Federal Court of Appeal Decisions

Date: 19990621

Dockets: A-229-95 and A-230-95

CORAM:      STRAYER J.A.

         DÉCARY J.A.

         ROBERTSON J.A.

BETWEEN:

     A-229-95

     TERRADOR INVESTMENTS LTD.

     Appellant

AND:

     HER MAJESTY THE QUEEN

     Respondent

    

     A-230-95

     SERIN HOLDINGS LTD.

     Appellant

AND:

     HER MAJESTY THE QUEEN

     Respondent

    

     Heard at Vancouver (British Columbia) on Thursday, May 20, 1999.

     Judgment delivered at Ottawa (Ontario) on Monday, June 21, 1999.

REASONS FOR JUDGMENT BY:      DÉCARY J.A.

CONCURRED IN BY:      STAYER J.A.

     ROBERTSON J.A.

     Date: 199906-21

     Dockets: A-229-95 and A-230-95

CORAM:      STRAYER J.A.

         DÉCARY J.A.

         ROBERTSON J.A.

BETWEEN:

     A-229-95

     TERRADOR INVESTMENTS LTD.

     Appellant

AND:

     HER MAJESTY THE QUEEN

     Respondent

    

     A-230-95

     SERIN HOLDINGS LTD.

     Appellant

AND:

     HER MAJESTY THE QUEEN

     Respondent

    

     REASONS FOR JUDGMENT

DÉCARY J.A.

[1]      Appeal No. A-230-95 ("the Serin appeal") is an appeal from a judgment of the Tax Court of Canada¹ which dismissed Serin's claim for an allowance for doubtful debts in 1987 and a deduction for bad debts in 1988 and which also dismissed Serin's claim for an income loss on an advance of $42,914.34 to Strand Properties (U.S.) ("Strand") in 1988. Appeal No. A-229-95 ("the Terrador appeal") is an appeal from a judgment of the Tax Court which dismissed Terrador's claim for an allowance for doubtful debts in 1987 and a deduction for bad debts in 1988.

[2]      The two appeals were heard together in the Tax Court and were based on common evidence. They were disposed of by the Tax Court judge in one set of reasons.

[3]      They were also heard together in this Court and this set of reasons will be filed in, and dispose of both.

[4]      The relevant facts are as follows.

[5]      Both Serin Holdings Ltd ("Serin") and Terrador Investments Ltd. ("Terrador") are corporations resident in Canada. Up to April, 1985, Serin held 100% of the shares of Serin (U.S.) Holdings Ltd. ("Serin (U.S.)"). Serin wished to liquidate its Serin (U.S.) assets and in order to do so with the full benefit of American legislation, it had first to divest itself of at least 20% of the shares of Serin (U.S.). Therefore, on April 19, 1985, Serin transferred 21% of the shares of Serin (U.S.) to Terrador and kept the remaining 79%.

[6]      On April 24, 1985, Serin (U.S.) was liquidated. As partial consideration for the sale of all its properties, Serin (U.S.) received interest bearing promissory notes. At the time of liquidation Serin (U.S.) distributed the promissory notes with a value of (U.S.) $1,661,782.00 and cash in the amount of approximately (U.S.) $117,000.00 to Serin and Terrador as liquidation proceeds in proportion to their shareholdings of Serin (U.S.).

[7]      Serin and Terrador each elected pursuant to subsection 93(1) of the Income Tax Act² ("the Act") to deem a portion of their share of the proceeds of disposition on liquidation to be a dividend received from Serin (U.S.). The deemed dividend was equal in amount to the balance of Serin (U.S.)'s "exempt surplus account" as that term is defined in regulation 5907. Upon liquidation the deemed dividends were included in computing the income of Serin and Terrador for the 1985 taxation year as required by subsection 90(1) and paragraph 12(1)(k) of the Act.

[8]      In computing their taxable incomes for the 1985 taxation year, Serin and Terrador each claimed a deduction pursuant to subsection 113(1) of the Act, as the dividend included in their income pursuant to subsection 90(1) and paragraph 12(1)(k) was paid out of the "exempt surplus" of Serin (U.S.).

[9]      Serin advanced a further sum of $42,914.34 to Strand in order to protect its interest in and increase the probability of repayment of amounts owing under the two promissory notes between Serin and Strand.

[10]      Although a few payments were made to Serin and Terrador on account of the principal and interest outstanding on the notes, Serin and Terrador were unable to collect the balance outstanding. As a result, Serin, in 1987, claimed a reserve for doubtful debts in the amount of $355,143.00. In 1988, Serin claimed a bad debt expense, net of the doubtful debts reserve taken in 1987, in the amount of $1,097,199.00, and an additional bad debt of $42,914.34 in respect of the amount advanced to Strand. In 1987 Terrador claimed a reserve for doubtful debts in the amount of $94,405.14. In 1988, Terrador claimed a bad debt expense, net of the doubtful debt claimed in 1987, in the amount of $291,660.88.

[11]      The Minister of National Revenue ("the Minister") denied the claims. Instead, he allowed Serin capital losses of $1,097,199.00 and $42,914.34 in 1988. The Minister allowed Terrador a capital loss of $291,660.88 in 1988. The Tax Court judge dismissed the taxpayers' appeals with respect to these claims.

-      The advance made by Serin to Strand

[12]      I shall deal first with the second issue, which arises only in the Serin appeal.

[13]      The Tax Court judge found that the amount of $42,914.34 which Serin had advanced to Strand was done with the joint purpose of protecting the income stream Serin was receiving on the amounts which Strand owed to it and of protecting the underlying debts as capital assets. He concluded that since he could not find that the principal purpose of the advance³ was to protect the income stream, the loan was on account of capital.

[14]      The only ground advanced by Serin to challenge that finding, which is essentially a finding of fact, is that the Tax Court judge ignored the fact that by 1988 Serin regarded itself, in its income tax report, as being in the lending business. Whatever value one might give to this self-serving evidence, and assuming for the sake of discussion that the evidence was ignored by the judge, it would not be sufficient to vitiate the finding by the judge that Serin "was not in the business of lending money".

[15]      I therefore find for the respondent on the second issue in the Serin appeal.

-      The "doubtful debts" and "bad debts" issue.

[16]      As even counsel for the respondent disagrees with the approach taken by the Tax Court judge, it is not necessary to give it any attention.

[17]      The solution, in my view, rests in a plain reading of the provisions of the Act. The relevant provisions read as follows (I have reproduced the text as it was amended in 1987, both counsel recognizing that the amendments did not affect the 1987 taxation year in these appeals):

SECTION 12:      Amounts to be included as income from business or property.    (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: [...]    (d)      Reserve for doubtful debts. " any amount deducted under paragraph 20(1)(l ) as a reserve in computing the taxpayer's income for the immediately preceding taxation year; [...]    (i)      Bad debts recovered. " any amount, other than an amount referred to in paragraph (i .l), received in the year on account of a debt or a loan or lending asset in respect of which a deduction for bad debts or uncollectable loans or lending assets had been made in computing the taxpayer's income for a preceding taxation year; [...]    (k)      Dividends from other corporations. " any amount required by subdivision i to be included in computing the taxpayer's income for the year in respect of a dividend paid by a corporation not resident in Canada on a share of its capital stock or in respect of a share owned by the taxpayer of the capital stock of a foreign affiliate of the taxpayer; [...] SECTION 20:      Deductions permitted in computing income from business or property.    (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: [...]      (l) Reserve for doubtful debts. " a reserve determined as the aggregate of          (i) a reasonable amount in respect of doubtful debts that have been included in computing the income of the taxpayer for that year or a preceding year, and [...]      (p) Bad debts. " the aggregate of          (i) all debts owing to the taxpayer that are established by him to have become bad debts in the year and that have been included in computing his income for the year or a preceding taxation year, and [...] SECTION 93:      Election re disposition of share in foreign affiliate.    (1)    Where at any time a corporation resident in Canada has so elected, in prescribed manner and within the prescribed time, in respect of any share of the capital stock of a foreign affiliate of the corporation disposed of by it or by another foreign affiliate of the corporation, for the purposes of this Act, an amount equal to the lesser of      (a) the amount designated by the corporation in its election, and      (b)the proceeds of disposition of the share shall be deemed to have been a dividend received on the share from the affiliate by the disposing corporation or disposing affiliate, as the case may be, immediately before the disposition and not to have been proceeds of disposition. [...] SECTION 113:      Deduction in respect of dividend received from foreign affiliate. (1) Where in a taxation year a corporation resident in Canada has received a dividend on a share owned by it of the capital stock of a foreign affiliate of the corporation, there may be deducted from the income for the year of the corporation for the purpose of computing its taxable income for the year, and amount equal to the aggregate of    (a)      an amount equal to such portion of the dividend as is prescribed to have been paid out of the exempt surplus, as defined by regulation (in this Part referred to as "exempt surplus") of the affiliate; [...] and for the purposes of this subsection and subdivision i of division B, the corporation may make such elections as may be prescribed.

ARTICLE 12:      Sommes à inclure comme revenu tiré d'une entreprise ou d'un bien.    (1) Sont à inclure dans le calcul du revenu tiré par un contribuable d'une entreprise ou d'un bien, au cours d'une année d'imposition, les sommes appropriées suivantes: [...]    d)      Provision pour créances douteuses. " toute somme déduite à titre de provision en application de l'alinéa 20(1)l ) dans le calcul du revenu du contribuable pour l'année d'imposition précédente: [...]    i)      Mauvaises créances recouvrées. " toute somme reçue dans l'année " sauf si elle est visée à l'alinéa i. l) " sur une créance un prêt ou un titre de crédit qui a fait l'objet d'une déduction pour mauvaises créances ou pour prêts ou titres de crédit irrécouvrables dans le calcul du revenu du contribuable pour une année d'imposition antérieure: [...]    k)      Dividendes distribués par d'autres corporations. " toute somme qui doit, en vertu des dispositions de la sous-section i, être incluse dans le calcul du revenu du contribuable pour l'année à titre de dividende payé par une corporation ne résidant pas au Canada sur une action de son capital-actions ou relativement à une action du capital-actions d'une corporation étrangère affiliée du contribuable, appartenant à ce dernier; [...] ARTICLE 20:      Déduction admises lors du calcul des revenus d'une entreprise ou d'un bien.    (1)    Nonobstant les dispositions des alinéas 18(1)a), b) et h), lors du calcul du revenu tiré par un contribuable d'une entreprise ou d'un bien pour une année d'imposition, peuvent être déduites celles des sommes suivantes qui se rapportent entièrement à cette source de revenus ou la partie des sommes suivantes qui peut raisonnablement être considérée comme s'y rapportant: [...]    l)      Provision pour créances douteuses. " la provision égale au total des montants suivants:      (i)      un montant raisonnable au titre des créances douteuses incluses dans le calcul du revenu du contribuable pour l'année ou pour une année d'imposition antérieure, [...]    p) Créances irrécouvrables. " le total des montants suivants;      (i) les créances du contribuable qu'il a établies comme étant devenues de mauvaises créances au cours de l'année et qui sont incluses dans le calcul de son revenu pour l'année ou pour une année d'imposition antérieure, [...] ARTICLE 93:      Choix relatif à la disposition d'une action dans une corporation étrangère affiliée. (1) Lorsque, à une date quelconque, une corporation résidant au Canada en a fait le choix, de la manière et dans les délais prescrits, en ce qui regarde toute action du capital-actions d'une corporation étrangère affiliée de cette corporation dont elle a disposé, ou dont une autre corporation étrangère affiliée de la corporation a disposé, aux fins de la présente loi, une somme égale au moins élevé des montant suivants:      (a) le montant indiqué par la corporation dans son choix, ou      (b) le produit de disposition de l'action est réputée avoir été un dividende reçu, immédiatement avant la disposition, sur l'action, de la corporation affiliée, par la corporation ou la corporation affiliée qui a procédé à la disposition, et non un produit de disposition. [...] ARTICLE 113:      Déduction au titre d'un dividende reçu d'une corporation étrangère affiliée.    (1) Une corporation résidant au Canada qui, dans une année d'imposition, a reçu un dividende sur une action lui appartenant du capital-actions d'une corporation étrangère affiliée de cette corporation, peut déduire se son revenu pour l'année, aux fins du calcul de son revenu imposable pour cette année, le total des sommes suivantes:    a)      la fraction du dividende qui est prescrite avoir été prélevée sur le surplus exonéré défini par règlement (appelé "surplus exonéré" dans la présente partie) de la corporation affiliée; [...] aux fins du présent paragraphe et de la sous-section i de la section B, la corporation peut faire tout choix qui peut être prescrit.

[18]      Once a taxpayer has voluntarily elected, pursuant to subsection 93(1), to treat part of the proceeds of disposition comprised of some cash and of some promissory notes, as a "deemed dividend received", the cash and parts of the promissory notes at issue loose their identity "for the purposes of this Act". When the deemed dividend is included in the taxpayer's income pursuant to paragraph 12(1)(k), it is included as a "paid" dividend, not as cash and parts of promissory notes. And it is only as a "received" dividend that if may afterwards be deducted from the taxpayer's taxable income pursuant to subsection 113(1).

[19]      The "deemed dividend" being said by the Act to have been "paid" and "received", it cannot at the same time be a "doubtful debt" or a "bad debt". What is deemed to have been paid cannot also be said to be due. The taxpayer cannot have its cake and eat it, too. Once it elects to treat proceeds of disposition as paid dividends rather than as cash and promissory notes, the proceeds find their way into its income through paragraph 12(1)(k). The proceeds of disposition cannot then make their way into the taxpayer's income as a reserve for doubtful debts nor as bad debts. Paragraphs 20(1)(l) and (p) of the Act cannot come into play because it cannot be said that the debts reflected in the promissory notes have not been included as such in the taxpayer's income.

[20]      It would not only be wrong in law to equate the "deemed dividend" with the promissory notes, it would also be wrong in fact. The proceeds of liquidation, in the case at bar, consisted of some cash and of promissory notes. In its election the taxpayer designated an amount which was less than the total value of the proceeds. As a result only an unspecified portion of the cash and promissory notes received were designated as a deemed dividend. The taxpayer eventually recovered part of the promissory notes. However, as the taxpayer had designated an amount less than the total value of the proceeds, it is unclear the extent to which the amounts recovered were from the promissory notes which were deemed dividends. It is therefore not possible to suggest that the deemed dividend and the promissory notes are one and the same.

[21]      I also find for the respondent on the first issue.

[22]      Both appeals should be dismissed with only one set of costs.

     "Robert Décary"

J.A.

"I agree

     B.L. Strayer J.A."

"I agree:

     "J.T. Robertson J.A."

__________________

¹      Terrador Investments Ltd. v. Canada, [1995] 2 C.T.C. 2260.

²      L.C. 1970-71-72, c. 63, as. amended.

³      See Taylor v. M.N.R. (1978), 78 DTC 6176 at 6179 (F.C.A.), Le Dain J.A.).