Date: 20000107
Docket: 97-2326-IT-G
BETWEEN:
ROBERT J. DAVISSON,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
O'Connor, J.T.C.C.
[1] This appeal was heard at Regina, Saskatchewan on November 4, 1999. Testimony was given by the Appellant and by Mr. Heppner, the Appellant's Chartered Accountant. Also, several passages from the discovery of Ernie Karnes, an auditor with Revenue Canada, were read in by counsel for the Appellant.
Issue
[2] The issue is whether in the 1992 taxation year the Appellant should have included in his income an amount of $84,573 as a shareholder benefit pursuant to subsection 15(1) of the Income Tax Act ("Act") and/or as an indirect payment pursuant to subsection 56(2) of the Act. The amount of federal tax in dispute is approximately $25,000.
Facts
[3] The principal facts are as follows:
1. Bob Davisson Restaurants Corporation ("the Restaurant Corporation") in 1992 was a corporation registered to carry on business in Saskatchewan. The Appellant was its president, a director and the sole shareholder. There were no restrictions in the Articles of Incorporation as to what businesses the Restaurant Corporation could carry on. However, as mentioned below, there were restrictions in an Agreement with a third party.
2. Davisson Twin Arena Corporation ("the Arena Corporation") was a corporation having its registered office in the City of Swift Current, Saskatchewan. Linda Davisson, the Appellant's wife, was the sole shareholder, president and director of the Arena Corporation.
3. The Restaurant Corporation was carrying on the business of a McDonald's franchise in Swift Current.
4. The Arena Corporation was involved with developing and constructing an indoor rink facility in Regina, Saskatchewan with a view to operating same once completed.
5. An Agreement (Tab 5 of Exhibit A-1) between the Appellant, the Restaurant Corporation and McDonald's provided that the Appellant was to be personally liable for the covenants contained in the Lease Agreement and License Agreement with McDonald's. Said Agreement provided further at paragraph 10:
(10) The Assignee covenants and agrees with McDonald's that it will not carry on any other business except that of operating the McDonald's restaurant nor will it directly or indirectly maintain or invest in any other assets except those assets directly related to the McDonald's restaurant business.
6. Further, the License Agreement with McDonald's, which was binding on the Restaurant Corporation and the Appellant, provided as follows:
SECTION 18
MATERIAL BREACH
The parties agree that the happening of any of the following events shall constitute a material breach of this License and violate the essence of the Licensee's obligations and, without prejudice to any other of its rights or remedies at law or in equity, the Licensor, at its option, may terminate this License upon the happening of any of the following events:
...
(b) If the Licensee shall be adjudicated a bankrupt, become insolvent, or if a Receiver, whether permanent or temporary, for all or substantially all of the Licensee's property, shall be appointed by any Court of competent jurisdiction, or if the Licensee shall make a general assignment for the benefit of his creditors, or shall make a proposal under The Bankruptcy Act, or commence any proceedings to wind-up or liquidate or dissolve his business; ...
7. The Arena Corporation had mortgages upon its own property which were guaranteed by the Appellant and by Linda Davisson. The principal secured lender was Saskatchewan Economic Development Corporation ("SEDCO"). The amount of its loan was approximately $1,450,000 and was secured by a first mortgage on the arena property. Other loans owed by the Davissons at the time of the Proposal mentioned below dated July, 1991 ("Proposal") were approximately $376,000 to CIBC and $114,000 to HongKong Bank. The Restaurant Corporation guaranteed the amounts owing to CIBC as well as certain loans by Lloyds Bank Canada. The Restaurant Corporation, however, was not a guarantor of the SEDCO mortgage.
8. The Arena Corporation ran into considerable construction problems resulting mainly from cost overruns, false declarations by contractors and other factors. The Restaurant Corporation over the years 1988 to 1992 made payments totalling approximately $450,000 mainly to banks, creditors of the Arena Corporation and to the Arena Corporation in an effort to complete construction and bring the arena into operation. Revenue Canada was statute barred from assessing the Appellant in respect of all amounts advanced by the Restaurant Corporation with the exception of an amount of $84,573 described below. The financial difficulties of the Arena Corporation continued and finally SEDCO foreclosed on the arena property shortly before the Proposal.
9. The Restaurant Corporation did not receive any monies from the Appellant or from the Arena Corporation in respect of the said payments of $84,573. Further, there was no loan agreement between the Appellant or the Arena Corporation and the Restaurant Corporation, no interest was charged on the $84,573 and no arrangements for repayment were made.
10. From 1989 through 1991 considerable pressure was applied by various creditors demanding payment. By letter dated July 19, 1991 Deloitte & Touche, on behalf of the Davissons, advised the creditors of Davissons' Proposal to settle the claims of the said creditors. The said letter provided, inter alia, as follows:
Failure of this Proposal will mean that Mr. and Mrs. Davisson will be deemed to be bankrupt, precipitating termination of the McDonalds Franchise and the loss of the Davissons' sole source of employment income.
...
Mr. and Mrs. Davisson's Proposal provides for payment of the sum of $75,000 towards preferred and unsecured claims outstanding as at the date of the Proposal. Funding for this payment is to be made by way of a $75,000 payment to the Trustee by the Restaurant Corporation (from the proceeds of refinancing the Restaurant Corporation's debt).
...
Under the terms of the Proposal, preferred creditors' claims will be paid in full. Due to the size of the debt owing to Sedco, the Proposal requires that Sedco agree to file as an unsecured creditor, thereby waiving any rights they may have had to be classified as a preferred creditor. Therefore, the only anticipated preferred claim would be that of Revenue Canada Taxation of approximately $15,000. The balance of funds paid under the Proposal would be distributed on a prorata basis to all unsecured creditors (including Sedco). A draft dividend schedule is enclosed which provides an estimate of the amounts that would be payable to creditors under the proposal (based upon known claims at present).
Mr. and Mrs. Davisson have, for the most part, either incurred their debts in a joint capacity or guaranteed each other's debts. To simplify the administration of the Proposal (and to minimize costs), creditors are required to agree to merge or consolidate the individual debts of Mr. and Mrs. Davisson. In other words, the individual debts of Mr. and Mrs. Davisson will be treated as joint debts for purposes of administration of the Proposal. The Trustees's fees are based upon time expended by the Trustee and his staff, at their normal billing rates, and will be paid by the Davissons directly.
...
The Restaurant Corporation's major asset is the McDonalds franchise, which was acquired in 1983 for approximately $500,000. The Restaurant Corporation has pledged all of its assets in support of a line of credit from the CIBC for approximately $225,000. McDonalds actually owns the land and buildings that comprise the restaurant operations.
...
In addition, the Restaurant Corporation has guaranteed the Davissons' land loans with the CIBC (approximately $375,000).
...
In addition, the CIBC has agreed to settle the Restaurant Corporation's guarantee of the Davissons' land loan for approximately $35,000 (subject to acceptance of this Proposal and refinancing of the Restaurant Corporation's debt).
...
With respect to the 2nd mortgage to the HongKong Bank, it is the Davissons' view that there is a nominal amount of surplus available to the HongKong Bank after payout of the first mortgage, and, practically, this nominal surplus would not be realizable by the HongKong Bank in the event of realization (foreclosure). In the interests of providing a fair return to the HongKong Bank for its security value and to alleviate further disruption to the Davissons' personal lives, the Davissons have offered to pay the HongKong Bank $5,000 as a settlement to discharge the second mortgage. The HongKong Bank would also be entitled to claim as an Unsecured Creditor in the Proposal for the balance of their claim.
...
REFINANCING OF THE RESTAURANT/FUNDING THE PROPOSAL
Preliminary discussions have been held with a lender who is prepared to "consider" providing a loan to the Restaurant Corporation. The lender has indicated that they feel the maximum amount of debt which the restaurant corporation can service in today's economy is in the range of $325,000-350,000 (the Trustee agrees with this observation and feels that there is little hope of locating any potential lenders who would advance larger amounts). The lender has also indicated that funding of the new financing could be in place within 30 days to 60 days following formal approval of the Davissons' Proposal.
Proceeds from the refinancing of the Restaurant Corporation will be used as follows:
1) Payment to Trustee – Proposal $75,000
2) Payout CIBC restaurant secured loans 225,000
3) Settlement to CIBC on Restaurant
Corporation's guarantee of Twin
Arenas' loans 35,000
$335,000
11. The amounts required to meet the Proposal were provided by the Restaurant Corporation and various payments were made by the trustee under the proposal including $84,573 as follows:
HongKong Bank $30,000
CIBC 16,301
Kraus McKay 780
SEDCO 36,849
Other 643
$84,573
It is difficult to correlate these amounts with the figures in the Proposal but it is not disputed that these were the amounts actually paid by the trustee.
12. The passages read in from Mr. Karne's discovery were mainly to the effect that the Restaurant Corporation benefitted from the payments because the license was not pulled. They also disclose that Revenue Canada assessed under subsection 15(1) and 56(2) rather than under 15(2) dealing with loans to shareholders. The testimony of Mr. Heppner was mainly to the effect that the payments were either loans by the Restaurant Corporation or a business expense of the Restaurant Corporation.
Submissions of the Appellant
[4] Counsel for the Appellant submitted that the $84,573 did not represent a shareholder benefit nor an indirect payment but rather was either a loan or a business expense of the Restaurant Corporation or an amount expended to save the McDonald's license. Thus it was not includable in the Appellant's income. Moreover, subsection 56(2) seeks to avoid income splitting which is not in issue in this appeal.
Submissions of the Respondent
[5] The Respondent contends that since the $84,573 was expended by the Restaurant Corporation to pay creditors of either the Arena Corporation or the Davissons, thereby eliminating the Appellant's liability to those creditors, a shareholder benefit was conferred on the Appellant or there was an indirect benefit conferred.
Analysis and Decision
[6] The most relevant provisions of the Act are subsections 15(1) and 56(2) which, so far as material, provide as follows:
15(1) Benefit conferred on shareholder. – Where, in a taxation year, a benefit has been conferred on a shareholder, ... otherwise than by
...
the amount or value thereof shall, ... be included in computing the income of the shareholder for the year.
56(2) Indirect payments. – A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person ... shall be included in computing the taxpayer's income to the extent that it would be if the payment or transfer had been made to him.
[7] With respect to the submission of counsel for the Appellant that the $84,573 should be considered a loan either to the Appellant or to the Arena Corporation, I find that the evidence does not support this conclusion. There was no loan agreement and no agreement for repayment was established. Moreover, as to the Arena Corporation, it had ceased operations when the payments were made.
[8] With respect to Appellant's counsel's submission that the said amount should be characterized as a business expense of the Restaurant Corporation, once again I find that the evidence does not support this conclusion. Moreover, it is difficult to conclude that an amount allegedly paid to save the license of the restaurant could be considered as an ongoing business expense. In any event, even if it could be categorized as a business expense, the question still remains as to whether a benefit has been conferred on the Appellant or did an indirect payment exist.
[9] As to Appellant's counsel's submission, which seems to be his principal submission, that the amount was an expenditure that benefitted the Restaurant Corporation by saving its license, I have examined the authorities submitted by the Appellant and conclude that those authorities do not support that position, especially when one considers the authorities submitted by counsel for the Respondent discussed below.
[10] In Doyle v. R., [1997], 1 C.T.C. 2659 the legal costs paid by a company on behalf of certain shareholders was held to be a benefit to the shareholder concerned as that payment removed the liability of the taxpayer to pay the lawyer's bill and was taxable under subsection 15(1). Margeson J. stated as follows:
55 The payment by the Company, in accordance with the agreement reached, satisfied the legal liability of Alfred Doyle to pay the legal costs of the Appellants as between solicitor and client but it also removed the liability of the Appellants to pay their lawyers' bill which they otherwise would have been responsible for paying.
...
59 Even if the Court was to conclude that the Company or Alfred Doyle had also received a benefit that would not preclude the finding that the Appellants had received a benefit under the Act.
60 Counsel for the Appellants argued that the action taken had as its purpose the benefit of its shareholders and the Company. Even if the Court accepted that proposition that would not preclude a finding that the Appellants had also received a benefit as a result of the action.
...
63 The Tax Review Board concluded that: “The taxpayers did not receive any benefits per se from the fact that the companies paid the legal expenses”. This Court has difficulty in accepting that proposition and to the extent that the two cases cannot be distinguished this Court believes that the results reached in Kenora Miner et al., supra, and Harold E. Croteau, supra, should be followed.
[11] In Vine Estate v. R. [1990], 1 C.T.C. 18, Jerome, A.C.J. of the Federal Court held that certain amounts advanced by a corporation to another corporation, both of whom were controlled by the taxpayer, were income of the taxpayer as funds "appropriated for the benefit of the shareholder" under paragraph 15(1)(b) or payment made at the direction of the taxpayer as a benefit he desired to confer on another person within the meaning of subsection 56(2). Jerome, A.C.J. stated as follows:
23 Youngman v. The Queen, [1986] 2 C.T.C. 475, 86 D.T.C. 6584 (F.C.T.D.) involved a taxpayer who lived in a house built for him and his family by a company in which he was the controlling shareholder. The Court held that the taxpayer had received a taxable benefit from the company, the measure of which was the company's equity in the property, that is, the cost of acquiring the luxury home. Regarding paragraph 15(1)(c), on which the assessment was based, McNair, J. states, at 479 (D.T.C. 6587):
There is no definition of “benefit” or “advantage” in the Act and the words are thus capable of the broadest possible interpretation. Nor is there any simple, prescribed formula for resolving any question of shareholder benefit within the meaning of paragraph 15(1)(c). Essentially, each case must be decided on its own particular facts.
24 At 481 (D.T.C. 6589):
The words of paragraph 15(1)(c) of the Act are capable of the broadest interpretation and this applies perforce to the words “the amount or value thereof” as used therein. In fact, the word “amount” is substantially defined by subsection 248(1) to mean “money, rights or things expressed in terms of the amount of money or the value in terms of money of the right or thing”. Taken in context, the words amount and value appear to be used synonymously and interchangeably. According to standard dictionary usage, the word “value” standing alone is generally taken to mean the material or monetary worth of a thing or the fair equivalent thereof.
[12] With respect to retroactively considering the payment as a loan, Kempo, T.C.J. in Groeneveld v. M.N.R. [1990], 1 C.T.C. 2314 concurred with Respondent's counsel's following submission:
24. If not for the Respondent's auditors, the Appellant would have been free to take the $40,000.00 out of Dunbow as a loan repayment and escape any tax liability. “After the fact” (hearing transcript page 90) attempts by the Appellant's accountants to adjust the records to reflect a more favourable outcome, are of no help to the Appellant. The Court is not to determine the most favourable accounting treatment the Appellant could have used, but it must look to what treatment the Appellant in fact used. Similarly, the Appellant's accountants cannot, after the Respondent's auditors determine the Appellant failed to report income in his return of income, alter the records to reflect a more favourable treatment.
[13] In summary, the payment by the Restaurant Corporation of $84,573 to the trustee under the Proposal and the subsequent payment by the trustee to the creditors mentioned above conferred a benefit on the Appellant because as a result of the acceptance of the Proposal and that payment he was no longer liable to those creditors. It matters not that the Restaurant Corporation also benefitted by retaining its license. In my opinion, this is clearly a benefit to be included in income in accordance with subsection 15(1) of the Act. Further in my view it can also be characterized as an indirect payment for the benefit of the Appellant's wife or the Arena Corporation as contemplated in subsection 56(2) of the Act.
[14] Consequently the appeal is dismissed with costs.
Signed at Ottawa, Canada this 7th day of January 2000.
"T.P. O'Connor"
J.T.C.C.