Michael Bendall v. Her Majesty the Queen, [1995] 2 CTC 2172, 96 DTC 1626

Bonner J.T.C.C.:-The appellant appeals from assessments of income tax for the 1984, 1985 and 1986 taxation years. In his returns of income for those years the appellant sought to deduct business losses of $20,314.13, $411.58 and $40,095.50 respectively from what was described as a retail sales business. The composition of the losses was as follows:

On assessment the Minister of National Revenue (’’Minister”) disallowed the deduction of the losses. Broadly speaking the Minister took the position that the appellant did not carry on any business and that, to the extent that the appellant incurred expenses, he did not do so for the purpose of gaining or producing income. It was the view of the Minister that the appellant was a participant in a ’’tax scheme" designed to create the illusion that business was carried on at a loss and thus to secure a tax reduction.

The arrangement in which the appellant participated has already been the subject of litigation. I refer to the decisions of the Federal Court-Trial Division and the Federal Court of Appeal in Moloney v. Canada, [1989] 1 C.T.C. 213, 89 D.T.C. 5099 (F.C.T.D.); [1992] 2 C.T.C. 227, 92 D.T.C. 6570 (F.C.A.). Both counsel were aware of the Moloney decisions but the appellant’s counsel sought to distinguish the case on the basis of differences in the evidence. He relied on the testimony of the appellant, who was the only witness called in this appeal, to establish that what was sought was not a tax advantage but rather an income producing investment. As well he relied on evidence present in this case and, I gather, absent in the Moloney case, to indicate that business was in fact carried on by the appellant. Finally counsel pointed to evidence regarding the circularity of the transactions which was present in Moloney and absent here. While I must decide the case on the evidence before me the legal principles on which Moloney rested will govern, if applicable.

At all relevant times the appellant lived and worked in Vancouver, British Columbia. He appears to be intelligent and well educated. He holds a Bachelor’s degree in mechanical engineering and a Master’s degree in computer science. In 1984 the appellant and his wife had a conversation with an accountant named Bea Haid regarding an opportunity to make what the appellant described as an "investment” in the marketing of speed reading courses. Ms. Haid was associated in some way with H.N. Thill & Associates Inc. (hereinafter "Thill"). She drew the appellant’s attention to a speed reading scheme available to clients of Thill.

The structure of the arrangement disclosed by the appellant’s testimony and by the documents entered in evidence was as follows: A company called Applied Research Ltd. ("Applied Research") owned the copyright to a self-taught course of instruction in speed reading. Thill promoted the sale to Canadians of licences to sell the course in named territories located in the U.S. For each territory the licensee was to pay a licence fee of $100 and an "advance royalty” of $20,000. Another company, Omni Educational Marketing Corp. ("Omni") held itself out to be prepared to market the courses on behalf of the licensees of Applied Research. Omni offered each licensee a cash performance bond of $17,500 in support of its promise to market. The appellant said he prepared an analysis of cash flow based on various assumptions as to the level of sales which Omni might attain in his territory. There was, I note, no evidence indicating that there existed any rational basis for the assumptions which he made. The appellant stated that in the worst case, if Omni sold nothing, the performance bond money would not have to be repaid to Omni. On February 25, 1984 the appellant purchased one territory in Bay City in the State of Michigan.

On the surface at least the arrangement had almost magical qualities. It was structured in such a way that the licensee was not required to invest any of his own cash. The cash bond payment to the licensee was to be made at the outset with the consequence that the licensee could use the bond money as part payment of the $20,100 payable to Applied Research for each territory. Thus there was only $2,600 left to be dealt with. It was assumed that the entire $20,000 was deductible forthwith as a business loss in computing income for tax purposes. The appellant gave Thill a promissory note in the amount of $2,600 payable on August 31, 1984. The appellant testified that it "may have been" indicated to him that it might be in his tax return for 1984, generated in large part by the supposed business loss, was approximately $11,000 and thus more than ample to pay the $2,600.

The appellant asserted that initially he had some misgivings about the arrangement as outlined to him. He testified that he was troubled by the tax implications which seemed "too good to be true". After some further investigation he concluded, he said, that all persons concerned, Revenue Canada included, would benefit from this scheme and he decided to proceed. He said that he regarded the arrangements as an investment offering to him an opportunity to make money which would serve to replace income previously earned by his wife. She was planning to leave the workforce. The assertion that Revenue Canada would benefit was based on the premise that the "investment" would yield taxable income in the future.

During the period between 1984 and 1986 Omni apparently did nothing to market the speed reading course within the appellant’s Michigan territory. Certainly it did not pay anything to the appellant. The assumptions of fact on which the assessments rested included the following:

Omni had neither a marketing program in place nor sufficient employees to carry out a marketing and distributing business;

The evidence did not establish that the assumption was wrong in fact. The appellant produced a booklet, Exhibit A-9, which states that it was designed to show how Omni planned to sell the course. He said that he received the booklet in the "1984 to 1986 timeframe". The clear inference to be drawn from the booklet is that no marketing activities had been undertaken in the U.S. prior to the time of publication.

In 1986 the appellant discussed the acquisition of further territories with the staff at Thill. He said that on that occasion he asked about Omni’s marketing program and was told that "it was progressing". Despite the fact that his 1984 "investment" had been made two years previously, the appellant did not ask if anything had been sold. He simply proceeded to acquire licences for two more territories, this time located in West Palm Beach, Florida. This transaction differed from the 1984 arrangement only in matters of detail. It called for the payment of two $100 licence fees and the payment of $40,000 in advance royalties. On this occasion the cash bond was $17,000 per territory leaving the appellant with an out of pocket cash of $6,200 for two territories after the endorsement over to Applied Research of the $34,000 performance bond cheque from Omni.

It is evident that the appellant, a person who lived and worked in Vancouver was in no position to personally sell speed reading courses in territories located in Michigan and Florida. Obviously, if he had been inclined to sell the courses in his territories, he would have been entirely dependent on Omni or some like organization to do the work on his behalf. His action in making the 1986 arrangements despite Omni’s failure to sell anything in his 1984 territory and after only a cursory inquiry at Thill’s Office as to what had been happening casts doubt on his professed intention to make an ’’investment". That doubt is intensified and becomes disbelief when the objective facts are considered. At the outset the appellant signed a "client application form" requesting that Thill "act in an advisory and consultative capacity with respect to Canadian tax legislation". That document contemplates that the advice might well involve entry into an arrangement of the sort now under consideration. The adoption of that advice resulted in claims for deductions of $20,000 for each territory which deductions were consequent on expenditures of $2,600 in one case and $3,100 in the other. In my view, it is impossible to conclude that any of the parties to the transactions seriously expected that Omni would make any attempt to sell the courses. One of the findings of fact on which the assessments rested was: "Omni was merely an instrument or agent of Applied for the sole purpose of implementing the tax scheme and was not carrying on business". It was not shown to be wrong in fact. What was sought by the appellant and what was delivered to him were one and the same, namely, an ostensible basis for claiming tax deductions.

Counsel for the appellant relied on evidence as to events subsequent to 1986 in an attempt to distinguish Moloney by showing that the business of selling the courses was in fact carried on. The appellant produced a copy of the May 1987 issue of a magazine named "Enjoy". The publication was one which was stated to be intended for distribution free of charge in certain areas of the U.S. The copy produced by the appellant contained an advertisement placed by Omni for the speed reading course. The appellant said that the copy which he produced had been furnished to him at a ceremony marking the shipment from premises occupied by Thill to a destination in the U.S. of a batch of the magazines. The appellant admitted that an investment in the magazine was in some way involved with tax deductions. In light of the atmosphere of unreality surrounding the activities of Thill, Applied Research and Omni and in the absence of the evidence of some person having some personal knowledge of the circumstances surrounding the placing of this ad and the distribution of the magazine, I can accord no weight to this evidence. Even if I could, the evidence does not establish that the appellant carried on business through the agency of Omni either during the years in issue or at all.

The appellant also produced two letters in an attempt to establish that the business of exploiting his territory ultimately commenced and actually generated income. The first was dated May 16, 1994 and was written on Thill letterhead. It bore the salutation "Dear Licensee” and advised that Quantus Marketing Ltd. had assumed the obligations of Omni. It reviewed the prospects for future sales and discussed the tax consequences to investors of such sales. The second letter was addressed to the appellant, dated November 1, 1984 and was apparently signed by one Ron Thill. It stated:

Cairn Marketing has been assigned to market the Advanced Reading Course in the U.S.A. in association with Quantus Marketing.

As a result of our recent meeting we are enclosing a statement of account that reflects the sale of 300 courses in your territory.

Enclosed was an account indicating that 300 courses had been sold, that $5,500 was due to the appellant and that a cheque in that amount was also enclosed. The authors of the two letters were not called to testify and it was not suggested that either of them was unavailable. The letters may be genuine or they may be concocted for hidden motives. Without the evidence of the authors the letters can be accorded no weight. Even if weight were given to them, they do not show that the appellant carried on business at a loss in 1984, 1985 and 1986.

The issue here is whether the appellant carried on a ’’business” within the meaning of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the ’’Act"). That word is to be given its ordinary meaning [1] and that meaning does not include a tax avoidance scheme which is nothing more than a pale imitation of a business. The appellant was not involved in a commercial activity either directly or through Omni as his agent. The objective evidence regarding the manner in which the scheme operated and the actions and inaction of the parties point clearly to a conclusion that both the appellant and the promoters of the scheme were indifferent to the marketing of the speed reading course and to the earning of profits from that activity. There can be no doubt that what was sought was a tax deduction which would result in a refund part of which was to go to enrich the promoters of this scheme and the remainder of which was to go to the appellant. I disbelieve the appellant’s testimony as to his subjective intention. As noted in Symes v. The Queen, [1993] 4 S.C.R. 695, [1994] 1 C.T.C. 40, 94 D.T.C. 6001, at page 736 (C.T.C. 58; D.T.C. 6014), per lacobucci J.:

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.

In my view the deduction of the component elements of the "losses" is prohibited by paragraph 18(1 )(a) of the Act.

The ratio of the decision of the Court of Appeal in Moloney, supra, is contained in the following passage at page 228, D.T.C. 6571 (Hugessen J., speaking for the Court):

In our view the judgment under appeal is based on the Trial judge’s findings of fact, notably that the appellant never intended to carry on the business of marketing the speed reading course himself or through Omni, that neither the appellant nor Omni had the means or the ability to do so, and that the sole purpose of the scheme was to obtain tax refunds and nothing else.

That decision is none the less applicable despite the absence in this case of evidence showing the "circularity and simultaneity of the transactions between the related companies". The essential facts in this case and in Moloney are the same. I will therefore dismiss the appeals with costs.

Appeals dismissed with costs.