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Docket: 2004-2943(IT)I |
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BETWEEN: |
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DAVID JOHNSON, |
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Appellant, |
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and |
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HER MAJESTY THE QUEEN, |
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Respondent. |
Appeal heard on February 3, 2004 at Ottawa, Ontario
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Before: The Honourable Justice Diane Campbell |
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Appearances: |
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Agent for the Appellant: |
Gordon J. Smith |
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Counsel for the Respondent: |
Marie-Eve Aubry |
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1999 taxation year is allowed, without costs, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the Appellant will be permitted to claim an allowable business investment loss in the amount of $13,350.00 in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 11th day of April 2005.
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"Diane Campbell" |
Campbell J.
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Citation: 2005TCC205 |
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Date: 20050411 |
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Docket: 2004-2943(IT)I |
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BETWEEN: |
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DAVID JOHNSON, |
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Appellant, |
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And |
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HER MAJESTY THE QUEEN, |
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Respondent. |
REASONS FOR JUDGMENT
CampbellJ.
Introduction:
[1]This appeal is in respect to the Appellant's 1999 taxation year. In his tax return for that year, the Appellant deducted an interest expense of $2,603.00 and an allowable business investment loss ("ABIL") of $13,350.00. The Minister reassessed the Appellant on March 31, 2003 disallowing the ABIL in the amount of $13,350.00 and disallowing the deduction of the interest expense in an amount of $2,560.00.
[2] The Minister confirmed the Appellant's reassessment for the 1999 taxation year based on the following assumptions of fact found at paragraph 19 of the Reply to the Notice of Appeal:
19. In confirming the Appellant for his taxation year 1999, the Minister assumed the following facts:
(a) the Corporation (the "Corporation" as defined in paragraph 4 of this Reply) was incorporated under the Business Corporations Act (Ontario) on March 11, 1988;
(b) the Appellant did not substantiate that he invested the amount of $17,800 in the Corporation;
(c) financial statements of the Corporation for the fiscal year ending February 28, 1999 list $28,472 in cash, total assets of $1,187,155, liquidities in an amount of $28,472, revenues of $181,739 and a net profit of $2,834;
(d) the cheques numbered 4 and 5 dated May 4, 1988 and June 9, 1988 respectively in the amounts of $4,590 and $4,080 made by the Appellant to the Corporation were applied to the Appellant's shareholder's loan account; and
(e) the Appellant did not substantiate that he incurred interest expenses in excess of an amount of $43 for the 1999 taxation year.
The assumption of facts outlined in paragraph c was first made by the Minister in confirming the reassessment. [Emphasis is mine]
Section B of the Reply, under the heading "Other Material Facts", went on to list the following at paragraphs 20, 21 and 22:
20. The Appellant has not proven that Corporation was a Small Business Corporation during the 1998 and 1999 taxation years.
21. The Appellant did not demonstrate that the Corporation was neither bankrupted nor insolvent during the 1999 taxation year.
22. The Appellant did not demonstrate that the Corporation permanently ceased to carry its activities during the 1999 taxation year.
[3] The issues to be decided and as listed in paragraph 23 of the Reply to the Notice of Appeal are as follows:
23. The issues to be decided are whether:
(a) the Corporation was a Small Business Corporation;
(b) the Appellant is entitled to a Business Investment Loss in the amount of $17,300 for his 1999 taxation year; and
(c) the Appellant is entitled to a deduction of interest expense of an amount of $2,560.
[4] As a preliminary matter, the Respondent advised me that the parties had agreed that paragraph 20, listed under "Other Material Facts", was no longer in issue and as a result paragraph 23(a) was no longer an issue. The two remaining issues as contained at paragraph 23(b) and (c) are therefore before me for decision.
The Appellant's Evidence:
[5] Edward Securities Inc. was incorporated on March 11, 1988 to carry on the business of development of limited partnerships, particularly with respect to Egyptian Arabian horses. These limited partnerships offered investors farm loss deductions. David Edwards was the owner of this company and he also owned six or eight other corporations. One of these corporations was Edwards Arabians which owned a farm property where the horses resided. In addition to its involvement with limited partnerships, Edward Securities Inc. also registered in 1988 with the Ontario Securities Commission to operate a full securities company. According to the Appellant's evidence, Mr. Edwards asked him to become a part owner of Edward Securities Inc. He subscribed for 153 Class A preferred shares and paid $15,300.00, as well as 25 Class A shares for which he paid $2,500.00, together with 51 common shares at $1.00 per share. He used personal lines of credit to purchase the shares. He stated that this money went into a shareholder loan account to be applied against the purchase of these shares because at the time he put the money into the company the share structure had to be first approved by the Ontario Securities Commission as part of the licensing of the company as a securities dealer. Edward Securities Inc. was required, by securities legislation, to maintain as a reserve at all times $25,000.00 in net free capital and $10,000.00 for a contingency bond. The corporation provided this $35,000.00 amount through the purchase by the Appellant of the 178 Class A preferred shares in the amount of $17,800.00 and 51 common shares in the amount of $51.00. The balance of the $35,000.00 was paid through share subscription by David Edwards.
[6] Eventually in 1996 and 1997, the CRA successfully challenged the farm loss deductions which were offered to investors through the limited partnerships and as a result that revenue source ceased. In 1999 David Edwards held an auction at the horse farm in Addison, Ontario where horses worth from $30,000.00 to $60,000.00 were sold for as little as $300.00. The farm property, which consisted of the farmhouse and two large barns, was repossessed by the Business Development Bank.
[7] As a result of the horse auction by Edwards, the Appellant stated that there was a great deal of "bad press in the newspapers" where Edwards was referred to as a horse thief, a crook and someone who was evading taxes. This type of publicity occurred in July 1999. According to the Appellant, Edwards Securities had no source of income respecting these limited partnerships and its only other source of income, the sale of mutual funds, also became non-existent. He stated that David Edwards' credibility was so severely affected by the media coverage that there were simply no more clients and without clients there were no sources of income for the company. David Edwards informed the Appellant that the company no longer existed. Edwards was eventually prohibited from ever having an investment license again within the Province of Ontario. The Appellant had his license suspended for a two-year period. The Appellant testified that the company basically ceased to exist in December 1999. He expected that the company would eventually be wound up. However the Appellant stated that David Edwards simply destroyed all the records and books of the company, without pursuing a formal dissolution, and walked away. Edwards went through personal bankruptcy around 2001 and listed all of his companies.
[8] There were no employees of Edward Securities at the end of 1999. A part-time bookkeeper who was trying to assist the few remaining clients in finding other investment companies, was employed until August 1999. Most of the investors of Edwards Securities owed money in respect to these limited partnerships, but because they had been challenged by the CRA, they were not paying their accounts to the company. Because of all the negative publicity surrounding the limited partnerships the mutual fund clients were leaving to go with other brokers. He explained that the receivables listed on the company's December 31, 1999 balance sheet had no value because they were in respect to the other companies owned by David Edwards and therefore they had no fair market value. In respect to all of the companies, in which Edwards was involved, the Appellant stated that they had no assets and no income. According to the Appellant, the only asset of Edwards Securities was "... the receivables from investors and there was no way investors were going to pay up on investments that had gone down the drain, basically." (Transcript, page 18.)
[9] On cross-examination, the Appellant stated that, according to the Ontario Securities Commission, the $35,000.00 reserve in Edwards Securities was to be maintained and not be used. However David Edwards did access some of this money in violation of the Securities Commission Regulations. Once the part-time bookkeeper was discharged in August 1999, very few entries were made on the corporate balance sheet for the period ending December 31, 1999 and therefore the books were not up to date. The "Due from Shareholders" entries were correct, he stated, but went on to explain that they were due from related companies of David Edwards which were insolvent. He also stated that any money coming into Edwards Securities was being paid out to help fund these other related companies. These amounts were all due on demand plus interest bearing but they were all due from the related companies owned by David Edwards. He also confirmed that he did request payment of the loans receivable in respect of the limited partnerships but those investors had walked away after the CRA challenge and there was no hope of collecting. He identified amounts on cross-examination that came into the company under the heading "Due from Affiliates" and re-routed to help the other related companies. He admitted that the company had some revenue but that the revenue in 1999 was used to pay legal fees and expenses.
Respondent's Position:
[10] The Respondent's position is that the Appellant is not entitled to an ABIL in the amount of $13,350.00 since he has not satisfied the conditions set out in subparagraph 50(1)(b)(iii) of the Income Tax Act (the "Act"). In addition the Appellant is not entitled to deduct the interest expense of $2,560.00.
[11] In respect to the claim for an ABIL, the Respondent placed the most emphasis on the first condition in subparagraph 50(1)(b)(iii). To support the contention that Edwards Securities at the relevant time was not in a state of insolvency, a number of arguments were relied upon which are dealt with in detail in my analysis.
[12] In respect to the last three conditions of subparagraph 50(1)(b)(iii), the Respondent argued that the Appellant had not presented sufficient evidence to satisfy these three conditions.
[13] With respect to the second issue, the deductibility of the interest expense, the Respondent again argued the lack of supporting documentation.
Analysis:
Issue #1:
[14] Is the Appellant entitled to an ABIL for the 1999 taxation year? With respect to the ABIL, the only remaining issue is whether or not the Appellant can meet the four criteria listed in subparagraph 50(1)(b)(iii) of the Act which states:
50. (1) For the purposes of this subdivision, where
...
(b) ...
(iii) at the end of the year,
(A) the corporation is insolvent,
(B) neither the corporation nor a corporation controlled by it carries on business,
(C) the fair market value of the share is nil, and
(D) it is reasonable to expect that the corporation will be dissolved or wound up and will not commence to carry on business
and the taxpayer elects in the taxpayer's return of income for the year to have this subsection apply in respect of the debt or the share, as the case may be, 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.
[15] The Reply to the Notice of Appeal does not contain assumptions of fact relating to the last three conditions found in subparagraph 50(1)(b)(iii) and except for the Crown's allegations, no facts would have been assumed respecting the first condition. While the file was in the Minister's hands, the only assumed fact with respect to the ABIL was that the investment of $17,800.00 was not substantiated. (See the Assumptions of Fact and other Material Fact reproduced at pages 2 and 3 of this judgment.)
[16] It therefore follows that the onus of proof, with respect to these four conditions in subparagraph 50(1)(b)(iii) should lie with the Respondent and not with the Appellant as it usually does in such appeals. In support of this, I refer to the case of Canada v. Loewen, [2004] F.C.A. 146 where Justice Sharlow, at paragraphs 10 and 11, summarizes the rule as follows:
[10] Nor is it open to the Crown to plead that the Minister made a certain assumption when making the assessment, if in fact that assumption was not made until later, for example, when the Minister confirmed the assessment following a notice of objection. The Crown may, however, plead that the Minister assumed, when confirming an assessment, something that was not assumed when the assessment was first made: Anchor Pointe Energy Ltd. v. Canada, 2003 DTC 5512 (F.C.A.).
[11] The constraints on the Minister that apply to the pleading of assumptions do not preclude the Crown from asserting, elsewhere in the reply, factual allegations and legal arguments that are not consistent with the basis of the assessment. If the Crown alleges a fact that is not among the facts assumed by the Minister, the onus of proof lies with the Crown. This is well explained in Schultz v. Canada, [1996] 1 F.C. 423 (C.A.) leave to appeal to the S.C.C. refused, [1996] S.C.C.A. No. 4.
[17] At paragraph 40 of Jacques St-Onge Inc. v. The Queen, 2003 DTC 153, Justice Archambault stated the following:
[40] However, this question was never raised either in the Respondent's pleadings or at the hearing. The facts set out in the Reply to the Notice of Appeal, which the Minister relied on in making his assessment, make no reference to Salvage's solvency status. No application was made to amend the Reply to the Notice of Appeal. The argument related only to the issue of whether it was reasonable to expect on April 30, 1994, that Salvage would be dissolved or wound up. According to the case law concerning the burden of proof, what a taxpayer must do is demolish the facts on which the Minister relied in making his assessment. If the Minister did not state a relevant fact in his Reply to the Notice of Appeal, it is difficult to criticize the taxpayer for not having demolished it. It would therefore be totally inappropriate to dismiss Management's appeal on the basis of its solvency.
This rational applies to my conclusions on the last three conditions of subparagraph 50(1)(b)(iii) and I could dispose of these three conditions on this basis alone. Even if I do not rely on the decision in the case of Jacques St-Onge Inc., I remain unconvinced by the Respondent's arguments on these last three conditions of subparagraph 50(1)(b)(iii)
[18] The Respondent's arguments, made in summation, regarding these last three conditions, are as follows:
As for the second condition found in section 50(1)(b)(iii), that neither the corporation or a corporation controlled by it carries on business -
Whether or not a business has ceased is a question of fact.
The evidence revealed that Edwards Securities, in December of 1999, as well as the Appellant and Mr. Edwards, the other shareholder, were still registered with the Securities Commission.
The Financial Statement of February of 1999, Exhibit R-1, indicated a net income of $2,839. As well, the Balance Sheet of December of 1999, Exhibit R-2, showed that the Accounts Payable had increased in the amount of $1,923 since February, this indicating a certain activity. Therefore, it is submitted that the Appellant had not demonstrated that Edwards Securities had ceased to carry on business.
As for the third condition, which is that the value of the share is nil, the Appellant did not present direct evidence on this point. However, the Financial Statement, Exhibit R-1, and the Balance Sheet, Exhibit R-2, do show that the shareholder equity did increase from February to December of 1999; therefore, on their face, those two documents establish that as of December of 1999, the value of the share was not nil.
As for the final condition, which is found at Section 50(1)(b)(iii), it is reasonable to expect that the Corporation will be dissolved or wound up and will not commence to carry on business.
There again the Appellant testified that he thought the Corporation would be dissolved or wound up at some point. He did not present any other evidence.
(Transcript, pages 90-91.)
[19] The short answer to the Respondent's arguments respecting these last three conditions at subparagraph 50(1)(b)(iii) is that at the end of the 1999 taxation year, Edwards Securities Inc. was simply worth nothing and had no prospect of commencing business operations anytime in the future. The evidence of the Appellant sets out the state of affairs of Edwards Securities in 1999. Because of the CRA challenge, limited partnerships in farm loss deductions could no longer be offered and as a result the horses had been auctioned off at sacrifice prices, the farmland and barns had been repossessed, Edwards' investment license was taken from him permanently and the Appellant had his license suspended for a period of two years. Because of the bad publicity and media coverage surrounding the horse auction, Edwards was construed as a thief and crook. With all credibility gone, investors in the mutual funds aspect of the company exited, as the Appellant put it, "in droves". With no clientele and no prospect of any, how could there by any value to this company or its shares or any prospect of it continuing or re-commencing business.
[20] From this evidence, and from the evidence as a whole, it is clear that at the end of the 1999 taxation year:
(a) The corporation was not carrying on business and the Respondent did not question whether "a corporation controlled by it carries on business" under clause 50(1)(b)(iii)(B);
(b) The fair market value of the corporation's shares were nil; and
(c) It was "reasonable to expect", with reference to both the subjective and objective test of reasonable (as dealt with by Justice Archambault at paragraphs 25-36 of Jacques St-Onge Inc.) that the corporation would be dissolved or wound up and would not commence to carry on business. In fact here the evidence supports that the corporation has not carried on business since 1999.
[21] With respect to these last three conditions of subparagraph 50(1)(b)(iii), I conclude that the Respondent has not met this burden respecting the ABIL. Even if the burden had not shifted and remained with the Appellant, I would have come to the same conclusion because I found the Appellant a credible and straightforward witness. I am therefore prepared to accept his version of the facts in response to the Respondent's arguments.
[22] I turn next to the first condition of subparagraph 50(1)(b)(iii), that is, was the corporation insolvent at the end of the 1999 taxation year, which is the condition where the Respondent placed the most emphasis and reliance.
[23] The Respondent initially addressed the definition of the term "insolvent". Although it is not defined in the Act, the Respondent stated that "... it is reasonable to expect that the usual meaning of "insolvency" - namely, the inability to pay liabilities as they come due - is the meaning that should be given to the word". (Transcript, page 86.) The first question which arises from the definition offered by the Respondent is whether this meaning of "insolvency" is the one to be used for the purpose of subparagraph 50(1)(b)(iii). According to several passages contained in the decision of Will-Kare Paving & Contracting Ltd. v. Canada, [2000] 1 S.C.R. 915, it is pertinent to first consider whether the word "insolvency" has an "established and accepted legal meaning (paragraph 33 of Will-Kare). According to the Supreme Court decision in Robinson v. Countrywide Factors Ltd., [1978] 1 S.C.R. 753, there should be both a "technical and a general sense" attached to the word "insolvency". Laskin C.J.C., dissenting in this decision, summarized the two as follows at page 760:
The view taken by the Privy Council and by this Court as to the meaning of "insolvency", as well after as before the abolition of Privy Council appeals, has been a uniform one. Lord Thankerton, speaking for the Privy Council in the Farmers' Creditors Arrangement Act reference, supra, at p. 402, expressed it as follows:
In a general sense, insolvency means inability to meet one's debts or obligations; in a technical sense, it means the condition or standard of inability to meet debts or obligations, upon the occurrence of which the statutory law enables a creditor to intervene with the assistance of a Court, to stop individual action by creditors and to secure administration of the debtor's assets in the general interest of creditors; the law also generally allows the debtor to apply for the same administration.
[24] Subparagraph 50(1)(b)(ii), which is located in this provision just prior to the relevant section I am dealing with here, states:
(ii) the corporation is a corporation referred to in section 6 of the Winding-up Act that is insolvent (within the meaning of that Act) and in respect of which a winding-up order under that Act has been made in the year, or ...
Section 3 of the Winding-up and Restructuring Act, R.S.C. 1985, c. w-11, as amended by 1992, c. 26, s. 19, deems a company insolvent in six different instances, one of which is "if it is unable to pay its debts as they become due" (paragraph 3(a)). This Act seems to extend the general meaning of "insolvency" by deeming, for example, acknowledgement by the company of its insolvency (para. 3(d)). Should this be applied in like fashion to subparagraph 50(1)(b)(iii)? I believe that since Parliament explicitly included a reference to this Act in subparagraph 50(1)(b)(ii) but not in subparagraph 50(1)(b)(iii), then Parliament clearly intended that the general definition of "insolvency" would apply in subparagraph 50(1)(b)(iii). Since the definition proposed by the Respondent is similar to the general definition found in the case of Robinson, I propose to use the Respondent's general definition in my analysis of the first condition of subparagraph 50(1)(b)(iii), that is, whether the corporation is insolvent at year end. I also base this on the fact that I would arrive at the same conclusion whether I relied on the general definition or the technical definition.
[25] The Respondent offered a number of arguments as to why the corporation was insolvent at the end of the 1999 taxation year. Firstly, the Respondent argued that the documents offered by the Appellant, the financial statement and the balance sheet, did not clearly establish that the corporation was insolvent. (Transcript, pages 85-86.) This summary by the Respondent of the Appellant's position respecting these documents is not entirely accurate. During his testimony, the Appellant made the following clarification regarding the corporation's balance sheet for the period ending December 31, 1999:
This came from the internal accounting records of the "New Views Accounting Programme" of Edwards Securities and although it says "Dec. 31, 1999", the bank was only reconciled up until August 31st. So very few entries actually were in there from August 31st to the end of December. (Transcript, page 38.)
In addition the other main shareholder of the corporation, David Edwards, destroyed all of the books and records of the corporation before he "walked away", according to the Appellant's testimony. This fact brings into question the reliability of the corporation's balance sheet in its totality. However, I accept the Appellant's evidence concerning those entries in the balance sheet where the Appellant could justify them. The corporation's part-time bookkeeper was employed only until August 1999 and at that time the Appellant stated very few entries were made subsequent to this. The Appellant here had to depend on the few records he could collect and his recollections respecting the financial position of the corporation during this period. Since I accept the Appellant's evidence as credible, I reject the Respondent's submissions in respect to these documents.
[26] Secondly, the Respondent argued that:
The Appellant testified that $25,000 of this amount could not be used, as it was a reserve requirement of the Securities Commission. In the Balance Sheet, Exhibit R-2, dated December 31, 1999, the amount appearing on that document was $10,922. The Appellant explained that it was his feeling that Mr. Edwards was probably the one that took the money out of the account. (Transcript, pages 86-87.)
[27] Although there was no direct evidence on this point, the implication was that this reserve was to be a constant if the corporation was to retain its license and good standing with the Ontario Securities Commission. When the balance sheet shows a reduction in the reserve at December 1999 then I conclude the reduction is attributable to Mr. Edwards' use of this money, as the Appellant alleged, even though he would have been prohibited from using it. I therefore do not believe that these amounts were available to pay liabilities as they became due. In addition, the Appellant testified that Edwards would have withdrawn the funds in issue for purposes other than those relating to corporate business. The Appellant's own testimony on cross-examination best describes the circumstances respecting the use of this money:
Q. ... The cash, now, is in the amount of $10,922.12; therefore, you will agree with me that there is less than $25,000?
A. Absolutely. He chewed up some of that. And that again is a violation of OSC Rules.
So, yes, that is correct, that figure.
Q. Therefore, on December 31, 1999, Edwards Securities was still registered with the Securities Commission?
A. It was still registered, but had not - the Filing was supposed to be for February 28th. The normal Filing would have been February 28, 2000. He thought he could put the money back - I'm assuming he thought he could put the money back before there was any violation. But --- (Transcript, page 40.)
[28] Based on the Appellant's evidence, which I accept as credible, the money was therefore not available to pay the corporation's liabilities as they became due and in any event it would be entirely insufficient.
[29] Thirdly, the Respondent's arguments in respect to the corporation's assets were as follows:
As for Accounts Receivable, in February of 1999 the amount was $16,971. The Appellant explained that this amount represented commissions that were owed to Edwards Securities. He acknowledged the fact that in December of 1999, as shown in Exhibit R-2, Edwards Securities did receive this payment. However, he could not explain what was done with this amount.
Another asset that figured on the Financial Statement consisted of the Loans Receivable, in the amount of $15,000.
The Appellant testified that these loans were made to investors. He acknowledged the fact that they were payable on demand. He also stated that he tried to collect the amounts, but could not produce any letters, and he did not take any actions against these investors.
As for the "Due from Affiliates", in February of 1999, as shown in Exhibit R-1, the amount of $4,479 was owed to Edwards Securities. The Appellant acknowledged the fact that he did receive payment, but once again could not say what was done with that money.
. . .
Finally, for the "Due from Shareholders", which was the biggest asset shown in Edwards Securities Financial Statement, in February of 1999 the amount was $1,094,283. The Appellant testified that this amount was owed by a corporation, 622291 Ontario Ltd. The Appellant did not ask 622291 Ontario Ltd. to repay this amount. Not even a small portion of it. He acknowledged the fact that this amount was payable on demand, as shown in Note 2 of the Financial Statement, Exhibit R-1.
Further, as shown by the Balance Sheet, Exhibit R-2, an amount of close to $90,000 was loaned to 622291 Ontario Ltd. between February of 1999 and December of 1999.
The Appellant testified that since 1998, Edwards Securities was troubled financially.
This fact is clearly not substantiated by the Balance Sheet and the Financial Statement, which showed that Edwards Securities, in this period, was able to find $90,000.00 to loan.
(Transcript, pages 87-89.)
[30] The Appellant stated that all or substantially all of the amounts receivable by the corporation were used to pay either the legal bills relating to the Securities Commission's investigation of the corporation or to assist other related companies controlled by Edwards. As for amounts that were identified as "accounts receivable" or "Due from Shareholders", according to the Appellant's evidence, they contained for the most part, amounts due from the other companies which Edwards controlled and which were insolvent. In fact, in response to the question on cross-examination: "Isn't it true that this 'Due from Shareholders loan' ... in the amount of over $1 million was payable on demand?" The Appellant responded:
It was due on demand and interest-bearing, which is clearly stated in the Notes. But they were all Companies owned by David Edwards.
So, he could demand the money from himself. Big Deal!
It's in the Notes, but it doesn't really mean anything.
(Transcript, page 47.)
His evidence was that some receivables had been sold on terms to investors and were therefore owed by investors in respect to the limited partnership projects but that there was no expectation that they would pay "... on investments that had gone down the drain, basically." (Transcript, page 18.) He testified that he requested repayment of these loans but the response was
A lot of laughter ... David Edwards handled pretty much all of that. But the investors weren't going to pay for something where they had lost all of their investment and all of their deductions."
(Transcript, page 50.)
[31] Fourthly, in respect to the corporation's equity, the Respondent argued as follows:
The Appellant also acknowledged the fact that between February of 1999 and December of 1999, the amount of re-paid earnings increased by $44,239. As a result, the Shareholder's Equity also increased between February of 1999 and December of 1999, from $495,644 to $540,883. (Transcript, page 88.)
[32] First, even if the equity could be applied to pay liabilities as they became due, there would still be more than $100,000.00 in the difference between the $682,000.00 in liabilities and the $540,883.00 in equity. Second, before the equity could be applied to the liabilities, there would need to be shareholder approval. Third, transforming one source of financing (equity) to another source of financing (liability) does not improve, in theory, the corporation's financial position. I therefore do not believe that the Respondent's fourth argument respecting the first condition of subparagraph 50(1)(b)(iii) is of much help in the facts of this case.
[33] The Respondent's final argument respecting clause 50(1)(b)(iii)(A) related to the corporation's liabilities and went as follows:
Finally, for the liabilities of Edwards Securities, Exhibit R-1, the Financial Statements and Exhibit R-2, the Balance Sheet, both show that a Note was payable, and the Appellant referred to a Subordinated Note of the amount of $682,000.
The Appellant testified that this Note was due to an affiliated corporation. The Appellant also testified that there were no actions pending to recover this amount. (Transcript, page 89.)
In addition the Respondent referred to the fact that between February 1999 and December 1999 according to these documents, the assets of the corporation had increased by $55,079.00 while the liabilities had only increased by approximately $10,000.00.
[34] During 1999, most of the money received by the corporation was not retained but was paid to David Edwards' related companies. It is logical to assume here that if further funds had been available to the corporation, the appropriate legal avenues would have been pursued against the corporation to recover the $682,000.00. Therefore at the end of 1999, this liability was still a heavy burden on the corporation's finances. Had this not been the case, it may have been possible to attribute a nil value to the corporate liabilities. In that case I may have been inclined to follow the reasoning expressed by the CRA in Technical Interpretation 9802347 (June 15, 1998) where it states:
... the word 'insolvent' should be given its ordinary meaning since the term is not defined in the Act. The dictionary defines 'insolvent' as follows: 'unable to pay its debts'. Accordingly it is our opinion that a corporation possessing neither assets nor liabilities at the end of the taxation year could not as a general rule be considered insolvent for the purposes of subparagraph 50(1)(b)(iii) of the Act.
[35] Again I would have come to the same conclusion respecting clause 50(1)(iii)(b)(A) even if the burden had not shifted to the Respondent because I found the Appellant's testimony credible.
[36] In summary, the Respondent has not met the burden respecting the four conditions of the Act set out in subparagraph 50(1)(b)(iii) and the Appellant is therefore entitled to the ABIL for the 1999 taxation year.
Issue 2:
[37] In respect to the deductibility of the interest expenses, the Respondent took issue with the lack of supporting documentation.
[38] The Appellant's evidence respecting these interest expenses was that he used lines of credit to provide the money to the corporation in 1988 to become a part owner. The money went into a shareholder loan account and was eventually used to purchase shares. The investments, some of which belonged to his wife, were in the vicinity of $80,000.00. After using lines of credit to finance this amount he rolled it into a mortgage against his residence. He testified that he was unable to obtain supporting banking information for the Canada Trust line of credit as the Toronto Dominion Bank had taken over this trust company and all records relating to the relevant period had been destroyed. Neither could he provide information on his Scotia line of credit because he was informed that there were no records, not even on microfiche, prior to 1990.
[39] Since some of the corporate investments belonged to his wife, when asked how he calculated the interest expense deduction for the CRA, he stated:
I forget what the breakdown is ... But the interest portion is my percentage of that $80,000."
(Transcript, page 24.)
[40] Although the Appellant was a credible witness, it is not sufficient, when there is no supporting documentation and the Appellant is simply unable to provide any satisfactory figures to support his claim, to be successful. The Appellant needed to prove that:
(1) he borrowed money for the "purpose of gaining or producing income from the business or property";
(2) he was charged interest on the loan; and
(3) he paid that interest.
[41] The Minister's position is summed up in the testimony of Robert Dupont, an auditor with the CRA, who stated in this regard:
Respondent counsel:
Q. Can you explain to the Court why you disallowed the interest expense?
Mr. Dupont:
A. The interest expense that Mr. Johnson claimed --- He didn't give me any documentation to show that the expense was incurred or that it had been incurred for investment purposes.
(Transcript, page 72.)
. . .
A. He had stated, also, that he had transferred that amount on to his mortgage and that he had bought a house in 1987.
. . .
What we would have liked to have seen would have been the mortgage documents from the Registry Office to show how much the mortgage was at that time and then how much he would have increased his line of credit; or how much he paid for the shares. But I didn't get any of that information.
Justice Campbell:
Q. Did you ask for that and it just wasn't provided?
A. Yes. It wasn't provided.
(Transcript, page 75.)
[42] After hearing the evidence of the Appellant and Mr. Dupont, I still have absolutely nothing concrete before me that would permit me to attempt a breakdown of the capital and interest charges. The Appellant did not supply the necessary documents to the auditor nor did he provide me with any explanation as to why a copy of his mortgage document from the Registry Office could not be obtained. He had to know it could be relevant as the auditor had requested it. The Appellant made no attempt to provide this basic information nor did he attempt to give me a reliable breakdown of the $80,000.00 as between he and his wife. He simply stated that he forgot what the breakdown was. The burden here is on the Appellant and he has simply provided nothing in the way of documentary evidence or corroboration from other witnesses. I consider it extremely detrimental to an Appellant's case when they cannot personally provide me with their own formulation of a breakdown that they supposedly used in support of their claim. In addition it would have been very easy for the Appellant to obtain a duplicate registered copy of his mortgage documentation. I therefore dismiss the Appellant's claim for a deduction of interest expenses.
[43] The appeal is therefore allowed, without costs, to the extent that the Appellant will be permitted to claim the ABIL in the amount of $13,350.00.
Signed at Ottawa, Canada, this 11th day of April 2005.
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"Diane Campbell" |
Campbell J.
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CITATION: |
2005TCC205 |
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COURT FILE NO.: |
2004-2943(IT)I |
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STYLE OF CAUSE: |
David Johnson and Her Majesty the Queen |
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PLACE OF HEARING: |
Ottawa, Ontario |
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DATE OF HEARING: |
February 3, 2005 |
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REASONS FOR JUDGMENT BY: |
The Honourable Justice Diane Campbell |
DATE OF JUDGMENT: April 11, 2005
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APPEARANCES: |
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Agent for the Appellant: |
Gordon J. Smith |
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Counsel for the Respondent: |
Marie-Eve Aubry |
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COUNSEL OF RECORD: |
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Counsel for the Appellant: |
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Name: |
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Firm: |
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For the Respondent: |
John H. Sims, Q.C. Deputy Attorney General of Canada Ottawa, Canada |