Lipper v. The Queen, 79 DTC 5246, [1979] CTC 316 (FCTD)

Addy, J:—The plaintiff appeals his income tax assessment for the 1971 taxation year. The part of the assessment in issue before me pertains to a Capital cost allowance of $11,243.40 which the plaintiff claimed as a limited partner entitled to a 1/88th share in a limited partnership known as “Cine- fund Chou Investments,’’ which had purchased certain rights to two films known as “Tiki Tiki” and “Fleur Bleue.”

The limited partnership was constituted pursuant to The Limited Partnerships Act, RSO 1970, c 247 and consisted of several limited partners and of one general partner, a corporation known as “Chou Investments Ltd.” The latter had no assets and was obligated to contribute only $1,000 to the partnership. However, in accordance with The Limited Partnerships Act and the partnership agreement, the general partner had full and exclusive control of the investment of the partnership, which was allegedly constituted for the sole purpose of investing and acquiring certain rights in the two motion pictures.

The plaintiff contributed a total of $5,000 to the capital of the limited partnership, which capital totalled $440,000, and was not committed to contribute any further moneys. As in the case of all of the other limited partners his liability for any debts of the partnership was strictly limited to the amount which he had contributed and all losses, in excess of the aggregate capital contribution of the partners, were to be borne by the general partner and the assets of the firm.

A form of contract was entered into between the limited partnership and Potterton Productions Inc (hereinafter referred to as “Potterton”) whereby the partnership undertook to purchase the interest of Potterton in the film “Tiki Tiki,” which was a full length feature consisting in part of live action and in part of animated characters, for the total sum of $1,334,857.20. $255,132.31 of the purchase price was payable on the execution of the agreement in cash and the balance of $1,074,724.89 was to be paid from whatever portion of the proceeds of the earnings of the film might be receivable by the partnership and, in any event, the remainder was to be payable in 11 /2 years, that is, in July 1982. The down payment provided for in the agreement was made. By another form of contract executed on the same day, the limited partnership purported to acquire from Potterton for the amount of $248,555.03 all of the latter’s rights in the motion picture film “Fleur Bleue” which was a short film, involving certain scenes of nudity, which might be considered objectionable by some viewers. The purchase price was payable $124,867.69 in cash and the balance of $123,687.34 was payable to Potterton under substantially the same conditions as for the film “Tiki Tiki.” The down payment in this case was also paid as agreed.

All of the above-mentioned agreements including the main partnership agreement were entered into and executed during the last ten days of December 1971.

The first question in issue is whether the plaintiff, since he had only disbursed $5,000 by the end of 1971 and was not legally obligated in any way to disburse any more, could at law claim for that year a capital cost allowance based on a capital investment in excess of that amount (ie, $11,243.40) or, put in another fashion, whether he could claim a capital cost allowance which would in fact put his capital cost account in a deficit position.

Paragraph 12(1)(b) of the Income Tax Act in effect in 1971 reads as follows:

12.(1) In computing income, no deduction shall be made in respect of

(b) an outlay, loss or replacement of capital, a payment on account of capital, or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part,

Paragraph 11 (1)(a) provides that there may be deducted in computing the income of the taxpayer for a taxation year:

(a) such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation;

Motion films fall within class 18 of Schedule B of the Regulations and section 1100 of the Regulations provides for the capital cost allowances which may be claimed. It is clear from paragraph 12(1 )(b), paragraph 11 (1 )(a) and from other sections of the Act such as subsection 20(5), which deals with undepreciated capital cost, that it is only the capital cost to the taxpayer which must be considered.

It is undisputed that, if the films earned any income in future years the taxpayer would then be obliged to contribute his share of the earnings towards retiring the debt created by the purchase of the film rights, but it is obvious that this liability was essentially and entirely a contingent one. Because, among other things, of the subject-matter of the films, the audience to which they were addressed and the earning records of Canadian films generally to which I shall refer later on, it was abundantly clear in 1971 that there was no certainty as to what net amounts would be realized to apply on the balance payable or when any such amounts might be obtained. Lawrence H Mandel v The Queen, [1977] 1 FC 673, affirmed on appeal in [1978] CTC 780; 78 DTC 6518, firmly establishes the principle that a contingent liability to contribute towards capital costs is not to be taken into account in such circumstances in calculating capital cost to the taxpayer unless and until the contingency arises. It was also confirmed by expert witnesses at trial that this was in accordance with generally accepted accounting principles.

The expert witnesses Bonham and Blazouske stated (and I fully accept their evidence on this point) that a limited partner in a limited partnership where he has contributed his share of the capital must not be shown as being in a deficit position in his capital cost account, as there is no liability to pay beyond the amount of capital contributed. This limitation has not only been provided for in a partnership agreement but is clearly set out in section 3 of The Limited Partnerships Act, RSC 1970, c 247, which reads as follows:

3. General partners are jointly and severally responsible as general partners are by law, but limited partners are not liable for the debts of the partnership beyond the amount by them contributed to the capital.

In compliance with that principle article 8.04 of the limited partnership agreement reads as follows:

SHARING OF LOSSES

8.04 Losses, if any, of the Partnership shall be borne by all the partners in the proportion that each such partner’s capital contribution to the Partnership is of the aggregate capital contribution of all such partners to the Partnership; provided the liability hereunder of each Limited Partner shall be limited to the amount which such Limited Partner contributed to the capital of the Partnership. The amount, if any, by which such losses exceed the aggregate capital contribution of all partners shall be borne by the General Partner.

Although it is clear that there is an absolute liability of the partnership under both agreements to Potterton to pay the balance due on both films in 1982, it is equally clear that, at law, the liability rests entirely and exclusively on the general partner and not on the taxpayer, a limited partner. The only remaining liability of the limited partner is the contingent one to which I have already referred which is not to be taken into account unless and until the contingency arises. A taxpayer cannot at law, in the absence of any specific statutory provision to the contrary, claim any part of a capital cost allowance which is based exclusively on another taxpayer’s liability to pay. It matters not what the taxpayer’s proportion of interest in the asset might be. The question is to be decided on the basis of its cost to him. As my brother Cattanach, J, stated in the case of Morris Besney v Her Majesty The Queen, [1974] CTC 54; 73 DTC 5592, at p 62 (5599):

In my view both the plaintiff and Milton had no interest in the land at all relevant times, but the capital cost allowance which the plaintiff is entitled to claim as a deduction does not turn upon the proportionate interest in the land but upon the respective contributions to the capital cost made by the plaintiff and Sorokin.

I therefore conclude as a question of law that the total capital cost to the taxpayer for the two films in 1971 could not be taken to exceed $5,000 and that, if the two films were the only property held in that class by the taxpayer, pursuant to paragraph 11 (1)(a) and Regulation 1100, the total capital cost allowance for that year could not exceed 60% of $5,000 or $3,000.

It appears in fact that the only other property held in that class by the taxpayer in 1971 was an interest in a film known as “Selfish Giant.” This film was not part of the assets of the limited partnership agreement. The taxpayer claimed the maximum capital cost allowance of 60% on his interest in this film. This allowance was at one time but is no longer contested by the defendant. The matter may therefore be considered from a practical standpoint as if the films of the limited partnership were the only assets of the taxpayer in that class.

By far, most of the time at trial was taken up with the issue of whether the undertaking to pay the balance in July 1982 had any bona fide business purpose, whether it was but a cloak that concealed the real purpose and therefore constituted a sham and also, whether, in effect, Potterton’s purported right to collect was, in practical terms and to the knowledge of all interested parties, inoperative. Unlike the situation in the Mandel case supra, where the argument of sham was rejected, that argument was not advanced in the case at Bar with regard to the whole amount of the alleged purchase price, but only as to the unpaid portion of the purchase price. Alternatively to the allegation of sham in its strict sense, which in effect he did not advance too strenuously, counsel for the defendant argued that, although the provisions for payment of the balance in 1982 appeared, according to the legal form of the agreement, to be part and parcel of a bona fide business transaction, they constituted in fact and in substance, to the knowledge of all interested parties, only the main element of a tax evasion scheme and had no true business purpose.

It is trite to say that, upon the issue being raised, it then becomes the duty of the Court to consider the true substance of a transaction as well as its legal form. (See The Commissioners of Inland Revenue v His Grace the Duke of Westminster, [1936] AC 1; Dominion Taxicab Association v MNR, [1954] SCR 82; and Dominion Bridge Company Limited v Her Majesty The Queen, [1977] CTC 554; 77 DTC 5369.)

As to the limited partnership relationship itself, it does have a business purpose and is an ideal vehicle for encouraging bona fide investment, but it is also an ideal vehicle for tax shelter purposes. A question can arise, as in the present case, as to whether the essential or fundamental purpose of a contract into which the limited partners enter is to obtain a tax advantage rather than to engage upon a bona fide business venture, which might at the same time and quite legitimately involve certain tax advantages which would minimize the possible losses and, therefore, render the venture considerably more attractive.

One of the expert accountants called by the plaintiff admitted during his cross-examination to the authorship of three lengthy and quite technical articles which dealt very fully with this matter as well as with the tax advan- tages to the purchaser in agreeing to an artificially inflated purchase price, where there is no direct recourse against him. It also dealt with the use in a limited partnership, of a general partner without assets who guarantees the payment of the inflated purchase price by what appears to be a full recourse undertaking.

These articles were filed at trial as Exhibits D-5, D-6 and D-7. In D-6 entitled “Motion picture Films as a Tax Shelter’’ he stated:

Returning to the non-recourse situations described earlier, so long as the taxpayer can lever his investment with non-recourse debt, or use the limited partnership route (or some of the more popular “guaranteed” income routes which will be outlined later on), he has everything to gain and nothing to lose if the film goes bust. In practical terms, it would be rare to find a tax shelter movie deal in which the purchaser unconditionally binds himself to pay a firm price for his interest without such price being so high that the producer is assured of receiving the lion’s share of the revenue if the film proves to be a success; hence the use of nonrecourse obligations.

In D-5 entitled: “Motion Pictures as a Tax Shelter’’ he states:

Many film promoters, realizing that investors are not eager to risk 100 cents on the dollar in a speculative investment such as a film, have attempted to use the tax system to encourage investors to buy their films. Under this scheme, the investor’s “cost” of a film for CCA purposes is artificially inflated by including non-recourse (or no-risk) obligations issued by the investor, so that the amount he could write off through CCA would be well in excess of the amount he has “at risk.”

and later on in the same article:

Achievement of the same cash benefit has been attempted through the use of a limited partnership, whereby a group of taxpayers (eg, five limited partners) would collectively invest cash of, say, $50,000 and their limited partnership would acquire a film by making a $50,000 cash down payment and issuing a $450,000 full recourse (ie, unconditional) promissory note guaranteed by the general partner (a shell corporation). If the film went bust the liability of the limited partner would be restricted to their capital contributions ($50,000), and the liability of the partnership would be limited to its assets (the film). If the note went unpaid because the film was a bust, the general partner (corporation) could simply go bankrupt.

In D-7, an article entitled “A Cineramic View of Motion Picture Film Investments’’ he also repeated the same general idea:

In non-recourse situations, further abuse can occur with respect to the purchase price of the film. While the investors (whether directly owning an undivided interest or whether using the limited partnership vehicle) have an arm’s length interest in ensuring that their down payment is not excessive vis-à-vis the actual value of the film, they actually have little to lose in paying an inflated price which is represented only by non-recourse obligations. Admittedly, an inflated sales price will reduce the investor’s ultimate profits should the film prove to be a success; however, /t appears that most investors are more concerned with immediate tax benefits or deferrals rather than with what is often the dubious possibility of eventual profits in the future—most films being a bust.

Insofar as the vendor is concerned, ie, the distributor, he can afford to take back even an unreasonably large note. Should the film be successful, the note would be paid and the vendor’s trading profit will be relatively large; if the film proves to be a bust, the vendor still has the original cash down-payment as well as any payments made on account of the note. It should be remembered that such payments come off the top, or at least are on a pro rata basis.

It would therefore appear that both the investor and the vendor might tend to place a high value on the film at the time of sale, ie, to the extent that the price is represented by non-recourse obligations.

[The italics in the above extracts are mine.]

Several facts were established in evidence on behalf of the defendant, which would tend to establish the existence of an inordinately exaggerated purchase price, the artificiality of its unpaid balance and certain unrealistic conditions of repayment which might bring into question the existence of any true business purpose of the transaction from the taxpayer’s point of view.

The following facts would tend to indicate that the vendor Potterton never expected to receive the final amount expressed to be due it under a full recourse obligation payable in 1982:

1. The general partner possessed no assets and was in effect but an empty shell. Notwithstanding that it was the sole entity against whose credit and on whose covenant Potterton would have any recourse for the payment to it of some $1,300,000 in 1982, the latter firm, although quite experienced in business affairs chose to make no enquiries whatsoever or to even consider the proposed debtor’s solvency, credit or potential ability to pay.

2. Potterton entered into a new distribution agreement with Commonwealth United Entertainment Inc (hereinafter referred to as “Commonwealth”) on December 22, 1971, just seven days before signing the agreement with the limited partnership. Having regard to the time which would normally be required to organize such a partnership, negotiate and decide upon its terms, obtain from the limited partners the financing required to make the down payment on the films and negotiate and engross in an agreement the rather complicated terms of the transfer and make the necessary arrangements with the distributors and creditors such as The Canadian Film Development Corporation (hereinafter referred to as CFDC), it is not unreasonable to suppose that the new distribution agreement with Commonwealth of December 22,1971 was entered into for the sole purpose of allowing the sale to go through. It is clear, however, that some time before December 22 (refer documents in Exhibit D-1 tab 11) that Commonwealth had not lived up to a number of its commitments with Potterton under a previous agreement. It is also apparent that Commonwealth was involved in litigation in the United States regarding, among other things, the distribution of the film Tiki Tiki. There appears to have been at that time little indication, if any, that the distribution of the films would prove to be in any way successful from a business standpoint.

3. Documents 6, 7 and 9 in Exhibit D-1 show that Potterton, before December 15, 1971, had received correspondence from distributors and, as to Fleur Bleue, copies of correspondence from theatre operators, all of which would indicate that both films would be unlikely to turn out to be a financial success at the box office.

4. The balance sheets of Potterton for 1971, after reciting a receivable of $1,328,412 from the sale of the films, contained the following statement in a note pertaining to that entry: “The company does not expect to receive any payments from the purchasers other than its percentage interests in net revenues.” The accountant of Potterton, who was called by the defendant but on the insistence of the plaintiff who required formal proof of Potterton’s financial statements for subsequent years, attempted on cross-examination by the plaintiff’s counsel to explain away that note by claiming that it meant that the company did not expect to receive during 1971 any payments other than from the revenues produced by the films.

I completely reject this statement: in the first place there were no revenues in 1971 from the films and in the second place, when preparing a financial statement some time after the close of the financial year, one does not mention that the client does not expect to collect a debt during that year as it is obvious from the balance sheet itself that the debt has not in fact been collected. I find that the note meant that at the end of 1971, that is, only two days after the sale, in the auditor’s view, Potterton did not expect in the future to collect any amount of the $1,300,000 except through its share of the net proceeds from film distribution revenue, in other words, that it did not expect to collect the balance purported to be payable in 1982 from the general partner under the full recourse provision of the agreement. Potterton’s financial statement for 1972 contained the same note. In the 1973 statement the entire amount was completely written off. In January 1975, a proposal under Part 3 of The Bankruptcy Act RSC 1970, c B-3, was made by Potterton to his creditors. In that proposal no mention whatsoever was made of the balance owing (either contingently or otherwise) on the sale of the films to the partnership.

From the above evidence I conclude that the vendor Potterton never intended to collect the balance of the sale price of the films under the full recourse obligation it had against the general partner on behalf of the limited partnership and which became due in 1982.

The next question is whether the purchaser, that is the partnership, really expected ever to pay off the vendor, discharge the existing liabilities against production revenue and eventually realize a profit on the moneys invested or even recuperate them.

There was, at the time of the sale of the partnership, a total of some $1,583,000 owed by Potterton to CFDC, Famous Players Limited, Commonwealth and Cinefund Limited. These amounts, however, were not payable by Potterton personally but were payable solely out of the receipts to be realized from the showing of the films. In the two agreements for sale of the films entered into between Potterton and the partnership, the latter assumed the payments of these debts and, except for $380,000 payable in cash, the balance was also to be payable only out of the net proceeds from the films. The $380,000 in cash went to Cinefund Limited leaving a balance owing to that particular firm of some $52,000 from a total previous indebtedness to it of some $432,000. However, in addition to this, the sum of $1,203,000 was also payable to Potterton first out of the proceeds and secondly, if not paid in this manner, then by the partnership in 1982 under its undertaking to pay Potterton. This in effect meant that pursuant to the two agreements, the partnership had either paid or undertaken to pay out of proceeds and, finally, in 1982 a total amount in excess of $2,400,000 of the films.

When one considers that the owner of a film, when it is shown in moving picture theatres, can only expect to receive approximately 20% of the gross box office receipts, it is obvious that, if all of the revenue were to come in from that source, the films would have to gross, without even considering interest, over $12,000,000 at the box office.

There was uncontradicted evidence that in 1971 Canadian feature films generally had not attained any degree of financial success and there was further evidence that even today, now that Canadian films have at least achieved some limited financial success on the film market, the gross box offfice receipts of the five most financially successful Canadian films are as follows:

One must therefore conclude that the two films in issue here would have to prove jointly seven times more successful than the average of the five most successful Canadian films today, before the partnership could hope to realize any profit on its investment, even if one were to disregard the question of interest.

It is true that some revenue can be produced for TV rights, but there is no evidence that amounts of any significance whatsoever, have ever been realized from that source or any sources other than box office receipts, in so far as Canadian films are concerned.

The evidence of Mr Stevenson, one of the experts called by the defendant, impressed me. He stated that the fair market value of the films in 1971 was $250,000 for ‘‘Tiki Tiki” and $25,000 for “Fleur Bleue” or a total of $275,000. The experts of the plaintiff, needless to say, were of a totally different view. I was impressed by Mr Stevenson’s evidence and subsequent facts reveal that his estimate was, if anything, very generous indeed. It is obvious that the market value of the films in December 1971 and the likelihood and extent of any future success from a financial standpoint must be judged on the evidence available to prospective investors at that time and not determined ex post facto in the light of subsequent events. However, where, as in the case at Bar, large and totally irreconcilable differences occur in the opinion evidence of various experts, subsequent events can be used to test the accuracy and, at times also, the bona tides of the opinions expressed.

The following evidence was given by an expert called on behalf of the plaintiff who had been involved with the distribution of the films:

1. In so far as “Fleur Bleue” was concerned, the exclusive TV rights for viewing in Canada for a period of seven years were sold at a gross price of only $12,000 which, after deducting commission brought in a net fee of $10,200. The only gross income from foreign distribution of the film amounted to $2,000. The expenses in that case amounted to $4,320 resulting in a net loss of foreign distribution of $2,320.

2. To market “Tiki Tiki” in Canada, between $15,000 and $20,000 was expended. Of this amount $7,500 was advanced by CFDC (in addition to the amounts advanced at time of production). Between $2,000 and $5,000 were realized on the film for a net loss of between $15,000 and $17,000.

When futher cross-examined as to his view of the values to be attached to the films, even at the present time, and in the light of the extremely poor financial returns during some eight years since the films were originally marketed, the opinion of the same expert seemed to remain stubbornly divorced from the realities of life. This can readily be seen from an examination of the profit and loss portions of financial statements of the partnership:

Revenue from the films for the year 1971 is shown at $13,628 with expenses amounting to $15,000. For 1972, a revenue from the films of $3,284 is shown, against which is charged a management fee of $12,000 and distribution expenses, etc, of $9,687 for a net loss before amortization of $18,403.

The financial statement of the partnership for the first six months of 1973 established revenue earned in the amount of $583 and expenses for management, etc, amount to $6,252 for a total loss before amortization of $5,669.

In the years 1973 and 1974, the total income from distribution of films amounted to $943 and to $68 respectively while expenses for management, distribution, etc, amounted to $11,173 and $252 for a loss of $10,230 and $184. In the years 1975 and 1976, there was no revenue whatsoever from film distribution nor were there any expenses.

To summarize, at no time since the films were purchased did the revenue from film distribution even exceed the costs for management and distribution.

He seemed either blinded by his personal view of the artistic and technical merits of the films and confused these with the likelihood of commercial success which depends entirely on the extent of a film’s appeal to the public, or else he deliberately refused to consider the only yardstick by which value can be measured from an investment standpoint and, that is, the likelihood of a financial return on the investment. I cannot accept his opinion as to the value of the films in 1971.

Another expert called by the plaintiff based his entire opinion on the cost of production of the films, yet, although apparently an experienced accountant in the film industry, he did not examine the records or books of the producer, nor did he examine the general financing of the film nor the cost to Potterton of the Russian film which was used for all of the live action portion of “Tiki Tiki.” He did not make any projection as to revenue to determent what would have to be earned yearly throughout the period in order to finance the purchase. It appears to me that he was totally incapable of justifying the market value of the film by the very method by which he purported to establish it. He accepted the cost of production as given and then, in effect, stated that in his view the film was worth that amount because that was the cost of production. It is interesting to note also that, in his opinion, he assumed that the films were absolutely transferable by the purchasers while in fact they were not.

Especially in the case of an artistic work such as a film, I do not accept that the actual cost of production necessarily reflects the true market value, even where the work is produced by someone experienced in the art. A film is a unique commodity and must not be likened to physical assets such as buildings, automobiles, machines and other manufactured chattels where, when normal care is exercised and accepted and proven methods are employed in creating the asset, the cost of production will normally prove to be a good means of determining its ultimate market value as of the date of completion of the work, after adding thereto whatever other normal costs might be involved before the asset is marketed or marketable.

A film must entertain in order to have any commercial value from a distribution standpoint. Otherwise, it is both useless and valueless as an investment, regardless of the cost of production. Conversely, a low budget film might well prove to be of considerable value. To say that a film has a certain value merely because that is what it costs to produce it is to disregard, ignore or disregard the difference between an asset which derives its value from its practical utility and one the value of which depends entirely on its esthetic and entertainment appeal and on the universality of that appeal in modern society and, more particularly, in the United States of America where 55% of the revenue from any successful film is to be realized.

To the argument advanced by counsel for the plaintiff based on some statements to that effect by certain of his experts that, since the films had not yet been shown in the USA, they might still be expected to generate considerable income from that market in the future, I prefer the view that, on a balance of probabilities, since eight years have now elapsed and the films have not yet been successfully marketed there, one must conclude that they are not in fact economically marketable in the USA as evidenced by their complete lack of success in Canada coupled with the fact that their themes are quite local in character and possess nothing resembling a universal appeal nor do they touch upon matters of special concern or interest to the USA.

I conclude that the fair market value of the films in 1971 did not exceed the estimate given by the expert Stevenson, namely: $250,000 for “Tiki Tiki” and $25,000 for ‘‘Fleur Bleue” for a total of $275,000. I therefore find that even the amount paid in cash, ie, $380,000, actually exceeds the fair market value of the films.

As to the purchasers, there is no suggestion that they were inexperienced nor any suggestion that they had been tricked or induced into paying an exaggerated price for the films. On the contrary, evidence adduced on their behalf tended to show that, on good business advice, they had believed and are still of the view today that the investment at the timewasfinancially sound. I cannot accept this anymore than I can conceive that purchasers such as the plaintiff would be willing to pay, without any true expectation of profit, namely ten times the value of the asset in any bona fide transaction.

The plaintiff is a lawyer, a member of a reputable law firm and evidently not inexperienced in business. He did not, however, bother to make any enquiry as to the credit of the general partner or who its principal might be, although he knew that the general partner would be solely responsible for making all business decisions and for entering into all contracts on behalf of the partnership and, more particularly, into a management contract with Cinefund Ltd. Furthermore, the latter company had, according to the terms of the original offering to the proposed limited partners, undertaken to purchase an interest in the partnership equal to 10% of the invested funds. Yet, even at the time of trial, some eight years later, he did not know whether Cinefund Limited had fulfilled its original announced commitment in this regard.

I find that the plaintiff had little or no concern as to how the business of the partnership or its assets would be managed or administered and this is very indicative that the purpose of the investment might not have been to obtain a financial return on it but to obtain what was presented to him as great tax advantage, which advantage might well equal or at least approach if not exceed the amount of his investment within a few days after it was made.

As to the agreements themselves, they contain some very strange provisions regarding the amount payable by the partnership to Potterton in 1982.

1. Potterton is, according to the contracts, absolutely entitled at law to claim in full in 1982 the payment due it, notwithstanding the fact that neither CFDC, Commonwealth or Famous Players have been reimbursed, since the latter are entitled to recoup their advances solely from earnings and since the debt due Potterton is not conditional upon any earnings whatsoever being produced or upon those creditors being paid.

2. Strangely enough, the financial statements themselves do not reflect this final debt due to Potterton.

3. The provisions in the agreement referring to some continuing liabilities, obligations or undertakings on the part of Potterton to those same creditors are completely fictitious and of no effect, as the creditors are only entitled to be reimbursed from earnings produced by the films and have no recourse whatsoever against Potterton.

4. The amount of box office receipts required to be generated in order to enable the partnership to pay Potterton would be nothing short of astronomical. Since the net return to an absolute owner of a moving picture film is in the order of 20% of the gross box office receipts, and since the partnership is entitled to only a one quarter share of the net receipts of ‘‘Tiki Tiki’’ or, in other words, 5% of the gross box office receipts, that film would have to produce approximately $20,000,000 at the box office in order to enable the partnership to pay just $1,000,000 to Potterton. In the case of “Fleur Bleue” the right to share being 50%, it would have to gross $10,000,000 in order to produce $1,000,000 to apply on Potterton’s claim.

One might well be inclined to believe that these apparent absurdities resulted solely from the insertion of an amount due Potterton unconditionally in 1982 in an attempt to implant or graft the characteristic of a full recourse obligation upon what was essentially and fundamentally a contingent liability, ie, the production debts owed to CFDC, Commonwealth and Famous Players, payable solely out of future earnings. Since both liabilities are necessarily quite distinct as to incidence and as to character, the inevitable result was to create two distinct liabilities.

I conclude that the amount to be paid after December 31, 1971, was, to the full Knowledge of both the purchasers and the vendors, a grossly and artificially inflated amount which bore no relation whatsoever to the value of the assets which are the subject-matter of this trial, and I find further that none of the parties ever expected these moneys to be paid. Furthermore, as stated by the witness Blazouske, financial statements must reflect reality and economic substance. This principle has been fully recognized by the courts. See MNR v Publishers Guild of Canada Limited, [1957] CTC 1; 57 DTC 1017, MNR v Anaconda American Brass Limited, [1955] CTC 311 ; 55 DTC 1220 and The Sun Insurance Office v Clark (1912), 6 TC 59. The preparation of accounting statements requires professional judgment and the unpaid balance of sale shown in the 1971 statement had no economic substance and was not a proper entry. The witnesses Warehouse and Lowe in testifying as to cost, in my view, merely considered the matter mechanically having regard to the actual figures as entered in the books and without due regard to the true substance of the matter which these figures were supposed to represent.

The expert witness Bonham, called by the defendant, stated as follows In his written opinion:

... it is my opinion that the most appropriate accounting treatment in the accounts of the limited partnership under generally accepted accounting principles in 1971 would have been:

1. On the basis of the assumption set out in 6 above:

(a) To record in 1971 as an asset the motion picture films acquired at a cost of $380,000.

(b) In subsequent years, if, as and when any further payments are made against the balance of the contractual purchase price, to record an appropriate increase in the cost of the motion picture films.

(c) In 1971 and in subsequent years to base the annual amortization charge for motion picture films on the cost of the films as recorded under (a) and (b) immediately above.

Counsel for the plaintiff did not quarrel with the opinion set out above providing the assumption in paragraph 6 of Mr Bonham’s opinion was established. I also accept that opinion. Counsel for the plaintiff forcefully argued, however, that the assumption in paragraph 6 had never been established. That paragraph reads as follows:

6. That, as at December 31, 1971, it appeared very unlikely that the exploitation of the films themselves would produce any substantial amount of money to apply against the balance of the purchase price, nor was there any apparent financial capacity in the general partner for that purpose. Therefore the apparent debt (being the balance of the purchase price becoming due no later than July 17, 1982) was to the full knowledge of all parties (including the creditor) not what it purported to be; there being no likely source of funds from which it would be payable. In other words, this was a highly speculative venture and both the vendor and purchaser of the films knew from the outset that the films themselves constituted the only possible source of funds to pay the balance of the purchase price and that substantial funds from this source were very unlikely to materialize.

For the reasons already stated and the conclusions of fact which I have enumerated, I do not hesitate in finding that the factual assumptions contained in paragraph 6 of Mr Bonham’s opinion have been fully established in evidence by the defendant.

It was further established, however, that a 10% commission, that is, an additional sum of $38,000, was also payable as the result of the payment of $380,000 for the films. This commission is properly chargeable to the capital cost of the asset and I, therefore, find that the capital cost of the films to the partnership for the taxation year 1971 was $418,000 and that, as the plaintiff had a 1/88th interest in the partnership he is assessable for that year on the basis of a capital cost to him or 1 /88th of $418,000 or $4,750. As this amounts to a few dollars less than the actual assessment appealed from, the matter will be referred back to the Minister for reassessment on that basis.

The defendant will be entitled to her costs.