Tax Court of Canada Judgments

Date: 20010326

Docket: 98-95-IT-I; 98-96-IT-I; 98-139-IT-G

BETWEEN:

MARK KLUCZNYK, ALICIA KLUCZNYK, STANLEY KLUCZNYK,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Hamlyn, J.T.C.C.

[1]            The appeals are from assessments of tax by Stanley Klucznyk with respect to his 1993, 1994 and 1995 taxation years, by Alicia Klucznyk with respect to her 1993, 1994 and 1996 taxation years and by Mark Klucznyk with respect to his 1993 taxation year. They will be collectively called the "Appellants".

[2]            The following were set forth in each Appellant's Amended Notice of Appeal:

1.              The amounts claimed as a loss were a result of an investment in shares of a Canadian controlled private corporation defined under the Act as a small business corporation

2.              The investment in shares was an arm's length transaction.

3.              The investment in the said shares became a business investment loss when the small business corporation became insolvent and ceased to carry on business.

4.              The original investment was $750,000.

5.              The amount of the business investment loss is $458,000, which is a permitted deduction under the ABIL provision of the Income Tax Act.

[3]            In computing their income for the taxation years in issue, the Appellants claimed the following deductions:

APPELLANT	TAXATION YEAR	DEDUCTION	AMOUNT DEDUCTED
Stanley	1993	Allowable business investment loss	$184,639.50
	1994	Non-capital loss carried forward from 1993	$ 87,515.59
	1995	Non-capital loss carried forward from 1993	$ 6,797.00
Alicia	1993	Allowable business investment loss	$ 18,000.00
	1994	Allowable business investment loss	$ 30,000.00
	1995	N/A
	1996	Non-capital loss of other years	$ 10,000.00
Mark	1993	Business investment loss	$ 92,319.75

[3]            In reassessing each Appellant, the Minister disallowed the deductions.

[4]            The Minister in his Reply for each Appellant set forth the following pertinent assumptions:

(a)            the Appellant (Stanley Klucznyk), his mother, Alicia Klucznyk, and his son, Mark Klucznyk (collectively the "Klucznyks"), loaned $750,000.00 (the "Loan") to Woodmere Court Investments Inc. (the "Corporation");

(b)            the Loan was not used to enable the Appellant to purchase shares of the capital stock of the Corporation;

(c)            in filing their income tax returns the Klucznyks allocated 25% of the Loan to each of Alicia Klucznyk and Mark Klucznyk, and 50% of the Loan to the Appellant;

(d)            the Loan was made by way of a promissory note dated March 22, 1985, with an interest rate of 2% per month;

(e)            funds for the Loan were obtained by a $300,000.00 mortgage in favour of the Ukrainian Toronto Credit Union, and a $500,000.00 demand loan from the Toronto Dominion Bank;

(f)             in 1989 the Klucznyks received not less than $292,000.00 from the Corporation as repayment of a portion of the Loan;

(g)            at all relevant times the Loan constituted the Corporation's only asset;

(h)            at all relevant times none of the fair market value of the assets of the Corporation was attributable to assets that were:

                (i) used primarily in an active business carried on primarily in Canada by the Corporation or by a corporation related to it;

                (ii) shares of the capital stock or indebtedness of one or more small business corporations that were at that time connected to the Corporation; or

                (iii) assets described in subparagraphs (i) and (ii) above;

(i)             throughout the relevant periods the Corporation was not a small business corporation, for the purposes of the Income Tax Act, R.S.C. 1985, c. 1(5th Supp.), as amended.

THE EVIDENCE

[5]            Two witnesses were called by the Appellants: John Kotowski, one of the shareholders and operating officers of Woodmere Court Investments Inc. (Woodmere), and the Appellant Alicia Klucznyk.

THE EVIDENCE OF JOHN KOTOWSKI

[6]            In 1985, John Kotowski told the Appellant Mrs. Klucznyk that Woodmere wanted to acquire El-Beth Enterprises Limited and Refined Alloys Limited carrying on business in partnership under the name of Aluminum Reduction Company (ARCO). At that time ARCO was in or on the brink of receivership. Mr. Kotowski told Mrs. Klucznyk that he, on behalf of Woodmere, was looking for funds ($750,000). In response, Mrs. Klucznyk apparently said to Mr. Kotowski 'why not me'. Mrs. Klucznyk thereafter advanced funds and all the shares behind ARCO were purchased by Woodmere. The shares were registered in the name of Woodmere. Woodmere was a holding company of the Kotowski family. No arrangements were made to transfer any of the shares to the Appellants, however, Mr. Kotowski stated that a portion of the shares were held by Woodmere for the Appellants.

[7]            At the beginning ARCO was managed by Mr. Kotowski. Shortly thereafter, to keep the business going, ARCO borrowed several million dollars from a Mr. Miller. Mr. Miller provided the funds through a corporation known at that time as Sarsvati Inc. As security for this loan from Mr. Miller, Woodmere agreed to pledge all of the issued corporate shares behind ARCO to Sarsvati Inc. Eventually Mr. Miller, after a series of events, took over from Mr. Kotowski the management and control of ARCO. In 1990 ARCO went into receivership and went out of business.

THE EXHIBITS

[8]            At the time of the acquisition of the corporate shares behind ARCO in March and April 1985 several documents were created and issued.

[9]            Exhibit A-1, Tab 6 is a partial funds payment acknowledgement (dated March 22, 1985) signed by the solicitor for ARCO and directed to Mrs. Klucznyk. It refers to the purchase and sale of shares without specificity. It states the transfer of the shares had been signed and that the solicitor would hold the shares in escrow pending the receipt of the funds due and payable.

[10]          Exhibit A-1, Tab 7 is an acknowledgement (dated March 23, 1985) from Mrs. Klucznyk to the solicitor for ARCO that funds had been paid in trust to the solicitor for ARCO for the purpose of purchasing shares of ARCO. It also indicates that $50,000 of the funds are non-refundable if there is a default in the completion of the transaction. Further, it states that Woodmere and Mr. Kotowski are acting on behalf of Mrs. Klucznyk and that Mrs. Klucznyk is responsible for the completion of the transaction by Woodmere.

[11]          Exhibit R-1, Tab 1 is a promissory note (March 22, 1985) in the amount of $750,000 executed by Woodmere to Mrs. Klucznyk. The interest rate was to be 2% per month and a payment schedule was set out.¹

[12]          Exhibit R-1, Tab 2 is an agreement (March 22, 1985) executed by Woodmere to Mrs. Klucznyk granting an exclusive option to purchase the corporate shares behind ARCO exercisable at any time prior to the date that Woodmere repaid the loan of $750,000.[1]

[13]          Exhibit A-1, Tab 8 is an acknowledgement (April 3, 1985) from Woodmere and Mrs. Klucznyk to the solicitor for ARCO. Mr. Kotowski signed on behalf of both Woodmere and Mrs. Klucznyk. The acknowledgement states that the transaction with respect to the sale and purchase of shares by Woodmere had been completed and that no solicitor had the authority to act on behalf of Woodmere and Mrs. Klucznyk, and that Woodmere and Mrs. Klucznyk wanted to close without any solicitor acting on their behalf.

[14]          Other exhibit documents that were referred to in the course of the evidence related to matters occurring some four years after the original sale and purchase of the shares of ARCO.

[15]          Exhibit R-1, Tab 5 is an Affidavit of John Kotowski (July 27, 1989) filed in an action[2] in the Supreme Court of Ontario between Woodmere and El-Beth et al. wherein the deponent speaks to the issue of who owns ARCO. Therein Mr. Kotowski states that Woodmere is the registered holder of all the issued and outstanding shares of El-Beth and Refined Alloys and that Woodmere beneficially owns all the issued and outstanding shares of El-Beth and Refined Alloys and that Woodmere has the right to vote or cause to be voted all of the shares of El-Beth and Refined Alloys.

[16]          Exhibit R-1, Tab 6 are Minutes of Settlement[3] (July 30, 1989) in the above-noted action. The Minutes of Settlement make reference to the debt of Woodmere to Mrs. Klucznyk. The Minutes of Settlement state the claims of Alicia Klucznyk are warranted by Woodmere as "valid indebtedness" and that on the original capital advanced by Mrs. Klucznyk in the amount of $750,000 there was an anticipated settlement with Mrs. Klucznyk in the amount of $500,000 on account of the interest due and payable on the principal sum. Mr. Kotowski executed the Minutes of Settlement on behalf of Woodmere.

THE EVIDENCE OF MRS. KLUCZNYK

[17]          Mrs. Klucznyk's viva voce evidence was that she advanced the money to ARCO's solicitor (Exhibit A-1, Tab 6) and executed the undertaking to do so (Exhibit A-1, Tab 7) as part of the purchase and sale of the shares behind ARCO. She also stated she was to be a shareholder of ARCO. Mrs. Klucznyk, however, could not say if and when she acquired the shares but at the time of the advancing of the monies she asked and received the promissory note (Exhibit R-1, tab 1) and a share option purchase agreement (Exhibit R-1, tab 2) from Woodmere. Mrs. Klucznyk's position was precise. She wanted security. She said while she trusted Mr. Kotowski, she said she was 'never sure'. Eventually Mrs. Klucznyk sued to recover on the promissory note given to her by Woodmere because in her view Mr. Kotowski caused her money to be lost. In an apparent settlement of the law suit, Mrs. Klucznyk received $292,000.

ANALYSIS

[18]          The evidence of Mrs. Klucznyk was that notwithstanding the promissory note and the share option agreement, she was purchasing a proportionate share of the shares of ARCO.

[19]          Little evidence beyond this supports the Appellants' position that the Appellants purchased shares of ARCO. Indeed, most of the evidence leads to a contrary conclusion.

[20]          The evidence of Mr. Kotowski, in respect of the ARCO share ownership, is in conflict on several points with the documentary evidence, and this conflict is not explained away by Mr. Kotowski's bare assertion that he did not want to reveal to anyone the ownership of the ARCO shares. His evidence is particularly troubling when he (Mr. Kotowski), under oath in the Affidavit (Exhibit R-1, tab 5), swears that Woodmere is the beneficial owner of all the issued and outstanding shares of El-Beth and Refined Alloy and that the shares are free of all encumbrances.

[21]          Further, there is no sustainable evidence that the reference to a share purchase (Exhibit A-1, tab 6) to Mrs. Klucznyk was ever completed. Indeed, the evidence is to the contrary.

[22]          In summary, the promissory note for $750,000 to Mrs. Klucznyk, the option agreement giving Mrs. Klucznyk the right to buy shares (Exhibit R-1, tab 2), and the Minutes of Settlement wherein Woodmere warrants and represents that Mrs. Klucznyk was owed $500,000 against the principal sum of $750,000 (Exhibit R-1, tab 6), all point to the conclusion there was a loan of $750,000 by Mrs. Klucznyk to Woodmere, secured by a promissory note and a share purchase option agreement. I conclude from the totality of the evidence that the Appellants did not acquire any interest in the shares of the corporations behind ARCO.

[23]          The provisions of the Income Tax Act provide that a business investment loss (paragraph 39(1)(c)) is a special type of capital loss resulting from the disposition of shares or a debt of a "small business corporation". A business investment loss can be incurred when there is a deemed disposition for nil proceeds (i.e. this can occur where the corporation is bankrupt or insolvent or when the debt is considered to be uncollectible)(subsection 50(1)). A small business corporation (subsection 248(1)) is defined as a Canadian-controlled corporation of which all or substantially all of the fair market value of its assets are used in an active business carried on primarily in Canada. Shares or debt of a connected corporation may be considered in the determination. Subsection 125(7) provides that active business carried on by a corporation means any business carried on by the corporation other than a specified investment business or a personal services business and includes an adventure or concern in the nature of trade. A specified investment business carried on by a corporation means in part the principal purpose of which is to derive income from property including interest, dividends or royalties.

[24]          The issue that remains is whether the Appellants met the onus of demolishing the assumptions set out herein and relied upon by the Minister in making the assessments. In this case the Minister's stated assumptions about Woodmere as a corporate entity, i.e. not a small business corporation, and the use of the corporate assets, i.e. the fair market value of the corporate assets not used in active business carried on primarily in Canada, have not been addressed. Indeed, the Appellants did not present any evidence to show that the loan, which is the subject of the Minister's assumptions, was a business investment loss within the meaning of the Act.

[25]          The appeals are dismissed. There will be no order as to costs as two of the appeals heard together with the General Procedure appeal were heard under the Informal Procedure.

Signed at Ottawa, Canada, this 26th day of March 2001.

"D. Hamlyn"

J.T.C.C.

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