The Queen v. Shefner Estate, 93 DTC 5482, [1993] 2 CTC 273 (FCTD)

Denault, J.:—The plaintiff is appealing by way of trial de novo a judgment of Garon, T.C.C.J. of the Tax Court of Canada on July 13,1989 which maintained the defendant's appeal of notices of reassessment for the 1981 and 1982 taxation years.

Facts

The defendant owned one third of the shares in East End Development Corporation: one share was owned directly by him and 99 shares were owned by Alderton Central Corporation, a company wholly-owned by him and of which he was President. Mr. Ben Miller and his corporation, Miller Inc., owned one third and Mr. Max Schuchmann owned the remaining third of the shares in East End.

East End was formed in the 1960s to develop and sell a large tract of land in Ville d'Anjou. In 1967, Ville d'Anjou expropriated part of that land and payments were made to East End in the amount of $841,156.

In 1978, following an extensive inquiry into the expropriation files and administration of Ville d’Anjou, the Tribunal de l'expropriation reduced the amount of compensation to $328,533. Subsequently, Ville d'Anjou demanded a refund of the excess compensation. Since East End no longer had any assets or funds, Ville d'Anjou threatened to pursue criminal and civil action against Mr. Shefner and Aiderton Central Corporation, Mr. Miller and Miller Inc., and Mr. Schuchmann.

On September 21, 1981, Mr. Shefner paid to Ville d'Anjou an amount of $443,000, representing one third of the excess compensation plus five per cent interest since 1967. In return, he received a“ Quittance” forestalling any further claims or legal action on the part of Ville d'Anjou against Mr. Shefner, his family or any companies in which he was involved. Mr. Shefner claimed this amount as an eligible capital expenditure on his 1981 and 1982 income tax returns. It is this deduction which the Minister of National Revenue disallowed in its reassessments for 1981 and 1982.

Decision of the Tax Court of Canada

Justice Garon of the Tax Court allowed the defendant's appeal of the Minister's reassessment on the basis that the payment represented a business expense giving rise to a business loss deductible in 1981 and subsequent years pursuant to subsection 3(d) and section 111 of the Income Tax Act, R.S.C. 1952,

c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). He found that the whole of the evidence indicated that Mr. Shefner was a land trader at the time that the payment in question was made. While he did not personally dispose of any land since 1969, a number of corporations in which he played a key role were involved in the purchase and sale of lands since then, including East End Development. With regards to the nature and purpose of the payment, the Court found that it was dictated by business considerations, it was made to satisfy a legal obligation and it could be viewed as a reimbursement of excess compensation received: "[l]t was therefore a payment in connection with a business deal relating to the land trading activities of Shefner and of East End . . . on the whole of the evidence, Shefner made the payment of $443,000 in the course of his land trading activities and in consequence of his carrying on that type of business. It was one facet of a commercial transaction" (at page 8).

Plaintiff's position

The plaintiff submits the following propositions:

1. the payment is not an expense incurred for the purpose of gaining or producing income pursuant to paragraph 18(1)(a);

2. the payment is not an eligible capital expenditure pursuant to paragraph 14(5)(b);

3. the payment does not result in a capital loss ora business investment loss pursuant to paragraphs 18(1)(b) and 39(1)(c); and

4, the payment constitutes a non-deductible outlay.

In support of the submission that the payment was not an expense incurred for the purpose of earning income, the Minister contends that there is no past or future source of business income either from East End or Mr. Shefner's personal business from which the deduction can be expected to be offset. The Minister maintains that in 1981 Mr. Shefner did not carry on directly or indirectly any land sale business; he did not personally have an inventory of land nor did any business income from the corporations flow through them to Mr. Shefner. Further, he had no reasonable expectation of profits from his land dealings. Finally, because the corporations in which Mr. Shefner is involved hold land does not mean that the profits from the disposition of these lands becomes his business income. The Minister distinguishes M.N.R. v. Freud, [1969] S.C.R. 75, [1968] C.T.C. 438, 68 D.T.C. 5279 on the basis that Mr. Shefner's business or businesses are not single purpose corporations and that the payment is not part of the corporations' running expenses. The remaining three propositions were not dealt with in the plaintiff's submissions.

Defendant's position

The defendant submits that the payment was a business expense giving rise to a business loss which was fully deductible from Mr. Shefner's income for 1981 and subsequent years. In the alternative, the plaintiff submits that the expense is deductible as an eligible capital expenditure.

In support of the contention that the payment was an ordinary business expense, the defendant develops two business rationales: Mr. Shefner fulfilled a business obligation which could have been imposed upon him within the context of his real estate activities because of threatened criminal and civil proceedings brought by Ville d’Anjou and/or that the payment was made to preserve and maintain Mr. Shefner's business reputation. In addition, the defendant submits that Mr. Shefner was a land trader over the course of many years including the year in which he claimed the deduction.

Issues

The central issue to be determined in this case is whether the payment was a business expense giving rise to a business loss deductible pursuant to paragraph 3(d) of the Income Tax Act. This determination involves two questions:

1. Can Mr. Shefner's activities during the years in question be considered a business within the meaning of the definition provided in subsection 248(1)? Specifically, could Mr. Shefner be considered a land trader?

2. Was the expense incurred for the purpose of gaining or producing income within the meaning of paragraph 18(1)(a)? Specifically, was the payment made within the context of a commercial operation?

Analysis

Mr. Sheffner passed away in 1986, and his former accountant, Leon Miller, was the only witness to testify at trial. In my opinion, the evidence reveals, through Mr. Miller’s testimony, that Mr. Shefner was engaged in land trading activities during the course of many years, including 1981 and 1982, through his specific involvement with East End, the activities of a number of corporations in which he was the driving force and his general business affairs.

It is common ground between the parties that East End was a land trading company. Its purpose was to buy large tracts of land in the east end of Montreal to develop into subdivisions and to later sell. While the day to day management of the company was the responsibility of Mr. Schuchmann, the evidence demonstrates that Mr. Shefner remained actively involved in the decisions of East End. The company has been inactive since 1970 or 1971, but it is still in existence.

The evidence also indicates that Mr. Shefner was involved as the majority shareholder and driving force in a number of corporations: Europe Realties Inc., Shefner Corporation, D.A. Shefner & Co. Ltd., Bar Dan Realties Inc., Ariel Realties Inc., Ascot Construction Ltd. and Twenty-Five Corporation. These companies were variously involved in land trading, general real estate activities (including the development of rental properties), general contracting and the steel warehouse business. Several of these corporations reported considerable rental income in 1981 and 1982.

In his personal capacity, Mr. Shefner purchased and later sold at a loss a tract of land on the south shore of Montreal in the 19605. He claimed this as a business loss on his 1969 income tax return. The Minister objected to this deduction and Mr. Shefner appealed this decision. In 1973, the Tax Review Board allowed the deduction and it would appear that the basis for their decision was that Mr. Shefner was engaged in land trading activities. In addition, Mr. Shefner owns and manages a multi-tenant industrial building which is the source of reported rental income in 1981 and 1982.

The determination that Mr. Shefner or his corporations were a business in 1981 and 1982 pursuant to paragraph 18(1)(a), is a question of fact based on whether his intention was to earn profit by buying and selling property. In Johns-Manville Canada Inc. v. The Queen, [1985] 2 S.C.R. 46, [1985] 2 C.T.C. 111, 85 D.T.C. 5373, the Court approved a "common sense appreciation of all the guiding features" to determine the intention of the taxpayer. The jurisprudence presents a number of criteria, none of which is conclusive; it is necessary to look at the surrounding circumstances such as the number of similar transactions, related activity, corporate objects and powers, and the degree of organization.

Mr. Shefner's history of business activities in real estate transactions indicates the general course of conduct of a trader (Rudelier Ranches & Livestock Co. v. Canada, [1989] 1 C.T.C. 417, 89 D.T.C. 5180 (F.C.T.D.)). The fact that his sources of income in 1981 and 1982 were rental income and salary does not negate the existence of a business involved in land trading activities. The whole of the evidence indicates that Mr. Shefner was a land trader and was engaged, both in a personal capacity and through the corporations in which he was involved, in business activity in 1981 and 1982.

The second, and more important consideration, is the nature of the expenditure itself. Generally, subsection 9(1) and paragraph 18(1)(a) provide that the expense must be incurred for the purpose of earning income, not be a personal expense, and be of an income nature as opposed to a capital expenditure. The determination of a business purpose is a question of fact: is the expense normally considered to be an expenditure in the pursuit of income. The defendant provides two business rationales for the expense: (a) Mr. Shefner fulfilled a business obligation which could have been imposed upon him by Ville d'Anjou following threatened legal action; (b) the payment was made to preserve and maintain the business reputation of Mr. Shefner and his related corporations.

In his decision, Mr. Justice Garon was convinced of the former rationale and cited Imperial Oil v. M.N.R., [1947] C.T.C. 353, 3 D.T.C. 1090 (Exch. Ct.) in support of the view that the discharge of a legal liability incurred as part of business operations is a business expense. In my view, Mr. Shefner's decision to settle with Ville d'Anjou prior to having the legal obligation imposed upon him and prior to incurring considerable legal costs represents a prudent and reasonable decision made within the context of an ongoing commercial operation or transaction. Upon consideration of Ville d'Anjou's claims against East End for the excess compensation, the Quebec Superior Court pierced the corporate veil and imposed direct liability upon Mr. Miller, Mr. Schuchmann and Miller Inc. (La Corporation municipale de ville d'Anjou v. East End Development Corporation et al. (December 7, 1984), Court file no. 500-05-013489-826 (unreported)). It is probable that Mr. Shefner, had he not settled with Ville d'Anjou, would have faced the same result.

The second rationale is also valid. In Mitchell v. Noble (B.W.) Ltd., [1927] 1 K.B. 729,11 T.C. 372 (C.A.), the Court found that the transfer of shares because of fraud on the part of the shareholder was a business expense because the companies immediate and future interests depended upon the avoidance of scandal; the payment was not to purchase an asset of value but to ensure the continuance of the company. Mr. Shefner's payment to Ville d'Anjou was similar in nature. Mr. Shefner continued to do business in Ville d'Anjou and the immediate vicinity. By settling with the city he avoided the possible scandal a lengthy legal battle would entail and the damage to his business reputation the imposition of criminal or civil liability could cause. As in Lawson (HM Inspector of Taxes) v. Johnson Matthey pic, [1992] B.T.C. 324, [1992] 2 All E.R. 647 (H.L.), at page 329 (All E.R. 653),"the goodwill of the taxpayer company was not improved but was saved from extinction".

In a case not argued by either side, Hillsdale Shopping Centre Ltd. v. M.N.R., [1981] C.T.C. 322, 81 D.T.C. 5261 (F.C.A.), the taxpayer had acquired some land in a plan to develop a shopping centre. The plan fell through, and the land was expropriated. The taxpayer received compensation for the land and treated it as a non-taxable capital receipt. The Minister assessed tax on the compensation, viewing it as income from an adventure in the nature of trade. The Court of Appeal, like the trial judge, saw that the taxpayer had two intentions in acquiring the land: to develop the shopping centre or to dispose of the land at a profit. As in Regal Heights Ltd. v. M.N.R., [1960] S.C.R. 902, [1960] C.T.C. 384, 60 D.T.C. 1270, this was enough to make the compensation income from an adventure in the nature of trade and taxable. Mr. Shefner's plans in relation to the land purchased by East End and expropriated by Ville d'Anjou may be similarly characterized. If the compensation provided by Ville d'Anjou was taxable as business income in Mr. Shefner's hands, then it follows that a reimbursement of that money should be considered a business expense.

Conclusion

Upon considering the submissions of counsel and reviewing all of the circumstances presented in evidence, I conclude that the reimbursement of compensation paid to Ville d’Anjou in the amount of $443,000 was a business expense giving rise to a business loss fully deductible pursuant to paragraph 3(d) of the Income Tax Act. Consequently, the application is dismissed with costs.

Application dismissed.