Entitled to deduct interest expenses on 2004 Quest loan he used to satisfy judgments against himself and Hollinger Inc.
Julius Melnitzer | June 21, 2019 5:03 PM EDT
The Tax Court of Canada has ruled that former media mogul Conrad Black is entitled to deduct interest expenses on a $32.3 million loan he used to satisfy judgments against himself and Hollinger Inc., a company he once controlled.
“The whole area of interest deductibility is an historic quagmire full of factual difficulty and interpretive morasses,” said William Innes, a veteran tax lawyer who is counsel at Rueters LLP in Toronto. “It’s apparent from reading the judgment that Mr. Black used his very forceful and engaging personality to sail through the pitfalls, and the judge appears to have accepted his evidence essentially without question.”
The June 14 decision from Tax Court Chief Justice Eugene Rossiter came almost exactly one month after U.S. President Donald Trump pardoned Black — a Canadian-born British citizen whose former international newspaper empire included the National Post, Chicago Sun-Times, the U.K’s Daily Telegraph and the Jerusalem Post — for his 2007 convictions on fraud and obstruction of justice, charges that stemmed from allegations that he siphoned millions of dollars from the sale of newspapers owned by Hollinger Inc.
Black was effectively the controlling shareholder of Hollinger Inc. (Inc.) and Hollinger International (International), both public corporations of which he was the CEO and chairman of the board.
In 2004, International sued Black and Inc. in Delaware for reneging on agreements to repay certain non-compete payments that they had received. The suit resulted in a US$8.69 million judgment plus interest against Black, and a further US$21.15 million judgment for which Black and Inc. were jointly responsible.
The joint damages represented the non-compete payments made by International to Inc., but Black received none of that money.
After the Delaware judgment was issued, Black borrowed $32.3 million from Quest Capital Corp. By the terms of the loan, Black could use the money only to satisfy the damages.
Black used part of the money to pay the US$8.69 million individual judgment against him. Inc. paid US$5.96 million of the joint damages, with Black using the bulk of the Quest loan to pay the remaining US$15.3 million.
At trial in the Tax Court, Black testified that the US$15.3 million was a loan to Inc., which did not have the liquidity to fund the money due to International. He advanced the loan because the consequences of non-payment were grave, including seizure of Black’s personal assets and Inc.’s head office in Toronto.
Failure to pay the judgment could also have been treated as a default under security provided by Inc. and others to Wachovia, a U.S. financial services company (which subsequently merged with Wells Fargo). According to Rossiter, that would “apparently have had a catastrophic effect” on Inc. and Black.
“Black wanted to help Inc., but remain whole,” Rossiter wrote. “He accepted that there might be an accrual of interest over time due to Inc.’s liquidity issue, but he did not feel that he was in danger of not being repaid the principal and interest as Inc. was (at the time) a successful company.”
(Black) accepted there might be an accrual of interest due to Inc.’s liquidity issue, but (felt he would be) repaid the principal and interest as Inc. was (at the time) a successful company.Tax Court Chief Justice Eugene Rossiter
The difficulty Black faced in the Tax Court was that the loan to International was never put in writing. But he testified that Inc.’s audit committee approved the loan and agreed to repay him what the Quest transaction would cost him.
Black also testified that the loan agreement with International was never properly documented because time was of the essence, as the judgments had to be paid within a few weeks. He stated that Inc.’s lawyer “had led him to believe that they would complete the documentation.”
The relationship between Black and Inc., however, deteriorated and became confrontational. In August 2006, Black sued Inc. for repayment of the loan. Some years later, Black agreed to release his claim against Inc. as part of an omnibus settlement of several lawsuits.
But when Black sought adjustments to his 2005, 2006 and 2007 tax returns to include the interest and other expenses on the Quest loan, the Canada Revenue Agency refused to make them. CRA also denied non-capital losses related to the Quest loan claimed by Black in 2008.
The CRA’s position before the Tax Court was that the advance to Inc. was not an enforceable loan and that the money borrowed from Quest was used to pay the joint damages. Interest on the loan, therefore, was not deductible, as the proceeds had not been used for the purpose of earning income.
As Rossiter saw it, Black and Inc. had a binding loan agreement.
“The judge’s reaction during the hearing was ‘If it wasn’t a loan, what was it?’,” said David Nathanson in DLA Piper (Canada) LLP’s Toronto office, who represented Black.
In reaching his conclusion, Rossiter noted that all the key witnesses from Inc. testified that there was a loan agreement, albeit not in writing; that audit committee meeting minutes suggested there was a loan, as did Inc.’s press release announcing Black’s “advance” of the US$15.3 million; that Inc.’s financial statements for several years showed an amount was due to Black “although the explanation evolved as time progressed and management changed”; and that although Inc.’s full board had not given formal approval to the loan, there was approval by the independent directors, the only ones who could give approval, albeit in the audit committee environment.
Finally, Rossiter concluded that one of Black’s purposes in making the loan to International was to earn income.
“While I find that this was an ancillary purpose compared to his primary purpose of helping Inc., that was a bona fide objective of his investment, which is capable of providing the requisite purpose for interest deductibility (under the Income Tax Act),” Rossiter wrote.
Innes believes an appeal by the CRA to the Federal Court would likely not succeed.
“This will be a very difficult decision to attack,” he said.