Anderson v. MNR, 92 DTC 1778, [1992] 2 CTC 2113 (TCC)

Sobier, T.C.C.J.:—The appellant appeals from the reassessments by the respondent with respect to the 1983, 1984 and 1985 taxation years, whereby the respondent disallowed the deduction by the appellant of contributions made by her to Donald R. Anderson Associates Ltd. (DRAAL).

The appellant's husband, Donald R. Anderson, controlled DRAAL, which carried on an actuarial consulting business, working closely with pension funds.

It was Mr. Anderson's view that because of inflation, investments made by pension funds might not be adequate to cover future pension liabilities. Although he was not an investment advisor, he wished to match investment policy with actuarial concepts. He wished to encourage pension funds to invest in younger industries, rather than the traditional manufacturing and resource industries. Mr. Anderson set about to change pension funds’ attitude towards investment and in that regard he decided to set up an investment fund specially tailored to pension funds.

This was to be a fund which would invest in small business development corporations ("SBDC's") in order to take advantage of participating in new businesses, and also to take advantage of the grants provided by the Ontario government to persons investing in SBDC's.

To carry out his plan, it was decided to form a trust, Venture Link Investment Trust (the "trust"), with National Trust Company, Ltd. ("National Trust") as trustee. Pension funds would invest in units of the Trust, which in turn would invest in SBDC's and other venture capital investments. Venture Link Management Corporation (the"manager") would manage the funds held in trust and be paid fees and commissions by the trust. National Trust would hold the investments as bare trustee for the trust. National Trust would not give investment advice, but it could sell units of the trust to some of its customers who were also pension funds.

In conjunction with Mr. Anderson, National Trust produced an offering circular or booklet offering the trust units. Mr. Michael S.F. Howe, then an employee of National Trust, began working with Mr. Anderson in 1983. National Trust's contribution to the scheme was in marketing, including assistance in preparation of the marketing booklet and providing Mr. Howe's time. Although National Trust was intended to be the trustee and was described as such in the circular, no trust agreement was ever entered into. The offering circular also mentioned an advisory and management agreement, however, no such agreement was ever executed.

Mr. Anderson gave evidence concerning retaining solicitors to draft agreements and to obtain clearances from Revenue Canada as well as evidence concerning identifying businesses in need of venture capital.

The years 1983 and early 1984 were spent in drafting documents and “educating” National Trust as well as identifying prospective purchasers of trust units. At this time, one Dr. George Lewis who was perceived as a venture Capitalist, became involved, since Mr. Anderson was perceived not as a venture capitalist, but as an actuary. Early in 1984, Messrs. Howe and Anderson together with Dr. Lewis were ready to start selling and it was then that they began calling on the pension funds. Sales efforts made in 1984, made it apparent that there was little interest in the proposed scheme and by 1985, it was abandoned without any investment by a single pension fund.

Mrs. Anderson became involved when it appeared that her husband was unable to interest a financial backer for the scheme. She feared that any backer might exact too high a price, leaving Mr. Anderson with very little for his idea and efforts. Mr. and Mrs. Anderson stated that they negotiated and executed an agreement (the"agreement"), dated November 10, 1983, among themselves and various other entities they controlled. The agreement referred to another agreement, between DRAAL and Venture Link Enterprises ("VLE"), a sole proprietorship established by Mrs. Anderson. No agreement setting forth the terms recited in the agreement was produced. Oral evidence was given concerning this agreement but its terms were never fully explained.

It was clearly shown that the appellant advanced funds to DRAAL to cover DRAAL's overhead costs such as rent, telephone and secretarial expenses. Mrs. Anderson advanced $20,000 in both 1983 and 1984 and $24,000 in 1985. Cheques were drawn on VLE's account, made payable to DRAAL. It was stressed that the moneys were used by DRAAL and not by the manager or the trust, and that the funds were used for the day to day operations of DRAAL. Whatever the use, the funds were in fact paid but the question to be asked is: Why were these funds contributed or advanced? Mrs. Anderson did not expend the funds in carrying on any business of her own.

The agreement called for Mr. Anderson to see to the initial distribution of shares of the Manager, on a two-third to one-third basis between DRAAL and VLE and also in the words of the agreement:

In consideration of the assistance which Enterprises [VLE] has provided in engaging Associates [DRAAL] to establish Management [the Manager], Management shall pay to Enterprises 20% of its annual profits before taxes, as a bonus.

The issue which is joined is whether Mrs. Anderson was entitled to deduct the contributions from other income for the taxation years in question. She would not be entitled to deduct the advances unless they were made in accordance with paragraph 18(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") [1] for the purpose of earning income from a business. Mrs. Anderson has not established that she carried on any business or that she was engaged in any business.

No income was generated by the trust, the manager or DRAAL in connection with the sale of trust units. The appellant argues that M.N.R. v. M.P. Drilling Ltd., [1976] C.T.C. 58, 76 D.T.C. 6028 (F.C.A.) stands for the proposition that there need not be revenue before proper expenses may be chargeable against income whether or not any income resulted from such expenditures. In M.P. Drilling, the Minister attempted to categorize the disputed expenses as capital while the Court held that if they were expenses incurred for the purpose of earning income from a business and in themselves were not of a capital nature, they cannot be rendered non-deductible by virtue of paragraph 12(1)(a) [now 18(1)(a)]. While this is true, the reverse is also true. If the expenses were made on capital account, they cannot be made deductible whether revenues were present or not. The funds received by DRAAL were used by it to carry on its entire business not merely the promoting of the trust and would be deductible by DRAAL in calculating its income. However, the use by the recipient of the funds is not determinative of the nature of the payment by the taxpayer.

At the commencement of the hearing, counsel for the appellant pointed out that in confirming the assessment the respondent based the confirmation on the grounds that the expenses were not made for the purpose of gaining or producing income from a property or business, within the meaning of paragraph 18(1)(a) of the Act. However, in the last paragraph of his reply to the notice of appeal, the respondent states:

10. In the further alternative, the respondent submits that the expenses were incurred in an unsuccessful attempt to establish a business and were thus on capital account the deduction of which is prohibited by paragraph 18(1)(b) of the Act.

This was the first time the expenses were alleged to have been made on Capital account and it was pointed out that the onus therefore shifted to the respondent to prove that the expenditures were made on capital account. Even if the onus did shift to the respondent, the appellant's own evidence leads one to the inescapable conclusion that the contributions were on account of Capital.

In this regard, the comments of Jackett, P. in Canada Starch Co. Ltd. v. M.N.R., [1968] C.T.C. 466, 68 D.T.C. 5320 [Ex. Ct.] at page 471 (D.T.C. 5323) are relevant when dealing with capital versus income expenditures. He states:

For the purpose of the particular problem raised by this appeal, I find it helpful to refer to the comment on the “ distinction between expenditure and outgoings on revenue account and on capital account” made by Dixon J. in Sun Newspapers Ltd. et al. v. The Federal Commissioner of Taxation (1938), 61 C.L.R. 337 at page 359, where he said:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.

In other words, as I understand it, generally speaking,

(a) on the one hand, an expenditure for the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such an entity, structure or organization, is an expenditure on account of capital, and

(b) on the other hand, an expenditure in the process of operation of a profit-making entity, structure or organization is an expenditure on revenue account.

Applying this test to the acquisition or creation of ordinary property constituting the business structure as originally created, or an addition thereto, there is no difficulty. Plant and machinery are capital assets and moneys paid for them are moneys paid on account of capital whether they are

(a) moneys paid in the course of putting together a new business structure,

(b) moneys paid for an addition to a business structure already in existence,

or

(c) moneys paid to acquire an existing business structure.

What did Mrs. Anderson receive in consideration for her contributions to DRAAL? She received a right to call on DRAAL to ensure that she receive from the manager 20 per cent of the gross profits of the manager earned from managing the trust and one-third of the shares of the manager, which could produce dividend income. She was thus expending moneys for the creation of a structure for earning profit. The moneys were used for the purpose of acquiring an income stream or source, which is a capital outlay.

Having found that the expenditures were not made for the purpose of gaining or producing income from a business, and also having found that the expenditures were made on capital account, the appeals are dismissed.

Appeals dismissed.