K.J. Beamish Construction Co. Ltd. v. MNR, 90 DTC 1584, [1990] 2 CTC 2199 (TCC)

Christie, A.C.J.T.C.:—The appellant's 1982 taxation year is under review. The question is whether the appellant can deduct $678,575 as a loss on current account in computing its income for that year or is it limited to deducting 50 per cent of that amount ($339,288) as an allowable business investment loss in accordance with the respondent's reassessment.

At the outset of the trial, counsel for the appellant moved to amend the notice of appeal to include reliance on paragraph 20(1)(p) of the Income Tax Act ("the Act") on the ground that part of the taxpayer's ordinary business was the lending of money. In this regard he made reference to the reasons for judgment delivered by Garon, T.C.J. in Wesco Property Developments Ltd. v. M.N.R., [1989] 2 C.T.C. 2431; 89 D.T.C. 590. [1]

The appellant is a private company incorporated under the laws of Ontario. At all times material to this appeal it was controlled by Mr. Kingston J. Beamish. It has been in business for some 44 years. The principal nature of that business is the construction of roads and the manufacture of asphalt. In addition it has been involved from time to time in the acquisition, development and sale of real estate.

The only witness called at the trial was Mr. John Hartley, comptroller and vice president, finance, of the appellant. He was employed by the appellant in 1980 which was long after many of the events referred to in his evidence. He had, however, prepared himself as best he could including a study of relevant business records.

The appellant's participation in real estate ventures took different forms, but always with the same objective of making profit on the acquisition and development of real estate. Participation was by way of a syndicate or a partnership or an interest in a corporation. In each instance the appellant held a minority position. In one case the appellant acquired the entire interest in a parcel of land in Richmond Hill for development and sale. In addition it sought to make profits by building roads in relation to these developments.

These are the essential facts placed before the court regarding the real estate development ventures of the appellant. Basector Developments Ltd. was incorporated for the purpose of acquiring title to two parcels of land, one of 51 acres and the other of 97 acres both in the County of Peel, Ontario. The property was held in trust by the company for the members of the syndicate. Under an agreement dated November 22, 1965, the syndicate consisted of the appellant and eleven others and it was constituted to purchase and develop the real estate. The appellant had a 10 per cent interest in the syndicate. The 97 acres were sold in 1966 and the 51 acres in 1968. The sales realized profit. All proceeds received by the appellant from the syndicate were treated as business income for tax purposes.

Skyork Construction Ltd. was incorporated for the purpose of acquiring title as nominee of a syndicate to three parcels of real estate in the County of Peel consisting of 50.2, 57 and 40 acres and for the purpose of holding that property on behalf of the syndicate in trust for the members thereof. Under an agree-

or such part of the following amounts as may reasonably be regarded as applicable thereto:

(p) the aggregate of debts owing to the taxpayer

(i) that are established by him to have become bad debts in that year,

and

(ii) that have (except in the case of debts arising from loans made in the ordinary course of business by a taxpayer part of whose ordinary business was the lending of money) been included in computing his income for the year or a previous year.

Since each debt in issue in the present case had not been included in computing the appellant's income for the particular year in respect of which the deduction is sought or a previous year it follows from the wording of paragraph 20(1)(p) of the Act that for such a debt to be deductible, the following three requirements must be satisfied:

1. the debt had become bad in the year;

2. part of the ordinary business of the taxpayer was the lending of money; and

3. the bad debt arose from loans made in the ordinary course of business of the taxpayer.

Counsel for the respondent argued that the debt written off by the appellant had not gone bad in the year in respect of which the deduction was claimed.

ment dated January 16, 1967, the syndicate consisted of the appellant and ten others and it was constituted to purchase, develop and sell the real estate. The appellant had a ten per cent interest in the syndicate which was in existence from January 1967 until 1976. The real estate was sold at a profit and all of the proceeds received from the syndicate were treated as business income.

Old Stump Fence Developments was a five-member partnership, one of which was the appellant. Under an agreement dated August 24, 1967, one of the partners, H.B. Morrison Ltd., purchased two parcels of land in the County of Halton on behalf of the partnership. Title to the real estate was registered in the name of Old Stump Fence Developments Ltd. (which was not a partner) and it was dealt with in the manner directed by the partnership. The purpose of the partnership was to acquire and develop the real estate. The appellant had a 20 per cent interest in the partnership. The land was subdivided and serviced and lots were sold to builders. The sales were made from 1972 to 1975. The appellant constructed roads for the partnership under contract and received payment for this. All amounts received by the appellant from the partnership were treated as business income.

Dungate Inc. was incorporated for the purpose of acquiring 110 acres of land in Oakville as nominee of a syndicate and for the purpose of holding that property on behalf of the syndicate in trust for the members thereof. The syndicate consisted of the appellant and fourteen others and it was constituted for the purposes of acquiring, developing and selling the property. The appellant had a ten per cent interest in the syndicate which was in existence from September 1972 to 1986. The purchase price of the property was $656,000 and the vendors took back a mortgage for $490,500. The syndicate was in default under the mortgage and the mortgagee sold the property under the power of sale in the mortgage. In computing its income for 1986 the appellant treated its share of the syndicate's loss as a business loss.

What is referred to in evidence as the Moorlands Subdivision is a parcel of land that was formerly a campground on the outskirts of Beaverton. In 1973 it was acquired by Tribee Investments Ltd.. A syndicate consisting of Tribee, H.B. Morrison Ltd. and the appellant was formed to develop and sell the property. The original concept was to develop a mixed multi-family residential and commercial subdivision. This plan was frustrated by local residents and government authority so the plan was changed to provide for the subdivision of the property into six single family residential lots. The property was rezoned and subdivided in 1983. In that year Tribee and Morrison sold their interests in the syndicate to the appellant who became the sole owner of the property in August of that year. The lots were sold in 1986 and the profits on the sales were reported by the appellant as business income in 1986.

On March 27, 1973, a shareholders' agreement was entered into among Ebaron Investments Ltd. (the controlling ownership of which was with Svetislav Bogdanovic-Baron), Alice Boccia, Radovan M. Radovich and the appellant in relation to Three B & R Developments Ltd. ("Three B & R”). I shall deal with this matter in some detail because the transactions that gave rise to the litigation under consideration pertaining to Garrison Village Developments Ltd. ("Garrison") are directly patterned on it. With one exception the individuals involved are the same in both undertakings. Alice Boccia is the wife of Eugene Boccia. She did not participate in the Garrison venture, but Eugene Boccia Holdings Ltd. did and it was controlled by Eugene Boccia.

The shareholders' agreement recites that Three B & R is the owner of certain real estate in Ontario and is carrying on the business of real estate development. The real estate referred to is in Whitby. Shares in Three B & R were held as follows: Ebaron Investments Ltd. - directly 24; Bogdanovic-Baron as nominee for Ebaron Investments Ltd. - 1; K.J. Beamish Construction Co. Ltd. - directly 24; Kingston J. Beamish as nominee for K.J. Beamish Construction Co. Ltd. - 1; Alice Boccia - 25 and Radovich - 25.

It is the stated desire of these shareholders to regulate the management and operations of Three B & R. The agreement specifies that only Bogdanovic- Baron, Kingston J. Beamish, Alice Boccia and Radovich can be directors of Three B & R and that if any of them became unable to act as director, the appellant had the right to replace Kingston J. Beamish, Ebaron Investments Ltd. had the right to replace Bogdanovic-Baron, Alice Boccia or her representative had the right to replace her and Radovich or his representative had the right to replace him. Clause 3 provides that certain things shall not be done without the unanimous consent of the shareholders such as, declaring dividends, issuing additional shares of Three B & R or selling them, shares held by the shareholders being “transferred, assigned, charged or in any other manner encumbered or disposed of" or disposing of "the whole or a substantial part of the Company's (Three B & R's) undertaking." It also specified that all documents, deeds, contracts and agreements of every description required to be signed by the company must first be approved by all members of the Board of Directors and that the presence of all directors is necessary to form a quorum for a meeting of the directors unless a director waives his right to be present in writing. Clause 10 provides:

10. Subject as may hereafter be unanimously agreed, the gross revenues received by the Company from time to time shall be applied in the following manner:

(a) Firstly to pay all interest payments payable under any mortgages accrued against the property of the Company.

(b) Secondly to pay any principal payments which may be due and payable

under any mortgages secured against the property of the Company.

(c) Thirdly to pay all maintenance, realty taxes, and operating expenses in connection with the company.

(d) Fourthly any surplus remaining in the hands of the Company from time to time shall be applied to reduce pro rata the principal amount owing by the Company to any one or more of the parties hereto who are not in default under paragraph 11.

(e) Finally, subject to paragraph 11, any balance or surplus remaining in the hands of the Company after the application of funds in the manner aforesaid, shall be available for distribution to the shareholders, upon the unanimous agreement of all parties, unless the aforesaid is varied by unanimous agreement of all parties.

Clause 11 requires shareholders to advance to Three B & R within 10 days of being requested in writing sums of money in proportion to their ownership interest as may be required to complete the purchases of real estate; make mortgage payments; pay land taxes; pay for engineering and planning studies; pay legal and accounting fees and to pay other reasonable and necessary operating expenses. If a shareholder fails to pay an amount as required, it becomes "an amount in default” and the shareholder is a "defaulting shareholder”. The amount in default bears interest at the rate of 12 per cent from the date of default until payment is made to Three B & R. If the amount in default plus interest is not paid within 60 days from the due date and if there is a second default and the defaulting shareholder does not pay all amounts in default plus interest within 30 days from the due date, a defaulting shareholder is not entitled to participate or share in any profits of Three B & R earned at any time before or after the date the defaulting shareholder was first in default. Clause 11 goes on to provide:

The defaulting shareholder shall only be entitled to participate or share in the profits of the Company, when moneys are available for distribution among the shareholders of the Company under Paragraph 10(e) and after paying the amount in default plus accrued interest as aforesaid, to obtain his pro rata share of the said amount available for distribution under Paragraph 10(e) or the balance owing to such shareholder for his capital contribution to the Company, whichever is the lesser.

Clause 12 provides that if a shareholder desires to sell his, her or its share and interest, either in whole or in part, in Three B & R the shareholder “shall be at liberty to do so" [2] subject to a right of first refusal, that is to say the share and interest must be offered to the other shareholders at a specified price. If all of the other shareholders fail to accept the offer within 60 days then the share and interest may be sold to another or others at the same or a higher price.

The Whitby property was subdivided, serviced and developed. The appellant constructed roads on the property under contract and was paid by Three B & R. It was sold in one transaction in Three B & R's fiscal year ended February 28, 1977. The profit on the sale was reported as business income and it was distributed to the shareholders of Three B & R as dividends. The payment of these dividends to the appellant did not attract tax.

In 1973 the appellant acquired 24 acres in Richmond Hill. This land was purchased for development and sale, but development was delayed because of a lack of water and sewage facilities in the year. It was not possible to develop the property in isolation but only as part of a larger area. In 1983 the appellant joined a group of owners who owned over 700 acres in the area. The property has now been subdivided and services are being installed. In 1988 the appellant entered into an agreement for sale with a builder in respect of the residential lots. An additional lot zoned industrial is in the process of being sold. At the date of the trial no sales had been completed. The Court was informed that when they are the profits will be dealt with by the appellant as business income.

Apart from the foregoing, the appellant in three instances disposed of real estate and treated the proceeds as on capital account: (i) the expropriation of part of a gravel pit that had been acquired near Uxbridge, Ontario, for the manufacture of asphalt; (ii) a site acquired for the future development of a division of the appellant that was sold to an associated company which required the site for the expansion of its operations; and (iii) the sale to a developer of the head office of the appellant in Thornhill, which had been the head office for 25 to 30 years.

We now come to the Fort Erie land development project by Garrison that precipitated this appeal. Garrison was incorporated under the Business Cor- porations Act of Ontario. Mr. Paul M. Valenti, a professional engineer and solicitor of Toronto wrote Garrison to inform it that two parcels of land had been acquired in Fort Erie by Bogdanovic-Baron in trust for a company to be formed, namely, Garrison. Together the two parcels consisted of 122.7 acres ("the site"). Valenti also informed Garrison that the land was in the process of being transferred to it. He was the solicitor for Garrison and had also acted in that capacity for Three B & KR.

A shareholders' agreement dated June 30, 1974, was entered into among Onway Consultants Ltd. ("Onway") which was controlled by Bogdanovic- Baron, Eugene Boccia Holdings Ltd. (“Boccia Holdings”) which as previously mentioned was controlled by Eugene Boccia, Radovan M. Radovich and the appellant. It states that Garrison is the owner of real estate in Ontario and that it is in the real estate development business. All of the issued shares of Garrison are held as follows: Onway—24; Bogdanovic-Baron as nominee for Onway—1; the appellant—24; Kingston J. Beamish as nominee for the appellant—1; Boccia Holdings—24 and Eugene Boccia as nominee for Boccia Holdings—1; and Radovich—25. The price of the shares was $1 each. What has been said about the terms of the shareholders' agreement in relation to Three B & R applies to the shareholders' agreement in relation to Garrison, even down to the numbers assigned to the clauses in the agreements except that the rate of interest payable to Garrison respecting an amount in default under clause 11 was "4 per cent above the prime rate charged by chartered banks" instead of the 12 per cent payable to Three B & R.

On September 5, 1975, a management agreement was entered into between Garrison and Bogdanovic-Baron whereby the latter was engaged as general manager to provide specified management services. Work was done on the site by way of preparation of the surface, but the installation of services had to be held in abeyance pending entering into a subdivision agreement.

A loan secured by a mortgage on the site was due on June 30, 1979, and pursuant to paragraph 11 of the shareholders' agreement the shareholders of Garrison were called on for additional funds in the amount of $72,000 each to pay this debt. Radovich could not comply with this request and at a meeting of shareholders on June 21, 1979, it was agreed that the appellant and Boccia Holdings would each advance 50 per cent ($36,000) of the amount due by Radovich. This placed him in default under the shareholders' agreement. By letter dated August 3, 1979, the appellant sent cheques to Bogdanovic-Baron, one for $36,000 and the other for $72,000. Boccia Holdings also paid these amounts and Onway paid $72,000, with the result that the debt secured by the mortgage was retired.

On October 10, 1979, Garrison entered into a subdivision agreement with the Corporation of the Town of Fort Erie which included provision for the installation of services. On June 17, 1980, Bogdanovic-Baron had submitted a detailed report to the directors of Garrison that included reference to the cost of servicing the site and the estimated market value of serviced land. To assist in financing the work under the subdivision agreement, Garrison borrowed $1,410,000 from the Toronto-Dominion Bank. Repayment was secured by a mortgage on the site dated October 9, 1979. In addition each of the shareholders of the appellant gave a guarantee of up to $300,000 (total $1,200,000) to the bank in respect of Garrison's liability to it and in addition they guaranteed payment of interest owing to the bank by Garrison.

On June 12, 1981, the appellant, Onway, Boccia Holdings, Radovich and Garrison entered into an agreement whereby the right of first refusal under clause 12 of the shareholders' agreement of June 30, 1974, was "waived for a 50 day period, to allow the shareholders to discuss purchase and sale of shares.” It was also provided that: "Upon termination of the 60 day period, the Share- holders Agreement shall continue in full force and effect as if this amendment had not been made." What transpired at this meeting is not in evidence. Whatever it was it did not result in the purchase or sale of any shares.

Various unsuccessful efforts were made to sell all or part of the site and in October 1981 J.J. Barnicke Ltd. ("Barnicke"), a real estate broker of Toronto, was given an exclusive listing to sell the whole of the site. It expired December 31, 1981. This was replaced by another exclusive listing, again with Barnicke that expired January 31, 1982. On January 26, 1982, the site was advertised for sale in the Globe & Mail’s Report on Business. It was also advertised in the Financial Post. By letter dated January 27, 1982, from the appellant to Barnicke the exclusive listing agreement was extended to April 30, 1982. Because of the depressed condition in the real estate market all of this came to naught. There was no response to the advertisements either by telephone or letter.

On June 11, 1982, Radovich was notified by Garrison's secretary that since he last contributed under the shareholders' agreement, the shareholders had each been called on for $148,167. On November 17, 1982, a receiving order was made against Radovich under the Bankruptcy Act. No payment was made of what he owed under the shareholders' agreement.

Also on June 11, 1982, Garrison's secretary notified Bogdanovic-Baron that since Onway last contributed under the shareholders' agreement, the shareholders had each been called on for $55,415. Again, as in the case of Radovich, the default by Onway was made up by the appellant and Boccia Holdings and that sum was not recovered from them. In June of 1982 Bogdanovic-Baron made two unsuccessful attempts to sell Onway's shares in Garrison and Ebaron Investments Ltd.'s shares in Three B & R. The shares were offered to Kingston Beamish and Eugene Boccia and two weeks later to the appellant and Boccia Holdings.

At a special meeting of the shareholders of Garrison on June 14, 1982, they declared that they would not make any further advances to Garrison and that the Town of Fort Erie and the bank should be so informed. The Toronto- Dominion Bank thereupon exercised its power of sale under the mortgage and held a public auction of the site on November 17, 1982. No bids were made. The appellant then honoured its $300,000 guarantee to the bank and also paid $21,238 in interest under the guarantee. The witness, Hartley, does not know how the site was eventually disposed of. Finally in December 1982 the appellant terminated its relationship with Garrison by selling its shares in that company for $10.

Included in the appellant's return of income for 1982 are financial statements pertaining to it for the year ended December 31, 1982, prepared by Smith, Nixon & Co. Chartered Accountants of Toronto. On page 2 there is a statement of assets in which this appears: "Investments (Note 4)." That note is on page 8 and shows Three B & R and Garrison as investments.

It is the position of the appellant that the acquisition of the 25 shares of Garrison by the appellant was an adventure in the nature of trade and that deductible business losses in respect of the adventure total $678,575. This sum falls into five categories. First, the shares were purchased for $25 and sold for $10; second, 6 non-interest-bearing advances to Garrison by the appellant under clause 11 of the shareholders' agreement made from 1974 to 1981 in the total amount of $247,137; third, advances made on behalf of defaulting shareholders in 1979, 1981 and 1982 in the sum of $105,795; fourth, the payment to the Toronto-Dominion Bank of $300,000 under the guarantee of October 9, 1979, plus $21,238 paid to the bank under the guarantee in respect of interest owing under the mortgage given by Garrison in favour of the bank dated October 9, 1979; and fifth $4,390 for legal and consulting fees.

My appreciation of the evidence is that in respect of the 122.7 acres in Fort Erie the shareholders of Garrison set out to do what the shareholders of Three B & R had successfully accomplished and in the same manner. The land was acquired in trust by Bogdanovic-Baron for a company to be created. Garrison is incorporated and title to the land is unconditionally transferred to it. Only 100 shares are issued and 25 are received by each of four shareholders for $1 per share. Under the shareholders' agreement of June 30, 1974, it is said that Garrison is the owner of the land, that it is in the business of real estate development and that the shareholders are desirous of regulating the management and operations of Garrison. There is, however, no suggestion that the shareholders themselves are to be engaged in the business of developing the land through a syndicate or partnership as happened with respect to Basector Developments Ltd., Skyork Construction Ltd., Dungate Inc., Tribee Investments Ltd. and the Old Stump Fence Developments Ltd.. Counsel for both parties volunteered that if either of these methods had been adopted the dispute would not have arisen. Nor is there any suggestion or evidence that Garrison was acting as agent for the shareholders in developing land. [3]

The disposition of the shares in Garrison or all or part of its undertaking was tightly controlled; the management agreement pertaining to the development of the land did not involve any shareholder as party, it being solely between Garrison and Bogdanovic-Baron; the subdivision agreement of October 10, 1979, was entered into between Garrison alone the Corporation of the Town of Fort Erie. Possible liability under this extensive agreement could also have been a contributing factor in the appellant and the other shareholders wanting the benefit of the limited liability afforded by Garrison entering into the contract with Fort Erie. While the description of Garrison and Three B & R as investments in the financial statements accompanying the appellant's 1982 return of income is not conclusive it is not, on the other hand, something to be totally disregarded. It is to be weighed in the context of the other relevant evidence. I believe it can be inferred from the evidence that if unfavourable economic conditions had not intervened to ruin Garrison's venture at Fort Erie and it had, as anticipated, realized a profit it would have been distributed to the shareholders as dividends as was done by Three B & R.

I find the shares in Garrison were an investment. They were acquired by the appellant with the intention of deriving income from them by way of dividends out of the profits expected to be realized by Garrison. The intention attributed to the appellant in this regard is by law that of its controlling shareholder, Kingston J. Beamish. But the loss on the shares themselves is the relatively trivial sum of $15.

I also think that the advances made by the appellant and other shareholders under clause 11 are properly to be regarded as advances of working capital to Garrison. The use of the phrase “capital contribution to the Company" in clause 11 of the agreement relates to such advances. The advances were for the purpose of enabling Garrison to operate and meet expenses in the process of creating marketable building lots for sale. The loss on these advances is on capital account: Stewart & Morrison Ltd. v. M.N.R., [1974] S.C.R. 477; [1972] C.T.C. 73; 72 D.T.C. 6049. The advances made on behalf of the defaulting shareholders are in the same category. The classification of the money paid under the guarantee is governed by M.N.R. v. George H. Steer, [1967] S.C.R. 34; [1966] C.T.C. 731; 66 D.T.C. 5481. The facts are that in February 1951 the respondent and one Montague entered into an agreement with W. Buechner and S. Yeske to acquire an interest in Locksley Petroleums Ltd. which had a farm-out agreement with Imperial Oil on a quarter section of land in Alberta. There was an obligation to drill four wells on the land, three of which remained to be financed and drilled when the agreement was made in February 1951. The respondent and Montague agreed to guarantee the company's indebtedness to the Toronto-Dominion Bank up to $125,000, the liability of each of them being limited to $62,500. The consideration which the respondent received for becoming liable on the guarantee was 250 shares of the company and entitlement to certain specified royalties. Because of financial difficulties encountered by the company the respondent was required in 1957 to pay the bank $62,500 under the guarantee. The question was whether he was entitled to deduct this amount in computing his income for 1957. The Supreme Court said no. In delivering the judgment of the Court, Judson, J. said at page 732 (D.T.C. 5482):

I have no difficulty in defining the character of this transaction. The company needed money for the drilling of three wells. The convenient way of supplying this money was by a bank loan with the respondent's guarantee to the extent of $62,500. The guarantee meant that at some time the respondent might have to step into the bank's shoes to this extent. This happened in 1957. He was then subrogated to the bank's position. He subsequently proved as a creditor in the company's bankruptcy and received two dividends—one in 1959 for $6,119 and the other in 1961 for $3,200. The transaction was a deferred loan to the company, part of which was recovered in the bankruptcy. These bankruptcy dividends, contrary to the obiter dictum in the judgment of the Exchequer Court, were not income but a partial recovery of a capital loss. They are in no way analogous to the consideration received in 1951 as the respondent's remuneration for the guarantee, which I have characterized as a deferred loan.

It is enough therefore to decide this case to say that in my opinion the loss here is a loss of capital and that its deduction is prohibited by Section 12(1)(b) [now s. 18(1)(b)] of the Act.

With respect to the legal and consulting fees, nothing was placed before the court which could form a basis on which to set aside the respondent's assumption on reassessing that these payments were on account of capital.

The foregoing is sufficient to dispose of this appeal in favour of the respondent. But as counsel for the appellant understandably relied on the relatively recent decision of the Federal Court-Trial Division in Cull v. The Queen, [1987] 2 C.T.C. 63; 87 D.T.C. 5322, because he found it to bear the closest resemblance to the case at hand, I think I should indicate why, apart from differences in the facts, I have come to a different conclusion from that arrived at in Cull. The reasons for judgment in Cull state that M.N.R. v. Freud, [1969] S.C.R. 75; [1968] C.T.C. 438; 68 D.T.C. 5279 (S.C.C.) is directly applicable to that case. Both Freud and Cull refer to another Supreme Court of Canada decision, Fraser (No. 2) v. M.N.R., [1964] S.C.R. 657; [1964] C.T.C. 372; 64 D.T.C. 5224. The essence of the appellant's position is that its acquisition of the 25 shares of Garrison was an adventure in the nature of trade and this allowed the claimed deductions to be made as losses on current account.

Fraser followed and applied Associated London Properties Ltd. v. Henriksen (H.M. Inspector of Taxes) (1944), 26 T.C. 46, a decision of the Court of Appeal in England. The facts in Associated London Properties are that the company, a trader in real estate, and an individual caused a company to be formed in which each held 50 per cent of the shares. They advanced money to the new company to enable it to purchase a site that the appellant owned as part of its trading inventory and they guaranteed a bank loan to enable the new company to erect a building on the site. When the building was erected the appellant sold its shares in the new company at a substantial profit to the individual who held the other shares. The appellant's position was that the profit arose out of the sale of the shares and not out of the sale of land and as the company did not deal in shares, the profit did not arise from its trade. This was rejected. In delivering the judgment of the Court of Appeal, Lord Greene, M.R. said at page 53:

The Supplemental case contains this finding; "Pursuant to the Order of the King’s Bench Division herein dated 26th October, 1942 we, the Commissioners who heard the appeal, have duly reconsidered our finding in paragraph 8 of the case stated herein. After again considering all the facts and having regard to the inclusion of the profit in the accounts and the prospectus, we find that the profit was made in the ordinary course of the company's trade and therefore liable to tax." In my opinion, that finding is one for which there was ample evidence. When that is said, it seems to me all argument is at an end. In fact the Commissioners are finding, if I may expand the clear meaning of what they say, that, it being the business of the Appellants to deal in real estate, this was the particular method of dealing in real estate which they happened to adopt, and, therefore, must be treated as a method of exploiting its real estate assets just as though they had made a direct sale to a purchaser out and out. There is nothing in law which prevents the Commissioners from finding as a fact that a profit made in these circumstances is to be treated as a profit made in the ordinary course of the Appellants’ business.

In my opinion, this is a pure question of fact. The finding of the Commissioners is binding upon this Court, and they have made no error in law. There was ample evidence to support their finding: therefore, the result is that the appeal must be dismissed with costs.

In Fraser, Mr, Justice Judson who delivered the judgment of the Supreme Court dismissing the appeal from the Exchequer Court gave this “bald outline of the problem” at pages 372-73 (D.T.C. 5224):

The appellant, together with an associate, both of whom were experienced operators in the field of real estate, bought vacant land in 1952, incorporated two companies to hold the land in two parcels, built on one parcel a store in the year 1953 and sold the store shortly before completion to Dominion Stores. The other parcel they sold at about the same time to a single purchaser. The mode of sale in each case was by way of shares, the appellant and his associate being equal shareholders in the two companies. The appellant claims that he made a capital gain. The Minister of National Revenue assessed the profit as income. The judgment of the Exchequer Court was that the profit was income.

I flesh this out by adding that title to 10 acres was acquired in trust for the appellant and his associate by their solicitor on October 31, 1952, and title to an additional 113 acres was acquired in the same way on January 2, 1953. On March 15, 1953, Aidershot Investments Ltd. was incorporated and on June 1, 1953, the Company accepted an offer by the solicitor to sell it 36.17 acres. The land was conveyed to the company and it issued preference shares to the appellant and his associate. They also acquired some common shares. On November 18, 1953, Aldershot Realty Ltd. was incorporated. On March 1, 1954, the balance of the property was conveyed to the company and it also issued shares in the manner just described.

Judson, J. concludes his reasons for judgment in these words at page 376 (D.T.C. 5226):

Some point was made of the fact that the appellant did not in one case sell a store and in the other case vacant land but shares in two companies. I agree with Cameron, J. that this was merely an alternative method that they chose to adopt in putting through their real estate transactions. The fact that they incorporated companies to hold the real estate makes no difference. Associated London Properties, Ltd. v. Henriksen (H.M. Inspector of Taxes) (1942-45), 26 T.C. 46.

Mr. Justice Cameron who heard and disposed of the case in the Exchequer Court, [1963] C.T.C. 130; 63 D.T.C. 1083, said at page 140 (D.T.C. 1088):

Counsel for the appellant stressed the fact that the profits made by the appellant were not made by the sale of the land but by the sale of shares received on the transfer of the land to the two companies. That profit, it is said, is a capital profit. I cannot agree with that submission. In my view, the appellant and Grisenthwaite, instead of selling the land as they might have done, adopted another method, namely, to cause two companies to be incorporated, sell the land for shares in these companies, and then sell the shares so received. That was the particular alternative method they chose to adopt in their real estate transactions.

This is immediately followed by the quotation already cited from the reasons for judgment delivered by Lord Greene in Associated London Properties Ltd.

I note in particular these two matters; first, nothing was said by the English Court of Appeal, the Exchequer Court or the Supreme Court of Canada about the legal nature of the “alternative method" adopted and, second, nothing was said that derogates in any way from the fundamental principle laid down in Salomon v. A. Salomon and Company Ltd., [1897] A.C. 22; [1985-9] All E.R. 33, that a corporation is regarded in law as a legal entity with a personality of its own and it is quite distinct from its shareholders. Salomon was acknowledged a few years later by the Supreme Court in Soper v. Littlejohn (1902), 31 S.C.R. 572 at 578. In Jack Appleby v. M.N.R., [1975] 2 S.C.R 805; [1974] C.T.C. 693; 74 D.T.C. 6514 Mr. Justice Pigeon said at page 698 (S.C.R. 813; D.T.C. 6517):

Ever since Salomon v. Salomon, [1897] A.C. 22, it has been accepted that although the shares of a limited company may be beneficially owned by the same person who also manages it, its business is nevertheless in law that of a distinct entity, a legal person having its own rights and obligations. The Income Tax Act unmistakably implies that this rule holds good for tax purposes.

Although this is said in a dissenting judgment there is nothing in the other judgments that in any way detracts from its validity as a general proposition. In Williams & Humbert Ltd. v. W. & H. Trade Marks Ltd., [1986] A.C. 368; [1986] 1 All E.R. 129, Lord Scarman said at page 429 (AIl E.R. 134):

This heretical submission flies in the face of the principle established in Salomon v. A. Salomon & Co. Ltd. [1897] A.C. 22 and reaffirmed in £.B.M. Ltd. v. Dominion Bank [1937] 3 All E.R. 555, 564-565 [4] where Lord Russell of Killowen said that it was:

of supreme importance that the distinction should be clearly marked, observed and maintained between an incorporated company's legal entity and its actions, assets, rights and liabilities on the one hand and the individual shareholders and their actions, assets, rights and liabilities on the other hand.

In Kosmopoulos v. Constitution Insurance Company of Canada et al., [1987] 1 S.C.R. 2; 34 D.L.R. (4th) 208, Madame Justice Wilson, who delivered the judgment of the majority, said at page 213 (S.C.R. 10):

As a general rule a corporation is a legal entity distinct from its shareholders: Salomon v. Salomon & Co., [1897] A.C. 22 (H.L.). The law on when a court may disregard this principle by “lifting the corporate veil” and regarding the company as a mere "agent" or "puppet" [5] of its controlling shareholder or parent corpora tion follows no consistent principle. The best that can be said is that the "separate entities" principle is not enforced when it would yield a result "too flagrantly opposed to justice, convenience or the interests of the Revenue": L.C.B. Cower, Modern Company Law 4th ed. (1979), at page 112. [6]

Fraser is considered in Freud. The facts in Freud are that the respondent Freud, a lawyer, and one Kettlewell, a tool and die maker, conceived the idea of designing and producing a prototype of a small sports car which would be sold with its specifications to a car manufacturer. A retired engineer named Porritt was also involved. A company was incorporated in Michigan and the project got under way in 1958. Money for it was advanced to the company by the respondent Freud and Kettlewell who held shares in it along with some friends. In 1960 the other shareholders declined to advance additional money to the company. The respondent persisted and in that year spent $13,840 in a “final attempt" to sell "the concept of the small personal sports car embodied in the last prototype which was driveable.” Part of this money was disbursed by cheques to the company and the rest paid directly for labour, material and expenses. The attempt failed and the venture was a total loss. Freud was first considered by the Tax Appeal Board, 37 Tax A.B.C. 303; 65 D.T.C. 110. At the commencement of the reasons for judgment, R.S.W. Fordham, Q.C., said: "This is one of those appeals where the Board would like to grant some relief, but cannot do so, by reason of the state of the law applicable.” He went on at page 304 (D.T.C. 111):

The full evidence adduced has been examined carefully, as well as the case law involved, but I am unable to find any error on the respondent's part. Viewed from whatever angle, I think that the expenditure made must be regarded as a capital outlay that, it was hoped, would bring about a marketable asset, the sale of the right to manufacture which would prove profitable to the appellant. He was in no position, financially, to manufacture the vehicle on his own account. Such a course would have required a vast amount of capital. Evidently—although it is easy for an onlooker to be wise after the event—this was but another instance of the truth of the adage that the cobbler should stick to his last.

The appeal to the Exchequer Court came on for hearing before Mr. Justice Gibson: [1966] C.T.C. 641; 66 D.T.C. 5414. Section 3 of the Income Tax Act in 1960 provided :

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.

In allowing the appeal His Lordship said at pages 643-44 (D.T.C. 5415-16):

As the evidence discloses and which is not disputed, the appellant did not at any time intend that Detroit-National Automobile Company would produce this small personal sports car the concept of which the appellant and Mr. Kettlewell had. Instead they intended to sell the idea and obtain the gain through such sale.

In my view, if the appellant had been successful and realized a profit therefrom, this gain clearly would be income from a source outside the sources specified in Section 3 but within the meaning of "sources" in the opening words of the section. In other words, it would not have been a windfall gain and so not a capital gain.

In my view also, the moneys paid out in 1960 by the appellant were moneys spent by him for the purpose of obtaining an income from a source within the meaning of the opening words of Section 3 of the Act.

The appellant therefore in computing his income for the taxation year 1960 was entitled to deduct the loss from such potential source because it is his net income only in this sense that is taxable (cf. George H. Steer v. M.N.R. (1965) 2 Ex. C.R. 458; [1965] C.T.C. 181; and Wood v. M.N.R., September 7, 1966, unreported).

On the appeal to the Supreme Court this solution was, perhaps understandably, not adopted by it.

In referring to Fraser Mr. Justice Pigeon said in Freud that he considered that decision to rest on the nature of the outlay involved in the acquisition of the shares of Aldershot Investments Ltd. and Aidershot Realty Ltd. by their shareholders. By the nature of the outlay is meant whether the shares were acquired as trading assets or investments. His Lordship then indicates that the basic operation of Aidershot Investments Ltd. and Aldershot Realty Ltd. was the acquisition of land with a view to profit on resale so that the land became a trading asset of the companies. He then goes on at page 442 (D.T.C. 5282): "The conclusion reached [in Fraser) implies that the acquisition of shares in companies incorporated for the purpose of holding such land was of the same nature seeing that upon selling the shares instead of the land itself, the profit was a trading profit not a capital profit on the realization of an investment." Pigeon then states that: “This principle appears equally applicable in the circumstances of this case". This follows on the same page:

If the respondent and his friends had been successful in selling the prototype sports car, they might well have done it by selling their shares in the company instead of having the company sell the prototype, and there can be no doubt that if they had thus made a profit it would have been taxable. Because no sale could be made, respondent and his friends obviously never reached the point at which consideration would be given to the method to be adopted for realizing the profit. This should not alter the situation because the decision in the Fraser case implies that, irrespective of the method adopted, any profit would have been income, not capital gain. Also in that case it must be noted that the companies alone held the land just as in the present case the company owned the prototype sports car.

It is clear from the three sets of reasons for judgment in Freud that the only issue was whether the $13,840.47 was deductible from other income in computing the taxpayer's income for 1960. As already said, part of this amount were advances to the company by cheques and the rest was direct payments for labour, material and expenses. Whatever the loss on the shares of the Michigan company may have been, it was not an issue in the litigation. Because of this it strikes me that all that is said in Freud about the acquisition of shares being an investment or a trading operation is obiter dicta. [7] Mr. Justice Pigeon dealt separately with the $13,840 and whether it, as alleged by the appellant, consisted of outlays on account of capital and hence capital losses. First he noted at pages 442-43 (D.T.C. 5282) that ”. . . the sums paid direct to third parties might well have been considered as voluntary payments and not recoverable." The reasons go on, however, to assume that the entire $13,840 was a debt owing by the company to the respondent and say that: ”. . . this does not necessarily imply that the outlay was an investment. Obligations to pay money can be trading assets just like other things.” This passage at page 443 (D.T.C. 5282-83) follows:

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. [8] 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 the respondent in the last year, when the speculative nature of the undertaking was even more marked

matter is essentially determined by ascertaining the intention of the shareholder in acquiring the shares. In M.N.R. v. Foreign Power Securities Corporation Ltd., [1967] S.C.R. 295; [1967] C.T.C. 116; 67 D.T.C. 5084, Cartwright, J. (later C.J.) speaking for the Court said: "The question (whether shares are an investment or trading assets) is essentially one of fact depending on the intention with which the respondent acquired the shares." Also, to my mind, what is said obiter in Freud about the basic operation of the corporations in Fraser and what is to be implied from the acquisition of shares in those corporations cuts across the principle that a company and its shareholders are separate and distinct legal entities.

than at the outset due to the financial difficulties, cannot be considered as an investment. Whether it is considered as a payment in anticipation of shares to be issued or as an advance to be refunded if the venture was successful, it is clear that the monies were not invested to derive an income therefrom but in the hope of making a profit on the whole transaction.

It is clear from this extract that in the ordinary course a loan made by a person who is not in the business of making loans is an investment and that this rule was not applied in Freud because of what His Lordship regarded as the quite unusual and exceptional circumstances of the case.

Although there was no guarantee involved in Freud, Pigeon, J. considered Steer, supra. He said at pages 443-44 (D.T.C. 5283):

In that case, it was held that a guarantee given to a bank for a company's indebtedness was a deferred loan to the company and that a large sum paid to the bank to discharge this indebtedness was a capital loss. The decision cannot imply that loans are always investments but only that such was the character of the loan in the circumstances of that case because, as we have seen, there are at least three recent cases in this Court where loans were held to be trading operations with the consequence that profits and losses were on income not capital account.

What is said about Steer in Freud in no way suggests that the former was incorrectly decided.

The facts in Cull are that the plaintiff was a member of a partnership in the practice of law at Sudbury. One of the partners, Mr. Desmarais, acted for Messrs Simmons and Lacasse and for their real estate brokerage firm, an incorporated company. In 1974 Simmons and Lacasse secured an option to purchase real estate called the Ravina Gardens property. The next month Simlac Holdings Ltd. ("Simlac") was incorporated and the option was transferred to it. In August 1974 Simlac secured an option to purchase additional real estate called the Fay Bell property. The options were exercised and Simlac acquired the Fay Bell property in November 1976 and it acquired Ravina Gardens in January of 1979. It was intended to subdivide and sell lots from both parcels. In the summer of 1975 Simmons and Lacasse asked Desmarais if he and his partners would be interested in acquiring a one-third interest in the proposed developments The plaintiff was "somewhat of a local expert" in land development and this, along with financial resources the partnership would bring, would benefit Simmons and Lacasse. From the point of view of the partners, apart from anticipated profits from developing Ravina Gardens and Fay Bell, there was a potential for legal business from purchasers of the lots. In August 1976 the plaintiff and his partners purchased 50 shares of Simlac from Simmons and Lacasse and in January 1977 they purchased an additional 50 shares from that source. The price of the shares was $100,000. The other 200 shares remained with Simmons and Lacasse and their wives. On August 10, 1976, the plaintiff became a director of Simlac.

When the plaintiff and his partners acquired the shares of Simlac they guaranteed to the Royal Bank payment of one-third of the debts incurred and to be incurred by Simlac. In October 1977 the bank called for payment of interest in the amount of $30,000. Ten thousand dollars was advanced by the partnership to Simlac for payment of that interest. Additional sums were advanced by the partnership from time to time. In 1979 the partnership paid with borrowed funds $28,400 due under a mortgage on the Fay Bell property.

I am unable to escape the conclusion that in making the sale to Associated Mr. Curlett was disposing of at least a part of his money-lending business and that the sale which he made was a sale of property which was included in the inventory of that business. I am, therefore, of the opinion that it was a sale made 'in the course of carrying on the business' and was income from that business within the meaning of section 3 of the Income Tax Act.

By 1978-79 the development venture was in financial difficulties. In 1979 Simmons and Lacasse each sold 75 shares of Simlac and each new shareholder gave a personal guarantee to the bank for a proportionate amount of Simlac's indebtedness. Problems increased until the partnership and other shareholders were in default with the bank. The bank called on the personal guarantees and it assumed control of the properties. The shares became worthless.

In computing its income the partnership sought to deduct $178,000 in respect of its dealings pertaining to Simlac. One hundred thousand related to the price of the shares and $78,000 to advances made by the shareholders to Simlac and money paid under the guarantee to the bank. The reasons do not indicate the division of the $78,000 between the two. The Minister of National Revenue reassessed on the basis that the losses were of a capital nature.

In her reasons for judgment Madame Justice Reed refers to Fraser and Freud. She quotes from the latter and the quotation includes what I have already said about Freud to the effect that Pigeon, J. observed there that the basic operation of the two companies involved in Fraser was the acquisition of land for resale at a profit so that the land was a trading asset of the companies and that Fraser implies that the acquisition of shares of companies incorporated for the purpose of holding such land is of the same nature. Reed, J. said at page 68 (D.T.C. 5325):

In my view the Freud case is directly applicable to the present situation. The shares in the hands of the partnership were not, as the defendant claims, merely of the usual and normal investment character. They were acquired for the purpose of acquiring an interest in the lands under option and in the development project, for the purpose of making a profit therefrom, either by Simlac selling its assets or by the shareholders selling their shares.

With deference, my understanding is that a person who acquires a share in a corporation does not thereby acquire an interest in land that is an asset of the corporation. The legal interest in the land is exclusively vested in the corporation, not its shareholders, and if a profit is made on the sale of the land that profit belongs to the company and it remains with it until distributed to the shareholders by way of dividends or it is otherwise disposed of. The same applies to an option to acquire land held by a corporation. "A share is intangible property, a chose in action, a relationship between the shareholder and the company involving rights and duties": Thorson, P., Braun v. The Custodian, [1944] Ex. C.R. 30 at page 40; [1944] 3 D.L.R. 412. See also Palmer's Company Law, 23rd (1982) ed. at page 384:

A share in a company is the expression of a proprietary relationship: the shareholder is the proportionate owner of the company but he does not own the company's assets which belong to the company as a separate and independent legal entity.

Reed, J. then says at page 69 (D.T.C. 5326):

Having found that the loss sustained by the partnership with respect to the shares resulted from an adventure in the nature of trade, engaged in through the acquisition of the Simlac shares, the advances should carry the same characterization.

Again with deference, I find nothing in Freud indicating that the characterization of advances made to a company by a shareholder is ipso facto determined to be on current account by a finding that the acquisition of shares in the company was an adventure in the nature of trade. Indeed in Freud where the acquisition of the shares is said to have been "a trading operation” it is stated to be "obvious" that where a loan is made by a shareholder who is not in the business of lending money the loan is ordinarily to be considered as an investment.

In Steer the court did not address itself to the question of whether the appellant had acquired the shares in the company to which the guaranteed loan was made as trading assets in deciding if the loss of the money paid under the guarantee was a capital loss or a business loss. As previously indicated in these reasons Mr. Justice Judson said: "I have no difficulty in defining the character of this transaction." The transaction that he defined was the company's requirement for money to drill three oil wells, the loan of that money to the company by a bank under a guarantee given by a shareholder and payment to the bank under that guarantee. It was a consideration of this that determined that the loss there was a loss of capital.

Her Ladyship goes on to approve deducting the entire $178,000 in computing the income of the partnership.

I have noted on other occasions that I regard myself bound by decisions of the Federal Court—Trial Division. But this is necessarily subject to the caveat that it does not apply when I am satisfied that a judgment of the Federal Court—Trial Division is inconsistent with higher judicial authority to which I must also pay heed. Where I perceive conflict between Cull and such higher authority is:

(a) Steer is a precedent for the proposition that money paid pursuant to a bank guarantee under the circumstances existing in Cull is an outlay on account of capital.

(b) In Freud, Mr. Justice Pigeon said that it is 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. There, in deviating from the general rule, he found ”. . . that the circumstances of the present case are quite unusual and exceptional.” There is no suggestion of the existence of circumstances of that kind in the reasons for judgment in Cull. Nor is there anything in the facts of that case that indicate unusual and exceptional circumstances. The acquisition by taxpayers of shares in corporations involved in the development of real estate is commonplace.

(c) There was no weighing of the evidence to ascertain the intention with which the plaintiff acquired the shares in Simlac and a determination of the fact therefrom of whether the shares were an investment or were acquired as trading assets. This is the essential approach: M.N.R. v. Foreign Power Securities Corporation Ltd., [1967] S.C.R. 295; [1967] C.T.C. 116; 67 D.T.C. 5084. The acquisition of shares of Simlac by the partnership points to an investment: Irrigation Industries Ltd. v. M.N.R., [1962] S.C.R. 346; [1962] C.T.C. 215; 62 D.T.C. 1131.

Reverting now to the matter mentioned at the commencement of these reasons about the appellant amending its notice of appeal to invoke paragraph 20(1)(p) of the Act and Wesco. As will be seen from the footnote there, among the things the appellant must establish in order to succeed is that the loans were made in the ordinary course of its business. The funds advanced by the appellant to Garrison under section 11 of the shareholders' agreement were expressly said in evidence to have been without interest. There is no evidence that there was other consideration payable in lieu of interest. There is no evidence that interest or other consideration was payable in respect of the amounts paid to Garrison on behalf of the defaulting shareholders. The shareholders agreement does not deal with payments made on behalf of defaulting shareholders, it only provides that defaulting shareholders must pay Garrison prime plus four per cent. Also the fact that the appellant paid the bank under the guarantee to it in respect of Garrison's default is not indicative of the appellant being in the business of making loans. The absence of a requirement that interest or some other consideration be payable in respect of loans made eliminates the possibility of a reasonable expectation of profit and consequently the existence of a loan business. In Wesco Judge Garon found that there was an obligation to pay interest in respect of the loans that were treated as bad debts.

The appeal is dismissed.

Appeal dismissed.