Citation: 2006TCC608
Date: 20061106
Docket: 2003-529(IT)G
BETWEEN:
JACK GREENBERG,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
McArthur J.
[1] This is an appeal from a reassessment in respect of the Appellant's 1997 taxation year wherein the Minister of National Revenue ("Minister") adjusted the Appellant's active business income by disallowing a bad debt expense of $226,750, and recharacterized this amount as on account of capital.
[2] The Appellant, Jack Greenberg, is a practicing lawyer in the City of Toronto. As part of his law practice, he was in the business of seeking and cultivating emerging businesses with potential, and grooming them to go public. An integral part of this process was that the Appellant would advance his own funds by way of loans to the corporation until he made it a public corporation, when it was in a position to raise funds without the Appellant's assistance and then the Appellant's loans would be repaid. As consideration for these services, he would customarily receive 50% of the corporation's issued shares for which he paid one cent per share. He referred to these as founding shares. If the corporation prospered, he would be rewarded. If it failed, he would lose the money he had advanced. It was such a loss that he seeks to write off as an income expense.
[3] One corporation to which the Appellant made such loans was Zynex Systems Inc. (Zynex) which was a Canadian-controlled private corporation at all relevant times. Zynex was incorporated by Mr. Marc Lowman to develop interactive computer video training packages, and carried on an active business in developing and selling these interactive computer video packages. Mr. Lowman needed money and approached the Appellant, being aware of his lending funds to keep businesses operating until he made a public offering or private placement. He saw a future in Lowman's business and began lending it his own personal funds commencing with $20,000 in January 1998. Zynex was acquired by Zynex Corporation (the public corporation). The Appellant's advances to Zynex totaled $291,750.00. Zynex and the Corporation did not succeed, and eventually ceased operations. The Appellant sold the loans on January 2, 1997 for $65,000 to an independent third party and suffered a loss of $226,750. He recorded the proceeds of disposition of $65,000 as income in his 1997 tax return and expensed the net advances.
[4] He gave evidence with respect to his history of grooming other junior corporations in a similar manner prior to, or simultaneously with, the Zynex deal. He presented two large binders of documentary evidence in support of his oral testimony.
[5] The broad issue is whether the Appellant's loss on the disposition of his debt in the amount of $226,750 was on account of income or capital. The narrow issue is whether the Appellant's advances to Zynex formed part of an adventure in the nature of trade.[1]
[6] Mr. Greenberg's position is that he is entitled to deduct his loss in the amount of $226,750 as a bad debt expense. He first argued that the money he had advanced to Zynex was an intrinsic part of a larger transaction which in total was made for the purpose of earning income from an adventure in the nature of trade. He presented two alternative arguments: a) the advances were made in the ordinary course of his business and that he held the loans as trading assets, and b) he is entitled to deduct the bad debt expense because his ordinary business includes the lending of money pursuant to clause 20(1)(p)(ii)(A) of the Income Tax Act. At the outset of trial, he abandoned his claim for an allowable business investment loss (ABIL) under section 39 of the Act.
[7] The Respondent's position is that the Appellant's loss in the amount of $226,750 was on account of capital and not income, and that the Appellant's advances were not an adventure in the nature of trade. In the alternative, counsel for the Respondent submitted that the Appellant failed to satisfy either of the two positive tests set out in Easton v. Canada:[2] (i) were the loans made in the ordinary course of his business? and (ii) did he hold the shares as a trading asset and not as an investment? In the further alternative, the Respondent submits that the Appellant's ordinary business did not include the lending of money and, therefore, he is not entitled to deduct the bad debt expense of $226,750 pursuant to clause 20(1)(p)(ii)(A) of the Act.
[8] The Respondent wishes to isolate the Appellant's funding of Zynex from the overall transaction. This is not realistic in that the loans cannot and do not stand on their own. They are just one part of the entire services or package rendered by the Appellant to Zynex, forming a complete deal. He would not have considered lending money to Zynex without having control of the corporation for the purpose of taking it public, and being in a position to sell his shares at a substantial profit. In order for Zynex to operate until more serious funds could be raised, it depended on interim financing. His advances were unique to the Appellant's commercial business of grooming cash-strapped junior corporations with potential. Both questions arising from the Eastontest are answered affirmatively. Firstly, the loans were made in the ordinary course of the Appellant's business, and secondly, the Appellant held the shares as a trading asset and not as an investment.
[9] I agree with the Appellant that his situation is similar to that in M.N.R. v. Freud.[3] In Freud, the taxpayer was engaged in the practice of law. He and an associate set about to develop a prototype sports car with the intention of selling their idea to someone else who would be interested in putting it into production. From time to time, the taxpayer advanced money to the corporation. His efforts failed and he sought to deduct advances from his income. The Supreme Court of Canada found that the operation was an adventure in the nature of trade and the loss incurred was deductible on account of income.
[10] Pigeon J. of the Supreme Court of Canada (all concurring) stated at page 440:
It must also be noted that the Income Tax Act defines business so as to include "an adventure or concern in the nature of trade" (Section 139(1)(e) [predecessor to current subsection 248(1)]). By virtue of this definition, a single operation is to be considered as a business although it is an isolated venture entirely unconnected with the taxpayer's profession or occupation. This consequence of the definition has been recognized and given effect to in many cases but I will refer only to one of them namely McIntosh v. Minister of National Revenue, [1958] S.C.R. 119, [1958] C.T.C. 18, in which it was held that a single venture of speculation in land gave rise to taxable income when profit was obtained as a result of an acquisition made with a view to a profit on the resale. Kerwin, C.J. said (at pp. 120-121; p. 20):
It is quite true that an individual is in a position differing from that of a company and that, as stated by Jessel, M.R. in Smith v. Anderson (approved by this Court in Argue v. Minister of National Revenue ),
"So in the ordinary case of investments, a man who has money to invest, invests his money and he may occasionally sell the investments and buy others, but he is not carrying on a business."
However, it is also true, as well in the case of an individual as of a company, that the profits of an isolated venture may be taxed: Edwards (Inspector of Taxes) v. Bairstow et al. It is impossible to lay down a test that will meet the multifarious circumstances that may arise in all fields of human endeavour. As is pointed out in Noak v. Minister of National Revenue, it is a question of fact in each case, referring to the Argue case, supra, and Campbell v. Minister of National Revenue, to which might be added the judgment of this Court in Kennedy v. Minister of National Revenue, which affirmed the decision of the Exchequer Court.
In the present case I agree with Mr. Justice Hyndman's findings with reference to the appellant that:
"Having acquired the said property there was no intention in his mind to retain it as an investment, but to dispose of the lots, if and when suitable prices could be obtained."
Such being the principles to be applied in cases when a profit is obtained, the same rules 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.
[11] The present case is stronger than Freud in that Zynex was one of several similar ventures entered into by the Appellant. I have no doubt that had Zynex been successful, and had the Appellant been able to convert his loans to shares and then sold the shares, the profits on the sale would have been taxable on income account. He had no intention to retain the shares as an investment. Had Zynex redeemed its debt to the Appellant, and had the Appellant sold his founder's shares, the interest and the profit on the sale of those shares would also have been taxable on income account. The Respondent is often ready to share in a taxpayer's profits but not his or her losses.
[12] Pigeon J. continues at page 442:
It is clear that while the acquisition of shares may be an investment, ... it may also be a trading operation depending upon circumstances. ... Due to the definition of business as including an adventure in the nature of trade, it is unnecessary for an acquisition of shares to be a trading operation rather than an investment that there should be a pattern of regular trading operations. 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 acquisition 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. This principle appears equally applicable in the circumstances of this case. If the respondent and his friends had been successful in selling the prototype sports car, they might well have done it by selling their shares in the company instead of having the company sell the prototype, and there can be no doubt that if they had thus made a profit it would have been taxable. Because no sale could be made, respondent and his friends obviously never reached the point at which consideration would be given to the method to be adopted for realizing the profit. This should not alter the situation because the decision in the Fraser case implies that, irrespective of the method adopted, any profit would have been income, not capital gain,
As in Freud, the circumstances of the present case are unusual. From the outset, it was a venture in the nature of trade and it remained the same throughout. The advanced funds were not an investment. The following from a continuation of Pigeon J. at page 444, applies equally to the present case:
... Therefore, the venture, from its inception, was not for the purpose of deriving income from an investment but for the purpose of making a profit on the resale which is characteristic of a venture in the nature of trade. Nothing indicates that the character if the operation had changed when the outlays under consideration were made. On the contrary, the venture had become even more speculative, it was abundantly clear that respondent could have no hope of recovering anything unless a sale of the prototype could be accomplished. The outlays cannot be considered as a separate operation isolated from the initial venture, they have none of the characteristics of a regular loan.
In my view, 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.
[13] I have quoted at length from Freud because of its importance to the Appellant's submissions and it was cited with approval by Robertson J. in Easton, which was relied upon by the Respondent.
[14] The Appellant's primary activity was the practice of law. Within that practice, he applied his expertise grooming small companies with potential for growth. Payment for his services was through the issuance of shares. Loaning the company money was a necessary part of the whole package. He could be repaid by turning the private company into a public one by using his legal skills and corporate expertise. Yes, he charged interest but not at higher rates, which would be expected from such high risk loans.[4] This evolution was facilitated by his using corporate control to enable him to make decisions necessary to achieve his client's objectives. I have no doubt that he was in the business of making private companies public ones. Lending the private company money to operate was one of the necessary steps along the way. I believe his testimony that upon a successful transition to public company status, he would dispose of his shares.
[15] I have no difficulty in concluding that his business of grooming and funding emerging businesses, and then selling the shares once the company became successful was not for the purpose of deriving income from an investment but for the purpose of making a profit on the sale of the shares. Such is characteristic of an adventure in the nature of trade.
[16] The Respondent also referred to a more recent decision of the Federal Court of Appeal that sets out a general proposition about advances made by a shareholder to or on behalf of a corporation. In Easton, Robertson J. states at page 5468:
As a general proposition, it is safe to conclude that an advance or outlay made by a shareholder to or on behalf of the corporation will be treated as a loan extended for the purpose of providing that corporation with working capital. In the event the loan is not repaid the loss is deemed to be of a capital nature for one of two reasons. Either the loan was given to generate a stream of income for the taxpayer, as is characteristic of an investment, or it was given to enable the corporation to carry on its business such that the shareholder would secure an enduring benefit in the form of dividends or an increase in share value. As the law presumes that shares are acquired for investment purposes it seems only too reasonable to presume that a loss arising from an advance or outlay made by a shareholder is also on capital account. The same considerations apply to shareholder guarantees for loans made to corporations. In The Minister of National Revenue v. Steer, [1967] S.C.R. 34, it was held that a guarantee given to a bank for a company's indebtedness by the taxpayer in consideration for shares in the company was to be treated as a deferred loan to the company and that monies paid to discharge that indebtedness were to be treated as a capital loss. That case, however, does not stand for the proposition that every time a corporation fails to reimburse a shareholder with respect to an advance, outlay or payment on a guarantee that the loss is necessarily on capital account. There is only a rebuttable presumption of such. I turn now to the circumstances in which that presumption can be rebutted.
[17] Robertson J. then carves out two exceptions to the general proposition at page 5468:
There are two recognized exceptions to the general proposition that losses of the nature described above are on capital account. First, the taxpayer may be able to establish that the loan was made in the ordinary course of the taxpayer's business. The classic example is the taxpayer/shareholder who is in the business of lending money or granting guarantees. The exception, however, also extends to cases where the advance or outlay was made for income-producing purposes related to the taxpayer's own business and not that of the corporation in which he or she holds shares. For example, in L. Berman & Co. Ltd. v. M.N.R., [1961] C.T.C. 237 (Ex.Ct.) the corporate taxpayer made voluntary payments to the suppliers of its subsidiary for the purpose of protecting its own goodwill. The subsidiary had defaulted on its obligations and as the taxpayer had been doing business with the suppliers it wished to continue doing so in future. [Berman was cited with apparent approval in the Supreme Court decision in Stewart & Morrison Ltd. v. M.N.R., [1974] S.C.R. 477 at 479].
The second exception is found in Freud. Where a taxpayer holds shares in a corporation as a trading asset and not as an investment then any loss arising from an incidental outlay, including payment on a guarantee, will be on income account. This exception is applicable in the case of those who are held to be traders in shares. For those who do not fall within this category, it will be necessary to establish that the shares were acquired as an adventure in the nature of trade. I do not perceive this "exceptional circumstance" as constituting a window of opportunity for taxpayers seeking to deduct losses. I say this because there is a rebuttable presumption that shares are acquired as capital assets: see Mandryk v. The Queen, 92 D.T.C. 6329 (F.C.A.) at 6634.
(Emphasis added)
[18] Counsel for the Respondent also submitted that because the Appellant was not a taxpayer whose ordinary business includes the lending of money, he did not fall within clause 20(1)(p)(ii)(A) of the Act. Therefore, he was not entitled to deduct the loss at issue as a bad debt expense.
[19] Having found that the Appellant's activities constituted an adventure in the nature of trade as described in Freud, I do not find it necessary to analyze clause 20(1)(p)(ii)(A) of the Act, or to refer further to Easton.
[20] For the foregoing reasons, I am of the view that the Appellant's loss on the disposition of his debt in the amount of $226,750 was on account of income.
[21] Accordingly, the appeal is allowed, with costs, and the reassessment is referred back to the Minister for reconsideration and reassessment on the basis that the Appellant is entitled to deduct the amount of $226,750 on account of income.
Signed at Ottawa, Canada, this 6th day of November 2006.
"C.H. McArthur"
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