "beneficial ownership" in the Quebec context is "full ownership".
[30] As to the debt of $131,106 which was claimed as a bad debt in 1988, counsel for the respondent argued that it had been paid in full by means of the giving in payment of the immovable. Accordingly, under s. 12(1)(i) of the Act the amount should be included in the year of receipt, namely 1989, the year in which the debt was paid by the debtor by transferring its ownership of the immovable in lieu of the debt. Nor are the interest and charges in the amount of $42,634.57 resulting from the principal debt deductible since they were paid by the debtor when it gave its immovable in payment.
[31] Sections 79 and 248(3) of the Act read as follows:
[TRANSLATION]
79. Mortgage foreclosures and conditional sales repossessions.
Where, at any time in a taxation year, a taxpayer who
(a) was a mortgagee or other creditor of another person who had previously acquired property, or
(b) had previously sold property to another person under a conditional sales agreement,
has acquired or reacquired the beneficial ownership of the property in consequence of the other person's failure to pay all or any part of an amount (in this section referred to as the "taxpayer's claim") owing by that person to the taxpayer, the following rules apply:
(c) there shall be included, in computing the other person's proceeds of disposition of the property, the principal amount of the taxpayer's claim plus all amounts each of which is the principal amount of any debt that had been owing by the other person, to the extent that it has been extinguished by virtue of the acquisition or reacquisition, as the case may be,
(d) any amount paid by the other person after the acquisition or reacquisition, as the case may be, as, on account of or in satisfaction of the taxpayer's claim shall be deemed to be a loss of that person, for that person's taxation year in which payment of that amount was made, from the disposition of the property,
(e) in computing the income of the taxpayer for the year,
(i) the amount, if any, claimed by the taxpayer under subparagraph 40(1)(a)(iii) in computing the taxpayer's gain for the immediately preceding taxation year from the disposition of the property, and
(ii) the amount, if any, deducted under paragraph 20(1)(n) in computing the income of the taxpayer for the immediately preceding year in respect of the property,
shall be deemed to be nil,
(f) the taxpayer shall be deemed to have acquired or reacquired, as the case may be, the property at the amount, if any, by which the cost at that time of the taxpayer's claim exceeds the amount described in subparagraph (e)(i) or (ii), as the case may be, in respect of the property;
(g) the adjusted cost base to the taxpayer of the taxpayer's claim shall be deemed to be nil, and
(h) in computing the taxpayer's income for the year or a subsequent year, no amount is deductible in respect of the taxpayer's claim by virtue of paragraph 20(1)(l) or (p).
248(3) References to property beneficially owned and to beneficial owner of property.
In its application in relation to the Province of Quebec, a reference in this Act to any property that is or was beneficially owned by any person shall be read as including a reference to property in relation to which any person has or had the full ownership whether or not the property is or was subject to a servitude, or has or had a right as a usufructuary, a lessee in an emphyteutic lease, an institute in a substitution or a beneficiary in a trust, and a reference in this Act to the beneficial owner of any property shall be read as including a reference to a person who has or had, accordingly as the context requires, such ownership as a right in relation to that property.
[32] Section 12(1)(i) of the Act reads as follows:
12. Income inclusions.
(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:
. . .
(i) Bad debts recovered — any amount, other than an amount referred to in paragraph (i.1), received in the year on account of a debt or a loan or lending asset in respect of which a deduction for bad debts or uncollectable loans or lending assets was made in computing the taxpayer's income for a preceding taxation year . . . .
[33] In my view, the appellant's proposition that its ownership did not become beneficial in 1989 is not supported by either the facts or the law. The meaning in taxation law of the term "beneficial ownership" is not narrower than that of "ownership" as understood in the civil law of Quebec. There is no other way to interpret s. 248(3) of the Act. The fact that someone undertakes to dispose of property even before acquiring it does not mean that the person does not become the owner thereof at the time of acquisition. How could the person dispose of the property without having acquired it?
[34] The instant case concerns the application of ss. 12(1)(i) and 79 of the Act in the year in question. The deed of giving in payment was valid in 1989. No court had ruled it to be invalid and no action in nullity had been brought (if such an action could have affected its application, which is a point on which I do not have to rule). I refer to Volume 11 of the Traité du Droit Civil du Québec, L. Faribault, at p. 520, regarding the nature and effect of giving in payment:
[TRANSLATION]
Giving in payment has much in common with a sale, when something is given in lieu of a sum of money. In this case two legal operations are merged into one. Once the giving in payment has been accepted by the creditor the parties are in the same position as if the debtor had paid his debt with money and the creditor at once used the money to purchase for cash the thing offered by his or her former debtor.
However, Pothier observes that there is a difference between an agreement to sell something to a creditor for a price which will offset what is owed and an agreement to give something to the creditor in payment of what is owed. In a sale the extinction of the debt of the former creditor is only incidental, while in a giving in payment it is the primary result sought by the debtor. The comparison between the two contracts results from the wording of our article 1592.
(Emphasis added.)
[35] The deed of giving in payment mentioned in paragraph 15 of these reasons says nothing to the contrary. The debtor's debt is extinguished. By means of the giving in payment the appellant received payment of the debtor's debt, in principal and interest. Under s. 12(1)(i) of the Act, therefore, it must include in its income the payment of the debt deducted as a bad debt in 1988 and is also barred from claiming $42,000 in interest on the debt.
[36] The Act lays down special rules for mortgage foreclosures. The process set out by Parliament must be followed. Section 79(f) of the Act provides that the taxpayer is deemed to have acquired the property at the cost of the claim on that date. Section 79(e) does not apply here, since what is at issue is not be repossession of property formerly owned by the appellant. Nor does section 79(h) apply since the original debt was extinguished by the giving in payment.
[37] It is quite possible that but for execution of the plan proposed by the appellant to the other creditors the appellant would not have been in a favourable position and could not have resold the immovable at a good price. The loss would then have been calculated by applying s. 79 and the other relevant provisions of the Act. The acquisition of an immovable is a legal act distinct from that of its sale and has different legal effects both in civil law and in tax law. The fact that there is a close relationship between the two acts alters neither their nature nor their effects. The giving in payment took place in 1989 and that is the taxation year in which its effects, namely the payment of the debt and the acquisition of ownership, must be taken into account.
[38] The appeal is accordingly dismissed with costs.
Signed at Ottawa, Canada, July 15, 1998.
"Louise Lamarre Proulx"
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]