The Queen v. John Woods, 77 DTC 5411, [1977] CTC 597 (FCTD)

Grant, DJ:—This is an appeal by the plaintiff from the judgment of the Tax Review Board dated June 4, 1976 whereby that Board allowed the defendant Woods’ appeal from the assessment of his income tax returns for the years 1969, 1970 and 1971 by the Minister of National Revenue and referred such assessments back to such Minister for reassessment.

The defendant Woods had been employed as a salesman of new and used automobiles in the City of Hamilton from the year 1957. In 1965 he entered into a verbal arrangement with one Paul Warbeck who was then the owner of all issued shares in a company named Midtown Rambler (Hamilton) Limited (hereinafter called “Midtown”) which carried on a garage business including sale of motor vehicles. The agreement between such parties was that Woods was to be sales manager at a salary of $250 a week with the privilege of buying shares in the company. Woods, with Warbeck, gave guarantees to the Bank of Nova Scotia for advances to Midtown. Woods also executed a bond to the Industrial Acceptance Corporation Ltd on October 12, 1965 whereby he guaranteed to such company payment of all loans which such company had then or might thereafter make to Midtown.

About July of 1967 Woods became aware that Midtown was in serious financial difficulties and that he was liable on the guarantees which he had given on behalf of such company in a substantial amount. He attempted to cancel the bond given to Industrial Acceptance to avoid further liability thereon but found he could not do so until he had given 30 days’ notice of withdrawal to such company. He then left his employment with Midtown on August 1 of that year but later concluded that his best chance of extricating himself from such financial problems was to take over Midtown and carry on the business himself. The executives of American Motors, the suppliers of the Rambler motor vehicle, were willing to continue Midtown as one of its distributors of such automobile in the Hamilton area if Woods should take over such company.

Woods thereupon entered into an agreement with Warbeck which is dated September 1, 1967 and provided:

(a) The only three outstanding shares of Midtown held by Warbeck should be assigned to Woods for a consideration of $3.

(b) Woods was to collect for the credit of Warbeck all accounts receivable owing to Midtown in the approximate sum of $8,482.38 and from the proceeds thereof to pay Midtown’s indebtedness to the Bank of Nova Scotia in the sum of $3,100 and to indemnify Warbeck from any further claims or demands from such bank and to provide him with a release from Industrial Acceptance Corporation.

(c) Warbeck was to be allowed salary to August 31, 1967 and he was to pay General Acceptance Corporation the balance of $4,509.02 owing to such company by Midtown and to indemnify Midtown and Woods of and from any claim or demands of General Acceptance Corporation.

(d) Warbeck agreed to sell to Woods a shareholder’s loan made by him to Midtown on which there was owing to Warbeck the sum of $13,021 and for which Midtown’s accounts receivable had been assigned to him as collateral security therefor. Warbeck further agreed to assign such accounts receivable to Woods.

(e) Warbeck admitted on cross-examination that he had paid nothing for the shareholder’s loan. It was submitted by counsel for him that he gave consideration therefor by assumption of the debts of the company but these were to be paid from the proceeds of the accounts receivable. The liability to Industrial Acceptance Corporation was only of a contingent nature. Such shareholder’s loan was valueless at the time because Midtown was then bankrupt and all accounts receivable were needed to pay creditors.

Woods carried out all terms of the agreement. The Rambler automobile agency was continued with Midtown under Woods’ management. Further audit revealed that Warbeck’s indebtedness to the company was greater than had been anticipated. This resulted in no payment being made to him from the proceeds of the accounts receivable. Woods took over ownership and control of Midtown on September 1, 1967 and operated such business successfully and profitably in the years thereafter until the present time. On such last-mentioned date he advanced to Midtown, from his own funds, the sum of $4,200.

Woods’ reason for taking over Midtown may have been to extricate himself from paying the debts of such company for which he had become liable by reason of his guarantee thereof. Such acquisition Was a Capital transaction. It involved the continuation of this established business operated by Midtown. The money earned thereby was income from a business. The fact that Woods has carried it on profitably to the present time is some indication that his intention at the time of acquisition was to carry on this established business as a trading venture. The purchase of the shareholder’s loan from Warbeck was incidental to its operation, rather than to the acquisition of such company. It was not part of the business but rather an asset belonging to Warbeck. It cost Woods nothing and at the time was of no value. The taxpayer submits that his attainment of such loan was an investment by him in the company but the fact that he withdrew moneys as soon as profits were available is some proof he did not regard it as such on September 1, 1967.

If Warbeck had paid himself any portion of such loan out of the company’s funds prior to conveying it to Woods, such amount would have been considered as a return of moneys loaned and he would have received it free of income tax. It does not follow that Woods acquired the right to so treat the moneys taken by him from the company as he paid out no money in securing it. (See MNR v Sissons, [1969] CTC 184 at 187; 69 DTC 5152 at 5154.)

During the years 1968 to 1971, the defendant caused Midtown to pay him the following amounts:

Such amounts were earned in the business as a result of Woods’ sales ability and efforts. This is an indication that such earnings were not repayment of capital but rather profit from the business. (See MNR v Sissons, supra, at page 187 [5154].)

The defendant did not include any such amounts in his income tax returns for such years. In assessing such returns the Minister of National Revenue deducted from such amount the sum of $4,200 that the defendant had advanced to Midtown but assessed the balance thereof as income for the year in which it was received by such taxpayer. This resulted in the Minister adding to the defendant’s declared income for the years 1969, 1970 and 1971 the following amounts, namely:

For the 1969 taxation year—$7,568.98

For the 1970 taxation year—$1,151.45

For the 1971 taxation year—$ 180.59

The defendant objected to such assessment but on reconsideration the Minister confirmed the same. The defendant then appealed from the assessment to the Tax Review Board and by judgment dated June 4, 1976 the Tax Review Board allowed the appeal and referred the assessments back to the Minister for reassessment on the basis that such amounts should not be taxed as income.

The Income Tax Act, RSC 1952, provides as follows:

3. The income of a taxpayer for a taxation year for the purposes of this Part is his income for the year from all sources inside or outside Canada, and, without restricting the generality of the foregoing, includes income for the year from all

(a) businesses,

(b) property, and

(c) offices and employments.

4. Subject to the other provisions of this Part, income for a taxation year from a business or property is the profit therefrom for the year.

139. (1) In this Act.

(e) “business” includes a profession, calling, trade, manufacture or undertaking of any kind whatsoever and includes an adventure or concern in the nature of trade but does not include an office or employment;

The loan could have been cancelled by Warbeck rather than assigning the same to Woods. The latter says he gave no thought at the time of acquisition thereof as to whether he could later take payment from Midtown profits and avoid paying income tax thereon by charging such payments against such loan. I have hesitation in accepting such testimony. He is a very shrewd businessman who has proved himself capable of making Midtown sales agency a profitable business. In November of 1968 he purchased another Rambler agency in Hamilton operated by a company named John Hunter Motors Limited. In that case he was not obligated by guarantees of the Hunter company as he was in Midtown but he again took an assignment of a shareholder’s loan although it was worthless at the time because of the insolvency of that company. He later attempted to charge withdrawals of profits from that company to himself against such loan to avoid payment of income tax thereon.

I am convinced that he took over the shareholder’s loan in the Midtown acquisition with the conviction that he could make a success of such business and that it would provide profits from which such shareholder’s loan could be paid to him. He was further of the opinion that such payments to himself could be made free from income tax. This opinion is supported by his failure to report such payments in the following year, 1969, and the three subsequent years and by following a similar procedure in the Hunter transaction.

The source of funds which Woods withdrew in these three years was profits in the operation of Midtown. He seeks to avoid taxation thereof by allocating them as repayment on the shareholder’s loan. But except as to the $4,200 which he had put into the business, no element of repayment was involved because there had been no such outlay by him.

It was urged for the taxpayer that the securing of the shareholder’s loan was an investment by him.

I am convinced from all the surrounding circumstances which led to Woods’ acquisition of such loan that he did not regard it as an investment at the time. I find on all the evidence that he intended it should be and it was in fact part and parcel of a profit-making scheme in the operation of the business which he took over and thereafter operated.

The facts in this case are very similar to those in S S Steeves v Her Majesty the Queen, [1977] CTC 325; 77 DTC 5230, and MNR v Sissons (Supra).

I find, therefore, that the amounts included by the Minister in the taxpayer’s income tax returns for the years in question were properly included. The appeal is therefore allowed and the judgment of the Tax Review Board is set aside and the assessment by the Minister is affirmed.

As promised at the close of argument, counsel will now have an opportunity of making their submissions as to costs in writing.