Tax Court of Canada Judgments

Date: 19981203

Docket: 97-3235-IT-I

BETWEEN:

OREST V. NOWAKIWSKY,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Christie, A.C.J.T.C.

[1] This appeal is governed by the Informal Procedure prescribed under section 18 and following sections of the Tax Court of Canada Act.

[2] The issue is whether the appellant is entitled to deduct an allowable business investment loss ("ABIL") of $102,479.00 in computing his income tax for 1992.[1] The loss is said to have been incurred in 1990 and carried forward to 1992. It is made up of two categories: first, a shareholders loan to Memtek Corporation ("Memtek") in the sum of $97,262.00. Second, amounts totalling $39,377.00 alleged to have been expended by the appellant for the business purposes of Memtek. These are also characterized by the appellant's agent as a shareholder loan to Memtek. Particulars are set out in Ex. A-1-7. It reads:

1990 ALLOWABLE BUSINESS

INVESTMENT LOSS

1. Shareholder loan balance of May 31, 1984

(As Reassessed by Revenue Canada) $ 97,262.00

2. American Express

- travel paid by Orest Nowakiwsky 4,801.31

3. Mastercard

- paid by Orest Nowakiwsky $ 7,106.61

589.00 7,695.61

4. Legal and accounting fees paid

by Orest Nowakiwsky personally

on behalf of Memtek corporation. 18,447.00

5. Scotia-Line

(incurred on behalf of Memtek

corporation) 8,433.05

Business Investment Loss 136,638.97

x    75%

Allowable portion $102,479.22

[3] Memtek was incorporated in May 1980. Its purpose was "to conduct business in the field of reverse osmosis, to commercialize technology that was developed at N.R.C. in the field of membrane technology and in particular reverse osmosis and ultra filtration". The appellant was president and the majority shareholder. There is also evidence of the incorporation of Memcare Corporation ("Memcare") in 1982. The appellant referred to it as a "sister corporation". It provided technological and consultation services to Memtek. It was also controlled by the appellant.

[4] Memtek was indebted to the Canadian Imperial Bank of Commerce in the sum of approximately $125,000.00. In 1985 it was in financial difficulty. Repayment of the loan was demanded and this led to the appointment on August 9, 1985 of Thorne, Riddell Inc. as receiver. A vice-president of that corporation, Brian P. Doyle, C.A., dealt with this receivership.

[5] The appellant's employment was terminated on September 23, 1985 and he was denied further access to Memtek's premises. By mid-October the employment of all employees of Memtek had been terminated. Memtek's assets were sold. Among the purchasers of these assets was the appellant. By bill of sale dated November 26, 1985 he acquired specified assets "In trust for Memcare Corporation". The assets were: an F.D.I.R. which is an instrument that measures organic compounds, a welder, a milling machine and an I.B.M. computer system.

[6] A statement of claim dated March 4, 1987 issued out of the Supreme Court of Ontario. Memtek and the appellant were the plaintiffs. The defendants were the Receiver and Doyle. Memtek sought damages for breach of contract and future loss of profit. In the alternative it asked for damages for breach of a fiduciary relationship. The appellant claimed damages for breach of contract regarding services performed by him for the defendants. Paragraphs 4 to 8, 17 and 18 of the statement of claim read:

"4. The Plaintiff, Memtek Corporation, is a company incorporated pursuant to the law of Canada and carries on business in the Regional Municipality of Ottawa-Carleton.

5. The Plaintiff, Orest Nowakiwsky, resides in the Regional Municipality of Ottawa-Carleton and was, at all material times, the President and Chief Operating Officer of Memtek Corporation.

6. The Defendant, Brian Doyle, is a Chartered Accountant residing in the City of Ottawa, in the Regional Municipality of Ottawa-Carleton and was, at all material times, a partner in the chartered accounting firm of the Defendant, Thorne Ernst & Whinney, the successor to the firm of Thorne Riddell.

7. The Defendant, Thorne Ernst & Whinney, is a body corporate, carrying on a chartered accounting practice in the City of Ottawa, in the Regional Municipality of Ottawa-Carleton, and is the successor to the firm of Thorne Riddell.

8. The Plaintiff corporation carried on business in the Regional Municipality of Ottawa-Carleton from July of 1990 until August of 1985. The Company was in the process of manufacturing reverse osmosis equipment for the filtration of liquids, and at all material times the Plaintiff, Orest Nowakiwsky, owned seventy-four percent (74%) of the Corporation.

17. The Defendants proceeded to carry on as Receivers pursuant to the provision of the Security Agreement but did not proceed to restructure the Company but seized all of the assets of the Company, terminated the employees and wound up the Corporation including the sale and assignment of the trade marks of the Plaintiff Corporation.

18. As a result of the Defendants' actions, the Plaintiffs lost all of the Sales Contracts that they had entered into, lost the ability to continue with the research and planning, and lost the ability to carry on business."

[7] An order issued on consent of the parties dismissing the action without costs. The order is dated December 28, 1988. The appellant said that the action was discontinued because of his inability to finance it further. The statement of claim and this order were placed in evidence by the appellant.

[8] Memtek became involved in the United States in a trade mark dispute with a Massachusetts corporation also called Memtek Corporation. A Washington firm of attorneys had been acting for Memtek. It withdrew from the proceedings by application made on April 19, 1990 to the U.S. Department of Commerce, Patent and Trade Mark Office. This was also related to a lack of funds.

[9] Memtek was dissolved on October 4, 1993 for failure to file annual returns. This is set out in a letter sent by Industry Canada dated February 14, 1997.

[10] Counsel for the respondent placed in evidence the appellant's income tax return for 1992. It shows total income of $230,000.00. Apart from 1985 there is no evidence regarding the appellant's income in other years.

[11] Exhibit A-1-7, which is reproduced in paragraph 2 of these reasons, pertains to the appellant's shareholder loan balance as of May 31, 1984 in the sum of $97,262.00. Counsel for the respondent placed in evidence a Notice of Reassessment addressed to the appellant. It relates to his 1985 taxation year and it adds 50% of $97,262.00 or $48,361.00 to what may be deducted.[2] In the result the appellant's "Revised Taxable Income" for that year was minus $43,240.00. Counsel placed in evidence a further Notice of Reassessment also addressed to the appellant. It relates to his 1992 taxation year and it allows as a deduction a non-capital loss of $43,240.00.

[12] As will also be seen from Ex. A-1-7 the amount of expenses alleged to have been incurred by the appellant on behalf of Memtek totals $39,377.00. This consists of four items.

[13] First, $4,801.00 paid to American Express. Ex. A-1-8 dated December 29, 1992 shows the breakdown of this amount and states: "During the course of the receivership, Mr. Nowakiwsky incurred the following expenses trying to raise financing for the company."

[14] Second, $7,696.00 paid to Mastercard. This is made up of $7,107.00 and $589.00. A Mastercard statement for September 9, 1985 shows a new balance of $7,107.00, but this does not establish precisely when these charges were incurred or their purpose. The same document shows that between July 6, 1985 and September 9, 1985 $535.00 was charged to Mastercard. The greater part of these individual charges pertained to restaurants in Nepean and Ottawa. The average charge was $8.25. This suggests to me expenditures within the ambit of the phrase "personal and living expenses" rather than outlays for the business purposes of Memtek. In referring to this document the appellant said:

"Most of these you will notice are restaurant bills where we took out – we basically had lunch meetings during which we discussed the various business matters, and in particular towards the end of July and August they mainly centred on refinancing the company."

As for the $589.00, all there is is a Mastercard document indicating that payment of that amount was received on August 9, 1985.

[15] Third, there is legal and accounting fees paid on behalf of Memtek. The amount is $18,447.00. Ex. A-1-10 shows legal fees of $11,217.00, all of which relates to MEMTEK CORPORATION AND OREST NOWAKIWSKY, Plaintiffs and THORNE ERNST & WHINNEY AND BRIAN P. DOYLE, Defendants. These were billed in October 1986, September 1988 and February 1989.

[16] The accounting fees are said to have been incurred in the sum of $6,766.00 billed by Cox, Snowdon & Merritt, Chartered Accountants on March 15, 1988 ($3,000.00) and in December 1988 ($3,736.00). Ex. A-1-10 states the accounting fees were incurred to: "(1) Prepare May 31, 1985 financial statements and Federal and Provincial corporate tax returns; (2) Prepare Corporation Part VIII tax return to eliminate a part VIII tax assessment of $1,029,968.68." The appellant's agent said the balance of $464.00 could not be substantiated ($18,447.00 - $11,217.00 + $6,766.00 = $464.00).

[17] Fourth, there is $8,433.05 paid to Scotia-Line. The documentary evidence in this regard is a two-page document entitled "Memtek Corporation accounts payable as of August 9, 1985", one item of which is "Scotia Bank $8,433.05" with a hand-written note "Paid by Orest". The appellant said that document was prepared by the Receiver. There is also a statement from Scotia Bank-Scotia Line dated June 14, 1985 showing the balance due by the appellant to be $7,663.51.

[18] The appellant placed in evidence financial statements showing that during the period May 31, 1986 to May 31, 1992 Memcare had income of $1,389.00, $48,968.00, $11,715.00, $55,753.00, $18,566.00, $28,650.00, $549,015.00 respectively.

[19] In the course of cross-examination this exchange took place between counsel for the respondent and the appellant:

"Q. Yes, but in 1985, when all the assets were sold and most of the creditors weren't able to get paid, it was reasonable for you to assume that you weren't going to get paid your shareholder loan if you were behind all of these other creditors?

A. Well, of course, yes.

Q. And why wouldn't you have claimed the loss in 1985?

A. I was in such state of mind that I did not even file income tax returns until probably I think 1988 or so.

Q. And we're talking about personal tax returns?

A. Personal tax returns. That whole idea of – like, I was devastated by this whole operation, where all my personal finances, my whole life energy went into restructuring this company, and it was all destroyed and removed from me. So it took a while for me to even get my mind around the idea of how to proceed. And I believe it was only in '88 or so that I started to tie up the loose ends concerning the operation, and asked Mr. Snowdon to file tax returns both for the company for myself."

A little later the appellant testified that the last income tax return filed by Memtek was in respect of 1985. This was done in 1988.

[20] Regarding the expenses said to have been incurred by the appellant on behalf of Memtek after the Receiver was appointed, he was asked if this had been done with the acquiescence of the Receiver. He replied: "Some actions may have been." At the end of cross-examination he stated that the Receiver refused to honour those claims. It took the position that these outlays had been made without its authority.

[21] This is said in Shkolny v. The Queen, [1996] 3 C.T.C. 2532 (T.C.C.) at 2535:

"A business investment loss for a taxation year is a capital loss and one of the circumstances that can create such a loss under the Income Tax Act (the 'Act') is where an individual has lent money to a Canadian-controlled private corporation that is a small business corporation[3] and the debt is established by the individual to have become a bad debt in the year: (paragraph 39(1)(c) and subsection 50(1) of the Act).

I emphasize that the loss is capital in nature. Section 40 of the Act states general rules applicable to taxable capital gains and allowable capital losses. What is relevant for the purposes of this appeal in subparagraph 40(2)(g)(ii) of the Act provides that a taxpayer's loss from the disposition of a debt, is nil unless the debt was acquired by the taxpayer for the purpose of gaining or producing income from a business or property.

An allowable business investment loss is a fraction of a business investment loss. For 1991, the year under review, that fraction is ¾:[4] (paragraph 38(c)). The usual rule that capital losses can only be offset against capital gains does not apply to an allowable business investment loss. Under paragraph 3(d) of the Act an allowable business investment loss is treated on the same basis as a non-capital loss from such sources as employment, business or property, resulting in allowable business investment losses being deductible against all sources of income in calculating income."

[22] The appellant contends that basically it is for the taxpayer to determine in what year a debt owing to him became a bad debt and in this regard the Court was referred to Beaudry v. The Queen, 98 DTC 1898 with special emphasis on what Rip, T.C.J. said at page 1903. I agree. But these reasons for judgment also indicate that a taxpayer is not vested with unfettered discretion to make the determination. It must be reasonable having regard to all of the relevant circumstances.

[23] In my opinion the evidence clearly establishes that any debts owing by Memtek became bad debts by the end of 1985. By that time the Receiver had put an end to the appellant's employment by the company and he was barred from the company's premises. All of the persons employed by Memtek were no longer employees. The company's assets had been sold. There is no evidence of business activity by Memtek after that time. Paragraph 18 of the Statement of Claim states that as a result of the Receiver's activities Memtek "lost the ability to carry on business". The last return of income filed by Memtek was in respect of 1985.

[24] Further, the evidence indicates that after the Receiver was appointed on August 9, 1985 the appellant was without authority to create the relationship of creditor and debtor between himself and Memtek. What he did in this regard was in defiance of the Receiver.

[25] The whole of the evidence leads to the conclusion that this appeal cannot succeed. Accordingly judgment shall issue dismissing it. I believe this is consonant with the decision of this Court in Duncan v. M.N.R., 86 DTC 1549.

Signed at Ottawa, Canada, this 3rd day of December 1998.

"D.H. Christie"

A.C.J.T.C.C.

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