Date: 20000301
Docket: 98-514-IT-G
BETWEEN:
WILLIAM H. JOHNSTON,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bell, J.T.C.C.
ISSUES:
[1]1. Whether the Appellant, in his 1993 taxation year,
suffered a non-capital loss in the amount of $57,000 arising from
a "joint venture"; and
2. Whether in the absence of entitlement to a deduction of
that amount as a non-capital loss, the Appellant is entitled to
claim an allowable business investment loss in respect of
same.
FACTS:
[2] I will outline a number of statements from the agreed
facts and supplement it with viva voce evidence.
[3] The parties filed a Partial Statement of Agreed Facts.
This was supplemented by the testimony of the Appellant and
several other participants in "joint venture
operations".
[4] One Wayne Sheldon Leard ("Leard") incorporated a
number of corporations, two of which were WSL Sales Inc.
("WSL") and Wayne S. Leard Holdings Inc.
("Holdings"). Those two corporations perpetrated an
elaborate scheme to defraud people who were willing to advance
money to a large number of joint ventures.
[5] Leard, or one of the companies would have persons furnish
a cheque in accordance with the terms of a joint venture
agreement for which the co-venturer would receive a promissory
note and a post-dated cheque. Within a relatively short period,
such as thirty-five to forty-five days, a representative of Leard
or his company would retrieve the post-dated cheque and give a
cheque representing the return of the initial advance plus an
additional sum to the co-venturer. Additional co-venturers were
attracted on this basis. The monies received by Leard or his
companies under the joint venture agreements were often used for
his personal purposes and to pay previous co-venturers the return
of their advance plus an additional sum.
[6] The fraudulent scheme employed by Leard and his companies
was to convince people to invest in purchases of bankrupt or
surplus merchandise to be re-sold in a short period of time for a
profit. Ninety percent of these transactions did not, in fact,
occur. Leard and his companies perpetrated the fraud by
purchasing commodities, renting warehouses to store same, hiring
employees, and selling commodities below purchase price in order
to provide a facade to support, or lend credibility to, the
fraudulent scheme. This "pyramid" scheme involved about
230 participants.
[7] The Appellant entered into five separate joint ventures
with WSL in 1992. At no time did that company intend to fulfil
any of its obligations under the agreements. No merchandise was
in fact acquired in accordance with the terms of the fifth joint
venture.[1] It is
agreed that it is uncertain whether any merchandise was acquired
pursuant to the first four joint venture agreements.
[8] The Appellant had no knowledge of the fraudulent scheme
when making his fund contributions under the joint venture
agreements. In respect of each of the first four joint ventures,
the Appellant contributed a certain amount of money and received
an amount a short time thereafter in excess of the contribution.
The total sum received under those first four joint venture
agreements, in excess of his contributions, was $31,460.
[9] Copies of the five joint venture agreements were filed
with the Court. In each case, the agreement was between WSL and
William Johnston. Those agreements provided respectively that WSL
had experience in purchasing inventories in bulk and in reselling
such inventory in bulk on a timely basis and that it and Johnson
had agreed to form a venture for the purpose of purchasing and
reselling such inventory. Pertinent portions of the fifth
agreement, being representative, read as follows:
Purpose
WSL and the Co-Venturer hereby form a joint venture for the
purpose of purchasing and then reselling inventory ... described
below:
Purchase of wax paper
Loan
Each of the Co-Venturer and WSL agrees to fund the operations
of the venture by loaning to the joint venture the amount set
opposite their respective names on or before the date set forth
below:
[10] There followed the amount of the loan and the date of
same by both the co-venturer and WSL. Additional provisions of
the Agreement are described below in connection with the
promissory note given under the fifth joint venture.
[11] The document continued with a number of responsibilities
and operations required of the co-venturer. It then set forth
agreements of the co-venturer, namely, to assist WSL in
developing the selling and marketing strategy, to assist WSL in
generating sales leads and to consult with WSL from time to time
in respect of all aspects of the joint venture business.
[12] The five joint venture agreements included the
following:
Guarantee
Wayne S. Leard ... hereby guarantees that the Co-Venturer
shall receive payment of his loan in full and in the event after
distribution of the net revenues of the joint venture, the loan
of the Co-Venturer has not been repaid in full, Leard shall
promptly pay any deficiency. It is understood and agreed that
Leard is guaranteeing repayment of the loan made by the
Co-Venturer to the joint venture as a primary debtor and not as a
surety.
[13] The following five agreements dealt with, in order, the
purchase of aloe vera lotion, Tops N Trends, sewing machines,
Raleigh products and finally, in the fifth venture, wax paper.
The fifth joint venture was entered into by WSL Sales and the
Appellant on December 14, 1992. It provided for the contribution
of $57,000 by the Appellant. Whereas there was no contribution
amount prescribed for WSL in this agreement, the amounts of WSL
and the Appellant in each of the preceding four agreements were
as follows:
May 20, 1992 agreement Co-venturer $25,000 loan
WSL $37,500 loan + taxes etc
July 5, 1992 agreement Co-venturer $30,000 loan
WSL $560,200 loan
August 28, 1992 agreement Co-venturer $35,000 loan
WSL $1,215,000 loan
October 13, 1992 agreement Co-venturer $50,000 loan
WSL $890,000 loan
December 14, 1992 agreement Co-venturer $57,000 loan
WSL $
[14] Leard and his companies were petitioned into bankruptcy
in April, 1993, the scheme having fallen apart because of
Leard's inability to raise the funds to continue paying
investors in his pyramid schemes.
[15] The Trustee in Bankruptcy recovered amounts of money from
investors who made gains in dealing with Leard or his companies
and such amounts have been distributed to creditors.
[16] The Appellant, in computing income for his 1993 taxation
year, claimed a business investment loss in the amount of $25,540
and deducted 75 percent thereof, namely, $19,155 as an allowable
business investment loss ("ABIL") in respect of his
fifth and final joint venture. The sum of $25,540 was arrived at
by deducting $31,460, received as amounts in excess of his total
contributions for the first four ventures, from the amount
contributed by him, namely $57,000. The Minister of National
Revenue ("Minister") disallowed the ABIL deduction and
advised the Appellant that he had a capital loss in the amount of
$25,540. The Appellant then filed a Notice of Objection for this
1993 taxation year claiming $25,540 as a business loss.
[17] In evidence, the Appellant stated that he had never been
asked to assist WSL in any way in the joint ventures in which he
was involved. He stated that his understanding of the splitting
of profits was that he would receive 50 percent thereof and WSL
would receive 50 percent. He never asked for financial reports.
He stated that nothing during the entire period caused him to be
suspicious. He said that he did not notice that no contribution
was specified for WSL in the fifth joint venture agreement. He
also said that his ultimate actual loss was $55,008 because he
received, of the $57,000 advanced, the amount of $1,992 as a
distribution. He also testified that he understood that Leard
was, as set forth in the report of the Trustee in Bankruptcy,
buying high and selling low and that that kind of activity could
not produce profits. He said that he did not know what Tops N
Trends were or whether they were acquired. He admitted that he
knew nothing other than that he had been told that he might make
money by investing with WSL Sales. He said he knew nothing about
the activities conducted by Leard.
[18] Johnston also said that his understanding of the nature
of the co-venture agreement was that he would put up a certain
amount of money, that WSL would do the same and that he would
receive a percentage of the profits. He stated further that if
the goods weren't purchased:
Then I would receive my money back if the goods were not
acquired.
[19] He said that he had been at WSL's warehouse on one
occasion and saw camcorders, garbage bags, cutlery, exercise
bikes, television sets and other merchandise that was coming and
going. He also stated that he saw employees working there,
bringing things in and shipping things out. He said that he
substantially relied upon a friend of many years, Brian
McDonnell, whom he described as a very astute businessman. He
said that he felt that others would have done due diligence and
named four people who were "well-known business
people".
[20] The fifth joint venture agreement is shown as having been
made as of the fourteenth day of December, 1992. The Appellant
was given a promissory note which reads as follows:
PROMISSORY NOTE
$57,000
For value received the undersigned, WSL Sales Inc., for and on
behalf of the joint venture (the "Joint Venture")
referred to in the joint venture agreement (the "Joint
Venture Agreement") made as of the 14th day of
Dec, 1992 between the undersigned and William Johnson (the
"Holder") hereby promises to pay to the Holder the
principal sum of Fifty Seven Thousand Dollars ($57,000) Dollars
without interest thereon.
This promissory note is the promissory note referred to in
clause 2 of the Joint Venture Agreement and accordingly is
subject to the terms and conditions contained in the Joint
Venture Agreement.
The principal sum of this promissory note shall be due and
payable in accordance with the terms of the Joint Venture
Agreement.
This promissory note may not be assigned by the Holder without
the prior consent of the Joint Venture.
The undersigned for and on behalf of the Joint Venture hereby
waives presentment for payment, demand, notice of dishonour,
protest and notice of protest.
WSL SALES INC. for and on behalf of the
Joint Venture
By "Wayne
Leard" c/s
Duly Authorized Officer
[21] Clause 2 of the Joint Venture Agreement stated that:
All funds so advanced shall be made payable to WSL for and on
behalf of the joint venture and WSL upon receipt of the funds
shall hold such funds in trust for the joint venture and shall
issue on behalf of the joint venture, a promissory note
evidencing the advance of funds.
[22] One of the terms of the Joint Venture Agreement to which
the promissory note was subject is paragraph 3 which reads as
follows:
Term
The term of the joint venture shall be from date of signing
this agreement until the date that the Inventory has been
disposed of and the final distribution and report has been made
by WSL to the Co-Venturer. It is anticipated that the term of the
joint venture shall not exceed twelve months. If WSL has been
unable to purchase the Inventory, WSL shall promptly return the
funds received from the Co-Venturer and this agreement and the
joint venture shall be at an end.
[23] Also produced to the Court in respect of the fifth joint
venture agreement was a photocopy of a cheque from Wayne S. Leard
Holdings Inc. dated January 23, 1993 to the Appellant for $57,000
"re: Wax Paper". The Appellant stated that he thought
the wax paper wasn't purchased and that his money was being
returned. He also stated that he did not take the cheque to the
bank because Jack Asbury, who worked with Leard, asked the
Appellant to hold the cheque for a couple of weeks as they were
having financial problems. He stated that he later heard
"that the wheels had fallen off the whole company" and
that the cheque was invalid, he did not take it to the bank
because he felt that there would be no funds to cover it.
[24] On cross-examination, the Appellant with respect to
inventory, had the following exchange with Respondent's
counsel:
Q. I understand, but you understand from the agreed facts that
the parties have arrived at, after investigations and the like,
that 90 percent of these joint venture agreements were
productive of no inventory at all?
A. Yes. That's so stated in the -- yes.
Q. And you also understand that the remaining ten percent were
used by Mr. Leard and his companies as, in effect, window
dressing so that he might perpetrate the fraud. Isn't that
the case?
A. Yes.
Q. And you understand as well that in many cases Mr. Leard
would pay one joint venturer with the product that he had
obtained from another joint venturer?
A. Yes.
Q. And you understand as well that Mr. Leard apparently paid
amounts in excess of what he then sold product for?
A. It looks like it, yes.
Q. So he paid high and sold low, all to create the facade of a
business activity?
A. It looks like that's the way it was happening.
Q. And you have no doubt that if a business were carried on in
that way, that it could not be productive of profits could
it?
A. It could not.
Q. And it could not also be productive of profits if Mr. Leard
was continually using one joint venturer's advance to pay
another, could it?
A. No, it couldn't.
Q. Eventually, he would run out of people that would be
prepared to contribute to these joint venturers, isn't that
the case?
A. I think that has happened.
[25] He stated that he had not investigated Leard or his
companies very carefully, but that he relied on others.
[26] Here follows another portion of the exchange between
Respondent's counsel and the Appellant:
Q. Were you provided with a statement from WSL as to what the
Tops N Trends were?
A. No, I was not.
Q. You don't even know today what Tops N Trends are, do
you?
A. No, I do not know.
[27] He then stated that he did not know whether they were
acquired, that he was not given any financial statements setting
out the profit on that joint venture, that he did not know
whether the return received was referable to any business
activity, that he did not know the price of the inventory, that
he did not know the intended selling price of the inventory and
that he knew nothing other than the fact that he had been told
that he might make some money by investing with WSL. He said that
he never put his mind to why WSL would enter into an agreement
where it was contributing $560,000 and he was contributing
$30,000 only and that the profits were to be shared on an equal
basis. He said that he gave no thought to his potential
contribution of effort to sales, that he had not asked Leard
about that and that he was completely passive in regard to this
joint venture. The Appellant then admitted that he was somewhat
blinded by greed in his dealings with WSL.
[28] The Appellant acknowledged that the buying and selling of
merchandise in the circumstances that existed would never have
created a profit. With respect to the fifth joint venture under
review the following exchange between Respondent's counsel
and the Appellant took place:
Q. Now, there is a suggestion in your Notice of Appeal that
there was a debt owed you by WSL in 1993 of $57,000?
A. Yes.
Q. How do you say that debt arose?
A. Well, I just gave them a cheque for $57,000 to purchase wax
paper, which fell through.
Q. Well, you don't say that there was any wax paper that
Mr. Leard or WSL ever intended to buy do you?
A. No, I don't know.
Q. So you gave Mr. Leard or his company $57,000 and they
intended to pocket it?
A. I guess you could say that yes.
...
Q. ... At no time did you lend $57,000 to the company, did
you? You loaned it to the joint venture, didn't you?
A. The joint venture, yes.
Q. And if there was a debt to the company it arose because of
its failure to carry out the terms of the joint venture. I gather
that's what you say?
A. Yes.
Q. So you would agree that you did not acquire that debt for
the purpose of earning income?
[29] This question was met by an objection from
Appellant's counsel on the basis that it was a legal
conclusion.
[30] Appellant's counsel produced Brian McDonnell as a
witness. He gave evidence concerning his due diligence in
checking Leard and visiting the premises where Leard/WSL had
assets of all kinds for sale with 25 or 30 employees being busy
dealing with these assets.
[31] A Mr. Lacey, who gave evidence on behalf of the
Appellant, among other things described the nature of the
merchandise operation of Leard/WSL directed, obviously, to
establishing the fact that it seemed legitimate.
[32] A Mr. Suchard gave similar evidence describing the
locations where "every kind of inventory imaginable"
was presented. His other evidence is not of assistance in the
determination of the Appellant's issues.
[33] Respondent's counsel read into evidence certain
portions of his examination of the Appellant. In that material,
the Appellant said that he had made no enquiries as to why WSL
was to contribute a different amount to the joint venture from
his contribution and yet was to receive only 50 percent of the
return. With respect to the aloe vera lotion joint venture, the
Appellant said that he did not know what WSL was to contribute
and was unable to say that any such lotion was purchased. He
stated also that he had received no financial statements
respecting the joint ventures. He said that he did not know
whether there was ever a purchase of Tops N Trends and that he
did not know what that presumed inventory was.
[34] The following exchange took place:
Q. So far as you know, Mr. Leard, through WSL, simply took
your money?
A. Yes.
Q. And he could have done anything with it as far as you
know?
A. Yes.
[35] The Appellant stated that he did not know what Raleigh
products were purchased and, indeed, whether any were ever
purchased. The Appellant also said that the wax paper transaction
did not take place and this exchange respecting the fifth joint
venture took place:
Q. I notice that in this case there is no reference to any
contribution by WSL at all. Do you see that?
A. Yes, I do.
Q. Did you enter into this agreement on the basis that you
were to provide $57,000 and WSL was to provide nothing?
A. I can't remember.
Q. Let me put it this way. Have you any information which
would indicate that WSL had an obligation to make any
contribution?
A. I'm not sure.
Q. Is this the full and complete agreement that was entered
into in December of 1992?
A. Yes.
MR. GALWAY: To the best of our knowledge.
THE DEPONDENT: To the best of my knowledge it is
Q. ...Do you have any other source of information, and apart
from the terms of the joint venture agreements themselves, in
regard to this venture?
A. No, I don't.
...
Q. Do you have any knowledge of any business plan in respect
of Leard or his companies?
A. No.
A. Were you provided with any prospectus in regard to your
investment?
A. No.
[36] The Appellant then said that he did not know what it was
going to cost to acquire the inventory, did not know the sale
price, did not know whether Leard or his companies invested any
money, didn't do any work as contemplated by the contract and
did not know what enquiries others had made to satisfy themselves
that Leard was reliable.
APPELLANT'S SUBMISSIONS:
[37] The Appellant claims entitlement to the deduction of a
"business loss"[2] in the sum of $57,000 for his 1993 taxation year
arising out of his fifth joint venture agreement with WSL.
Alternatively, the Appellant seeks deduction of 75 percent of the
sum of $57,000 as an allowable business investment loss under
sections 38(c), 39(1)(c), 40(2)(g)(ii) and
50(1)(a) of the Income Tax Act
("Act").
[38] Respecting his first submission, Appellant's counsel
submitted that the Appellant's activities were "an
adventure or concern in the nature of trade" within the
meaning of the description of "business" in section
248(1) of the Act. It reads as follows:
"business" includes a profession, calling, trade,
manufacture or undertaking of any kind whatever and ... an
adventure or concern in the nature of trade but does not include
an office or employment.
[39] He submitted that a single transaction may constitute an
adventure or concern in the nature of trade and referred to
Jake Friesen v. H.M.Q., 95 DTC 5551. In that case, the
Appellant and others acquired a parcel of vacant land for the
sole purpose of reselling it for a profit. When the property
decreased in value, Friesen deducted the decline in value as a
business loss relying on section 9, 10(1)[3] and 248(1) of the Act. The
Supreme Court of Canada found that the venture was a
"business" within the definition of that word,
constituting an adventure in the nature of trade.
[40] Counsel then referred to the oft cited case of M.N.R.
v. Taylor, 56 DTC 1125 in which the Exchequer Court
of Canada enumerated tests for the determination of whether
Taylor's purchase and sale of 1,500 tonnes of lead was an
adventure or concern in the nature of trade. At 1137 Thorson, P.
said:
I am also of the view that it is not possible to determine the
limits of the ambit of the term or lay down any single criterion
for deciding whether a particular transaction was an adventure in
trade for the answer in each case must depend on the facts and
surrounding circumstances of the case. But while that it so it is
possible to state with certainty some propositions of a negative
nature.
[41] He stated that it is the nature of the transaction, not
its singleness or isolation, that is to be determined. He said at
1139 et seq:
... if the transaction is of the same kind and carried on in
the same way as a transaction of an ordinary trader or dealer in
property of the same kind as the subject matter of the
transaction it may fairly be called an adventure in the nature of
trade. ...
And there is the further established rule that the nature and
quantity of the subject matter of the transaction may be such as
to exclude the possibility that its sale was the realisation of
an investment or otherwise of a capital nature or that it could
have been disposed of otherwise than as a trade transaction.
[42] He also said that it is not essential that an
organization be set up to carry a transaction into effect, and
that a transaction being different from other activities of the
taxpayer does not, of itself, exclude it from being an adventure
in the nature or trade. He stated further that dealing with a
commodity the same way as a dealer, is a relevant factor and that
the nature and quantity of the subject matter of a transaction is
also relevant.
[43] Counsel then referred to Friesen v. Canada [1995]
T.C.J. No. 922 (T.T.C.). The Appellant became a real estate agent
in 1948. In 1974 he began operating a land development business
and was carrying it on at the date of the hearing. He had a
history of dealing, as a principal, in real estate. In 1983 or
1984 he met a Terry Jacobs ("Jacobs") on a cruise.
Jacobs sought money from Friesen to effect the sale of three of
five houses he was buying in Seattle. Friesen went to Seattle,
met a prospective purchaser of a house, and upon return to
Winnipeg, sent Jacobs a cheque for $10,000. Later, having
received a frantic telephone call from Jacobs respecting a
difficulty with the property and having been informed by Jacobs
that another $12,000 would enable him to effect the purchase of
another property, the Appellant sent a cheque for that sum to
Jacobs. Jacobs simply stole Friesen's money. The Tax Court
found that Friesen made a joint venture with Jacobs with respect
to the initial house, which venture extended to the second
property. It concluded that the money was used in the course of
business and the Court found that Friesen was entitled to a
deduction.
[44] Appellant's counsel then referred to Kosowan v.
Canada [1996] T.C.J. No. 683 in which this Court
determined that money advanced by the Appellants for a
questionable business venture that did not succeed were advanced
for the purpose of obtaining a profit that was purely
speculative. It stated that if a profit had been obtained that it
would be taxable and that, accordingly, the sums advanced were
considered as outlays for gaining income from an adventure in the
nature of trade.
[45] Appellant's counsel then referred to Kleinfelder
v. M.N.R., 91 DTC 913. In that case this Court found that
monies advanced for the purchase and sale of automobiles and
subsequently lost, the transaction never having taken place, were
not deductible. Appellant's counsel, conceding that this case
appeared not to be helpful to his cause, attempted to distinguish
same by quoting this Court in support of his statement that there
was "no formal agreement in place" and that "there
was no real organizational structure in place to carry out the
transaction. He sought to support his position by referring to
the Court's words "vague and imprecise", found in
the following portion of the Reasons for Judgment, at 916:
The transaction of buying the automobiles never took place,
marketing never took place and the evidence about how the actual
business was to be carried on was vague and imprecise. The
infusion of capital by the Appellant was to start the business
but that business operation never started. ... The monies were
not expended by the partnership for the purpose of gaining or
producing income in that, the other partner ... misdirected the
funds.
[46] Appellant's counsel said:
The only other point, Your Honour, that I would like to make
here is that my friends focussed on the fact, well, the joint
venture didn't carry on business. Here, I am referring to
paragraph 14 of my factum. The fact is the focus has to be not on
the joint venture. The focus has to be on Mr. Johnston's
intentions, Mr. Johnston's activities and whether there is
some organizational structure in place to carry this thing
through.
[47] His statement in his factum is:
It is submitted that the focus of the Court's analysis
should centre on Mr. Johnston's actions and intentions, and
the organizational structure in place, not on whether the joint
venture was actually completed.
[48] Counsel then turned to a discussion of the concept of
reasonable expectation of profit. He was addressing the
Respondent's alternative submission that without a reasonable
expectation of profit the Appellant could not be seen to have
carried on business. For the reasons outlined below, I will not
pursue his submissions in this regard.
[49] Finally, Appellant's counsel presented his
alternative submission, namely, that the Appellant was entitled
to a business investment loss as defined in section 39.
RESPONDENT'S SUBMISSIONS:
[50] Respondent's counsel referred to Moldowan v.
R., 77 DTC 5213 and quoted from 5215 as follows:
Although originally disputed, it is now accepted that in order
to have a "source of income" the taxpayer must have a
profit or a reasonable expectation of profit. Source of income,
thus, is an equivalent term to business: ...
There is a vast case literature on what reasonable expectation
of profit means and it is by no means entirely consistent. In my
view, whether a taxpayer has a reasonable expectation of profit
is an objective determination to be made from all of the facts.
The following criteria should be considered: the profit and loss
experience in past years, the taxpayer's training, the
taxpayer's intended course of action, the capability of the
venture as capitalized to show a profit after charging capital
cost allowance. The list is not intended to be exhaustive.
[51] He then said that the above tests must apply and that
what the taxpayer may feel or think is not an appropriate test.
Counsel referred to Kleinfelder, supra, quoting the
following portions, namely:
The transaction of buying the automobiles never took place,
marketing never took place, and the evidence about how the
business was to be carried on was vague and imprecise. The
infusion of capital by the Appellant was to start the business
but that business operation never started ...
[52] Counsel submitted that that was the situation with the
present Appellant and went on to quote from Kleinfelder as
follows:
... The monies were not expended by the partnership for the
purpose of gaining or producing income in that the other partner
Mr. Gee misdirected the funds.
The capital expenditure by the Appellant was not an outlay or
an expense for the purpose of gaining or producing income from
the business in which the taxpayer was engaged.
The taxpayer was not engaged in the business of loaning money.
The monies were advanced to start a business that never started
operation; the alleged partner misdirected the funds. The
promissory note was issued by the alleged partner to give some
assurance to the Appellant for the capital monies advanced and
not as a business activity of loaning money.
[53] Counsel then referred to the agreement in the transaction
giving rise to this appeal. He stated that the Appellant entered
into this agreement in December, 1992, that he did not know what
WSL's contribution was going to be[4], did not know what the cost of wax
paper, the subject matter of the venture, would be, did not know
whether there was an intended buyer, did not know the price at
which the wax paper might be sold and did not know what expenses
might be expected to be incurred in marketing the wax paper. He
submitted, as in Kleinfelder, that capital was advanced
but was not used to buy wax paper. He stated that no business was
ever commenced by WSL and the Appellant as it related to wax
paper but that the monies were taken from the Appellant and he
was defrauded of same exactly as occurred in Kleinfelder.
He referred to the underlying flaw in the agreement which a
prudent person would have ascertained without much thought,
namely the disproportionate contribution under other agreements
with a 50 percent return to the Appellant. He submitted that, in
effect, the Appellant did not inquire as to the reason for such
disproportionate contributions, did not know whether any of the
goods that were the subject of the joint venture agreements had
ever been purchased, what their cost had been, what price they
were to be sold at and what expenses would be incurred in
relation to them. He stated that the Appellant had the right to
obtain financial statements but never sought them. He further
stated that the Appellant did not even know the nature of the
inventory in the second and fourth joint ventures. He said that
the Appellant did not provide assistance to the joint venture as
contemplated by its terms and did not ask why he had been called
upon so to do. He stated further that the Appellant did not
consult with WSL from time to time as required by the terms of
the contract. Counsel submitted that Johnston simply advanced the
money and in a short period thereafter, received money. With
respect to the joint venture giving rise to the loss of $57,000
he said:
... if you then look at the joint venture agreement dealing
with the purchase of wax paper, how is it ever possible for Mr.
Johnston to obtain a profit from having participated in that
joint venture when the funds are never used to buy the very
subject matter of the joint venture?
[54] Counsel then referred again to the Moldowan
decision with reference to "an objective determination"
and "the capability of the venture as capitalized to show a
profit after charging capital cost allowance". He also
referred to the absence of a "business plan",
apparently in the Respondent's continued presentation in many
cases, an important ingredient in determining whether a business
existed.
[55] Finally, on this point, counsel said that the alleged
partner misdirected the funds and the promissory note was issued
"to an alleged partner to give some assurance to the
Appellant for the capital monies and not as a business activity
of loaning money". He concluded as follows:
In my submission, that ought to be the end of the matter when
it comes to the question of a business loss. There was no
activity which could be said constituted a business.
The fact that Mr. Leard was a skilful con artist does not
change the underlying facts as they related to Mr. Johnston's
involvement in the joint venture agreement of December 14, 1992.
It may provide an explanation as to why Mr. Johnston has been
defrauded, but it does not create a business undertaking that Mr.
Johnston entered into on December 14 of 1992...
[56] Respondent's counsel then responded to the alternate
position of the Appellant, namely that he was entitled to an
allowable business investment loss if he failed in his
submissions respecting a non-capital loss. He submitted that the
Appellant did not dispose of a share of the capital stock of a
small business corporation and that the funds advanced by the
Appellant to the joint venture were advanced as a loan to the
joint venture, not to a small business corporation. He said
further that the Appellant did not dispose of a debt owing to the
Appellant by a Canadian-controlled private corporation that was a
small business corporation and if it did make such disposition
the loss would be deemed to be nil unless the debt was
"acquired for the purpose of gaining or producing income
from a business or property". He said that the debt arose
from the fact that the joint venture was not carried out and that
the Appellant therefore had a right to the return of his monies.
He submitted that there was security for that right by virtue of
the promissory note but that the note did not provide for payment
of interest. He concluded that when the Appellant acquired the
debt, he did not acquire it for the purpose of earning income but
simply had a right, because of fraud, to make a claim against WSL
for return of those monies. Counsel also submitted that the
Appellant did not invest, either by equity or debt, in WSL with a
view to obtaining profits from its illegal activities. He said
that a debt arose from the failure of WSL to carry out the terms
of the agreement and that it was not, therefore, acquired by the
Appellant to earn income.
ANALYSIS AND CONCLUSION:
[57] I have concluded that the Appellant was not engaged in
the conduct of a "business" as that term is described
in section 248 of the Act, namely:
"business" includes a profession, calling, trade,
manufacture or undertaking of any kind whatever and ... an
adventure or concern in the nature of trade but does not include
an office or employment.
The Appellant entered into five separate and distinct joint
ventures, the fifth of which gave rise to the loss under
examination in this appeal. The Partial Statement of Agreed Facts
reads, in part, as follows:
At no time did WSL Sales intend to fulfil any of its
obligations under any of the five joint venture agreements. While
the five joint venture agreements contemplated the purchase and
sale of certain merchandise, no merchandise was in fact acquired
in accordance with the terms of the fifth joint venture and it is
uncertain whether any merchandise was in fact acquired pursuant
to the first four joint venture agreement (sic), or whether these
transactions were part of the facade described in paragraph 4
above.
That facade was described as purchasing commodities, renting
warehouses to store such commodities, hiring employees and
selling commodities below purchase price in order to provide
support to, or lend credibility to, the scheme. The Appellant
advanced money "to the joint venture". No inventory was
purchased. The Appellant made no enquiries about the acquisition,
acquisition cost, sale cost or indeed with respect to any other
aspect of the alleged venture. He had no knowledge of the
contribution of WSL and made no enquiry of WSL about the absence
from the agreement of any amount to be contributed by it. WSL did
not conduct any business whatever with respect to wax paper but
simply took monies from the Appellant and ultimately defrauded
him as it did others. The Appellant did not seek financial
statements from WSL and provided no assistance to the joint
venture and made no enquiries as to why he was not called upon to
do so. Although there is no such legal entity as a joint venture,
the "venture" in this case was one in name only with
absolutely no business activity giving it any status or
legitimacy.
[58] I do not accept the submissions of Appellant's
counsel that the Appellant was involved in an "undertaking
of any kind whatever". In the decision of Friesen in
this Court, the Appellant, who lost money to a fraud artist, had
been a real estate agent and was operating a land development
business when he decided to participate in the prospective
purchase of real property in Seattle and in respect of which he
lost the funds advanced. In Friesen (S.C.C.), the
Appellant had actually, together with others, acquired a parcel
of vacant land for the purpose of resale at a profit. No similar
condition exists in this case. Indeed, the Kleinfelder
decision, in my opinion, was not only correct on its facts but is
supportive of my conclusion here. The purchase of automobiles
never took place, marketing never took place and no business
operation was commenced. No wax paper was purchased, no marketing
of same took place and no business respecting same was commenced.
I come to this conclusion relying on the facts and with no
reference to or reliance upon Respondent counsel's
submissions regarding no reasonable expectation of profit which
has, in my opinion, nothing to do with the determination of
whether a business existed in this case.
[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 ¾ 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 a 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.[5] 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.
Signed at Ottawa, Canada this 1st day of March,
2000.
"Bell"
J.T.C.C.
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