Belton Lumber Company Limited v. Minister of National Revenue, [1972] CTC 2065, 72 DTC 1076

W O Davis:—This appeal came on before me for hearing at the City of London, Ontario, on November 30, 1971, at a sittings of the Tax Appeal Board as it was then constituted. The appellant company appeals from a reassessment to income tax dated February 20, 1970, whereby, in levying tax in respect of the appellant’s 1968 taxation year, the Minister of National Revenue disallowed a loss of $92,511 which, in its income tax return for the year in question, the appellant claimed it had suffered in the operation of its business.

For many years the appellant has carried on the business of the wholesale and retail sale of lumber and builders’ supplies. In order to assure itself of an adequate supply of raw lumber for its business, the appellant was in the habit of negotiating therefor with sawmills having timber rights in the northern parts of Ontario and Quebec. As a rule these sawmills required advances of funds against deliveries of raw lumber in order to enable the sawmill operator to pay, equip and provision the crews sent into the bush to cut timber and skid it to the sawmill, and for many years the appellant followed the practice of making such advances as and when necessary. In some cases, and during certain years, these advances against deliveries exceeded the value of the raw lumber eventually delivered to the appellant by some of these suppliers and, in such event, any overpayment was treated as an item of additional cost in respect of the lumber actually supplied, and was thus recorded in the books of the company as a business expense.

For some years prior to 1968, however, the appellant was dealing, inter alia, with a supplier known as P P Vaillancourt Inc, and it seems that, in addition to having received advance funds from the appellant for wages and other operational expenses, P P Vaillancourt Inc had found itself in need of substantial additional funds for the purchase of machinery and equipment to enable it to cut and ship raw lumber in sufficient quantities to satisfy its commitments to the appellant and others. The said supplier had therefore made arrangements with the Bank of Montreal for a line of credit and, as an accommodation, repayment thereof had been in turn guaranteed by the appellant, who, admittedly, held no share interest in the Vaillancourt enterprise.

In the course of 1967, due to serious financial indebtedness from which it was unable to extricate itself, P P Vaillancourt Inc was compelled to abandon its lumbering business. At this time it was indebted to the Bank of Montreal, through its line of credit, in an amount of $158,616. The appellant was called upon to make good to the Bank on its guarantee, and did so.

It is on the record that, on November 20, 1967, the appellant, having discharged its liability to the said Bank, took over certain security which had been pledged with the bank as collateral by P P Vaillancourt Inc and consisting, in particular, of a mortgage which the Bank of Montreal had held on all the fixed assets of the said P P Vaillancourt Inc. The appellant immediately took steps to realize on this mortgage, and succeeded in recovering $85,000 thereunder, leaving an unrecovered balance of $73,616 in respect of the monies paid out by it in the process of honouring its guarantee. There had been certain added disbursements and expenditures which the appellant had had to make in the attending circumstances, and which can be set forth as follows:

This out-of-pocket balance of $92,521 the appellant sought to deduct from its 1968 income for taxation purposes.

From a consideration of all the facts which have been disclosed in the evidence adduced at the hearing, I have reached the conclusion that the liability assumed in connection with Vaillancourt Inc’s line of credit, and which the appellant was called upon to pay, was nothing other than an outlay of capital made by it on behalf of P P Vaillancourt Inc, no doubt with the hope of preserving what had in the past proved to be, for the appellant, a valuable source of lumber at an advantageous price. This amount was therefore not deductible as a business expense by reason of the provisions of paragraphs 12(1)(a) and (b) of the Income Tax Act.

The judgment of the Supreme Court of Canada in MNR v George H Steer, [1967] SCR 34; [1966] CTC 731, appears to be very much in point. Put briefly, the facts of that matter were that the taxpayer and an associate made an agreement with two other individuals to acquire an interest in a petroleum company. The two other individuals had obtained a farm-out agreement from Imperial Oil which they had assigned to the petroleum company in return for 1,000 shares and a stated royalty. They had incurred an obligation to drill four wells on the property, and when they admitted the taxpayer and his associate into the enterprise, three wells remained to be drilled. Each of the four participants then received one-quarter of the 1,000 shares assigned by the company and a one-quarter interest in the stated royalty, and the taxpayer and his associate agreed to guarantee advances from the bank up to a maximum of $62,500 each. In 1957, the latter were called upon to make good on their undertaking to the bank. Part of the taxpayer’s outlay was later recovered, as, following the bankruptcy of the company, certain distributions were made to its creditors, which included Steer and his associate.

The taxpayer in that case sought to treat his $62,500 outlay as a deduction from his 1957 income. However, the Supreme Court of Canada held that the transaction entered into by the taxpayer was in the nature of a deferred loan to the company, and that whatever amount of the said outlay remained unrecovered after receipt of his share of the distribution made to the unsatisfied creditors of the bankrupt company was a non-deductible capital loss within the meaning of paragraph 12(1 )(b) of the Act.

If I have correctly interpreted the evidence, this same principle is present in the instant matter, and I therefore conclude that the appeal cannot succeed and it is therefore dismissed.

Appeal dismissed.