A-666-01
2003 FCA 38
Larry W. Rich (Appellant)
v.
Her Majesty the Queen (Respondent)
Indexed as: Rich v. Canada (C.A.)
Court of Appeal, Décary, Rothstein and Evans JJ.A.-- Toronto, October 29, 2002; Ottawa, January 27, 2003.
Income Tax -- Income Calculation -- Capital Gains and Losses -- Allowable business investment loss (ABIL) -- Special type of capital loss given preferential treatment -- 75% of loss deductible against income from any source -- Unpaid debt owed by corporation operated by taxpayer's son -- Appeal from decision of T.C.J. debt not proven bad in 1995, tax year for which deduction claimed -- ABIL rules explained -- Whether loan made to gain, produce income -- Need not be primary purpose of loan -- Predominant purpose was to help out son -- Taxpayer was 25% owner of debtor company -- Interest-bearing loan -- Court not to second-guess taxpayer's business acumen -- As to whether debt bad in 1995, T.C.J. held taxpayer took early opportunity to write off -- Seven factors considered in determining whether debt bad -- Creditor need not exhaust all possible collection recourses -- Non-arm's length situation justifying closer scrutiny, not in itself supporting finding creditor dishonest in concluding debt bad -- All evidence as to debtor's financial condition negative -- Loss of account of major customer -- Negative cash flow -- In debt to major supplier -- No evidence workout, refinancing possible -- No reasonable collection possibility had taxpayer taken proactive steps -- Overriding error by T.C.J. by inferring collection resulting from proactive steps.
This was an appeal from the decision of a Tax Court Judge, reported at 2001 DTC 985, holding taxpayer not entitled to an allowable business investment loss (ABIL) on his 1995 income tax return. The loss arose due to an unpaid debt owed to taxpayer by DSM Foods Inc, a company operated by taxpayer's son and of which taxpayer was a 25% owner. The conclusions of the Judge below were that, while there was a debt, the predominant purpose of the loan was to help taxpayer's son rather than to gain income. And, although DSM qualified in 1995 as a small business, taxpayer had not made an honest and reasonable determination that the debt had become bad.
The ABIL is a special type of capital loss that receives preferential treatment for income tax purposes. It arises on the disposition of shares or a debt of a "small business corporation" which is defined as a Canadian-controlled private corporation that uses substantially all of its assets in an active business in Canada. Unlike ordinary capital losses, which may be deducted only against capital gains, an ABIL may be deducted from income from any source. In 1995, the ABIL was 75% of the business investment loss. Taxpayer's counsel pointed out that loans are frequently made to small business corporations other than at arm's length.
Held (Evans J.A. dissenting), the appeal should be allowed.
Per Rothstein J.A. (Décary J.A. concurring): The initial question for determination was whether the debt was incurred for the purpose of gaining income. This requirement is imposed by Income Tax Act, subparagraph 40(2)(g)(ii). Gaining income need not, however, be the exclusive--or even the primary--purpose of the loan, so long as it was one of its purposes. The evidence was that it was an interest-bearing loan and there was no finding of a sham. The Judge did, however, find that there had been but a faint hope that taxpayer would reap interest and dividends. Even so, it is not for the Court to second-guess the business acumen of taxpayers.
As to whether the debt became bad in 1995, the question is whether, having considered the relevant factors, the creditor honestly and reasonably determined the debt to be bad. In making that determination, a taxpayer should take into account the following factors: (1) history and age of the debt; (2) debtor's financial situation (revenues and expenses, whether earning income or incurring losses, cash flow and assets, liabilities and liquidity); (3) total sales in comparison with those of prior years; (4) debtor's cash, accounts receivable, and other current assets compared with prior years; (5) debtor's accounts payable and other liabilities compared with prior years; (6) general business conditions in the country, debtor's community and in the debtor's line of business; and (7) taxpayer's experience in writing off bad debts. The debtor's future prospects could be relevant if there is evidence of some future event that will probably occur which might render the debt collectible. It is, of course, otherwise if such future event is mere speculation. There is no requirement that a creditor exhaust all possible recourses of collection. While a non-arm's length situation may justify closer scrutiny, that alone does not support a finding that the creditor did not honestly and reasonably determine the debt to be bad. The evidence was that, by the end of 1995, debtor had a negative cash flow and lost its Costco account which, while actually a money loser, did provide two-thirds of debtor's cash flow. As the Tax Court Judge put it to counsel for the Minister "do you have to flog a dead horse?" Upon a consideration of the seven above-mentioned factors, all of the evidence regarding debtor's financial and business circumstances was negative. The debt to taxpayer was some years old and no payment thereon made in recent years. This debt was postponed to that of another creditor while a bank held an assignment of book debts on receivables. 85% of debtor's accounts payable was owing to its major supplier. Two-thirds of its revenues disappeared when the Costco account was lost.
The Tax Court Judge nevertheless concluded that taxpayer "took an early opportunity to write-off this debt" in not having taken any proactive steps. But none of the evidence suggested that more could have been productively done herein. What could the Judge have had in mind in indicating the necessity for more proactive steps? Perhaps the Judge's view was based on the facts that taxpayer's accounting firm was also that of debtor and that taxpayer owned 25% of the debtor company. This intimate knowledge might have allowed taxpayer to undertake proactive steps. There is, however, no legal requirement to take proactive steps where the evidence is not to the effect that collection is reasonably possible. There was here no evidence to suggest that a workout or refinancing was possible. There was simply no evidence to support the inference drawn by the Tax Court Judge that additional steps could reasonably have resulted in collection. Indeed, the evidence was all to the contrary. There is no obligation upon a taxpayer to think up every conceivable proactive step and demonstrate that none would be productive. On the evidence, it could not be concluded that taxpayer had taken an early opportunity of writing off the loan. There was sufficient evidence that, at the end of 1995, the indebtedness amounted to $125,000 and, under the ABIL, taxpayer is entitled to claim a deduction of 75% of that amount.
Per Evans J.A. (dissenting): Admirable as it is that parents assist their children in getting established, if they expect other taxpayers to share the burden of helping out a child's struggling business, they can anticipate close scrutiny by both the tax collector and the courts.
There was evidence before the Judge below on which he could conclude that, in all the circumstances, a reasonable person, acting in a businesslike manner, would have further explored repayment possibilities.
In reviewing the record to ascertain whether the Judge fell into error, three general considerations had to be taken into account. First, the loan was not at arm's length. Given that taxpayer's predominant purpose was to assist his son's business, why would he try to recover the loan debt if able to deduct a substantial portion thereof from his own income tax? Secondly, in discharging the burden of proof on the balance of probabilities, taxpayer was well placed to adduce evidence as to the futility of making further inquiries about loan repayment possibilities. The final consideration is that appellate courts are to give a high degree of deference to the findings of fact by trial judges.
When asked why he had sent him a demand letter, taxpayer testified he supposed his son would come to him and propose a long-term loan repayment. Taxpayer must, therefore, have believed that the debtor company was in a position to make some such proposal. Indeed, he testified as to his surprise at being told the debtor was unable to repay any portion of the loan. It was open for the Judge to have considered it unreasonable that taxpayer accepted at face value his son's curt response that no repayment was possible. Even if taxpayer did not wish to push the debtor into bankruptcy, that does not explain why he failed to pursue a financial workout. In view of the absence of supporting documentation and bookkeeping errors, it was not unreasonable that the Judge did not regard the corporate records as definitive of its financial position. Added to that, the auditor testified that taxpayer had been less than forthcoming and had initially failed to disclose a material fact: that the DSM Foods president was his son. Nor was it irrelevant that, by November 1996, debtor had been able to repay almost all of its rather substantial old debt to its principal supplier.
statutes and regulations judicially
considered
Income Tax Act, R.S.C., 1985 (5th Supp.), c. 1, ss. 38(c), 40(2)(g), 248(1) "small business corporation" (as am. by S.C. 1994, c. 7, Sch. II, s. 192; Sch. VIII, s. 139).
cases judicially considered
applied:
Geoffrey Hogan v. Minister of National Revenue (1956), 56 DTC 183 (T.A.B.); No. 81 v. Minister of National Revenue (1953), 53 DTC 98 (T.A.B.).
referred to:
Ludco Enterprises Ltd. v. Canada, [2001] 2 S.C.R. 1082; (2001), 204 D.L.R. (4th) 590; [2002] 1 C.T.C. 95; 2001 DTC 5505; 275 N.R. 90; Stewart v. Canada, [2002] 2 S.C.R. 645; (2002), 212 D.L.R. (4th) 577; [2002] 3 C.T.C. 439; 2002 DTC 6969; 288 N.R. 297; 50 R.P.R. (3d) 157; Housen v. Nikolaisen, [2002] 2 S.C.R. 235; (2002), 211 D.L.R. (4th) 577; [2002] 7 W.W.R. 1; 10 C.C.L.T. (3d) 157; 30 M.P.L.R. (3d) 1; 286 N.R. 1; 219 Sask. R. 1.
authors cited
Krishna, V. Fundamentals of Canadian Income Tax, 6th ed. Toronto: Carswell, 2000.
APPEAL from a decision of the Tax Court of Canada (2001 DTC 985), that taxpayer was disentitled to claim an allowable business investment loss in his 1995 income tax return for failure to prove the debt was bad in that year. Appeal allowed.
appearances:
David J. Rotfleisch and William I. Innes for appellant.
Bobby Sood for respondent.
solicitors of record:
Rotfleisch & Samulovitch, Toronto, and Fraser Milner Casgrain, Toronto, for appellant.
Deputy Attorney General of Canada for respondent.
The following are the reasons for judgment rendered in English by
Rothstein J.A.:
ISSUE
[1]The issue in this appeal is whether the appellant is entitled to an allowable business investment loss (ABIL) of $93,758 (75% of an indebtedness of $125,000) on his 1995 income tax return. The loss arose from an unpaid debt owed to the appellant from DSM Foods Inc., a company operated by the appellant's son. The appellant is entitled to the ABIL of $93,758 provided:
1. there was a debt of $125,000 owed to the appellant by DSM;
2. the debt was incurred for the purpose of gaining or producing income;
3. DSM was an eligible small business in 1995; and
4. the debt became bad in 1995.
DECISION OF THE TAX COURT JUDGE
[2]The learned Tax Court Judge found [2001 DTC 985]:
1. there was a debt;
2. the predominant purpose of the loan was the appellant helping his son, not the reaping of interest or dividends (the appellant was a 25% owner of DSM);
3. it had been agreed that DSM was a small business in 1995; and
4. the appellant's assessment of the debt fell short of an honest and reasonable determination that the debt had become bad.
[3]The Tax Court Judge extensively reviewed the accounting evidence over the period from 1989 to 1995 inclusive, but, in view of his finding that the debt was not proven to be bad in 1995, found it unnecessary to "grapple further with the determination of the amount of the loan".
THE ABIL RULES
[4]In Fundamentals of Canadian Income Tax, 6th ed. (Toronto: Carswell, 2000), at page 423, Professor Krishna explains that an ABIL is a special type of capital loss that receives preferential treatment for income tax purposes. An ABIL arises on the disposition of shares or a debt of a small business corporation. A "small business corporation" is a Canadian-controlled private corporation that uses all or substantially all of its assets in an active business in Canada (see Income Tax Act, R.S.C., 1985 (5th Supp.), c. 1, subsection 248(1) [as am. by S.C. 1994, c. 7, Sch. II, s. 192; Sch. VIII, s. 139]).
[5]Unless a lender is in the money-lending business, a bad debt would normally be treated as a capital loss. However, unlike ordinary capital losses, which may be deducted only against capital gains, an ABIL may be deducted against income from any source.
[6]In 1995, the ABIL was 75% of the business investment loss (see Income Tax Act, paragraph 38(c)).
[7]Counsel for the appellant explained that the purpose of the ABIL rules was to encourage investments in small business corporations. A bad debt from a small business corporation could be deducted from the lender's income from any source, although the amount of the deduction was limited as indicated in paragraph 6. Counsel also pointed out that loans to small business corporations were frequently made on non-arm's length bases. The appellant in this case did not claim to be a money lender and only sought to deduct the ABIL arising from his loss on the DSM loan.
WAS THE LOAN MADE FOR THE PURPOSE OF GAINING OR PRODUCING INCOME?
[8]Subparagraph 40(2)(g)(ii) of the Income Tax Act requires that the debt be incurred for the purpose of gaining or producing income in order for the ABIL to apply. Subparagraph 40(2)(g)(ii) provides:
40. (1) . . .
(2) Notwithstanding subsection (1),
. . .
(g) a taxpayer's loss, if any, from the disposition of a property, to the extent that it is
(i)
. . .
(ii) a loss from the disposition of a debt or other right to receive an amount, unless the debt or right, as the case may be, was acquired by the taxpayer for the purpose of gaining or producing income from a business or property (other than exempt income) or as consideration for the disposition of capital property to a person with whom the taxpayer was dealing at arm's length,
The Minister agrees that, though gaining or producing income need not be the exclusive or even the primary purpose of the loan, as long as it was one of its purposes, that is sufficient to meet the requirements of subparagraph 40(2)(g)(ii) (see Ludco Enterprises Ltd. v. Canada, [2001] 2 S.C.R. 1082, at paragraph 50). I believe the Tax Court Judge was also of that view, from comments he made during the argument before him, at page 388 of the transcript:
His Honour: Mr. Sood, are you suggesting that the familial relationship was the only purpose for the advance of these funds?
Mr. Sood: Well, Your Honour, if not the only purpose, then the primary purpose indeed.
His Honour: Well, there is [sic] a big difference there, whether it's the primary purpose or the only purpose, I mean there can be a number of purposes.
[9]The documentary evidence indicates that the loan was intended to bear interest and there was no finding of sham or "window dressing". In addition, the appellant was a 25% shareholder of DSM.
[10]The Tax Court Judge found that the predominant purpose of the loan was to help the appellant's son and his son's company. At paragraph 31, he stated:
Dad was helping his son and his son's company with an expectation to be repaid. This, I find was the predominant purpose, while the normal purpose of a bona fide commercial investor to reap interest and dividends was, in this situation, a faint hope.
The finding of the Tax Court Judge that the "predominant purpose" of the loan was to help his son necessarily implies that there was another subordinate purpose. The evidence was that the loan was to bear interest. In addition, the appellant was a shareholder of DSM entitling him to dividends. The Court is not to second-guess the business acumen of taxpayers (see Stewart v. Canada, [2002] 2 S.C.R. 645 (S.C.C.), at paragraph 55). The subordinate purpose is sufficient. The requirement of subparagraph 40(2)(g)(ii) is satisfied.
DID THE DEBT BECOME BAD IN 1995?
[11]The Tax Court Judge found that the appellant took an early opportunity to write off the debt, which on balance he found was not reasonable. He was of the view that the appellant had to make a concrete effort to deal with the debt prior to declaring it bad. His reasons at paragraphs 28 and 29 state:
Was the Appellant's assessment at December 31, 1995 honest and reasonable and conducted in a pragmatic businesslike approach? Firstly, the Appellant could not have relied on the October 31, 1995 statements as it appears the first version of those were not released until July, 1996. Those statements showed a net loss of approximately $65,000, but also showed the write off of the $125,000 shareholder loan. These are subsequently revised by the Appellant to indicate that the loan had not in fact been written off. Reliance on the loss of the Costco contract is also somewhat suspect, as Michael Rich's testimony was that that particular contract was too costly to maintain in any event. So what we really have is a lack of repayments from DSM triggering the Appellant's request to his son and his son's response. There was no further communication between the Appellant and his son thereafter. There was no evidence of the Appellant, in his capacity as owner of DSM or as the professional accounting advisor to DSM in exploring possible workouts, in assisting with finding other refinancing options, in projecting future cash flow or doing anything at all to assist DSM with it's [sic] financial problems. By this I do not mean exhausting all legal recourses of collection; I mean more proactive positive action to assist DSM than negative enforcement action against DSM. In fact there was none of either.
Both the Appellant and his son used the same language that any action by the Appellant against DSM would bankrupt the company. They testified however that they did not even discuss any action, positive or negative. I conclude the Appellant, rather than approaching this in a truly businesslike manner, took an early opportunity to write-off this debt, an opportunity which on balance I find was not to be reasonable. This is not a case of an arm's length loan. The Appellant was the 25 percent owner of a family-owned business operated by his son. The Appellant's chartered accountant firm was also the accounting firm for the business. In such circumstances I expect some concrete effort from the Appellant to deal with the debt prior to declaring it bad. His letter of September 17, 1995 with no follow up was not sufficient. I find that in December, 1995 the Appellant's assessment of the debt falls short of an honest and reasonable determination the debt had become bad.
[12]The assessment of whether a debt is bad is one based upon the facts at a particular point in time, i.e. December 31, 1995. The Income Tax Act does not prescribe factors to be considered in assessing the collectibility of a debt. However, Tax Appeal Board judgments in Geoffrey Hogan v. Minister of National Revenue (1956), 56 DTC 183 and No. 81 v. Minister of National Revenue (1953), 53 DTC 98, suggest some of the factors to be taken into account. After the creditor personally considers the relevant factors, the question is whether the creditor honestly and reasonably determined the debt to be bad.
[13]I would summarize factors that I think usually should be taken into account in determining whether a debt has become bad as:
1. the history and age of the debt;
2. the financial position of the debtor, its revenues and expenses, whether it is earning income or incurring losses, its cash flow and its assets, liabilities and liquidity;
3. changes in total sales as compared with prior years;
4. the debtor's cash, accounts receivable and other current assets at the relevant time and as compared with prior years;
5. the debtor's accounts payable and other current liabilities at the relevant time and as compared with prior years;
6. the general business conditions in the country, the community of the debtor, and in the debtor's line of business; and
7. the past experience of the taxpayer with writing off bad debts.
This list is not exhaustive and, in different circumstances, one factor or another may be more important.
[14]While future prospects of the debtor company may be relevant in some cases, the predominant considerations would normally be past and present. If there is some evidence of an event that will probably occur in the future that would suggest that the debt is collectible on the happening of the event, the future event should be considered. If future considerations are only speculative, they would not be material in an assessment of whether a past due debt is collectible.
[15]Nor is it necessary for a creditor to exhaust all possible recourses of collection. All that is required is an honest and reasonable assessment. Indeed, should a bad debt subsequently be collected in whole or in part, the amount collected is taken into income in the year it is received.
[16]Whether the creditor has a non-arm's length relationship with the debtor may also be relevant in some cases. However, the predominant consideration will be the ability of the debtor to repay the debt in whole or in part. The non-arm's length relationship may justify closer scrutiny than in non-arm's length situations. But a non-arm's length relationship alone, without more, cannot lead to a finding that the creditor did not honestly and reasonably determine the debt to be bad.
[17]Earlier in his reasons, and well before his assessment of whether the debt was bad, the Tax Court Judge described the financial situation of DSM through the early 1990's and at December 31, 1995. At paragraph 13 he stated:
DSM appears to have operated on a rather tight financial basis throughout the early 90's, with a reliance on the family loans. From 1991 to 1993 the company appeared to be in a break-even position although little in a way of wages appear to have been paid to the Rich family. Through 1993 to 1995 sales increased considerably, but this appears to have been due to the Costco account, which did not result in profits, just increased cash flow. This problem appears to have become acute in 1995. Normal margins for the business were 30 to 38 percent, according to Michael, but Costco was down to 20 percent. By the end of 1995 DSM was operating on a negative cash flow. It also owed its major supplier, Select Foods, approximately $184,000, and it was critical that some arrangement had to be made to ensure a continued supply. Then Costco pulled out. Although it appears that DSM was losing money with Costco, according to Michael, that contract did provide two-thirds of their cash flow. The company ended up losing approximately $65,000 in 1995.
[18]The learned Judge expressed a view of the circumstances in a question to the Minister's counsel during argument:
His Honour: Mr. Sood, do you have to flog a dead horse though? Is that what you're saying? I mean he writes a letter, he gets a response from his son saying basically, "You're not going to be paid". He is aware of the circumstances at that the [sic ] time that the company was at best struggling and at worst perhaps going down the tubes.
What other steps are you suggesting he has to take before he can satisfy a test of a reasonable determination that "I'm not going to get paid"?
Counsel for the Minister, relying on Interpretation Bulletin 159R3, then argued before the Tax Court Judge that a debt cannot be considered bad unless the creditor exhausts all legal means of collection and that it would shock the jurisprudence if a single letter from a father to a son, as in this case, were to constitute sufficient collection effort to qualify for writing off a debt. The Tax Court Judge replied:
His Honour: Well, Mr. Sood, I don't think it would be that shocking. I mean it depends on the circumstances and, you know, you refer me to what the interpretation bulletin says, but I haven't seen a case that says in a similar situation that the taxpayer has to go to a lot of lengths to determine that a debt is bad when it's in the taxpayer's view apparent that he's not going to get paid.
I mean if there were something that I could hang my hat on in case law that you can put me to I would be happy to hear that. But, you know, interpretation bulletins are only that.
Of course, it is open to the Tax Court Judge, upon reflection, to change his mind from what he had thought during the proceedings. However, the conclusion he ultimately reached must be based upon the evidence and the proper application of the test for determining whether the debt is bad.
[19]Having regard to the usual factors to be taken into account and on which evidence was led, the following considerations are relevant. Although the Tax Court Judge referred to some of these considerations early in his reasons, they do not appear to have been taken into account in his analysis of whether the debt was bad on December 31, 1995.
1. History and age of the debt
The indebtedness first arose in 1989. There was considerable activity in the appellant's shareholders' loan account with the company in 1990, 1991 and 1992. Thereafter, the loan fluctuated somewhat, but always was in the range of $125,000. There was no activity in the loan account during 1995. In 1994, a general security agreement was entered into between DSM, the appellant and another creditor, L. Barkin Investments Limited owned by the appellant's father-in-law, securing their positions as creditors of DSM. The debt to the appellant was identified as $130,000. The security agreement was intended to cover future debts as well as existing ones. However, the Barkin indebtedness was given priority over the appellant's.
2. The Financial Position of DSM
As earlier found by the Tax Court Judge, the evidence showed:
1. the company operated on a rather tight financial basis through the early 1990s;
2. in that period, the company appeared to be in a break-even position;
3. little in the way of wages was paid to the Rich family;
4. Costco was DSM's major customer, accounting for 2/3 of its cash flow;
5. the Costco account was lost in December 1995;
6. by the end of 1995, DSM was operating on a negative cash flow; and
7. at the end of 1995, DSM's major supplier was owed $184,000 and it was critical that some arrangement had to be made to ensure continued supply.
Earlier in his reasons, the Tax Court Judge set out highlights of the financial statements of DSM for the years 1989 to 1995 inclusive. They showed that, in every year, DSM had a working capital deficit and at the end of each year, a total deficit in its shareholders' equity account of the following amounts for 1989 to 1994:
| 1989--$187,324 |
| 1990--$258,236 |
| 1991--$261,403 |
| 1992--$259,752 |
| 1993--$292,207 |
| 1994--$258,793 |
The deficit in 1995 was $324,420 but the Tax Court Judge said that the financial statement for 1995 would not have been before the appellant on December 31 and, therefore, this amount cannot be taken into account. Nonetheless, in each of the prior years, the company had a significant deficit.
3. Changes in Total Sales Compared With Previous Years
The Costco account had just been lost. At that time, it had accounted for about two-thirds of DSM's sales.
4. Cash and Total Receivables and Changes Compared with Prior Years
The financial statements show that throughout the period 1989 to 1994, the company had little or no cash at year end. Its accounts receivable climbed to a high of $73,185 in 1994 as compared to $54,919 the previous year and $20,000 to $30,000 in the years before that. However, the accounts receivable were secured to the bank under a general assignment of book debts.
5. Accounts Payable and Changes Compared to Prior Years.
Bank indebtedness was $110,995 at the end of 1989 and was being reduced gradually so that at the end of 1994, it was $44,192. At the end of 1995, it was $34,884. At the same time, other payables were increasing. There was no evidence of whether the bank had been putting pressure on DSM for repayment. But there was evidence that by 1996, the bank wished to, and did, terminate its loan to the company.
Other payables had been $59,686 in 1991 and reached $215,850 in 1994. At the end of 1995, they were $219,893. The payables at the end of 1995 included the payable to DSM's major supplier of $184,000.
[20]Each of the past and present facts in evidence before the Tax Court Judge with respect to the condition of the company were negative. The debt was some years old and no payments had been made on it in recent years. The debt was postponed to that of the Barkin debt and the bank held an assignment of book debts on the receivables. Of the company's accounts payable of close to $220,000, 85% was due to its major supplier. For the company to continue to receive the supply of products, arrangements had to be made with the supplier. Two-thirds of the company's revenues disappeared with the loss of the Costco account. While the Tax Court Judge discounted the loss of the Costco account because the company was losing money on the account, the loss of such a major account cannot be considered irrelevant to the company's prospects. The assets and liabilities and deficit in the shareholders' equity account all showed that the company was struggling, if not failing.
[21]Nonetheless, the Tax Court Judge concluded that the appellant "took an early opportunity to write-off this debt" because proactive steps had not been taken. I do not say that in appropriate circumstances more steps might not have to be taken before a debt is declared bad. However, there must be some evidence to suggest that it was unreasonable not to do more. There is no evidence to indicate what more could have been productively done in this case. In view of the evidence, all of which was negative, in respect of the prospects of the company, it is not clear what the Tax Court Judge could have had in mind when he determined that more proactive steps had to be taken before the appellant could declare the company's debt to him to be bad.
[22]It appears that the Tax Court Judge's requirement that there be a concrete effort to deal with the debt was based upon the fact that the appellant's chartered accountancy firm did the accounting for the company and that the appellant was a 25% owner of the company. I infer that the Tax Court Judge thought that the intimate knowledge of the company and the expertise of the appellant indicated that he was in a position to take proactive steps. Further, it was surely in the appellant's own interest to take steps to seek refinancing or other possible workouts.
[23]However, there is no legal requirement that proactive steps be taken in all cases. The obligation to take such steps will only arise where there is some evidence to show that collection on the loan is reasonably possible. This, of course, would include cases in which the Minister has assumed that collection was reasonably possible and the taxpayer has failed to address or has inadequately addressed that assumption.
[24]Here, the question is whether it was honest and reasonable for the appellant to consider the debt to be bad on December 31, 1995. If there was some evidence to suggest that a workout or refinancing might have been available to enable collection of some or all of the loan, I would agree that the appellant, being intimately involved with the company, would have to show that he had at least attempted some proactive steps before declaring the loan bad.
[25]In requiring the appellant to have taken proactive steps to meet the honest and reasonable standard, the Tax Court Judge had to have drawn the implicit, factual inference that collection was not futile. Here, there was no evidence to suggest that a workout or refinancing might be available. All the evidence was to the contrary. There was, therefore, no evidence to support the implicit inference of the Tax Court Judge that there was a reasonable possibility of collection from the proactive steps he required of the appellant.
[26]Appellate courts can only interfere with inferences drawn by a trial judge when the error is clearly wrong or what is the same thing, a palpable and overriding error. The appellate court cannot reweigh evidence already considered by the Trial Judge. See Housen v. Nikolaisen, [2002] 2 S.C.R. 235, at paragraphs 19-25. It is only open to an appellate court to find that an inference of fact made by a trial judge is clearly wrong or constitutes a palpable and overriding error if there is no evidence to support the inference or, I would add, where the inference is contrary to the overwhelming weight of the evidence.
[27]This is not a case of reweighing evidence. It is one of absence of evidence supporting the inference drawn by the Tax Court Judge that further steps could reasonably result in collection. Rather, the evidence is all to the contrary. I must conclude that the Tax Court Judge made a palpable and overriding error in respect of the inference he drew, that proactive steps could reasonably result in collection.
[28]The test the appellant had to meet was that he made an honest and reasonable determination that the loan was bad. It follows that, in the absence of any evidence to suggest that proactive steps could reasonably result in collection of all or part of the loan, such proactive steps were not rationally connected to the determination of whether the assessment made by the appellant was honest and reasonable.
[29]Of course, the onus is on a taxpayer to demolish the assumptions made by the Minister in his reply to the notice of appeal. Here, there was no express assumption that the loan could be recovered through the taking of proactive steps. However, even if there had been, there is no obligation on the taxpayer to try to think of every conceivable proactive step and show that none would be productive. It is sufficient that the taxpayer provides evidence as to the condition of the debtor and its inability at the relevant time to repay the loan in whole or in part. That was the evidence in this case.
[30]I conclude, based on the only relevant evidence in the record, that declaring the loan bad as of December 31, 1995, was not an early opportunity for the appellant to write off the loan and that the declaration that the loan was bad was honest and reasonable.
AMOUNT OF INDEBTEDNESS
[31]That then leaves the amount of the indebtedness. The Tax Court Judge made no determination on this point. It is, therefore, open to this Court to do so and in view of the time and expense involved in remitting the matter to the Tax Court for determination and the length of time that the matter has been outstanding, I think is appropriate for this Court to do so in this case.
[32]The Tax Court Judge made reference to adjustments to the loan account and that he was not prepared to rely solely on the financial statements to prove the amount of the indebtedness. In argument before this Court, counsel for the appellant explained the adjustments and that such adjustments as were made in this case were not unusual in the preparation of financial statements from a set of books. Further, amounts in the range of $125,000 appeared in the financial statements over a period of years. There is no suggestion over that period of time that the appellant was, in some way, trying to create a fictitious loan for the purpose of write-off in 1995. In 1994, a security agreement was entered into which referred to an amount of $130,000.
[33]The appropriate standard of review is proof on a balance of probabilities, not one of bookkeeping perfection. In all the circumstances, I am satisfied that there is sufficient evidence that the indebtedness amounted to $125,000 at the end of 1995. I would observe that under the ABIL, the appellant is only entitled to a deduction of 75 percent of that amount.
CONCLUSION
[34]In the circumstances, I would allow the appeal with costs here and in the Tax Court and remit the matter to the Minister of National Revenue for reassessment in accordance with these reasons.
Décary J.A.: I agree.
* * *
The following are the reasons for judgment rendered in English by
[35]Evans J.A. (dissenting): It is admirable that parents help their children to become established in their careers. However, when parents ask other taxpayers to share the burden of assisting a child's struggling business by deducting from their own income part of a loan as a bad debt, they can expect the tax authorities and the courts to examine the claim with care.
[36]I am unable to agree with my colleague Rothstein J.A. that the Tax Court Judge made a reversible error in concluding that Larry W. Rich had not proved that he made an honest and reasonable determination that, at the end of 1995, the debt owed to him by his son's business, DSM Foods Inc., was not collectible. Accordingly, in my opinion, the Tax Court Judge did not err when he found that Mr. Rich could not rely on the ABIL provisions to partially write off the debt against his income for 1995.
[37]After reviewing in full the Tax Court Judge's reasons, the transcript of the oral evidence, and the documentary evidence, I am of the view that there was evidence before him on which he could reasonably find that, in all the circumstances, a reasonable person, acting in a businesslike manner, would have explored further with his son the possibilities for repayment.
[38]In so concluding, I am mindful of the very circumscribed limits which the Supreme Court of Canada in Housen v. Nikolaisen, [2002] 2 S.C.R. 235, imposed on appellate courts' ability to interfere with the findings of fact made by trial court judges who saw and heard the witnesses and immersed themselves in the evidence. I am not persuaded that the Judge in this case either misapprehended the evidence, or based his factual findings on such a slender evidential base as to warrant a conclusion that material factual conclusions were so clearly wrong or unreasonable as to constitute palpable or overriding error.
[39]The Judge did not make an explicit finding of fact on the practical utility of Mr. Rich's exploring repayment options with his son. However, it is clear from the first extract of the transcript quoted by Rothstein J.A. at paragraph 18 of his reasons that the Judge appreciated that, after writing a demand letter, a taxpayer who knew that a debtor company was in financial difficulty did not necessarily have to take further steps to attempt to recover the loan in order to claim it as a bad debt for tax purposes. Accordingly, in treating Mr. Rich's failure to make follow-up inquiries on the demand letter as relevant to determining the reasonableness of Mr. Rich's assessment, the Judge must have concluded that, after hearing all the evidence and reflecting on it, further inquiries by Mr. Rich were not so clearly doomed to failure that a reasonable person would not have made them before regarding the debt as bad.
[40]I do not regard it as reversible error in this case that the Judge neither expressly made a finding on this issue, nor indicated on what evidence he relied to support it. There were no conflicts in the testimony to be resolved. Moreover, the failure of Mr. Rich to make inquiries was simply a part of the overall factual situation to which the Judge had to apply the legal standard that, to treat a debt as bad, the taxpayer's assessment must have been honest, reasonable and made in a businesslike manner.
[41]In these circumstances, it is appropriate for an appellate court to examine the record to see whether there was evidence on which the Tax Court Judge, as the trier of fact, could reasonably have regarded as a relevant factor the failure of Mr. Rich to take further exploratory steps towards the recovery of his money.
[42]Three general considerations have framed my review of the record to see if the Tax Court Judge made a palpable and overriding error in basing his conclusion, in part, on Mr. Rich's failure to explore repayment possibilities.
[43]First, the loan in question was not at arm's length. The Judge found that Mr. Rich's predominant purpose in advancing the money (and, incidentally, in providing through his firm free bookkeeping and accounting services to the company) was to assist his son in his business. Hence, if Mr. Rich were able to deduct a portion of the loan from his income tax, he would have little incentive to attempt to recover the rest of the loan from his son. For this reason, a court should be slow to conclude that the taxpayer has discharged the evidential burden of demolishing the Minister's assumptions.
[44]Second, the taxpayer has the burden of proving on the balance of probabilities the reasonableness of the determination that the debt was not collectible. In my view, this means that the taxpayer also has the burden of establishing that a factor that is often relevant to a reasonableness determination was not relevant here. In this case, despite the difficulty of proving a negative, the futility of further inquiries about how the loan might be repaid is a matter on which the taxpayer is well placed to adduce evidence.
[45]Third, as I have already noted, Housen v. Nikolaisen, supra, has emphasized the high degree of deference that appellate courts must give to the findings of fact by trial judges in order to ensure the effective and efficient division of responsibilities between them. It is not for this Court to re-weigh the items of evidence before the Judge when they point to different conclusions.
[46]In my opinion, the following items of evidence provide sufficient support for the factual finding implicitly made by the Tax Court Judge so that he cannot be said to have made a palpable and overriding error.
[47]First, when asked what his purpose was in writing the demand letter, Mr. Rich stated that he hoped that Michael (his son) would then "come to me and state okay, let's sit down and work out an arrangement to repay this loan." Unlike previous years, no repayments on the loan were made in 1995. Mr. Rich also said that he had expected Michael to come up with some proposal for the long-term repayment of the loan (Appeal Book, Vol. IV, page 133 of the transcript).
[48]I infer from this that, as someone intimately familiar with the finances of the company, Mr. Rich must have thought that it was in a position to come up with some such proposal. Indeed, he testified that he was surprised to be told in the reply to his demand letter that the company could not even start to repay any part of the loan (Appeal Book, Vol. IV, page 133 of the transcript). Further, in light of these circumstances, including the reasons given by Mr. Rich for writing the demand letter and the letter's lack of specificity, it was open to the Judge to regard it as unreasonable for Mr. Rich to accept at face value Michael's curt and formal statement that no repayment of the loan was possible.
[49]Second, when asked why he did not pursue further steps to secure repayment, Mr. Rich said that it would have put the company into bankruptcy to have sent in a receiver or put the company in for collection (Appeal Book, Vol. IV, page 134 of the transcript). However, this answer does not explain why he did not pursue less formal routes, such as discussing a financial work-out. Further, if he thought that the company was failing, it is odd that he did not initiate discussions with Michael since his and his father-in-law's investment in the company were also at risk. I also note that, while DSM Foods had been indebted to Mr. Rich for several years, Mr. Rich continued to make new loans to the company from time to time after previous loans were partially retired.
[50]Third, it was not necessarily unreasonable for the Judge not to regard the company's financial records as definitive of the state of its financial position. He had noted the absence of supporting documentation and the bookkeeping errors that had taken Mr. Rich a lot of time and effort to put right, including an erroneous entry in DSM Food's books writing off the debt to Mr. Rich. Indeed, in his testimony, Michael Rich appeared to regard the debt as forgiven in 1995 in order to appease the company's banker and to provide comfort to another lender, his grandfather (Appeal Book, Vol. IV, pages 51-52 of the transcript).
[51]Fourth, while the Judge did not impugn Mr. Rich's credibility as a witness, the Judge found his answers to two questions to be unsatisfactory: paragraphs 6 and 19. The latter, which concerned apparently large loans by DSM Foods to Michael, he regarded simply as indicative of Mr. Rich's lack of scrutiny when dealing with DSM Foods. Further, Mr. Lomas, the auditor, testified that Mr. Rich had been less than forthcoming with him in that he did not initially disclose a material fact, namely that the president of DSM Foods was his son: Appeal Book, Vol. V, page 313.
[52]Fifth, while the Judge understandably attached less weight to events after 1995, it was not irrelevant to the possible utility of exploratory discussions between Mr. Rich and Michael that, in April 1996, DSM Foods entered into an arrangement with its principal supplier for the repayment, in monthly instalments of $4,000, of its accumulated debt of approximately $185,000. The evidence was that by November 1996, the company had repaid all but $1,500 of the old debts. On the strength of this record, presumably, the supplier agreed to the repayment of the company's new debt in reduced monthly instalments of $1,500. This is an indication that it might have been fruitful for Mr. Rich to have discussed the staged repayment of his loan with Michael, especially since, prior to 1995, DSM had had a record of repaying Mr. Rich when receivables came in.
[53]When these evidential items are considered within the context of the three framing principles that I identified at the start of these reasons, I cannot conclude that the Tax Court Judge made a palpable and overriding error in implicitly finding that it was not futile for Mr. Rich to have discussed with his son repayment strategies before determining that the debt was not collectible for the purpose of asking other taxpayers to share in his loss.
[54]For these reasons, I would have dismissed the appeal.