Isaac Meisels Investments Limited v. Minister of National Revenue, [1983] CTC 2301, 83 DTC 256

D E Taylor:—This is an appeal heard in Toronto, Ontario, on February 28, 1983 against an income tax assessment for the taxation year 1977 in which the Minister of National Revenue determined that an amount of $101,050 should be treated for tax purposes as a capital loss. The significant portions of the notice of appeal are as follows:

1. The Appellant is a company duly incorporated under the laws of the Province of Ontario, having its head office at the Municipality of Metropolitan Toronto, in the Judicial District of York and carries on an active real estate business consisting of rentals, buying, selling, construction, development (including re-zoning) and exploitation for maximum profits of real property of all kinds as well as an active business of money lending.

2. The Appellant’s real estate ventures are in general, carried on by it as a sole proprietorship, as a partner, or as a member of a joint venture, at times as a direct participant and at other times through the vehicle of a limited company specifically incorporated for a particular venture.

3. Louis Weisfeld (Ontario) Ltd (“Weisfeld Ltd”) is a company duly incorporated under the laws of the Province of Ontario, having its head office at the Municipality of Metropolitan Toronto, in the Judicial District of York and was incorporated specifically by the Appellant together with others for the purpose of purchasing a parcel of real property for development, resale and/or construction with the sole purpose of financially exploiting that real property in the most advantageous way possible as a single venture only (being an isolated transaction) and not for the purpose of carrying on any business in an ongoing manner.

4. In due course, a business decision was made by the taxpayer together with its partners that the most advantageous way of exploiting the real property and maximizing any profits to be realized therefrom, was the construction and sale of some thirty-six (36) condominium units and sixty-four (64) townhouse units with the intent of building the units, selling the units, dividing the anticipated profits and the ultimate winding up of Weisfeld Ltd.

5. In order to fund the Weisfeld Ltd venture, the Appellant advanced to it the sum of Forty Thousand Dollars ($40,000.00) in or about August 1973, the sum of Forty Thousand Dollars ($40,000.00) in or about September 1973, the sum of Ten Thousand Dollars ($10,000.00) in or about July 1974 and the further sum of Eleven Thousand Dollars ($11,000.00) in or about August 1974, totalling in the aggregate, One Hundred and One Thousand Dollars ($101,000.00). In addition, the Appellant as an equal participant in the venture, subscribed for fifty per cent (50%) of the issued shares of Weisfeld Ltd at a subscription price of Fifty Dollars ($50.00) so that in the aggregate, the Appellant’s cash contributions to the venture, amounted to One Hundred and One Thousand and Fifty Dollars ($101,050.00).

6. The corporate entity, Weisfeld Ltd, was utilized solely for the purpose of acting as a corporate vehicle for the transaction and to shield the taxpayer and its partners from any further liability in connection with the venture and more particularly, from the substantial liability to the Manufacturers Life Insurance Company, the mortgagee providing the financing. The benefit of limited liability, in view of the substantial risk to the venture, was essential.

7. The venture not only being speculative, proved to be a financial disaster, substantial losses were incurred and on or about the 7th day of January, 1976, foreclosure proceedings were commenced by the Manufacturers Life Insurance Company against Weisfeld Ltd. In due course, a final order of foreclosure was obtained during the Appellant’s 1977 taxation year (being its fiscal period ending the 31st day of May, 1977) thereby culminating in a loss to the Appellant in the amount of One Hundred and One Thousand and Fifty Dollars ($101,050.00) being the aggregate amount of its advances to the venture through Weisfeld Ltd.

8. In computing its income for its 1977 taxation year, the Appellant claimed as a deduction from income the sum of One Hundred and One Thousand and Fifty Dollars ($101,050.00) as a non-capital loss realized in its 1977 taxation year.

Statutory Provisions upon which the Appellant Relies and the Reasons which it Intends to Submit

1. In computing its income for its 1977 taxation year, the taxpayer is entitled to deduct the sum of One Hundred and One Thousand and Fifty Dollars ($101,050.00) as a trading loss incurred by it in the course of its real estate business operations pursuant to the provisions of paragraph 18(1 )(a) of the Income Tax Act, SC 1970-71-72, c 63, as amended.

3. In the alternative, the sum of One Hundred and One Thousand and Fifty Dollars ($101,050.00) constitutes a debt owing to the taxpayer from Weisfeld Ltd arising from a series of loans made in the ordinary course of business by the taxpayer, part of whose ordinary business was the lending of money, and is accordingly, deductible from income in its 1977 taxation year pursuant to the provisions of paragraph 20(1 )(p) of the Act.

The respondent contended:

— The appellant was not in the business of money lending.

— The appellant was credited with a shareholder’s advance in the amount of $101,050.00 by “Weisfeld Ltd Ltd” in prior to the Appellant’s 1977 taxation year.

— “Weisfeld Ltd” became unable to repay the amount of $101,050.00 in the appellant’s 1977 taxation year.

— The appellant suffered a net capital loss in the amount of $50,525.00 with respect to the amount of $101,050.00.

In assessing, the respondent relied, inter alia, upon paragraphs 38(b), 39(1 )(b), 40(1 )(b), 40(2)(g)(ii) of the Income Tax Act, SC 1970-71-72, c 63, as amended.

Mr Isaac Meisels, President of the appellant company, testified regarding the business activity of the company — in effect it was his holding company, and it was his practice to incorporate separate related corporations for var- ious particular ventures. “Louis Weisfeld Ltd” was just one in which he had used this method, but it had turned out badly from a business viewpoint.

It was noted by counsel for the appellant that “Meisels Ltd” because of its varied real estate oriented business operations, would have a difficult time claiming a capital gain on any transaction involving the sale of real estate, or even the sale of the shares in one of its subsidiaries where real estate was involved. The logical extension of that proposition in his mind, then, was that any loss incurred under similar circumstances should not be described as a Capital loss. Therefore, the loss in this matter aximotically had to be on income account. Counsel based this contention on his reading of Ronald K Fraser v MNR, [1964] CTC 372; 64 DTC 5224. See also Fraleigh, [1981] CTC 3044; 81 DTC 944. As counsel portrayed it, the situation before the Board was identical to that in Fraser (supra) — only the results were the reverse, a loss rather than a profit. I would agree that Weisfeld Ltd was incorporated by Meisels Ltd just as Aidershot was incorporated by Fraser (see Fraser (supra)) for the express purpose of holding land for sale. If either Weisfeld Ltd (this appeal) or Aldershot (Fraser) had sold the land at a profit, the gain would have been on income account to those respective companies. The underlying proposition by the appellant in Fraser (supra), as I read the case, was that since the shareholder Mr Fraser could only hope to obtain income from Aidershot by way of dividends on his shareholdings, such shareholdings were therefore an investment on capital account, and the resultant gain on the sale of the shares a capital gain. That proposition was rejected by the Court. According to the Court, the sale of the shares in Aidershot had merely “short-circuited” the more lengthy process of Aldershot selling the real estate, gain a profit, and declaring a dividend of that profit to the shareholder Mr Fraser.

Similarly, it is argued that in the instant case, has Weisfeld Ltd been profitable, the income stream to Meisels with regard to the investment in the shares of Weisfeld could have come only by way of dividends and would have been on income account. Counsel for the appellant also relied upon the case of Freud v MNR, [1968] CTC 438; 68 DTC 5279, because Freud (supra) in turn relied for the answer to one of the questions raised therein, on Fraser (supra). That question raised by the Minister in Freud (supra) provoked this critical comment to be found on 441 and 5281 respectively:

On the first question, the decision of this Court in Fraser v Minister of National Revenue (1964 SCT 657 (64 DTC 4224)) appears to be in point. It was there held that where real estate operators had incorporated companies to hold real estate, the sale of shares in those companies rather than the sale of the land was merely an alternative method of putting through the real estate transactions and the profit was therefore taxable. This decision does not in my view necessarily imply that the existence of the companies as separate legal entities was disregarded for income tax assessment purposes. On the contrary, it must be presumed that the companies remained liable for taxes on their operations and their title to the land, unchallenged. I must therefore consider that the decision rests on the view that was taken of the nature of the outlay involved in the acquisition of the companies’ shares by the promoters.

The learned justice then proceeded to demonstrate that the only view which could fit the circumstances of Fraser (supra) (and then which in turn might have any application to Freud (supra)) was that when the business method chosen by which to acquire the land was the holding in a company interposed for that purpose, where the alternative of share capital of holding the land directly was available to the taxpayer, such shareholdings need not be considered as a capital investment but rather could be regarded as a trading outlay. The same situation obtains in this appeal. Meisels could have held the land itself, but chose not to for business reasons. The logic pro- posed by counsel for the appellant appears to me to be well founded to the degree this matter can be superimposed over the Fraser (Supra) case.

In the present appeal, I would point out that the appellant has not demonstrated to the Board that the loss through winding up of the company of the $50 invested by Meisels in the shares of Weisfeld Ltd, may be equated to a sale of those shares. But even allowing that such might be the case, the Fraser (Supra) proposition, as interpreted by counsel for the appellant, would only provide relief for this taxpayer up to the extent of that $50 share investment. Certainly this taxpayer has not shown that there was some kind of “operating loss” of a further $101,000 which would have resulted in a theoretical net deficit value of the shares (as opposed to a gain in Fraser (supra)) totalling the amount at issue in this appeal of $101,050.00. What has been demonstrated to the Board is that in addition to the loss of the $50 share capital investment, Meilsels also lost the loan amount of $101,000. The loan of $101,000 did not give to Meisels any equity or proprietorship interests in the real estate held by Weisfeld — and to that degree I would only regard Fraser (supra) as providing for the allowing of the appeal up to the extent of $50. I am far from certain that such a loss is covered by the principle enunciated by the Court in Fraser (supra). In addition, while the amount of $101,000 was clearly a loan from Meisels to Weisfeld, there was no evidence provided regarding the manner in which any income was to be earned therefrom — separate and distinct from possible dividends on the shares held. (See Highfield Corporation Ltd v MNR,* [1] [1982] CTC 2812; 82 DTC 1835.

So, we have an outlay of $50 by Meisels for the corporate shares of Weisfeld Ltd which, by virtue of Fraser (supra) is not to be regarded as an investment but as a trading operation — see Freud (supra) at 442 and 5282 respectively:

Due to the definition of business as including an adventure in the nature of trade, it is unnecessary for an acquisition of shares to be a trading operation rather than an investment that there should be a pattern of regular trading operations. In the Fraser case, the basic operation was the acquisition of land with a view to a profit upon resale so that it became a trading asset. The conclusion reached implies that the acquisition of shares in companies incorporated for the purpose of holding such land was of the same nature seeing that upon selling the shares instead of the land itself, the profit was a trading profit not a capital profit on the realization of an investment.

Then the question arises, does the determination in Freud (supra) assist this taxpayer in the deductibility of the $101,000 loan amount at issue? As I read that case, no attempt was made by the taxpayer to deduct his outlay, whatever it was, for shares in the US company established to produce the prototype car. Whether or not that outlay might have been deductible (based on Fraser (supra)) need not be addressed. However, the amount of $13,480 allowed as a deduction by the Court in Freud (supra) was a loan — and to that extent it has characteristics similar to the amount of $101,000 at issue in this appeal. The loan in Freud (supra) provided no equity interest in the sports car being developed, nor did the loan in this matter provide any such interest — and again to that extent they are on common ground. But any effort to equate these amounts for purposes of deductibility based on Freud (supra) beyond that point runs into extreme difficulty. The “loan” in Freud was made at a time when the outlay in capital stock had been virtually lost. The “loan” then, by its very nature, was not an investment designed to earn income in its own right. It was not an “addition to capital” to protect capital already invested. It was a further outlay of the same nature as the Original outlay made for the acquisition of shares in the company — and that already had been determined by the learned justice to have been a trading account venture, not an investment.

In the instant matter, we have quite a different situation. The loan of $101,000 was provided as working capital — nothing more and nothing less

— during the years 1973 and 1974, not during the year under appeal — 1977. The financial difficulties of Weisfeld Ltd did not engulf the company until some time not earlier than 1976. It cannot be said that the loan in question here was advanced in order to protect the income base inherent in the capital stock of Weisfeld held by Meisels. The loan was a separate and distinct transaction — it had all the characteristics of just that (a loan) — quite distinctly different than that portrayed in Freud (supra), and it was an investment on capital account, not a trading operation on income account. It must be so dealt with for income tax purposes. That part of the appellant’s proposition has not been supported.

I would note two other points. First, the appellant did not attempt to challenge the assumption of the Minister — “The appellant was not in the business of money lending”. And second, the appellant did not pursue the alternative contention in the notice of appeal that the amount of the loan might be deductible as a bad debt. The board is not required to rule on these points but refers again for the record, to the recent case of Highfield (supra) in which similar questions are addressed.

In summary, therefore, the appeal is allowed in part in order that the amount of $50, laid out by the appellant for the acquisition of capital stock in the corporation Weisfeld Ltd, be deductible as claimed. In all other respects the appeal is dismissed.

Appeal allowed in part.