The Queen v. Lavigueur, 73 DTC 5538, [1973] CTC 773 (FCTD)

Walsh, J:—These proceedings are based on a reassessment of defendant’s income for 1967 as a result of which additional tax of $222.19 was assessed. Defendant opposed this, the reassessment was confirmed and defendant appealed to the Tax Review Board, where his appeal was maintained. Plaintiff now asks that the assessment be confirmed and the action be maintained with costs. The assessment is based on the following facts. Between February 1 and November 21, 1967 defendant and his associate, Robert Bolduc, with whom he was in partnership, made 29 different advances of between $1,000 and $10,000 totalling $111,500 ‘to a company known as Radal Limited which funds the company required to enable it to continue its operations. The company had been incorporated in 1964 by lon Rainu and Charles Dallaire for the manufacture and sale of hydroplane floats. Radal Limited had leased premises from Messrs Bolduc and Lavigueur for 3 years from January 1, 1966 for $48,600, the monthly rental being $1,350. The lease was for an entire floor of a new building, one of six built on the Metropolitan Boulevard in the east end of Montreal which provided a total of 54 floors of an area of about 15,000 square feet per floor, making it a very large development and Messrs Bolduc and Lavigueur were very anxious to obtain and retain tenants, even to the extent of helping them with loans when they were in financial difficulty, according to the evidence of Mr Lavigueur. Radal Limited, which was engaged in perfecting and building prototypes of a new type of hydroplane float designed by Mr Rainu, an engineer, so that same could be approved by the Department of Transport and put on a production basis for sale, was in financial difficulties even at the time the lease was signed and it was understood that they would not be required to pay the rental for the first year each month as it became due but could postpone payment until the end of the year. By December 1966 the first prototype had been produced and approval by the Department of Transport was anticipated momentarily. Mr Rainu approached Messrs Bolduc and Lavigueur explaining that they had used all their funds in connection with the building of the prototype and did not even have sufficient money for the week’s payroll but hoped to obtain the necessary approval and commence production at an early date. As a result of this they loaned them $3,000 at first followed by another loan the next week of a further $3,000, then $5,000 more, then $10,000, and so forth from time to time until the total had reached the figure of at least $111,500. Mr Rainu was under the impression that $20,000 had been loaned prior to January 27, 1967 and Mr Lavigueur’s evidence was to this effect also but bank statements and cheques are no longer available to substantiate any loans made prior to January 27, 1967. The evidence of Mr Real Parent, on the other hand, assessor for plaintiff who had examined cheques issued by Messrs Bolduc and Lavigueur to Radal Limited was to the effect that the first cheque was issued on March 6,1967 for $2,000 followed by one on March 9 for $10,000, on March 23 for $5,000 and so on to a total of $111,500. If additional loans had been made prior to January 27, 1967 there was no evidence substantiating this other than the recollection of Messrs Lavigueur and Rainu.

The evidence disclosed that on January 27, 1967 Messrs Bolduc and Lavigueur each acquired 300 fully paid preferred shares of Radal Limited of a par value of $10 each making a total of $6,000 due to the company and on the same date they received by transfer from Dallaire Metal Industries Inc and lon Rainu an additional 700 preferred shares each and by transfer from Messrs Charles Dallaire and lon Rainu and their nominees a further 1,140 ordinary shares each. Since there were 4,560 ordinary shares of no par value outstanding they now owned between them one-half of the ordinary shares of the company. In addition to these shareholdings Mr Rainu continued to own 1,732 preferred shares and Dallaire Metal Industries Inc 11,000 preferred shares, and Messrs Dallaire and Rainu each owned or controlled 1,140 ordinary shares. The financial statement of Radal Limited as of May 31, 1968 shows that it received advances of $42,692.80* [1] from the Ministry of Industries which appears as contributed surplus, and that it had outstanding bank loans of $29,626.71. The loans from Messrs Bolduc and Lavigueur are not shown as current liabilities but were apparently included in the sum of $131,338.10 shown as due to directors.

Plaintiff contends that defendant became a shareholder of Radal Limited in order that he could oversee the business of the company, take part in its decisions, sign its cheques and participate in its profits, that the advances were not made in the normal course of business affairs of Messrs Bolduc and Lavigueur as any loans that they made to others during the years 1964 to 1967 were in the nature hypothecs resulting from sale of immovable property and represented only about 2.07% of their capital invested in immovables, and that they were bona fide shareholders of the company Radal Limited, the shares being held free and clear of any charges, privileges or other agreements. Plaintiff further contends that defendant’s share of the said sum of $111,500 claimed as a bad debt as of December 31, 1967 cannot be so claimed as it had never been included in its income, that it was a capital loss within the meaning of paragraph 12(1)(b) of the Income Tax Act and that paragraphs 11 (1 )(e) and 11(1)(f) have no application.* [2]

Defendant for his part contends that he became a shareholder of Radal Limited only at the suggestion of Mr Rainu as a means of guaranteeing loans already made and any future loans and so that he and Mr Bolduc could oversee the use of the money loaned, and that if he or Mr Bolduc countersigned cheques signed by Mr Rainu or Mr Dallaire on behalf of the company thereafter, as they did, this was merely to control the spending of the money and did not constitute an active participation or interest in the business of the company. This evidence was corroborated by Mr Rainu.

The business of Radal Limited went from bad to worse despite Mr Rainu’s continuing optimism and finally in 1968, when it became evident that the loans could not be repaid (or, of course, the rental paid) either by Radal Limited or by Messrs Dallaire or Rainu who had guaranteed them, defendant and his partner, Bolduc, entered into an agreement with Messrs Dallaire and Rainu and Radal Limited dated July 30, 1968, which gave a final discharge of their claims and reconveyed the ordinary shares and preferred shares of the company back to Messrs Rainu and Dallaire.* [3] In addition, Messrs Bolduc and Lavigueur undertook to pay to the discharge of the company half of a bank loan amounting to $29,625.80. (It came out in evidence that they had guaranteed this loan and in actual fact had to pay all of it themselves in due course.) A new company had been formed known as Radal (1968) Limited and Messrs Bolduc and Lavigueur undertook to rent it the premises in question for one year from June 1, 1968 for the sum of $9,600 payable in ten instalments, the first to become due on August 1, 1968. The evidence disclosed that Mr Rainu had still hoped to be able to interest someone in buying from the company the prototypes which it had completed of the hydroplane floats and the rights to the considerable research that had gone into them and the tools and equipment that had been designed and made for the manufacture of them. There was no hope of anyone taking over the old company with its heavy indebtedness but once it was freed from this by the intervention of Messrs Bolduc and Lavigueur, he hoped that the new company would be able to dispose of its business as a going concern. Messrs Lavigueur and Bolduc had cooperated by entering into this agreement to make this possible. This hope was unfortunately never realized.

On these facts it is defendant’s contention, in which it was sustained by the decision of the Tax Review Board, that he should be permitted to deduct the sum of $55,750 as a bad debt either by virtue of paragraph 11 (1)(f) of the Act on the basis that his business always consisted partially in the loaning of money, or that the loans were made by him and his partner, Bolduc, in the normal course of their activity as lessors of property and accordingly deductible by virtue of paragraph 12(1)(a) of the Act. Alternatively, defendant contends that the construction and sale of the hydroplane floats was a speculative operation and that for this reason the bad debt should be considered as resulting from an adventure in the nature of trade and deductible as a loss in the calculation of his income.

Research expenses of the company totalled $228,315.73 by May 31, 1968. Mr Rainu testified that he had put all the money he could into the company and his associate, Mr Dallaire, had put so much money into it through his company Dallaire Metal Industries Inc, a prosperous corporation, that Mr Rainu was afraid that he would be damaging the financial status of that company if he put any more money into Radal Limited. Eleven thousand seven hundred preferred shares of a value of $117,000 were issued on September 30, 1966 to Dallaire Metal Industries Inc against its cash loans and advances as well as amounts due to it for sales made to Radal Limited, some of the machine work of Radal Limited having been done by Dallaire Metal Industries Inc. Eleven thousand of these shares were, on April 19, 1967, transferred to Messrs Bolduc and Lavigueur as a collateral guarantee for advances made or to be made to Dallaire Metal Industries Inc. The agreement provided that in the event the loans were not paid by October 20, 1967 with interest due, or if the borrower became bankrupt, Messrs Bolduc and Lavigueur could, at their discretion, retain the ownership of the shares which had been so transferred as a collateral guarantee, applying the real value of them against the amount due. While this had nothing to do with the loans made by Messrs Bolduc and Lavigueur to Radal Limited with which we are here concerned, this agreement was invoked by plaintiff to indicate that Messrs Bolduc and Lavigueur were well aware of the distinction between acquiring shares as a collateral guarantee and acquiring outright ownership of them as they did in connection with the loans to Radal Limited, there being no written agreement whatsoever in the case of these latter shares that they were merely being put up as a guarantee for the advances made to the company.

Mr Rainu further testified that the first prototype was completed in December 1966 and that eventually the company made about thirteen pairs of floats in all but that none of them were really production models, each being an improvement over the earlier versions. Perhaps six or seven pairs were sold in all and considerable trouble was encountered with them.

The situation with respect to payment of the shares issued on January 27, 1967 to Messrs Bolduc and Lavigueur is far from clear. As previously stated, the evidence of Mr Parent, who examined their cheques issued to Radal Limited totalling $111,500, indicates that the first such cheque was issued on March 6, 1967. On the other hand, the 600 preferred shares of treasury stock acquired by Messrs Lavigueur and Bolduc, issued as fully paid, would indicate the necessity of paying $6,000 to the company, and the other 1,400 preferred shares which they acquired by transfers from Messrs Rainu and Dallaire would presumably involve payment to them for these shares as well as for the 2,280 ordinary no par value shares which they acquired by transfer from them or Dallaire Metal Industries Inc at the same time. It was suggested that these shares might have been issued or transferred, as the case may be, with the consideration given in payment for them being the $20,000 allegedly advanced by Messrs Bolduc and Lavigueur prior to January 27, 1967 which advances both Messrs Rainu and Lavigueur insisted had been made although no cheques could be produced covering them. However, Mr Remi St-Louis, another assessor of the federal income tax Department testified and pointed out that the statement of Messrs Lavigueur and Bolduc for the year ended December 31, 1966 gives no indication of any loans due to them by Radal Limited or Messrs Rainu or Dallaire, and Radal Limited’s statement of January 31, 1967 shows no loans payable to Messrs Lavigueur or Bolduc. In the Bolduc and Lavigueur statement of December 31, 1967 bad debts are shown as $151,500 ‘and it was $111,500 of this amount which was disallowed by the Minister. It was suggested that if the amount of $20,000 loaned had been converted into shares, this amount would no longer appear as outstanding loans made by Messrs Lavigueur and Bolduc in their statement of December 31, 1966 nor as loans due by Radal Limited in its statement of January 31, 1967. However, only $6,000 of any such loans could have been written off by Radal Limited by the conversion of same into preferred shares issued from its treasury as the balance of the preferred shares and all the common shares acquired by Messrs Lavigueur and Bolduc were not acquired from the company but by transfer from Messrs Rainu and Dallaire or Dallaire Metal Industries Inc. Moreover, the shares were not issued or transferred until January 27, 1967 so the loans to the extent that they were made before the end of December 1966 should have appeared as such in the financial statement of Messrs Lavigueur and Bolduc as of that date.

The procedure adopted in connection with the 29 loans made following March 6, 1967 was for Messrs Bolduc and Lavigueur to issue a cheque to Radal Limited which was then deposited in its account and the bank presented the company with a note for signature. The notes were always specified as being repayable in one year with interest at the bank rate. Since Messrs Bolduc and Lavigueur were large scale developers, themselves operating to a considerable extent with funds borrowed on hypothecs or from the bank, it was evident that they were making no direct profit when they made these loans at the bank rate of interest to Radal Limited. Mr Lavigueur insisted that his only reason for making the loans was to keep Radal Limited in business so that they could continue to rent the business premises they occupied from him and Mr Bolduc, and eventually pay the arrears and current rent of same. He stated that he had no interest whatsoever in acquiring an ownership interest in the company and accepted shares in same only at Mr Rainu’s suggestion as a further guarantee-of the advances he was making. He considered the shares to be worthless and did not consider the ‘acquiring of these shares as an inducement for the making of the loans, even though the $111,500 with which we are here concerned was advanced after he and Mr Bolduc became shareholders. He stated that he had every intention of reassigning the shares to Messrs Rainu and Dallaire Metal Industries Inc when the loans were repaid, despite the fact that there was no written agreement to this effect. His and Mr Bolduc’s business consists of developing and leasing commercial property and they are not interested in acquiring interests in other businesses. It is not the first time that they have helped out a lessee with loans although it is the first time that they ever took shares as a partial guarantee of them. In one case, that of the Fontainebleau development they were forced to take the building back to protect their loan but eventually sold same, recovering most of their loan in this manner. They had 277 lessees in their buildings and in 1964 received $386,000 rental income, in 1965 $539,000, in 1966 $689,000 and in 1967 $843,000. To keep their buildings rented they frequently assisted tenants whose businesses were just starting up or who were in difficulty. A list of loans made by them in 1965 and 1966 was submitted indicating some seventeen such loans, several of which were for even greater sums than the amounts loaned to Radal Limited. Four of these loans have not been fully repaid according to this list. He explained that very often the larger loans were made because they were forced to draw from the lenders at pre-arranged dates substantial sums which they had borrowed by means of hypothecs on buildings they were constructing, and they did not always immediately have use for these funds. They were anxious to put them out on short term loans to recover the interest which they themselves were paying on these sums until they were ready to use them themselves. These loans were not therefore made with the intention of making a profit from them but solely to keep such disposable funds productive by recovering from borrowers the amount of interest which they themselves had to pay to financial institutions from whom they had borrowed these funds. Not all these loans were made by them to tenants, some being made to contractors and other business associates. He readily conceded that in the present case it made no business sense to lend to the lessee, Radal Limited, which could not even pay the current rental, amounts totalling $111,500 in order to protect rental of $48,600 due over a 3-year period by virtue of the lease. His explanation was that Mr Rainu was very persuasive and optimistic about the eventual success of the hydroplane floats and his enthusiasm was infectious so that he convinced them that the business would succeed. He saw the floats being produced by 25 or 30 employees working on the premises and had no reason to believe that the business would not prosper. Had he been asked for a substantial sum at one time he probably would have refused, but each week or two he was lending a relatively small sum to pay the current payroll or for some special purpose and the total mounted. up gradually. Once having started making these loans it seemed good business to continue in an attempt to keep the company solvent in the hope of recovering the amounts already lent and the rental due.

His evidence was corroborated by Mr Rainu. Having heard their evidence and been able to examine their demeanour and attitude when testifying, I am satisfied that they were telling the truth and that both of them had the best of intentions and exhibited great goodwill to each other throughout their dealings. As experienced businessmen, Messrs Lavigueur and Bolduc were certainly misguided in continuing to make the loans to the extent that they did, but I accept Mr Lavigueur’s evidence to the effect that in becoming shareholders of the company they were not doing so with the view of eventually profiting from this, nor was the acquisition by them of shares of the company an inducement for the making of the loans. The fact that they ceded their shares back so readily on July 30, 1968, when it finally became apparent to them that they could not recover their loans, and in fact would have to make good to the bank the amounts owed by Radal Limited to it which they had guaranteed, tends to corroborate their lack or interest in the ownership of shares in the company as such.

On the conclusions I have drawn from the evidence submitted as set out above two of defendant’s contentions can readily be disposed of. I do not find that the uncollectable loans constitute “doubtful debts arising from loans made in the ordinary course of business by a taxpayer,

part of whose ordinary business was the lending of money” (italics mine) within the meaning of subparagraph 11(1)(e)(ii) or 11(1)(f)(ii) of the Act. It is true that the taxpayer has established that he and his associate, Bolduc, frequently loaned money but part of their ordinary business was not the lending of money. These loans were made either on a short term basis to avoid leaving funds on which they would have to pay interest themselves, having borrowed same, idle until they required these funds for the use of their business, or occasionally, as in the present case, to help a tenant who was temporarily in financial difficulties. In either case the rate of interest charged was such that no profit would be realized by the taxpayer or Mr Bolduc from these loans which were made at the same rate of interest as they themselves were paying. The basic underlying principle of the taxing sections of the Income Tax Act is that profits should be taxed as income, but if a given transaction does not and cannot yield a profit then surely losses resulting from such a transaction should not be deductible. Money-lending with a view to making a profit on same was not part of the ordinary business of Messrs Lavigueur and Bolduc and no reserve should be allowed for these loans as doubtful debts under subparagraph 11(1)(e)(ii) of the Act or deduction made for them as bad debts under subparagraph 11 (1)(f)(ii).

Since I have concluded that the loans made by Messrs Bolduc and Lavigueur to Radal Limited were not made as an investment in that company with a view to making a profit from same, despite the incidental acquisition of shares in same by them, defendant Lavigueur’s alternative argument based on the Supreme Court case of MNR v Henry J Freud, [1968] CTC 438; 68 DTC 5279, that they should be deductible as a loss from a speculative undertaking, being an adventure in the nature of trade, must also faii.

This leaves for consideration defendant’s primary argument based on paragraph 12(1)(a) of the Act which reads as follows:

12.(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,

Defendant contends that these loans and the manner in which they were made constituted an outlay or expense for the purpose of gaining Or producing income from his and Mr Bolduc’s business of renting property and that they were made for the purpose of keeping Radal Limited as a solvent company which would hopefully pay the rental due by virtue of its 3-year lease for a floor of one of their rental properties. If the rental had been paid, including the arrears that were due at the time of making the initial loan, this rental would have constituted income from the business and, according to defendant’s contention, the loans were made solely for this purpose. The fact that the amounts eventually loaned exceeded the income which might have been received even had Radal Limited, as a result of the loans, overcome its financial difficulties merely indicates that Messrs Bolduc and Lavigueur used bad business judgment, but does not affect their purpose for making the loans. The case of Associated Investors of Canada Limited v MNR, [1967] CTC 138; 67 DTC 5096, while not directly in point is of some assistance. In that case Jackett, P, as he then was, stated at page 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; [1953] CTC 310, and the foreign exchange cases such as Tip Top Tailors Limited v MNR, [1957] SCR 703; [1957] CTC 309. 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. (Note that, while Section 12(1)(b) prohibits any deduction of a “loss . . . of capital” in computing profit from a business, there is no prohibition against deduction of other losses in either Section 12(1 )(a) or Section 12(1 )(b).)

At page 145 [5100], referring to the loans which were made to commission salesmen to provide them with an income during the period while they were awaiting returns from their sales, he states:

They 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 operations.

In the present case, as in that case, the loans did not result in the acquisition of any asset or advantage of an enduring nature nor create a trading structure of a permanent character (unless plaintiff’s contention that they were made because Messrs Lavigueur and Bolduc had become shareholders of the company and expected eventually to share in its profits as such, and that the shares were, therefore, an asset or advantage of an enduring nature, is accepted and I have rejected this contention). The loans were apparently an integral part of the profitmaking activities of the business, since from time to time, although not carrying on a money-lending business as such, Messrs Lavigueur and Bolduc did lend money to lessees to retain them as such with a view to keeping the premises rented and collecting as much rent from same as possible. The fact that in the present case this attempt had disastrous consequences does not affect the intention at the time the loans were made, nor does the fact that the eventual loss exceeded the total amount of rent which could have been collected affect the situation, since it is an expense not chargeable against the particular revenue collectable from this tenant but against Lavigueur and Bolduc’s total rental income from all their properties.

For this reason I believe that defendant Lavigueur’s one-half share amounting to $55,750 of the $111,500 loaned to Radal Limited should be deducted as an outlay or expense made for the purpose of gaining or producing income from his business and that plaintiffs action should therefore be dismissed, and defendant’s income tax assessment for 1967 should be referred back to the Minister for reassessment on the basis of allowing this deduction.

When we come to the question of costs, defendant raises an interesting issue concerning the application of subsection 178(2) of the present Income Tax Act which reads as follows:

178. (2) Where, on an appeal by the Minister other than by way of crossappeal, from a decision of the Tax Review Board, the amount of tax that is in controversy does not exceed $2,500, the Federal Court, in delivering judgment disposing of the appeal, shall order the Minister to pay all reasonable and proper costs of the taxpayer in connection therewith.

Attorneys for defendant contend that since the amount of tax that is “in controversy” is only $222.19, this subsection must be applied whatever may be the total amount of the income or the deductions that may result in preceding or future years as a result of same. If this interpretation is accepted this subsection of the Act in question then requires the Minister to pay ‘‘all reasonable and proper costs of the taxpayer in connection therewith”. Defendant states that this goes much further than merely taxable court costs which, if it won its case, the Minister would have to pay in any event, and also extends to solicitor and client fees which it may have to pay over and above these taxable court costs. Counsel for defendant contended further that even if the Minister won the appeal by virtue of subsection 178(2) the Minister would still have to pay defendant ‘all reasonable and proper costs” although in this case there would be no taxed court costs in favour of defendant, and he contends further that in this event the Minister would not be entitled to collect his own taxed court costs unless these were included in the reasonable and proper costs of the taxpayer that he was forced to pay as a result of the taxation of a bill of costs in favour of the Minister. I am in agreement with these contentions.

However, counsel for defendant goes further and submits that the reasonable and proper costs are determined not with regard to the amount of tax which was the object of the suit but with regard to the nature of the case and the services which defendant’s attorney has had to render to him in connection therewith. Reference is made to the provisions of section 79 of the by-laws of the Quebec Bar to provide that in evaluating his services, an attorney may take into account his experience, the time devoted to the matter, the difficulty of the problems submitted, the importance of the matter and the judicial and extra-judicial fees already provided in the tariff.

While there is no doubt that the matter in issue was an important and interesting one and that counsel for defendant is experienced in these matters and can be presumed to have devoted considerable time to the preparation of the case, it nevertheless appears to me to be contrary to the spirit and intention of subsection 178(2) to argue that on the one hand the Minister should pay all reasonable and proper costs of the taxpayer because the amount of the tax involved in the assessments for the year which is before the Court does not exceed $2,500, while, on the other hand, in estimating what are the reasonable and proper costs, consideration should be given to the fact that a sum substantially more than this will be involved if the total amount of income to be deducted over a period of years is taken into consideration, and that because of this the importance of the matter is consider- ably greater than one involving a tax of under $2,500 with the result that if the fees which taxpayer’s counsel charges to taxpayer reflect the fact that this larger sum is in issue, these should be considered as reasonable and proper costs of the taxpayer which the Minister will be obliged to pay under subsection 178(2). I should have thought that in the present case if subsection 178(2) is to be applied, the reasonable and proper costs of the taxpayer should be limited to those which would be reasonable in an action involving a tax of under $2,500. While in view of the difficulty of the issue these reasonable and proper costs would be more than the mere taxable costs allowed in a Class I action into which category this action would fall, they must nevertheless be kept in moderation and not exceed proper solicitor and client fees which the defendant might reasonably be expected to pay himself but for subsection 178(2) in an action in which the amount in issue did not exceed $2,500. If the parties cannot agree on the amount of costs to be taxed on this basis under Rule 349 they may appeal same to the Court.