A W Prociuk (orally: April 6, 1978):—At the commencement of the hearing, by consent of all parties, these two appeals were heard on common evidence. The appellants, Anne E Flintoft and William J Flintoft, are husband and wife, and are the sole shareholders of Yule Mortgage Ltd, a company, incorporated pursuant to the laws of the province of British Columbia with its offices at Vancouver, and which was and is engaged in the business of property rentals and money lending since 1959. Jack Lee is the son of the appellant Mrs Anne E Flintoft, by her first marriage, and a stepson of the appellant William J Flintoft.
Jack Lee Ltd was incorporated in 1967, pursuant to the laws of the province of British Columbia, to be engaged in public relations business. Its sole shareholders, on a 50/50 basis, were and are the said Jack Lee and the appellant William J Flintoft.
The appellants appeal from the reassessment of their personal incomes for the taxation year 1971 by notice of reassessment dated June 8th, 1976, wherein a sum of $7,431.25 in each case was added to their respective incomes on the premise that it was an indirect payment received from Yule Mortgage Ltd, within the meaning of subsections 8(1), 16(1) and 137(2) of the Income Tax Act, RSC 1952, c 148, as amended, which read as follows:
8.(1) Where, in a taxation year,
(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction,
(b) funds or property of a corporation have. been appropriated in any manner whatsoever to, or for the benefit of, a shareholder, or
(c) a benefit or advantage has been conferred on a shareholder by a corporation,
otherwise than
(i) on the reduction of capital, the redemption of shares of the winding-up, discontinuance or reorganization of its business,
(ii) by payment of a stock dividend, or
(iii) by conferring on all holders of common shares in the capital of the corporation a right to buy additional common shares therein,
the amount or value thereof shall be included in computing the income of the shareholder for the year.
16.(1) A payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.
137.(2) Where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatsoever 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 III applies, or
(c) deemed to be a disposition by way of gift to which Part IV applies.
The facts of the case are essentially not in dispute and are as follows, as related by William J Flintoft, who appeared on behalf of both appellants at the hearing. Jack Lee lived with the appellants for a while after they became married. He finished his schooling and went to work for the Vancouver Sun. Later he went into public relations work, mainly with PNE on a salary basis. He decided to establish himself as an independent public relations entity but required funds to achieve this objective. He approached his step-father, the appellant herein, and requested a loan of $15,000 from Yule Mortgage Ltd.
The appellant states that, in his view, on the basis of what he had heard and observed of Lee’s endeavours in public relations, there were good prospects of Lee being successful as an independent contractor. However, he states further that he wanted to protect the loan and Jack Lee Ltd was incorporated with each holding a 50% interest without right of disposing of the shares allotted to each, unless consented to in writing by the other shareholder. An Agreement dated November 7th, 1967, was drawn up between Jack Lee Ltd and Yule Mortgage Ltd, including Jack Lee and the appellant William J Flintoft personally, in their personal capacities. The said agreement was filed as Exhibit A-1 and reads as follows:
THIS AGREEMENT dated the 7th day of November, 1967.
BETWEEN:
JACK LEE LTD, a company duly incorporated under the laws of the province of British Columbia, and having its registered office at 201 - 535 Thurlow Street, in the city of Vancouver, in the province of British Columbia;
OF THE FIRST PART
AND:
JACK LEE, public relations man, of 4345 Baker View Street, in the district of North Vancouver, in the province of British Columbia;
OF THE SECOND PART
AND:
YULE MORTGAGE LTD, a company duly incorporated under the laws of the province of British Columbia, and having its place of. business at 700 St Andrews Road, in the municipality of West Vancouver, in the province of British Columbia;
OF THE THIRD PART
AND:
WILLIAM JAMES FLINTOFT, businessman, of 700 St Andrews Road, in the municipality of West Vancouver, in the province of British Columbia;
OF THE FOURTH PART
WHEREAS Yule Mortgage Ltd (hereinafter called “Yule”) has agreed to lend to Jack Lee Ltd (hereinafter called “the company’’) the sum of $15,000;
AND WHEREAS Jack Lee has agreed to personally guarantee the repayment of the said loan of $15,000 to Yule;
AND WHEREAS Jack Lee and William James Flintoft are the holders of 50 shares each in the capital stock of the company;
AND WHEREAS the financial and business success of the company is wholly contingent upon the continued efforts of Jack Lee for and on behalf of the company;
NOW THEREFORE THIS INDENTURE WITNESSETH that in consideration of the mutual covenants and agreements herein contained the parties hereto agree each with the other as follows:
1. Yule hereby agrees to lend the company the sum of $15,000 bearing interest at 8% per annum to be repaid out of 100% of net profits of the company until the whole of the said sum of $15,000 plus interest is fully repaid to Yule, such payments to be made at the end of each fiscal period of the company and shall be applied firstly in payment of interest and secondly in reduction of the principal balance then remaining unpaid.
2. Jack Lee in his personal capacity hereby covenants and agrees with the company and with William James Flintoft and Yule that in the event that the company is unable, for any reason whatsoever, to repay all or any part of the loan referred to in paragraph 1 hereof, he shall and does hereby personally agree and undertake to repay the said sum of $15,000, or any part thereof from time to time remaining unpaid, and interest thereon at the rate of 8% per annum to the date of such payment. Provided however that in the event that Jack Lee shall become personally liable for the obligation hereunder he shall, within 60 days after becoming personally liable, commence payments of $250 per. month to Yule, and such payments shall be applied firstly in payment of interest and secondly in reduction of principal until the whole amount of the obligation assumed is paid.
3. Until the loan referred to in paragraph 1 hereof is wholly repaid by either the company or Jack Lee, as the case may be, Jack Lee shall devote his full time, energies and best efforts in the operation and administration of the affairs of the company.
4. The company hereby agrees with Yule to forthwith apply for a minimum insurance policy of $20,000 on the life of Jack Lee to secure the loan referred to in paragraph 1 hereof.
5. Jack Lee hereby agrees with the company and William James Flintoft to draw a maximum salary of $900 per month and no more than $100 per month for miscellaneous expenses, provided however that this term may be varied by the mutual consent of Jack Lee and William James Flintoft.
6. It is agreed between the parties hereto that the company shall, at the expense of the company, lease a car for the use and benefit of both the company and Jack Lee.
7. Jack Lee and William James Flintoft shall each subscribe and pay for 49 shares of the capital stock of the company, provided however and it is understood between the parties that until the loan referred to in paragraph 1 hereof is fully repaid there will be no division of earnings in any form whatsoever notwithstanding the shareholders’ equity in the company and thereafter any earnings paid or dividends declared shall be in accordance with the shareholders’ respective interests.
8. Jack Lee and William James Flintoft hereby covenant and agree with each other that they shall not transfer, assign, set over or sell all or any part of their interest in the company or issue any further shares in the company unless mutually agreed in writing between them.
9. Time shall be of the essence of this agreement.
This agreement shall enure to the benefit of and be binding upon the parties hereto and their respective heirs, successors, administrators, executors and assigns.
It was a term of the agreement that Jack Lee would be the sole manager, worker and driving force of Jack Lee Ltd. Flintoft states that he merely entered the picture to protect the loan his company advanced. Yule Mortgage Ltd loaned $15,000 to Jack Lee Ltd, which the latter agreed and covenanted to repay with interest at 8% per annum out of its annual profits. Jack Lee personally guaranteed the repayment of the loan in the event that the company was unable to do so. It came out that the actual amount of the loan was $14,625 as the first $375 were used up in establishing the company.
Flintoft initially assisted Lee in setting up the office and thereafter played no part in the company’s operations. Jack Lee Ltd, through the efforts of Jack Lee, experienced varying degrees of success and failures.
The appellant William J Flintoft states that while he was after Lee on numerous occasions to commence repayment of the loan pursuant to the terms of the agreement, Lee always promised to do so. But his company, that is Jack Lee Ltd, never appeared to make sufficient money to cover his company’s operating costs and have a surplus to apply towards the discharge of the loan.
Yule Mortgage Ltd, at all times, employed a firm of chartered accountants who audited and prepared its financial statements.
In 1971 Yule Mortgage Ltd, on the advice of its accountants, wrote off some $46,000 as bad debts, including the loan to Jack Lee Ltd. To that date Yule Mortgage Ltd had not received any repayment from Jack Lee Ltd nor from Jack Lee personally. The appellant nevertheless continued in his effort to obtain repayment of the loan. In September of 1974 Jack Lee succeeded in obtaining, what then appeared to be a financially lucrative position with an eastern firm called Analytical Communications Incorporated (hereinafter referred to as “ACI”). Jack Lee also succeeded in obtaining a further loan of $6,000 from the appellant Flintoft personally. In return he assigned the sum of $25,000 of what he was to receive from ACI and directed ACI to pay the said sum to Yule Mortgage Ltd. I infer from the evidence that $25,000 was made up of the $15,000 with interest owing to Yule Mortgage Ltd and the remainder included the $6,000 which Lee borrowed personally. (See page 2 of Exhibit A-3, a letter dated September 12th, 1974). Lee did not remain with ACI long enough to earn the said assigned sum of $25,000, but he did repay the $6,000. The original loan and interest thereon owing to Yule Mortgage Ltd still remains unpaid. Mr Flintoft remains firm in his conviction that Lee will eventually repay, as he has obtained a further written undertaking from Lee dated January 15, 1977, to that effect which was filed as Exhibit A-2 and which reads as follows:
Mr W J Flintoft,
Yule Mortgage Ltd
700 St Andrews,
West Vancouver, BC
January 15, 1977
Dear Jim:
This letter will confirm that I remain indebted to your company, Yule Mortgage Ltd, for the sums of money that Yule Mortgage Ltd advanced to form Jack Lee Limited on November 7, 1967.
As you know, the finances of Jack Lee Limited were never sufficient enough for the company—or me, personally—to effect repayment to Yule Mortgage Ltd.
However, even though the debt is now long outstanding, may I reiterate my intention to completely repay the debt when possible.
Yours truly,
(Signed) Jack Lee
Jack Lee,
#2301, 1651 Harwood St Vancouver, BC
Flintoft, in his evidence, also stated that he had threatened Lee, presumably with civil action, for the recovery of the account but he has entertained substantial doubts whether that would assist in collecting the amount as Lee is and has been for some time in an employee Situation.
In 1976 the respondent’s local district office conducted an audit of Yule Mortgage Ltd as well as Jack Lee Ltd. It was noted that in the books of Jack Lee Ltd the shareholders’ account of Jack Lee was credited with $14,862.50 and loans payable were debited for the same amount. The respondent accordingly assessed both appellants, as stated earlier, on the basis of indirect payments deemed to have been received from Yule Mortgage Ltd. Jack Lee Ltd has been inactive since 1973 or 1974 and Jack Lee has since then become an employee of various firms. There is also some suggestion that Jack Lee Ltd did very little work after 1971.
At the hearing the appellant stated that at no time had his company, Yule Mortgage Ltd, directly or indirectly forgiven the indebtedness. Mr M G Aikman, CA, acting on behalf of the appellants, stated that he checked with the former accountants of Jack Lee Ltd with reference to the book entry referred to above, and was informed that that simply meant that Jack Lee was taking personal responsibility for repayment of the loan to Yule Mortgage Ltd, as Jack Lee Ltd was inactive at that time.
Counsel for the respondent, W Mah, Esq, in his summation stated that the respondent regarded the 1967 transaction as bona fide and legitimate. However, in June of 1976 the respondent took the position that when Yule Mortgage Ltd set up the amount of the loan as a bad debt in 1971, as it was permitted to do, the Board ought to interpret this as in effect forgiveness of the debt and accordingly the assessment of the individual shareholders of Yule Mortgage Ltd ought to be sustained.
With every deference to counsel for the respondent, I am constrained to say that in the light of the totality of the evidence before the Board, such a submission, in my humble opinion, totally defies all sense of logic, and the proper interpretation of the relevant sections of the Act. In setting up a bad debt in 1971, which Yule Mortgage Ltd was bound by law to do, and I refer to paragraph 11 (1 )(f) of the old Act; whence it determined that it became a bad debt in that year and not at a later date. If recovered at a subsequent date then, of course, it would be deemed income. The respondent, it will be noted, did not challenge the writing off of this item at any time. How then can it be said that subsection 137(2), for instance, applies in 1971? There was no sale, exchange, declaration of trust or a transaction of any kind. It was merely a proper accounting entry reflecting the position of that account. As to subsection 8(1), it is admitted that in 1967 it was a bona fide transaction.
The evidence satisfies me that Yule Mortgage Ltd believed that it would collect a fair market interest rate on the loan and that full recovery in due course would be achieved. Jack Lee Ltd used the funds in an attempt to generate income for that corporation but did not succeed. It is difficult to see how in 1971 the appellants, or either of them, had any benefit from the loan made to Jack Lee Ltd in 1967 and which loan was disbursed as operating expenses of that company.
Subsection 16(1) refers to payment or transfer of property made pursuant to the direction of or with concurrence of a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred upon the other person. This could only have happened in 1967 at the time the loan was made if the circumstances had been different.
The case at bar differs substantially from the cases cited and I refer especially to Estate of C A Pitt v MNR, 22 Tax ABC 57; 59 DTC 275, and to MNR v Allan Bronfman, [1965] CTC 378; 65 DTC 5235, where in one case there was an actual forgiveness of indebtedness, and in the latter substantial gifts given to immediate members of the family.
In conclusion, I hold that the appellants have: been successful in totally demolishing the assumptions of fact on which the respondent based his reassessment and are entitled to succeed.
Accordingly, the appeal in each case is allowed.
Appeal allowed.