James v. The Queen, 95 DTC 394, [1995] 1 CTC 2024 (TCC)

Sobier J.T.C.C.:-The appellant appeals from the assessment by the Minister of National Revenue (the "Minister"), for his 1986 taxation year, whereby the Minister disallowed a business loss of $25,100 claimed by the appellant.

The appellant holds a bachelor of science degree in business administration and a master’s degree in business administration from the University of Denver. He obtained a law degree from the University of British Columbia in 1971, articled and was called to the bar, but did not practice law. He carried on a publishing business (the "business"), started by him in law school, which was known as "Self-Counsel Press". SelfCounsel Press began by publishing lecture notes, which were sold to law students. Later, it published several "how-to" books, on such matters as how to obtain a divorce, how to incorporate a company and how to start and run a small business. The appellant took his common-law wife in as a partner, however he left the business when they separated in 1983. His interest was purchased by his former partner and she continued the business. Mr. James received his money through a scheme known as a "butterfly" which resulted in him receiving dividends in 1986. From the period between 1983 and 1986, he had no full-time employment or business, but did some consulting and was involved with other legal publishers. In 1986, he received actual dividends of $263,000 and taxable dividends of $394,000 resulting from the sale of the business. In addition, in that year, he started a business known as Auto-Cash International.

With the cash he received from the disposition of his interest in the business, he looked for investments. He stated that he was looking for an investment which was in the service industry and not manufacturing, had no high fixed overhead or staff, and was located in the Vancouver area.

Through Auto-Cash International, Mr. James met one Bruce Chambers, who came as a customer to borrow money on the security of his automobile. At that time Mr. Chambers told the appellant that he was involved in West Coast Dart Digest Ltd. ("West Coast"), a publisher of activity magazines, one of which was known as West Coast Dart Digest ("Dart Digest"). He presented Mr. James with a selling instrument known as a "viable business plan with 5 to 1 tax deferral".

In brief, West Coast would sell to proposed investors the rights to sell advertising and distribute Dart Digest in a particular area. The license fee for this was $100. However, the agreement which was entered into between West Coast and the investor required the investor to put up $25,000 as an advance against royalties, and it was represented that this $25,000, being a prepaid expense, could be deducted from other income of the investor. Helvitia Marketing Services Inc. ("Helvitia") a marketing company was established, which would market Dart Digest and sell advertising on behalf of the investor and receive a portion of the advertising fee for its efforts.

In order to show its good faith, Helvitia would post a performance bond in the form of a $20,000 cheque payable to the investor. This cheque would then be endorsed over by the investor to West Coast as part payment of the guaranteed minimum royalty for the first year. It then transpired that the $20,000 which was used to partially pay the royalties was then advanced by West Coast to Helvitia as working capital.

In the case of Mr. James, the balance of $5,100 was paid by cheque to West Coast. In other instances, other investors issued promissory notes to satisfy this amount.

Mr. James said he became interested in the scheme and was determined to investigate it to see whether he would invest.

Included in the material provided by Mr. Chambers, were letters from a certified general accountant, Mr. John Edwards, and a lawyer, Mr. Baillie, of Anderson Baillie & Company, a law firm in Vancouver, discussing the tax treatment of the scheme. Mr. James stated that he made enquiries about West Coast, he saw its premises and it appeared to him that there was sufficient equipment to print magazines. He stated he made enquiries in the marketplace, with respect to the success of this type of publishing business, and talked with publishing acquaintances in the Vancouver area. His feedback was that the plan would be viable. He also stated that he talked with potential advertisers and received positive responses concerning getting orders.

The licence agreement with West Coast was signed on April 18, 1986 as was the marketing agreement or sublicence with Helvetia. The cheques were negotiated at the same time. Delta, British Columbia, was the area assigned to Mr. James by West Coast. He claims to have made enquiries in the Delta market, including enquiries at city hall regarding population growth and the number of business licenses issued. He also talked with city planners and made calls to solicit ads. When Mr. James entered into the marketing contract with Helvitia, he expected Helvitia to begin marketing for him.

He claims that the marketing agreement was non-exclusive and that it was his intention, at all times, also to sell advertising and earn additional income in that manner. Prior to starting with Helvitia, he did not meet with Mr. Edwards, who controlled Helvitia but talked with him on the telephone and discussed tax matters and asked when Helvitia would begin marketing. At that time, he was informed that marketing was underway but not in the Delta region, but that they would start in Delta at any time.

As stated above, the material provided to the investors included a letter from Anderson, Baillie & Company, which letter appeared to be an opinion as to the tax treatment of the scheme. Mr. James claims to have discussed the entire matter with Mr. Baillie. Mr. Baillie assured him that people involved were sound business clients of his. Mr. James said he did not think there would be any problems, since they were already publishing the magazines and that they would continue to do so. However, he got very little comfort from his enquiries as to when they would begin marketing in Delta.

At the same time, Mr. James claims he was also involved in Auto- Cash International. He arranged for his brother to manage that business. However, this proved to be unsatisfactory and Mr. James was forced to take over the business himself and stated that he could not devote time to selling advertising since he was forced to manage Auto-Cash International.

It was Mr. James’ evidence that after he made his investment, he continued to make enquiries with Helvitia and Mr. Chambers, and felt that they were Stalling.

There continued to be representations by Helvitia as to marketing, but it did not appear to bear fruit. In July or August 1986, Mr. James pretty much gave up on this scheme and did not pursue it. He took no steps to recover his money.

A series of letters was sent in 1988 dealing with the problems with the British Columbia Securities Commission. At the same time, assessments were being made against some of the investors and Mr. James and others were apprised of this. It was Mr. James’ evidence that he was informed by Mr. Chambers that a questionnaire would be sent to him by Revenue Canada and Mr. Chambers allegedly told Mr. James and others how to answer these questions. In due course, the questionnaire was sent and filled in by Mr. James.

As it can be seen from the facts just summarized, Mr. James claims he, unlike others, was not interested in the project as a tax scheme alone but as a business from which he could earn income. He would have a tax deferral in 1986, a year of high income and lower income in other years which would bear less tax. He went through the steps to see if this was a viable operation prior to investing, and of course he did take advantage of the tax aspect of the scheme and deducted the $25,000 as a business loss in his 1986 income tax return.

For the appellant to be able to deduct a business loss, it goes without saying that he must have a business. Therefore, one must ask oneself was there a business which was carried on by Mr. James in 1986?

His decision to examine the scheme, to discuss it with various people and then invest, has all of the earmarks of a person involved in the early stages of setting up a venture or a business. He had no place of business, and no product to sell. There was no Dart Digest for the Delta area. He did not commence marketing, nor did Helvitia, simply because there was no product to market. He did not sell ads in the Delta area in the Dart Digest. There was no indicia of a business, such as invoices, business cards, letterhead, telephone number, etc. No income was generated and no expenses were paid. There was nothing but the agreements.

Notwithstanding the large volume of evidence given by or on behalf of the appellant, he failed to establish that he carried on a business. It appears that his enquiries were made prior to entering into the agreements and making his investment in April 1986. There was a very short period of time between the signing of the agreements and abandoning the scheme, 1.e., from April to July or August 1986. It is clear that after he executed the agreements with West Coast and Helvitia, nothing further was done by him or Helvitia to market Dart Digest or to sell advertising. During this period, he made enquiries as to when the business would commence, but no busi ness was in fact begun.

Counsel for the respondent referred to Egan v. M.N.R., [1991] 1 C.T.C. 2709, 91 D.T.C. 797 (T.C.C.). In that case, the appellant acquired certain licences under agreements, permitting to use the licensors’ planning system in various territories, and sought to deduct management and licence fees paid by him under the agreements. Beaubier J.T.C.C. found, at page 2711 (D.T.C. 799) "that Mr. Egan did not carry on a business respecting these contracts", since there was no "evidence that Mr. Egan for [sic], any person representing him, ever did anything to obtain income from these contracts, once they were entered into".

In Colby v. M.N.R., [1991] 2 C.T.C. 2511, 91 D.T.C. 1237 (T.C.C.), this Court had occasion to deal with the question of whether there was a business being carried on by the appellant.

There the appellant sold his coffee supply business and later travelled with his wife and friends through the Far East and Israel, allegedly looking for some new product around which he could build a marketing business. He attempted to deduct a portion of those travel costs as a business expense. These expenses were disallowed by the Minister. At page 2514 (D.T.C. 1239), the Court said:

After the sale and during the time that the travel expenses were incurred, the appellant had no source of income; therefore, no business. What the appellant was doing at the time was considering opening a new business and searching for a product to sell. See Bancroft v. M.N.R., [1989] 1 C.T.C. 2196, 89 D.T.C. 153 (T.C.C.) at page 2199 (D.T.C. 155) where Judge Lamarre Proulx of this Court stated:

The appellant was in the process of creating a business structure. He never finished creating it. He never commenced his proposed business of a year-round country retreat. I am of the view that the evidence disclosed that the appellant never carried on a business nor did he commence a business.

Having ceased carrying on the coffee business, the evidence disclosed that no new business was established and operating at the time the trip was taken. Accordingly, the expenditures incurred for travelling were not made for the purpose of gaining or producing income from a business. This portion of the appeal fails.

Similarly, here the appellant did not carry on a business and therefore the expenditures were not made for the purpose of gaining or producing income from a business or property as required by paragraph 18(l)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

The license produced no income. In Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, Mr. Justice Dickson (as he then was), stated at page 313 (D.T.C. 5215):

Although originally disputed, it is now accepted that in order to have a "source of income" the taxpayer must have a profit or a reasonable expectation

of profit. Source of income, thus, is an equivalent term to business: Dorfman v. M.N.R., [1972] C.T.C. 151, 72 D.T.C. 6131. See also paragraph 139(l)(ae) [now subsection 248(1)] of the Income Tax Act which includes as "personal and living expenses" and therefore not deductible for tax purposes, the expenses of properties maintained by the taxpayer for his own use and benefit, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit.

Dealing with Moldowan, Reed J., in Coupland v. The Queen, [1988] 1 C.T.C. 414, 88 D.T.C. 6252 (F.C.T.D.), had this to say at page 417 (D.T.C. 6254):

In my view, the Moldowan case sets out rules which are applicable in all cases, regardless of whether the business under review is farming or of some other type. Also, I do not accept that there is unfair treatment because a taxpayer must demonstrate that he is engaged in a genuine business enterprise before being allowed to deduct, for tax purposes, the expenses related thereto. This rule is designed to prevent taxpayers writing off personal expenses under the guise of business expenses. It is designed to promote equity as between taxpayers.

Having determined that there was no business being carried on, I need not deal with the question of the expenses being unreasonable, or if allowed would unduly or artificially reduce the appellant’s income. There being no business or source of income, the deductions were properly disallowed by the Minister.

For these reasons, the appeal is dismissed, with the costs on a party- and-party basis.

Appeal dismissed.