Date: 20000217
Docket: 97-2884-IT-I
BETWEEN:
HELEN LEPP,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor Judgment
(Reasons delivered orally from the Bench at Winnipeg, Manitoba, on January 13, 1999)
Sarchuk J.T.C.C.
[1] This is an appeal by Helen Lepp with respect to an assessment of tax for the 1993 taxation year. In that year, the Minister of National Revenue disallowed a claim for an allowable business investment loss (ABIL) in the amount of $74,319. A number of facts were assumed by the Minister and these are set out in paragraphs 6(a) to 6(p) of the Reply to the Notice of Appeal as follows:
(a) Lepp Fleet Commodities Inc. ('Fleet') was incorporated on December 1, 1987 and has its registered office at 67 Ethelbert Street, Winnipeg;
(b) during the period from 1987 to 1993 (the 'Period') Wilfred Victor Lepp, the husband of the Appellant, ('Wilfred') was the Director, President, Secretary and the sole shareholder of Fleet (owning one share);
(c) during the period, the title to 67 Ethelbert Street, Winnipeg, was registered in the name of the Appellant and she and Wilfred resided at that address;
(d) 2563623 Manitoba Ltd. (2563623) was incorporated on March 13, 1990 and has its registered office at 67 Ethelbert Street, Winnipeg;
(e) during the period, Wilfred was the Director, President and Secretary of 2563623 and the Appellant was the sole shareholder (owning one share) of 2563623;
(f) during the period, the Appellant did not own any share(s) in Fleet;
(g) in or about November, 1990, the Toronto Dominion Bank Ltd. (the 'TD Bank') granted Fleet an operating line of credit in the amount of $125,000 (the 'line of credit');
(h) Fleet, Wilfred, the Appellant and other corporations, owned or managed by Wilfred, guaranteed the repayment of the said line of credit;
(i) the Appellant placed a collateral mortgage in favour of the TD Bank on 67 Ethelbert Street to further secure its repayment;
(j) on or about March 17, 1992, the TD Bank demanded payment of its funds from all parties concerned and the TD Bank commenced legal proceedings to collect its debt and enforce its security;
(k) the parties settled the litigation as per terms of the Settlement Agreement dated April 15, 1993;
(l) the Appellant refinanced the mortgage on 67 Ethelbert Street and paid the sum of $99,725.42 to the TD Bank from the mortgage funds to discharge her liability;
(m) the Appellant considered the sum of $99,725.42 referred to in (l) above as a business investment loss and requested to claimed (sic) an ABIL in the amount of $74,319.00 for the 1993 taxation year;
(n) the Appellant received no consideration from Fleet for giving the TD Bank her guarantee and the collateral mortgage on 67 Ethelbert Street to secure repayment of $125,000.00 operating line of credit provided by the TD Bank to Fleet;
(o) the Appellant did not give the TD Bank her guarantee and a collateral mortgage on 67 Ethelbert Street for the purpose of gaining or producing income from a business or property;
(p) the Appellant was not in the business of lending money to third parties.
[2] The evidence is that a company called Lepp Fleet Commodities Inc. was carrying on business and at all relevant times its director, president and sole shareholder was Mr. Lepp, the husband of the taxpayer. In November 1990, Fleet arranged an operating line of credit with the Toronto-Dominion Bank in the amount of $125,000.00. To acquire that line of credit, the Appellant, who was the owner of and held title to a residence at 67 Ethelbert Street, was asked to and did guarantee the repayment of any default under the line of credit and in order to do so, placed a collateral mortgage on this property in favour of the bank.
[3] Fleet failed to pay its indebtedness to the bank, as a result of which legal proceedings were commenced and ultimately, since she was the only one with any assets, a settlement was reached whereby the debt of Fleet was paid by the Appellant. In settling the bank claim, the Appellant paid the sum of some ninety-nine thousand odd dollars to it, considered this sum to be a business investment loss and sought to claim it as an ABIL in her 1993 taxation year.
[4] The Appellant's difficulty with the Minister's disallowance of the ABIL is based on a misconception or misunderstanding of the underlying principles relating to the deductibility of ABILs. This is coupled with a failure to recognize the separate legal identities of the various companies which inter alia included another company in respect of which the Appellant was the sole shareholder. It is absolutely clear that in order for there to be an ABIL it must be established that the money, in this case the amount paid on the guarantee (and the guarantee itself), must have been used for the purpose of earning income.
[5] In The Queen v. Shell Canada Ltd., 98 DTC 6177, the Federal Court of Appeal made a number of comments regarding the meaning of the phrase "the purpose of earning income" in the context of an obligation to pay interest on monies borrowed pursuant to a guarantee. Although Shell deals with the payment of interest, the concept is the same. The Court said at page 6183:
The third element is that the money must be used for the purpose of earning income. This expresses the fundamental principle of tax justice, that unless the expense is incurred for an income earning purpose, then it cannot be deductible. Therefore, to the extent that an expense is incurred for personal reasons or for earning income that is exempt from taxation, the deduction cannot be allowed. ...
In his reasons, Linden J.A. referred to the decision in Alberta 74712 Ltd. v. The Queen, 97 DTC 5126 in which the Court said:
... where the interest deduction was disallowed because the use to which the money was put could not have earned income for the business. In that case, the taxpayer was part of a group of companies and, in the course of the group's reorganization, it guaranteed loans made to other members of the group. In that case when the guarantee was called in, the taxpayer was forced to borrow funds in order to satisfy it,
That is exactly the case here. The Court also held that the interest in Alberta 74712 Ltd. could not be deductible because the purpose for extending the guarantee was not to earn income. Robertson J. made the important point that "purpose" and "use" were terms that had to be evaluated in an objective sense and not subjectively. I make that point because in this case Mr. Lepp spent considerable time explaining that if his companies were ultimately successful, it would be to the benefit of his wife. That is not the kind of evaluation that is required in these cases. Even though subjectively Mr. Lepp may have felt that if his wife provided a guarantee for his company then at some point of time she might derive a substantial benefit that is not sufficient to entitle her to an ABIL. The interest paid in this case is quite bluntly non-deductible because the satisfying of the guarantee would never earn income for the taxpayer. This is a difficult concept for many taxpayers but is one which has been encountered by the Court on a number of occasions with the same result.
[6] In this case, the guarantee was not given in the course of a business carried on by the Appellant, nor was it an adventure in the nature of trade. The loan guaranteed in this case was made in order to induce the bank to advance the capital required by Mr. Lepp's company, of which he was the sole shareholder, in order that it could carry on its business. That was the sole purpose of the guarantee. It is not sufficient, as I earlier said, to argue that the Appellant, at some point of time, might have benefited or indirectly received some of the profits earned by Mr. Lepp's company at some unstated time in the future and to contend, on that basis, that consideration had been given because that is not what is meant by the word "consideration". All of the economic benefits of the guarantee were for the account of Lepp Commodities and for the benefit of its shareholder Mr. Lepp. The guarantee was not made in order to provide any economic benefit for this Appellant within the meaning that is generally attributed to that phrase.
[7] Last, what has to be said is that there was no arrangement as to any form of interest to be paid. There was no arrangement relative to repayment in the event of default by the company. There was no agreement, oral or written, setting out the terms and conditions of the Appellant's participation. To put it clearly, the granting of the guarantee was not, in fact or in law, for the purpose of gaining or producing income. It was done simply to assist the Appellant's husband and his company.
[8] I appreciate the problems inherent in this type of a situation for a taxpayer but I must say that there is no basis upon which the Court could reach any other conclusion. Accordingly, the appeal is dismissed.
Signed at Ottawa, Canada, this 17th day of February, 2000.
"A.A. Sarchuk"
J.T.C.C
.COURT FILE NO.: 97-2884(IT)I
STYLE OF CAUSE: Helen Lepp & Her Majesty the Queen
PLACE OF HEARING: Winnipeg, Manitoba
DATE OF HEARING: January 13, 1999
REASONS FOR JUDGMENT BY: The Honourable Judge A.A. Sarchuk
DATE OF JUDGMENT: January 22, 1999
APPEARANCES:
Agent for the Appellant: Wilfred Lepp
Counsel for the Respondent: Lyle Bouvier
COUNSEL OF RECORD:
For the Appellant:
Name: N/A
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada