Cull v. The Queen, 87 DTC 5322, [1987] 2 CTC 63 (FCTD)

Reed, J.:— The issue in this case is a narrow one: the proper characterization of certain losses incurred by the plaintiff with respect to shares held by him in trust for a partnership of which he is a member. The plaintiff contends the losses were with respect to revenue. The Minister contends they are of a capital nature.

The plaintiff is a member of a law partnership operating in Sudbury. The partnership's practice during the relevant years was of a general nature. The plaintiff himself had prior to 1976 developed considerable expertise in municipal law including land planning, land development, assessment and expropriation. He acted as counsel for the assessment commissioner from 1970 onward. He had acted as counsel for the city of Sudbury from 1968 to 1970 and even after that date acted as city solicitor although in private practice at the time. His work for the city of Sudbury involved him in doing extensive work on an urban renewal project which was commenced by the city in 1968 and continued through the years following.

One of his partners (a Mr. Desmarais) acted for Messrs. Simmons and Lacasse and for their real estate brokerage firm, Gaston Lacasse Realty Ltd. In May of 1974 Simmons and Lacasse took out an option to purchase what is called the Ravina Gardens property. In June of 1974 Simlac Holdings Limited was incorporated and the option to purchase was transferred to that company. Mr. Desmarais acted as solicitor for Simmons and Lacasse with respect to both these transactions. In August of 1974 Simlac Holdings acquired an option to purchase on what is called the Fay Bell property. Mr. Desmarais acted as solicitor with respect to this transaction. Both parcels of land were acquired for the purpose of developing them into subdivisions.

In late summer of 1975 Simmons and Lacasse approached Mr. Desmarais and asked if he and his partners would be interested in taking a one-third interest in the proposed development of the Ravina Gardens and Fay Bell properties. Involving the plaintiff and his law partners would provide Simmons and Lacasse with additional financial resources, which they needed. It was also anticipated that the plaintiff's expertise in dealing with land development would be put at the companies' disposal. The plaintiff described himself as somewhat of a local expert in this field. The partnership discussed the proposal for some time. As well as the potential for profit, which would arise from the development itself, the partnership was aware of the potential for legal business which might arise as a result of this association e.g.: the possibility of being chosen to act for the purchasers of the lots once subdivided.

In August of 1976 the partnership agreed to participate in the business venture. This was effected by the partnership purchasing 100 shares of Simlac Holdings (50 were purchased in August 1976 and 50 more in January, 1977). Those shares were purchased from Simmons and Lacasse who, together with their wives, had up until that time held all 300 shares of the company. On August 10, 1976 the number of directors of Simlac was increased from two to three and the plaintiff became a director of the company. It was contemplated that the plaintiff would not charge for his services for development work (dealing with city officials, the planning department, etc.) but the partnership would charge for services provided with respect to matters such as litigation, financing, and corporate work. As of the date of the August 1976 purchase, approval of a draft plan of subdivision had been given for the Fay Bell property; an application for such approval had been filed with respect to the Ravina Gardens property. The option to purchase the Fay Bell property was exercised by Simlac and the purchase of that property was accomplished in November 1976. The option to purchase Ravina Gardens was exercised in January of 1979. The various steps, negotiations, approvals, meeting of conditions, survey work, etc. that have to be obtained before a plan of subdivision can be registered was worked on during all this period of time and indeed until 1980-1981. This work was financed by the Royal Bank with, initially, no demands being made with respect to repayment of principal or interest.

When the plaintiff and his partners acquired the 100 shares of Simlac they had been asked to give and had given personal guarantees to the Bank for a one-third share of the debts, which were arising and would arise in the future as a result of the bank advances. Simmons and Lacasse had previously signed personal guarantees for 100 per cent of the indebtedness. As noted above, the Bank originally had not insisted on any repayment of either principal or interest on the advances. In October of 1977, however, the Bank began to insist on the payment of the interest owing: $30,000 accrued interest as of that date and monthly payments of interest as they arose thereafter. The partnership advanced a one-third share ($10,000) to Simlac for payment of the accrued interest. The partnership advanced additional sums for the payment of the interest which increased over time as both the principal sum and interest rates rose.

When the Fay Bell property had been purchased in November 1976, the vendors of that property took back a $75,000 mortgage. This was a one-year mortgage; it was subsequently extended for a second year. By March 30, 1979 the vendors were insisting that the mortgage loan be paid in full. The principal, by then, had been reduced and that outstanding amount was $56,800. The partners paid one-half of this ($28,400). They borrowed from the Bank to do so. The partnership continued its regular advances in order to allow the interest owing to the Bank to be paid. I should also note that the original purchase by the partnership of the Simlac shares in August 1976 and January 1977 was financed by loans from the Bank.

By 1978-79 it was clear that there was a softening of the real estate market in Sudbury. The expenses of development were increasing (the partners were paying $15,000 per month as their share of the bank interest). Simmons and Lacasse felt unable to continue such expenditures. Thus, in 1979, unbeknownst to the partners, until after the transactions were complete, Simmons and Lacasse sold off 75 shares each, out of the 100 each had previously owned. These were sold to various business people in Sudbury. Each shareholder thus brought in was required to file a personal guarantee with the Bank for the amount of the indebtedness their share or shares represented.

In any event, by the time all the work required for registration of a plan of subdivision on part of the Ravina Gardens property had been done (i.e.: after delays caused by residents' appeals to the O.M.B.; negotiations for sewer installation by the local authority; negotiations with local authorities over street planning, traffic studies etc.) the economy was in a downturn; that of Sudbury was in a particularly bad situation; the introduction of automation in the mines made it clear that a smaller work force was going to be required; there was no market for the subdivision lots. This eventually led to most of the shareholders defaulting on their monthly interest payments to the Bank; the partners eventually did so as well. The Bank called the personal guarantees which it held and exercised its power of sale with respect to the Ravina Gardens and Fay Bell properties. There were no purchasers.

These events led the partnership to list on its books for 1981 (and to claim for tax purposes) business losses of $178,000. The value of the shares was written down on the partnership books from a value of $178,000 to $1. The $178,000 consisted of the $100,000 which had originally been paid for the 100 shares and $78,000 which had been paid as advances over the years. It is not disputed that the shares are valueless. It is not disputed that there has been no disposition of the shares and no disposition of the land.

The Minister argues that the losses should be treated as capital in nature and therefore: (1) there is no loss deductible in so far as the shares are concerned because there has been no disposition of the shares; (2) only 50 per cent of the losses which arose as a result of the advances are to be allowed as business losses for the 1981 year.

The Minister’s argument that the losses which accrued in so far as the plaintiff is concerned, were capital and not revenue focuses on the fact that the partnership held shares in the corporation, Simlac, and not the assets of the company directly. While the shares were shares of the partnership the profits or loss therefrom, of course, flow through to the individual partners. It is argued that shares by their very nature are a capital investment, except in the hands of a securities trader, and that there is a presumption that the acquisition of shares is a capital acquisition. Reliance was placed on Irrigation Industries Limited v. M.N.R., [1962] C.T.C. 215; 62 D.T.C. 1131 (S.C.).

It was argued that, as in that case, there was no demonstrated intention in the present one, that the plaintiff and his partners intended to dispose of the shares in Simlac as soon as possible, in order to make a profit. It was argued that the investment in the Simlac shares was, as in the investment in the Irrigation Industries Ltd. case, an isolated purchase of shares by the partnership. It was argued, that as in the Irrigation Industries Ltd. case, the activity carried on by the company was not the usual business enterprise of the taxpayer.

With respect to the first argument, I note that the evidence discloses that the plaintiff and his partners had not really focused on future options with respect to how a profit would be realized from the development project. The plaintiff stated that, as is usual with development schemes, they had left future possibilities open; they would have been willing to realize their profit through any number of mechanisms, that is from the sale of lots, or from the sale of blocks of land, or from the sale of shares. With respect to the second argument it is abundantly clear that the fact that the acquisition of the shares was (almost) an isolated transaction is a neutral factor in many cases. I think it is so here. It reveals nothing about the nature of the activities engaged in. With respect to the third argument, that the activity was different from the partnership's usual occupation, that is true but there was a clear linkage, as is obvious from the recitation of the facts above. Also, that factor is only one which is to be taken into account in the context of the whole situation when determining whether a purchase is of a capital or revenue nature.

The plaintiff argues that regardless of the prima facie rule that a purchase of shares is of an investment or capital nature (except in the case of securities trader) the Supreme Court decisions in Fraser v. M.N.R., [1964] C.T.C. 372; 64 D.T.C. 5224 and M.N.R. v. Freud, [1968] C.T.C. 438; 68 D.T.C. 5279 are applicable. In the Fraser case the taxpayer was an experienced operator in the real estate field. He incorporated two companies; one for the purpose of constructing a shopping centre, the other for the purpose of constructing an apartment building. When the shares in the respective companies were sold (without the proposed projects being completed) the Court held that the profit arising therefrom was to be treated as income not capital since the sale of the shares was merely an alternative method the taxpayers had chosen to adopt in putting through their real estate transactions.

In M.N.R. v. Freud, [1968] C.T.C. 438; 68 D.T.C. 5279, a lawyer organized a company for the purpose of developing and promoting a special type of sports car for which he thought there might be a market. He and some friends advanced money to the company for this purpose in exchange for shares. The project got into difficulty and was abandoned. The Court held that the loss was deductible from the taxpayer's income and not merely capital in nature. At page 442 (D.T.C. 5282) it was said:

It is clear that while the acquisition of shares may be an investment. . . it may also be a trading operation depending upon circumstances. . . . In the Fraser case, the basic operation was the acquisition of land with a view to a profit upon resale so that it became a trading asset. The conclusion reached implies that the acquisitions of shares in companies incorporated for the purpose of holding such land was of the same nature seeing that upon selling the shares instead of the land itself, the profit was a trading profit not a capital profit on the realization of an investment.

And at page 444 (D.T.C. 5283):

.. .the payments made by respondent could not properly be considered as an investment in the circumstances in which they were made. It was purely speculation. If a profit had been obtained it would have been taxable irrespective of the method adopted for realizing it. Such being the situation, these sums must be considered as outlays for gaining income from an adventure in the nature of trade, that is a business within the meaning of the Income Tax Act, and not as outlays or losses on account of capital.

The defendant focuses on the decision in the Fraser case and argues that in the present case the shares were not merely an alternative way of dealing in land, they were not merely an alternative way of dealing with the underlying asset and therefore do not fall within that exception. Reference is made to Blok-Andersen v. M.N.R., [1972] C.T.C. 338; 72 D.T.C. 6309 (F.C.T.D.) and Welden and Robb v. The Queen, [1980] C.T.C. 301; 80 D.T.C. 6224 (F.C.T.D.). I think the defendant's argument focuses on too narrow a view of the principle and also too narrow a view of the facts in this case. It focusses on the Fraser case (where the enterprise was profitable and a disposition of shares actually occurred) without due regard to that in Freud (where the enterprise was profitable and a disposition of shares actually occurred) without due regard to that in Freud (where the enterprise was not successful). Also, the jurisprudence which has flowed from those cases must be kept in mind: Hornstein v. M.N.R., 36 Tax A.B.C. 392; 64 D.T.C. 684 (T.A.B.); Deloro v. M.N.R., [1965] C.T.C. 321; 65 D.T.C. 5194 (Ex. Ct.); Dubrovsky v. M.N.R., [1967] Tax A.B.C. 617; 67 D.T.C. 445 (T.A.B.); Slater et al. v. M.N.R., [1966] C.T.C. 53; 66 D.T.C. 5047 (Ex. Ct.); Burgess et al. v. M.N.R., [1973] C.T.C. 58; 73 D.T.C. 5040 (F.C.T.D.); McKinley v. M.N.R., [1974] C.T.C. 170; 74 D.T.C. 6138 (F.C.A.); The Queen v. Dumas, [1981] C.T.C. 1; 80 D.T.C. 6276 (F.C.T.D.); Mould v. The Queen, [1986] 1 C.T.C. 271; 86 D.T.C. 6087 (F.C.T.D.); Factory Carpet Ltd. v. The Queen, [1985] 1 C.T.C. 267; 85 D.T.C. 5464 (F.C.T.D.).

In my view the Freud case is directly applicable to the present situation. The shares in the hands of the partnership were not, as the defendant claims, merely of the usual and normal investment character. They were acquired for the purpose of acquiring an interest in the lands under option and in the development project, for the purpose of making a profit therefrom, either by Simlac selling its assets or by the shareholders selling their shares. Had the partnership realized a profit from the venture, there can be no question that, on the basis of the Fraser line of cases, it would have been business income, and not a capital gain. Thus, the taxpayer should be allowed to treat the losses according to the same principle. In the Freud case, at page 441 (D.T.C. 5281), the Court stated:

. . .the principles to be applied in cases when a profit is obtained, . . . must be followed when a loss is suffered. Fairness to the taxpayers requires us to be very careful to avoid allowing profits to be taxed as income but losses treated as on account of capital and therefore not deductible from income when the situation is essentially the same.

The defendant argues that the plaintiff or the partnership did not control the Simlac corporation; that the articles of incorporation are broadly drafted so as to allow Simlac to engage in other areas of business activity besides real estate development; that there was documentary evidence that the distribution of dividends was considered to be a possibility; and, that there was no evidence that the partnership intended to dispose of its shares for profit quickly. With regard to this last it is noted that Simmons and Lacasse sold their shares in 1979-1980. The rhetorical question is put why didn't the partnership sell its shares at that time too?

None of these arguments carry much weight in the circumstances of the present case. While the partnership did not (at least prior to the 1979-1980 sale of the Simmons and Lacasse shares) control the enterprise, the plaintiff was very closely involved. He was one of three members of the board of directors; he was actively engaged in the development project. With respect to the articles of incorporation, whatever they may say, the fact is that Sim lac engaged in one activity and one only: the attempted development of the Ravina Gardens and Fay Bell properties. Dividends are always a possibility if one holds shares; this is not a significant factor in this case. With regard to the lack of evidence concerning a resale of the shares by the plaintiff; it is unlikely they would do so until the shares could be sold at a profit. For the partnership to have sold its shares at the price Lacasse and Simmons sold theirs in 1979-80 would have been to incur a loss, particularly in view of the sums which had been expended with respect to the payment of interest on account of bank advances.

Having found that the loss sustained by the partnership with respect to the shares resulted from an adventure in the nature of trade, engaged in through the acquisition of the Simlac shares, the advances should carry the same characterization. I do not accept the defendant's argument that the decisions in Stewart and Morrison Limited v. M.N.R., [1972] C.T.C. 73; 72 D.T.C. 6049 (S.C.C.) and Isaac Meisels Investments Ltd. v. The Queen, [1985] 1 C.T.C. 9; 85 D.T.C. 5029 (F.C.T.D.) are applicable. The provision by the partnership of advances to the company to keep the venture alive must be regarded as part and parcel of the venture. The advances to Simlac were ancillary to and part and parcel of a speculation or trading transaction. As such they can properly be regarded as trading assets: see Esar et al. v. The Queen, [1974] C.T.C. 34; 74 D.T.C. 6062 (F.C.T.D.) especially at 41 (D.T.C. 6067). Also in the Freud case at page 443 (D.T.C. 5282-5283) the Supreme Court stated:

. . Obligations to pay money can be trading assets just like other things (Scott v. M.N.R., [1963] S.C.R. 223; [1963] C.T.C.176; M.N.R. v. Maclnnes, [1963] S.C.R. 299; [1963] C.T.C. 311; M.N.R. v. Curlett, [1967] S.C.R. 280; [1967] C.T.C. 62. It is true that in those cases the conclusion that the acquisition of mortgages at a discount was a speculation, not an investment, rests upon a consideration of the large number of operations of a similar nature that were effected. But, on account of the definition of "business", this is not the only basis on which this conclusion can be reached. As previously pointed out, a single venture in the nature of trade is a business for the purposes of the Income Tax Act "as well in the case of an individual as of a company".

It is, of course, obvious that a loan made by a person who is not in the business of lending money is ordinarily to be considered as an investment. It is only under quite exceptional or unusual circumstances that such an operation should be considered as a speculation. However, the circumstances of the present case are quite unusual and exceptional. It is an undeniable fact that, at the outset, the operation embarked upon was an adventure in the nature of trade. It is equally clear that the character of the venture itself remained the same until it ended up in a total loss. Under those circumstances, the outlay made by respondent in the last year, when the speculative nature of the undertaking was even more marked than at the outset due to financial difficulties, cannot be considered as an investment. Whether it is considered as a payment in anticipation of shares to be issued or as an advance to be refunded if the venture was successful, it is clear that the monies were not invested to derive an income therefrom but in the hope of making a profit on the whole transaction.

One last point needs to be considered. The defendant referred to the fact that the partnership financial statements for the years prior to 1981 described the Simlac shares as investments. I accept the plaintiff's argument that little or no weight should be attached to that fact. In Armstrong v. The Queen, [1985] 2 C.T.C. 179 at 183; 85 D.T.C. 5396 at 5398, Mr. Justice Rouleau dealt with a fact situation where the taxpayer had on his income tax returns listed a horse as inventory. He wrote:

. . .considerable attention at trial was devoted to the implications of the description of the horse as "inventory" in the plaintiff's 1981 tax return. It is alleged by the defendant that this provides an indication that the plaintiff was engaged in the business of buying and selling race horses with the result that the excess of the price over costs should be regarded as profit from that business and taxed as income. I do not draw such an inference . . . It is well established that a taxpayer can neither increase nor decrease his tax liability by the intentional or erroneous use of magic words in his accounts. The words used may be indicative of the nature of a transaction. However, in the final analysis the task for this Court is to decide on the actual nature of the transaction and the substance of the matter on the basis of all the facts and circumstances. See Sanders v. M.N.R. (1954), 10 Tax A.B.C. 280 at 283; 54 D.T.C. 203 (T.A.B.) at 204; Sterling Trust v. C.I.R. (1925), 12 T.C. 868 (Eng. C.A.) per Pollock, M.R. at 882 and per Aitkin, L.J. at 888; and Glenboig Union Fireclay v. C.I.R. (1930), 12 T.C. 427 (Ct. of Sess.) per Lord President Clyde at 450 .. .

I think this conclusion is equally applicable here. The description of the properties on the partnership's financial statements cannot override the conclusions which arise from the facts as a whole.

The plaintiff has met the onus of proof on him. He has rebutted the Minister’s assumptions. The appeal will therefore be allowed. The assessment is referred back to the Minister for reassessment consistent with these reasons. The plaintiff is entitled to his costs against the defendant.

Appeal allowed.