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CCRA Opinion - August 21, 2002
There has been a delay in CCRA being able to start processing the refunds stemming from the Eron losses. This document is an explanation of the delay, as well as a copy of the Opinion issued by CCRA on August 21, 2002.
In early 2002, PricewaterhouseCoopers (PwC) received a phone call from an Eron investor who was having difficulty in dealing with CCRA on his income tax returns with regards to his Eron losses.
This investor was one of 325 investors in the EIC project. [EIC was the project, which Eron `rolled out' in May 1997 to other projects, and subsequent to Eron's demise, Justice Tysoe ruled that all EIC transfers were to be `rolled back' to EIC effective October 3, 1997.]
The investor had filed his Eron losses directly with CCRA, outside of the process that has been put in place by PwC. He had submitted copies of his `term sheets' as evidence of his investments (losses). Additionally, he was also claiming all his investments as Allowable Business Investment Losses (ABILs), even though not all were eligible for ABIL treatment.
Unfortunately, the investor submitted a term sheet for Riva Pointe (in error as he was actually deemed to be in EIC) to CCRA, and claimed this investment as an ABIL. In reality, losses stemming from Riva Pointe are treated as a Capital Loss. CCRA denied the investor's verbal claim that he submitted his Riva Pointe term sheet in error, and denied that he would receive an ABIL. CCRA was under the belief that the Riva Pointe term sheet submitted was the project the investor should reside in for his loss.
March 2002 - It was at this point that PwC spoke with both parties, and did confirm that the investor was actually rolled back to EIC, and that his ABIL should stand. CCRA then requested proof of Justice Tysoe's ruling, which was faxed forthwith.
As CCRA's opinion on the rollout/rollback situation occurring in EIC could affect 325 lenders, they undertook to halt all Eron transactions (refunds) while their Legislation Section digested the information submitted. CCRA then issued the following opinion on August 21, 2002 (pages 2 - 5 of this document).
In summary, all investments which were originally invested in EIC, and subsequently rolled out (around May 1997) to other Eron projects, are deemed to be rolled back into EIC effective October 3, 1997. Accordingly, all EIC investors will stand with an ABIL treatment for their loss in EIC.
CCRA has now resumed their processing of the Eron losses, and we expect tax refunds to begin in Fall 2002.
PricewaterhouseCoopers Inc.
Judicial Trustee
CCRA Opinion
Eron- Mortgage Investments
This memorandum is in reply to your request for assistance in reviewing the facts and circumstances surrounding the loss in value of investments made through the ERON group of companies ("ERON") and the tax treatment of these losses. The companies concerned have been put under the care of a Judicial Trustee. We acknowledge receipt of the attachments to your request being copies of a court order handed down by the Supreme Court of British Columbia and a memorandum from the Vancouver TSO describing a specific investors case.
You have described the scenario as follows:
At the time operations were suspended in October 1997, ERON consisted of the Eron Mortgage Corporation, Eron Investment Corporation as well as numerous project companies in which individuals had invested funds. For the purposes of identifying tax deductible losses of investment capital created by the failure of ERON, you had taken the position that October 3, 1997 was the date on which the investments in ERON mortgages would be considered to have gone bad. Through discussions with PricewaterhouseCoopers ("PWC"), the Judicial Trustee appointed by the B.C. Supreme Court, it is evident that, for most investors there would be no, or minimal recovery and therefore the value of the investment should be considered to be nil. Any recovery realized after the capital loss had been determined, would be treated as a capital gain.
PWC, on behalf of the investors, had asked for special administrative relief for ABIL treatment, however we could not agree to such a request. Instead, in response to several submissions made by PWC, Vancouver TSO Audit undertook to examine all the available records in order to make determinations of ABIL status on each corporate entity that was part of ERON. Of the dozens of companies holding mortgage investments at the time of collapse, a significant number were determined to qualify as business investment losses.
You are concerned about the determination of the "actual location of the investment at a particular point in time; namely, at the time its value was lost". You described the typical investment as being placed initially in the name of EIC for a term of usually six months. At the expiry of that term, the individual's investment was allocated, with the signed permission of the investor, to a particular project. The background description in the court order revealed that often the funds did not get to the project or the project was oversubscribed. If the funds never made it to the project, you were asking whether it can be argued that the investment remained with EIC. Alternatively, given an investor's agreement was obtained to assign his or her funds to a particular project, you asked whether this fact would attach the investment to the particular company regardless of the fact that the actual funds never made it to the chosen project.
Our Comments (CCRA)
As stated in Issue-No 21 ITT dated June 14, 2001: "The Supreme Court has held, in Shell Canada Limited v. The Queen, 99 DTC 5669, [1999] 4 CTC 313, and other decisions, that the economic realities of a situation cannot be used to re-characterize a taxpayer's bona fide legal relationships. It has held that, absent a specific provision of the Income Tax Act (the Act) to the contrary or a finding that there is a sham, the taxpayer's legal relationships must be respected in tax cases. Thus, generally and subject to the general anti-avoidance rule (GAAR), re-characterization is permissible only if the label attached by the taxpayer to the particular transaction does not properly reflect its actual legal effect."
Given the forgoing statements, we must apply this position in the context of the Eron situation. That is, the nature of the loss to the investor must be determined by the legal relationship in existence at the time of the loss. There is no better indicator of the nature of the investor's loss in this case then the judgements rendered by the Supreme Court of British Columbia in determining the entitlements to recoveries if any, in the matter of the financial demise of the Eron group of companies.
As far as any beneficial entitlement to mortgages, we are prepared to accept the "bare trust" arrangement where the conditions conveyed by Justice Tysoe in his decision of November 1999 were met. In paragraph 16 of that decision Justice Tysoe directs the Judicial Trustee (PricewaterhouseCoopers) to accept a trust claim if it is satisfied that:
(a) a trust declaration in respect of the relevant mortgage was executed by an Eron trustee;
(b) the trust claimant advanced funds proportionate to its claim to EMC (Eron Mortgage Corporation) or to one of its agents and was not repaid the funds or did not have the funds transferred to another mortgage;
(c) - (i) the trust claimant was shown as a beneficiary in the trust declaration in respect of the mortgage;
- (ii) the trust claimant is included in Eron's list of investors in respect of that mortgage, unless the trust declaration, having been executed after the signing of the term sheet and advancement of funds by the trust claimant, did not contain the name of the claimant and the Judicial Trustee is not satisfied that the omission of the claimant's name from the trust declaration was due to inadvertence; or
- (iii) the Judicial Trustee is otherwise satisfied that the Eron trustee intended the trust claimant to be a beneficiary of the mortgage (which may be based on the claimant's term sheet if the Judicial Trustee is satisfied that the omission of the claimant's name from the trust declaration or the list of investors was due to inadvertence).
Similarly, the Supreme Court's decision in the matter of investments in EIC dated July 12, 1998 should also be followed. In that report Justice Tysoe found at paragraph 32:
"The investors had no control over the use of the funds by EIC and none of the mortgages were held in trust for any of the EIC investors. Despite the use of the word "security" in EIC's promotional materials and the typical EIC loan agreement, no security was held for the EIC investors and the investors were simply lending money to EIC (emphasis mine) on the basis of its covenant and the knowledge that EIC was investing the monies in EMC mortgages. The investors were unsecured creditors of EIC entitled to share pro rata with other unsecured creditors in the net amount realized on EIC's assets."
He continues at paragraph 35:
[35] In addition, unlike the conclusion of the trial judge in Winnipeg Mortgage that the documentation created equitable mortgages or trusts, it is my view that the allocation of the mortgages by EIC to the investors had no effect in law. EIC did not grant security to any of the investors and subject to possible exceptions which I will discuss below, the holder of the mortgages did not execute trust declarations in favour of any of the EIC investors. (emphasis mine)
Therefore once again, the legal form of the transaction cannot be ignored, and an investor holding a promissory note from EIC, held just that regardless of any purported allocation by EIC of investors to specific mortgages by term sheet, other allocation or signature by an investor attesting agreement to invest. Basically if a valid trust indenture or contract was not executed establishing the bare trust relationship, none existed and the investor did not have equitable recourse in the specific mortgages. Instead, in such cases the investors held a debt receivable from EIC.
We trust the above comments will be of assistance.
CCRA
Business and Partnerships Division
Income Tax Rulings Directorate
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