Steven Michael Overgaard v. Minister of National Revenue, [1982] CTC 2351, 82 DTC 1278

Guy Tremblay:— This case was heard in Toronto, Ontario, on December 2, 1981.

1. The Point at Issue

Pursuant to the pleadings, the issue is whether the appellant, a self-employed person, is correct in deducting in the computation of his income for his 1977 taxation year the amount of $16,775 detailed as follows as business losses: $13,132 (incurred on Chateau Suisse restaurant), $1,000 (incurred on Roynat Guarantee), and $2,643 (rental loss on White Egret condominium in Florida).

The respondent allowed only $1,067.12 on the rental loss and contended that there was no business loss on the two other items, but only capital loss and thus allowed 50% of those losses: $7,066, $2,000 of which is for the 1977 taxation year.

2. The Burden of Proof

2.01 The burden is on the appellant to show that the respondent’s assessment is incorrect. This burden of proof results especially from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

2.02 In the same judgment the Court decided that the assumptions of fact on which the respondent based the assessments are also deemed to be correct. In the present case, in paragraph 7 of the Reply to Notice of Appeal, the respondent described the facts on which he based his assessment:

7. In reassessing the Appellant as aforesaid the Respondent relied upon the following findings or assumptions of fact:

(a) at all material times, the Appellant was self-employed, carrying on business as a management consultant under the style of “S M Overgaard and Associates”; (the words “management cosuitant” are in dispute)

(b) at all material times, the Appellant was a shareholder of Chateau Suisse Restaurant Limited; (admitted by the appellant during the trial)

(c) during the 1977 taxation year, the Appellant was a creditor in the bankruptcy of Chateau Suisse Restaurant Limited to the extent of $13,132; (admitted by the appellant during the trial)

(d) the amount of $13,132 referred to in paragraph 7(c) was a liability of Chateau Suisse to the appellant arising from non-interest bearing cash advances made by the Appellant to the corporation; (admitted by the appellant during the trial)

(e) during the 1977 taxation year, the Appellant became liable to Roynat Limited to the extent of $1,000, pursuant to a guarantee by the Appellant for a loan from Roynat to Chateau Suisse; (admitted by the appellant during the trial)

(f) during the 1877 taxation year, the Appellant held a one-third partnership interest in a condominium in Florida, hereinafter referred to as “White Egret”, which was a rental property of the partnership from which it earned rental revenue; (admitted by the appellant during the trial)

(g) the White Egret partnership expended $3,201.37 in excess of revenues in the 1977 taxation year with respect to its rental activities. (admitted by the appellant during the trial)

3. Withdrawal

At the end of the trial, the appellant withdrew the point concerning the rental loss of $2,643 on the White Egret condominium in Florida. It was admitted by the appellant indeed that the said amount comprised $1,067.12 for the 1977 taxation year, and the balance for the 1976 taxation year. The respondent, in reassessing, applied the approriate losses to the appropriate years.

4. The Facts

4.01 The appellant was 32 years old in 1977. He is an engineer, an accountant and an MBA. He said that the words “management consultant” used in subparagraph 7(a) of the Reply to Notice of Appeal quoted above in paragraph 2.02 do not really describe what he was doing in 1977 and the years before, despite his own declaration in his 1977 income tax return that he was a management consultant.

What I am involved in is in dealing with business primarily owner/operated businesses, where I have come into the company, generally in a situation where there was a financial problem. I know from my own experience that a financial problem is only the symptom of the real problem, and the real problems are usually other things.

In those cases I have negotiated arrangements whereby I would go in with money on occasion and assist in the turn-around or the treatment of the problem and the compensation would be generally speaking some form of return in a number of ways, basically though I was always striving to achieve some form of equity either by option, by purchase et cetera. (SN p 7)

4.02 The appellant filed as Exhibit A-1 a list prepared by him of 30 activities he named “business ventures”. This list includes the “name of business”, the “name of principals involved” and a “brief description” of the said business”.

This list of 30 “business ventures” is only, according to him, a part of his activities during the years 1974 to 1978. There were 20 to 25 others in which he participated.

4.03

In the early years I started off with smaller type operations simply because to style myself as a merchant bank when in fact my resources were somewhat limited would be a little presumptuous, so that the types of investments that were made were of a modest nature.

I found always great difficulty in finalizing the deals. Now, I know from experience that that is in fact what really happens. It takes a long time to ultimately close and finalize a deal. And I have a history of many deals particularly in the formative years where these things fell apart.

Eight (8) years ago I was an MBA, today I am an MBA with experience, and I think that if you track through you will see that the quality and the nature of the business that I am doing has improved, the style in which I conduct the business has not changed at all.

So that is what I have been calling management consulting on a broad scale, my wife can’t even explain what I do, she calls me an engineer because I am also an engineer. It is just a nice way of dealing with the subject.

Now, I understand that it has caused considerable misunderstanding, and I guess this is the one that I have had to deal with now, that is why if you would have asked me five (5) years ago what do I do, I would have said honestly management consulting, not understanding that it would have an implication, whereas if you ask me today, I will say entrepreneur because that is basically what it is. (SN pp 8 and 9)

4.04 The remuneration in those activities combined interest, shares, salaries, Commissions, etc. The loans were part of his overall activities. Most of them were in the form of advances made by him making payments for operating expenses of supplies, etc. They were not lump sum advances as might customarily be made by a bank. The appellant’s counsel summarized the testimony of the appellant concerning the loans very well: “It was an unusual pattern, but it did form part of a long and continuing pattern of venture, capital speculative trading, involvement in turning around business situations.” (SN pp 52 and 53)

4.05 In computing his income from business for the 1977 taxation year, the appellant calculated his net revenue as follows:

4.06 By reassessment, confirmation of which was given on March 20,1980, the respondent did not permit the appellant to deduct the sum of $16,775 as non-capital losses in the computation of his income for the 1977 taxation year and recomputed the appellant’s total income as follows:

4.07 Among the 30 business ventures described in Exhibit A-1, the appellant said he made 10 loans or advances. Those business ventures are described as follows in Exhibit A-1:

The appellant explained that many loans were made through “Canadian Pulse”. “Just by way of explanation, we assembled money in Canadian Pulse in order to amass a larger amount of capital, and that became the investing body and it was then streamed through there.” (SN p 12)

4.08 The appellant also testified that in 1977, he declared as income an amount between $15,000 to $21,000 which was the result of a business venture named in Exhibit A-1 as “G A MacEachern Ltd”, the description of which is:

Speculative turnaround project with equity agreement. Company successfully

sold. Reached settlement.

4.09 Chateau Suisse

Concerning “Chateau Suisse”, the appellant testified as follows in examination-in-chief:

Chateau Suisse Restaurant was a new venture. I received a twenty-five per cent (25%) interest for putting together the financing package and the arranging for a site, things of that type. When we started out we thought we had enough money, by the time the construction was completed it was necessary to seek additional financing which I subsequently did, and among other things it was required that we give our guarantees, the various shareholders to support that financing which I did. And that was done equally by all shareholders.

The operation started and within a very short period of time it became apparent to us as investors that the — the one investor who was both the manager and the chef was in over his head, the operation was losing money. He used up the bank line, bills were presented; I happened to be located in an office right beside that particular building at the time; and I ended up advancing money to cover purchases of groceries and food, and things like that. So I was dispensing cash, some items I paid for directly, other items I advanced moneys and they were then used to settle the accounts on basically a COD basis. Finally we fired the manager who was also the investor, and I went in and operated for about three or four (3-4) weeks. It was an impossible situation and it was subsequently, a receiver was appointed and subsequently it was petitioned into bankruptcy. (SN pp 14 and 15)

This business was incorporated. The restaurant is located in Toronto. It went into bankruptcy in November 1976. The appellant realized that there was no hope of getting the money back in late 1977.

4.10 In cross-examination, the appellant answered affirmatively to the following question concerning the advances to the Chateau Suisse: “And you hoped to preserve the investments that you had already made? Exactly.” (SN p 29)

Concerning the interest on the said advances, the appellant affirmed “there was an understanding that there would be interest paid, but it was never — we never really had the time to get back to deal with this.” It was only a verbal agreement. (SN p 30)

4.11 In cross-examination, the appellant also said there were 5 shareholders in the company, Chateau Suisse: “Two (2) people were in the restaurant business, one (1) person was just a straight investor, and the other person was in business but not in the restaurant business.” The original problem in this venture is that the partner who was in charge of the day-to-day operation “was taking money and supplies”. He was fired and replaced.

4.12 Still in cross-examination, the appellant testified he had an enterprise: S M Overgaard and Associates. The office is at home. There are four (4) to five (5) persons (engineers and accountants) who are involved in some of the ventures. “They wee basically in there to watch over our investments.” (SN pp 31, 32)

Q How many clients would you say you served per year? A I am not sure that I would call them clients, but it is my experience that in order to do what we call, what we characterize as a deal, we use a rule of thumb, that you have to look at a hundred (100) to get one (1). The listing that I have given you is far from complete. I have — I would say that I look at a minimum, sometimes it is like, it is one day, or a half a day investment of time. I would say that I would look at a minimum, a minimum of twenty-five (25) investment opportunities a year, minimum.

Q Do they approach you for guidance in terms of turning a business around or making it more successful? A Most of them come now on a referral basis. Usually because there is a shortage of capital in some form or another.

Q Do they rely on your knowledge as an engineer? A No.

Q Do they rely on your knowledge as an MBA? Or accountant? A No, I think they rely on my business knowledge, and my investment knowledge, and my financing knowledge. (SN pp 32, 33)

4.13 Concerning the different ventures, the appellant said . . in a number of cases the advances were on the basis that I would get a percentage of the company, they were sort of down payment if you like on an option or an opportunity to acquire a certain percentage of the company.” (SN p 35)

He also considered the receipt of shares as part of his consideration (SN p 36). This is what happened in the Chateau Suisse deal (SN p 38 and also see quotation in paragraph 4.09).

4. Law — Cases at Law — Analysis

4.01 Law

The main provisions of the Income Tax Act involved in the present case are paragraphs 18(1)(a), 38(b), 39(1)(b), 50(1)(a) and subparagraph 40(2) (g)(ii).

4.02 Cases at Law

The cases at law to which counsel for both parties referred the Board are as follows:

A. By the appellant

A-1 Loans

1. Ben Rosenblat v MNR, [1955] CTC 323; 55 DTC 1205;

A-2 Advance

2. MNR v James N Sissons, [1969] CTC 184; 69 DTC 5152;

3. Alexander Dewar v MNR, [1972] CTC 2499; 72 DTC 1421;

4. Stephen S Steeves v HMQ, [1976] CTC 470; 76 DTC 6269;

5. Victor V & Mary Spencer v MNR, [1978] CTC 2109; 78 DTC 1129;

6. HMQ v Samuel Eidinger, [1979] CTC 296; 79 DTC 5218.

A-3 Partnership

7. David Rothenberg v MNR, [1965] CTC 1; 65 DTC 5001.

B. By the respondent

8. Stewart & Morrison Limited v MNR, [1972] CTC 73; 72 DTC 6049;

9. Donald Preston McLaws vMNR, [1972] CTC 165; 72 DTC 6149;

10. Charles Chaffey v MNR, [1978] CTC 253; 78 DTC 6176;

11. HMQ v Doral Investment Corporation, [1979] CTC 398; 79 DTC 5316;

12. Alfred M Kotelko v MNR, [1977] CTC 2274; 77 DTC 205;

13. Harry E Candib Co Ltd v MNR, [1970] Tax ABC 1227; 70 DTC 1784;

14. Gordon Rosenberg v MNR, [1968] Tax ABC 1131; 68 DTC 830;

15. MNR v George H Steer, [1966] CTC 731; 66 DTC 5481;

16. MNR v Henry J Freud, [1968] CTC 438; 68 DTC 5279;

17. Henry Wertman v MNR, [1964] CTC 252; 64 DTC 5158;

18. Harry Walsh and Archie Robert Micay v MNR, [1965] CTC 478; 65 DTC 5293.

4.03 Analysis

4.03.1 As the point concerning the rental loss is settled (see para 3), there remains the Chateau Suisse loss in the amount of $14,132.

The amount is not in dispute. The sum of $13,132 was advanced to Chateau Suisse and $1,000 was paid to Roynat Guarantee because the appellant had guaranteed the debt.

The point is whether these amounts must be considered as part of an investment or as part of a business. In the latter case, they should be totally deductible pursuant to paragraph 18(1 )(a). In the former case, they should be 50% deductible pursuant to subparagraph 3(b)(ii), paragraphs 38(b), 39(1)(b) and subparagraph 40(2)(g)(ii).

4.03.2 When one considers the description of the work done by the appellant, the loans and the advances made in 10 different ventures (para 4.01 to 4.07 of The Facts), it seems at first glance that the loans and the advances are part of the business of the appellant, and therefore must be totally deductible as business expense.

However, to resolve a problem of this nature, each case must be studied on its own merits even if the appellant officially were in the lending business.

4.03.3 Concerning the Chateau Suisse venture, the Board states first that the appellant received 25% of the shares in payment for services rendered (“financing package and the arranging for a site, things of that type”, SN p 14, para 4.09 of The Facts). The advances were made because one of the main partners was taking money and supplies (paras 4.09 and 4.11). The appellant testified that these advances were made “to preserve the investments” (para 4.10). Therefore, it is obvious that the appellant wanted to protect his capital which would give him in return a salary or dividends.

4.03.4 It seems to the Board that the case of Chateau Suisse is like many of the other ventures. The appellant indeed testified that the ventures are “investment opportunities” (para 4.12 quotation). Also in Exhibit A-1 prepared by the appellant, in the descriptions of the said ventures in which he made advances or loans, the words “investment lost” or “investment recovered” are currently used (para 4.07 of The Facts).

Moreover, “in a number of cases the advances were on the basis that I would get a percentage of the company . ..” (para 4.13 quotation). This seems to me the substance of an investment. Moreover, speaking about his associates he said: “they were basically in there to watch over our investments” (para 4.12). The outlays made in honouring the guarantee given by the appellant is of the same nature.

4.03.5 The courts have, on many occasions, given decisions to the same effect,

Charles Chaffey v MNR, (supra)

The advances made by the Taylor-Chaffey partnership to Canadia were, in my opinion, loans to provide it with working capital and were outlays of a capital nature, the loss of which was a capital loss to the partnership and to the partners, the deduction of which is prohibited by section 12(1 )(b) of the Income Tax Act.

and Donald Preston McLaws v MNR, (supra)

In my opinion the appellant’s outlays were on account of capital, within the meaning of Section 12(1)(b) and the claimed deductions are prohibited. In my view of the situation, the guarantee was given to protect and preserve the source of income, a business which was in immediate danger of bankruptcy and whose existence was imperilled. The character of the ensuing outlays in honouring the guarantee is quite different from expenditures which fall naturally into the category of income disbursements and business losses. In my opinion, the outlays are of the character of payments on account of capital and are not of the kind of expenditures on account of capital and are not of the kind of expenditures that the Statute contemplated to be allowed as deductions under the language “made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer”, in Section 12(1 )(a), or under the language “business losses sustained . . . in the course of the carrying on of a business”, in Section 32(5)(d).

5. Conclusion

The appeal is dismissed in accordance with the above Reasons for Judgment.

Appeal dismissed.