Dubé, J.:—This appeal is from the reassessment of the plaintiff's 1981, 1982 and 1983 taxation years. The appeal was heard at the same time as the companion action of Harold Freeman (1-2403-87) and the same reasons for judgment will apply mutatis mutandis to both cases.
At the outset of the hearing, the parties filed a joint agreed statement of facts and definition of issues in each case. No witnesses were called. The facts are somewhat complex but the basic issue is whether or not the losses sustained by the plaintiff in each case constitute a non-capital loss as claimed by the plaintiff, or a capital loss as assessed by the Minister of National Revenue.
For the purposes of this judgment the essential facts may be reduced as follows. Both plaintiffs, “ Easton" and “Freeman”, are lawyers who are also involved in several businesses, at times jointly and at other times separately, including the promotion of a pulp mill, the establishment of marinas, the development of residential properties, the operations of a chain of short order restaurants, and other activities.
In early 1975, both plaintiffs conceived the idea to develop certain property located at Secret Cove, B.C. Their joint intention was to acquire lands adjacent to the Secret Cove Marina, already established by them to subdivide the land, develop and ready it for construction and to build houses thereon. On June 4, 1975, both men obtained an option to purchase a lot for the price of $150,000 which they exercised in June 1976. The title to the property was transferred jointly to their names. They deposited the certificate of title in escrow upon the approval of the subdivision plan. The funds for the purchase of the property were provided by Freeman and Easton and borrowed by them in part from the Bank of Nova Scotia and the Toronto-Dominion Bank.
On June 17, 1976, both men entered into an agreement with one Aaron Kagna and his wife Toby Kagna ("the Kagnas") whereby they provided the Kagnas an undivided one-third interest in the property. Easton was already the sole shareholder, officer and director of the British Columbia Corporation, incorporated in 1972, named Rayfield Holdings Ltd. ("Rayfield") which at that time had no assets or function save as a holding company for Easton. On June 23, 1976, Easton entered into an agreement for the sale and transfer by him to Rayfield of his one-third interest in the property for the price of $50,000 payable; $6,000 cash and the balance by Rayfield's assumption of the plaintiff's liability to the vendors of the property arising from the exercise of the option.
On June 23, 1976, Freeman entered into a similar agreement with Fairlyn Holdings Ltd. ("Fairlyn") with respect to his undivided one-third interest in the property. The Kagnas, at the same time, entered into a similar agreement with Bairdmore Enterprises Ltd. ("Bairdmore"). The next day a joint venture agreement was entered into between Fairlyn, Rayfield and Bairdmore ("the corporate co-venturers") so as to set out the responsibility of the parties, the obtaining of a land use contract from the local authorities, the development of the land, and the construction of dwellings under the name Secret Cove Developments (the “ joint venture"). On September 29, 1977, the property was subdivided and the land use contract was granted providing for 29 residences to be constructed.
To finance the development and construction costs of the joint venture, each of the co-venturers, Freeman, Easton and the Kagnas, contributed $46,696 in the Secret Cove Development venture through their respective companies. Further financing was obtained by the corporate co-venturers. Together they ultimately borrowed approximately $4,100,000 from the Bank of Montreal (the "bank"). Thereupon the bank required debenture security for the moneys advanced and to be advanced. Each corporate co-venturer was required to execute and deliver joint and several debentures on his prospective assets to the bank.
In addition, the individual co-venturers were severally required to guarantee their liabilities to the bank of their respective company to the extent of the principal sum, totalling $300,000 each. This was accomplished in each case by two separate documents of guarantee of $150,000 each. In consideration of the granting of the loan, Freeman and Easton executed two such documents of guarantee in favour of the bank for the liability of their companies in the principal sum of $150,000, on October 3, 1979 and September 30, 1980 respectively.
During the course of construction the bank advanced funds in excess of $3,900,000 and amounts totalling $4,100,000 were secured by debentures executed jointly by the corporate co-venturers in the years 1979, 1980 and 1981. In April of 1981, the project began to look marginal because of escalating construction costs, the down-turn in the economy and the cancellations of property sales. The bank requested additional guarantees from the individual coventurers. In the latter part of 1980, the contractor Chartwell Development Corp. defaulted in the course of the performance of the construction contract and subsequently went into bankruptcy. As a consequence, the plaintiff and Freeman took over the construction project on a daily basis and became directly involved.
During the summer of 1980, a few of the residences were marketed, although not completed for occupancy and on October 31, 1980, a company agreed to purchase all of the residences not already sold at a fixed purchase price of $98,100 per unit. In the fall of 1981, the real estate in British Columbia collapsed and so did the joint venture, thus completely eliminating any equity in the joint venture.
The bank declared the loans to be in default. The corporate co-venturers were placed in receivership by the bank under the terms of the debentures in October 1981. On October 20, 1981, the bank made demand on both plaintiffs for payment under the guarantees. In 1982, the bank determined that its losses were substantially in excess of $1,000,000 and formerly required both plaintiffs to make payment under the guarantees. The plaintiffs admitted to owing the bank $300,000 but refused to pay any amount in excess thereof.
The total claim of the bank against Easton was for an amount of $400,000 and against Freeman for $523,727.73. The bank commenced an action against both plaintiffs. On March 14, 1986, Easton made a cash payment of $300,000 to the bank in settlement and on May 1984 Freeman made a cash payment of $350,000 in settlement. This agreed statement of facts applies to both plaintiffs save where otherwise described. The further agreed statement of facts which I now abridge applies only to the plaintiff Easton.
In 1972, Easton became a 33 /s per cent shareholder in Crescentview Enterprises Ltd. (” Crescentview"), a Canadian-controlled private corporation which was engaged in the business of providing bridge financing for real estate development projects by third parties. Easton reviewed all loan applications made to Crescentview and approved or disapproved the same and determined the terms of loan including security, interest rates and repayment schedule.
Crescentview obtained a line of credit from its bankers, the Bank of British Columbia in the amount of $3,000,000 and the bank required Easton and two other shareholders to execute unlimited guarantees in favour of the bank. On February 5, 1980, Easton signed a memorandum of agreement with Crescentview wherein he and two other shareholders contracted to guarantee debts owed by Crescentview to the Bank of British Columbia for an annual fee of one per cent of the average indebtedness of the company to the bank.
Crescentview carried on a successful financial business until 1981 when the Bank of British Columbia refused to continue providing a line of credit and Crescentview defaulted in its repayment to the Bank of British Columbia, ceased operations and became bankrupt in 1982.
In July 1983, the Bank of British Columbia demanded that Easton honour its guarantee. In November 1983, the Bank of British Columbia agreed to settle its claim for the sum of $133,334. The plaintiff paid the amount by borrowing that sum from the same bank on a personal loan which said loan has been repaid at the rate of $18,000 per year, plus interest since 1984.
The issue to be resolved in the case of the plaintiff Easton, as agreed to by the parties, are as follows:
(a) whether the non-capital loss of $300,000 was a loss of Rayfield or a loss of the plaintiff;
(b) whether the Minister properly disallowed the $300,000 non-capital loss claimed by the plaintiff in his T1 Income Tax Return for the 1982 taxation year on the basis that the plaintiff's claimed loss was non-capital; and
(c) whether the non-capital loss of $133,334 was a loss of Crescentview or a loss of the plaintiff;
(d) whether the Minister properly disallowed the $133,334 non-capital loss claimed by the plaintiff in his T1 Income Tax Return for the 1983 taxation year on the basis that the plaintiff's claimed loss was non-capital; and
(e) whether the non-capital loss of $133,334 was correctly allowed in the plaintiff's 1983 taxation year as an allowable business investment loss in the amount of $66,667.
The issues to be decided with reference to the plaintiff Freeman are as follows:
(a) whether the non-capital loss of $300,000 was a loss of Fairlyn or a loss of the plaintiff;
(b) whether the Minister properly disallowed the $300,000 non-capital loss claimed by the plaintiff in his T1 Income Tax Return for the 1982 taxation year on the basis that the plaintiff's claimed loss was non-capital; and,
(c) whether the non-capital loss of $300,000 was correctly allowed in the plaintiff's 1984 taxation year as an allowable business investment loss, on the basis that the Bank guarantees were paid by the plaintiff in that year.
The plaintiff's counsel referred to seven judicial decisions in the matter favouring the taxpayer and the defendant referred to eleven cases wherein the courts held otherwise. Obviously, each case will turn on its own factual situation. However, there are basic criteria which emanate from the jurisprudence that can be of assistance in resolving the issues.
The Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") does not define the terms " capital loss" or "business loss". The Minister of National Revenue and the taxpayers have had to turn to the courts for guidelines to characterize losses and gains as either capital or business.
The courts have been unable to enunciate a simple principle that serves, in all circumstances, to solve the question as to whether a particular transaction is capital in nature. The general concept, however, is that a transaction whereby an enduring asset or advantage is acquired for the business is a capital transaction. On the other hand, if the transaction is an integral part of the taxpayer's current business operations, then the transaction is a business transaction (Associated Investors of Canada Ltd. v. M.N.R., supra, note 1).
It is now well-settled that even a single operation may be considered as a business although it is an isolated venture entirely unconnected with the taxpayer's profession or occupation. Generally, a loan made by a person who is not in the business of lending money is 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 (M.N.R. v. Henry J. Freud, supra, note 1).
The key factor in characterizing the nature of any particular gain or loss is the intent of the taxpayer at the time the expenditure was incurred or the asset acquired. In order to determine the taxpayer's intent, all the facts must be considered in the context of the taxpayer's entire course of conduct. The determining factor is how the taxpayer intended to profit. Therefore, if a taxpayer acquires an asset with the intention of deriving a stream of income therefrom, the subsequent loss is a capital loss. If the asset was acquired with the intention of disposing of it, the taxpayer may claim a business loss if the venture proves unsuccessful (Roger Lachapelle v. M.N.R., supra, note 2).
In order to determine the proper characterization of a loss sustained upon disposition of an asset, the courts have approached the matter by asking whether the asset was acquired as an investment, thus a capital loss, or for the purpose of trade, resulting in a business loss (Roger Lachapelle v. M.N.R., supra, note 2).
In the situation of a taxpayer who has sustained a loss on a loan or guarantee, the courts have considered the practical and commercial aspects of the situation to determine the proper characterization of a particular transaction. The "usual test" whether such a payment is one made on account of capital is whether the loan or guarantee was made with a view of bringing into existence an advantage for the enduring benefit of the taxpayer's business (The Queen v. H. Griffiths Company Ltd., supra, note 2).
In a situation where the money required by a company was needed for a particular purpose and that a convenient way for the company to obtain this money was through a bank loan with the taxpayer's guarantee, then the guarantee is considered a deferred loan by the taxpayer to the company and thus a capital outlay by the taxpayer (M.N.R. v. George H. Steer, supra, note 2). In the event that the taxpayer is required to make payment on the guarantee, then the taxpayer's loss is a capital loss. In these situations, the limited liability feature of the incorporation may prove to be a very valuable shield protecting the taxpayer against the company's creditors, thus compensating to some degree for the lack of deductibility afforded by the guarantee, for the business of the company is not that of the taxpayer (The Queen v. H. Griffiths Company Ltd., supra, note 2).
Ever since the English Court of Appeal decision in Salomon v. A. Salomon and Company Ltd., [1897] A.C. 22, referred to in Beamish (K.J. Beamish Construction Co. Ltd, v. M.N.R., supra, note 2 at page 180 (D.T.C. 1592)), it has been accepted that although the shares of a corporation may be owned by the same person who also manages the corporation, the business of the corporation is nevertheless that of a distinct entity: the corporation has its own rights and obligations.
In my view, the plaintiffs have sustained a capital loss. Although they are both lawyers, they are also involved in several businesses. Some of these businesses might be or have been adventures in the nature of trade. The real estate development they launched at Secret Cove, B.C., was for the purpose of creating an enduring asset. Had they eventually sold the whole project at a profit, it would undoubtedly have been considered to be a capital gain. However, due to unfortunate economic circumstances, the joint venture collapsed and produced a capital loss.
So as to finance the development and construction costs of the joint venture, certain arrangements had to be made with the Bank of Montreal including the personal guarantees of the two plaintiffs. When the two companies were placed in receivership by the bank, the latter made demand on both plaintiffs. The guarantees are to be considered as deferred loans by the plaintiffs to the two companies. When they were called upon to repay, their loss must be considered a capital loss.
The limited liability feature of the incorporation of the two companies did prove to be a very valuable shield to them as they could not be called upon to make good for the companies' other obligations. However, the plaintiffs cannot have it both ways. In order to obtain the loans from the bank they had to provide their personal guarantees for which they remained personally responsible.
As mentioned earlier, generally a loan made by a person who is not in the business of lending money, is considered to be a capital investment, as is clearly the case in this instance. Both plaintiffs were not speculating. They were investing with a view of bringing into existence an advantage for their own enduring benefit. They acquired an asset with the intention of deriving a stream of income therefrom, thus their subsequent loss is a capital loss.
Where a taxpayer has sustained a loss on a guarantee for a loan, the courts must look at the practical and commercial aspects of the transaction. In the instant case, I view the guarantees by the plaintiffs as investments on their part in a joint venture which they felt was to be for their enduring benefit. Unfortunately, and through no fault of their own, the project became a victim of the economic down-turn of the early 19805. Consequently, their loss is of a capital nature.
The particular situation of the plaintiff Easton in his dealings with Crescentview, wherein Easton contracted to guarantee debts owed by Crescentview to the Bank of British Columbia, calls for the same conclusions. When Crescentview defaulted and became bankrupt, the plaintiff Easton had to make good on his guarantee. He and the bank settled for the sum of $133,334 which must be considered to be a capital loss, for the same reasons.
I must also find that the defendant correctly allowed the losses for the years in question, that is, on the basis that the bank guarantees were paid by the plaintiff during those years (Hamnett P. Hill v. M.N.R., supra, note 2).
Consequently, in answer to the issues raised in both cases, I must reply as follows: in the case of both plaintiffs, (a) the loss was the loss of the plaintiffs and not that of their companies; (b) the Minister properly disallowed the $300,000 non-capital loss claimed by the plaintiffs and properly allowed the capital loss for the years in question when the loans were repaid.
In the case of the plaintiff Easton, (c) the capital loss of $133,334 was the loss of the plaintiff; (d) the Minister properly disallowed the $133,334 as a noncapital loss; and (e) the Minister correctly allowed, in the plaintiff's 1983 taxation year, the amount of $66,667 as an allowable business investment loss.
Both plaintiffs' actions are therefore dismissed with costs.
Appeals dismissed.
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