Laxton v. The Queen, 88 DTC 6008, [1988] 1 CTC 19 (FCTD), rev'd , in part, 89 DTC 5327 (FCA)

Reed, J.:—The plaintiff appeals a reassessment of his taxable income for the 1981 and 1982 taxation years. The Minister of National Revenue reassessed the plaintiff on the basis that certain amounts should have been included in his income for those years, on account of an interest-free loan which he held at the time.

In August of 1979, the plaintiff, a firm of accountants and the Western Regional Council of the International Woodworkers of America (the I.W.A.), agreed to enter into a joint venture for the purpose of constructing an office building on Pender Street in Vancouver. It was contemplated that on completion of the building, the three joint venturers would be among the tenants of the building, as well as remaining its owners. This, in fact occurred, and remains so to this day.

The joint venture agreement provided that: the plaintiff would hold a 36.66 per cent interest; the accountants would hold a 31.67 per cent interest and the I.W.A. would hold a 31.67 per cent interest. The plaintiff subsequently, in 1982, increased his percentage ownership first to 45 per cent and then to 50 per cent. The joint venture operated through the vehicle of a corporation named "Evergreen Building Limited” which was a bare trustee. The joint venturers were shareholders of that corporation.

While the joint venture agreement provided for financial liability to be shared among the three parties in accordance with their proportional interest in the joint venture, in reality each was required by the bank from which financing was received, to become liable for 100 per cent of the financing debt. The plaintiff alleges that as a practical matter, his risk was greater than the others because his financial situation was stronger (e.g. the I.W.A., he alleges, is not a legal entity and in any event has no assets independent of its individual local members).

The agreement provided that the plaintiff taxpayer would have the primary responsibility for the management of the construction of the building and, after completion, he would act, at least for a short time, as building manager:

Article 7 - Management

7.1 It is agreed that John Laxton shall be responsible for management of development up to and until the completion of construction and for that purpose he shall devote such time and skill to the development as is necessary to have the construction completed expeditiously.

7.2 It is further agreed that John Laxton will be advanced as an interest-free loan, the following amounts on the following terms:

(a) advances will be made in monthly installments of $10,000 each, commencing April 1, 1979 and on the first day of each month thereafter up to and including June, 1980;

(b) the said advances are to be derived solely from mortgage funds and the provisions of Article 9.3 herein may not be used to generate sufficient monies to make such advances;

(c) in the event of a cash shortfall, one-half of the amounts advanced pursuant to subclause (a) hereof shall be repaid by John Laxton;

Article 8 - Management Following Construction

8.1 Following completion of construction the Developers [the joint venturers] will contract for the long-term management of the lands and premises.

8.2 Commencing April 30, 1981, John Laxton shall oversee the general management of the lands and premises on behalf of the Developers for which John Laxton shall be paid a monthly fee computed on an annual basis as follows:

(a) $450,000 minus such interest-free loans made to John Laxton pursuant to Article 7.2 hereof, together with any other interest-free loans made to John Laxton, multiplied by an amount equivalent to the prime rate charged by the Bank of Montreal, Main Branch, Vancouver, B.C., to its most favoured commercial customers;

Thus the management fee was to be calculated by reference to the interest payable on $450,000 as that might fluctuate from time to time. The cash component of that fee was to vary depending upon whether or not the plaintiff had been advanced the total amount of $450,000 as an interest-free loan, or some lesser amount. It was contemplated that the plaintiff would be entitled to the first $450,000 profit, if the building were ever sold. And, that the $450,000 loan (or whatever amount was in fact outstanding) would be repaid by the plaintiff out of the profits occurring on sale. If there were no profits, the plaintiff would be obligated to repay the principal amount of the loan directly.

Article 3.1 of the agreement provides:

The Developers [the joint venturers] further agree that should the said lands and premises be sold, the profit, if any, shall be allocated as to John Laxton, the first $450,000, and the balance, if any, to the Developers in accordance with their respective proportions. The $450,000 paid to John Laxton or such part thereof as is necessary shall be used first to repay any loans made by the Developers to John Laxton.

The project was commenced in the spring of 1979 and the plaintiff began in April of that year receiving instalments of $10,000 per month by way of an interest-free loan. The building was completed in August 1980. The plaintiff had received, as of that date, a total of $229,000. There was some suggestion in the evidence that the amount might be less because certain sums had been advanced back to the joint venture in August and September 1980 ($17,000 and $18,000 respectively). I do not consider this evidence reliable enough to dislodge the conclusion, which appears from the rest of the evidence, that the total was $229,000. These amounts were advanced to the plaintiff out of the financing moneys (mortgage) provided to the venture group by the bank. The venture, of course, paid the bank interest on this financing.

With the completion of the building the plaintiff took on the role of building manager and management fees pursuant to Article 8 of the joint venture agreement became payable. The plaintiff acted as building manager for two years (1981 and 1982); after that time professional building managers were employed.

The Minister’s argument is simple: the income received by the plaintiff, as compensation for the services he provided as building manager in 1981 and 1982, must include not only the cash payments he received during those years but also an amount attributable to the value of the interest-free loan (which during the years in question stood at $229,000). It is clear that the amount paid in cash pursuant to clause 8 was intended to vary with the amount of loan which might be outstanding. Indeed, the plaintiff invoiced Evergreen Builders Limited on this basis (Exhibit 5). Had there been no loan advanced to the plaintiff, the cash fees payable would have been much larger (i.e. the total amount of the fee would have been paid in cash). The larger the loan outstanding, the smaller would be the management fees paid by way of cash.

The Minister argues that it is simply a matter of applying section 3 of the Income Tax Act, R.S.C. 1952, c. 148.

The income of a taxpayer for a taxation year . . . is his income for the year determined by the following rules:

(a) determine the aggregate of amounts each of which is the taxpayer’s income

for the year (other than a taxable capital gain . . .) [Emphasis added.]

The term "amount" is defined by subsection 248(1):

“amount” means money, rights or things expressed in terms of the amount of money or the value in terms of money of the right or thing [Emphasis added.]

It is argued that the value of the interest-free loan constituted the value of a right or thing (the right to the use of the money loaned), which was obtained by the plaintiff as part of the compensation paid to him as management fee.

Alternatively, it is argued subsection 245(2) of the Income Tax Act applies: 245(2) Where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatever is that a person confers a benefit on a taxpayer, that person shall be deemed to have made a payment to the taxpayer equal to the amount of the benefit conferred notwithstanding the form or legal effect of the transactions or that one or more other persons were also parties thereto; and, whether or not there was an intention to avoid or evade taxes under this Act, the payment shall, depending upon the circumstances, be

(a) included in computing the taxpayer's income for the purpose of Part I,

(b) deemed to be a payment to a non-resident person to which Part XIII applies, or

(c) deemed to be a disposition by way of gift.

The decision in M.N.R. v. Dufresne, [1967] C.T.C. 153; 67 D.T.C. 5105 (Exch. Ct.) is cited for the proposition that the term "transactions" in subsection 245(2) is a very broad concept. In the Dufresne case a taxpayer who controlled a family company had issued stock options to members of the family company. He and his wife refrained from exercising theirs but the children of the family did so. This was held to constitute a transaction conferring a benefit on the children. It would seem clear that the making of the loans by the joint venture and the payment of the management fees in 1981 and 1982 by reference to the amount of the loans outstanding were transactions within the terms of subsection 245(2). That subsection would not be inapplicable merely for inability to find a transaction or transactions to which it might attach.

The plaintiff argues: (1) there is no specific section (such as subsection 15(1) which deals with shareholder benefits) which requires that the interest attributable to an interest-free loan, conferred on an individual, be treated as either income or a benefit; (2) the economic reality of the situation must be looked at and in this case there was no economic advantage to the plaintiff arising out of the way the transaction was structured; (3) at the very least, since the plaintiff held a one-third (approximately) interest in the joint venture, he was indebted to himself for one-third the amount and the benefit payable to him should be reduced by at least one-third; (4) if a benefit was conferred, it was conferred in 1979 and 1980 when the loans were made and not in 1981 and 1982.

With respect to the first argument, it is of course true that there is no section of the Act (comparable to subsection 15(1)) specifically dealing with the fact situation now in issue. This is irrelevant, however, if the situation falls within one of the more broadly drafted sections such as sections 3 or 245(2).

The plaintiff's second argument, if I understand it correctly, is that: the payment of the management fee was calculated by reference to the interest payable on $450,000; the cash portion payable was reduced by reference to the amount of any interest-free loan the plaintiff might hold; thus, requiring the plaintiff to pay interest on the loan (as it is argued the defendant's portion would require him to do) would lead to a directly proportional increase in the cash management fee he would receive. It is argued that the foregone interest on the loan is a direct set off to the increase in the cash management fee he would otherwise receive and, therefore, there is no economic advantage to the plaintiff arising from the structure of the transaction. It is argued that the plaintiff is in no better position than would have been the case had interest been charged and, therefore, the interest-free loan cannot be an economic advantage; it cannot be a benefit. Secondly, the plaintiff argues that the loan received by him was used to invest in various income producing (or at least potentially so) assets. Had he not received the interest-free loan, he would have borrowed for this purpose; the interest on that borrowing would have been tax deductible as an expense. Thus, it is argued that to now treat the use of the loan as income in his hands, amounts to double taxation — the income potential for the loan has been taxed twice. (That is, the profit from the investments entered into with the loan money has been taxed without any deduction having been made therefrom for interest expense because the plaintiff did not borrow for that purpose.)

I have considerable difficulty with the plaintiff's arguments. With respect to that concerning double taxation, I think it is irrelevant what use the plaintiff made of the loan money. And, in any event the evidence tendered for the purpose of proving how the money was used is simply not sufficient to support the conclusions sought to be drawn therefrom. With respect to the argument that the structure of the transaction is such that even had the plaintiff paid interest on the loan, there would have been no change in his economic position (i.e. no less favourable economic position would have resulted), I do not see the relevance of that factor. The plaintiff received economic advantage in the form of cash compensation plus an interest-free loan. The question is whether all of that amount should be taxed as income or only the cash component.

With respect to the plaintiff's third argument, I accept counsel for the defendant's position that this is not a case of "self-dealing" where the taxpayer "borrower" and the taxpayer “income recipient” are one. The joint venture, through the vehicle of Evergreen Building Limited (as bare trustee), is interposed. Even though the taxpayer may, as a practical matter, be ultimately liable (along with the other joint venturers) for the total amount of the joint venture's debt, this does not mean he has paid the cost of borrowing. The cost of borrowing was borne by the joint venture. The fact that the plaintiff pays one-third of that (subsequently increased to 45-50 per cent) does not mean that he can ignore for the purposes of his income calculation, remuneration paid to him by the joint venture in the form of an interest-free loan.

Where an agreement explicitly provides that a taxpayer's remuneration for services is to take the form of an interest-free loan, the taxpayer should be required to recognize that remuneration in some form in his taxable income. This is particularly so where there are acknowledged borrowing costs being paid by another in order to obtain the funds being loaned to the taxpayer. It is difficult to understand why the value of the benefit received by the taxpayer should not be equated to the amount of the borrowing costs, or in this case, by reference to the calculation as provided for in Article 8 of the joint venture agreement. The fact that the taxpayer may himself be liable (as a member of the joint venture) for part of the borrowing costs is an independent matter and indeed, in this case, his tax returns were prepared on that basis. The cost of borrowing by the joint venture was accounted for as an expense of the joint venture and the plaintiff's proportion of that expense was carried into his income tax return under the joint venture account. It seems to me that to allow a one-third reduction of the income attributable to the interest-free loan would be to allow that deduction twice over.

The decisions in M.N.R. v. Pillsbury Holdings Limited, [1964] C.T.C. 294; 64 D.T.C. 5184 (Exch. Ct.), Sewell v. M.N.R., [1968] Tax A.B.C. 358; 68 D.T.C. 328, and Bartley v. M.N.R., 42 Tax A.B.C. 237; 66 D.T.C. 752, were cited for the proposition that there is no obligation to charge interest on a loan and that an interest-free loan does not constitute a taxable benefit.

The Sewell and Bartley cases both deal with gift tax. That alone may be enough to distinguish them. But in any event, I note that in the Sewell case the Board held that no benefit had been conferred, because the sons would not obtain title to the property in question until the purchase price had been paid in full; the sale transactions had not been completed. While the Board referred to the fact that there was no obligation to charge interest on deferred payments, it did so only to support its position that the failure to charge interest did not mean there had been a section 111 disposition. In the Bartley case, while the Board held that there was no obligation on the father to charge his son interest, it also held that the value of the benefit conferred could not be calculated because the principal amount owing might be paid off at any time.

The Pillsbury case held that the foregiveness of interest was a bona fide business transaction and not a benefit conferred on a shareholder qua shareholder. Whatever the circumstances of these cases cited, it seems clear to me that the benefit of the interest-free loan conferred on the taxpayer in this case, for the reasons given above, is income, either pursuant to section 3 and the definition of "amount" in subsection 248(1) or it is a benefit falling under subsection 245(2).

What then of the argument that if a benefit has been conferred it should be attributed to the year or years in which it was made. The Bartley and Sewell cases are referred to for this proposition. As noted above, both those cases relate to gift taxes (now defunct) and there was an attempt to do a present value calculation (see Bartley case at page 239 (D.T.C. 754)) as of the year the loan was made. That may be appropriate with respect to gift tax, where there is an assumption that the gift is made in the year the loan is given. But I do not think that applies in a case such as the present where the benefit conferred by the interest-free loan is seen as component of the compensation being paid for management services which is calculated and invoiced on a monthly basis over several years. The benefit occurs on a continuing basis, as long as the loan remains outstanding.

The plaintiff's claim is dismissed except to the extent that a recalculation is required on the basis that the correct values for the benefits received are $34,206.88 (not $34,457.94) in 1981 and $37,116.88 (not $37,279.17) in 1982. This adjustment is one that is agreed upon by the parties.

Claim dismissed.