Seymour Pepper, Elaine Pepper, Dean Pepper, Brenda C. Pepper, Jody H. Pepper and York Super Pharmacy Limited v. Minister of National Revenue, [1992] 2 CTC 2259

Taylor, T.C.J.:—These are appeals heard on common evidence in Belleville, Ontario on June 9, 1992, against income tax assessments which are detailed below. While the points at issue were somewhat different for the various appellants, the Court's understanding of the conduct of the trial was that whatever evidence—all or part—which applied could be and should be taken into account. There were certain agreements reached between the parties before the trial, and these are also indicated:

For York, counsel for the appellants pointed out that for the year 1983, the only item at issue was for the disallowance of a convention expense deduction and that would not be contested. For the year 1984, the only item remaining in issue was an amount of $69,000 claimed by York but disallowed by the respondent arising out of a loan to York Gift Boutique Ltd. (York Boutique), an operation conducted on the same premises as York, but allegedly that of Florence Pepper, in the years relevant the wife of Seymour Pepper, the majority shareholder of York. The amount remaining at issue for York in 1985 is $205,000 for a loan to DeJose Holdings (DeJose), a partnership of Seymour Pepper, Dean Pepper and Jody Pepper, which operated fast food restaurants.

York Boutique, while a separate company, operated at the back of the premises occupied by York, and was managed by York Management. The only purpose given for setting it up as a corporation was that there appeared to be tax benefits in doing it that way. Little was provided at the hearing which would

♦Judge's Note—I used the term “loan” in these reasons for simplicity, but the amounts involved may be composed of actual loans and advances, or in some situation amounts paid by York to retire debt obligations incurred by the other entities. No definitional character is accorded simply by the use of the term "loan". distinguish York Boutique from York. There was some limited information provided regarding shareholdings etc. in York and Boutique, but I do not regard it as a requirement here to determine if that aspect has any bearing on the issue. Neither party raised the corporate structure of York Boutique, or the possible interrelationship of the two companies as any factor to be considered. For York Boutique, while allegedly a different structure, there was no basic evidence provided that whatever it did, or whatever obligations it incurred were materially different from the situations which would have obtained, simply had York Boutique been visibly (or perhaps invisibly) a section in the store of York selling its particular products. It was asserted that there was some "synergy" between York and York Boutique which was designed to benefit both operations. The evidence to support that view was lacking but in my view quite irrelevant in any event. Therefore, I regard York Boutique in all its aspects as simply an operating part of York. Whether York Boutique was successful or unsuccessful, in its rather surrealistic entity is quite unimportant to the determination of this issue—I would suggest any financial result accomplished would have been a simple internal mathematical determination, arising out of adjustment and agreement between York and York Boutique, both controlled ultimately by Seymour Pepper either by shareholdings or by credit available. There was no evidence of investment contribution or financial stability from any other source. The argument that somehow York loaned to York Boutique may be a fiction but at the same time the losses and the obligations encountered by York Boutique (the dollar basis of the alleged ” loan") were recognized as the responsibility of York—nothing could be clearer than that York eventually made good, in the name of York Boutique, for these amounts, totalling $69,000. The activity surrounding the operation of York Boutique, as supported by York, is not one which qualifies York for the added identification of "lending of money". Nor were the small and isolated instances described in Court which indicated that York had made advances to two or three other parties over the years of any relevance or importance when casting the activity of York against the framework outlined in Highfield Corporation Ltd. v. M.N.R., [1982] C.T.C. 2812, 82 D.T.C. 1835, relied upon by the appellant. In that decision the corporation Highfield established for the Court that it had acted as "banker" for a group or series of operations conducted by other entities in which it had some interest. To reach the level of money-lender" expected in Highfield, supra, requires a greater degree of established support than anything shown in this part of these appeals. The operation was no different than if York had decided to set up a section in its pharmacy store, selling somewhat different, but related products and lost money on the venture, finally ceasing to operate it. That does not mean that the product line itself—or a part of it—would be discontinued necessarily in the total store premises, but that does not enter into our determination here. As I see it, the $69,000 at issue in the year 1984 is a deductible item for York not as a "bad debt loan”, covered by paragraph 20(1)(p) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), but arising as an “expenditure for the purpose of gaining or producing income from a business or property" paragraph 18(1)(a) of the Act. There was no evidence in my opinion that the deduction should be barred by virtue of paragraph 18(1)(b) of the Act, as a“ "capital" item, although that was one position contended by the respondent.

The only item therefore remaining is that described as the" loans" to DeJose for the purpose of acquiring certain fast food franchises and operating them over the years at issue. The witnesses for the appellants described the process by which the financial support for DeJose came from York, and how it was recognized" in the record of York as" receivables” eventually translated into a form of debenture etc., all reflected in the corporate minutes of York, leading up to the ultimate withdrawal from the fast food operations and the payment of the outstanding accounts by York. Counsel for the appellants recognized that there was little basis upon which to contend that paragraph 18(1)(a) of the Act— “for the purpose of gaining or producing income” for York provided for the deductions claimed and to that important extent there is a distinction to be made from York Boutique. This amount totalling $205,000 stands or falls on the issue of moneylending to use the words of counsel. I have already noted that the activities of York, up to and including 1984 and the results of York Boutique, in these circumstances, "do not a money lender make". The question then is whether loaning of the $205,000, some part of which occurred (in terms of the "loans" made) in the year 1982 continuing between and culminating in 1985 with closing down the restaurant operations. Separate records and financial statements were regularly maintained by DeJose and these apparently were in accordance with the situation shown in the statements of York. As of March 31, 1985 the following comment was made by the accountants for York, in the statements:

Allowance for bad debts—Dejose Holdings Inc.

Management feels that it is prudent to establish a provision for the possible noncollection of moneys due from DeJose Holdings Inc. as follow:

	Port Hope	Cobourg	Total
Loan receivable	$170,571.36 $210,076.08 $380,647.44
Market values as provided by
Seymour Pepper			175,000.00
Seymour Pepper
Provision
March 31, 1985			$205,647.44

The estimated market value is basically the bank liabilities rounded" up to the bottom of the range of $175,000-$200,000 as provided by Seymour Pepper.

Simply put during the time of operation a total of $380,647.44 had been advanced by York, and as noted above, the advice from the auditors of York was that a substantial reserve against loss should be established. Some evidence was tendered with regard to the amount involved and its composition. Counsel for the respondent raised the issue of the collectibility of the amount—with the implication that little or no effort was made by York to collect and that even if the sons Dean and Jody Pepper were not in a financial position to repay their partnership shares, Seymour Pepper certainly had the financial resources so to do, and as a partner had the obligation to fulfil that commitment from DeJose to York. That point might have relevance and indeed it might be necessary to adjudicate it—but only if it is first determined that the $205,000 qualifies as a loan, and that it was made by York acting as a moneylender. In that light the precise words of paragraph 20(1)(p) of the Act become important:

Bad debts.—the aggregate of bad debts owing to the taxpayer

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

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

I do note that a more accurate basis for the claim for the amount (in view of the wording of the auditor's advice note above) might be under paragraph 20(1)(l) of the Act, and the distinctions were outlined in Highfield, supra, on page 2829 (D.T.C. 1847):

Subparagraph 20(1)(p)(i) read “that are established by him to have become bad debts in the year, and I would note the emphasis to be placed on past tense and the reference to the financial period. The claim must be one that can be asserted as having become uncollectible by the end of the fiscal year. To whatever degree “hindsight” (at the date of preparation of financial statement for example) may be permissible in the utilization of paragraph 20(1)(l) of the Act I find no similar flexibility for paragraph 20(1)(p). I would also suggest that paragraph 20(1)(p) may well be called into play and the amount declared a “bad debt” in the “second year"—that is the year following its inclusion as part of a reserve established under paragraph 20(1)(p) (see earlier comments).

[Emphasis added.]

However, I do not intend to make an issue of that contrast—it is unimportant in this context.

As I see it York must show that this was a "loan", that “it was made in the ordinary course of business”, and “by a taxpayer part of whose ordinary business included the lending of money".

The evidence could be sufficient to establish that this amount claimed resulted from loans—but I feel no requirement to determine that specifically. I am quite satisfied that the transactions cannot be described as "in the ordinary course of business”. It has not been shown that the "ordinary course of business” of York as a pharmacy included making loans to its shareholders, or for that matter to any one else; and it certainly cannot be said that the "ordinary business was the lending of money". The simple fact is that the transactions which culminated in debts of some $380,647.44 (see above) were an attempt on the part of York (dictated by its shareholders) to finance the setting up of a separate business, the fast food restaurants which had nothing at all to do with York. It appears to me that the loans which may have been made to the partnership DeJose represented an investment on capital account—if not arguably simply advances to shareholders. I noted in High- field, supra, that it was not the use of either of the specific terms "loan" or "investment" which should provide comfort to either party. But these amounts at issue whatever called do not meet the requirements under which York would be a "money lender”, to qualify for the deduction claimed under paragraph 20(1)(p) of the Act. I noted also in Highfield, supra, that the mere term "capital" does not of itself exclude a claim for deductibility under paragraph 20(1)(p) of the Act (it is clearly different under subsection 18(1) of the Act) but the loan itself, even if on capital account, must meet the conditions implicated in paragraph 20(1)(p) of the Act under which such a loan was made. In this set of circumstances, the amount of $205,000 does not so qualify—it does not result from transactions reaching the level of "money lender” on the part of York.

The appeal of York Super Pharmacy Ltd. with respect to the year 1984, in which a claim for deduction in the amount of $69,000 was made is hereby allowed. The appeals of York Super Pharmacy Ltd. for the years 1983 and 1985 are dismissed. The appeals of Seymour Pepper, Dean Pepper and Jody Pepper for the years 1982, 1983 and 1984 are dismissed. The appeals of Brenda Pepper for the years 1982 and 1984 are dismissed, and the appeal of Elaine Pepper for the year 1984 is dismissed. There is no award as to costs.

Appeals allowed in part.