William S J Buckler v. Minister of National Revenue, [1985] 1 CTC 2428, 85 DTC 396

Kempo, TCJ:—This is an appeal involving the 1979 and 1980 taxation years of the appellant.

Issue

The issue for determination is whether certain amounts in respect of an advance minimum royalty payment called for under a licence agreement are deductible as an outlay or expense that was made or incurred for the purpose of gaining or producing income from a business within the meaning of paragraph 18(1)(a) of the Income Tax Act (the “Act”) and secondly, would the deduction be precluded by subsection 245(1) of the Act in that, if allowed, it would unduly or artificially reduce income.

The applicable provisions of the Act are as follows:

18.(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) 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 business or property; . . . .

18. (9) Notwithstanding any other provisions of this Act,

(a) in computing a taxpayer’s income for a taxation year from a business or property . . . no deduction shall be made in respect of an outlay or expense to the extent that it can reasonably be regarded as having been made or incurred

(i) . . .

(ii) as, on account or in lieu of payment of, or in satisfaction of . . . royalty in respect of a period after the end of the year,

(iii) . . .

(b) such portion of each outlay or expenses made or incurred as would, but for paragraph (a), have been deductible in computing a taxpayer’s income for a taxation year shall be deductible in computing his income for the subsequent year to which it can reasonably be considered to relate; . . . .

245. (1) In computing income for the purpose of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

Facts

The essential facts and the Minister’s position on reassessment is best set forth by setting out paragraphs 4 to 8, inclusive, of the reply to notice of appeal, as follows:

4. The Respondent, the Minister of National Revenue, in assessing the Appellant as aforesaid, relied upon the following assumptions of fact, inter alia:

(a) Cannon Business Systems Inc (hereinafter called “Cannon”) was a company incorporated under the laws of the Province of British Columbia, December 8, 1977 and in 1979 and 1980 was involved in selling franchises for speed reading courses as tax shelters;

(b) Cannon’s function in the tax shelter scheme was to market speed reading franchise areas to investors on behalf of the copyright holder St John International Ltd, an entity under the laws of the Cayman Islands (hereinafter called “St John”);

(c) in the years 1978, 1979 and 1980 speed reading franchise sales by Cannon were as follows:

1978 — 7 investors

1979 — 60 investors

1980 — 118 investors

TOTAL 185 investors

(d) Raesan Development & Management Corporation was a company incorporated

in the State of Washington on March 20, 1979 (hereinafter called “Raesan”);

(e) Raesan’s function in the speed reading tax shelter scheme was to contract with the individual investors to market the speed reading courses to the retail market in the respective franchise areas of the investors;

(f) in his 1979 taxation year, the Appellant purchased through Cannon for $100 a franchise area by signing to Cannon in trust, which agreement contained an understanding that an advance royalty of $20,000 would be paid to the copyright holders;

(g) at the same time the Appellant executed the aforesaid agreement, he executed a licence agreement between himself and St John whereupon, inter alia, he was to pay $100 on execution of the agreement (paid to Cannon as aforesaid) and the said $20,000 as advance royalties based on the royalty of $20 per course on a minimum acceptable distribution of 1,000 courses. The 1,000 courses were to be sold in the first year, or the $20,000 or balance was to be forfeited to St John. The said courses were calculated on the basis of a sale of one course to each 40 of the total population of the franchise area, which in the Appellant’s case, was approximately 40,000;

(h) again at the same time and with the same representative of Cannon, the Appellant executed:

(i) a standard operating agreement with Raesan whereby Raesan undertook to market over a ten year period on behalf of the Appellant the advance reading courses for $125, of which sum $35 was payable to the Appellant; and

(ii) a performance bond agreement with Raesan whereby Raesan guaranteed to sell the 1,000 courses required under the operating agreement, however to be sold within 10 years.

The performance bond was in the amount of à ($15,000) of the total required advance royalty ($20,000). Under the terms of the performance bond agreement, the funds were to be held by the Appellant and released upon Raesan completing the sale of the 1,000 courses in accordance with the schedule for completion of sales by Raesan. Further, the performance bond provided for any balance of bond funds remaining unreleased at the expiration of the operating agreement to be forfeited as damages for lack of production by Raesan;

(i) In his 1979 taxation year, the Appellant purchased for $100 the said franchise and executed the said agreements and further paid to Cannon in trust advance royalties of $5,000 being 25% of the advance royalty of $20,000;

(j) the Appellant immediately thereafter received a cheque from Raesan in the amount of $15,000 drawn on the Community State Bank in Washington, USA, being the amount of the performance bond which the Appellant deposited in his account and forthwith forwarded another cheque from his account to St John in accordance with the agreement with St John requiring the $20,000 advance payment;

(k) in his 1980 taxation year, the Appellant purchased the said franchise agreement as aforesaid for $100, paid $5,000 to Cannon (as he did in his 1979 taxation year), and received immediately from Raesan a cheque made out to the Appellant and St John drawn on the Community State Bank, Blaine, Washington, USA, for $15,000 in accordance with the performance bond agreement;

(l) the Appellant without depositing the said cheque endorsed it and forwarded it to Cannon for forwarding to St John purporting to complete the payment of $20,000 advance royalties required;

(m) the cheque from Raesan for $15,000 in 1979 deposited to the account of the Appellant was cleared through the Community State Bank, Blaine, Washington, USA, prior to the Appellant forwarding the same amount to St John;

(n) in his 1980 taxation year, the cheque from Raesan for $15,000 payable to St John and the Appellant was never cleared through the Raesan bank account upon which it was drawn in Blain, Washington;

(o) Raesan did not have nor could have acquired funds needed to cover all of the performance bond cheques issued as performance bonds to its 60 investors in 1979 and 118 investors in 1980, and in fact, of the total cheques drawn on the account of Raesan as performance bonds totalling 178, only 7 were cleared including that of the Appellant;

(p) the cheque of the Appellant cleared as set out in (0) above was cleared with funds provided to Raesan indirectly from Cannon;

(q) the sole purpose of the Appellant in paying the aforesaid $15,000 in accordance with the terms of the franchise agreement was to minimize his tax payable in each of his taxation years;

(r) the said amount of $15,000 paid by the Appellant in his said taxation years as a balance of the advance royalty payment was a disbursement or expense for which there was no bona fide business purpose and was a transaction or operation motivated solely for tax advantages which, if allowed, would unduly or artificially reduce the Appellant’s income;

(s) the proportion of the $5,000 royalty payment actually made by the Appellant which was allowed by the Minister as a deduction was the only portion reasonably relating to the tax year in which it was allowed and was an expense or disbursement in that year only in accordance with normally accepted accounting principles;

(t) the Appellant purchased the aforesaid tax shelters in 1979 on the 17th day of July, and 1980 on the 19th day of February, and 1981 on the 23rd day of January notwithstanding that he was advised every 6 months by Raesan that there were no sales of the courses in his franchise areas, such advice being given:

(i) with respect to the 1979 year by Notice dated February 1, 1980

(ii) with respect to the 1980 year by Notice dated July 1, 1980 and February 1, 1981.

B. THE STATUTORY PROVISIONS UPON WHICH THE RESPONDENT RELIES AND THE REASONS WHICH HE INTENDS TO SUBMIT.

5. The Respondent relies, inter alia, upon Sections 18(l)(a), 245(1), 9(2) and 18(9) of the Income Tax Act, c 63, SC 1970-71-72, as amended.

6. The proportion of the $5,000 advance royalty payment actually made by the Appellant in each of his taxation years allowed by the Minister as a deduction was the only portion reasonably relating to the tax year in which it was claimed in accordance with normally accepted accounting principles and was the only portion allowable pursuant to Section 18(9) of the Income Tax Act and the Minister properly disallowed any additional amount to be claimed in each of the said taxation years by the Appellant.

7. The $15,000 claimed as additional advance royalty payments in each of the Appellant’s taxation years was a payment made by virtue of a transaction motivated solely for tax advantages with no bona fide business purpose and thus was a transaction or operation which if allowed would unduly or artificially reduce the Appellant’s income within the meaning of Section 245(1) of the Income Tax Act, and the Minister properly disallowed such deductions.

8. The expenditures to the extent of $17,698.63 in 1979 and $12,970.77 in 1980 in respect to the advance royalty payments were not outlays or expenses incurred by the Appellant for the purpose of gaining or producing income within the meaning of Section 18( l)(a) of the Income Tax Act, and were properly disallowed as deductions by the Respondent.

The viva voce evidence given at the hearing was that of the appellant who is a medical doctor earning the bulk of his income during the years in question from employment as a medical consultant in a hospital.

The appellant, in anticipation of his pending retirement, was thereby interested in obtaining a source of income for and during his retirement years and, following the information and advice given by a patient during a casual conversation in this respect, he contacted Cannon and was visited by their saleswoman, Teresa Oldring. Previous to this, and although the appellant had heard of the name “Cannon Business Systems”, he had had no knowledge of the speed reading franchises being offered for sale by them or anyone else.

The appellant stated unequivocally that he had not heard of and was not in any way connected with or to St John or Raesan or Cannon or any of their principals either before or after the subject transactions and that all of his dealings were conducted solely and entirely through Teresa Oldring. He had not made inquiries of anyone as to the legal existence or affairs of St John or Raesan or whether or not the latter could lawfully conduct any marketing business in Canada or as to its financial resources. He did not have any marketing or financial projections available or done for his guidance and did not seek any professional tax advice in 1979.

Following the telephone calls to two existing franchise investors whose names had been given to him by Ms Oldring, and after personally determining that the idea, nature and extent of the speed reading course was a good one that was marketable, he studied and negotiated the purchase of a franchise area in Surrey, British Columbia, as being the one with the most likely growth potential. The financial terms of the transaction were not negotiable.

The appellant, being desirous of retirement (future) income, was not overly concerned as to the number of immediate sales in any available area but rather was looking for future sales/income potential that he felt was to be had in the developing areas of attraction to younger professional people and families who in turn would be more amenable to taking speed reading courses.

The appellant candidly conceded that any expectation of 1,000 sales in the chosen area in the first year would be overly optimistic and unrealistic. His needs were in respect of the long term, and the franchise licence was to be for 20 years. He also candidly admitted that deductibility of the $20,000 minimum advance royalty for the first year was an essential part of the attractiveness of the whole transaction along with, obviously, the fact that he would have the immediate use of Raesan’s $15,000 performance bond money pending actual sales by them or its forfeiture to him after 10 years as called for in the operating agreement. Absent the fiscal deductibility of the $20,000 he stated he probably would not have taken the plan seriously.

The appellant’s perspective of the whole matter was that of a tax deferral; that is, he would have the fiscal benefit of a large deduction to be operative immediately in and for his high income working years then remaining, with the opposite effect happening in his retirement years when the income ensued — “like an RRSP”.

The appellant knew that no sales had occurred in his Surrey franchise district when he purchased a franchise district in Toronto in 1980 and also that no sales had occurred in either district when he purchased a franchise area in Montreal in 1981. Apparently after 1979 all of the British Columbia franchise districts had been sold.

Prior to the Toronto district purchase in 1980 the Appellant attended at the office of a chartered accountant, Con Buckley, (whom he was told was apprised of the whole scheme) seeking reassurance and an opinion as to its viability, future income potentiality and the fiscal deductibility of the minimum advance royalty amounts.

The appellant’s recollection of the events relating to the method payment in 1979 was that he had issued one, and only one, cheque for $20,000 and notwithstanding the photocopies of two cheques shown to him and identified by him, he disagrees with the factual assumptions of the Minister in that respect as set out in paragraphs 4(i) and 4(j) of the reply which are repeated for convenience:

4. (i) in his 1979 taxation year, the Appellant . . . paid to Cannon in trust advance royalties of $5,000 . . .;

4. (j) the Appellant immediately thereafter received a cheque from Raesan in the amount of $15,000 . . . which the Appellant deposited in his account and forthwith forwarded another cheque from his account to St John. . . .

The appellant has no knowledge of, nor was it shown that he could or should have had knowledge of, those matters asserted by the Minister in paragraphs 4(n), 4(o) and 4(p) of the reply which are repeated for convenience:

4. (n) in his 1980 taxation year, the cheque from Raesan for $15,000 payable to St John and the Appellant was never cleared through the Raesan bank account upon which it was drawn in Blaine, Washington;

4. (o) Raesan did not have nor could have acquired funds needed to cover all of the performance bond cheques issued as performance bonds to its 60 investors in 1979 and 118 investors in 1980, and in fact, of the total cheques drawn on the account of Raesan as performance bonds totalling 178, only 7 were cleared including that of the Appellant;

4. (p) the cheque of the appellant cleared as set out in (o) above was cleared with funds provided to Raesan indirectly from Cannon.

Analysis

I am satisfied that on the evidence, and objectively viewing the transaction in its totality, [1] that the appellant has successfully met the onus of establishing, on the balance of probabilities, that:

(a) as to paragraph 4(q) of the reply, supra, the subject transactions in each of the two years in issue were motivated by and entered into for the joint and equally important purposes of gaining and producing income as well as to minimize his tax payable in each of these years. While the Minister’s counsel has argued that the appellant had no reasonable expectation of profit in this venture and therefore the subject deduction should be precluded by paragraph 18(l)(a) of the Act, (see paragraphs 7 and 8 of the reply, supra) the evidence before me was that something of a businesslike approach was attempted and employed by the appellant and that 500 sales had occurred in the appellant’s Surrey district for the period ending June 30, 1984 resulting in a modest monetary return to him. And notwithstanding that this information as to the sales had not in all probability been known or disclosed to the Minister by anyone prior to the subject reassessments and their confirmation, one cannot be unmindful of the implications of inconsistency here arising from the fact that the respondent did allow a deduction pursuant to subsection 18(9) of the Act, supra, of $5,000 out of the total of $20,000 paid;

(b) as to paragraph 4(r) of the reply, supra, the payment of the $15,000 in each of the subject years was a disbursement or expense for which there existed a bona fide business purpose and which, on the facts of this case, was not motivated solely for tax advantages — notwithstanding its source, reason for receipt and method of payment.

There still remains the matter as to whether or not the $15,000 paid in each of the years, if allowed, would unduly or artificially reduce the appellant’s income within the meaning of subsection 245(1) of the Act, supra.

In my opinion there was insufficient evidence before me from which an inference could reasonably be drawn that the amounts in question were, in respect of the applicability of that subsection, excessive, unreasonable, unnatural or not in accordance with normality. [2]

While the Minister’s counsel asserted that the source of the $15,000 had the effect of “tainting” the whole transaction, [3] the evidence at the hearing fell far short of establishing any connection or conspiracy between or amongst the parties to the subject transactions that could support an inference amounting to an artificiality, simulation or fiction in respect thereof. [4]

The absence of any identifiable provision of the Act encouraging investment or business activity in the nature of franchising speed reading courses does not assist either party to this Appeal. [5]

Similarly I am unable to find, on the evidence heard, that the conduct of this taxpayer amounted to a “designed effect of defeating the expressed intention of Parliament, [6] nor is there any contradistinction to be found in this case in respect of the interpretative guidelines formulated by Estey, J in Stubart Investments Ltd v The Queen.

Conclusion

Accordingly I am unable to find that the $15,000 payments in issue would, if allowable, unduly or artificially reduce the appellant’s income within the meaning of subsection 245(1) of the Act for his 1979 and 1980 taxation years and find that they are allowable in accordance with (and by agreement of both counsel in this respect) the provisions of subsection 18(9) of the Act, supra.

The Appeal is therefore allowed and the matter is referred back to the Minister for reconsideration and reassessment on the aforementioned basis.

The Appellant is entitled to his party and party costs.

Appeal allowed.