Garon, T.C.J.:—This is a case where the appellant appeals income tax assessments made by the Minister of National Revenue on November 4, 1985 with respect to its 1981, 1982 and 1983 taxation years.
The issue has to do with the disallowance by the respondent of amounts claimed as bad debts by the appellant and deducted by it under paragraph 20(1)(p) or section 9 of the Income Tax Act.
In computing its income, the appellant deducted certain amounts owing by two companies, I.C.B.I. Developments Ltd. (I.C.B.I.) and Lobstick Resorts Ltd. (Lobstick) pursuant to advances or loans that had been made to them by the appellant prior to the years in issue in these appeals. The appellant had loaned or advanced to Lobstick and I.C.B.I. approximately $388,000 and $970,000 respectively. In computing its income for the years 1981, 1982 and 1983 the appellant deducted the following amounts opposite the taxation years hereinafter set out with respect to loans made to the companies mentioned below:
| $87,000 | I.C.B.I. | 1981 | |
| $25,000 | I.C.B.I. | 1982 | |
| $66,850 | I.C.B.I. | 1983 | |
| $79.609 | Lobstick | 1983 | |
| TOTAL | $258,459 | ||
As appears from the notification of confirmation dated February 9, 1986, the respondent disallowed these amounts claimed by the appellant on the basis that the advances were not bad debts within the meaning of paragraph 20(1)(p) of the Income Tax Act and were not a capital loss from the disposition of property within the meaning of paragraph 39(1 )(b) of the Act.
Many of the facts giving rise to these appeals are not disputed.
The evidence indicates that the appellant was in the land development business and carried out various projects with others for the development of land. The appellant would either undertake the land development directly itself or in many cases it would embark upon the venture by either of the following three methods: joint venture, syndicate or corporation. The appellant's memorandum of association shows that it was empowered to carry on all activities relating to a land development business.
It is common ground that Mr. Norman Trouth held in the relevant years 50 per cent of the shares of the appellant and therefore did not control same. The other shareholder who also owned 50 per cent of the shares was Mr. David J. Freeze. Mr. Trouth was also a director and president of the appellant at the material times. Mr. Trouth had considerable experience in the land development business and was a land evaluator.
The appellant dealt at arm's length during these years with I.C.B.I. and Lobstick, the two corporations to which funds were advanced or loaned. Both of these corporations carried on the business of developing land. I.C.B.I. was engaged in carrying out a single project, known as the Big Sky Project. In fact, I.C.B.I. was formed for the sole purpose of pursuing a land development venture in the Big Sky area of Montana, in the United States of America. Likewise, Lobstick was involved in one project, referred to as the Lobstick River Project, which will be described later.
Mr. Norman Trouth was also a director and the chief operating officer of each of I.C.B.I. and Lobstick.
Mr. Trouth testified that the standard way for the appellant to carry on business through the corporation method was for each shareholder to acquire a few common shares in a corporation in return for a small invest- ment and then advance funds pro rata to his shareholding to the corporation in question.
Mr. Trouth indicated that he or through a company which he controlled, Trouth Agencies Ltd., would conduct the business of the joint venture company not for a fee but for a reimbursement of costs.
There is ample evidence which shows that the appellant made advances to a number of joint venture corporations as the standard method of operating. Exhibit A-1 contains a list of eight development projects in which the appellant participated during the period running from 1972 to 1986. Its interest varied from a low of 15 per cent to a high 75 per cent. All of these projects were undertaken through either a corporate entity, joint venture or syndicate. Where a corporate entity format was used, the financing of the project was made through shareholder's loans and any profits were distributed as dividends. It is also established that where the joint venture or syndicate format was adopted the development project was funded by straight debt and profits were distributed as income to each of the participants. Another Exhibit A-3 tendered in evidence in the form of an excerpt from the accounts receivable of the appellant's general ledger shows that the appellant made a large number of loans to individuals and to corporations in the course of carrying on its land development business. A total of more than 60 transactions were involved. In some ten of such transactions, the amounts were in excess of $50,000; in a few cases, the amounts involved were over $500,000. There were occasions where the appellant lent money to persons purchasing assets from itself and in such cases the loan took the form of an agreement for sale or mortgage back.
With respect to the advances made to I.C.B.I. the evidence is to the effect that the project was financed through shareholder's' loans and in particular through loans from the appellant. These loans to I.C.B.I. were made pursuant to the terms of a memorandum of agreement dated December 30, 1977 which, in turn, makes reference to the guarantee of the repayment of I.C.B.I.'s indebtedness to the Canadian Imperial Bank of Commerce given by the eight guarantors including the appellant's two equal shareholders, Messrs. Norman Trouth and David J. Freeze. The loans from the shareholders to I.C.B.I. were in proportion to their shareholders' interests. 1.C.B.1. in turn lent money to I.C.B.I. Development of Montana Ltd., a U.S. corporation. This appears clearly from the I.C.B.I.'s balance sheets as at August 31, of the years 1980 through 1988.
In the above-noted agreement of December 30, 1977 entered into between all eight shareholders and principals of the companies which are themselves shareholders of I.C.B.I. there is a statement in its preamble reading in part as follows: ”. . . And whereas the parties hereto have agreed that each party will be responsible for payment to the bank for a proportion of the indebtedness of the Company based on the proportion of the number of shares of the Company which are owned or controlled by such party as of the date of execution of this agreement". There is also a clause in this agreement stipulating that “. . . All indebtedness over and above $600,000 owing by the Company to its shareholders shall bear interest from the date of advance to the Company until paid, at the rate of Fifteen (15%) per cent per annum."
The evidence is also clear that in line with this agreement the appellant put up 1/2 of the initial $600,000 as seed money and that the excess contribution over $300,000 was provided as operating funds and would bear interest. It was also established that the aggregate of appellant's shareholder's loans on November 2, 1978 was $527,524. This is $227,524 in excess of the $300,000 representing the non-interest bearing portion of the amount owing to the appellant. The amount written off by the appellant never reached the noninterest bearing portion of the indebtedness. Interest was therefore payable on the other portion of the loans written off but was never paid because the project ran into serious financial difficulties. I do not entertain doubts about the point that at the time the advances of funds subsequently written off were made, the appellant had a reasonable expectation of earning interest thereon.
On September 1, 1978, Mr. Trouth forwarded a letter to all shareholders to I.C.B.I. on behalf of the latter company. The body of that letter reads as follows:
As Managing Director of the Company, I have to advise you that since we have defaulted and Quit Claimed on the Purchase Agreement with McBride (except for the back land option) that the possibility of recovering all of your shareholders loans to I.C.B.I. is very slight. The bank has first call on our income and some of the shareholders have incurred debts owing to them which also takes precedence over the shareholder's advances.
It would therefore appear that if it is to your advantage that you may wish to write off half of your shareholder's advance. For the record they are listed below.
Boonville — $150,000.00 Wesco - $300,000.00 Goodacre — $ 75,000.00 Holmes — $ 50,000.00 Truant - $ 25,000.00
Mr. Trouth stated that the appellant wrote off such portion of that debt in respect of which there was no realistic hope of recovery.
I shall now deal with the second project, the Lobstick Project. It was intended to be a recreational home development on the Lobstick River to the west of Edmonton. This project was funded in part by shareholder's loans. As appears from excerpts from the appellant's general ledger, there were nine advances made by the appellant to Lobstick over an 11-year period beginning in February 1975 and the outstanding balance of such advances as at November 26, 1986 amounted to $106,947.92. The shareholders of Lobstick were three friends. This situation explains in part why there was no precise arrangement respecting the payment of interest on these advances. The fact that these advances to Lobstick were to bear interest cannot be doubted. This is evidenced by entries in the appellant's general ledger, made at various dates in 1978, 1979, 1980 and 1981, by a resolution passed by the appellant's two directors sometime in 1982 waiving additional interest charges on funds advances to Lobstick and by the resolution made sometime in 1982 by the shareholders of Lobstick indicating that it will endeavour to reimburse Trouth Agencies Ltd. and the appellant for all interest charges to that date. I accept Mr. Trouth's testimony that interest was to be paid on these advances and that they were made for the purpose of gaining or producing income. In 1983, the appellant determined that there was no reasonable prospect of the Lobstick indebtedness ever being repaid. The evidence is clear that sales fell off dramatically in 1983. This is illustrated by a document outlining a summary of sales made by Lobstick during the period running from 1975 to 1988 inclusive; this document was tendered in evidence as Exhibit A-17.
Analysis
The matter of the deductibility of the subject debts could first be considered in light of the provisions of paragraph 20(1 )(p) of the Act as they read at the material times:
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:
(p) the aggregate of debts owing to the taxpayer
(i) that are established by him to have become bad debts in that year, and
(ii) that have (except in the case of debts arising from loans made in the ordinary course of business by a taxpayer part of whose ordinary business was the lending of money) been included in computing his income for the year or a previous year.
Since each debt in issue in the present case had not been included in computing the appellant's income for the particular year in respect of which the deduction is sought or a previous year it follows from the wording of paragraph 20(1)(p) of the Act that for such a debt to be deductible, the following three requirements must be satisfied:
1. the debt had become bad in the year;
2. part of the ordinary business of the taxpayer was the lending of money; and
3. the bad debt arose from loans made in the ordinary course of business of the taxpayer.
Counsel for the respondent argued that the debt written off by the appellant had not gone bad in the year in respect of which the deduction was claimed.
I find the evidence on this point to be overwhelming. We have the testimony of appellant's president who was really familiar with the situation. He made the judgment call that the portion of appellant's indebtedness in the three years in issue that it deducted could simply not be recovered. On the evidence, and with the benefit of hindsight respecting what happened in subsequent years there can be no question that Mr. Trouth's decision was fully supported by the evidence at hand. He took into account the proper factors and came to the right conclusion. The argument advanced by counsel for the respondent that a debt cannot be bad in part only is, in my view, clearly not tenable. In this connection, I would like to refer to the following passage of the Income Tax Appeal Board decision in the case of Geoffrey Hogan v. M.N.R., 15 Tax A.B.C. 1; 56 D.T.C. 183, at page 17 (D.T.C. 193):
. . . And when, after considering those factors, an honest opinion has been arrived at that a debt, in whole or in part, is bad, then it is my opinion that the provisions of the Act have been wholly satisfied and that the debt should be written off. See also Schecter v. M.N.R., 13 Tax A.B.C. 204.
The second requirement for the entitlement to the deduction of bad debts under paragraph 20(1)(p) is that part of the ordinary business of the taxpayer was the lending of money.
As mentioned earlier, the appellant was during the three years in issue and for a substantial period before and after these three years a land development company. As mentioned earlier, in some cases, the appellant would be involved in development projects in association with others through a separate corporate entity as in the cases of I.C.B.I. and Lobstick projects.
The evidence is clear that the advances made by the appellant to I.C.B.I. and Lobstick were advances made in the ordinary course of conduct of the appellant's business. As was explained by the appellant's president, this method of operating was adopted by the appellant in all its developments, no matter whether these developments were undertaken through a syndicate, a joint venture or, as in the present case, through a corporation. Exhibit A-3 referred to earlier lists a great number of loans involving very substantial sums of money. It is well settled that the question whether or not a taxpayer is carrying on a money lending business is essentially a question of fact to be determined in each case. Here there is no doubt that the making of advances was part and parcel of the appellant's ordinary business. I agree with the contention of counsel for the appellant that the advances were made by the appellant as part of its usual business operations with a view to making a profit. The money-lending feature of the appellant's business was an important part of its total business operations in the taxation years under appeal. There was the required degree of system and continuity in its lending operations to justify a finding that part of the appellant’s ordinary business was the lending of money. Apart from other considerations, there was an expectation of interest in respect of the making of such advances. I am, therefore, of the view that this second requirement of paragraph 20(1)(p) of the Income Tax Act is met in the present case.
I shall now advert to the third requirement relative to the point that the debts in question arose from loans made in the ordinary course of the appellant's business.
It is clear on the evidence that the bad debts in issue related to the appellant's ordinary business activities as a land development company. It cannot be, in my view, seriously disputed that the advances or loans that could not be repaid to the appellant by I.C.B.I. and Lobstick were made in connection with business deals or transactions of a class usually entered into by the appellant. As a matter of fact, advances or loans were frequently made by the appellant to a group or entity involved in purchasing, subdividing, servicing, managing and selling lands. Those loans or advances were made in the course of such activities. They were an integral part of the appellant's earning process. I therefore find that the third element required by paragraph 20(1)(p) is satisfied here.
Before concluding, I would like to comment on the following decisions mentioned to the Court by counsel for the respondent: S.F.G. Construction Ltée v. M.N.R., [1983] C.T.C. 2467; 83 D.T.C. 401; Charles Chaffey v. M.N.R., [1978] C.T.C. 253; 78 D.T.C. 6176, and Stewart & Morrison Ltd. v. M.N.R., [1972] C.T.C. 73; 72 D.T.C. 6049.
In the case S.F.G. Construction the taxpayer deducted as bad debts certain loans made to a company in which it had a minority interest. However, in its judgment, the Tax Review Board simply disallowed the taxpayer's losses on the ground that such losses were capital losses. The issue in the present case, to the extent that the application of paragraph 20(1)(p) is concerned, is not whether the losses were capital losses, but rather whether the above-noted three requirements found in paragraph 20(1)(p) are satisfied here. It should not be overlooked that subsection 20(1) of the Act provides that notwithstanding inter alia paragraph 18(1)(b) "which prohibits the deduction of capital losses" there may be deducted bad debts.
The decision in the Charles Chaffey case could be easily distinguished on its facts from the present case. In that case, the Federal Court of Appeal agreed with the finding of the Federal Court-Trial Division that the advances were not loans made in the ordinary course of the taxpayer's business and the deductibility of these unpaid advances could not therefore be brought within the terms of paragraph 11(1)(f), the predecessor of the present paragraph 20(1)(p) of the Act.
With respect to the decision of the Supreme Court of Canada in the Stewart & Morrison Ltd. case mentioned by counsel for the respondent, I would simply point out that this case does not deal with the application of what is now paragraph 20(1)(p) of the Act but with the predecessor of the present paragraph 18(1)(b) which provides that no deduction shall be made in respect of capital losses. This is a totally different issue.
In view of the conclusion at which I have arrived to the effect that the debts written off by the appellant in the present case are deductible under paragraph 20(1)(p) of the Act, I do not have to consider the proposition put forward by the appellant to the effect that the subject debts are deductible under section 9 of the Income Tax Act because they are an integral part of the appellant's business activities and are not on account of capital.
I do not have either to deal with the alternative argument advanced by the appellant to the effect that, should the bad debts not be deductible under paragraph 20(1)(p) or not be a general business expense that could be written off in computing income under section 9, they constitute “business investment losses" within the meaning of paragraph 39(1)(c) of the Income Tax Act. It is to be noted that under this alternative argument only one-half of the amounts, the deduction of which was claimed by the appellant, would be deductible in each of the taxation years under consideration. In this regard, the provisions of paragraph 3(d) regarding the deduction of a "taxpayer's allowable business investment loss” and the definition of the latter phrase in paragraph 38(c) are of interest.
For these reasons, I will allow the appeals with costs and refer the matter back to the respondent for reconsideration and reassessment on the basis that the appellant is entitled to deduct the full amount of the debts written off in the years under appeal.
Appeals allowed.