Date: 20000417
Docket: 98-2519-IT-G
BETWEEN:
KENNETH WAYNE JAMES,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1] This appeal is from an assessment for the appellant's 1993 taxation year.
[2] The issue will become clear from a brief summary of the somewhat unusual facts.
[3] Mr. James was the sole shareholder and employee of Ken James Backhoe Service Co. Ltd. The company's year-end was October 31.
[4] On March 26, 1993, unbeknownst to Mr. James, the company was struck from the British Columbia Register of Companies. Nonetheless, after that date Mr. James carried on the backhoe business under the company name, invoiced customers in the name of the company and drew amounts from the business. In 1994 he hired a new accountant, Mr. Ellis, having lost his previous one in 1992. Mr. Ellis, in reconstructing the accounts for 1993 and 1994, did not know of the company's demise on March 26, 1993 and regarded Mr. James' drawings after March 26, 1993 as loans by the company to him. The Department, knowing what neither Mr. Ellis nor Mr. James knew, that the company came to an end on March 26, 1993, treated the amount calculated by Mr. Ellis as owing to the company as an amount distributed on the winding-up of its business under subsection 84(2) of the Income Tax Act, or alternatively as a shareholder benefit under section 15.
[5] The issue is whether the assessment made on this basis is correct.
[6] In more detail, these are the facts. The following is a partial agreed statement of facts filed by counsel for the parties, based upon a notice to admit served by the respondent on the appellant.
1. The Minister of National Revenue (the "Minister") initially assessed the Appellant, Kenneth James, for the 1993 taxation year by Notice dated October 24, 1994.
2. The Minister reassessed Mr. James for the 1993 taxation year by Notice of Reassessment dated October 6, 1997. The Minister, among other things, added a taxable dividend of $78,581 to Mr. James's income, as well as allowing for a dividend tax credit of $10,477.
3. The amount of the taxable dividend was calculated by the Minister as follows:
Due from shareholder $65,262
Fair market value of capital assets 9,000
Less:
Accounting fees assumed by Mr. James (2,000)
James Excavating Ltd. payable (9,395)
Paid up capital of shares (2)
Deemed dividend $62,865
Taxable dividend (125%) $78,581
4. Ken James Backhoe Service Co. Ltd. (the "Company") was incorporated under the British Columbia Company Act on October 31, 1980.
5. The business of the Company was to provide backhoe services.
6. The backhoe services involved providing a backhoe and operator for such jobs as ditching, ground clearing work, ground levelling work and landscaping work.
7. The Appellant, Kenneth James, was the only shareholder of the Company from October 31, 1980 through to March 26, 1993.
8. Mr. James was the Company's only employee through to March 26, 1993.
9. Mr. James's employment with the Company involved operating a backhoe.
10. After 1992, the business that Mr. James worked for was James Excavating Ltd. formerly known as Stan Holman Holdings Ltd.
11. On March 26, 1993, the Company was struck from the British Columbia Registrar of Companies and dissolved for failure to file annual returns as required under the British Columbia Company Act.
12. The Company stopped operating its business as of its date of dissolution on March 26, 1993.
13. When the Company's business was wound-up and discontinued the paid-up capital in respect of Mr. James's share of the Company was not reduced.
14. The unaudited financial statements for the company show a balance of owed to Mr. James by the Company as at October 31, 1992 of $239.
15. From time to time after March 26, 1993, Mr. James purported to make drawings as a shareholder of the Company because, at the time, he did not know that the Company had been struck from the Register of Companies and he thought the Company still existed.
16. The drawings that Mr. James purported to make between March 26, 1993 and October 31, 1993 are reflected in the unaudited financial statements for the Company that show a balance owed by Mr. James to the Company as at October 31, 1993 of $65,262. These drawings are the amount shown as "due from shareholder" in fact 3 above.
17. Mr. James's accountant, Murray Ellis, using information provided by Mr. James, prepared the unaudited financial statements for the Company as at October 31, 1993, as well as the Company's 1993 income tax return. He prepared these documents in or about September 1994.
18. Mr. James first became aware that the Company had become struck from the Registrar of Companies on or about May 29, 1995, when Revenue Canada advised Mr. Ellis.
19. Revenue Canada has known since on or before May 29, 1995 that the Company was struck from the Registrar of Companies on March 26, 1993.
20. By letter dated April 23, 1999, Revenue Canada advised the Company that as at April 21, 1999 it owed $30,479.35 in respect of its 1993 corporate tax arrears.
21. Mr. James took no steps to restore the Company to the Register of Companies.
22. The Company has never been restored to the Register of Companies.
[7] Mr. James struck me as a perfectly honest man, quite unsophisticated in matters of tax, accounting or bookkeeping. He tended to leave everything to the accountants. Throughout 1993 he continued to draw moneys from the business and to act generally as if the company continued to exist. There is no suggestion that he acted other than in good faith.
[8] In the latter part of 1994 he retained Mr. Murray Ellis CA to prepare the 1993 and 1994 returns of the company. Mr. Ellis, coming upon the scene after the event, had to proceed upon certain assumptions and to draw inferences from the materials before him. The one critical fact that he did not have before him was that the company ceased to exist on March 26, 1993.
[9] I come now to the interesting piece of accounting detective work done by Mr. Ellis.
[10] Exhibit A-3 was prepared by him on September 30, 1994 and is headed
Ken James Backhoe Service
Account Summary
10/30/93
10/30/93 would have been the 1993 fiscal year-end of the company, if it had existed then.
[11] This working paper shows the shareholder's loan account of $238.66 owed by the company to Mr. James on October 30, 1992. It also shows a cash shortfall of $2,326.16, which Mr. Ellis treated as a drawing by Mr. James and $6,314.84, which he treated as a further drawing. This amount represented the principal payments on an amount owing on a truck owned by Mr. James but used by the company.
[12] A further amount of $69,416.57 was treated as a wage expense. Someone — possibly the previous accountant — had issued a T-4 slip to Mr. James for the period ending December 31, 1992 in the amount of $12,556.80.
[13] If one nets all of these amounts out the following is the result
($2,326.16 + $6,314.84 + $69,416.57 = $78,057.57)
minus [$238.66 + $12,556.80]
= $65,262.11
[14] It is this figure that Mr. Ellis recorded in the financial statements of the company for the period ending October 31, 1993 as owing to the company by Mr. James.
[15] I should mention a number of other assumptions on which Mr. Ellis proceeded in addition to the erroneous assumption that the company existed after March 26, 1993.
(a) That $69,416.57 mentioned above was debited as wage expense. This appears from his working paper, exhibit A-3. This amount does not, however, appear as a deduction in the profit and loss statement for the period ending October 31, 1993.
(b) That he could not file T-4 slips for these drawings because it was much too late. He was right on this point, but for the wrong reasons. The reason T-4 slips could not be issued was that when the returns were prepared in late 1994 there was no one to issue them, as the company no longer existed and they would have incorrectly reflected salary or wages received from a non-existent entity.
(c) That the drawings of $69,416.57 were all made after March 30, 1993. A note on exhibit A-3 reads
Dave, the 12,556 credit/wage likely offset any drawings to 3/93. Excess likely taken 4/93 – 10/93.
[16] He supported the third assumption further by pointing out that the backhoe business is slow in the winter and does not pick up until the spring or summer. Mr. James confirmed this. I think this assumption is probably correct.
[17] In the result we have a construction (or reconstruction) of accounts based upon assumptions that were perhaps understandable and even reasonable. Objectively, however, some were wrong.
[18] I turn now to the assessment. When the audit was being done in 1997 the company of course had ceased to exist on March 26, 1993 and the Department knew it. The assessor therefore treated the 1993 corporation return as the final return of the company. The 1993 return was therefore assessed as filed with a net income of $59,307. Although there were negotiations and correspondence between the assessor, Ms. McDonough, and Mr. Ellis on a number of issues the assessment that ultimately was issued with respect to the deemed dividend of $62,865 mentioned in the agreed statement of facts, and the resulting taxable dividend of $78,581 was calculated as set out above and in Ms. McDonough's letter of July 24, 1997.
[19] The essential premise on which the assessment was based is that the accounts prepared as of October 31, 1993 became frozen in time as of March 26, 1993 and that the figures on March 26, 1993 were the same as on October 31, 1993. I can understand the assessor proceeding on this basis, as a practical matter. Ms. McDonough said in her evidence "I did the best I could with what I had." I am sure this is so and I have sympathy for her. She worked under considerable difficulty. However, in the same way as some of the hypotheses upon which Mr. Ellis proceeded were erroneous (notably the existence of the company after March 26, 1993), so too was the assumption made by Ms. McDonough that the accounts which were prepared as of October 31, 1993 and were intended to tell the company's financial story as of that date could be moved backwards in time, unchanged, to March 26, 1993. This premise was factually erroneous. On March 26, 1993 the sum of $65,262 was simply not owing by Ken James to the company. However questionable it might have been to treat as loans to a shareholder amounts withdrawn by Mr. James from a company it was erroneously thought existed, at least this much can be said: the advances or withdrawals or whatever label one may choose to put on them were all made after the company ceased to exist.
[20] The Crown's position is based on two provisions of the Act, as follows:
Subsection 84(2):
Where funds or property of a corporation resident in Canada have at any time after March 31, 1977 been distributed or otherwise appropriated in any manner whatever to or for the benefit of the shareholders of any class of shares in its capital stock, on the winding-up, discontinuance or reorganization of its business, the corporation shall be deemed to have paid at that time a dividend on the shares of that class equal to the amount, if any, by which
(a) the amount of value of the funds or property distributed or appropriated, as the case may be,
exceeds
(b) the amount, if any, by which the paid-up capital in respect of the shares of that class is reduced on the distribution or appropriation, as the case may be,
and a dividend shall be deemed to have been received at that time by each person who held any of the issued shares at that time equal to that proportion of the amount of the excess that the number of the shares of that class held by the person immediately before that time is of the number of the issued shares of that class outstanding immediately before that time.
Subsection 15(1.2):
For the purposes of subsection (1), the value of the benefit or advantage conferred on a shareholder, in circumstances where a loan or other obligation to pay an amount is settled or extinguished at any time without any payment by him or by payment by him of an amount that is less than the amount of the obligation outstanding at that time, shall be deemed to be the amount, if any, by which the obligation outstanding at that time exceeds the aggregate of the amount, if any, of the benefit in respect of the obligation that was included in the shareholder's income at the time the obligation arose and the amount so paid, if any.
(Subsection 15(1) generally includes in income the value of benefits conferred on a shareholder by a corporation.)
[21] Counsel for the respondent referred to a passage in RMM Canadian Enterprises Inc. et al. v. The Queen, 97 DTC 302, where it was said at page 308:
The words "distributed or otherwise appropriated in any manner whatever on the winding-up, discontinuance or reorganization of its business" are words of the widest import, and cover a large variety of ways in which corporate funds can end up in a shareholder's hands.
[22] I agree. There must, however, be something there to distribute. The assessment proceeds on the footing that on March 26, 1993 Mr. James owed his company $65,262 and that on that day, when unbeknownst to the appellant the Registrar of Companies terminated the company's existence, the amount of that indebtedness was distributed to Mr. James. For one thing, there was no indebtedness to the company on March 26, 1993. For another, even if there were, it does not follow, as a matter of law, that where a company ceases involuntarily to exist any amounts owing by a shareholder to that company are automatically distributed to that shareholder.
[23] The same observation is true of subsection 15(1.2). For a benefit to be conferred by a corporation by the forgiveness of a debt there has to be a debt owing by the shareholder and it has to be forgiven. Here there was none on March 26, 1993 and none could have arisen after that date because the company did not exist.
[24] It is true that after March 26, 1993 Mr. James may, in all innocence, have withdrawn money from the business. Even if the assumption is correct that once the company ceases to exist and the sole shareholder purports to carry on the business in the name of the company, the business is that of the sole shareholder, it does not follow that the amounts withdrawn bear any necessary correlation to the profit of the business.
[25] It is, I suppose, conceivable that some indeterminate amount may have slipped through the tax net through a series of misapprehensions and erroneous assumptions on the part of everyone. That is simply the way things worked out in this instance. The amount might very well be minimal. There is no way of determining at this stage. The loss, if any, to the fisc need not be the cause of great distress or lamentation. In any event, that is not the case that the appellant had to meet.
[26] The appeal is allowed with costs and the assessment for 1993 is referred back to the Minister of National Revenue for reconsideration and reassessment to delete from the appellant's income the taxable dividend of $78,581 included by the Minister on assessing.
Signed at Ottawa, Canada, this 17th day of April 2000.
"D.G.H. Bowman"
A.C.J.