Taylor v. The Queen

Taylor v. The Queen Court (s) Database Tax Court of Canada Judgments Date 2003-08-06 Neutral citation 2003 TCC 550 File numbers 2002-37(IT)I Judges and Taxing Officers Alexander A. Sarchuk Subjects Income Tax Act Decision Content Docket: 2002-37(IT)I BETWEEN: DARRYL TAYLOR, Appellant, and HER MAJESTY THE QUEEN, Respondent. ____________________________________________________________________ Appeal heard on April 11, 2003, at Toronto, Ontario, By: The Honourable Justice A.A. Sarchuk Appearances: For the Appellant: The Appellant himself Counsel for the Respondent: John Grant ____________________________________________________________________ JUDGMENT The appeal from the assessment of tax made under the Income Tax Act for the 1999 taxation year is allowed and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the Appellant is entitled to claim an allowable business investment loss calculated on the basis that his business investment loss was $41,400. Signed at Ottawa, Canada, this 6th day of August, 2003. "A.A. Sarchuk" Citation: 2003TCC550 Date: 20030806 Docket: 2002-37(IT)I BETWEEN: DARRYL TAYLOR, Appellant, and HER MAJESTY THE QUEEN, Respondent. REASONS FOR JUDGMENT Sarchuk J. [1] This is an appeal by Darryl Taylor from an assessment of tax with respect to his 1999 taxation year by virtue of which the Minister of National Revenue (the Minister) denied the Appellant's claim for a business investment loss in the amount of $55,800 which would have resulted in an allowable business investment loss (ABIL) of $41,850. [2] The ABIL claimed by the Appellant pertained to an investment in IT Professional Magazine Inc. (IT Professional), a business which was incorporated on or about June 5, 1998. Its shareholders were Michael Bessey (55%), Louis Laskovski (25%) and the Appellant (20%). IT Professional ceased operations and became insolvent on or about March 31, 1999. In assessing the Appellant, the Minister does not dispute that IT Professional was a small business corporation and accepted that the amounts in issue were uncollectible as of March 1999. However, the Minister does contest the assertion that the debt was owed to the Appellant and that the loans were advanced by him for the purpose of earning or producing income from a business or property. [3] Because of the nature of the advances and the circumstances under which they were made, I propose to deal with them separately. (i) The Canada Trust loan: In or about September 1998, the Appellant borrowed $35,000 from Canada Trust which monies were advanced to IT Professional. In return, IT Professional provided the Appellant with a promissory note in the amount of $35,000 which stated among other things that it would repay the Appellant for interest "once IT Professional Magazine becomes a profitable entity". This promissory note also provided that "in the event that IT Professional Magazine ceased operations or fails to reach a state of profitability, Mr. Darryl Taylor shall be held solely responsible for the repayment of the loan and all interest accrued to the financial institution that provisioned the loan (Canada Trust)". Neither the promissory note nor the partnership agreement which forms part of Exhibit A-6 contained any reference to an interest rate payable on the principal amount advanced. (ii) The balance of the "business investment" amounting to $20,800 reflected several different payments described by the Appellant as follows: (a) The amount of $2,500 deposited on August 7, 1998 into the bank account of IT Professional represented a partial payment towards the $6,400 purchase price of his shares; (b) the amount of $5,500 was obtained from his father[1] of which $3,900 was used to pay the balance due for the purchase of the shares and the amount of $1,600 was "provisioned to the magazine".[2] (c) The amount of some $10,659.09 represented the total interest paid on the $35,000 Canada Trust loan.[3] [4] The evidence indicates, and the Appellant does not dispute, that all of the foregoing amounts, including the loans from his father, the Canada Trust loan and the interest thereon were paid by DQuest Technologies Inc., (DQuest) a company of which the Appellant is the president and sole director. The Appellant maintains that these funds were derived from salary owing to him by DQuest and in support referred to an undated letter from DQuest "to whom it may concern" signed by him as president which reads as follows: Let it be known that all monies paid by DQUEST TECHNOLOGIES INC. to Mr. Bevan Taylor, Canada Trust, IT Professional Magazine etc. were taken directly from Mr. Darryl Taylor from DQUEST TECHNOLOGIES INC. These tax paid funds were derived from salary owing to Mr. Darryl Taylor from DQUEST TECHNOLOGIES INC. The funds were reported on his 1999 tax return and the tax was paid on the income. The tax paid monies drawn by Mr. Darryl Taylor are reflected in DQUEST TECHNOLOGIES financial statement dated July 31, 1999 under the expenses category as Management Fees. This included checks (sic) written by DQUEST TECHNOLOGIES INC. on behalf of Mr. Darryl Taylor.[4] [5] The Appellant testified that he and his partners made diligent efforts to "obtain capital investment from outside investors, including financial institutions, as corporate loans. Also, the Business Development Bank of Canada was approached". They were unsuccessful and in order to keep the project going each of the three shareholders made loans to IT Professional. The Appellant made specific reference to the repayment schedule which would commence only after a "state of profitability had been established" and noted that "we, as shareholders, did not want the Magazine paying us back any loans until the Magazine was in a profitable position, and in a position where it could sustain paying us back the loans". Analysis [6] The Respondent's primary position is that there was no debt owing to the Appellant by IT Professional. This position is founded on the premise that the loan was in fact made by DQuest, the Appellant's corporate vehicle, and not the Appellant personally. The Respondent further contends that if there was a debt owing to the Appellant, the funds at issue were not invested in IT Professional for the purpose of gaining or producing income as required by the provisions of paragraph 39(1)(c) of the Income Tax Act. [7] I am unable to accept the position advanced by the Respondent. To do so would be to ignore the Canada Trust loan agreement, the renewal notices and an account information document, all of which clearly support the Appellant's position that the monies were borrowed by him personally. Furthermore, the loan agreement indicates that the money was deposited by Canada Trust directly into IT Professional's Royal Bank U.S. account.[5] Further support is provided for the Appellant's position by the promissory note from IT Professional dated September 21, 1998 previously referred to.[6] There is no evidence before the Court capable of supporting the Respondent's contention that these funds were advanced to IT Professional by the Appellant's company, DQuest. Whether the amounts subsequently paid by DQuest to Canada Trust and to the Appellant's father were what he described as "tax paid income" or whether in fact they represented a shareholder benefit is not in issue before this Court. [8] The Respondent further argues that the funds were not advanced to IT Professional for the purpose of earning or producing income from a business or property. Counsel referred to Wierbicki v. Canada[7]in support of the proposition that funds advanced to a corporation for the purpose of keeping it afloat do not constitute funds advanced for the purpose of earning or producing income from a business or property. I do not believe this decision assists the Respondent since in Wierbicki, the Court found, inter alia, that there was no evidence that the monies were advanced "with any intention or expectation of creating an indebtedness ... ". That is not the case in the present appeal. In this context, I make specific reference to the loan agreement with IT Professional which provides that: (i) All loans provisioned to IT Professional Magazine Inc. by either Shareholders or Private Investors shall be re-paid in full with interest according to the terms set fourth (sic) in the loan agreement schedule if an when the Corporation becomes a profitable entity; (ii) All loans conjointly signed by the Directors of IT Professional Magazine shall be the sole responsibility of the investor that provisions the loans to the Corporation; and (iii) The re-payment schedule of all loans provisioned to IT Professional Magazine Inc. shall commence the first fiscal quarter after a state of profitability has been established. Notwithstanding the fact that this could be described as a contingent lending arrangement, as suggested by the Respondent, it is clear that the Appellant's motivation for advancing the funds was to create a binding lending agreement with the expectation that the business would in due course generate profits. [9] In Byramv. Canada,[8] the issue was whether a taxpayer was entitled to claim an allowable capital loss pursuant to subparagraph 40(2)(g)(ii) of the Act for losses incurred on interest-free loans issued to a corporation for the purpose of earning dividend income. The Crown in that case argued that loans must produce an independent income stream for the taxpayer, through interest or fees, before any losses occasioned by such loans are deductible under subparagraph 40(2)(g)(ii) and that the potential dividend income from a subsidiary is too remote to support the deduction under that subparagraph.[9] McDonald J., speaking for the Court, made the following observations: [13] Subparagraph 20(1)(c)(i) allows for the deduction of interest where money is borrowed and then used for the purpose of earning income from business or property. In Bronfman, the Court held that the application of paragraph 20(1)(c) requires an examination and characterization of both the use of the borrowed money and the purpose behind such use. For a taxpayer to deduct interest under this section, the purpose of borrowing the money must have been to earn income and the borrowed money had to be directly used in an eligible manner to produce this income. [14] In contrast, subparagraph 40(2)(g)(ii) of the Act provides that any capital loss from the disposition of a debt is deemed to be nil, unless the debt was acquired for the purpose of gaining or producing income from a business or property. The relevant portions of this section read as follows: 40(2)(g) a taxpayer's loss, if any, from the disposition of property, to the extent that it is ... (ii) a loss from the disposition of a debt or other right to receive an amount, unless the debt or right, as the case may be, was acquired for the purpose of gaining or producing income from a business or property (other than exempt income) or as consideration for the disposition of capital property to a person with whom the taxpayer was dealing at arm's length, ... is nil. [15] Unlike paragraph 20(1)(c) this section only requires a single stage inquiry, namely what was the purpose for acquiring the debt. The two stage inquiry laid down in Bronfman clearly indicates that there is a distinction between use and purpose. Therefore, while there are some similarities in the general language of paragraph 20(1)(c) and subparagraph 40(2)(g)(ii), it is significant that section 40 does not contain a "source" directed preamble nor does it refer to use as well as purpose. Accordingly, it would be wholly inappropriate to apply the direct/indirect use limitation imposed in Bronfman to this section. [16] The language of section 40 is clear. The issue is not the use of the debt, but rather the purpose for which it was acquired. While subparagraph 40(2)(g)(ii) requires a linkage between the taxpayer (i.e. the lender) and the income, there is no need for the income to flow directly to the taxpayer from the loan. [17] Such an approach is also consistent with commercial reality. Frequently, shareholders make such loans on an interest-free basis anticipating dividends to flow from the activities financed by the loan. To adopt the position of the Minister would require that this Court ignore this reality. It would also be contrary to the comments of the Supreme Court of Canada in Stubart Industries Ltd. v. The Queen. Commercial reality is to be considered by the Courts in interpreting tax provisions like subparagraph 40(2)(g)(ii) so long as it is consistent with the text and purpose of the provision. [18] The ultimate purpose of a parent company or a significant shareholder providing a loan to a corporation is, without question, to facilitate the performance of that corporation thereby increasing the potential dividends issued by the company. This purpose is clearly within the scope of both the text and the purpose of subparagraph 40(2)(g)(ii), a section which is directed towards preventing taxpayers from deducting losses that are not incurred for the purpose of earning income from a business or property. [19] There is a growing body of jurisprudence that considers current corporate reality as being sufficient to demonstrate that the expectation of dividend income justifies a capital loss deduction under subparagraph 40(2)(g)(ii). As articulated above, this approach is consistent with current corporate realities and the purpose of subparagraph 40(2)(g)(ii). [10] The argument advanced on behalf of the Respondent suggests that the deduction of an ABIL should be disallowed on the basis that the funds were invested for a purpose other than to generate income. This argument is not supportable. It is true that the loan was advanced to a start-up operation that had not begun generating profits but this does not by itself mean that the business will not be successful. It is clear that the funds were loaned to the corporation by the Appellant for the benefit of the business with a realistic expectation of recouping the principal with interest.[10] In my view, that is sufficient to constitute a lending arrangement for the purpose of sections 39 and 50 of the Act. [11] I should specifically note that the amount of $10,659.09 representing interest on the Canada Trust loan does not form part of the debt owing to the Appellant by IT Professional and accordingly cannot be included as part of his business investment loss for that taxation year. The balance in the amount of $1,600 which, according to the Appellant, "was provisioned to the Magazine" has not been established to be a debt owing to the Appellant by IT Professional. [12] The evidence adduced by the Appellant establishes that the amount of $6,400 reflected the purchase price of his shares in IT Professional and that the amount of $35,000 constitutes a debt owing to him by IT Professional for the purposes of paragraph 39(1)(c) of the Act. Both amounts are, in my view, this taxpayer's business investment loss for taxation year 1999 and, therefore, he is entitled to an allowable business investment loss calculated on that basis. Signed at Ottawa, Canada, this 6th day of August, 2003. "A.A. Sarchuk" CITATION: 2003TCC550 COURT FILE NO.: 2002-37(IT)I STYLE OF CAUSE: Darryl Taylor and Her Majesty the Queen PLACE OF HEARING Toronto, Ontario DATE OF HEARING April 11, 2003 REASONS FOR JUDGMENT BY: The Honourable Justice A.A. Sarchuk DATE OF JUDGMENT August 6, 2003 APPEARANCES: For the Appellant: The Appellant himself Counsel for the Respondent: John Grant COUNSEL OF RECORD: For the Appellant: Name: N/A Firm: N/A For the Respondent: Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada [1] A "repayment schedule" filed by the Appellant (Exhibit A-4) indicates that the amount ultimately paid by DQuest to his father was $5,750. [2] Although the Appellant's testimony was unclear, I took him to mean that the money was paid into IT Professional's account. There was no indication as to the purpose underlying the provision of these funds. [3] It should be noted that these three amounts being $2,500, $5,500 and $10,659.09 do not add up to $20,800. [4] Exhibit A-3. This document was first provided to the Respondent several days prior to the commencement of the trial and given the language used therein raises a question regarding the date of its origin. [5] Exhibits A-7, A-8 and A-9. [6] Exhibit A-6, page 2. [7] 1996 T.C.J. No. 1303. [8] 99 DTC 5117 (F.C.A.). [9] The Crown relied on The Queen v. Bronfman, 87 DTC 5050 (S.C.C.) and Canada Safeway Ltd. v. M.N.R., 57 DTC 1239 (S.C.C.). [10] See Exhibit A-6, paragraph 1.