T-1406-74
The Queen (Plaintiff)
v.
Frank Leslie (Defendant)
Trial Division, Addy J.—Toronto, December 12,
1974; Ottawa, March 10, 1975.
Income Tax—Defendant selling business to company con
trolled by him and taking promissory note as part payment—
Repaying part of note 10 years later—Whether part of defend
ant's 1969 income—Whether payment pursuant to bona fide
business transaction and not an appropriation—Income Tax
Act, R.S.C. 1952, c. 148 as am. ss. 8(1)(a), (b).
Defendant caused a company of which he was the controlling
shareholder to be incorporated in order to acquire a business
which he operated. Purchase price of $25,380 was paid by
issuing 10,000 common shares to the vendor, and the balance
was secured by a promissory note for $15,300. Net value of the
business was $5077.85 and included in the balance was
$20,222.15 allocated to goodwill. Ten years later $7,762.68 was
paid in partial satisfaction of the note. Plaintiff claims that this
amount should have been included in defendant's 1969 income
under section 8(1)(a) or (b) of the Income Tax Act.
Held, setting aside the judgment of the Tax Review Board,
and confirming the original assessment, this was not a bona
fide business transaction; defendant was the controlling share
holder, and assets worth $5,075.00 were transferred for
$25,380. As to whether the note was unenforceable because of
failure of consideration regarding the goodwill, the original
agreement does not differentiate between goodwill and other
assets. The note was given only for part of the balance of the
price of all assets sold. Between parties who have entered into
an otherwise enforceable contract, once the Court is satisfied
that there is valuable consideration, it will not consider the
sufficiency.
When an enforceable obligation has been entered into in one
year and creates a taxable benefit to the obligee, and the
obligation is paid in a subsequent year, it is when the benefit is
created, not when the taxpayer actually receives payment, that
the amount should be taken into account. The debt, however,
must be well-secured. If there are not sufficient assets to create
the expectation that the debt will be paid, the benefit is not
conferred until assets are accumulated sufficient to create a
real benefit. Here, no security existed for any amount in excess
of the actual 1959 value of the assets. No benefit was then
conferred in 1959.
Kennedy v. M.N.R. [1973] F.C. 839, followed.
INCOME tax appeal.
COUNSEL:
G. W. Ainslie, Q.C., and C. H. Fryers for
plaintiff.
D. C. Nathanson for defendant.
SOLICITORS:
Attorney General of Canada for plaintiff.
D. C. Nathanson, Toronto, for defendant.
The following are the reasons for judgment
rendered in English by
ADDY J.: The defendant, who was at all ma
terial times the owner of the majority of the voting
shares of Headwater-Perth Cheese & Foods Lim
ited (hereinafter referred to as "the Company"),
had, pursuant to an agreement for sale, dated the
5th of March 1959, sold to the Company, as a
going concern, a storage and food distribution
business which the defendant had been carrying on
for some time. The defendant had caused the
Company to be incorporated as a private company
under the laws of the Province of Ontario for the
purpose of acquiring these assets. The letters
patent incorporating the Company were dated the
4th of March 1959. The purchase price was paid
by issuing 10,000 common shares to the vendor for
a total expressed consideration of $10,000.00 and
the balance was secured by a promissory note to
the defendant vendor for $15,300.00. The promis
sory note bore interest at 3% and contained privi
leges and conditions extremely favourable to the
purchaser Company.
The tangible assets, other than the goodwill,
amounted to $11,851.41 and the current liabilities
amounted to $6,773.46. The net value of the busi
ness exclusive of goodwill was therefore $5,077.85.
Included in the balance of the purchase price was
an amount of $20,222.15 allocated to goodwill. It
is uncontested and was freely admitted by the
defendant at trial that, in fact, there was no value
whatsoever to the goodwill.
Ten years after the sale, namely, in 1969, an
amount of $7,762.68 was paid by the Company to
the defendant in partial satisfaction of the promis
sory note issued to him.
The plaintiff claims that the said amount of
$7,762.68 should, by virtue of section 8(1)(a) or
alternatively 8(1)(b) of the Income Tax Act',
properly be included in computing the defendant's
income for the 1969 taxation year. The defendant,
on the other hand, claims that the said amount was
a payment made pursuant to a bona fide business
transaction within the meaning of section 8(1)(a)
and did not constitute an appropriation under sec
tion 8(1)(b) and, therefore, should not have been
taken into account in computing the income in
1969, since whatever benefit the defendant did
receive was in fact received in 1959, at the time of
the closing of the sale, pursuant to the agreement
for sale and the transferring of the assets. The
relevant portions of section 8(1) of the Income
Tax Act read as follows:
8. (1) Where, in a taxation year,
(a) payment has been made by a corporation to a sharehold
er otherwise than pursuant to a bona fide business
transaction,
(b) funds or property of a corporation have been appropriat
ed in any manner whatsoever to, or for the benefit of, a
shareholder, or
(e) a benefit or advantage has been conferred on a share
holder by a corporation,
the amount or value thereof shall be included in computing the
income of the shareholder for the year.
Having regard to the fact that the defendant
vendor was the controlling shareholder of the com
pany which was purchasing the assets from him,
and having regard also to the fact that assets of
the total net value of some $5,075.00 were trans
ferred to the purchasing company for a total con
sideration of $25,380.00, I find no difficulty what
soever in concluding that the transaction cannot be
termed a "bona fide business transaction" as con
templated by section 8(1)(a) of the Act. Though,
it might well be argued that, as the Company had
no other assets in 1959 except those purchased
from the defendant and that as a result the shares
would not have had any value whatsoever, then,
even when discounting the shares completely, the
Company, at that time, had but a net worth
business assets of $5,075.00 and a liability towards
the vendor of $15,300.00, any such transaction
could still not be characterized as a bona fide
business transaction in view of the great and very
1 R.S.C. 1952, c. 148, as amended to 1969.
evident deficiency in the consideration passing
from the vendor to the purchaser. It follows, there
fore, that if "the payment was made" in 1969,
then, pursuant to section 8(1)(a), the sum of
$7,762.68 would be taxable in that year providing
the other provisions of section 8(1) do not require
the amount to be taken into account in 1959 rather
than in 1969. Similarly, of course, if funds of the
Company in that amount had to be considered as
having been appropriated for the benefit of the
defendant in 1959, then, also under section
8(1)(b), the amount would also be taxable in that
year.
There can be no question of the defendant in
this case being a holder in due course of the
promissory note. The plaintiff, therefore, argues
that, as there was a total failure of consideration in
so far as goodwill is concerned, the promissory
note of $15,300.00 was unenforceable as between
the original parties to the note, namely the defend
ant and the Company, and that the promise to pay
by the Company in effect constituted a nullum
pactum. As a consequence, no appropriation or
payment took place in 1959 but that in 1969, when
the amount of $7,762.65 was paid without any
legal obligation on the Company to pay it, the
payment or appropriation then took place.
In order to determine whether the promissory
note constituted a nullum pactum, one must look
at the original agreement for sale of which it
constituted an integral part. There is no question
of all of the formalities under The Corporations
Act of Ontario not having been complied with or
of the agreement not being valid on its face or
properly executed. The issue was never raised by
the plaintiff and the agreement, which appears to
be regular on its face, is to be presumed to have
been properly executed after the normal legal for
malities had been complied with. The sole question
is one of consideration: in the appendix to the
agreement, the amount of goodwill is included
with the other assets for total assets in the amount
of $32,073.00 and the liabilities, as stated previ
ously, amount to $6,773.00 for a total net value of
$25,300.00 expressed in the agreement, which
amount the Company was obliged to pay by the
transfer of $10,000.00 worth of shares and the
aforesaid note of $15,300.00. By the express terms
of the agreement, there is therefore no distinction
made between the goodwill and the other assets in
so far as payment for the transfer of same is
concerned. The promissory note of $15,300.00 is
not expressed in the agreement to be given for any
part of the goodwill but merely for part of the
balance of the purchase price of all of the assets
sold. It is not a question, therefore, of there being
no consideration for the note, which might very
well have been the case if the note had been
expressed in the agreement to be given in payment
of the goodwill, in which case the promise to pay
being a promise to pay something for nothing,
would constitute a nullum pactum by reason of
total failure of consideration.
On this issue, it is interesting to note that para
graph 11 of the defendant's statement of defence
reads as follows:
11. The amount assigned to goodwill by the Defendant and
Headwater-Perth Cheese & Foods Limited was $20,222.15,
which was paid for by Headwater-Perth Cheese & Foods
Limited by the making of a promissory note in favour of the
Defendant in the amount of $15,300 bearing interest at the rate
of 3% per annum, the balance being covered by the issuance to
the Defendant of fully paid common shares of Headwater-
Perth Cheese & Foods Limited.
(This pleading is, of course, contrary to the express
terms of the agreement as above mentioned.) Such
an admission, as that contained in the above-quot
ed paragraph, might well have been very damaging
if not fatal to the defendant had the plaintiff
chosen to admit the pleading as being factual, but
the plaintiff in his reply pleaded as follows:
3. He admits that the amount assigned to goodwill by the
Defendant and Headwater-Perth Cheese and Food Limited was
$20,222.15, and otherwise joins issue with paragraph 11 of the
Statement of Defence, and says that the parties to the agree
ment of purchase and sale expressly agreed that the promissory
note was merely to secure the unpaid purchase price payable
under the agreement of sale.
The issue having been joined on that aspect of
the case, the Court is then obliged to make a
finding of fact on the matter and, as stated above,
the evidence establishes that the facts coincide
with the above-quoted pleading of the plaintiff.
There is a fundamental distinction to be drawn
at law between a situation where there is total
failure of consideration and one where the con
sideration flowing from one party might not be
commensurate with the value of the promise of or
the value of what is given by the other party.
Between parties who have entered into a contract
which is otherwise legal and enforceable, the
Court, once it is satisfied that there exists in fact
valuable consideration, will not concern itself with
the sufficiency of same nor will it, on the grounds
of insufficiency of consideration or inequality of
undertaking, allow a party to a contract to avoid
his obligations thereunder.
It seems to me clear, therefore, that the agree
ment between the defendant and the Company did
not constitute a nullum pactum nor did the pro
missory note issued pursuant thereto. The note,
which was given in 1959, was fully enforceable
between the parties. The mere fact that an agree
ment is not an arm's length transaction, or does
not constitute a bona fide business transaction
under the Income Tax Act, does not render that
contract void or unenforceable between the parties.
It might also be quite true that the agreement is
the very type of agreement which, had there been
creditors of the Company at the time it was made,
might have been set aside at the suit of one of the
creditors and declared void and unenforceable in
so far as creditors are concerned. But, again, the
fact that a contract might be voidable at the
instance of creditors does not render it void, void-
able or unenforceable as between the immediate
parties thereto.
Since the defendant received in 1959 a valid
negotiable instrument, which was enforceable
against the maker, in the amount of $15,300.00
plus interest, and since the instrument could be
validly negotiated at any time to a holder in due
course, it might seem at first that, in accordance
with the argument advanced by the defendant,
pursuant to section 8(1)(b), funds in the amount of
at least $15,300.00 2 were appropriated in 1959 to
and for the benefit of the defendant or, alternative
ly, under section 8(1)(c) a benefit in that amount
was conferred on the defendant, and that, in both
cases, the amount of the note (subject perhaps to
some discount, having regard to the low rate of
interest and the length of time before maturity)
should, in accordance with the concluding words of
section 8(1) have been included in computing the
2 (Shares in the nominal amount of $10,000.00 having also
been received.)
income of the defendant for the year 1959 and
would have nothing to do with the taxation year
1969.
Generally speaking, when a legally enforceable
obligation to pay has been entered into, in one
taxation year, and this obligation creates a taxable
benefit in the hands of the obligee or of the payee
and the legal obligation is met and paid in a
subsequent taxation year, it is when the legally
enforceable benefit is created and not when the
taxpayer actually receives payment that the
amount should be taken into account. This princi
ple was approved by my brother Cattanach J. in
Kennedy v. M.N.R. 3 and his decision was con
firmed on this point by the Court of Appeal in
Kennedy v. M.N.R. 4 .
In the above-mentioned case, Jackett C.J. also
clearly re-states the distinction made in other cases
between "income" and a "benefit" as contemplat
ed in section 8(1) as follows (refer pages 842 and
843 of the above-mentioned report of the case
before the Court of Appeal):
In the case of "income", it is assumed, in the absence of special
provision, that Parliament intends the tax to attach when the
amount is paid and not when the liability is created. (The
courts naturally react against taxation before the income
amount is in the taxpayer's possession.) Here, the question is
when a "benefit" has been "conferred" within the meaning of
those words in section 8(1). In my view, when a debt is created
from a company to a shareholder for no consideration or
inadequate consideration, a benefit is conferred. (The amount
of the benefit may be a question for valuation depending on the
nature of the company.)
Immediately following that, however, in the
same paragraph he goes on to state:
On the other hand, when a debt is paid, assuming it was well
secured, no benefit is conferred because the creditor has merely
received that to which he is entitled. I am, therefore, of the
opinion that the $53,000 promissory note must be taken into
account for the purposes of section 8(1) in the year in which it
created an indebtedness from the company to the appellant,
namely, 1965. [The underlining is mine.]
He then goes on to state in the following
paragraph:
The question of benefit or no benefit in the 1965 taxation
year is, in my view, primarily a question of fact in connection
3 72 DTC 6357.
4 [1973] F.C. 839.
with which the onus of proof was on the appellant [taxpayer].
[The word in parenthesis is mine.]
The underlined words "assuming it (the debt)
was well secured" obviously do not refer to the
type of instrument under which the debt is
secured, that is, whether it is secured by a simple
promise, a promissory note, a charge or a mort
gage, since in the Kennedy case (supra), the debt
was only secured in that sense by a promissory
note and it is evident that a promissory note of
itself does not constitute security: the security, in
so far as a promissory note is concerned, depends
entirely on the maker's ability to pay. The type of
security contemplated in the above-quoted passage
must be taken to refer to the existence of sufficient
assets to create a good or a sound expectation of
the debt actually being paid. In such a case, a
benefit is in fact being conferred at the time the
legal debt is created. Conversely, if there are no
assets, then, although a legal debt might be creat
ed, there is no benefit conferred at the time,
although a benefit might well accrue if and when
assets are accumulated sufficiently to allow the
obligation to mature into a real benefit.
In the case at bar, as stated previously, the net
assets transferred to the Company amounted to
$5,077.85 after deducting liabilities and these were
the total assets of the Company. On the security of
these assets, the Company gave the defendant
vendor the promissory note for $15,300.00 and
issued to him shares of the nominal value of
$10,000.00. Whatever legal benefit was granted in
fact to the defendant in 1959 necessarily must be
something in excess of the actual value of the
assets transferred to the Company by him, that is,
an amount over and above the sum of $5,077.85.
On the facts, it is clear that there existed no
security whatsoever for any such amount in excess
of $5,077.85 in 1959, since the Company had no
other assets whatsoever with the result that no
benefit was in fact conferred upon the defendant
at that time. It is interesting to note that, at the
time of the sale, the potential of the Company to
generate revenue and to possibly accumulate assets
in the future depended not on the Company itself
but entirely upon the work, industry, ability, know-
how and business connections of the defendant.
Had the Company possessed of itself any such
potential, then, some value might possibly have
been allocated to this asset as goodwill and the net
assets of the Company would have been increased
accordingly. Since, for the reasons above men
tioned, no benefit was in fact conferred at the time
of the sale in 1959, the Minister, in my view, was
correct in assessing the taxpayer in 1969 under
section 8(1)(a) for the amount which he actually
received as it was a payment made by the Com
pany to one of its shareholders otherwise than
pursuant to a bona fide business transaction, and
no taxable benefit to which this amount refers had
been conferred on the taxpayer in 1959.
The assessment was actually made in the
amount of $7,956.22. In the pleadings and at the
opening of trial, counsel for the plaintiff agreed
that there had been an error and that the assess
ment should have been in the amount of $7,762.68,
rather than $7,956.22, and agreed that, if he suc
ceeded, the assessment should be confirmed in the
lesser amount.
The judgment of the Tax Review Board will
therefore be set aside and the original assessment
confirmed in the amount of $7,762.68. The plain
tiff will be entitled to costs.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.