The plaintiff is one of a number of individuals who put money into what is called the “golf course operation". On May 29, 1974 the plaintiff and others (all of whom, except for two, are medical doctors) entered into an agreement which anticipated the purchase of 167 acres in Richmond Hill. The property, at the time, was being run as a golf course and an existing agreement for its purchase by a corporation, named Charter York, had been signed. Of the two members of the group of individuals who were not doctors, one was a dentist, the other was a Mr. Kotowski. (This group is sometimes referred to as "the doctors" or "the doctors' group", despite the fact that all are not such).
Mr. Kotowski had been employed for twelve years as a tax auditor with Revenue Canada, before leaving that employment to establish his own business. In the course of establishing this business, in the late 1960s, he was introduced to the plaintiff. At that time he persuaded the plaintiff and some of the other doctors that a legitimate means of reducing the tax payable on their professional income was to take part ownership in certain apartment buildings. The plaintiff’s evidence was that prior to 1973, he had been able to depreciate the buildings against his professional income. Changes in the tax law, in 1973, made it no longer possible to do so and, thus, a replacement for this income tax reducing technique was sought.
In any event, the May 29, 1974 agreement which led to the purchase of the golf course property, was one whereby the doctors' group (through trustees) agreed to take over the pre-existing agreement to purchase, under which Charter York had agreed to purchase the golf course property from Schwartz Schwebel and Dym Limited, the vendors. The May agreement provided that two corporations, Downshire Investments Limited and John Kotowski and Associates Limited, would act as trustees for the doctors' group. Downshire Investments can be thought of as the alter ego of a Mr. DeCarlo. Mr. DeCarlo, through the vehicle of various corporations, was involved in the construction and land development business. (Among his companies, for example, was one which manufactured precast concrete components and another which provided certain engineering expertise.) Kotowski and Associates, as the name implies, was Mr. Kotowski's alter ego. It also should be noted that a portion of Charter York's shares were owned by DeCarlo Engineering, which in turn was wholly owned by Mr. DeCarlo.
The May agreement provided that the trustees, having stepped into Charter York's shoes, would complete the agreement to purchase and acquire title to the golf course property. This they did. The trustees were to act on behalf of the doctors' group described in the May agreement as the owners of the property, and who were described as forming a:
joint venture and not a partnership to the intent that each of the owners shall hold an undivided interest in the lands and in the Agreement of Purchase and Sale as Tenants in Common and as between themselves all profits, if any, and loss, if any, shall be borne by the owners and each of them in the proportions set out opposite their names . . .
The group was obligated to pay a certain maximum amount of money each month from April 1,1975 to December 1, 1977. The April 1,1975 payment was to be $135,000; $33,000 was to be paid each month thereafter from May through November 1975 and $25,000 for each of the months January 1976 to December 1976. The proportionate share of these sums, which each member of the group paid per month, depended on the size of interest which he held. The plaintiff, Dr. Ward, held a nine per cent interest.
The May 29,1974 agreement also provided for financiers: Asellus Investments Limited (another alter ego of Mr. DeCarlo) and Sellhurst Developments Incorporated (another alter ego of Mr. Kotowski). The financiers agreed:
. . . to advance to the Trustees on behalf of the Owners all of the funds required to acquire the lands . . . and to maintain the lands, and without limiting the generality of the foregoing, this shall include . . .
(a) Payment to Charter York of the deposit paid by it. . .; (b) The balance due on the closing of the transaction . . .;
(c) All fees of every nature and description required to be paid in the acquisition and maintenance of the said lands;
(d) All transfer taxes and disbursements required to be paid in the acquisition of the said lands;
(e) All realty taxes, business taxes and insurance premiums required to be in maintaining and holding the said lands;
(f) All wages and salaries required to be paid to any party in maintaining the said lands and any business located thereon;
all of such advances whether made upon acquisition of the lands or subsequent thereto, shall oe secured by the Trustees furnishing unto the Financiers a mortgage on the said lands . . . which mortgage shall bear interest at a rate equivalent to the prime rate charged from time to time by the Bankers for the Trustees, plus seven (7%) percent, and which mortgage shall mature on the 31st day of January 1978; . . . such interest to be payable upon maturity of the mortgage . . .
The monthly payments by the doctors' group were described to be “in partial payments [to the financiers] for the advances made" by the financiers on behalf of the doctors.
It is clear that what was contemplated was that the financiers would accept significant financial responsibility for the "golf course operation" on the expectation that at the end of three years an accounting would take place as between the financiers and the doctors' group. The financiers were, at that time, to acquire a 75 per cent interest in the property (the doctors' group retaining a 25 per cent interest). A preambular paragraph of the May 29,1974 agreement provided:
AND WHEREAS the Financiers, in consideration of their ultimate acquisition of an interest in the said lands, as hereinafter set out, have agreed to advance certain funds on behalf of the Owners for the acquisition of the said lands;
The above mentioned mortgage (including interest) from the trustee to the financiers was to become due and payable on January 31, 1978. And, paragraph 19 of the May agreement provided:
On the 31st day of January, 1978, or such other date as determined by the Auditors (which other date shall not be earlier than seven days prior to the 31st day of January, 1978, or later than seven days after the 31st day of January, 1978)
(a) the sums required to be paid as determined by the statement of the Auditors shall be paid to the party to whom a net balance is owing by way of cash or certified cheque;
(b) the amount required to be paid by the Financiers to the Joint Venture in order to obtain an undivided 75% interest in the lands and such sums shall be paid by the Financiers by way of cash or certified cheque to the Joint Venture;
(c) the Trustees shall furnish a good and proper deed in equal shares to the Financiers or as they may direct of an undivided 75% interest in the lands forming the subject matter of the within transaction; it being acknowledged that the cost of preparing same shall be borne by the Trustees, and the cost of registering same shall be borne by the Financiers;
(d) in making the calculation above noted, any interim profit shall be divided as follows:
|to the Financiers||- 75%|
|to the Joint Venture||- 25%|
In any event, the acquisition by the financiers never occurred. The agreement providing for such was extended to January 31, 1980; the doctors' group agreed to continue advancing $25,000 a month during 1978 and 1979. Before January 31, 1980 arrived foreclosure proceedings had been concluded against the property; Mr. DeCarlo had filed in bankruptcy; the doctors' interest in the property was lost.
One additional factor concerning the May 29, 1974 agreement must be noted. It provided for managers. These were to be Messrs. DeCarlo and Kotowski. It was their responsibility to
. . .operate and maintain the premises upon acquisition thereof without charge, and that all decisions pertaining to the operation and maintenance of the lands shall be at their sole and arbitrary discretion save for any limitations as to sale of the whole or any portion of the lands . . .
. . . carry on such business activity as they may deem fit on the subject lands . . . . . . shall direct the financiers to advance such funds from time to time in accordance with the above noted provisions as to advancement of funds . . .
. . . make such decisions as they may deem fit with regard to any matters arising from time to time pertaining to the use or intended use of the said lands, servicing the said lands . . . demolition of any structures on the said lands, creation of any easement. . . the dedication of any of the said lands for road widenings, parks, or for any other municipal or provincial uses . . .
At the time of the May 29,1974 agreement there were two mortgages on the property. One was from Vaughan Golf and Country Club to the Dominion Life Assurance Company, dated August 25, 1971, for $430,000 (of which $270,000 was, at the time, still outstanding). The second was from Schwartz, Schwebel and Dym Limited to the Vaughan Golf and Country Club for the amount of $5,138,226. This was dated May 23, 1974.
The purchase by the trustees (Downshire Investments Limited and Kotowski and Associates Limited) from Schwartz, Schwebel and Dym was for a price of $7.7 million. This was financed by a down payment of $650,000 and a $6.65 million "wrap around" mortgage as well as a $400,000 mortgage. The $6.65 million mortgage was a "wrap around" of the first and second mortgages and covered an additional sum of $1,241,774, which was advanced as principal at the time. This wrap around mortgage is referred to in the evidence as the third mortgage. A fourth and fifth mortgage were subsequently placed on the property by the trustees. The fourth was to Schwartz, Schwebel and Dym for the sum of $400,000. It "wrapped" the mortgage of the same amount, mentioned above, which had been given by Schwartz, Schwebel and Dym to the Vaughan Golf and Country Club on May 23, 1974. The fifth mortgage was given by the trustees to the financiers (Asellus Investments Limited and Sellhurst Developments Incorporated). It was dated June 31, 1974 but registered on title only on April 27, 1976. It was for the amount of $1 million.
Both doctors who gave evidence (the plaintiff, Dr. Ward, and his colleague Dr. Cook) testified that they paid little attention to what Kotowski was doing. They trusted him. The plaintiff, for example, did not read carefully the agreement of May 29, 1974, before he signed it. Nor did he seek legal advice with respect to it. There was no general meeting of the group to discuss the agreement, its implications, nor what the group’s plans for the property would be. It would appear that Mr. Kotowski dealt with each member of the group, individually. Part of the agreed statement of facts filed by the parties notes that: the plaintiff, Dr. Ward, did not become aware of the first, second, third and fourth mortgages until April 1979; the May 29, 1974 agreement called for the written consent of 51 per cent of the joint venture interests before any sale or mortgage of the property could occur; the plaintiff had no knowledge of any written consent to mortgage the property having been given subsequent to the May 1974 agreement. The plaintiff did not know that one result of the agreement (by virtue of stepping into Charter York's shoes) was that the Vaughan Golf and Country Club had the exclusive right to continue to run the golf club, until at least December 31, 1977 and that the managers, Messrs. DeCarlo and Kotowski, were not directly involved with that operation. Vaughan was to pay an annual rental of $75,000 for a lease of the 18 hole golf course (126 of the 167 acres).
As noted above, Mr. Kotowski was trusted by the doctors (at least by the plaintiff). He had set up the plaintiff's office accounting system and in the early years made out the plaintiff's annual income tax returns. Kotowski sent the doctors an annual statement, with respect to the “golf course operation", setting out the proportionate share each would be expected to pay, monthly, during the year. Dr. Ward sent Kotowski a series of postdated cheques in accordance with this schedule. At the end of the year Kotowski provided the doctors with a statement showing the rental income received from the golf course property, the amount of carrying charges and other expenses that had been incurred during the year, and the proportionate share of the loss, consequent thereon, that each member of the "doctors' group" could claim against his income.
The issues raised by these facts are: (1) the proper treatment, for tax purposes, of the carrying charges (taxes plus interest paid on the mortgage) and other expenses incurred by the venture, vis à vis the doctors' taxable income for the taxation years 1974-1978; (2) the amount of loss which can be claimed by the doctors in 1979 as a result of the foreclosure proceedings.
With respect to the first issue the plaintiff (and presumably each other member of the doctors' group) claimed each year, his proportionate share of the loss which had arisen as a result of the rental income ($75,000) received from Vaughan Golf and Country Club, always being less than expenses incurred with respect to the property. The Minister of National Revenue reassessed the plaintiff so as to prevent the claiming of a loss. The Minister proceeded on the basis that subsection 18(2) of the Income Tax Act applied to limit the amount of expenses which could be claimed. Subsection 18(2) provides that in some circumstances (e.g. where the land is held primarily for development or resale) the amount of carrying charges (mortgage inter- est and taxes) which can be claimed for tax purposes in a year will be limited so that they can not exceed the revenue obtained from the property for that year. The plaintiff argues that subsection 18(2) should not have been applied to limit the expenses he can deduct because the primary purpose of the acquisition was to reduce the doctors' taxable income, not for development or resale purposes. Secondly, if subsection 18(2) is applicable, he argues that subsection 18(3) should also have been applied. Subsection 18(3) exempts from the limitations imposed by subsection 18(2) amounts which relate to lands subjacent or contiguous to buildings or structures on the land. Thirdly, the exact amount of carrying charges which should be taken into account is in dispute. The Minister argues that only those which actually came out of the plaintiff's pocket can be claimed. The plaintiff argues that his proportionate share of the expenses incurred by or on behalf of the group as a whole, which will include amounts paid by the financiers on behalf of the doctor owners should be allowed. Lastly, despite the fact that the plaintiff was reassessed on the basis of subsection 18(2), the Minister now argues that subsection 18(2) does not apply, at all, to the computation of the plaintiff's income for the 1974-1978 taxation years. This, it is argued, proceeds on the ground that the plaintiff's activity was essentially that of an adventure in the nature of a trade, a joint venture; and, the expenditures incurred are to be recognized in the year in which the adventure is completed, that is, in 1979.
With respect to the second issue, the plaintiff claims that the golf course property constituted inventory in terms of subsection 10(1) of the Act; that on disposition of the property section 79 of the Income Tax Act applies; and, that a proper interpretation of this section enables the plaintiff and the other members of the doctors' group to claim as a non-capital loss their respective shares of the $4.5 million ($4,162,000) loss which, it is argued, flows from the application of that section. The plaintiff's share thereof would be $355,913. The defendant argues that the golf course property was not inventory in the hands of the doctors' group. It is argued that it was the trustees who were the owners of the property and it was the trustees who were liable for the various mortgage debts, not the doctors. Consequently, it is argued, the doctors' loss must be assessed only by reference to the amount actually paid out of their own pockets, $1,130,314.30 (the plaintiff's share being $92,728.29). As noted above it is argued that, despite the manner of reassessment for the 1974-78 taxation years, subsection 18(2) does not apply to the computation of the plaintiff's income at all. It is argued that the appropriate method of accounting for each member of the doctors' group is to treat the project as a joint venture with the profit and loss being calculated in the year of completion 1979, and only by reference to the amount paid out of each individual member's pocket.
It is first necessary to set out, in an abbreviated version, subsection 18(2) of the Income Tax Act, R.S.C. 1952, c. 148 as it read at the relevant time:
. . . in computing the taxpayer's income for a taxation year from a business or property, no deduction shall be made in respect of any amount paid... as. . . .
(a) interest on borrowed money used to acquire land. . ., or
(b) property taxes . . .
if. . . the land cannot reasonably be considered to have been in that year,
(c) used in, or held in the course of, carrying on a business by the taxpayer other than a business in the ordinary course of which land is held primarily for the purpose of resale or development . . .
except to the extent that the taxpayers gross revenue, if any, from the land for that year exceeds the aggregate of all other amounts deducted in computing his income from the land for that year.
Thus, if the business activity of the plaintiff taxpayer, with respect to the land, was “a business in the ordinary course of which land is held primarily for the purpose of resale or development . . .” then the carrying charge limitations apply (the interest and tax expenses to be deducted from income cannot exceed the revenue received from the land during the year).
Both counsel agree that the nature of the business in which the doctors' group was engaged must be ascertained by reference to their intention in acquiring the land. Counsel for the plaintiff argues that if a primary purpose did exist with respect to the acquisition it was to acquire a replacement for the apartment buildings which previously had been used by the doctors to reduce their taxable income. He argues, however, that a primary purpose simply did not exist, that intentions were rather fuzzy; that while the doctors may have intended some time down the road to sell the property, or a part of it, at a profit, thoughts were not crystallized at the time of acquisition.
Alternatively, counsel argues that intention is something that must be assessed on a year by year basis. The decisions in Edmund Peachey Limited v. M.N.R.,  C.T.C. 2564; 77 D.T.C. 410 (T.R.B.), and Kensington Land Developments Limited v. The Queen,  C.T.C. 367; 79 D.T.C. 5283 (F.C.A.), are cited for the proposition that a taxpayer's intention can change, thereby changing the basis on which he or she holds property. Counsel argues that prior to 1978 the primary intention in holding the golf course property cannot have been for its resale or development because the applicable zoning regulations at the time prevented such. In December 1977, a proposed plan of subdivision and proposed amendment to the applicable zoning by-law, was filed with the Richmond Hill Municipal Council. In April 1978 these were turned down as "premature" because the existing sewer lines were inadequate to support the proposed change. Counsel argues that whatever may have been the original intention of the plaintiff and the group, that intention changed in September 1977, when the doctors' group met for the purpose of extending the January 31, 1978 deadline (for the purchase of a 75 per cent interest by the financiers). At that time the group discussed the possibility of the golf course operation being run as a "semi-private course with pay-to-play and membership”. Counsel also argues that once the doctors found out about the foreclosure proceedings, whatever may have been their previous intention, it now became merely to salvage what they could. The plaintiff at that point became very active in trying to ascertain where the various funds had gone and why the project had failed.
I cannot accept the desire to reduce one's taxable income as a primary purpose. A desire to reduce one's taxable income immediately, but with the expectation that a profit will arise therefrom at a later date, is entirely consistent with the acquisition of a property for the purpose of development and resale. And, I have no doubt that the intention to obtain a profit, from development and resale, will always take precedence over the desire to reduce one's taxable income. In this case all the documentary evidence points to the fact that the property was being purchased for development and resale and within a fairly short time horizon: three years. Vaughan Golf and Country Club were to continue to operate the golf course under an exclusive lease for three years. When an extension was granted, in 1977, to the financiers, the lease arrangement with Vaughan was extended on a year to year basis. One of the major players in the scheme, as financier, as manager, and trustee, Mr. Decarlo, was involved in the land development and construction business. The May 29, 1974 agreement provided that at the end of the three year period the financiers would acquire a 75 per cent interest in the project. The powers given to the managers under the May 29, 1974 agreement are of a type one might expect to give individuals engaged in land development (e.g. power to dedicate land for parks, roads, etc.). Even if I accept that the plaintiff's personal intention with respect to the use of the property might have been somewhat unfocused I cannot believe that the project was presented to him other than as one for the subdivision and development of the golf course property, with the expectation that such would occur within a reasonably short period of time (three years). The running of the golf course was clearly an interim and secondary concern. That is why there was little concern that a profit was not being made therefrom in the short run. I note that on April 9, 1979 the plaintiff in preparing a note to file concerning a meeting he had had with a Mr. Chung of the Richmond Hill planning office wrote:
my reason for wanting information was to see for myself what was going on with the golf course and what our developers had done.
For the reasons indicated, I do not accept the plaintiff's argument that the intention of the doctors (or the intention of the group as a whole, i.e., the doctors and Messrs. DeCarlo and Kotowski) at the time of the acquisition of the business or at any subsequent date was primarily to reduce their taxable income or to operate a golf course. In my view the property was acquired for the purpose of development and resale and subsection 18(2) was properly applied.
Another argument arises out of the wording of subsection 18(2) as it existed prior to the 1978 amendment to the definition of business in subsection 248(1) of the Act. The subsection provided that the expense limitation would apply to "income . . . from a business or property" if the land could not reasonably be considered to have been “held in the course of, carrying on a business by the taxpayer ...”. The term "business" by definition includes an adventure in the nature of a trade but it is not synonymous with “carrying on a business”. This latter concept requires more than the isolated type of transaction referred to as “an adventure in the nature of a trade.” See Tara Exploration and Development Co. Ltd. v. M.N.R.,  C.T.C. 557; 70 D.T.C. 6370 (Ex. Ct.); affirmed  C.T.C. 328; 72 D.T.C. 6288 (S.C.C.) and Birmount Holdings Limited v. The Queen,  C.T.C. 358; 78 D.T.C. 6254 (F.C.A.). Thus, if the golf course operation "can be characterized as an adventure in the nature of trade" but not the carrying on of a business then, regardless of the purpose for which the land was acquired or being held, the expense limitation would apply. I think a proper interpretation of the "golf course operation” as it has been called is that it was an adventure in the nature of trade and not the "carrying on of a business". Therefore, the limitation imposed by subsection 18(2) would apply for a second reason.
The second aspect of the carrying charges to be considered is the application of paragraph 18(3)(c) [sic]. That subsection provides that the limitation of deductible expenses which is imposed by subsection 18(2) does not apply to buildings or structures on the property, nor to land subjacent or imme- diately contiguous thereto, which last is necessary for the use of the buildings or structures. The purpose of this subsection when read together with subsection 18(2) is to discourage the holding of vacant land for speculative purposes; see Hansen, Krishna and Rendall, Canadian Taxation (1981) at page 238. The sections were enacted to respond to a “housing crisis" which at the date of their enactment, it was thought, was being created by real estate developers and speculators holding large acreages of vacant land. Thus, land used in connection with a building or structure was exempted from the limitation imposed by subsection 18(2). It is common ground between the parties that paragraph 18(3)(c) was not applied in calculating the expenses allowed to the plaintiff and the other members of the group (this may in the ultimate calculation not matter much). It is common ground that the buildings on the property included:
(a) a dwelling house valued in 1974 in an agreement between Vaughan Golf and Country Club and Schwartz Schwebel and Dym at $90,000.00;
(b) a club house valued in 1974 in the above mentioned agreement at $150,000.00; and
(c) a pro shop, office and maintenance shop valued in 1974 in the same above mentioned agreement at $15,000.00.
The Minister has valued the buildings and lands thereunder at $320,000. It is also agreed that there will in addition be a value which should be attributed to the subjacent property as well as that immediately contiguous to those buildings and which amount should be taken into the computation envisaged by subsection 18(3). The representative for the defendant (Mr. Maid- ment) who was examined for discovery indicated that an amount of $40,000 per year had been calculated as attributable to the carrying charges for this area. I would note that both parties assumed that it was only the immediately contiguous area, an area reasonably restrained in size, comprising for example driveways and yards adjacent to the buildings mentioned which fall within subsection 18(3). No argument was made to me that all of the golf course property might have been considered as immediately contiguous to and necessary for the use of, for example, the club house or pro shop. Certainly there was no evidence adduced by the plaintiff to support such a contention. Accordingly, I make no finding as to whether the operating golf course property was in fact the kind of vacant land intended to be covered by subsection 18(2). Rather, I assume that it was not the case and that, as noted above, only land (parking lots, gardens, yards, etc.) in the immediate vicinity of the above mentioned buildings and subjacent thereto fall within the subsection 18(3) exemption. Since the defendant has made no reference to those in its calculation of the tax payable by the plaintiff yet did a calculation of its own that $40,000 per year would be attributable to this purpose (refer: examination for discovery of Mr. Maidment page 67-69) an order will be issued requiring a reassessment to take account of at least this amount and to allow it to be deducted as a business expense in the usual way before applying the expense limitation set out in subsection 18(2).
The third point that must be dealt with is the amount of carrying charges that were paid with respect to the property and the extent to which those which were paid "on behalf of the doctors" by the financiers, might enter into the calculation of the loss which the doctors may claim for tax purposes. It must be noted that, given the fact that section 18(2) applies to limit the carrying charges which are deductible, this determination is somewhat academic. Nevertheless, it does become relevant to the calculation of the adjusted cost base of the property on foreclosure. Therefore, I shall deal with the issue.
I will deal first with the question of how much, as a factual matter, was paid as carrying charges on the property. It is clear that $1,130,314.30 was paid by the members of the doctors' group. There is no dispute about this fact and the defendant accepts it. The defendant, however, argues that that is all that can clearly be shown to have been paid as carrying charges on the property. The doctors' group during the 1974-1978 taxation years claimed that $2,201,876 had been paid (this is the amount they had been given to understand, by Kotowski, had been paid). This sum included the amounts which the doctors had paid out of their own pockets as well as the amounts paid by the financiers (Asellus Investments Limited and Sellhurst Developments Limited) on behalf of the doctors. Each member of the group originally claimed his proportionate share of the $2,201,876 sum, before such losses were limited by the department's application of subsection 18(2). The evidence at trial proved that at least $2,528,069.24 had been paid as carrying charges. The defendant disputes both the $2,201,876 sum and the $2,528,069.24 amount. The defendant argues that the evidence respecting the determination of those amounts is based on hearsay and on unreliable evidence. Nevertheless, the evidence of Mr. MacDonald and Mr. de Pellegin establishes to my satisfaction that the amount of $2,528,069.24 was paid as carrying charges. As noted above, this did not all come out of the doctors' pocket. Indeed it is clear that it was not intended to do so. The doctors were buying themselves into a loss situation for a few years with the expectation that they would eventually make a profit from the development and resale of the property. While the May 1974 agreement contemplated that profits (see paragraph 19 of that agreement set out above) would be shared 75 per cent to the financiers and 25 per cent to the doctors' group, such an arrangement was not made with respect to expenses. The agreement provided that the financiers would make such outlays on behalf of the doctors and this they did although the record keeping was poor and the intercompany transfers at times somewhat convoluted. I think it has been proven that an amount of $2,528,069.24 was paid as carrying charges for the property.
It is clear that the joint venture, in a global sense encompassed not only the doctors' group but also Messrs. Kotowski and DeCarlo (in both their personal capacity and through their various corporate incarnations). The doctors' group, as such, while referred to in the evidence as “the joint venture" was really a subset of the joint venture proper. It is clear that the joint venture proper was structured so as to enable the doctors' group to take advantage of the losses which would be incurred in the early years of the development, while allowing for full participation of all members, in accordance with what it was assumed would be their proportionate share of the venture, once profits were available.
This raises the second aspect of this issue: was it appropriate for the doctors, as members of a joint venture, to claim as expenses incurred by the joint venture, amounts in excess of what they actually paid out of their pockets. The defendant argues that it was not, that each should be restricted in the amount which can be claimed to that actually paid by each: the "at risk” principle. But there was no provision in the Income Tax Act at the relevant time which so provided. (Refer: subsections 96(2.1)-(2.7) of the Act relating to limited partnerships, which were added to the Act in 1986.) See also: Watkins, The Demise of the "Equity Interest" Rule? (1984), 1 Can. Current Tax.
In The Queen v. Gelber,  C.T.C. 381; 83 D.T.C. 5385 (F.C.A), Mr. Justice LeDain said with respect to capital cost allowance which might be claimed by a taxpayer:
The degree to which an investment is at risk is not, in the absence of a provision in the Act or the regulations to that effect, a valid criterion as to what is capital cost.
And in the United Kingdom case Reed (H.M.I.T.) v. Young,  B.T.C. 242 (H.L.), it was held that a limited partner was entitled to claim as losses for tax purposes amounts in excess of her liability obligations under the partnership agreement. (It was this case which led to the 1986 additions to section 96 of the Canadian Income Tax Act; subsections 96(2.1) to (2.7) were added by S.C. 1986, c. 55, s. 25(1), applicable after February 25, 1986.)
In this case it is the income and expenses of a joint venture which are in issue, not those of a limited partnership. Nevertheless, there is, in some circumstances, a similarity in the manner in which tax liabilities is calculated. I note that in Grover and lacobucci’s text, Materials on Canadian Income Tax, at page 904, it is said:
Joint adventures appear to be almost indistinguishable from partnerships. A rather tenuous and questionable distinction may be suggested in that a partnership does not necessarily require a partner to contribute labour or capital whereas a joint venture by its very nature suggests a party has ventured something.
In this case the doctors submitted tax returns during the 1974-78 years in a manner similar to those which would pertain in a partnership situation. The department reassessed on that basis.
The agreement between the joint venturers (i.e. the members of what I have called the joint venture proper) was clearly designed to allow the doctors' group to take the benefit of the losses which it was anticipated would arise in the early years of the development project. (The tax consequences for the doctors disposition by them of a 75 per cent interest to the financiers is a matter which seems not to have been addressed.) During the 1974-1978 taxation years, the trustees, financiers and managers acted in accordance with the agreement; the accounting they provided to the doctors flowed the losses of the joint venture through to the members of that group. The Department taxed the members of the group on that basis. I have been referred to no authority which indicates that this was not allowed under the Income Tax Act at the time. It accords with what I understand to have been the rules applicable to partnerships. And, as noted above, the department during the 1974-1978 taxation years treated this method of dealing with the joint venture proceeds as appropriate.
That leaves for consideration the fourth argument with respect to the carrying charges. The defendant argues (refer paragraph 18 of the statement of defence) that the golf course operation should be characterized as "an adventure in the nature of a trade” and that once that is done, then, generally accepted accounting principles should be applied to require the plaintiff to deduct all expenses incurred with respect to the venture as expenses for the year in which the property was disposed of ("the year in which the adventure was completed") — in this case 1979. I understood this argument to be based on the evidence of Mr. Batch who testified that in the case of joint ventures the recommended method of accounting was of this nature. Reference was also made to the decision of this Court in Tobias v. The Queen,  C.T.C. 113; 78 D.T.C. 6028.
I have some difficulty with this argument. In the first place the Department reassessed the plaintiff for the 1974-1978 years on the basis that business income was being earned during those years and the losses associated therewith were claimable to the extent that they did not exceed such income. Secondly, as I understood both Mr. Batch and Mr. MacDonald's evidence it was that the applicability of the generally accepted accounting principles referred to by the defendant, depends upon whether or not the joint venture is of a long term or short term nature. If there is some degree of certainty that the joint venture will be completed within a short time frame then accounting for all expenses in the year the venture is completed is appropriate. Also the appropriateness of this accounting method depends upon whether or not revenues are earned by the venture in the short term. If they are not then the method which the department seeks to apply may be appropriate. In any event, it seems to me that in this case the argument that expenses should be accounted for only in the year of disposition of the property ignores the fact that there was no guaranteed short term conclusion to the venture and that there were annual revenues from the property being received. Thus accounting for the expenses in the year in which they occurred is in my view appropriate.
The conclusion arising from the above is that subsection 18(2) was properly applied to limit the expenses attributed to carrying charges which the plaintiff could deduct from his taxable income during the years 1974-1978, except that subsection 18(3) was not applied to exempt from that limitation an amount attributable to the buildings thereon and to the lands subjacent and contiguous thereto. The reassessment will be referred back to the Minister for reassessment on that basis.
That leaves tor consideration the more difficult question of what disposition should be made with respect to the losses which were incurred by the joint venture as a result of the collapse of the project in 1979.
Section 79 - Proceeds of Disposition on Foreclosure
As noted above, the second mortgage on the property fell into arrears. Vaughan Golf and Country Club commenced foreclosure proceedings in October 1978. The doctors first learned of these proceedings in April of 1979; they (particularly the plaintiff) took numerous steps to try to forestall the foreclosure, to find alternate buyers and to salvage the situation. These were to no avail; the foreclosure was concluded and the Vaughan Golf and Country Club repossessed the property.
The plaintiff argues that section 79 of the Income Tax Act applies to determine the amount of the loss suffered by him in 1979 as a result of the foreclosure. During the relevant period, section 79 read as follows:
Mortgage Foreclosures and Conditional Sales Repossessions
79. Where, at any time in a taxation year, a taxpayer who
(a) was a mortgagee or other creditor of another person who had previously acquired property, or
(b) had previously sold property to another person under a conditional sales agreement,
has acquired or reacquired the beneficial ownership of the property in consequence of the other person's failure to pay all or any part of an amount (in this section referred to as the "taxpayer's claim”) owing by him to the taxpayer, the following rules apply:
(c) there shall be included, in computing the other person's proceeds of disposition of the property, the principal amount of the taxpayer's claim plus all amounts each of which is the principal amount of any debt that had been owing by the other person, to the extent that it has been extinguished by virtue of the acquisition or reacquisition, as the case may be;
(d) any amount paid by the other person after the acquisition or reacquisition, as the case may be, as, on account of or in satisfaction of the taxpayer's claim shall be deemed to be a loss of that person, for his taxation year in which payment of that amount was made, from the disposition of the property;
(e) in computing the income of the taxpayer for the year,
(i) the amount, if any, claimed by him under subparagraph 40(1)(a)(iii) in computing his gain for the immediately preceding taxation year from the disposition of the property and
(ii) the amount, if any, deducted under
paragraph 20(1)(n) in computing the income of the taxpayer for the immediately preceding year in respect of the property,
shall be deemed to be nil;
(f) the taxpayer shall be deemed to have acquired or reacquired, as the case may be, the property at the amount, if any, by which the principal amount of the taxpayer's claim exceeds the amount described in subparagraph (e)(i) or(ii), as the case may be, in respect of the property;
(g) the adjusted cost base to the taxpayer of the taxpayer's claim shall be deemed to be nil; and
(h) in computing the taxpayer's income for the year or a subsequent year, no amount is deductible in respect of the taxpayer's claim by virtue of paragraph 20(1)(1) or (p).
The plaintiff argues that he and the other members of the doctors' group are "other persons" (i.e. the debtors) within the meaning of section 79. That the carrying charges, disallowed by the Minister for the taxation years 1974-1978 (as being in excess of the rental revenue received from the property during those years) should be added to the adjusted cost base on the property, in accordance with sections 53(1)(f) and 79. The plaintiff, therefore, calculates the loss which occurred as being:
(a) original cost $7,778,661 (b) carrying charges and expenses 2,024,287 (c) adjusted cost base 9,802,118 (d) proceeds of disposition 5,640,192 (e) non-capital loss $4,162,000
The plaintiff's share (nine per cent) of this is claimed by him as a non-capital loss for the 1979 taxation year i.e.: $355,913. It should be noted that the $5,640,192 proceeds of disposition is calculated on the basis that the debts extinguished by the foreclosure were the principal amounts outstanding on the first and second mortgages, $270,000 and $5,130,000 respectively, making a total of $5,640,192.
The defendant's argument is simple; the doctor owners were not the persons who owed the mortgage money to Vaughan; they were not on title as mortgagors. It was the trustees (Downshire Investments and Kotowski and Associates) who were the mortgagors. It was the trustees who were the owners of the property. It was the trustees who held the property as inventory. Therefore, the property cannot be considered to be inventory in the hands of the doctors and the loss which occurred to them can be no greater than their out of pocket expenses minus revenue received. This the defendant calculates as $1,130,314.30 which the doctors paid out of their own pockets minus the $100,000 which the doctors received as settlement.
The plaintiff's response to this argument is that if the doctors are not the "other persons" described in section 79 then the amount of the loss which they can claim is the whole $7.7 million or $9.9 million (depending on the treatment of the carrying charges).
I will start first with section 79. That section is what I will call a calculation section only. It makes no reference to who is or is not the taxpayer. It refers only to the debtor in a foreclosure transaction vis à vis the creditor mortgagee. In the case at bar the trustees were the debtors, but they were not the taxpayers; they had never been treated as such by the Minister; they never acted as such. The trustees were a mere conduit, acting on behalf of the beneficiaries of the trust: the doctors' group. Section 79, then, provides the rules which govern the calculation of the proceeds of disposition. This is to be calculated by reference to the original cost less the debt extinguished by the foreclosure. It is clear that this is the original cost of $7,778,661 minus the amounts extinguished by the foreclosure ($5,640,192) for a sum of $2,138,469. I think it is clear that the only debts extinguished by the foreclosure are the first and second mortgagees. Whatever may be the status of the subsequent mortgages, counsel for the plaintiffs invites me not to speculate thereon. Indeed, I do not need to do so. It is fairly trite law that the debt on the covenants with respect to those mortgages could not be extinguished by the foreclosure. As to who is liable on those covenants it is not an issue I need to decide.
In addition, while I have referred above to the proceeds of disposition being $2,138,469 there would of course have to be added to that amount the expenses which were disallowed as a result of the application of subsection 18(2). Subsection 53(1) of the Act provides:
In computing the adjusted cost base to a taxpayer of property at any time, there shall be added to the cost to him of the property such of the following amounts in respect of the property as are applicable: ... .
(h) where the property is land of the taxpayer, any amount paid by him after 1971 and before that time pursuant to a legal obligation to pay
(i) interest on borrowed money used to acquire the land, or on an amount payable by him for the land, or
(ii) property taxes (not including income or profits taxes or taxes imposed by reference to the transfer of property) paid by him in respect of the property to a province or to a Canadian municipality
to the extent that that amount was, by virtue of subsection 18(2), not deductible in computing his income from the land or from a business for any taxation year commencing before that time;
Having calculated the proceeds of disposition it is then necessary to turn to the charging sections of the statute. I would indicate that I accept that the doctors were the "owners" of the property. They were described as such in the May 29 agreement; they were treated as such by the financiers, managers and trustees; the planned acquisition of a three-quarter ownership interest by Asellus Investments Limited and Sellhurst Developments Incorporated never materialized. As noted above the trustees were a mere conduit vis a vis the doctors.
Turning then to sections 9 and 10 of the Act:
9 (1) ... a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.
(2) Subject to section 31, a taxpayer's loss for a taxation year from a business or property is the amount of his loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source mutatis mutandis.
10(1) For the purpose of computing income from a business, the property described in an inventory shall be valued at its cost to the taxpayer or its fair market value, whichever is lower. . .
The defendant argues that under the May 29, 1974 agreement the cost to the doctors was the amounts set out in schedule C to that agreement. These were the amounts they were bound to pay. While the purchase price under the mortgage was $7.7 million, and the doctors were to be the owners, it is argued that they were not obligated to pay the full purchase price. Under the terms of the agreement the financiers were to pay the amounts in excess of those set out in schedule C. The defendant argues that while these were expressed in the agreement as being made "on behalf of the doctors", they were not in fact such. It is argued that they should be seen as credit towards an acquisition which never in fact occurred. It is argued that the only cost to the doctors was the cost they paid out of their own pockets, that the only loss to them was this amount.
I find the Minister’s position in this case somewhat inconsistent. He reassessed the plaintiff during the 1974-1978 years on the basis that the joint venture was earning certain revenues and incurring certain expenses. The net result (loss) was divided among the doctors' group on the basis of their percentage share in the venture (albeit limited by subsection 18(2)). Yet in 1979 when the property was lost and foreclosure occurred, the Department changed the focus of its assessment. Instead of computing that assessment on the basis of the loss which occurred to the venture and dividing it among the members of the group, it focused on the cash outlay made by each individual doctor.
The plaintiff is right when he asserts that had the property been sold in 1979 at a profit, as a result of the doctors' efforts of that year, the doctors would have been fully taxed on the profit. The defendant's response to this assertion is that had there been a profit, others besides the doctors (i.e. Kotowski and DeCarlo) would have been asserting a right to share in that profit. Be that as it may, that did not happen. The acquisition by the financiers never occurred. The financiers' rights never crystallized. And, no argument is made respecting a deemed proportionate share of the loss that should be attributed to the financiers.
The circumstances in this case are unique and unusual. But it seems to me clear that under the May 1974 agreement the property was held by the trustees on behalf of the owners; the doctors were the owners. Whatever may have been the arrangement as between the doctors and the financiers, inter se, when the mortgages were foreclosed and the doctors were not able to find the funds to pay off those mortgages, they lost the property. Thus, in my view, the plaintiff is entitled to claim his respective share of the noncapital loss, which occurred as a result of the disposition of the property, calculated in accordance with subsections 9(2), 10(1) and section 79 of the Income Tax Act.
The assessment of taxes owing by the plaintiff for the 1974-78 years and for the 1979 taxation year will be referred back to the Minister for reassessment in accordance with these reasons.
Appeal allowed in part.