Moloney v. The Queen, 89 DTC 5062, [1989] 1 CTC 162 (FCTD), aff'd 92 DTC 6570 (FCA)

Rouleau, J.:—The plaintiff appeals the notices of reassessment issued by the Minister of National Revenue with respect to his 1980 to 1984 taxation years. This action was commenced by statement of claim on November 25, 1986.

The central issue in dispute between the parties is whether certain losses sustained by the plaintiff are properly characterized as losses on account of capital, or business losses. There is a subsidiary issue of the deductibility of certain sums of interest paid by the plaintiff during the taxation years in question. The plaintiff alleges that the losses in question are business losses and that the interest paid by him is deductible under paragraph 20(1)(c) of the Income Tax Act. The defendant takes the opposing position on both issues.

The plaintiff is a lawyer who has practised in Tillsonburg, a small town in Ontario, for over 20 years. His practice varied over the years but the plaintiff has considerable experience in the fields of real estate, municipal development and small business. In addition to his law practice, and perhaps as a natural development of it, the plaintiff became involved in several business ventures, including the purchase and sale of several pieces of real estate and the operation of a coin laundry. The plaintiff entered into these ventures either by himself, in partnership with other local businessmen or as a shareholder.

The plaintiff alleged that his involvement in these real estate transactions was sufficient to render the plaintiff a trader in real estate for the purposes of the Income Tax Act. The Minister of National Revenue agrees with the plaintiff's characterization of his activities, but only with respect to some of the transactions in which the plaintiff had been involved. The Minister provided an admission to the plaintiff in this respect for the purposes of this action.

In the briefest terms, the real estate interests of the plaintiff in respect of which the parties can agree that the plaintiff dealt as a trader are those where the plaintiff either owned the land directly himself or in concert with one or more partners, namely, in any of the plaintiff's ventures in which he acted other than as a shareholder. These interests have included a piece of undeveloped property owned in conjunction with his wife in Florida; a one- third interest in 76 acres of land and a farm house in Aylmer, Ontario; a four- sixth interest in 33 acres of undeveloped land in Vienna, Ontario; three building lots in Mount Elgin, Ontario in partnership with two others; and a half interest in two lots in Tillsonburg, Ontario.

There were however at least two transactions in which the plaintiff was involved which are central to this dispute and in respect of which the Minister does not concede that the plaintiff acted as a trader:

(a) in 1975, Mr. Mandryk became a shareholder in a numbered company, 315826 Ontario Limited; he was joined in this venture by the same Mr. Brown as well as a Mr. Walter Gordon;

(b) in the same year, Mr. Mandryk became a 50 per cent shareholder in a company called Stoney Court Limited (Stoney Court); the other shareholder in the Stoney Court project was a Mr. Anthony Brown.

In order to appreciate the reservations of the Minister of National Revenue with respect to these ventures, it is necessary to review these business activities in some detail.

315826 Ontario Limited was incorporated to operate a coin laundry in the Tillsonburg area. In 1975, Brown, Gordon and Mandryk conducted research in the local marketplace and decided that a coin-operated laundry had strong potential. To this end, the investors purchased the necessary equipment and opened their doors. The plaintiff put a lot of time and effort into the project, in addition to the financial backing he provided, he actually worked on the premises as an acting manager from time to time. As it turned out, the expected demand for the services offered did not materialise and to put matters simply, the venture was not a success.

From time to time, the three investors had borrowed money on the account of the numbered company from the Bank of Montreal in order to keep the business a going concern and they jointly and severally provided notes to the Bank providing security for the repayment of these loans. By 1980, the bank demanded that the parties honour the notes and the plaintiff for his part was required to make good on his share of the obligation in the amount of $9,636. Although the investors looked around for a purchaser for the laundry, none was forthcoming; the assets were sold and the numbered company became inactive.

The plaintiff's second disputed transaction was with respect to his shareholding in Stoney Court. This company was in the business of the purchase and development of land including the construction and sale of residential housing units. Mr. Brown and the plaintiff would purchase lots in the name of Stoney Court and then arrange to borrow funds from the bank to finance the construction of residential units. The constructed homes would then be mortgaged up to about 70 per cent of their value to another lender and the funds would be used to pay off the bank. The ultimate purchaser of the home would of course provide additional funds, which would ultimately lead to the discharge of the mortgage on the property or he would assume it, paying the balance in cash or providing a second mortgage back to Stoney Court.

In order to secure the loans to commence the construction of the homes, the plaintiff and Mr. Brown would sign personal notes on the advances made. As moneys came in on the individual housing projects the moneys would be used to retire some of the outstanding notes. Some of the Stoney Court projects were quite ambitious, one for example consisted of a multiunit town house, so considerable sums were needed by Stoney Court from time to time.

The plaintiff took an active role in the running of Stoney Court, its meetings took place at his offices, he did legal work for the company and he would sign personal covenants on the mortgages granted by third party financial institutions referred to above. Mr. Brown, a builder, made his contribution in his own field of expertise.

The Stoney Court project ran into trouble through a combination of factors. In the first place, interest rates rose sharply in the late 19705. In addition, the principals of Stoney Court started to experience difficulties in arranging mortgages as high as 70 per cent of the value of each development, as they had at the outset. The construction on the projects began to slow down and the plaintiff's partner, Mr. Brown, developed personal difficulties. Mr. Brown eventually left Tillsonburg, and went to British Columbia, where he declared bankruptcy and received an absolute discharge. Mr. Mandryk was left as the sole person responsible under the notes issued to the Bank of Montreal.

On December 3, 1980, the Bank of Montreal wrote to Stoney Court, Mr. Brown and Mr. Mandryk demanding payment of the outstanding balance of Stoney Court's indebtedness. Mr. Mandryk was by then aware that Mr. Brown was totally unable to assist in resolving Stoney Court's financial difficulties so he attended at the Bank of Montreal alone to discuss the situation.

By the time of this meeting the taxpayer's obligation to the bank was $245,700.46 including interest. This amount had built up between June of 1978 to December of 1980 by the signing of individual notes in all but two cases in the amount of $10,000. The remaining two notes dated August 20, 1979 and December 31, 1980 were in the amounts of $30,000 and $13,775.45 respectively.

It was decided that the taxpayer would provide approximately $15,000 of his own money and pay this money to the bank in partial satisfaction of his obligation. The taxpayer also signed a single note consolidating the balance of the moneys owed on the 20 earlier notes in the amount of $230,000. Mr. Mandryk became the sole owner of the company's assets as Mr. Brown's involvement had ceased entirely. The note from Mr. Mandryk to the Bank of Montreal was further secured by the pledging and assignment of numerous assets to the bank including several mortgages which were outstanding on properties sold by Stoney Court, the mortgage on Mr. Brown's home in favour of the taxpayer, and a 25 per cent stake in another real estate development company called Guysborough Properties Limited which had been purchased by Stoney Court.

After this serious reverse, Stoney Court's sales, which had been over $500,000 in 1980, fell to $44,000 in 1981 and were thereafter nil. Stoney Court does however still exist and the taxpayer keeps its minute book active. The taxpayer has been paying off his indebtedness to the Bank of Montreal including interest since 1980. The proceeds of each of the sales in real estate which he has effected of his other holdings discussed above have gone to reduce the amount of the principal owed to the bank.

This then was the taxpayer's situation during the taxation years in question. It is his contention that each of the notes which were signed by the plaintiff in order that advances could be made to Stoney Court were signed for the purposes of earning income. So too, he alleges, was the note signed by the plaintiff with respect to the laundry business. The plaintiff further argues that the interest which he paid between 1980 and 1984 on the note owed to the Bank of Montreal was properly deductible from business income earned during this period.

The defendant is of the view that the losses suffered by the plaintiff were capital losses giving rise to allowable business investment losses only. The defendant further contends that the interest paid by the plaintiff between 1980 and 1984 is not deductible because the sources of income which would have been earned with the use of the borrowed funds did not exist at the time when the interest was paid. Quite simply, the Minister is of the view that the plaintiff acquired the indebtedness of Stoney Court in exchange for the funds borrowed from the Bank of Montreal, and that given the state of Stoney Court at the end of 1980, the taxpayer could not have had a legitimate expectation that the assets of Stoney Court could have ever been income generating. For this reason, the sums paid to the bank could not be viewed as other than a capital loss. The taxpayer himself wrote off the whole amount as a bad debt at the end of the 1980 taxation year.

The Minister also concludes that the interest paid by the taxpayer after 1980 did not relate to any income generating project because Stoney Court was not active after its one sale in 1981.

I must say at the outset that I was surprised that the Minister conceded that the plaintiff was a trader in respect of some of the real estate ventures in which he was involved but would make no such concession with respect to the balance of his transactions. The jurisprudence reveals that the Minister is generally quite unsympathetic to the taxpayer who attempts to show that some of his transactions entered into in either the same or successive taxation years had the character of capital investments whereas others were business ventures. The slogan “once a trader, always a trader" immediately comes to mind. I further question what the Minister may have done if Stoney Court had been successful and the plaintiff was able to realize a considerable gain on the shares. Would he have allowed the gain to be treated as capital? I have my doubts.

This situation was commented on by Mr. Justice Pigeon in the Supreme Court of Canada in the case of M.N.R. v. Freud, [1968] C.T.C. 438; 68 D.T.C. 5729 and in my view it makes eminent sense that suspicion is aroused where a party attempts to argue that his affairs can be divided along such disparate lines. In this case however, it is the Minister who is attempting to establish that the plaintiff was involved in two very different types of transactions during the taxation years in question, and in this the Minister's representative faces an uphill battle.

In an attempt to distinguish Stoney Court and 315826 Ontario from the balance of the plaintiff's ventures, the defendant made much of the fact that the plaintiff's standard method of dealing in land was through a direct holding either by himself or in partnership with others. In the case of Stoney Court and the numbered company however, the plaintiff chose an incorporated company as the vehicle for his business, and the defendant found this very significant.

After having heard the testimony of Mr. Mandryk, I was satisfied that there were cogent business reasons for this choice and I did not hear anything more persuasive than Mr. Mandryk's explanations. I did not see any substantive differences between Mr. Mandryk's approach to the Stoney Court and numbered company ventures and the rest of his real estate projects.

In the first place, Stoney Court was a more ambitious project than any of the others and its financial and planning needs were more complex. More significantly, there was the need for a constant flow of funds, it was contemplated that a significant number of mortgages would be entered into at any one time and as builders, it made perfect sense that the parties would attempt to limit their liability by using a corporate structure. With respect to the laundry business, it is clear that the establishment of this venture was purely a business enterprise, and in fact the defendant did not address very much argument to the contrary.

The Minister's other fundamental objection with respect to the taxpayer's situation was that the investment of money in shares, as was decided by the Supreme Court of Canada in Irrigation Industries Limited v. M.N.R., [1962] C.T.C. 215; 62 D.T.C. 1131, is prima facie a capital investment. This may well be so, but the decision of the Supreme Court also reveals that the particular circumstances of each taxpayer are relevant to a final determination and that the treatment of shares as a capital investment is by no means an invariable rule. It is apparent that it is always open to the taxpayer to establish that the purchase of shares was other than a capital investment, see for example M.N.R. v. Freud, [1968] C.T.C. 438; 68 D.T.C. 5279, Fraser v. M.N.R., [1964] C.T.C. 372; 64 D.T.C. 6224 and Cull v. The Queen, [1987] 2 C.T.C. 63; 87 D.T.C. 5322.

In my view, the case turns upon the fact that the plaintiff was a trader in real estate during the taxation years in question. All the moneys advanced by him, (whether by way of cash infusion or by the signing of a note) flowed into the plaintiff's various ventures for the purpose of earning income from real estate. I believe that the distinction proposed by the Minister in this case is an artificial one. Can it be truly said that the plaintiff's involvement in the Stoney Court project was not in respect of real estate, but that instead, the plaintiff was in the business of giving guarantees and therefore would not be entitled to treat this loss as a business loss? I do not think so.

The plaintiff was clearly actively involved in developing the housing projects undertaken by Stoney Court. Every advance that was made to the company on the strength of the notes the taxpayer provided to the Bank of Montreal was money forwarded in expectation of earning income. The funds were advanced for the purposes of purchasing additional properties and continuing the company's construction plans. They were not merely for the provision of working capital by a lender who himself was a trader in real estate but had chosen to set up separate corporate bodies when the ventures were speculative and in which they intended to limit their exposure, as was the case in Isaac Meisels Investments Ltd. v. The Queen, [1985] 1 C.T.C. 9; 85 D.T.C. 5029. The various notes were not isolated transactions advanced speculatively but were in fact continuing advances to pursue the ongoing activities of the company.

When the taxpayer was ultimately forced to sign the final consolidating note to avoid the bank's possible seizure of all his remaining real estate assets and other ventures, he received an assignment of the assets of Stoney Court previously pledged to the bank, in return for the consolidated note; he held a very real expectation of salvaging something from the properties and mortgages held in the inventory of Stoney Court. He also had the very important motive of protecting the balance of his income generating assets from the reach of the bank. The defendant suggests that the $245,000 was for the "purchase of a receivable”. This may be what the bank's documents indicate but this is not truly representative of the situation. It was "houskeeping" and not a single transaction of lending money; nor was it for the alleged purpose of taking over the existing assets of Stoney Court.

In coming to this conclusion, I am very much influenced by the decision of Madam Justice Reed in the case of Cull, supra. The similarities between the plaintiff's case and that of the taxpayer in the Cull case are striking. In that case, a partnership consisting of several lawyers was a shareholder in a company formed to take advantage of a real estate development project. The lawyers gave personal guarantees for a share of the debt incurred by the corporation as well as interest thereon. After the project failed, and the partners were called upon to honour the amount of the guarantees, the partnership recorded a loss for the full amount and this was contested by the Minister of National Revenue.

Reed, J. was satisfied that on the facts of the case, the plaintiff has acquired the shares in question for the purpose of dealing with the land acquired by the corporation and not to invest in the shares themselves. She also found that once the venture of the plaintiff was properly characterized as an adventure in the nature of trade, it was logical that any advances made to the company were to be characterized in the same way; they were part and parcel of the plaintiff's business dealings and retained their essentially speculative character.

There is very little in the case before me that can be distinguished from the Cull case, supra. In fact, it is clear that the plaintiff Mandryk, as a 50 per cent shareholder in Stoney Court was in an even stronger position to exercise control over the assets of Stoney Court than was the Cull partnership which held a one-third interest in the underlying company. Furthermore, in the case before me, I have the Department's admission that the plaintiff was trading in real estate during the taxation years in question, whereas in the Cull case, the partnership was required to establish based on an isolated transaction, that it was involved in the trading of real estate.

If the taxpayer in the Cull case is entitled to deduct the amount of its business losses, as a person who is engaged in only a single venture in the nature of trade, then Mr. Mandryk, who has shown a long history of engaging in business ventures which was well documented before the Court, must be entitled to the same treatment.

As to the deductibility of the interest payments made by the taxpayer during the 1980 to 1984 taxation years, the plaintiff argues that he signed the note and agreed to additional interest payments to the bank in order to protect his real estate holdings from seizure; that these holdings generated income for the plaintiff and that hence paragraph 20(1)(c) of the Act provides that they can be deducted from income.

The defendant argues that as Stoney Court had essentially stopped its operations, there was no active source of business income to which the plaintiff could relate the cost of borrowing the money. In advancing this proposition, the defendant relies on the case of Russell I. Emerson v. The Queen, [1986] 1 C.T.C. 422; 86 D.T.C. 6184. This does not answer the plain- tiff's argument that the purpose of the borrowed funds was to protect the balance of the real estate interests of the plaintiff. As distinguishable from the Emerson case, supra, the plaintiff is still the holder of shares in Stoney Court and it is not up to the Court to speculate as to whether or not they may or may not generate income.

Further, after taking over the assets of Stoney Court in 1981, he disposed of a house and in subsequent years income from mortgages previously held by Stoney Court. He continued and continues up to this day transacting in real estate. His half interest in the Florida property was disposed of in 1980; the 33 acres referred to as the Vienna property was disposed of in 1981; of the three Mount Elgin properties, one was sold in 1982 and two in 1986; the downtown Tillsonburg land was expropriated by the municipality in 1984 from which he realized $41,000; the 76 acres in Aylmer sold in 1988, though not part of the taxation years in question, returned $70,000. He continues to hold the Guysborough property to this day. All were reported as income and undoubtedly support the plaintiff's contention of continuing activity in the field.

The interest payments are hence deductible.

Virtually every other authority discussed by the defendant was addressed at length by Madam Justice Reed in Cull. As the Minister is unable to distinguish this taxpayer's situation from the one laid out in Cull, I believe that in the interests of maintaining consistent jurisprudence from this Court, Mr. Mandryk is entitled to the remedy he seeks.

The Minister is directed to issue reassessments with respect to the taxation years in question reflecting the fact that the amounts claimed as losses on both the Stoney Court project and 315826 Ontario Limited are to be treated as business losses. Furthermore, the amounts attributable to interest on the loan taken out from the Bank of Montreal in December 1980 are deductible in each of the taxation years in question pursuant to paragraph 20(1)(c) of the Income Tax Act. The plaintiff is entitled to his costs.

Appeal allowed.