Gestion Louis Riel Inc. v. MNR, 85 DTC 550, [1985] 2 CTC 2211 (TCC)

St-Onge, TCJ [Translation]:—The appeal of Gestion Louis Riel Inc was heard on December 14, 1983 at the city of Québec, Québec, and the issue was whether the appellant could claim a deduction in respect of bad debts during its 1977 and 1978 taxation years.

The facts of this appeal are stated in the amended notice of appeal at paragraphs 1 to 13 inclusive, which read as follows:

Statement of Facts

1. The appellant, Gestion Louis Riel Inc, is a company whose shareholders at the time were Messrs Demontigny, Dion, Métivier and Gagnon.

2. Messrs DeMontigny, Dion, Métivier and Gagnon formed an architectural partnership at the time and provided their professional services under the name De- Montigny, Dion, Métivier, Gagnon et Associés.

3. The appellant was formed to render services to the architectural firm of De- Montigny, Dion, Métivier and Gagnon in addition to renting premises to them.

4. As business had fallen off, these architects wanted to create work for themselves in order to collect professional fees and accordingly embarked on a project to build condominiums for sale with a building contractor, Mr Jean-Marie Meunier, through the company Le Groupe Sigma Inc.

5. Le Groupe Sigma Inc was incorporated to carry out this single project, obtain income therefrom and minimize liability.

6. The appellant initially held 33/, per cent of the share capital of Le Groupe Sigma Inc, and then 50 per cent in 1978, or six common shares issued for a consideration of $1.00 each.

7. In December 1976 the appellant had to lend Le Groupe Sigma Inc the sum of $75,000.00 to enable it to cover the losses incurred to that date.

8. Le Groupe Sigma Inc was unable to finance this loan of $75,000.00 with financial institutions unless it was secured by the appellant.

9. This advance was made to Le Groupe Sigma Inc to carry out major repairs in connection with construction defects and thereby enable the company to continue in business, sell its condominiums, institute proceedings for defects in soundproofing in the amount of $270,000.00 against engineers and so make profits on the project.

10. The appellant has to date received only $14,651.00 in repayment of this loan from Le Groupe Sigma Inc.

11. At the time when the appellant made this loan, Le Groupe Sigma Inc was already in financial difficulties, having a deficit of $74,144.00 at July 30, 1976 and $142,474.00 at July 31, 1977, as appears from its financial statements.

12. For the taxation year ending June 30, 1977, the appellant analysed the financial position of Le Groupe Sigma Inc, determined with full knowledge of the facts that its loan of $75,000.00 was at risk and was becoming at least 50 per cent uncollectable, and therefore claimed a business loss of $37,500.00.

13. For the taxation year ending June 30, 1978, by which time Le Groupe Sigma Inc had ceased operations except for the action pending against the engineers, the appellant claimed a business loss of $22,849.00 since it had received $14,651.00 during 1978.

The appellant proved all these paragraphs except that paragraphs 9 and 13 should read that the suit for recovery was brought by the firm of architects and not by the appellant.

Put briefly, the positions of the parties are as follows: the appellant contends that this is a business loss spread over two years while the respondent maintains that it is a loss of a capital nature falling in 1982.

Mr Austin Métivier, an architect of the firm of DeMontigny, Dion, Métivier and Gagnon and a shareholder in and secretary of the appellant company, was the only witness heard, he filed documentary evidence to prove the allegations of the amended notice of appeal and also provided the following amplifications.

1. The appellant company and Le Groupe Sigma Inc were incorporated to build and sell the units of a condominium (as confirmed by the letters patent).

2. To carry out this project worth $1,081,600, the appellant borrowed the following amounts:

(a) $605,824 from La Mutuelle-Vie des Fonctionnaires du Québec and the Co-operators Life Insurance Company;

(b) $100,000 from the Provincial Bank of Canada; and

(c) the remainder pursuant to four letters of agreement for additional

loans and the sale of one unit to make up the total cost of the project.

3. Mr Austin Métivier was the architect for the project, and the members of his firm were all shareholders in the appellant company.

4. The firm of architects had in the past prepared plans for similar projects.

5. When the appellant company had sold 15 units, acoustic difficulties arose with respect to the party walls, even though Mr Métivier had retained the services of an acoustics expert.

6. To effect the necessary repairs and enable Le Groupe Sigma Inc to carry on its operations when its financial resources were exhausted, the appellant lent it the sum of $75,000 interest free.

7. The appellant had to sell the building in which the firm of architects had its offices in order to repay this $75,000 borrowed from Mr Fillion.

8. In 1977 the appellant claimed 50 per cent of the loss, or $37,500, and in 1978 claimed a further $22,849, representing the other half less $4,651 that the appellant had succeeded in obtaining from two co-owners of the units.

9. The firm of architects sued the firm of Mr Lortie for the sum of $269,000, and during April 1982 their action was dismissed.

10. In 1979 the firm of architects ceased to be a shareholder in Le Groupe Sigma Inc; it transferred its shares to Mr Meunier together with the lands which were the appellant company's sole asset for no financial consideration. In fact, the lands were mortgaged to Mr Meunier as the balance of the selling price.

Counsel for the appellant argued that this was a business loss of $60,000, because the project to build and sell condominium units was for both parties, the appellant and Le Groupe Sigma Inc, an adventure in the nature of trade. The loan could in no way be regarded as an investment since Le Groupe Sigma Inc was in a very bad financial position when the loan was made by the appellant.

The appellant deemed in 1977 that at least 50 per cent of the debt had become bad, and in the following year, it came to the same conclusion about the balance less some $14,000 that it had succeeded in recovering from two co-owners of the units.

Counsel for the appellant referred the Court inter alia to MNR v Henry J Freud, [1968] CTC 438; 68 DTC 5279, and Margaret Ann Frappier v The Queen, [1976] CTC 85; 76 DTC 6066, as authority for saying that this was an outlay of a business nature.

Counsel for the respondent also referred the Court to Freud (supra), as a basis for his argument that the appellant was not in the business of lending money, and that accordingly the loan that it made was an investment.

He further referred the Court inter alia to the following cases:

1. Stewart & Morrison Limited v MNR, [1972] CTC 73; 72 DTC 6049;

2. The Queen v Terrence T Malone, [1982] CTC 145; 82 DTC 6130; and

3. Steven Michael Overgaard v MNR, [1982] CTC 2351; 82 DTC 1278;

to support his argument that the loan made by the appellant represented working capital, and that the loss was thus of a capital nature.

He further maintained that an outlay made to protect the reputation of architects was a loss of a capital nature, and that such a loss could only be claimed in 1982, because not until April 1982 did the appellant know the outcome of the suit brought against the firm of Mr Lortie.

To decide this case, the Court must examine the evidence as a whole and analyse the many rules that have been used in the past to resolve such issues.

To say that the appellant was not in the business of lending money or that the outlay was made to protect the reputation of a firm of architects is not in itself sufficient to conclude that the loss incurred was of a capital nature.

The whole of the evidence indicates that Le Groupe Sigma Inc and the appellant company wished to build a condominium of 30 units and to sell the said units at a profit. The appellant made no investment in Le Groupe Sigma Inc; it held only six shares valued at $1 each.

The appellant did not even have the necessary funds to help Le Groupe Sigma Inc to solve the acoustic problems and avoid bankruptcy and so enable the company to complete the condominium and sell the units at a profit; it had itself to borrow the money and eventually sell its building to repay the lender.

Such behaviour is not the conduct of a taxpayer wishing to make a longterm investment, but rather of a taxpayer wishing to save the situation when he is involved in an adventure in the nature of trade and helps his partner out of a predicament so that they may jointly succeed in such an adventure.

It is for the taxpayer to establish whether and when a debt has become bad. The creditor, after considering all the factors relating to the debt, must decide whether it is collectable, regardless of whether it may subsequently be recovered.

It was argued by counsel for the respondent that the loss was of a capital nature, and that it could only be claimed in 1982, when the outcome of the action for recovery was known. The Court cannot accept this argument because the said action was not brought by the appellant but rather by the architects personally.

How can such an action help the appellant to determine the date of its loss of whatever nature when the action was not brought by the person claiming the loss?

In the circumstances, the Court prefers to rely on the rule stated in Freud (supra) and Margaret Ann Frappier (supra) as a basis for holding that an adventure in the nature of trade is involved here, and that the appellant clearly and reasonably determined when the debt became uncollectable.

This passage from Freud (supra) at 443 (DTC 5282) is applicable to the instant case, and I quote:

It is, of course, obvious that a loan made by a person who is not in the business of lending money is ordinarily to be considered as an investment. It is only under quite exceptional or unusual circumstances that such an operation should be considered as a speculation. however, the circumstances of the present case are quite unusual and exceptional. It is an undeniable fact that, at the outset, the operation embarked upon was an adventure in the nature of trade. It is equally clear that the character of the venture itself remained the same until it ended up in a total loss. Under those circumstances, the outlay made by respondent in the last year, when the speculative nature of the undertaking was even more marked than at the outset due to financial difficulties, cannot be considered as an investment.

In view of the unusual and exceptional circumstances of the transaction involved in the appeal, the Court decides that it is much more an adventure in the nature of trade than an investment.

The appeal is therefore allowed.

Appeal allowed.