REASONS
FOR JUDGMENT
Graham J.
[1]
In the years in question, the Appellant was in
the business of manufacturing and selling manufactured homes. In April 2001, in
anticipation of the sale of the Appellant’s shares to a third party named
R&M Frontier Holdings Corporation (“R&M”), the Appellant disposed of a
number of its assets to a related company. Two of those assets were shareholder
loans in subsidiary companies. The Appellant claimed non-capital losses
relating to the disposition of those shareholder loans in its taxation year
ending April 30, 2001. The Appellant carried those losses back to its taxation
year ending December 31, 2000. The Minister of National Revenue ultimately
reassessed to deny the losses and the carrybacks. The Appellant applied for a
loss determination. The Minister determined the Appellant’s non-capital losses
from its taxation year ending April 30, 2001 to be an amount that did not
include the losses that the Appellant claimed arose from the disposition of the
shareholder loans. The Appellant has appealed both the reassessment and the
loss determination.
[2]
The Appellant’s Appeal was originally heard
before a different judge who ruled in favour of the Respondent. On appeal, the
Federal Court of Appeal ordered a new trial before a different judge.
Issues
[3]
There are two issues in this Appeal. Since the
Appellant and the company that purchased the loans were related, the
disposition of the loans is deemed to have occurred at fair market value. The
first issue in this Appeal is what the fair market value of the shareholder
loans was on April 30, 2001. To the extent that the fair market value of the
loans was less than their face value, the Appellant would have incurred losses.
The second issue in this Appeal is whether any losses incurred were on income
account or capital account.
Witnesses
[4]
Robert Adria testified for the Appellant. Mr.
Adria is a chartered accountant and businessman. He joined the Appellant in
1992 as its Chief Financial Officer. At the time of the transactions in
question, he was the Appellant’s Chief Operating Officer. Mr. Adria is
currently a director of the Appellant. Mr. Adria became an indirect shareholder of the Appellant in 2003
as part of a management buyout. He indirectly owns approximately 25% of the
Appellant. Subject to the one point described in paragraph 15 below, I found
Mr. Adria to be a credible witness.
[5]
Brian Holterhus also testified for the
Appellant. Like Mr. Adria, Mr. Holterhus is a chartered accountant and
businessman and is currently a director of the Appellant. Mr. Holterhus worked
as the Corporate Controller of the Appellant from 1993 to 1997. He was then
hired to work for a subsidiary of R&M. At the time of the transactions, he
was the president and Chief Executive Officer of that subsidiary and was a
director of R&M. During his time at R&M, Mr. Holterhus gained extensive
experience in residential and commercial real estate development. Mr. Holterhus
was the lead negotiator at R&M for the purchase of the shares of the
Appellant. He became a director of the Appellant immediately following the
share purchase. He became a shareholder of the Appellant in 2003 following the
management buyout. He owns approximately 25% of the Appellant directly or indirectly.
Subject to the one point described in paragraph 15 below, I found Mr. Holterhus
to be a credible witness.
[6]
The Respondent did not call any witnesses.
Facts
[7]
In 2001, the Appellant was a wholly-owned
subsidiary of NorTerra Inc. (“NorTerra”). NorTerra was a holding company for a
number of different investments. The Appellant’s core business was building
manufactured homes. The Appellant had 3 plants employing 400 to 500 employees.
With a few exceptions that are not relevant for the purposes of the Appeal, the
Appellant sold its homes exclusively to dealers who, in turn, sold them to
consumers. The Appellant had approximately $60M in revenue from manufactured
home sales in 2001. The Appellant also operated 5 manufactured home dealerships
in various locations in British Columbia and Alberta and was involved in a
number of manufactured home parks either as an owner or a part owner (the “Park
Business”). Most of the manufactured home parks that made up the Park Business
were owned directly by the Appellant but two of the parks were held through
companies known as Valley Vista Seniors Park Inc. (“Valley”) and Lakeside Pines
Development Inc. (“Lakeside”).
[8]
The Appellant owned one-third of the shares of
Valley. The company was formed in approximately 1992 by 3 shareholders: a
landowner who wanted to develop its land; one of the Appellant’s dealers who
wanted to sell manufactured homes; and the Appellant. Each party received
one-third of the common shares of Valley for a total purchase price of $700
each. The shareholders agreed that the landowner would contribute the land, the
dealer would provide financing and look after sales and the Appellant would
provide both financing and overall management. The land was divided into 183
pads. The plan was to rent each of the pads to consumers and to require those
consumers to purchase one of the Appellant’s manufactured homes from the
dealer. The landowner contributed the land to Valley in exchange for preferred
shares. The dealer made an initial shareholders loan of $100,000. The Appellant
made an initial shareholders loan of $200,000.
[9]
The Appellant owned 50% of the shares of
Lakeside. Lakeside was formed in 1992 or 1993 by one of the Appellant’s dealers
and the Appellant. Each party received half of the shares of Lakeside for a total
purchase price of $1 each. Lakeside developed lots and sold them to people
along with one of the Appellant’s manufactured homes. The dealer and the
Appellant both made equal shareholder loans to Lakeside.
[10]
In late 2000, NorTerra made a decision that it
wanted to sell the Appellant. R&M had a manufactured home business that
would have been very compatible with the Appellant’s business. NorTerra
approached R&M to see if they were interested in buying the Appellant. NorTerra
was insistent that any sale be structured as a share sale. The initial offer
price put forward by NorTerra was approximately $15M. Copies of the
calculations by which NorTerra reached this initial offer price were entered
into evidence.
[11]
After receiving the initial offer from NorTerra,
R&M began a due diligence process. Mr. Holterhus testified that as part of
the due diligence process he prepared working papers by which he calculated
R&M’s view of the value of the assets of the Park Business including the
shares and shareholder loans of Valley and Lakeside (collectively, the “Park
Business Assets”) and the assets of the Appellant’s dealership business. His calculations indicated that the value of the Park Business
Assets was approximately $2.5M. As a result of that due diligence process,
R&M ultimately decided that it was not interested in buying the Park
Business Assets.
[12]
NorTerra agreed to transfer the Park Business
Assets from the Appellant to another subsidiary prior to the sale of the shares
of the Appellant to R&M. The parties agreed that the purchase price for the
Appellant’s shares without the Park Business Assets would be $10M. NorTerra and R&M signed a letter of intent to that effect.
[13]
In accordance with the parties’ agreement,
NorTerra incorporated a wholly‑owned subsidiary named 3556514 Canada Ltd.
(“514”). On April 30, 2001, 514 purchased all of the Park Business Assets
for $4,430,366.
[14]
On May 1, 2001, NorTerra sold the shares of the
Appellant to R&M. All proceeds of the sale of the Park Business Assets were
removed from the Appellant by way of dividend prior to the share sale.
[15]
There was evidence from both Mr. Holterhus and
Mr. Adria that, sometime between the initial $15M offer and the ultimate $10M
deal, there were preliminary negotiations that lowered the purchase price from
$15M to approximately $14M. They testified that NorTerra and R&M agreed
that the fair market value of the Park Business Assets was $4,430,366. The
concept that the witnesses were trying to convey was that the parties agreed
that the fair market value of SRI with the Park Business Assets was
approximately $14M and that once those assets (worth $4,430,366) were removed,
the price dropped to $10M. No documentary evidence was entered to support any
of these positions. The working papers that were entered into evidence do not
support the idea that a valuation of $14M was ever calculated or agreed upon.
On cross-examination, Mr. Holterhus was unable to adequately explain where the
$14M figure had come from or why NorTerra would agree that the fair market value
of the Park Business Assets was $4,430,366 when its internal valuation had
placed their value at approximately $2.5M. I do not accept Mr. Adria’s and Mr.
Holterhus’ testimony on these points. I find that the initial purchase price
offered by NorTerra was $15M, that there was never any negotiation of a $14M
price and that, while the $4,430,366 price for the Park Business Assets may
have been agreed upon by NorTerra and R&M, it was not determined by hard
bargaining between them.
Valuation of
the Shareholder Loans
[16]
At the time of the sale of the Park Business
Assets, the Appellant’s shareholder loan to Valley had grown to $1,316,946
including additional advances, unpaid interest, management fees and expense
recoveries and the Appellant’s shareholder loan to Lakeside had grown to
$427,680 including unpaid interest, management fees and expense recoveries.
[17]
Of the $4,430,366 purchase price for the Park
Business Assets, $1,332,797 was allocated to the shareholder loans: $356,602 to
the Lakeside loan and $976,195 to the Valley loan. The Minister did not
challenge the allocation of the balance of the purchase price among the
remaining Park Business Assets and did not take issue with how the disposition
of those assets was reported.
[18]
The $1,332,797 purchase price for the
shareholder loans was $411,830 less than the book value of the loans: $71,078
less than the book value in the case of Lakeside and $340,751 less than the
book value of the loan in the case of Valley. The $411,830 difference represents
the total amount of losses in issue.
[19]
The Appellant submits that the amounts that 514
paid for the loans represent fair market value. The Respondent presented no
evidence regarding the fair market values of the shareholder loans, choosing
instead to rely on its assumption of fact that their fair market values were
equal to their book values.
[20]
In the working papers that Mr. Holterhus
prepared as part of R&M’s negotiations with NorTerra, he valued the
shareholder loans to Valley at $960,000 and the shareholder loan to Lakeside at
$237,500. Mr.
Holterhus was not qualified as an expert witness. However, he is a chartered
accountant who, when he prepared his working paper valuation, had a strong
familiarity both with SRI’s business (having worked for the Appellant
previously), real estate valuation techniques, the particulars of the real
estate market in some of the areas where the Park Business Assets were located
and the manufactured home business in general. He toured each of the sites that
made up the Park Business Assets and asked extensive questions about their
operations. The Appellant provided him with detailed and open information about
the Park Business Assets. Most importantly, at the time Mr. Holterhus prepared
his working paper analysis, R&M was in the midst of arm’s length
negotiations with NorTerra for the possible acquisition of the Park Business
Assets meaning that Mr. Holterhus had a strong incentive to prepare an accurate
valuation. Based on all of the foregoing, I find that Mr. Holterhus’
calculations are good evidence of what an arm’s length purchaser (i.e. R &
M) would have been willing to pay for the Park Business Assets in April 2001.
[21]
The value of the Valley loan that was ultimately
used by the Appellant was $16,195 higher than that value determined by Mr.
Holterhus’. This
difference resulted in fewer losses being available to the Appellant than would
have been available had Mr. Holterhus’ figure been used. Similarly, the
valuation of the Lakeside loan that was ultimately used by the Appellant was
$119,102 higher than Mr. Holterhus’ value. This difference also resulted in fewer losses being available to
the Appellant than would have been available had Mr. Holterhus’ figure been
used. Since the use of these higher values hurt the Appellant’s position, I do
not consider these differences to undermine Mr. Holterhus’ calculations.
[22]
In addition to the above, there was a
significant amount of evidence indicating that both Valley and Lakeside were in
financial difficulties in April 2001. I find that that evidence supports
Mr. Holterhus’ conclusions on value.
[23]
Mr. Adria testified that, at the time of the
sale, the Appellant’s prospects of receiving full repayment of the Valley
shareholder loan were not good. The sales of manufactured homes in the area
around the Valley development were low as were the sales of homes in the
development. Approximately one-third of the pads remained vacant and the pace
with which homes were being sold suggested it would take another 10 years to
fill the pads. Valley was not producing enough cashflow from its rental
operations to cover the interest on the loans. Valley’s total debt, including
shareholder loans, preferred shares (which were effectively the same as debt
due to an agreement among the shareholders) and bank debt, exceeded the value of
its assets. Valley had tried to sell the property but had found it difficult to
attract a buyer who was interested in a partially completed development. While Valley
had had one offer at a good price in the previous year, the other terms of that
offer were unacceptable. In
addition, the shareholder who had originally contributed the land to Valley was
having health problems and his children, who were looking after his affairs,
had begun making all communications through their lawyer.
[24]
Valley continued to lose money after the asset
sale but, in October 2002, an unsolicited buyer bought Valley’s assets. All of
the shareholder loans were repaid, the preferred shares were redeemed and there
was additional cash remaining to be shared among the parties. 514 agreed to
waive approximately $55,000 in accrued interest but received approximately $80,000
to $90,000 of dividends from the additional cash remaining. The net effect was
thus that 514 came out ahead by between $25,000 and $35,000. Mr. Adria
attributed the change in the value of the company to the presence of a uniquely
motivated buyer, a change in provincial government, an improving regional
economy and improved airline access to the community where the development was
located. I accept that these factors would have affected the purchase price.
Based on the foregoing, I am not prepared to take this subsequent sale into
account when determining the fair market value of the loans in 2001.
[25]
Mr. Adria testified that, at the time of the
sale, the Appellant’s prospects of receiving full repayment of the Lakeside
shareholder loan were also not good. There had been no sales of lots in the
previous 4 months and sales in the area in general were not doing well. The
other shareholder was very pessimistic about the prospects of the development.
The shareholder loans exceeded the value of Lakeside’s assets. The other
shareholder and the Appellant had agreed to waive the interest on their loans
since January 2000. I
note, however, that the problems that Mr. Adria described for Lakeside do not
appear to be as serious as those he described for Valley. There was no bank
debt and the shareholders were getting along. I acknowledge that when Lakeside
was ultimately sold to a third party about 3 years later, 514 received less for
its loan than it had paid to purchase the loan from the Appellant but, due to
the time period that elapsed between the two events, I have not taken this
subsequent sale into account when determining the fair market value of the
loans in 2001.
[26]
The Respondent submitted that the value that Mr.
Holterhus calculated for the shareholder loans was neither negotiated with nor
agreed to by NorTerra. I acknowledge that fact. However, the value of the
Valley loan calculated by Mr. Holterhus was the same as the value first
proposed by NorTerra and the value of the Lakeside loan calculated by Mr.
Holterhus was only $112,500 lower than the value first proposed by NorTerra.
This means that, in the course of arm’s length negotiations, the parties were
only $112,500 apart on the value of two loans with a total face value of over
$1.7M. I do not consider a variation of approximately 6% to be a material
difference particularly because the result of that difference was that the
Appellant claimed fewer losses than it might otherwise have claimed.
[27]
The Respondent also submitted that there was a
very significant difference between the $2.5M value that Mr. Holterhus placed
on the Park Business Assets and the $4,430,366 purchase price that was
ultimately used when 514 acquired those assets. I agree. However, the portion
of the difference that can be attributed to the shareholder loans in question
is only the $16,195 and $119,102 described at paragraph 21 above. The balance
of the difference relates to the remaining assets. The Minister did not dispute
the value allocated to those assets so I do not consider any difference in
value on those assets to be relevant nor do I consider it to undermine the
value otherwise determined by Mr. Holterhus.
[28]
The Respondent highlighted the fact that in the
asset sale agreement the Appellant referred to the difference between the face
value of the loans and the sale price as an “Allowance for doubtful account”. I acknowledge this fact but I attach no significance to the
description. The simple fact is that the Appellant did not actually claim an
allowance for doubtful accounts in either its own financial records or its tax
return. The Appellant sold the loans and claimed the resulting loss. The issue
is whether that sale occurred at fair market value. The manner in which the
Appellant described the loss in the asset sale agreement is irrelevant.
[29]
The Respondent also focused on the fact that the
amount of the losses is very similar to the Appellant’s proportionate share of
the deficits of Valley and Lakeside. The Respondent referred to this as the Appellant attempting to “expense
the negative retained earnings” of Valley and Lakeside. Mr. Adria testified
that the Appellant did no such thing. He also walked me through the Appellant’s
books and records and demonstrated that no such thing occurred. The Respondent
did not call any witnesses on this point and offered little more than
speculation to counter Mr. Adria’s testimony. I have difficulty understanding
from an accounting point of view how one could ever expense a deficit. At worst,
the similarity of the numbers indicates that the Appellant used the deficits as
a rough method of valuing the loans, not that the Appellant somehow expensed
those deficits.
[30]
In summary, while the evidence entered by the
Appellant was by no means ideal, I find that the valuation that Mr. Holterhus
prepared during the negotiations is sufficient evidence of value to demolish
the assumption of fact made by the Minister. It is not necessary for me to
conclude that Mr. Holterhus’ figures are the correct fair market values nor
that the figures used by the Appellant are. I do not need to reach an exact
determination of the fair market value of the loans. It is sufficient for me to
find that the fair market value of the loans was no higher than the amounts
claimed by the Appellant. Based on all of the evidence, I make that finding and
therefore conclude that $411,830 in losses were incurred by the Appellant on
the disposition of the shareholder loans.
Capital Loss or
Non-Capital Loss
[31]
Having determined that the Appellant incurred
losses on its disposition of the shareholder loans, I must now determine
whether those losses were capital losses or non-capital losses.
[32]
Both parties referred me to paragraphs 15 to 17
of the Federal Court of Appeal decision in Easton v. The Queen, 97 DTC
5464.
[15] As a general
proposition, it is safe to conclude that an advance or outlay made by a
shareholder to or on behalf of the corporation will be treated as a loan
extended for the purpose of providing that corporation with working capital. In
the event the loan is not repaid the loss is deemed to be of a capital nature
for one of two reasons. Either the loan was given to generate a stream of
income for the taxpayer, as is characteristic of an investment, or it was given
to enable the corporation to carry on its business such that the shareholder
would secure an enduring benefit in the form of dividends or an increase in
share value. As the law presumes that shares are acquired for investment
purposes it seems only too reasonable to presume that a loss arising from an
advance or outlay made by a shareholder is also on capital account. …
[16] There are two
recognized exceptions to the general proposition that losses of the nature
described above are on capital account. First, the taxpayer may be able to
establish that the loan was made in the ordinary course of the taxpayer's
business. The classic example is the taxpayer/shareholder who is in the
business of lending money or granting guarantees. The exception, however, also
extends to cases where the advance or outlay was made for income-producing
purposes related to the taxpayer's own business and not that of the corporation
in which he or she holds shares. For example, in Berman & Co. v.
Minister of National Revenue, [1961] C.T.C. 237 (Can. Ex. Ct.) the
corporate taxpayer made voluntary payments to the suppliers of its subsidiary
for the purpose of protecting its own goodwill. The subsidiary had defaulted on
its obligations and as the taxpayer had been doing business with the suppliers
it wished to continue doing so in future. [Berman was cited with
apparent approval in the Supreme Court decision in Stewart & Morrison
Ltd. v. Minister of National Revenue, [1974] S.C.R. 477 (S.C.C.) at 479].
[17] The second
exception is found in Freud. Where a taxpayer holds shares in a
corporation as a trading asset and not as an investment then any loss arising
from an incidental outlay, including payment on a guarantee, will be on income
account. This exception is applicable in the case of those who are held to be
traders in shares. ...
[emphasis added]
[33]
The Appellant seeks to rely on the first
exception set out in Easton. The Appellant submits that it is saved by
both aspects of this exception, namely that it advanced the shareholder loans
in the course of its money lending business and that it advanced funds to
Valley and Lakeside not for the purpose of advancing those companies’
businesses but rather for the purpose of creating a market for its manufactured
homes.
Did the
Appellant Have a Money Lending Business?
[34]
The Appellant had a finance division. This
division provided a number of different types of financing:
(a) Trade Receivables: The Appellant
provided financing in the form of trade receivables on individual purchases of
manufactured homes by its dealers. The need for trade receivable financing
usually arose when a dealer had purchased a home for sale to a specific
customer but had not yet been paid by that customer. On any purchase, a dealer
would have 10 days to pay before interest would begin accruing. The Appellant
carried an average of $3M to $5M in trade receivables but, at certain times of
year, the balance could be as high as $12M. The Appellant earned interest of
approximately $300,000 per year from its trade receivables.
(b) Inventory Financing: The Appellant
provided inventory financing to dealers in situations where the dealers were
unable to obtain their own financing. The Appellant would take various forms of
security from the dealer including general security agreements and personal
guarantees.
(c) Working Capital / Start-up Financing:
The Appellant provided working capital or start-up financing to some of its
dealers. This financing differed from inventory financing in that it was
directed at financing aspects of the dealer’s operations other than its
inventory.
(d) Consumer Financing: The Appellant did
not actively seek to finance consumers. However, on rare occasions the
Appellant found itself holding debts directly from consumers in situations
where a dealer had defaulted on its obligations to the Appellant under one of
the above types of financing and the Appellant was thus forced to seize the
dealer’s consumer debts.
[35]
I accept that the above activities are evidence
that the Appellant was carrying on a money lending business. The Appellant
submits that the shareholder loans that it made to Valley and Lakeside were
part of that business. The Respondent concedes that the Appellant was in the
business of lending money but argues that the shareholder loans it made to
Valley and Lakeside were not part of that business. I agree with the
Respondent.
[36]
The factors that make the Appellant’s financing
business a money lending business are simply not present with the shareholder
loans. There was no evidence that the Appellant took any security for the loans
and the interest received on the loans did not appear to be an important factor
for the Appellant. In fact, in the case of the loan to Valley, the agreement
among the shareholders of Valley provided that interest on the shareholder
loans and dividends on the preferred shares were to be paid at the discretion
of Valley’s directors, that any payment of interest or dividends and that any
repayment of loans or redemption of preferred shares was to occur pro-rata
among the parties. A person in the money lending business would not put
themselves in a position where their ability to receive interest or a repayment
of capital was subject to the discretion of two other people.
Were the Shareholder Loans Made for a Purpose
Relating to the Appellant’s Business?
[37]
Having concluded that the Appellant did not make
the shareholder loans in the course of its money lending business, I must now
consider whether the Appellant made those loans for income producing purposes
relating to its own business and not for income producing purposes relating to
the businesses of Valley or Lakeside. The Respondent submits that the Appellant
made the loans in order to allow Valley and Lakeside to make money. The
Appellant submits that the entire purpose of the loans was to allow the
Appellant to make money from the sale of its manufactured homes. I accept the
Appellant’s position.
[38]
The caselaw in this area was thoroughly
canvassed by Justice Campbell in her decisions in Valiant Cleaning
Technology Inc. v. The Queen, 2008 TCC 637 and Excell Duct Cleaning Inc.
v. The Queen, 2005 TCC 776. In Excell Justice Campbell
summarized the caselaw as follows at paragraph 7:
In Easton v. R.
(1997), 97 D.T.C. 5464 (Fed. C.A.), the Federal Court of Appeal stated the
general proposition that an advance made by a shareholder to or on behalf of a
corporation will be treated as a loan for the purpose of providing working
capital to the corporation. Any resulting loss would therefore be capital in
nature as either the loan was given to generate a stream of income or to secure
an enduring benefit. However the Court in Easton recognized certain
exceptions to this general proposition. One of these exceptions exists where
the loan was made in the ordinary course of the business. This exception has
been recognized as extending to cases where the loan was made for income
producing purposes as it related to the taxpayer's own business (R. v.
Lavigueur (1973), 73 D.T.C. 5538 (Fed. T.D.) and Paco Corporation v. R.
(1980), 80 D.T.C. 6328 (Eng.) (Fed. T.D.)). Other examples of this exception
are where the loan was made for the purpose of increasing the profitability of
the taxpayer's own business (Williams Gold Refining Co. of Canada v. R.,
2000 D.T.C. 1829 (T.C.C. [General Procedure])) and where the loan was made for
the purpose of protecting the existing goodwill of the taxpayer's business (Berman
& Co. v. Minister of National Revenue (1961), 61 D.T.C. 1150 (Can. Ex.
Ct.)).
[39]
The parties took me through these cases. I found
the facts in Paco to be quite similar to the Appellant’s case and found
the decision to be very persuasive. In that case the taxpayer manufactured
machinery and equipment used to make concrete blocks. The taxpayer had been
successful in selling its products in North America and wanted to expand its
sales into Europe. The only way to successfully sell the products was through a
demonstration. The taxpayer was not interested in entering into the cement
block manufacturing business but it needed a manufacturer in order to
demonstrate its products. Since the product was not currently in use anywhere
in Europe, the taxpayer decided to establish a demonstration plant. The
taxpayer incorporated a company in France. The taxpayer took 60% of the shares
and the remaining 40% were held by local businesspeople. The taxpayer intended
to sell its shares in the company to the other shareholders once the plant was
in operation but planned, as a condition of the sale, to maintain the right to
bring potential customers to the plant. The taxpayer lent a significant amount
of money to the company. The taxpayer was ultimately unsuccessful in selling
its products in Europe and suffered a loss on its loans. The taxpayer claimed
the loss as a non-capital loss but the Minister treated it as a capital loss.
The Federal Court Trial Division held that the loss was a non-capital loss.
[40]
In the case at bar, substantially all of the
Appellant’s revenue came from selling its manufactured homes. The Appellant was
involved in the Park Business for the purpose of selling its homes, not for the
purpose of owning and operating a manufactured home park or speculating on the
sale of manufactured home lots. The Appellant only entered into deals in
respect of parks where the consumers who would be leasing pads or buying lots
in the parks were required to purchase one of the Appellant’s manufactured
homes as part of their purchase or lease. If the Appellant’s interest had been
in leasing or selling land it would not have cared whose manufactured homes
were placed on the lots. The Appellant sold its homes to dealers who then sold
them to the consumers who had leased a pad or purchased a lot. Thus, by
becoming involved in the parks, the Appellant was able to ensure that its
dealers had a market for its products and therefore that the Appellant would be
able to sell more products to the dealers. In addition, by supporting dealers
through these sales, the Appellant made it more likely that the dealers would
be financially viable and thus that the dealers would continue to be available
to make other sales of the Appellant’s manufactured homes to other consumers.
The Appellant’s strategy was to sell its interest in a given park once the
potential to place new homes in the park ended. It had no interest in earning
long term rental income.
[41]
The potential for the Appellant to earn revenue
as a result of the Valley and Lakeside developments was significant. Mr. Adria
testified that the average invoice for one of their manufactured homes is
$50,000. There were 183 pads in the Valley development. The Appellant’s potential revenues from selling homes to its
dealer for the Valley development were therefore approximately $9.15M. There
were 134 lots in the Lakeside development. The Appellant’s potential revenues from selling homes to its
dealer for the Lakeside development were therefore approximately $6.7M.
Admittedly there was revenue that Valley and Lakeside would earn from the rental
of the pads or sale of the lots, but there were also considerable expenses
associated with developing the parks, preparing the pads and lots for lease or
sale, actually leasing the pads or selling the lots and then operating the
park.
[42]
Counsel for the Respondent drew my attention to
the fact that the Appellant’s audited financial statements for its year ending
December 31, 2000 describe the shareholder loans as “equity investments” and that the Appellant had consistently referred to the loans it
made to Valley and Lakeside as shareholder loans and had only begun calling
them “receivables” in its Notice of Objection and Amended Notice of Appeal.
This choice of terminology suggests that the Appellant viewed the loans as
capital in nature. That said, I have given little weight to this point as, in
my view, the nature and purpose of the loans is more important than what the Appellant
called them.
[43]
Counsel for the Respondent also drew my
attention to the decision of Justice Bowie in Wescast Industries Inc. v. The
Queen, 2010 TCC 538. In my view, Justice Bowie’s decision does nothing to
alter the state of the law as described by Justice Campbell. Wescast can
easily be distinguished from the Appellant’s case. The taxpayer in Wescast
established a subsidiary for the purpose of earning income in the subsidiary
from the same business that the taxpayer itself carried on and then, on advice
from its accountants and lawyers, appears to have engaged in retroactive tax
planning designed to recharacterize the purpose of working capital advances
that it had made to the subsidiary as being on income account. As set out
above, Valley and Lakeside carried on completely different businesses from the
Appellant’s business and the Appellant’s purpose for lending money to those
companies never changed.
[44]
Based on all of the foregoing, I find that the
Appellant advanced the shareholder loans to Valley and Lakeside for the purpose
of earning income from its manufactured home business and thus that the losses
incurred on the ultimate disposition of those loans were non-capital losses.
Conclusion
[45]
The Appeal is therefore allowed with costs and
the matter is referred back to the Minister of National Revenue for reconsideration
and reassessment on the basis that the Appellant had an additional $411,830 in
non-capital losses in its taxation year ending April 30, 2001.
Signed at Ottawa,
Canada, this 5th day of June 2014.
“David E. Graham”
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