Marceau, J:—The issue in this action, taken against a decision of the Tax Review Board, is whether the defendant (hereinafter sometimes referred to as Doral), in computing its taxable income for the 1970 taxation year, was entitled to claim as a deductible expense a bad debt of $175,500.
The essential facts are mostly uncontested. In October 1965, East End Development Corporation (hereinafter East End) was formed for the immediate purpose of developing and selling a substantial tract of land it was to acquire in the northeast section of Montreal. On October 21, 1965, the parties who had caused East End to be incorporated entered into an agreement whereby: (1) they subscribed for 300 common shares in the newly-born corporation at a price of $1 per share as follows: Max Schuchmann, 100 shares; Aiderton Central Corporation, 99 shares; D A Shefner, 1 share; Milner Inc, 99 shares; Ben Milner, 1 share, and (2) three of them, Max Schuchmann, Aiderton Central Corporation and Milner Inc agreed to make not later than the next day loans and/or advances to the company, each for an amount of $155,000, with the stipulation that all further loans and/or advances to be made by them would be effected on an equal basis.
Mr Shefner was President of Aiderton Central Corporation and Mr Milner was President of Milner Inc: it had been understood that each of the three individuals was to have an equal share in the venture but while Schuchmann was formally acting only in his personal capacity, Shefner and Milner had elected to act through their respective companies.
On the same date, October 21,1965, another agreement was entered into between East End and Doral, the defendant corporation, a corporation that was controlled by Mr Schuchmann and whose business was to provide management services mostly in the real estate field. Under this agreement, Doral was assuming for a period of 10 years the administration of all the affairs of East End in return for a management fee of 5% of the proceeds of sale of each piece of land sold but not less than $10,000 per annum. It was provided that the services promised by Doral were in fact to be performed by Mr Schuchmann personally.
East End started its operations auspiciously. Its first years were very promising: business was quite active and the revenues were substantial. Toward the end of 1969, however, the tide changed dramatically. For reasons that are irrelevant to this case, the company suffered a tremendous drop in sales, and before the end of 1970, its land transaction totally collapsed. The company had no choice but to abandon its operations.
Two years previously, in 1968, at a time when the difficulties that lay ahead could not be foreseen, it had been decided (of course by Mr Schuchmann) that the defendant company, Doral, which was then receiving sizeable administration fees for the management services performed by Mr Schuchmann, would lend to East End the money required to repay Mr Schuchmann the advances he had made personally pursuant to his obligations under the initial agreement referred to above. A loan bearing no interest was then made in the amount of $178,500, an amount which was later increased to some $218,500. When it became clear in 1970 that East End would never repay the money it owed, Doral treated the loan as a bad debt and, in computing its taxable income for the year, claimed the amount still owing thereon, $175,500, as a deductible expense.
Was the respondent entitled to do so? That is, of course, the question raised by this appeal.
The Tax Review Board came to the conclusion that the deduction was allowable, in view of the facts that Doral was only the corporate vehicle Mr Schuchmann had always intended to use for his participation in the East End project; that the loan had been made at a time when the affairs of East End were good and Doral had reason to believe that a large incomeproducing future lay ahead as a result of its connection with it; that Doral had made the loan in an arms-length transaction with the intention of providing financing on the understanding that it would continue to earn income. I have difficulty in following the reasoning, the more so since the learned judge said he was of the belief that the money advanced by the partners pursuant to the agreement of October 21, 1965 represented payments on account of capital. But counsel for the defendant did not directly rely thereon.
Before this Court, the contentions made on behalf of the defendant were twofold: the loss was deductible either under subparagraph 11(1)(f)(ii) or under paragraph 12(1 )(a) of the Income Tax Act, RSC 1952, as it was in 1970. I will examine these contentions in order.
I. Paragraph 11(1)(f) reads as follows:
II. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 12, the following amounts may be deducted in computing the income of a taxpayer for a taxation year:
(f) the aggregate of debts owing to the taxpayer
(i) that are established by him to have become bad debts in the year, and (ii) that have (except in the case of debts arising from loans made in the ordinary course of business by a taxpayer part of whose ordinary business was the lending of money) been included in computing his income for that year or a previous year;
Referring to a number of cases that stood for the proposition that the exception in subparagraph 11 (1)(f)(ii) does not apply exclusively to a taxpayer whose business is essentially or at least to a substantial extent that of money lending*, counsel for the plaintiff [sic] submitted that even though Doral was mostly concerned with providing management services, it had in the past made a certain number of loans in a manner which permitted it to qualify as a money lender within the meaning of the section.
The submission does not deserve lengthy comments. Prior to the 1968 loan here in question, Doral had made exactly three loans: one in 1958 to a company wholly owned by Mr Schuchmann, Schuchmann Holding Corporation, and two, eight years later, in 1966, one of which was to Mr Schuchmann personally. Besides, as it was incidentally pointed out, the advance to East End was interest free. I fail to see how, in these conditions, it can seriously be contended that the loan was made within a pattern showing that the lending of money had become an integral part of the defendant’s income producing business.!
2. Paragraph 12(1)(a) reads as follows:
(1) In computing income, no deduction shall be made in respect of
(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer,
The contention made on behalf of the defendant with regard to this subsection can be summarized thus. Doral was not simply a creditor of East End, it was its manager and administrator. It had therefore an active and profitable stake in the trading operations of the company. The fees it earned out of the administration of the affairs of East End, which amounted during the period from 1966 to 1970 to some $147,354.55, constituted a major source of its income. The $175,500 advanced to East End and used by the latter for its land trading operations was, in that context, a “tied loan’’ made in order to earn income and in the expectation of the maintenance of future management and administration fees. The facts are therefore similar to those which had been established in cases like Associated Investors of Canada Limited v MNR, [1967] CTC 138; 67 DTC 5096, and Her Majesty the Queen v R Lavigueur, [1973] CTC 773; 73 DTC 5538, and the same reasoning should lend to the conclusion that the loan became in 1970 an outlay made “for the purpose of gaining or producing income from ... a business of the taxpayer” within the meaning of the exception referred to in paragraph 12(1)(a).
I am again unable to agree.
In the Associated Investors case, Jackett, P, as he then was, was dealing with a company which had been making on a regular basis, small advances to its commission salesmen to provide them with an income during the period while they were awaiting returns from their sales. Jackett, P found that the advances (145 [5100]):
_.. were by their very nature short term loans. They did not result in the acquisition of any asset or advantage of an enduring nature, nor did they create a “trading structure’’ of a permanent character. In my opinion, they were an integral part of the appellant’s current business operation.
The then president agreed that the loss suffered by the company as a result of the fact that some of the advances were not repaid was deductible under paragraph 12(1)(a) in view of the principle he had formulated thus (144 [5099]):
A profit arising from an operation or transaction that is an integral part of the current profit-making activities must be included in the profits from the business. See MNR v Independence Founders Limited, (1953) SCR 389 [53 DTC 1177], and the foreign exchange cases such as Tip Top Tailors Limited v MNR (1957) SCR 703 [57 DTC 1232]. If such a profit must be included in computing profits from a business, then a loss arising from any such source—that is, from an operation or transaction that is a part of the current profit-making activities of the business—must also be taken into account in computing the overall profit from the business.
In the Lavigueur case, my brother Walsh, in dealing with the case of a taxpayer who, with a view to keeping his income-producing buildings rented, had frequently assisted tenants who were in difficulty by making them loans, found again that the making of those loans had become an integral part of the profit-making activities of the business of the taxpayer, and that a loss arising therefrom was deductible under paragraph 12(1)(a).
I see nothing in the facts of the present case that could permit a reasoning to the same effect as that which prevailed in those cases. There was definitely no business reason behind the loan made by Doral to East End. Indeed, Doral had no benefit to gain therefrom: its administration fees were guaranteed by a long-term contract and it was not even a shareholder of the borrowing company. Even East End had no advantage whatever in completing the deal since nothing was compelling it to repay Mr Schuchmann at that time.
In my view, it cannot be said that the loss suffered by the defendant as a result of the fact that the money it advanced to East End in 1968 could not be repaid to it, could be considered as an outlay made in 1970 for the purpose of gaining income from its busine 3, within the meaning of the exception contained in paragraph 12(1)(a) of the Income Tax Act.*
The conclusion of the foregoing is clear: the deduction was not permissible under paragraph 11(1)(f) nor under paragraph 12(1)(a). While I have no reason to doubt Mr Schuchmann when he says that his intention had always been to participate in the East End project through his company Doral, I must deal with the situation that in fact existed. As I understand that situation and the provisions of the Act, the claimed deduction was properly disallowed by the Minister.
The action will therefore be maintained, the judgment of the Tax Review Board will be set aside and the assessment appealed against will be restored.
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