Picadilly Hotels Ltd. v. The Queen, 78 DTC 6444, [1978] CTC 658 (FCTD)

Collier, J:—For the plaintiff’s taxation year which ended April 30, 1971, the Minister of National Revenue included in taxable income an amount of $671,065. The Minister took the view this sum represented the proceeds of disposition of depreciable property, applying Subsection 20(1) of the “old” Income Tax Act*. [1] The effect of that Subsection is sometimes referred to as the recapture of capital cost allowances which are ultimately found to have been in excess of the real net cost of the property disposed of.

The taxpayer appealed to the Tax Review Board. It asserted the amount ought not to have been included in its 1971 taxation year, but in its 1974 year.

Alternatively, it argued that if there was a disposition of depreciable property in the year 1971, then the amount in question should have been allowed as a bad debt pursuant to subsection 11 (3d), or paragraph 11 (1 )(f)**. [2] As a further alternative, and assuming a disposition in 1971, it is then said the plaintiff should have been allowed, as a deduction, a reasonable amount as a reserve for a doubtful debt. Those contentions will become clearer when the facts are recounted.

The appeal to the Tax Review Board was dismissed. This appeal followed.

The plaintiff company!- [3] operated and managed hotels. The president and principal shareholder of the plaintiff was Mr Frank P Bernard. In 1964 the plaintiff had purchased the Georgian Towers Hotel in Vancouver, BC. In 1970 it agreed to sell the hotel to Oasis Hotel Ltd. The offer to purchase was accepted by the plaintiff on July 17, 1970.

The sale price was $3,850.000. The terms of payment were as follows:

(a) $200,000 in cash

(b) assumption by Oasis of a mortgage for $1,117,988.59 in favor of The Great West Life Assurance Company

(c) assumption by Oasis of $1,170,608.87 owing by the plaintiff under an agreement for sale between the plaintiff and G T Holdings Limited*. [4]

(d) the assignment by Oasis of a mortgage in its favor, called the “Exclusive mortgage”, covering certain property in Edmonton. The value was stated to be $314,607.64

(e) An assignment of Oasis’ interest, as vendor, under an agreement for sale covering property known as the Bonaventure Motor Hotel. The value assigned to this item was $431,336.77.

(f) the transfer by Oasis to the plaintiff of certain real property, in Alberta, valued at $60,000.

(g) The balance of $555,458.13 by monthly payments from Oasis of $3600 from August 1, 1970 to July 1, 1971; a $153,600 payment on August 1, 1971; $3600 per month from September 1, 1975 to June 1, 1975*. [5]

I shall sometimes refer to item (g) as the Oasis sub-agreement.

The closing date of the sale, and the effective date of possession by Oasis, was deemed to be July 1, 1970.

By the end of 1970 the plaintiff’s officers had become dubious about Oasis’ ability to manage and operate the hotel profitably. Inferior staff had been hired. The tour business had dropped off considerably. Disquieting reports were coming in from Alberta in respect of Oasis’ operations there, and in respect of its principals, Karl and Marianne Surowiec.

The payments on the Exclusive mortgage were coming in short. There was, apparently, some dispute between Exclusive and the Suro- wiecs. The plaintiff, on January 21, 1971, brought action in the Supreme Court of Alberta in respect of the defaults. A judgment was ultimately obtained. It was not fully collected from the Surowiecs until 1977.

At about the same time, Oasis threatened to bring action against the plaintiff in respect of the contract. A writ was issued, in May of 1971, in the Supreme Court of British Columbia. Damages for breach of contract and warranty, and for misrepresentation were claimed. Alternatively, recission was sought.

In the meantime Oasis had fallen into default in respect of the monthly payments due on the agreement for sale in favor of G T Holdings Ltd. In late 1971, or early 1972, it was in default, as well, in the payments due under the sub-agreement. Subsequently payments were made, under protest and in trust, from June to the end of 1971. After the latter date, no further payments were made.

Oasis did keep current the mortgage payments due to Great West Life. The payments in respect of the Bonaventure property were made. The Alberta property, valued at $60,000, was transferred without difficulty.

The plaintiff brought action, in January 1972, for specific performance of the 1970 agreement between it and Oasis. The suit was launched in the Supreme Court of British Columbia.

That action, and the action by Oasis against the plaintiff, were heard, at the same time, in April 1972, by McIntyre, J. The action by Oasis was, on August 3, 1972, dismissed. A counterclaim by the plaintiff, for specific performance of the July 1970 agreement, was allowed.

In the fall of 1972 Oasis sold the hotel to others. The plaintiff was paid out. It received, in October 1972, $522,628.08. The sale had taken place between the trial, earlier referred to, and the entry of formal judgment. Because the plaintiff was being paid, the plaintiff’s separate action against Oasis was, by consent, dismissed.

But the judgment for specific performance in the other action remained. Oasis appealed to the British Columbia Court of Appeal. The appeal was, in July 1973. dismissed. A further appeal to the Supreme Court of Canada was dismissed in 1974.

I go now to the plaintiff's submissions.

It is said there was no disposition of the hotel property until 1974 when the Supreme Court of Canada judgment was delivered. Oasis, it will be recalled. had been seeking damages for breach of contract, breach of warranty. or misrepresentation. under all or any of those heads. Alternatively, recission had been sought. The plaintiff contends there was no sale or disposition, in fact or in law, until that litigation had terminated: if recission had been obtained there was, retroactively. no sale or disposition; if damages had been awarded the net selling price could not have been ascertained until final judgment: until 1974, the plaintiff did not have an absolute right to the proceeds of the sale: nor was there, until 1974. a fixed sum determined.

I cannot agree with the submission.

There was a disposition. or sale, in July of 1970. .As it turned out, the courts ultimately enforced, against the purchaser, the terms of the sale. In July of 1970, the plaintiff transferred its interest in the property to Oasis, subject to the terms of the subagreement for sale and the other encumbrances. Oasis took possession. The fact that the contract might have been later set aside cannot change the nature of the transaction which occurred in July 1970.

Almost any sale of property can be said, generally speaking, to be subject to the possibility of recission by a court order. That possibility can exist for varying lengths of time, depending upon the applicable prescription periods. Subsequent litigation, and the possibility of a contract involving sale being rescinded by court order, cannot, to my mind, change the nature of the original transaction at the time it was entered into*. [6]

Nor is the position changed, in my opinion, because the plaintiff was contingently liable, in respect of the transaction, for a potential damage award. Whether the damages could have been set off against the sale price is a moot question. Assuming that result, there was still, nevertheless, a disposition or sale in 1970. The actual selling price might. for other purposes including tax, have had to be subsequently adjusted.

The alternative submissions are based on subsection 11 (3d) and paragraph 11 (1 )(e).

I set out the first subsection:

11. (3d) Where on amount that is owing to a taxpayer as or an account of the proceeds of disposition of depreciable property of the taxpayer of a prescribed class as determined for the purpose of section 20 is established Dy him to have become a bad debt in a taxation year, there may be deducted In computing his income for the year the lesser of

(a) the amount so owing to him. or

(b) the amount. if any. by which the capital cost to him of that property as determined for the purpose of section 20 exceeds the aggregate of the amounts. if any. realized by him on account of the proceeds of disposition.

The plaintiff must establish the amounts payable to it by Oasis, and the other sums payable which Oasis had assumed, were, in the 1971 taxation year, bad debts. The plaintiff relies on the history of alleged poor management, default, etc which I have already briefly outlined.

The expression “bad debt” is not defined in the statute. There has been, so far as the researches of counsel and myself disclose, little judicial exposition of the meaning of the expression. In Roy v MNR, 20 Tax ABC 385; 58 DTC 676, Mr Boisvert, of the Tax Appeal Board, said:

A debt is recognized to be bad when it has been proved uncollectable in the year.

In Greensteel Industries Ltd v MNR, [1975] CTC 2099; 75 DTC 63, Mr Cardin, of the Tax Review Board, said this:* [7]

. . . although as a general rule a debt becomes bad when all the assets of the debtor company have been disposed of . . .

Black's Law Dictionary]- [8] defines the expression as follows:

■’Generally speaking. one which is uncollectible.’

There was no evidence before me that the amounts payable by Oasis in 1971 were, on a balance of probabilities, uncollectable. Nor was there any evidence that Mr Bernard, in his business judgment in 1971, considered the so-called debt as uncollectable. The plaintiff had the right to foreclose under the sub-agreement.

It could have forced the return of the asset. There was also no evidence adduced to indicate that Oasis had no, or little realizable, other assets in 1971. Merely because there was some default in payments, and some doubt as to its management abilities, does not lead to any reasonable inference Oasis did not have other interests or assets out of which payment of the debt could have been realized.

The plaintiff is not entitled to any deduction under subsection 11 (3d).

Finally, the plaintiff submits it should have been permitted to deduct, for 1971, a reserve for a ‘‘doubtful debt’’. Paragraph 11 (1)(e) is as follows:

11. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 12. the following amounts may be deducted in computing the income of a taxpayer for a taxation year:

(e) a reasonable amount as a reserve for

(i) doubtful debts that have been included in computing the income of the taxpayer for that year or a previous year. and

(ii) doubtful debts arising from loans made in the ordinary course of business by a taxpayer part of whose ordinary business was the lending of money;

In Harlequin Enterprises Ltd v The Queen, [1974] CTC 838; 74 DTC 6634, affirmed [1977] CTC 208; 77 DTC 5164, Mahoney, J said:

This deduction was sought in an appeal to the Income Tax Appeal Board in respect of its 1949 income tax assessment by a taxpayer with which the present plaintiff may have had some connection. In that case. the learned member of the Board, R S W Fordham. QC. said. with reference to the term “doubtful debts”, that:

Those two words imply a definite financial indebtedness that. for some identifiable reason, probably—but not. it should be noted, certainly—will not be satisfied by the debtor.

I agree with that interpretation. For a debt to, be doubtful within the contemplation of subparagraph 11(1)(e)(i), its collectability must be attended by a doubt based on a real consideration, not on mere speculation. that leads to the conclusion that it will not likely be collected. A doubtful debt and a slow debt are not the same thing. There is nothing in evidence to support the proposition that the debt due from either Curtis company was doubtful as at December 31. 1969.

There is, as I see it, no evidence warranting the conclusion that, in 1971, the amounts payable by Oasis were in the category of “doubtful debts’’. The comments I made in respect of the evidence as to bad debts apply, with equal force, to this issue.

The appeal (action) is therefore dismissed. The assessment of the Minister is confirmed. The defendant is entitled to costs.