http://decision.tcc-cci.gc.ca/site/tcc-cci/decisions/en/item/65431/index.do 
Coveley et al. v. The Queen[1] (December 20, 2013) on its face is a rather simple case involving a claim to allowable business investment losses (“ABIL”s) in 2005:
[1] The appellants are the co-founders of cStar Technologies Inc (“cStar”). They are husband and wife.
[2] cStar was incorporated on March 30, 1998 and is in the business of developing wireless communication applications which enable machines and business systems as well as machines and people to communicate wirelessly.
[3] Mrs. Solbyung Coveley is the shareholder, president and chief executive officer of cStar. She is also an employee of cStar.
[4] Mr. Michael Coveley is the chief technology officer and senior vice‑president of cStar. He is also an employee of cStar.
[5] Starting in 1998, the appellants made loans to cStar comprising of their unpaid remuneration, cash advances and corporate expenses that they paid on behalf of cStar with their personal credit cards.
[6] In filing their income tax returns for the 2005 taxation year, each appellant claimed an allowable business investment loss (“ABIL”).
[7] In filing their 2006 income tax returns, each of the appellants claimed against their income a non-capital loss carry-forward arising from their ABIL claims in 2005.
[8] The Minister of National Revenue (the “Minister”) disallowed the ABILs claimed by the appellants for their 2005 taxation year, as well as the non-capital loss carry-forward for their 2006 taxation year, on the basis that the appellants did not meet the requirements of the Income Tax Act (the “Act”) for claiming an ABIL.
After a lengthy (163 paragraphs) set of reasons the Tax Court judge dismissed the appeals:
[156] In my view, the appellants did not make an honest and reasonable determination that cStar’s debt became a bad debt in the 2005 taxation year.
[157] As the Federal Court of Appeal recognized in Rich, supra, owner-managers are often in the best position to determine whether there is a reasonable prospect of collecting their debts. However, an assessment of the considerations previously enunciated leads me to conclude that cStar’s situation in 2005 was not different from that in previous years. While cStar was in a precarious financial situation in 2005, this does not suffice to justify a conclusion that the loans made to it had become bad debts.
[158] cStar continued to carry on business after the appellants determined that their debt had gone bad, and is in fact still operating. The appellants are correct in stating that the Act does not require that the debtor corporation cease operations before an ABIL claim for a bad debt is available.
[159] In the present appeals, the appellants’ conduct before and after the bad debt determination does not support a finding that there was a reasonable and honest determination that their advances to cStar had become bad debts. Quite the opposite, their conduct suggests that both of them were confident that the market would catch up and that cStar would eventually become profitable.
[160] In addition, there was no evidence that the appellants made reasonable efforts to recover their debts. There was no evidence that the appellants tried to sell any of cStar’s assets, such as patents. There was no evidence that they tried to sell any of cStar’ shares. The evidence showed that the appellants were not ready to share control of cStar with potential investors.
[161] For all these reasons, I am of the view that the appellants’ debt did not become bad in 2005.
[162] The appellants’ ABIL claims must consequently be disallowed for the 2005 taxation year. In addition, the appellants are not entitled to carry forward a non‑capital loss to the 2006 taxation year, for the following reasons:
(a) As regards Mr. Coveley, the loans were not made for the purpose of gaining or producing business income from cStar. If I had found that the loans by Mr. Coveley bore interest, his claim for an ABIL in 2005 would still have failed since the debt did not become bad in 2005. Accordingly, he was not entitled to carry forward a non‑capital loss to his 2006 taxation year.
(b) As regards Mrs. Coveley, the debt did not become bad in 2005. Accordingly, she was not entitled to carry forward a non-capital loss to her 2006 taxation year.
[163] The appeals are dismissed with costs.
Comment: On the evidence as summarized and accepted by the Tax Court judge it seems difficult to see how there was any possible recovery on these debts in 2005 (or thereafter for that matter):
[51] Mrs. Coveley and Mr. Coveley claimed ABILs of $1,191,757.74 and $1,659,982.92 respectively on their 2005 income tax returns. They amended their ABIL claims on October 7, 2011, namely, the day they filed their Amended Notices of Appeal. The new ABIL claims were $766,577.91 for Mrs. Coveley and $1,745,671.02 for Mr. Coveley.
[52] Both appellants testified that as of December 31, 2005, their prospects of collecting their loans from cStar were non-existent. According to Mrs. Coveley, after 206 stopped funding cStar in November 2005, cStar was no longer able to meet its obligations of approximately $85,000 monthly. In addition, the premises of cStar were hit by a tornado in August 2005 and Mr. Coveley had become ill in 2004.
[53] With annual expenses averaging approximately $1 million, cStar reported a net loss in each year of its operations during the relevant period. cStar’s yearly financial statements for its taxation years ending on March 31 reflect the following:
| |
Revenues |
Expenses |
SRED Credits |
Net Loss for
the Year |
Accumulated
Deficit |
| 1999 |
$0 |
$1,569,223 |
$321,580 |
$1,247,643 |
$1,247,643 |
| 2000 |
$ 49,241 |
$1,445,308 |
$300,627 |
$1,111,218 |
$2,358,861 |
| 2001 |
$ 76,905 |
$1,412,364 |
$354,200 |
$1,363,559 |
$3,368,220 |
| 2002 |
$215,810 |
$1,563,468 |
$481,649 |
$ 866,009 |
$4,234,229 |
| 2003 |
$121,379 |
$1,357,467 |
$427,694 |
$ 929,773 |
$5,164,002 |
| 2004 |
$171,972 |
$1,158,280 |
$395,068 |
$ 847,620 |
$6,011,622 |
| 2005 |
$ 82,140 |
$ 891,174 |
$335,968 |
$ 709,916 |
$6,721,538 |
| 2006 |
$0 |
$1,018,622 |
$367,352 |
$ 905,404 |
$6,676,942 |
[54] Besides owing money to the appellants, cStar was also indebted to Dr. Waters and 206. Furthermore, according to Mrs. Coveley, the world economic situation was not favourable to cStar in 2005. She pointed to the dot-com bubble, the tragic events of 9/11 and the severe acute respiratory syndrome (“SARS”) outbreak.
[55] A tornado hit the cStar premises on August 19, 2005. The storm lifted the roof off the building and forced sewage up the drains. Due to the flood, cStar lost equipment and documents. Some compensation was recovered from the insurance company in 2005 and in 2006.
[56] Mr. Coveley, who was the “top gun” at cStar, had been working very long hours in order to prepare for the demonstration of the Stealth Tag to the US Department of Homeland Security. Exhausted by his work, he became ill and was hospitalized with a double pneumonia in December 2004. In March 2005, he relapsed and was rushed to the hospital, where he was in intensive care for a cardiopulmonary failure; as a result he subsequently had to cut his hours of work to not more that nine a day and he was no longer able to travel.
While the court had a few reservations about the evidence of the taxpayers the obvious question is how would it be possible for cStar to repay these debts? There does not seem to be any evidence referred to in the reasons for judgment of any material amount of realizable assets. The possible sale of patents referred to by the Tax Court judge seems at odds with her earlier statement that Mr. Coverley owned the patents.[2] Similarly the possibility of selling shares does not seem to emerge from any of the evidence referred to in the reasons. On this basis then the case seems very close to the Rich decision referred to by the Tax Court judge where the taxpayer’s ABIL claim was allowed.
[1] 2013 TCC 417.
[2] [25] Mr. Coveley owned many patents. Some of them did not fit the business model of cStar. Mr. Coveley stated that he would assign patents to cStar once they fitted cStar’s business model.