REASONS
FOR JUDGMENT
D'Arcy J.
[1]
The Appellant has appealed reassessments in
respect of his 2004, 2005, 2006 and 2009 taxation years. Specifically, the
Appellant is disputing the Minister’s disallowance of amounts he deducted in
respect of legal fees in 2004, 2005 and 2006 when calculating his income from a
business. He is also disputing the resulting reduction of the non-capital loss
he claimed when calculating his 2009 taxable income.
[2]
I heard from two witnesses: the Appellant and Ms.
Lynette Radulski, a Canada Revenue Agency (“CRA”) income tax appeals officer.
[3]
The parties filed two joint books of documents.
The parties agreed that the documents contained in the books are accurate
copies of authentic documents.
However, the parties did not agree on the truth of the contents of the
documents or on the relevance of any documents. As a result, the only documents
I entered were the documents specifically referred to by a witness.
[4]
The parties also filed a short document entitled
“Agreed Facts”.
It is in effect a partial agreed statement of facts (“PASF”). A copy is
attached as Exhibit A to these reasons.
I. Facts
[5]
The Appellant is an entrepreneur. In the early
1990’s he lived in Arizona, in the United States and carried on a recreational
vehicle (“RV”) business and, “did a little bit of real
estate”.
[6]
At some point in the 1990’s, the Appellant and a
Doctor William Holtz began the business of providing services in respect of
casinos operated by Native Americans in Idaho, Washington and California. The
Appellant referred to this as the “Native
American casino business”.
[7]
The Appellant explained his business
relationship with Dr. Holtz as follows: the Appellant did the work and
developed the ideas with respect to the casino business, while Dr. Holtz provided
funding for the business, including the Appellant’s compensation. They shared
equally the profits realized from each of the United States endeavours. This
business appears to have been extremely successful.
[8]
In 2000, the Appellant returned to his home
province of Alberta. He testified that he was looking for opportunities to work
with First Nations in Alberta to develop a gaming industry. I will refer to
this as the Alberta casino business.
[9]
On January 19, 2000, New Buffalo Gaming Inc. (“New Buffalo”) was
registered as an Alberta corporation. The Appellant testified that he
incorporated the company for the purpose of carrying on the Alberta casino
business.
[10]
At the time of incorporation, the Appellant’s
father, Robert Horn, held legal title to 60,000 New Buffalo shares as bare
trustee for the Appellant (30,000 shares) and Dr. Holtz (30,000 shares). Three
individuals, Mr. Wyatt McNabb, Mr. Kevin Markiw and Mr. George Harder held the
remaining 40,000 shares. The Appellant described these three individuals as his
other business partners.
[11]
The Appellant testified that Dr. Holtz received
his shares in New Buffalo as consideration for his promise to provide funding
to New Buffalo. New Buffalo was to use this funding to carry on the Alberta
casino business, including the payment of compensation to the Appellant, Mr.
McNabb, Mr. Markiw and Mr. Harder.
[12]
The proposed compensation is set out in Exhibit
AR-30, which is the minutes of a July 31, 2001 New Buffalo shareholders
meeting. The minutes state that the Appellant is to be paid $14,000 per month.
The Appellant testified that the amount was to be paid to him as a
management/consulting fee. However, as I will discuss, New Buffalo did not pay
a management/consulting fee to the Appellant.
[13]
The Appellant stated that in early 2000 the
Alberta Government did not have a policy with respect to the operation of
casinos by Alberta’s First Nations. The Appellant then began working with the
Alberta Government to develop such a policy and the Alberta Government
eventually did develop policy. The PASF states that the Government of Alberta
approved a First Nations Gaming Policy on or about January 19, 2001. The
Appellant testified that once this occurred New Buffalo entered into agreements
with First Nations at Enoch, Whitecourt and Onion Lake.
[14]
Dr. Holtz did not provide the promised funding
to New Buffalo. As a result, New Buffalo did not have the funds to pay
compensation to the Appellant or to the other three shareholders. It appears
that by mid-2002, Dr. Holtz had informed the Appellant that he had secured
funding from two companies, Chatelaine Funding Corporation and Beau Park
Holdings Ltd. (“Chatelaine/Beau Park”).
[15]
The Appellant, Dr. Holtz, Chatelaine Funding
Corporation, Beau Park Holdings Ltd., New Buffalo, Robert Horn, Mr. Markiw and
a Mr. Zimmer entered into an agreement with respect to the funding of New
Buffalo (the “Memorandum of Agreement”).
The PASF states that the Memorandum of Agreement was effective July 22, 2002.
[16]
Paragraph 1 of the Memorandum of Agreement
states that the purpose of the agreement is to settle the differences between
the Appellant and Dr. Holtz with respect to the finances and ownership of New
Buffalo and between the Appellant, Dr. Holtz and Mr. Zimmer with respect to the
finances and ownership of other entities.
[17]
The Memorandum of Agreement deals with a number
of issues, including the following:
•
The repayment by New Buffalo of a shareholder
loan made by the Appellant’s father (paragraphs 3 and 4)
•
Agreement with respect to the election of directors
of New Buffalo (paragraph 5)
•
The entering into of a Confidentiality and Non-Disclosure
agreement and a Unanimous Shareholders Agreement (paragraphs 6 and 7)
•
The approval of a budget that sets out New
Buffalo’s cash requirement for the first four months of 2002, including $30,000
of salary for the Appellant. The budget also shows the amount of shareholder
loans each shareholder, including the Appellant, is required to make to New
Buffalo. (paragraphs 8 and 9; Schedule “B”)
•
The agreement of Chatelaine/Beau Park to provide
financial assistance to Dr. Holtz and the Appellant so as to allow each of them
to make his required shareholder loan, and to the Appellant “in providing to him an alternate source of
compensation during the time period that New Buffalo is unable to pay him
compensation” (paragraph 11). Paragraph 12
indicates that this compensation will be paid to the Appellant or his company.
The terms of the Chatelaine/Beau Park loan to the Appellant are set out in
Section F of the agreement.
•
A possible loan by Chatelaine/Beau Park to the
Appellant’s management company. Chatelaine/Beau Park will provide the loan if
the Appellant’s management company is providing services to New Buffalo on a “full time basis” and
not receiving compensation for these services. The loan is $7,500 per month and
is to be made until New Buffalo begins paying the Appellant’s management
company a monthly management fee of at least $7,500 per month. (clause (v) of paragraph
15 of Section F)
•
Acknowledgment by the Appellant that, as at the
closing date of the agreement, Chatelaine/Beau Park has loaned him $235,000
(USD) and that the Appellant will provide a personal guarantee for this amount.
(clause (viii) of paragraph 15 of Section F)
•
The agreement by the Appellant to provide his
shares in New Buffalo as security for the loans, to assign his shareholder’s
loan as security and to obtain life insurance in the amount of $1,000,000. (clause
xi of Paragraph 15 of Section F)
•
Agreement with respect to the holding of shares
or equity interests in other entities. The Memorandum of Agreement provides for
Chatelaine/Beau Park to make a loan of $15,000 to a company (referred to
as Quickdraw) that is owned 50% each by the Appellant and Dr. Holtz. (paragraph
16)
[18]
The Appellant testified that the only reason he
entered into the Memorandum of Agreement was to obtain payment of the
management/consulting fees owed to him by New Buffalo. This may be true;
however, the Memorandum of Agreement is clearly a loan agreement pursuant to
which Chatelaine/Beau Park agrees to loan monies to Dr. Holtz, to the Appellant
and potentially to a management company of the Appellant.
[19]
The Appellant testified that Chatelaine/Beau
Park only advanced funds for one month. As a result of Chatelaine/Beau Park’s
failure to advance funds under the Memorandum of Agreement, the Appellant
brought an action in the Superior Court of Arizona for an order rescinding the
agreement (the “Arizona Action”). The Appellant filed the action on June 18, 2003.
The action named Dr. Holtz, Chatelaine Funding Corporation, Beau Park Holdings
Ltd. and Mr. Zimmer as defendants.
[20]
The law firm Dillingham & Reynolds LLP filed
the action on behalf of the Appellant.
[21]
The complaint filed by the Appellant in the
Arizona Action states that Chatelaine/Beau Park and Dr. Holtz “failed to provide the funding agreed to [by the
parties], including the failure to fund Horn’s [the Appellant’s] ‘cash calls’
made by NBG [New Buffalo] and failed to fund Horn’s [the Appellant’s]
management company $7,500 per month . . . ”.
[22]
In the complaint the Appellant requests that the
Memorandum of Agreement be rescinded, that Dr. Holtz transfer his 30,000 shares
in New Buffalo to the Appellant’s trustee, that Chatelaine/Beau Park release
its security interest in the Appellant’s New Buffalo stock and that the
Appellant be released from his personal guarantee to Chatelaine/Beau Park.
[23]
During his testimony in chief, the Appellant
stated that in the summer of 2003 he brought a second action. He testified that
he brought this action in the Court of Queen’s Bench of Alberta. The Appellant
testified that the purpose of the action was to have funds paid to New Buffalo so
as to enable New Buffalo to pay for the Appellant’s services.
[24]
On cross-examination, it became clear that the
Appellant did not bring an action in the summer of 2003. Rather,
Chatelaine/Beau Park filed an action in the Court of Queen’s Bench of Alberta
against the Appellant and a company he controlled, 976344 Alberta Ltd., and an
action against the Appellant’s spouse (the “Chatelaine/Beau
Park Actions”). I was not provided with the
originating filings in these actions.
[25]
However, the parties did file an order made by
the Court of Queen’s Bench of Alberta on February 8, 2006 in the Chatelaine/Beau
Park Actions.
It appears from this order that the two actions related to the security
provided by the Appellant under the Memorandum of Agreement, to the payment of
monies by New Buffalo to the Appellant and to the payment of funds by the
Appellant to Chatelaine/Beau Park.
[26]
The Appellant’s testimony with respect to court
filings in the summer of 2003 damaged his credibility.
[27]
The Appellant testified that he did, at some
point in time, file an oppression action in the Court of Queen’s Bench of
Alberta. On cross-examination, counsel for the Respondent took the Appellant to
an originating notice he filed in the Court of Queen’s Bench of Alberta on June
24, 2005
(the “Oppression Action”).
The Appellant acknowledged that this was the oppression action in question.
[28]
The Appellant named New Buffalo and its
shareholders - Dr. Holtz, Mr. Markiw and Mr. Harder - as the respondents in
his application. The application asks for relief on the ground of oppression or
unfairness pursuant to section 242 of the Business Corporations Act of
Alberta.
[29]
The parties to this appeal filed an order of the
Alberta Court of Queen’s Bench dated December 20, 2005 (the “December 20, 2005 Order”)
made in the Oppression Action. The order addresses compensation, the adoption
of an expense policy, the amounts of shareholder’s loans, and the payment of
dividends.
[30]
With respect to compensation, the December 20,
2005 Order directs New Buffalo to pay to each of the Appellant, Mr. Markiw, Mr.
Harder and Dr. Holtz specified monthly amounts beginning on January 1, 2006 and
to pay a lump sum amount to each of those individuals for compensation that was
in arrears.
[31]
With respect to the Appellant, the December 20,
2005 Order directs New Buffalo to pay to him a monthly amount for the period from
January 1, 2006 to June 30, 2006, and then to pay him a monthly consulting
fee based on time worked, subject to a $10,000 monthly maximum. The order
directs New Buffalo to pay the Appellant $882,000 for arrears of compensation.
[32]
On February 7, 2006, the Appellant incorporated
1221385 Alberta Ltd. (“122 Ltd.”). He was the sole director and shareholder.
The Appellant testified that 122 Ltd. did not hold shares in New Buffalo. As
evidenced by Exhibit AR‑29, beginning in February 2006, 122 Ltd.
billed New Buffalo for consulting services provided by the Appellant to New
Buffalo. Apparently, the Appellant provided these services on behalf of 122
Ltd.
[33]
The Appellant implied that once New Buffalo paid
the invoiced fee to 122 Ltd., 122 Ltd. paid the amounts to the Appellant
as a management fee. As I will discuss, 122 Ltd. only paid a small portion of
the invoiced fees to the Appellant.
[34]
One of the Alberta casino projects that New
Buffalo was working on opened in 2006. This resulted in New Buffalo receiving
significant funds. As a result, New Buffalo started paying to 122 Ltd. the amounts
owed in respect of the invoices.
[35]
On January 23, 2008 a number of parties,
including the Appellant and Dr. Holtz, entered into a settlement
agreement.
The agreement settled a number of disputes between the parties. In particular,
the settlement agreement resulted in the Appellant, his spouse, 122 Ltd. and
another numbered company signing a release which ended all legal actions they
had previously filed against Beau Park and Chatelaine in Arizona and Alberta. Beau Park and Chatelaine
signed a similar release with respect to any actions they had brought against
the Appellant, his spouse and the two numbered companies.
[36]
The parties agree that the Appellant incurred
substantial legal fees in respect of the Arizona Action, the Chatelaine/Beau
Park Actions and the Oppression Action. As noted in subparagraphs k and n of
paragraph 12 of the Amended Reply, when assessing the Appellant the Minister
assumed that the Appellant paid legal fees in respect of the Alberta “lawsuit”
and the Arizona “lawsuit” (the “Legal Fees”) as follows:
|
|
Alberta lawsuit
|
Arizona lawsuit
|
Total
|
|
|
|
|
|
|
2004
|
$40,267
|
$69,054
|
$109,321
|
|
2005
|
$13,362
|
$80,881
|
$ 94,243
|
|
|
$50,229
|
$72,755
|
$122,984
|
|
|
|
|
|
[37]
The Appellant accepted these amounts at
paragraph 21 of his written submissions.
II. Positions
of the Parties
[38]
The Appellant argued that he incurred the Legal
Fees for the purpose of earning income from a business.
[39]
The Appellant further argued that he incurred
the Legal Fees for the primary purpose of causing the payment by New Buffalo of
consulting/management fees. The services provided by the Appellant in
consideration of the consulting/management fees were a distinct business of the
Appellant.
[40]
Although the litigation also concerned the
return by Chatelaine/Beau Park of the Appellant’s hypothecated shares of New
Buffalo, counsel argued that this was an ancillary or secondary purpose of the
litigation.
[41]
The fact that some of the fees may have been
paid by New Buffalo to 122 Ltd. and then by 122 Ltd. to the Appellant does
not, it was submitted, render the legal fees too remote for the purposes of
paragraph 18(1)(a) of the Income Tax Act (Canada) (the “Act”).
[42]
The Respondent argued that the legal fees were
not deductible on the basis that the Appellant did not incur them for the
purpose of gaining or producing income from a business; rather they were
incurred to protect a capital asset, that asset being the Appellant’s New
Buffalo shares.
[43]
She noted at paragraph 22 of her written
memorandum that, “there is no direct connection
between the Appellant’s business income and the legal fees claimed in 2004, 2005
and 2006. This necessary connection is absent, therefore legal fees are not
deductible by virtue of s.18(1)(a) of the ITA.”
[44]
The Respondent also argued that the Legal Fees
constitute a payment on account of capital. The fees were incurred to protect against
and to stop the wrongful foreclosure on the Appellant’s New Buffalo shares.
Counsel for the Respondent argued that “all of
the litigation was, in fact, to protect the share equity and that made it a
capital asset of” the Appellant.
III. Summary
of Law
[45]
Pursuant to section 9 of the Act, a taxpayer’s
income from a business is his profit from that business for the year, subject
to various adjustments and limitations provided for under the Act.
[46]
The first relevant provision is paragraph
18(1)(a). It provides that no deduction shall be made in respect of an outlay
or expense except to the extent that it was made or incurred by the taxpayer
for the purpose of gaining or producing income from the taxpayer’s business.
[47]
The Supreme Court of Canada stated in Symes v.
Canada,
at page 376 (58 C.T.C. 6014 OTC), that the test in paragraph 18(1)(a) is
straightforward: did the taxpayer incur the expense in question for the purpose
of gaining or producing income from a business?
[48]
The Supreme Court of Canada noted the importance
of objective evidence when making this determination:
As in other areas of law where purpose or intention
behind actions is to be ascertained, it must not be supposed that in responding
to this question, courts will be guided only by a taxpayer's statements, ex
post facto or otherwise, as to the subjective purpose of a particular
expenditure. Courts will, instead, look for objective manifestations of
purpose, and purpose is ultimately a question of fact to be decided with due
regard for all of the circumstances. . . .
[49]
In Ironside v. The Queen, my colleague
Justice Campbell, after referring to the Supreme Court of Canada decision is Symes,
stated that whether or not the purpose of an expenditure is to produce income
is a question of fact. She noted that the decision with respect to purpose
centres on the issue of “connectivity” between the need which the expense meets and the
business itself.
[50]
The second relevant provision with respect to
determining the profit of the Appellant under section 9 is paragraph 18(1)(b).
It provides, in part, that no deduction shall be made in respect of an outlay,
loss or replacement of capital or a payment on account of capital.
[51]
The Federal Court of Appeal in Imperial
Tobacco Canada Ltd. v. The Queen. noted that the Court should approach
paragraph 18(1)(b) as follows:
The statutory prohibition on the deduction of a
payment on account of capital requires consideration of the principles for
distinguishing capital and income. The determination is driven primarily by the
facts of the particular case, with the cases providing guidance on the factors
to be taken into account. . . .
IV. Application
of Law to Facts
[52]
I will first address the legal fees paid in
2004, 2005 and 2006 in respect of the Arizona Action. This was an action to
rescind the Memorandum of Agreement on the basis that Chatelaine/Beau Park and
Dr. Holtz had not made the loans contemplated in the agreement. In particular,
the Appellant alleged that Chatelaine/Beau Park had not made the contemplated
loans to him and his management company and Dr. Horn had not made the
contemplated shareholder loans to New Buffalo.
[53]
After reviewing the objective evidence before
me, the Memorandum of Agreement and the complaint filed by the Appellant in the
Arizona Action, I have concluded that the Appellant’s primary purpose in
bringing the Arizona Action was to have Chatelaine/Beau Park release its
security interest in the Appellant’s New Buffalo stock and release the
Appellant from his personal guarantee. As a result, the Legal Fees paid in
respect of the Arizona Action were not paid for the purpose of earning income
from a business carried on by the Appellant. They were paid to gain “clear”
title to a capital asset, namely the Appellant’s New Buffalo shares, and to
remove a personal guarantee.
[54]
I will now consider the legal fees paid in
respect of the Chatelaine/Beau Park Actions. On the basis of the objective
evidence before me, i.e., the February 8, 2006 order of the Court of Queen’s
Bench of Alberta, I have concluded that the primary purpose of this action was
to enforce the security provided by the Appellant under the Memorandum of
Agreement. In other words, by defending the action the Appellant was protecting
his interest in his New Buffalo shares.
[55]
As a result, the Legal Fees paid in respect of
the Chatelaine/Beau Park Actions were not paid for the purpose of earning
income from a business carried on by the Appellant. They were paid to protect
the Appellant’s title to a capital asset, his New Buffalo shares.
[56]
The primary purpose of the Oppression Action was
to protect the Appellant’s interests in New Buffalo; the Legal Fees with
respect thereto were not paid for the purpose of earning income from a
consulting business carried on by the Appellant.
[57]
I accept that the December 20, 2005 Order
directs New Buffalo to pay compensation and compensation arrears in respect of
services performed by the Appellant. However, the Appellant rendered these
services on behalf of 122 Ltd. Any benefit relating to the payment of these
amounts accrued to 122 Ltd. and not to the Appellant. In fact, as I will
discuss, in 2006, 122 Ltd. paid the Appellant less than $125,000 of the
approximately $568,000 it invoiced New Buffalo.
[58]
With respect to the Appellant’s argument that he
incurred the Legal Fees for the purpose of earning income from a business of
providing services to New Buffalo, there is no evidence before me that he
earned income from such a business.
[59]
It is not even clear to me what the nature of
the business that the Appellant carried on during the relevant period was. When
assessing the Appellant, the Minister made the following assumptions with
respect to the source of the Appellant’s income during the relevant years:
-
The only income earned by the Appellant in 2004
was from the business of selling recreational vehicles.
-
The Appellant earned no income from any source
in 2005.
-
In 2006, the Appellant earned consulting fees
from Voyager RV Ltd. and management fees from 122 Ltd.
-
At no time did the Appellant report any income
from New Buffalo.[18]
[60]
The Appellant, during his testimony, implied
that he personally rendered services in 2004 and 2005 to New Buffalo in
consideration of a consulting/management fee. This testimony is not consistent
with the evidence before me. As I will discuss, the evidence before me is that
the Appellant never received consulting/management fees from New Buffalo.
[61]
The only income the Appellant reported on his
2004 income tax return was income from a business and a capital gain from the
sale of shares.[19]
The Statement of Business Activities shows gross sales, commissions or fees of
$609,500, a cost of goods sold of $506,529 and numerous expenses, including
delivery, freight and express, maintenance and repair, and office expenses.
[62]
The Appellant at first denied selling
recreational vehicles after he returned to Canada. However, on
cross-examination, after being taken to his 2004 tax return, he admitted that
he did, as a sole proprietor, carry on in 2004 the business of selling
recreational vehicles in Canada.[20]
He stated that he required the money to support his family.
[63]
The Appellant’s testimony with respect to the
business he carried on in 2004 seriously damaged his credibility. I have placed
no weight on his testimony with respect to the source of his 2004 income.
[64]
I have concluded, on the evidence before me, that
the only income the Appellant reported on his tax return in 2004 was income
from the business of selling recreational vehicles and a capital gain.
[65]
The parties did not file the Appellant’s 2005
income tax return. In fact, the Appellant did not present evidence to refute,
even on a prima facie basis, the Minister’s assumption that the
Appellant earned no income from any source in 2005.
[66]
The parties did file the Appellant’s 2006 tax
return.[21]
The only income (loss) shown on the return is a loss from business activities
of $20,747. The Statement of Business Activities shows gross income of
$125,000.
[67]
It is not clear from the evidence before me what
the source of that gross income was. The Appellant testified that at least a
portion of the gross income represents consulting fees paid to him by his
company, 122 Ltd. However, a portion of the income may also represent fees paid
by Voyager RV Ltd.
[68]
As I discussed previously, during 2006, 122 Ltd.
issued invoices to New Buffalo for consulting services. These invoices exceeded
$568,000. I have assumed that 122 Ltd. paid a portion of the $568,000 to the
Appellant as consulting fees. It is not clear to me what the actual amount paid
was, but it was less than $125,000, which is the gross business income reported
on the Appellant’s 2006 tax return.
[69]
In summary, the Appellant reported income in
2004 from a business of selling recreational vehicles, no income in 2005 and
income from providing consulting services to 122 Ltd. and Voyager RV Ltd. in
2006. As the Minister assumed, the Appellant reported no income from providing
services to New Buffalo.
[70]
Further, the compensation arrears referred to in
the December 20, 2005 Order were paid in 2006 to 122 Ltd., not the Appellant.[22]
[71]
The objective evidence before me does not
support a factual finding that the Appellant carried on a business of rendering
consulting or management services to New Buffalo during the relevant period.
The Appellant may have carried on a business of providing services during this
period, but the evidence before me is that, when the Memorandum of Agreement
was signed in 2002, he rendered such services to a management company, which in
turn rendered the services to New Buffalo, and that he also worked as an
employee of New Buffalo. Beginning in 2006, he rendered such services to 122
Ltd., which in turn rendered the services to New Buffalo.
[72]
The Legal Fees were not incurred for the purpose
of earning income from services the Appellant provided to his management
company. The Appellant incurred the Legal Fees to protect his shareholdings in
New Buffalo and in an attempt to be released from his personal guarantee.
[73]
For the foregoing reasons the appeal is
dismissed, with costs to the Respondent.
Signed at Antigonish, Nova
Scotia, this 5th day of September 2017.
“S. D’Arcy”
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