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Citation: 2004TCC485
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Date: 20040709
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Docket: 2000-1962(IT)G
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BETWEEN:
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HANS LONGERICH,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
O'Connor, J.
[1] The issue in this appeal is
whether the Appellant is entitled to an allowable business
investment loss ("ABIL") in the 1994 taxation year. The
facts and the position of the Minister of National Revenue (the
"Minister") are set forth in the Reply to the Notice of
Appeal. Subject to certain additions which I have made for
clarity the relevant provisions of the Reply state the
following:
7. In
computing his income for the 1994 taxation year, the Appellant
claimed a business investment loss ("BIL") in the
amount of $233,342.00, and an allowable business investment loss
("ABIL") in the amount of $175,006.00. [It is to be
noted that at the hearing the figure $175,006.00 was agreed to be
$172,110 which is 3/4 of a total amount of $229,480 which is
comprised of $210,480 allegedly advanced to W.T.F. Canada and
$19,000 allegedly advanced to Klehini Resources as discussed
later.]
8. By Notice
of Reassessment dated August 3, 1999, the Minister reassessed the
Appellant's 1994 taxation year disallowing the BIL and
ABIL.
9. The
Appellant filed a Notice of Objection, dated October 12,
1999, to the reassessment.
10. The Minister confirmed
the reassessment of the Appellant's 1994 taxation year by
Notification of Confirmation dated January 28, 2000.
11. In so reassessing the
Appellant for the 1994 taxation year, the Minister relied on,
inter alia, the following assumptions of fact:
a) the facts
admitted and stated above;
b) the
Appellant claimed the ABIL with respect to an investment in
W.T.F. Canada Ltd. ("W.T.F. Canada") and Klehini
Resources Ltd. ("Klehini Resources");
c) at all
material times, W.T.F. Canada and / or Klehini
Resources did not carry on an "active business" or a
"business" as those terms are defined in subsection
248(1) of the Act;
d) at all
materials times, W.T.F. Canada and Klehini Resources were not
small business corporations within the meaning of 248(1) of the
Act;
e) the
Appellant was not owed a debt by W.T.F. Canada and / or Klehini
Resources, or any other Canadian-controlled private corporation
that was a small business corporation;
f) the
Appellant was not owed a debt by Canadian-controlled private
corporation that was a small business corporation that became a
bad debt at the end of the 1994 taxation year;
g) the
Appellant did not incur a debt for the purpose of gaining or
producing income from a business or a property or as
consideration for the disposition of capital property to a person
which whom the Appellant was dealing at arm's length;
h) the
Appellant did not make an election pursuant to subsection 50(1)
of the Act with respect to a debt or share(s);
i) the
Appellant was not a shareholder of W.T.F. Canada and / or Klehini
Resources;
j) the
Appellant was not a shareholder of a small business corporation
in any of the circumstances outlined in paragraph 50(1)(b) of the
Act;
k) in 1994 the
Appellant did not dispose of a share in the capital stock of a
small business corporation; and
l) the
Appellant did not incur a business investment loss in the 1994
taxation year.
B. ISSUES TO BE DECIDED
12. The issue is whether
the Appellant is entitled to a business investment loss and, if
so, for what amount.
C. STATUTORY PROVISIONS RELIED ON
13. He relies, inter
alia, on sections 3, 9, subsections 50(1), 125(7),
248(1), paragraphs 38(c), 39(1)(c), and
subparagraph 40(2)(g)(ii) of the Income Tax Act,
R.S.C. 1985, c. 1 (5th Supp.), as amended.
Submissions of the Appellant
[2] The Appellant takes issue with all
of the conclusions of the Minister set forth in the Reply. He
argues that he made the investment believing it was made with the
two Canadian corporations mainly W.T.F. Canada and Klehini
Resources and that they were small business corporations within
the meaning of subsection 248(1) of the Income Tax
Act (the "Act"). He also submits that
although he did not have shares in these companies the amounts he
advanced represented a debt even though there was no loan
documentation and no interest payable. He definitely suffered the
loss he states and the loss should be allowable as an ABIL in
1994 as he never received shares or any monies or other
funds.
[3] He also submits that he was
"duped" that the companies involved were in the active
business of defrauding him. He refers to the decision of the
Federal Court of Appeal in Her Majesty the Queen v. William H.
Johnston, dated April 25, 2001, where the Federal Court
of Appeal upheld a decision of the Tax Court of Canada,
Johnston v. Canada, 2000 DTC 1864, [2000] 2 C.T.C. 2602
(TCC), aff'd 2001 F.C.A. 122, 2001 DTC 5300 (F.C.A.). In that
case Bell J, found that an elaborate scheme of fraud being
carried out by certain corporations could qualify. Bell, J. at
paragraph 59 and following of the Tax Court decision summarized
the applicable provisions as follows:
[59] I agree with the Appellant's submission that he is
entitled to an allowable business investment loss. Section
38(c) provides that:
a taxpayer's allowable business investment loss for a
taxation year from the disposition of any property is 3/4 of his
business investment loss for the year from the disposition of
that property.
Section 39(1)(c) provides that:
a taxpayer's business investment loss ... from the
disposition of any property is the amount ... by which his
capital loss for the year from a disposition ... to which
subsection 50(1) applies ... of any property that is ... a debt
owing to the taxpayer by a Canadian-controlled private
corporation ... that is a small business corporation ...
Section 50(1)(a) provides that where:
a debt owing to a taxpayer at the end of a taxation year ...
is established by him to have become a bad debt in the year ...
the taxpayer shall be deemed to have disposed of the debt ... at
the end of the year for proceeds equal to nil ...
Section 40(2)(g)(ii) provides that:
a loss from the disposition of a debt ... unless the debt ...
was acquired by the taxpayer for the purpose of gaining or
producing income from a business or property ... is nil.
[60] Although the agreement in
question provided for a loan by the Appellant "to the joint
venture" the money was advanced to WSL "for and on
behalf of the joint venture". The Appellant is the only
party of the two parties to the Venture who advanced monies and
it was advanced to the other party. The agreement provided for
the issue of a promissory note by WSL evidencing the advance of
funds and provided further if WSL was unable to purchase the
inventory, it would promptly return the funds to the Appellant.
The promissory note made and delivered by WSL referred to the
joint venture agreement and set forth that it was subject to the
terms and conditions and provided that it was payable in
accordance with the terms of that agreement. I conclude that the
debt so acquired by the Appellant from WSL upon the loan of
$57,000 was acquired for the purpose of gaining or producing
income from a "business or a property". He had had four
previous joint venture experiences with WSL, each of which
produced a return greater than his advance. My conclusion that he
was not carrying on business is not inconsistent with this
determination, it being present to his mind that he was advancing
the sum of $57,000 for the purpose of gaining or producing
income. It matters not whether the income was to come from
business or property. If the income from the Appellant's four
previous ventures was income from a business it follows that a
loss from the fifth venture should be a business loss. I have
decided that it was not. If, however, the income from the
previous ventures was income from property the loss from the
fifth venture, identical in form, must be a loss from property
and accordingly, a capital loss.
[61] To qualify as a
"business investment loss" in 1993 the Appellant must
have a capital loss on the deemed disposition of debt which
became bad in that year. The Respondent's Amended Reply to
the Notice of Appeal reads in part:
In assessing the Appellant for the 1993 taxation year, the
Minister of National Revenue ... disallowed the deduction of the
ABIL and advised the Appellant that he has a capital loss in the
amount of $25,540.
In his submission, Respondent's counsel did not dispute
the existence of a capital loss. Rather, he tried to convince the
Court that the debt giving rise to the loss was not WSL's
debt, that WSL was not a "small business corporation"
within the meaning of section 39(1)(c) and that the debt
was not acquired to earn income, with the result that the
Appellant's loss would be deemed under section
40(2)(g)(ii) to be nil. The Respondent admitted in the
Reply to the Notice of Appeal that WSL was a Canadian-controlled
private corporation. I must determine whether it was a 'small
business corporation' as required by that section. The term
'small business corporation' is defined
in section 248 of the Act as
a Canadian-controlled private corporation all or substantially
all of the fair market value of the assets of which were used
principally in an active business carried on primarily in Canada
by it.
[62] The term "active
business", also defined in section 248, means any business
carried on by a taxpayer other than a specified investment
business or personal services business. It is clear that
WSL's activities did not constitute a "specified
investment business" or a "personal services
business". I accept the submissions of Appellant's
counsel that WSL was in the active business of defrauding. The
fact that such activities were criminal does not prevent them
from being characterized as a 'business' for income tax
purposes. [FOOTNOTE 5 : M.N.R. v. Eldridge,
64 DTC 5338; Buckman v. M.N.R., 91 DTC 1249.] During
the period in question WSL had employees, premises, warehouses
and inventory and was engaged in buying and selling merchandise.
It also had money, albeit advances from persons entering joint
ventures. These assets were used to perpetrate fraud on those
persons. I conclude, therefore, that WSL was using its assets in
the business of enticing and defrauding co-venturers. I am
satisfied from the foregoing that WSL was a small business
corporation owing a debt to the Appellant which debt was acquired
for the purpose of gaining or producing income from a business or
property. I am also satisfied that such debt was deemed to have
been disposed of in 1993 for proceeds equal to nil, thus
constituting a business investment loss within the meaning of
section 39(1)(c) of the Act.
[63] Accordingly, the
Appellant's first submission that the loss suffered in
respect of the fifth joint venture was a deductible
non-capital loss fails. His alternative submission that he
was entitled, in respect of the loss, to an allowable business
investment loss under section 3 and the above noted provisions,
succeeds.
[64] The appeal is allowed with
costs.
[4] The first submission of counsel
for the Respondent refers to subsection 50(1) of the
Act which reads as follows:
50.(1) Debts established to be bad debts and shares of
bankrupt corporation. - For the purposes of this subdivision,
where
(a) a debt owing to a taxpayer at the end of a taxation year
(other than a debt owing to the taxpayer in respect of the
disposition of personal-use property) is established by the
taxpayer to have become a bad debt in the year, or
(b) a share (other than a share received by a taxpayer as
consideration in respect of the disposition of personal-use
property) of the capital stock of a corporation is owned by the
taxpayer at the end of a taxation year and
(i) the corporation has during the year become a bankrupt
(within the meaning of subsection 128(3)),
(ii) the corporation is a corporation referred to in section 6
of the Winding-up Act that is insolvent (within the
meaning of that Act) and in respect of which a winding-up order
under the Act has been made in the year, or
(iii) at the end of the year,
(A) the corporation is insolvent,
(B) neither the corporation nor a corporation controlled by it
carries on business,
(C) the fair market value of the share is nil, and
(D) it is reasonable to expect that the corporation will be
dissolved or wound up and will not commence to carry on
business
and the taxpayer elects in the taxpayer's return of income
for the year to have this subsection apply in respect of the debt
or the share, as the case may be, the taxpayer shall be deemed to
have disposed of the debt or the share, as the case may be, at
the end of the year for proceeds equal to nil and to have
reacquired it immediately after the end of the year at a cost
equal to nil.
[5] Counsel argues that since no
election was made (and this was established) the Appellant cannot
claim an ABIL. I will return to this submission later. Although
the Appellant did claim an ABIL in his return he did not file the
subsection 50(1) election and therefore cannot qualify. Counsel
adds, "I simply wanted to put forth to you, that the
necessity of having an election was a conscious parliament choice
because it was actually added by way of amendment to apply to
1994 onward. So, it - before that subsection 50(1) didn't
actually have the necessity of having to make an
election".
[6] Counsel for the Respondent
submitted further:
And firstly, that is that the - it's the Appellant who has
the onus here to establish that the Minister's re-assessment
is wrong and that he's entitled to the business investment
loss that he has claimed. And it's not for the Minister to
disapprove his entitlement.
As indicated in the pleadings filed with the Court in the
Minister's Reply to Notice of Appeal, it is denied that the
corporations involved constituted small business corporations at
the relevant time. Moreover, it's also denied that the
corporations owed a debt to Mr. Longerich again at the relevant
time.
And so Mr. Longerich to succeed in his appeal would have to
rebut those assumptions and satisfy the Court that each element
required for a business investment loss has been satisfied.
[7] Another point made by counsel for
the Respondent is that the Appellant simply did not put forward
enough evidence to establish that he was entitled the ABIl which
he claims. She points out further:
The issue here then is not did Mr. Longerich lose money and,
therefore, he gets a business investment loss. If he can
establish that he lost money for the business of gaining or
producing income from the business or property, he might very
well be entitled to a capital loss.
But that is not what he is seeking, and so simply demonstrating
that he invested money, in whatever the form, which is a little
less than clear of how the process was to work, and in what
format he was supposed to get his money back, he indicates he was
supposed to get all of his money back.
[8] Counsel submitted further as
follows:
It's the submission of the Respondent that despite the fact
that the money granted was made payable initially to the Canadian
corporation, ultimately, where the money is going is the Hong
Kong corporation.
And by virtue of the documents it's the Hong Kongcorporation
that has the legal obligation to return the funds, if that's
what you're constituting as a loan to Mr. Longerich.
The Hong Kong corporation, of course, no matter what its activity
can't constitute a small business corporation in that
it's not a Canadian - - Canadian - - controlled private
corporation for the purpose of the business investment loss.
And, again, I realize that Mr. Longerich's testimony, his
intention might have been otherwise and it wasn't to go
through Hong Kong. His intention in this regard though
doesn't change the fact that it would appear that the money
is actually going to Hong Kong.
Recognizing that there's some inconsistencies between the
testimony and the documentation and even in and among the
documentation, I would simply submit that - - that that should
not lead to a finding then to simply accept what the test - -
what Mr. Longerich is stating because in this case it's
not that there's no documentation, he simply comes forth and
says, I have no documents believe me, and you make a finding
accordingly. Rather, he, himself has produced documents which run
contrary to what he says his understanding was of the
transactions at the time.
Moreover, as we heard at some length, no one knows what happen to
the money; which on one (1) hand isn't necessarily
determinative. However, on the other hand, if you think of it
this way, it certainly doesn't support that there was an
active business going on in Canada at that time. We hit a wall.
The money was given to W.T.F. Canada at that time and then no one
knows what - - what happens to the money.
I'm not submitting that that somehow meant that he wasn't
giving the money for a business purpose, but, it certainly fails
to establish that there was an active business at that time here
in Canada.
And I would submit the fact that W.T.F. Canada appeared to have
been collecting money from investors, including
Mr. Longerich; that collection of investment in and of
itself doesn't constitute an active business here in
Canada.
[9] With respect to the
Johnston decision (supra) counsel for the
Respondent submits as follows:
...
Mr. Longerich then goes on to state that W.T.F. Canada was in
the business of fraud and for that proposition he referred to -
he referred Your Honour to the case of Johnston and Her Majesty,
and that's a Federal Court of Appeal decision in 2001.
In that matter, the Federal Court of Appeal looked at the Tax
Court of Canada decision in which the Tax Court had allowed the
taxpayer an allowable business investment loss with respect to a
fraudulent pyramid scheme. And the Federal Court of Appeal stated
that they were unable to conclude that the Tax Court Judge
erred.
So, there is no more substantive reason in the Federal Court of
Appeal matter which - so for which you should then look to the
Tax Court decision for a more fulsome analysis of what exactly
transpired in that case.
...
In this particular matter, Justice Bell did allow the Appellant
an allowable business investment loss on the basis that the
corporation at issue was involved in a fraudulent pyramid scheme.
And that was the nature of its business, and that was the
business that was actually going on in Canada. And that's how
he found it to be an active - an active business at that
time.
Now, of course, this, although granted without further analysis,
this was affirmed, if you will, by the Federal Court of Appeal.
So, insofar as the Federal Court of Appeal has apparently said
there's a possibility that if you can establish that a
business is actually in the business of fraud, and that
that's how it can constitute an active business then, yes,
that's what this stands for, and that's - that's the
basis Mr. Longerich is putting forth before you.
However, I would draw several distinctions between the facts
before this Court and the evidence that was led before Justice
Bell, in which he made his findings.
In this particular matter before you today, we have nothing more
than Mr. Longerich's assertion that, in hindsight, he might
have been duped, possibly it was fraud, and I note he used the
word "possibly", and he could be no more certain than
that.
The evidence before you is simply that he never got his money
back. But there's no more evidence as to what happened to it
after it was given to W.T.F. Canada.
And in fact, on that point, I confirmed with Mr. Longerich,
that it's equally possible that the money goes to Hong Kong
and then for whatever array of business reasons, business breaks
down at that point. That doesn't mean it's fraud, and I
think that's important to note.
It's a pretty serious allegation to come into Court with
nothing more to say, well, because I lost my money, I think that
corporation was in the business of defrauding me. ...
But simply because a taxpayer has lost money does not establish,
for the Court, on a balance of probabilities, that the entire
scheme was nothing but a deliberate fraud, perpetuated upon the
investors, and that fraud was taking place in Canada, such that
W.T.F. Canada is suddenly now an active business, because
there's no evidence of any other business going on at that
time.
In this particular decision, there were a number of witnesses who
were called, and it was a very sophisticated fraud, and it - - it
goes on at length, at the type of deception that was involved.
...
... the point of - - of my distinguishing from this particular
case is simply that, if Your Honour reviews this decision, the
type of evidence that was before it to allow a Court to make a
finding of fraud was a world away from the evidence you have
before you.
Because all you have before you is the fact that
Mr. Longerich lost his money, he doesn't know what
happened to it and it was possibly fraud. I would submit that on
the evidence before you the onus has not been established - -
sorry, the onus has not been met - that he has established that
this was a fraudulent scheme, such that can be said that that was
- - that actually constituted the business of W.T.F. Canada.
[10] With respect to Klehini Resources
counsel for the Respondent established that the maximum amount
that could be considered to have been advanced to Klehini
Resources was $19,000 and it was established that Klehini was a
Canadian corporation. Counsel further pointed out that there was
no proof that an active business was being carried on in Canada
by Klehini. The Appellant gave evidence that a rather extensive
mining operation was being carried on by Klehini but there was no
further evidence submitted with respect thereto and she concludes
that the Appellant is not entitled to the amount with respect to
Klehini. Counsel for the Respondent concludes as follows in her
submissions:
In closing then, I would simply repeat the fact that it's
not just about whether Mr. Longerich suffered a loss and that
there is a capital loss if he just suffered a loss which
otherwise qualifies for a capital loss but that he is seeking
something more and that being -- to be able to offset, obviously,
business investment loss against all other income.
I just keep repeating that point, because I think it's
important that it not be watered down, and -- and certainly the
Court, and anyone can have great sympathy for Mr. Longerich that
he lost the money, but that that's not -- that's not the
-- the issue before the Court, that he lost the money and that he
thought something different was going to happen with it.
As I indicated, the purpose only goes so far as whether or not
the debt even qualifies insofar it was made for the proper
purpose.
But once you get into an analysis of whether a corporation was a
small business corporation, then unfortunately
Mr. Longerich's purpose, his intention no longer is
determinative to whether or not the corporations were small
business corporations at the relevant time. Those are my
submissions.
Analysis and Decision
[11] In my opinion the submissions of
counsel for the Respondent are correct. I suggest the
following are the main factors:
1. The monies although
initially advanced to W.T.F. Canada, in essence were funnelled to
a Hong Kong corporation and clearly could not be traced to an
investment in an active business in Canada.
2. The Appellant had the onus
of proof and he was far from meeting that onus.
3. For the reasons given by
counsel for the Respondent the Johnstondecision is
distinguishable. Moreover a fraud actually being carried out by
W.T.F. Canada was not established and all we know is that the
Appellant lost his money. It may have been his intention that the
money would be funnelled back to an active business corporation
carrying on a business in Canada but that intention is not
sufficient when it is not followed up by the actual confirming
facts.
4. In my opinion
subsection 50(1) of the Act requiring an election for an
ABIL to be accepted must be complied with and this was not done
whether with respect to W.T.F. Canada or Klehini Resources.
[12] For all of the above reasons the appeal
is dismissed with costs.
Signed at Ottawa, Canada, this 9th day of July 2004.
O'Connor, J.
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