I.B. Pedersen Ltd. v. The Queen, 94 DTC 1085, [1994] 1 CTC 2355 (TCC)

Rip, J.T.C.C.:—LB. Pedersen Ltd. ("corporation") appeals from an assessment with respect to its 1988 taxation year in which the Minister of National Revenue, Taxation ("Minister"), disallowed a reserve in the amount of $152,794.14 claimed as a deduction in computing its income under paragraph 20(1 )(m) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), or alternatively under section 9 of that statute. The appellant also appeals the assessment on the grounds that it ought not to have included in its income for 1988 the sum of $64,670.11 claimed as a reserve in 1987, which the Minister did not disallow.

The corporation was incorporated under the laws of Ontario in 1978. At all relevant times it operated a waste landfill site located near Uxbridge, Ontario. The shareholders of the corporation are 1.8. Pedersen ("Pedersen") and his wife Earla Pedersen. The landfill site was operated originally by Mrs. Pedersen's father until 1968 when Mr. and Mrs. Pedersen purchased the site. They continued to operate the business until 1978 when the site and the business were transferred to the corporation.

The appellant carried on its business under a certificate issued by the Ministry of the Environment of Ontario. Essentially the appellant’s landfill site is an excavation pit into which municipal waste or garbage was dumped. During each day the company bulldozed the waste received that day into the pit and then covered it with a layer of clean fill. The appellant would continue to monitor the site on a regular basis to ensure that there were no possible adverse environmental results caused by the buried waste such as seepage of contaminated liquid run off, called leachate, release of harmful gases caused by the decomposition of stored waste, the escalation of nuisance factors like vermin, blowing waste and odours.

The Regional Municipality of Durham ("municipality") was the appellant's largest customer in 1988, representing more than 90 per cent of its business. The municipality dumped all of its garbage on the land site pursuant to a written contract between it and the appellant. The contract in force during 1988 was dated July 15 of that year. Pursuant to clause 2 of the contract, the municipality used the landfill site "for the purpose of receiving, dumping and disposing of waste on a monthly basis". The consideration paid by the municipality was $16,281.83 per month.

Clause 6 of the contract provided that:

The contractor shall at his own expense obtain all licences and permits that may be required for or in connection with the use of the said facilities for the purposes aforesaid.

The licence referred to was an operating licence in the form of a certificate of approval from the Ministry of the Environment. Section 5 of the appellant's certificate of approval, dated September 4, 1985, provided that:

A detailed plan of closure shall be submitted to the Director, Central Region, Ministry of the Environment by September 30, 1986. If a closure plan is not submitted, or if it is not to the satisfaction of the Director, the Ministry of the Environment will impose one.

It was anticipated that the operators of landfills would provide a closure plan to the Ministry which would provide for the work to be performed by the operator during the time the landfill was no longer accepting waste. Apparently landfill sites have at least two phases, an active phase and a closed phase. During the active phase waste is received and revenue is earned. During the closed phase no waste is received and no revenue is earned, although expenses are being incurred.

By 1985 Pedersen thought the landfill site was reaching capacity and had "only two to three years left" of active operation. He stated that the company ceased operating the landfill site in 1991 as a result of losing its contract with the municipality which found a less costly landfill. There was evidence that the appellant sought an increase in fees in part to cover anticipated expenses during the closed phase. Pedersen testified that from time to time he subsequently has allowed individuals to dump on the site for a fee. Accordingly, the appellant has since 1991 received very little income from carrying on a business on the site or any other site.

Mr. Jim Hiraishi, P. Eng. ("Hiraishi"), an expert in waste site management, had been retained by the appellant to prepare a site closure plan for 1993 and to assist it to determine the amount of financial assistance it would be required to provide to the Ministry of the Environment. In 1988 Hiraishi had assisted in preparing a report for the appellant estimating costs for landfill site closure and long-term maintenance. According to Hiraishi, a closure plan generally provides for (a) on-going monitoring of service water, ground water and gas migration; (b) inspection of landfill cover for differential settlement, sideslope erosion, leachate seeps and implementation of remedial works as necessary; (c) maintaining drainage system, including clearing of debris and regrading; (d) inspection and repairs of fences and roads as required; (e) maintaining the site in an orderly and visually pleasing manner; and (f) submission of annual reports on site inspection and results of monitoring and maintenance programs to the Ministry of the Environment.

The contract between the corporation and the municipality also provided that the corporation secure a public liability insurance during the term of the contract in order to indemnify and save harmless

the region from all suits and action for damages and costs to which it may be put by reason of injury to persons or property resulting from negligence, carelessness, or any other cause whatsoever in the performance of the work, in guarding same, or from any improper material used in the construction. . . .

During 1987 and 1988 the Ministry was considering measures to ensure that there would be adequate funds for site closure costs, post-closure maintenance and compensation, including financial assurance from land site operations. However there was no legislation in force during those years and the appellant was not required by statute or by regulation to provide any form of financial assurance to the Ministry.

It was common knowledge in the industry that at some point in time the Ministry would insist upon certain guarantees to be provided by landfill operators. Hiraishi wrote to the appellant on May 12, 1988 advising that the certificate under which it was operating at the time did not specify any closure requirements but instead relied "on a submission of a closure plan to be approved by the Ministry". He added that the plan would identify the activities necessary to effect closure including considerations for grading, revegetation and long-term monitoring and maintenance. He stated that "there will likely be a requirement for contingency plans in case remedial works are required subsequent to closure". In his letter he anticipated conditions that may impact on closure costs: standard insurance such as general liability, and fire, coverage for pollution liability, performance bond, a small claims funds, and a post-closure fund to be administered by the Ministry to cover costs for long-term monitoring and maintenance of the site. Hiraishi also foresaw additional costs for long-term monitoring and maintenance of the site itself and suggested "budgeting about $25,000 a year for the foreseeable future".

Hiraishi anticipated that the rules would provide that the site, once closed, would remain the responsibility of the operator for a period of years determined by the Ministry, which he understood would be 25 years.

However Hiraishi testified that although the appellant was negotiating a closure plan with the Ministry in 1988 no closure plan had been submitted and the appellant had not been required to provide any form of financial assurance to the Ministry. Hiraishi stated the appellant and the Ministry had been discussing a closure plan for eight years and only recently had the appellant submitted such a plan. Even at time of trial no financial assurance plan had been provided; apparently such a plan is awaiting the decision of this appeal.

The appellant claims that its customers, in particular the municipality, knew that a significant portion of fees was to be used to provide for the safe keeping of the waste in the closed phase even though this was not explicitly set out in the contract. In other words, in the appellant’s view there is an implied but legal obligation in the contract for it to properly maintain and monitor the site for years after garbage is dumped in the landfill. The appellant disagrees with the disallowance of the reserve in its 1988 taxation year because it maintains that the amount claimed represents a reasonable reserve in respect of services that it will be required to perform, specifically by law and implicitly by contract, in the future in respect of maintaining the integrity of the site.

In the mid-1980s the appellant was aware its landfill site eventually would have to be closed and it was likely costs would be incurred during the closed phase. The appellant deducted amounts in computing its income as a reserve in respect of services it would be required to perform during the closed phase. Pedersen testified that the appellant’s reserve was calculated on the basis of the estimated cost to be incurred in closing the site and maintaining it after closure. The amount was equal to "what we could afford", that is, "what we had in the bank and what we didn't require for operating expenses”. The appellant deducted as much as it could in calculating the reserve, said Pedersen. He explained that if, for example, the appellant had $100,000 in the bank and required $25,000 for current operations it would claim $75,000 as a reserve. Pedersen testified that when he started hearing about Ministry Guidelines and other publicity he felt "we had a lot of catching up to do" and thought it best "to take as much as possible [as a reserve] because we needed it". Once the landfill site was closed, there would be no income and potential expenses.

The amounts claimed as a reserve were placed in short-term investments “since we never knew when we would need the money".

Positions of parties

The appellant disputes the assessment for 1988 on the basis it was inconsistent with the assessment for 1987, when a reserve was not disallowed. The appellant also objects to the inclusion in income for 1988 of the amount of $64,670.11, deducted as a reserve in 1987. The appellant says that if the Minister is correct and the amount claimed in 1988 is not a reserve allowed under paragraph 20(1)(m) of the Act, then the similar claim in 1987 was not a reserve either. Thus no amount ought to have been deducted under paragraph 20(1)(m) in computing the appellant’s income for 1987 and no amount is to be included in computing the appellant’s income for 1988 pursuant to paragraph 12(1)(e).

The appellant also claims, in the alternative, that the amount claimed in the reserve in the 1988 taxation year represents a fixed and ascertainable liability and is deductible in accordance with section 9 of the Act.

The Minister disallowed the amount claimed as a reserve in 1988 on the basis that the amount did not qualify as such under paragraph 20(1)(m) because the amounts were received by the appellant in 1988 in the course of its business that was on account of services rendered before the end of the year: paragraph 12(1 )(a). No amount was included in the appellant’s income from its business for 1988 in respect of services that it was reasonably anticipated would have to be rendered after 1988. Further, the deduction was prohibited by paragraphs 18(1)(a) and (e) as it was not an outlay expense made or incurred in the 1988 taxation year and, in any event, was a contingent liability. The appellant was not liable in 1988 to incur the expense claimed as a reserve notwithstanding it may become liable in future years.

The Minister also is of the view that the amount claimed as a reserve and deducted in computing the appellant’s income in 1987 is to be included in income for 1988 pursuant to section 9 and paragraph 12(1)(e) of the Act.

Statutory provisions

Paragraphs 12(1 )(a) and (e) read as follows:

12 (1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:

(a) any amount received by the taxpayer in the year in the course of a business

(i) that is on account of services not rendered or goods not delivered before the end of the year or that, for any other reason, may be regarded as not having been earned in the year or a previous year,

(e) any amount,

(i) deducted under paragraph 20(1)(m) (including any amount substituted by virtue of subsection 20(6) for any amount deducted under that paragraph) or subsection 20(7), or

(ii) deducted under paragraph 20(1)(n),

in computing the taxpayer's income from a business for the immediately preceding year;

Paragraphs 18(1)(a) and (e) provide that:

18 (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

(e) an amount transferred or credited to a reserve, contingent account or sinking fund except as expressly permitted by this part;

Paragraph 20(1 )(m) states:

20 (1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(m) subject to subsection (6), where amounts described in paragraph 12(1)(a) have been included in computing the taxpayer’s income from a business for the year or a previous year, a reasonable amount as a reserve in respect of

(ii) services that it is reasonably anticipated will have to be rendered after the end of the year

Paragraph 20(7)(a) adds:

20 (7) Paragraph (1)(m) does not apply to allow a deduction

(a) as a reserve in respect of guarantees, indemnities or warranties,

Paragraph 20(1 )(m) of the Act is complementary to paragraph 12(1 )(a) of the Act. The latter paragraph requires that amounts that are received or receivable in the year in the course of business be included in income whereas the former recognizes that a taxpayer may not have an unfettered right to all of the amounts included in income and permits a deduction of a reasonable reserve in respect of, among other things, services not yet rendered by the taxpayer.

Any reserve deducted in a year under paragraph 20(1 )(m) is to be included in computing income from a business for the taxpayer's immediately following taxation year pursuant to paragraph 12(1 )(e) of the Act.

Appellant’s submission

The appellant’s principal submission is that a portion of the fees received by it from the municipality in 1988 was included in its income pursuant to paragraph 12(1 )(a) and related to the services of safeguarding and monitoring waste deposited by the municipality that the appellant was by contract to perform after 1988. Moreover, the amount of $152,794.14 claimed by the appellant represented a reasonable amount that was deductible by it in computing income in 1988: paragraph 20(1)(m).

The facts in the appeal at bar are unique, appellant’s counsel stated, and the reasons set out in The Queen v. Nomad Sand & Gravel Ltd., [1991] 1 C.T.C. 60, 91 D.T.C. 5032 (F.C.A.) do not apply. The appellant may claim a reserve for the portion of its revenue that is unearned because it represented amounts received for services to be provided in the future. In Nomad Sand & Gravel Ltd., supra, the nature of the taxpayer's business did not give the taxpayer any on-going connection with its customers that would have allowed the taxpayer to demonstrate it had to provide future services. Once the gravel was trucked away, the customers ceased to have any interest in the pit. The appellant, on the other hand, is obliged to safeguard and monitor the site into the future.

Counsel also argues that since the appellant has consistently filed its tax returns on the same basis as in 1988, a denial of the reserve would create a potential inequity in the measurement of the appellant’s income for tax purposes. During the active phase of the site revenue is received. When the site is closed no revenue is received but expenses are incurred. Allowing a reserve during the years the site is open permits the appellant to defer recognizing revenue until the closed phase. In 1993, for example, the appellant will bring some of its deferred revenue into income and will deduct therefrom its current costs of safeguarding and monitoring the waste site. To deny the reserve means the appellant will have to pay additional tax and be limited in its ability to monitor and safeguard the closed site.

Counsel insisted the appellant was obliged under the contract with the municipality to provide future services. The contract required the appellant to obtain the necessary licences under which it may operate (Clause 6). Section 5 of the licence required the appellant to provide the Ministry of the Environment with a closure plan for the site. The closure plan provided for certain services to be provided by the appellant when the site was eventually closed. In counsel's view, "by requiring that the appellant be licensed as a term of the contract, the municipality was, by extension, demanding that the appellant agree to undertake the services of safeguarding and monitoring the waste after the closure of the landfill site".

Counsel also added that Clause 9 of the contract requiring the appellant to purchase a public liability policy during the term of the contract assumes that the appellant was under an obligation to safeguard the disposal of waste. In counsel's view the municipality minimized its future risk by ensuring the appellant properly monitor the waste into the future even though it was only able to obtain an indemnity in the contract for the currency of the contract.

Counsel for the appellant argued that part of the fees paid by the municipality to the appellant was for the safeguarding and monitoring of the site during the closure phase: Thus a portion of the fees received by the appellant from the municipality in 1988 was in respect of services to be rendered after 1988. The contract, however, did not allocate amounts paid for this service. However, counsel relies on Dominion Stores Ltd. v. M.N.R., [1966] C.T.C. 97, 66 D.T.C. 5111 at pages 103-04 (D.T.C. 5115-16), per Cattanach, J., for the proposition that where the parties to a contract have not allocated the consideration for a bundle of services, a reasonable amount shall be allocated to each.

The appellant realized that it would cost a significant amount to provide future service during the closure phase and so allocated a reasonable portion of the fees to the future services, according to counsel. The liability during the closed phase was not contingent since the appellant will definitely incur these costs. In accordance with the application of paragraphs 12(1 )(a) and 20(1)(m) the appellant is required to bring into its income for 1989 the amount of the reserve taken in 1988 and a new reserve will be allowed only if it is required to provide services after 1989. Thus the recognition of revenue is merely deferred until the services are provided, counsel pleaded.

Counsel submitted paragraph 18(1)(e) does not apply in the case at bar because the reserve claimed in 1988 is expressly permitted under paragraph 20(1 )(m): Sears Canada Inc. v. The Queen, [1986] 2 C.T.C. 80, 86 D.T.C. 6304 (F.C.T.D.) at page 85 (D.T.C. 6308), per McNair, J.; aff'd [1989] 1 C.T.C. 127, 89 D.T.C. 5039 (F.C.A.). The fact that reserves may be contingent does not automatically preclude their deduction under paragraph 20(1)(m). The deduction of reserves on account of goods and services that it is reasonably anticipated will have to be delivered after the end of the year are "expressly permitted" by paragraph 20(1)(m) which brings the matter within the exception set out in paragraph 18(1 )(e).

Counsel also argued that subsection 20(7) should not apply to his client's claims for reserves under paragraph 20(1 )(m) because certain services will have to be provided; the services are not in the nature of a warranty, indemnity or guarantee: Sears Canada Inc., supra. The appellant’s obligations to safeguard and monitor the waste are not in the nature of indemnifying the municipality, but to minimize damage.

Respondent's submission

The respondent's position is that no legislation was in force in 1988 requiring the appellant to provide financial assurance to ensure that there would be adequate funds for site closure costs, post-closure maintenance and compensation. Accordingly the appellant was not obligated to pay any amount to anyone with respect to these matters. No such expenses were incurred within the meaning of paragraph 18(1)(a) of the Act; the reserve represented amounts transferred to a contingency account and therefore are not deductible: paragraph 18(1)(e). Also no amount was deductible as a reserve under paragraph 20(1)(m) since no amount was included in the appellant's income under paragraph 12(1)(a), and in any event, the reserve was not in respect of services that had to be rendered after the end of the particular year, within the meaning of subparagraph 20(1)(m)(ii).

The amount of the reserve claimed and allowed in the appellant’s 1987 taxation year is required to be included in income for 1988: section 9 and paragraph 12(1)(e).

Analysis

There is no doubt that during 1988 the appellant had responsibilities not present in most businesses due to the very nature of its business. Since at least the 1970s society has been environmentally conscious and society, as well as government, has attempted to lay down guidelines as to how waste is to be treated not only when collected and deposited in a waste site, but also as it decomposes in the earth. A person carrying on such business must be politically and environmentally sensitive. As a result the owners of the business may be called upon to control and maintain in later years work it had carried on earlier and is responsible for damages such work may cause. See, for example, Nippa v. C.H. Lewis (Lucan) Ltd, (1991), 82 D.L.R. (4th) 417, 7 C.E.L.R. (N.S.) 149 (Ont. Gen. Div.); Gertsen v. Toronto (Municipality) (1973), 2 O.R. (2d) 1, 41 D.L.R. (3d) 646 (H.C.J.); Plater v. Collingwood (Town), [1968] 1 O.R. 81-89, 65 D.L.R. (2d) 492-500 (H.C.J.). It is obvious and certain that the appellant will be incurring costs in the future years. The real issue is whether the Act permits one in the appellant’s situation to deduct such expenses from income.

Unfortunately for the appellant I cannot find any relief in the Act permitting it to deduct these expenses in computing its income for 1988. The appellant’s situation is different from most ongoing businesses in that in 1988 it operated on only one landfill site which it has since ceased to use and, in fact, has since ceased to carry on any significant business. Thus it may reasonably be expected—and this expectation was present in 1988—that in future years the appellant will have to incur costs which it will be unable to deduct from income earned in those years since it will have no income. The appellant is in a very difficult and inequitable situation.

In The Queen v. Burnco Industries Ltd., [1984] C.T.C. 337, 84 D.T.C. 6348, Pratte, J., stated that it was the opinion of the Federal Court of Appeal that an expense within the meaning of paragraph 18(1)(a) (C.T.C. 337, D.T.C. 6348- 49):

. . is an obligation to pay a sum of money. An expense cannot be said to be incurred by a taxpayer who is under no obligation to pay money to anyone . . . [a]n obligation to do something which may in the future entail the necessity of paying money is not an expense.

It is the compensation the appellant may have to pay and the work to be carried on by the appellant during the closed phase which in the appeal at bar refer to the “something” which will entail the necessity in the future of paying money. While I am satisfied expenses will be incurred in the future, I am not satisfied that in 1988 the appellant was liable for these potential expenses. There was in 1988 neither statutory nor contractual liability for the appellant to provide any financial assurance. Any liability by the appellant to pay an amount either by regulation, statute or a common law would exist after 1988 when the Ministry had adopted regulations, or the statute had been amended or a tort had been committed. The appellant is in a situation not dissimilar to Nomad, supra, where the taxpayer did not have a current obligation to pay an expense in the future. See also Northern and Central Gas Corp. v. The Queen, [1985] 1 C.T.C. 192, 85 D.T.C. 5744 (F.C.T.D.). Any services the appellant may provide during the closed phase will not be services to the municipality.

I cannot agree with the appellant that a portion of the fee paid to it in 1988 by the municipality was for future services, that is, to close the waste site, maintain and supervise the site during closure and to provide compensation. appellant’s counsel submitted this was the unique difference between the facts in this appeal and Nomad. The appellant did not produce any evidence indicating what proportion of the fees was attributable to services to be performed after 1988, no official from the municipality testified with respect to this or any other questions bearing on the contract. The contract between the appellant and the municipality does not provide for the appellant to provide services to the municipality once the municipality dumps its waste in the landfill. Clause 6 of the contract simply satisfies the municipality that it is dealing with a bona fide landfill operator. The requirement of the appellant to obtain public liability insurance does not help the appellant: no evidence was adduced to demonstrate such a provision is not the norm in such contracts; it is simply comfort to the municipality. The contents of the appellant’s certificate of approval to operate is a matter between the Ministry and the appellant and in any event section 5 of the certificate was not implemented in 1988.

Paragraph 18(1)(e) does not permit a deduction in computing income for the year with respect to amounts claimed as reserves which are transferred and set aside as liabilities to be incurred in the future: Northern and Central Gas Corp., supra, and The Queen v. Foothills Pipe Lines (Yukon) Ltd., [1990] 2 C.T.C. 448, 90 D.T.C. 6607 (F.C.A.). The profit earned by the appellant in 1988 from its business was not held in 1988 subject to any specific and unfulfilled conditions. In Foothills, supra, Urie J., stated at pages 458-59 (D.T.C. 6614-15):

If an amount received is . . . in the nature of income, the fact that in the future the recipient may be under an obligation to repay it does not change the character of the receipt from income to a liability whether deferred or otherwise . . . it is important to have regard to the terms of the contract under which the amounts in question were paid.

It is clear from the terms of the contract that on executing the contract with the appellant, the municipality agreed to pay the appellant for disposing of the waste and for the appellant to be responsible for the landfill site in perpetuity. In other words, the municipality was paying the appellant to free it of its waste and any responsibility relating to the waste for all time.

Subparagraph 12(1)(a)(i) provides for the inclusion in income amounts received by a taxpayer in the year in the course of business that is on account of service not rendered before the end of the year or a previous year. Section 9 provides for receipts or receivables earned in the year to be included in that year’s income. Paragraph 20(1)(m) is available only in respect of amounts included in income under paragraph 12(1)(a).

All amounts received by the appellant in 1988 were earned in 1988, were correctly included in its income and were reported in its tax return for 1988 as income under section 9. I am not satisfied that any of the income received or receivable by the appellant in 1988 was conditional or contingent. As previously stated, I cannot find any evidence that any portion of the receipts of income in 1988 was in respect of services to be rendered after 1988. The reserve in paragraph 20(1)(m) is not available to the appellant.

The amount of reserve deducted by the appellant in computing its income in 1987 is to be included in its 1988 taxation year pursuant to paragraph

12 (1 )(e) of the Act: Dominion of Canada General Insurance Co. v. The Queen, [1984] C.T.C. 190, 84 D.T.C. 6197 (F.C.T.D.); affd [1986] 1 C.T.C. 423, 86 D.T.C. 6154 (F.C.A.), per Stone, J., at pages 435-36 (D.T.C. 6163-64). See also Sears Canada Inc., supra, at [1989] 1 C.T.C. 127, 89 D.T.C. 5039 (F.C.A.) per Mahoney, J. An amount purported to be a reserve was deducted by the appellant pursuant to paragraph 20(1)(m) in computing its income for 1987. Paragraph 12(1)(e) provides that any amount so deducted “as a reserve" in the immediately preceeding taxation year is to be included in computing income for the year. It does not matter that the taxpayer was not entitled to the reserve so long as it deducted the amount as a reserve in the previous year.

I have already commented on the peculiar situation in which the appellant finds itself. It will be obliged in future years to incur expenses when it probably will have no income from which the expenses may be deducted. There is no provision in the Act to write off in 1988 expenses for which the appellant will be liable after 1988. The appellant had not yet incurred a liability to pay these costs and the quantum of the costs has not been determined.

The appeal will therefore be dismissed with costs. Counsel for the appellant has requested that if its appeal is dismissed I issue an "order that the appellant be allowed to revise its business limit for 1988 so as to take advantage of the small business deduction in 1988”. Section 171 of the Act does not permit me to make such an order. However it is within the power of the Minister to make such a revision and I assume he will cooperate with the appellant in doing so.

Appeal dismissed.

John Burns, Gary Burns and Deborah Klebeck v. Her Majesty The

[Indexed as: Burns (J.) v. Canada]

Tax Court of Canada (Rowe, D.J.T.C.C.), January 20, 1994 (Court File Nos. 91-2289/90/91).

Income tax—Federal—Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63)—3, 18(1)(a), 38(c), 39(1)(c), 40(2)(g)(ii), 50(1)—Allowable business investment

The three appellants were siblings and were each shareholders in B Ltd. In 1982, their father, WB, died and his shares in B Ltd. were transferred equally to his children, the appellants and three other siblings. As a result, each appellant and his or her brothers and sisters held one-sixth of the shares in B Ltd. In 1982, WB also owned a one-half interest in W Ltd., a company which operated a farm implement dealership. One of the appellants’ brothers, GB, owned the other one-half interest. Upon his death, WB bequeathed his 50 per cent interest in W Ltd. in equal shares to his six children. Accordingly, each appellant held a V12 interest in W Ltd., which included a share in WB's loan to W Ltd., amounting to the sum of $25,695.50 to each appellant. After WB's death, GB owned /u of the shares in W Ltd. In November 1984, the line of credit to W Ltd. from the credit union had reached its limit and the family decided to reorganize both B Ltd. and W Ltd. It was decided that GB would sell his interest in B Ltd. to his siblings and the siblings would sell their interest in W Ltd. to GB. In addition, it was agreed that B Ltd. would be able to obtain machinery from W Ltd. at a rate as close to cost as possible. Farm Credit Corporation was approached and, with the support of the credit union, it agreed to lend the sum of $520,000 to pay down the indebtedness to the credit union and to buy out the share of GB in B Ltd. In return, the credit union would forgive the guarantees of the shareholders of W Ltd., (having inherited, through WB's estate, the potential liability arising from the guarantee of WB) with the exception of GB, who held /i2 of W Ltd.'s stock. The credit union advanced the sum of $300,000 to B Ltd. which paid the sum of $50,000 to each shareholder to reduce his/her shareholder’s loan and then each of the six children loaned the sum of $50,000 to W Ltd. As part of the consideration for the loan, the credit union required that the children postpone any demand for repayment of the loans and any interest in favour of the credit union. Unfortunately, W Ltd. did not fare well and over the course of a few years, it became obvious that W Ltd. would be unable to repay the appellants’ loans. In filing their tax returns for the 1986 and 1987 taxation years, each appellant claimed an allowable business investment loss ("ABIL") in respect of the $50,000 loan and the inherited $25,695.50 loan. The Minister disallowed the deductions (although the Minister was not entitled to reassess the 1986 taxation year for one of the appellants because his rights had been statute barred). In the alternative, the Minister claimed that the appellants were not entitled to deduct 50 per cent of the loss in each of their 1986 and 1987 taxation years. The main issue was whether subparagraph 40(2)(g)(ii) applied to deem the appellants’ losses to be nil. In other words, did the appellants make the loans for the purpose of gaining income from business or property? During the course of the hearing, the Crown conceded that the loan of $25,695.50 by each appellant to W Ltd. satisfied the requirements of an ABIL.

HELD:

As part of the negotiations at the time of the $50,000 loans, W Ltd. agreed to sell machinery, parts and equipment to B Ltd. at greatly reduced prices. Accordingly, the making of the loans to W Ltd. resulted in reduced costs to B Ltd., in which the appellants, as a unit, controlled the majority (60 per cent) of the shares. As such, the appellants were able to use their money in a way that would lead to the production of income, although not in a manner that was capable of being placed into a neat, tidy, labelled pigeonhole. In the result, subparagraph 40(2)(g)(ii) did not apply to the appellants' loans of $50,000 because the appellants did acquire the debt for the purpose of gaining or producing income from a business or property. In addition, with respect to the Minister's alternative argument, the appellants had demonstrated that there was no reason for the Minister to have taken the position that the loans to W Ltd. went bad only during the 1987 taxation year. The apportionment of the loss equally between the 1986 and 1987 taxation years was therefore correct. Appeals allowed.

C. Stewart for the appellants.

H. Irving for the respondent.

Cases referred to:

Lowery v. M.N.R., [1986] 2 C.T.C. 2171, 86 D.T.C. 1649;

Casselman v. M.N.R., [1983] C.T.C. 2584, 83 D.T.C. 522;

O'Blenes v. M.N.R., [1990] 1 C.T.C. 2171, 90 D.T.C. 1068;

Ellis v. M.N.R., [1988] 1 C.T.C. 2081, 88 D.T.C. 1070;

The Queen v. Lalande, [1983] C.T.C. 311, 84 D.T.C. 6159;

Sansoucy v. M.N.R., [1980] C.T.C. 2312, 80 D.T.C. 1276;

Business Art Inc. v. M.N.R., [1987] 1 C.T.C. 2001, 86 D.T.C. 1842:

Hogan v. M.N.R. (1956), 15 Tax A.B.C. 1, 56 D.T.C. 183;

Berretti v. M.N.R., [1986] 2 C.T.C. 2293, 86 D.T.C. 1719.

Rowe, D.J.T.C.C.:—These appeals were heard under the general procedure of this Court.

The appellant, John Burns, appeals from a reassessment of income tax for the 1986 and 1987 taxation years. The Minister of National Revenue, (the "Minister") in reassessing the appellant, disallowed a claim for an allowable business investment loss (ABIL) in the sum of $18,923.88 in each of the years under appeal and determined the loss to be nil in accordance with the meaning of paragraphs 38(c) and 39(1)(c) of the Income Tax Act, R.S.C. 1952,

c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") for purposes of section 3 of the Act.

The appellant’s brother, Gary Burns, appeals from a reassessment of income tax for the 1986 and 1987 taxation years, arising from the same facts. It was agreed by all parties that his appeal, 91-2291 and the appeal of Deborah Klebeck, 91-2289, from a reassessment for the 1987 and 1988 taxation years be heard together with the appeal of John Burns, on the basis that evidence taken on any of the appeals apply, where applicable, to the other appeals. Deborah Klebeck is the sister of John Burns and Gary Burns. Deborah Klebeck claimed an allowable business investment loss in her 1987 return of income together with a child tax credit based on that income. The Minister disallowed the deduction and calculated the child tax credit accordingly. In the 1988 taxation year, she claimed a non-capital loss available for carry forward from the 1987 taxation year, which was disallowed.

The following facts, as set forth in each appellant's notice of appeal, and as admitted in the relevant reply to notice of appeal, are:

1. At all relevant times, each appellant was an individual resident in Canada.

2. At all relevant times, each appellant was a shareholder of the corporation, Burns Farms Ltd. (BFL).

3. At all relevant times, BFL was incorporated pursuant to the laws of the Province of Saskatchewan.

4. In 1982, Wendell C. Burns, father of all three appellants, died and his shares in BFL were transferred equally to the three appellants and their three other siblings. As a result, each appellant and his or her brothers and sisters held one-sixth of the shares in BFL.

5. In 1982, Wendell C. Burns, upon his death, bequeathed his 50 per cent interest in Wynyard Farm Centre Ltd. (WFC) in equal shares to each appellant and three other brothers and sisters with the result that each appellant now held a '/12 interest in WFC, which included a share of the late Wendell C. Burns shareholder loan to WFC, amounting to the sum of $25,695.50 to each appellant.

6. The shareholder loans of the late Wendell C. Burns to WFC had no specific terms of repayment and no specific rate of interest thereon.

In the reply to notice of appeal of each appellant, the Minister conceded that the loan by each appellant in the sum of $25,695.50, obtained by way of inheritance from the father’s estate, was a debt acquired for the purpose of gaining or producing income from a business or property and would qualify as an ABIL. However, the Minister’s position is that each appellant is entitled to the ABIL, only in the 1987 taxation year, and not on the basis that 50 per cent of the ABIL can be claimed in each of the 1986 and 1987 taxation years. Each of the appellants loaned the sum of $50,000 to WFC and the Minister's position is that there is no entitlement at all to an ABIL as the loan was not for the purpose of gaining or producing income from a business or property pursuant to the requirements of subparagraph 40(2)(g)(ii) of the Act. In the alternative, the Minister's position is that if the appellants are entitled to an ABIL then it would arise in the 1987 taxation year and cannot be claimed on a 50-50 basis for each of the 1986 and 1987 taxation years. Despite the commonality of the appellants’ situation, the appellant, Deborah Klebeck, for her 1986 taxation year, claimed an ABIL in the sum of $6,423.88, being one- half of $12,847.75, the total allowable loss on the inherited loan of $25,695.50, the other half having been claimed by her during the 1987 taxation year. In addition, Deborah Klebeck claimed an ABIL in the sum of $12,500 for the 1986 taxation year as it related to the loan by her in the sum of $50,000 to WFC, with the claim for a further ABIL of $12,500 being made for the 1987 taxation year. The Minister allowed Deborah Klebeck’s claim for an ABIL in respect of the $50,000 loan to WFC, despite having rejected the same claim by her brothers and fellow appellants, John Burns and Gary Burns. The Minister, having run out of time to reassess her for 1986, was able to reassess with respect to her 1987 taxation year and took the position that she is not entitled to an ABIL in the sum of $12,500 for the 1987 taxation year for the same reason her brothers were denied the claim, namely, that the loan did not qualify under the Act as having been made for the purpose of gaining or producing income from a business or property and that the proper determination of the loss was nil.

The appellant, Gary Burns, was not present during the hearing and the following documents, by consent, were filed as exhibits.

The appellant, John Burns, testified he resides at Wynyard, Saskatchewan and is a teacher and a farmer, living on the farm property. Filed as exhibits were the following:

The appellant, John Burns, testified he is the brother of the other two appellants. Burns Farms Ltd. (BFL) was incorporated in 1975 and he was a shareholder at all relevant times. The corporation's business was a livestock and cropping operation on 1,000 cultivated acres and 400 acres of pasture. Prior to 1982, the appellant operated his own farm and was a teacher and program coordinator. In 1982, as a result of the death of his father, Wendell C. Burns on November 2, he came to hold, through inheritance, 110 shares of the common stock in BFL, which amounted to one-sixth of the total. He had not been a shareholder in Wynyard Farm Centre Ltd. (WFC) which was owned by Wendell C. Burns and Gordon Burns, brother of the three appellants. The value of the estate of the late Wendell C. Burns was approximately $1 million. Pursuant to the last will and testament (Exhibit A-16) of the late Wendell C. Burns, the residue was divided equally into six portions, one for each of his surviving children. Mr. Burns had held one share—or 50 per cent—of the stock of the corporation, WFC, which was also divided equally among the six children, with the result that Gordon Burns, having previously held one share (50 per cent) of WFC, ended up owing /2 of the shares of WFC, and each of tne appellants held '/12, as did two other siblings. At the time of his death, WFC was indebted to Wendell C. Burns, and the equal portion of that loan, bequeathed to each child, amounted to $25,695.50. In due course, the executor of the estate transferred the share in WFC to each beneficiary and the appropriate share certificate was issued. Subsequent to 1982, the scope of BFL farming operations expanded to include the land being farmed by the appellant and all family members became active in the farming business. The appellant stated he acted as manager, while Gordon Burns looked after the machinery and equipment and a brother-in-law concerned himself with the farm buildings. The appellant stated that his managerial duties were full-time and he did not have any outside income until he returned to his teaching profession in 1985. Currently, BFL farms 4,500 cultivated acres together with 400 acres of pasture. Some of the land was rented or leased and the overall operation included 1,600 acres of land in his own name. All family members agreed that the shareholder's loan inherited by them could continue to be owed to them by the business, WFC, a farm implement dealership in Wynyard.

In November, 1984, the line of credit to WFC from the Wynyard Credit Union had reached the limit and the manager spoke to the appellant in his Capacity as executor of the estate of the late Wendell C. Burns and also as a shareholder in WFC. In the spring of 1984, the family members met and discussed financial matters and recognized that funding to WFC was necessary and that it would have to come from BFL. All family members felt WFC was, despite hard times in the agriculture industry, still a viable business and that some restructuring would permit interest on debt to be reduced from 22 per cent annual interest to 12.5 per cent or 13 per cent. Before it would advance further funds to WFC, the credit union wanted personal guarantees from each of the six beneficiary-shareholders in WFC and numerous discussions were held by family members and contact was made with absent members, such as Gary Burns, who was living on Vancouver Island, British Columbia. Ultimately, it was decided that Gordon Burns would sell his share in BFL provided that the remaining shareholders would agree that BFL be used as a vehicle to provide some funding to WFC. The appellant stated that there was a verbal agreement with Gordon Burns that BFL would be able to obtain machinery from the WFC dealership at a rate as close to cost as possible. In addition, parts were to be sold to BFL at a discount and the WFC shop, if not otherwise occupied with other customers, would be made available to BFL for its needs from time to time. Prior to entering into this agreement with Gordon Burns, the appellant, John Burns, stated that while BFL had gotten some breaks from WFC in the past on commissions, it was not the same degree of advantage to be obtained under the new agreement. Farm Credit Corporation was approached and, with the support of the Wynyard Credit Union, the corporation agreed to lend the sum of $520,000 to pay down the indebtedness to the credit union and to buy out the share of Gordon Burns in BFL. In return, the credit union would forgive the guarantees of the shareholders in WFC, (having inherited, through the estate, the potential liability arising from the guarantee of Wendell C. Burns) with the exception of Gordon Burns, who held /i2, of the stock. The target date for the restructuring of the two corporations was November 1, 1984 but matters proceeded slower than anticipated. However, the agreement regarding the discount on farm machinery between WFC and BFL was carried out. The appellant referred to minutes of a meeting of shareholders of BFL, dated July 23, 1984 (Exhibit A-20) and further minutes meetings held on July 30, 1984 (Exhibit A-21) and September 24, 1984 (Exhibit A-22) approving a loan application by BFL to Farm Credit Corporation for a loan of $520,000 of which $100,000 would be used to buy out Gordon Burns interest in BFL. The credit union advanced the sum of $300,000 to BFL which then paid the sum of $50,000 to each shareholder to reduce their shareholder's loan and then each of the six Burns children loaned the sum of $50,000 to WFC. The credit union did not want WFC to be required to pay any interest on these loans and also insisted that each of the lenders execute a postponement of payment on the loan. The agreement to postpone any demand for repayment and any interest in favour of the credit union was filed as Exhibit A-19.

At a meeting of shareholders of WFC held on November 1, 1984, the three appellants and their two brothers and sisters, by written agreement (Exhibit A-24) sold their interest in WFC to Gordon Burns. At this point then, Gordon Burns held no interest in BFL, the remaining five Burns siblings held no shares in WFC and they had been released by the credit union from their guarantee for WFC loans. In 1985, the appellant, John Burns, was the president of BFL. He stated that on March 26, 1985, BFL bought a sprayer from WFC and purchased it at the price noted on the invoice (Exhibit A-26) which was at or near cost. On June 25, 1985 a particular blade was purchased by BFL from WFC and invoiced at cost (Exhibit A-27). On July 1, 1985, BFL purchased from WFC a used combine obtained on a repossession at less than market value. In August, September and October, 1985, the appellant provided invoices (Exhibits A-29 to A-32 inclusive) indicating purchases by BFL of certain parts and equipment from WFC at cost. In addition, he stated that BFL had rented a tractor from WFC in 1985 at the rate of $15 per hour when the normal rate was $35. The purchases made by BFL during 1985 were normal for an operation of that size. John Burns also stated that he was able to obtain items at cost from WFC, in particular an auger, and a tractor for which he paid the sum of $63,500 at a time when he believed the market value of the unit to be in excess of $80,000 (Exhibit A-35). These purchases were in his own personal capacity for his own farm. The appellant stated he held discussions with his brother, Gordon Burns, in the spring of 1985 about what he believed to be excessive inventory held by WFC.

By the fall of 1985, the situation was no better and the repair shop was closed over the winter in order to reduce costs. By the summer of 1986, the inventory was depleted and he believed WFC was unable to cover more than 50 per cent of the debts to the family members, each of whom was owed the sum of $50,000. The price of used machinery had plummeted. In the autumn of 1986, the credit union was owed a large amount of money by WFC and it had first call on all of its assets. Gordon Burns advised John Burns that the ability of WFC to pay even 50 per cent of the amount of the outstanding loans to the appellants would be an optimistic view of matters. By the spring of 1987, Gordon Burns was the sole employee of WFC but it was able to conduct some business by returning parts to the factory for rebate and holding an auction of remaining inventory. The appellant stated there was no thought given by family members to suing WFC and, in any event, the loans to WFC had not been personally guaranteed by Gordon Burns. The appellant, John Burns, accompanied Gordon Burns to visit a bankruptcy trustee in 1987. He stated he began thinking about claiming a loss on the loan to WFC and requested an adjustment to his 1986 taxation year by filing with Revenue Canada, Taxation the appropriate form (Exhibit A-11). He stated that while preparing the return of income for the 1986 taxation year that he had informed his accountant of the precariousness of the financial situation of WFC and had also informed his brother, Gary Burns, of the state of affairs.

In cross-examination, John Burns stated that the proceeds of the loan of BFL from Farm Credit Corporation went to pay off an existing mortgage and to purchase Gordon Burns' share in BFL at a price of $100,000. The money never left the credit union office and was part of an overall transaction in which the credit union made two loans totalling $300,000 to BFL which debited $50,000 from the shareholder's loan account of each of the six shareholders who then each loaned $50,000 to WFC. He stated the family members hoped the loans could be repaid as soon as possible. Gordon Burns also took out the sum of $50,000 from his BFL shareholder loan account before transferring over his shares to the others as part of the restructuring of BFL and WFC. All family members, except Gary Burns, were present during discussions about the loans to WFC and while there was nothing in writing, the general rule always followed by family members, including years prior to 1982, was that interest on such inter-family loans would bear interest at 10 per cent per annum. Upon being shown a T1 adjustment request, dated December 15, 1988, for his 1986 taxation year, he stated he believes that was a repeat submission as he was concerned there had been no response to an earlier request. He indicated that his brother, Gary Burns, is not a farmer and was living in Duncan, British Columbia, during the times relevant to this appeal.

Gordon Burns, testified he resides in Wynyard, Saskatchewan and is the brother of the appellants. In 1982, he owned one-sixth of the issued shares in BFL. He also owned one of the two issued shares in WFC, his father, Wendell

C. Burns, holding the other share. On July 27, 1982, he and his father guaranteed a $500,000 loan to WFC from the Wynyard Credit Union (Exhibit A-36). Following the death of his father in November, 1982, he stated that at least two meetings a month were held with other family members and several meetings were held on a regular basis with the management of the credit union as WFC was at the top of its line of credit. He also held discussions with John Burns, who was the manager of BFL, and told him that the only real source of raising money to inject into WFC would have to be BFL and the Burns family. He stated that “the only thing he had to work with was that they could purchase machinery at cost", and that this arrangement was a condition of the financing WFC received in November, 1984. In his view, the arrangement regarding discounted machinery cost was to extend to John Burns to his own farm and that he, as well as BFL, had the right to a discount on rates for leasing equipment or to use equipment belonging to WFC provided it was available at the time. An employee-manager of WFC was made aware of this arrangement. Gordon Burns indicated that there was not such discounting arrangement in place prior to 1984. He indicated that there was a discussion of interest to be paid and "we hoped to be able to pay interest" but times were tough. Pursuant to a share transfer from the other family members he became the sole shareholder in WFC. The arrangement with the credit union required that all six family members put $50,000 each into WFC for a total of $300,000 and the credit union then released the estate of Wendell C. Burns from the $500,000 guarantee. He stated he had been in business with his father since 1978. He stated that the sale of a blade to BFL was “almost at cost" and stated that it is difficult to determine the cost on trade-ins.The tractor rental to BFL was at a greatly reduced rate and other purchases by BFL were at cost plus shipping and handling charges. As for the Massey tractor purchased by John Burns, personally, Gordon Burns stated that the sum of $60,000 paid to WFC was only the cost price or less. In 1986, weekly meetings were being held with the credit union about the worsening financial situation of WFC. On October 25, 1986 minutes of a WFC shareholders and director's meeting of WFC (Exhibit A-38) referred to the intention of the company to cease operations effective December 31, 1986 and that the debt owin to the appellants and the other family members would not be paid in full and that they had been advised that the most they could expect to receive from WFC would be 50 per cent of the amount outstanding. He stated that the situation regarding inventory and outstanding liabilities was monitored constantly and after undertaking certain methods of disposal of remaining inventory, by the end of 1987, only the property itself remained. The real property was taken over by the credit union and was worth less than the debt against it. However, the credit union agreed to accept it in full satisfaction of the WFC debt and also released him from his personal guarantee. The hope had been that the sale of remaining equipment and inventory in 1987 would have been sufficient to pay towards the loans of the appellants and the other members of the family but only the credit union received any funds from WFC. The mark-up on goods sold by WFC varied from 10 per cent to 25 per cent, depending on the nature of the transaction and the demand.

In cross-examination, Gordon Burns identified financial statements of WEC for 1985 (Exhibit R-2), 1986 (Exhibit R-3), and 1987 (Exhibit R-4) and agreed that the five loans of $50,000 each by the family members to WFC were not reflected in any of those financial statements. In the 1988 financial statement (Exhibit R-6) there is a reference to loans to former shareholders and also to the state of affairs in 1987. A new accountant for WFC was retained for the 1988 year. At the time of receiving the loans from his siblings, he believed that repayment to them by WFC would depend on how well the business did and that there would be concessions made regarding the cost of equipment to "cover the interest since there was nothing documented”. In 1987, ne stated that he told his siblings that payment of their loans by WFC was hopeless. At the conclusion of his testimony, Gordon Burns stated that a farm equipment dealer in Wynyard, previously handling volumes ten times that of WFC, had also gone out of business due to the terrible conditions in the farming industry.

Roger Nupdal testified he has been the loans manager at the Wynyard Credit Union since 1982 and personally handled the WFC account subsequent to 1984. He was familiar with the personal guarantee of the late Wendell C. Burns (Exhibit A-39). Throughout 1984, he testified that he had serious concerns about the financial health of WFC and felt that it needed a major infusion of capital to survive. He spoke to John Burns and to Gordon Burns about the implication to the estate of the credit union calling for payment on the WFC loans. He was later advised that the sum of $300,000 would be injected into WFC and, provided certain conditions were met, including a postponement of payment and waiving of interest payments to the family member lenders, then the credit union was willing to release the estate from liability under the guarantee of the late Wendell C. Burns. On May 23, 1985 by letter (Exhibit A-40), he confirmed to the family solicitor that the beneficiaries of the estate of the late Wendell C. Burns, were not responsible for the debts of WFC. By the end of 1986, Roger Nupdal stated he believed WFC again required a major infusion of capital, failing which an orderly liquidation would have to take place. To some extent the process had already begun in 1985 but by the end of 1986 it became clear that the credit union would have to take a loss on its loans to WFC. On June 12, 1991, by quit claim (Exhibit A-41) and settlement agreement (Exhibit A-42) the credit union took the real property of WFC with an agreed upon value of $195,000 together with accounts receivable in the sum of $15,000 in full settlement of the WFC debts and wrote off about $80,000 in the process.

Deborah Klebeck testified that she is a farmer and has lived at Wynyard since 1983. The following exhibits were filed at the beginning of her evidence:

The appellant, Deborah Klebeck, stated that her claim for an ABIL in the 1986 taxation year was allowed. In 1982, she held 110 shares of BFL and decided to move to Wynyard and derive income from the farming operation. As a result of inheritance from her father's estate she also acquired an interest in WFC. In 1984, she attended meetings regarding the restructuring of WFC and BFL. John Burns was acting as manager of the BFL farming business. She recalls discussions of loans to be given to WFC and also BFL obtaining parts and machinery at cost. She did not recall any discussion regarding interest on any loans. In November, 1984, she believed WFC to be a viable business. However, with the buy-out of Gordon Burns from BFL, the remaining five shareholders would have a larger interest and would also be able to reduce the costs of machinery and parts. She stated she later relied on the advice of John Burns as to the potential of collecting on the loans to WFC by family members. For her 1987 taxation year, she claimed a child tax credit which was adjusted in the course of the reassessment.

In cross-examination, Deborah Klebeck stated that she received a letter from an accountant in 1988 suggesting the she could attempt to readjust her 1986 taxation return.

Wayne Coleman testified that he is an accountant in Saskatoon and prepared the 1986 and 1987 tax returns for BFL. He discussed the matter of the loans to WFC by the family members and whether or not they should claim an ABIL. Notes of his discussion were prepared by him on May 15, 1987.

Lavina Bukarak testified she is an appeals officer for Revenue Canada, Taxation and was familiar with the files of all three appellants. She stated that Deborah Klebeck was allowed an ABIL in the 1986 taxation year on both the loan to WFC, inherited through the estate, and with respect to her $50,000 loan to WFC. She stated there was no difference in the fact situation between that of Deborah Klebeck and her brothers, the other two appellants, except that a review of the file seemed to indicate that the assessor had been operating on the erroneous assumption that she had been a shareholder of WFC at the time of making the loan. The time limit during which a further reassessment could occur had expired.

In cross-examination, Ms. Bukarak stated she felt all of the appellants should be allowed an ABIL in respect of the loan inherited by them but not with respect to the $50,000 loan made by each of them to WFC as they were not shareholders of WFC and the loans bore no interest requirement. In her view, the loans of $50,000 were for the purpose of obtaining from the credit union a release of the liability of the estate flowing from the personal guarantee of the late Wendell C. Burns.

Counsel for the appellants submitted that in light of the Minister's concession that the loan of $25,695.50 by each of them to WFC would be subject to a claim for an ABIL, the only issue on that point was the timing of a claim and this affected the appellants John Burns and Gary Burns. The claim for an ABIL on this loan for the 1986 taxation year had been allowed for Deborah Klebeck. In his submission, the evidence demonstrated the appellants had made a reasonable determination that 50 per cent of the loan was uncollectible at the end of the 1986 taxation year and that the balance of the loan was uncollectible at the end of the 1987 taxation year. Further at issue, was the matter of the $50,000 loans made by each of the appellants to WFC which counsel submitted were debts acquired for the purpose of gaining income from a business or property and that the evidence indicated that the appellants had correctly determined at the end of the 1986 taxation year that 50 per cent of the debt was uncollectible and that at the end of the 1987 taxation year the remainder was also uncollectible. Counsel pointed out that the ABIL for the 1987 taxation year regarding the $50,000 loan to WFC affected the appeal of Deborah Klebeck which also had an impact on a loss carry forward at December 31, 1987 as well as a calculation of the amount of the child tax credit to which she was entitled.

Counsel for the respondent advised that Deborah Klebeck was entitled to claim an ABIL in the sum of $6,423.88 for her 1987 taxation year, arising out of the loan of $25,695.50, acquired by inheritance. However, the position of the Minister is that John Burns and Gary Burns had made no determination that the debt was partially bad at the end of the 1986 taxation year and that it was only in April, 1988, that they submitted their claim for an ABIL for their 1986 taxation year. As a result, the Minister would allow an ABIL of $12,847.75 to each of them for their 1987 taxation year. As for the ABIL claimed by the appellants with regard to the $50,000 loan made by each of them to WFC, the Minister’s position was that the allowance of the claim for an ABIL by Deborah Klebeck for the 1986 taxation year, was done in error. Counsel submitted that the appellants had failed to establish the debt was acquired by them for the purpose of gaining or producing income from a business or property and were therefore subject to the provisions of subparagraph 40(2)(g)(ii) of the Act. Further, even if the appellants had established that the debt was acquired for the requisite purpose, then they had failed to prove that the debt was partially bad at the end of the 1986 taxation year and an ABIL in the amount of $25,000 could only be made available to John Burns and Gary Burns in their 1987 taxation year. If the purpose test were satisfied, then Deborah Klebeck would be allowed an ABIL in the sum of $12,500 for her 1987 taxation year.

The scheme of the Income Tax Act regarding ABILs is that given a business investment purpose in certain circumstances, a business investment loss is a loss resulting from a disposition of shares or debt of a small business corporation pursuant to the provisions of paragraph 39(1)(c) of the Act. Where a taxpayer establishes that an amount owing to him on account of a disposition of capital property has become uncollectible, he is deemed to have disposed of the debt, pursuant to subsection 50(1). An allowable business investment loss or ABIL is a certain prescribed portion of the loss resulting from the disposition of the shares or debt of a small business corporation in accordance with the wording of paragraph 38(c) of the Act. In the event of an allowable business investment loss, the taxpayer is entitled to deduct prescribed amounts from any source of income under paragraph 3(d) of the Act. The significant requirement is that a taxpayer seeking the deduction flowing from an ABIL must not be prohibited from doing so by the effect of subparagraph 40(2)(g)(ii) which reads as follows:

40 (2) Notwithstanding subsection (1),

( g) a taxpayer's loss, if any, from the disposition of a 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 by the taxpayer 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;

Since the Minister has conceded the loan of $25,695.50 by each appellant to WFC satisfies the requirements for an ABIL, with only the timing of the bad debt in issue for John Burns and Gary Burns, I shall deal first with whether or not the loans of $50,000 made by each appellant to WFC were made under circumstances in which a claim for an ABIL is prohibited by the effect of subparagraph 40(2)(g)(ii) of the Act.

There is no doubt that there was more than one factor motivating the appellants to each advance, by way of loan, the sum of $50,000 to WFC. That company was a farm implement dealership with a history of substantial sales and had been operated by their father and brother since 1978. In 1984, despite some tough economic times, John Burns and Deborah Klebeck believed that WFC was a viable business. It became obvious that the Wynyard Credit Union was applying pressure to reduce the WFC line of credit. Following certain discussions among family members and with management of the credit union, the restructuring of BFL and WFC occurred and BFL took out a large mortgage from Farm Credit Corporation to liberate some capital. Contemporaneous with the reorganization of the two companies, the credit union, once the appellants and other family members injected the sum of $300,000 into WFC by way of loans, relieved the estate of tne late Wendell C. Burns from all liability flowing from the personal guarantee of Mr. Burns for the debts of WFC to the credit union. As a result, the BFL operation would be secure from any need to pay off, from its assets or cash flow, the WFC debt. In testimony, John Burns and Deborah Klebeck both stated that after buying out the share of Gordon Burns in BFL that they then owned one-fifth of the corporation, instead of one-sixth, and could therefore expect larger dividends. However, that must be balanced by the recognition that the appellants each sold a '/12 interest in WFC so that if it did undergo a revival, they would not derive any profit therefrom since they were no longer shareholders. The credit union insisted on receiving from the appellants a postponement of payment and also a waiver of any interest payments until the debt of WFC to the credit union had been fully satisfied. In any event, the loans to WFC did not provide for any interest thereon nor were there any specific terms of repayment. The only potential for gain accruing to Deborah Klebeck and Gary Burns to lend $50,000 to WFC was that BFL could purchase parts, and purchase or rent machinery and equipment at prices nearly at cost to WFC. The reduced cost of these purchases would then be reflected in the BFL balance sheet at the end of the year and the amount of corporate profit, available for distribution to the appellant as shareholders, would be increased. John Burns, because he owned and operated a farm in his own personal capacity apart from his involvement in BFL, purchased machinery, equipment and parts from WFC at reduced prices, almost at WFC cost. The evidence was that he saved nearly $20,000 on the purchase of a tractor for use on his own farm.

The wording of subparagraph 40(2)(g)(ii) of the Act requires that the debt acquired by the taxpayer be for "the purpose" of gaining or producing income "from a business or property". There are no words modifying or qualifying "purpose" so as to permit consideration whether the acquisition of the debt was a "major" purpose or "motivating" purpose or the "sole" purpose. Similarly, unlike some provisions in the Act, such as paragraph 18(1)(a), the wording does not require a direct link between the loan and the business or property which produces the income. Despite certain broad principles applying to an interpretation of the subparagraph, the relevant jurisprudence discloses that there are situations in which the decision turns on the facts peculiar to the case.

In Lowery v. M.N.R., [1986] 2 C.T.C. 2171, 86 D.T.C. 1649, the Honourable Judge Sarchuk, of the Tax Court of Canada, made a positive finding that the taxpayer did not give certain guarantees for the purpose of gaining or producing income but did so to help his son. Further, the learned judge found that the taxpayer's guarantee of his son's debt had its justification only in the context of the family relationship and that there were no indicia otherwise present which pointed to any business purpose whatsoever.

In Casselman v. M.N.R., [1983] C.T.C. 2584, 83 D.T.C. 522, the Honourable Judge Tremblay, of the Tax Court of Canada, found that the taxpayer's only motivation in guaranteeing the company's loans was to help her son and that she did not do so for the purpose of gaining or producing income.

The taxpayer's appeal in O’Blenes v. M.N.R., [1990] 1 C.T.C. 2171, 90 D.T.C. 1068, was dismissed by the Honourable Judge Garon, of the Tax Court of Canada. At page 2176 (D.T.C. 1072) of his judgment, Judge Garon stated:

On the whole of the evidence it is abundantly clear that when the appellant agreed to guarantee Glenwood's line of credit and to pledge through her husband the subject term deposits, she was not motivated by any benefit she might herself receive, Her purposes were not business purposes as far as her own situation was concerned. Family considerations played a key role. She wanted to assist Glenwood in which shareholding her husband owned a third interest. As well, that company was also at the time her husband's employer.

Subparagraph 40(1 )(g)(ii) of the Act when it mentions the purpose of the acquisition of a debt refers, of course, to the creditor’s purpose of earning income for her own account. The indirect advantage the appellant would derive in providing financial assistance to a company which in turn would procure a direct financial benefit to her husband is definitely too remote to meet the requirements of that subparagraph.

It has been suggested by the appellant that in 1981 as a result of the mortgage agreement dated June 1, 1981 and of the debenture of June 18, 1981, compensation was provided to the appellant. There is no question that by these two indentures the appellant would have received a significant benefit if Glenwood had been able to survive and pay off its indebtedness to the appellant. However, as pointed out by Judge Sarchuk in the case of Lowery, supra, to which case reference will be made later that the critical time at which the appellant’s purpose must be examined is the time at which she gave the guarantee and pledged her term deposits. Almost two years after undertaking to assist Glenwood she moved to secure her position at the time of the refinancing of Glenwood's operations. This belated action had nothing to do with the reason why she agreed in the first place to give the guarantee an pledge her term deposits. The evidence is clear that in 1981 the appellant was not released from her guarantee given to the Bank. The mortgage and the debenture given by Glenwood were not in respect of a new guarantee provided to the bank or a new pledge of the term deposits. There was no new injection of capital into Glenwood's business on the appellant's part.

On the whole of the evidence, I therefore come to the conclusion that the appellant has not established that when she undertook to grant the guarantee to the Bank and to pledge her term deposits she was motivated by the prospect of a financial gain or reward for herself. Her motives, however commendable they are, are of a personal or private nature.

In Ellis v. M.N.R., [1988] 1 C.T.C. 2081, 88 D.T.C. 1070, the Honourable Judge Brulé, of the Tax Court of Canada, dealt with the taxpayer's situation of not having been a shareholder of a hotel company to which the guarantee for a loan had been given and under circumstances in which his own company was only a minority shareholder in the hotel company. As a result, the taxpayer would be in no position to force the hotel company to distribute dividend income. The taxpayer's appeal was dismissed.

It is helpful in the present appeal to examine what the facts do not disclose. First, the evidence does not justify a finding of the sort in Lowery or Casselman, supra, that the loans were made only for the purposes of assisting a family member and were totally without any business component. The appellants in the present appeal together owned three-fifths of the shares of BFL and would not be in the minority position of the taxpayer in Ellis, supra, when it came to distributing dividend income. Because of the arrangement between BFL and WFC, entered into as part of the conditions under which the appellants made the loans, by which BFL could purchase machinery, parts and equipment from WFC at greatly reduced cost, the annual profit of the company, without more, would be increased by the amount of the savings and could be passed on to each appellant. The evidence of John Burns, Gordon Burns and Deborah Klebeck was that the concessions on the price of machinery, parts and equipment to be given in the future by WFC to BFL and to family members personally, was a significant part of discussions surrounding the making of the loans by the appellants to WFC. There were other considerations as well and it is not possible, nor is there any need in my view, to rank in priority any one or more of the bundle of reasons constituting the fabric of the decision of the appellants individually and collectively to loan the money to WFC.

The question that must then be answered is whether or not the purpose of the appellants in gaining income has sufficient nexus with the making of loan. The benefit to them had to travel a circuitous, albeit not tortuous, route in order to come home to roost. In The Queen v. Lalande, [1983] C.T.C. 311, 84 D.T.C. 6159, Décary, J., of the Federal Court-Trial Division, heard an appeal by two taxpayers who were doctors in a small town. One of them also owned the pharmacy. The taxpayers, without any payment therefor, stood surety on loans made by financial institutions to a non-profit corporation created for the purpose of building a 200 bed home for the elderly, which would preserve and expand the medical practice of the taxpayer-guarantors. At page 318 (D.T.C. 6164) of his judgment, Décary, J. stated:

The question is whether the debts at issue were in fact acquired ”. . . for the purpose of gaining or producing income from a business or property. . . .” This is essentially a question of weighing the facts of the case. The fact that there was no interest or costs attached to the debts in question is not relevant in deciding whether they were acquired for the purpose of gaining or producing income.

In my view, the aim was to increase a professional practice and so increase income. The advances and security are subject to the deduction provided in subparagraph 40(2)(g)(ii) of the Act.

In Sansoucy v. M.N.R., [1980] C.T.C. 2312, 80 D.T.C. 1276, Mr. Guy Tremblay, as he then was, of the Tax Review Board, allowed a taxpayer to deduct a debt, comprised of travel expenses paid by him while in the service of the employer that were not reimbursed due to the bankruptcy of the employer corporation. The travel expenses had been incurred during a trip to Europe to negotiate certain contracts for the sale of goods which would produce income to the company and increase the taxpayer’s own income because his remuneration was based on a salary of five per cent of the net profit of the company.

In terms of analyzing the relationship of the debt to the purpose of gaining or producing income from a business or property, the decision of the Honourable Judge Rip, of the Tax Court of Canada, in Business Art Inc. v. M.N.R., [1987] 1 C.T.C. 2001, 86 D.T.C. 1842 is helpful. At pages 2008-09 (D.T.C. 1848) of his judgment, Judge Rip stated:

However even if no interest was chargeable I do not believe that would be fatal to the appellant’s alternate submission. The fact that there may have been no interest attached to the debts in question is not relevant in deciding whether they were acquired for the purpose of gaining or producing income. See The Queen v. Lalande, [1983] C.T.C. 311, 84 D.T.C. 6159 at page 318 (D.T.C. 6164). It is not uncommon for a shareholder to lend money without interest and without security to the corporation since he anticipates that the loans will assist the corporation to earn income and to pay him income by way of dividends; the loan is made for the purpose of earning income from a property. Although the shareholder is a creditor of the corporation when he advances money to the corporation the shareholder does not see his advance of money to the corporation and his subscription for shares of the corporation as separate investments in two watertight compartments; rather he sees his money entering two compartments which open up into a single compartment for the use of the corporation. Purchasing shares and advancing money to a corporation are two ways of making an investment in the corporation. This is a sensible interpretation.

Similarly a shareholder of a corporation who may have incorporated a corporation for the purpose of acquiring product at a low cost and so reduce its own costs may advance money without interest to the corporation to enable the corporation to operate as intended; in this example even if the shareholder is not making loans for the purpose of producing income from its business, by having reduced costs, the loan is being made to earn income from property, that is, to receive dividends on the shares it owns in the corporation. It is not unusual for a person to invest in a corporation by subscribing for share capital and lending money without interest; as far as he is concerned the shares and his loans constitute a single investment and if later on, he is called on to advance further funds without interest he is only increasing his investment. I cannot subscribe to the theory that in such an example the non-interest bearing loans were not incurred for the purpose of earning income from property; if the loans were not advanced the corporation may have become bankrupt and the shares may have become worthless. Clearly the loans were made to earn income from property, that is, to place the corporation in a position where it will be successful and pay dividends.

The difference between the taxpayer's situation in Business Art Inc., supra, and that of the appellants in the within appeal is that they were not shareholders in WFC, the corporation to whom the loans were made. However, the making of the loans to WFC did in fact result in reduced costs of operation to BFL, in which they, as a unit, controlled the majority of the shares. As such, they were able to use their money in a way that would lead to the production of income, although not in a manner that was capable of being placed into a neat, tidy, labelled pigeonhole. Unlike the taxpayer's situation in Ellis, supra, there was more than a possibility of benefit, in that instance so remote that Judge Brulé concluded the loan guarantee was not undertaken for the purpose of gaining or producing income from a business or property.

Having regard to all of the evidence and in light of the decisions referred to herein, I find that subparagraph 40(2)(g)(ii) does not apply to the appellant's loans of $50,000 to WFC and that they did acquire the debt for the purpose of gaining or producing income from a business or property.

The issue that remains is whether the appellants, John Burns and Gary Burns, are entitled to claim an ABIL in each of their 1986 and 1987 taxation years on the basis that 50 per cent of both loans to WFC, that is, the inherited loan of $25,695.50 and the loan of $50,000, were uncollectible at the end of the relevant taxation year.

The decision of Mr. Fisher of the Income Tax Appeal Board in Hogan v. M.N.R. (1956), 15 Tax A.B.C. 1, 56 D.T.C. 183, has been regarded as a leading case with respect to what constitutes a bad debt within the meaning of subsection 50(1) of the Act. Reference to that Hogan decision is found in the decision of the Honourable Judge Sarchuk, of the Tax Court of Canada, in Berretti v. M.N.R., [1986] 2 C.T.C. 2293, 86 D.T.C. 1719, as he undertook an analysis of the appropriate method of establishing that certain debts had become bad in a particular taxation year. At pages 2297-98 (D.T.C. 1722) of his judgment, Judge Sarchuk stated:

Counsel for the appellant relied upon Hogan v. M.N.R. (1956), 15 Tax A.B.C. 1, 56 D.T.C. 183; Gestion Louis Riel Inc. v. M.N.R., [1985] 2 C.T.C. 2211, 85 D.T.C. 550; Ferriss v. M.N.R., [1964] C.T.C. 491, 64 D.T.C. 5304 and Roy v. M.N.R. (1958), 20 Tax A.B.C. 385, 58 D.T.C. 676. Certain principles can be excerpted from these decisions. There is for example no necessity that a debt be absolutely irrecoverable (vide Hogan) and that possible recovery in the future is not per se a bar to a determination of uncollectibility (vide Riel and Ferriss). These judgments also confirm the proposition that the determination of uncollectibility is to be made by the appellant and not by an official of the respondent or some other person.

However, one cannot ignore the fact that a taxpayer's decision that a debt is a “bad debt” must be made on the basis of a recent consideration of all of the known facts. In Hogan, supra, Mr. Fisher stated at page 17 (D.T.C. 193):

For the purposes of the Income Tax Act, therefore, a bad debt may be designated as the whole or a portion of a debt which the creditor, after having personally considered the relevant factors mentioned above in so far as they are applicable to each particular debt, honestly and reasonably determines to be uncollectable at the end of the fiscal year when the determination is required to be made, notwithstanding that subsequent events may transpire under which the debt, or any portion of it, may in fact be collected. The person making the determination should be the creditor himself (or his or its employee), who is personally thoroughly conversant with the facts and circumstances surrounding not only each particular debt but also, where possible, each individual debtor. . . .

In Roy, supra, Mr. Boisvert (T.A.B.) adopted the views of Mr. Fisher in the Hogan case previously referred to and added the following comment at page 403 (D.T.C. 680):

As the Act does not define a bad debt, it is necessary to turn to recognized accounting principles of business practice. A debt is recognized to be bad when it has been proved uncollectable in the year.

Reference should be made to one further comment in Hogan, supra, at page 11 (D.T.C. 190):

After all, the legislation indicates that it is the taxpayer who has to establish whether debts are bad or not, and his familiarity with the particular accounts and with his clients, their circumstances and all the other factors involved is, in my opinion, to be accepted if one is convinced from his evidence that he has acted honestly and on sound general principles.

[Emphasis added.]

In each of the decisions cited by counsel there was evidence upon which the Court was satisfied that the taxpayer acted in a pragmatic businesslike manner. In the case at bar the evidence adduced does not meet that test. Although it is reasonable to infer that Lachman discussed his calculations with the appellant at or about the time that he prepared the appellant’s 1982 income tax return, there is little evidence as to the considerations upon which the appellant acted. It was critical to his appeal that there be some acceptable evidence as to the basis upon which the taxpayer made the “bad debt’’ determination.

The evidence of Gordon Burns was that on October 25, 1986 WFC resolved it would cease to carry on business effective December 31, 1986, that the debt owing to the appellants would not be paid in full and that the most they could expect to collect would be 50 per cent of the amount outstanding. The minutes of a special meeting of WFC (Exhibit A-38) disclose that situation to have been recorded. It is clear that the appellants were well aware of that situation prior to the end of 1986. It was also clear on all of the evidence, including that of Mr. Nupdal, loans manager of the credit union, that the situation for WFC was precarious throughout 1986 and by the end of September, 1987, it was obvious that there would be no money at all forthcoming from WFC to pay on any of the loans owing to the appellants. As a result, the appellants were in a position to determine that the balance of the loans had become a bad debt prior to the end of the 1987 taxation year. The requests for an adjustment to their T1 returns for 1986 were made in March, 1988 but the evidence of Wayne Coleman, the accountant, is that the appellants, in March, 1987, were well aware of the loans to WFC not being fully collectible and discussions were held as to whether claims for an ABIL should be made. In my opinion, the appellants have demonstrated that there is no reason for the Minister to have taken the position that the loans to WFC went bad only during the 1987 taxation year. The apportionment of the loss equally between the 1986 and 1987 taxation years as claimed by John Burns and Gary Burns is correct. The timing of the bad debts did not affect the appeal of Deborah Klebeck and the only issue there was whether or not her $50,000 loan to WFC was prevented by the application of subparagraph 40(2)(g)(ii) from a claim for an ABIL, which I have found not to be the case.

The appeals of the appellants, John Burns and Gary Burns are allowed for the taxation years 1986 and 1987 and the appeal of Deborah Klebeck is allowed for the taxation years 1987 and 1988 and the matters are referred back to the Minister for reconsideration and reassessment on the following basis:

1. That the loans of $25,695.50 and $50,000 made by each of the appellants to WFC were debts acquired for the purpose of gaining or producing income from a business or property.

2. That the appellants made a reasonable determination that 50 per cent of the loans were uncollectible at the end of the 1986 taxation year and that the balance of the loans were uncollectible at the end of the 1987 taxation year.

3. That Deborah Klebeck’s child tax credit for the 1987 taxation year be recalculated and that her non-capital loss carried forward from her 1987 taxation year be allowed in computing income for her 1988 taxation year.

As to the matter of costs, Gary Burns was not present at the hearing and one counsel represented all of the appellants. Therefore, the appellants are entitled to one set of costs on a party-party basis.

Appeals allowed.