George Feher v. Minister of National Revenue, [1981] CTC 2323, 81 DTC 298

D E Taylor:—This is an appeal heard in Toronto, Ontario on February 26, 1981 against income tax assessments for the years 1974, 1975, 1976 and 1977. The issue to be determined was whether an amount of $40,595.19 should be a non-capital loss as contended by the appellant, or a capital loss as contended by the respondent.

The appellant is, and at all material times was an architect licensed to practise in the Province of Ontario. In the year 1973, in connection with a real estate development project of Wenfair Developments Ltd (“Wenfair”) in Belleville, Ontario, the appellant guaranteed some of Wenfair’s financial obligations with the Canadian Imperial Bank of Commerce (CIBC). On or about March 4, 1974, the Bank applied the sum of $41,910.19, from the appellant’s term deposits, against the guarantee. In filing his income tax returns for the relevant years, the appellant attempted to deduct the following amounts as a non-capital loss with respect to a payment by the appellant on a guarantee:

The Minister categorized the loss as a net capital loss and recomputed the appellant’s income in the relevant taxation years as follows:

(The Board makes no comment regarding the ‘“statute barred” note above with respect to the minister’s assessments.)

Contentions

For the appellant:

In the year 1972, the appellant was approached to provide his architect’s services and to participate as a principal in a project involving the construction of an apartment building in the City of Belleville. The project was carried on under a corporate entity known as Wenfair Developments Ltd. The intention at all times of the appellant was to engage in the project in order to earn fees for the provision of his services as an architect and to turn the project to account for profit in which, at the outset of the venture, he had hoped to participate.

The appellant, in fact, did the architectural work, acted as the CMHC liaison, obtained building permits, supervised the construction and undertook various other related activities in connection with the project

In the spring of 1973, it became apparent that the project was in serious financial difficulties which were compounded when the third mortgagee failed to advance funds which he committed for the project. The appellant, in order to attempt to save the project arranged for bank financing of $100,000. The appellant, as collât- eral to the said financing, agreed to deposit on account with the bank, the amount of $40,000. The said $40,000 was agreed to be deposited by the appellant on the basis that that amount represented the fees that the appellant had or would earn in the project and which he hoped to realize upon the completion of the project.

The reason the taxpayer agreed to provide a deposit of $40,000 as collateral to the loan arranged to finance the project was to enable the project to proceed so that he would recover his fee representing the professional services he had provided to the project. The professional services for which the appellant had not been reimbursed by the date that he provided the deposit was approximately $40,000.

The said $40,000 was an amount put at risk by the appellant for the purpose of gaining or producing income, viz fees from the performance of architectural services.

For the respondent:

In early 1973, the appellant guaranteed to the extent of $40,000 a loan of $100,000 received by Wenfair; Masron Contracting Ltd. (“Masron”) and Vigh Mechanical Contrcting Ltd (“Vigh”).

The appellant, at the time the guarantee was made, was at all material times a director and shareholder of Wenfair, Masron and Vigh.

This loan was for the purpose of developing a property in Belleville owned by Wenfair.

The appellant received $2,000 on distribution of the proceeds of the sale of the property;

The appellant further paid $685 on behalf of Wenfair;

The net loss with respect to the project was therefore:

Amount of guarantee	$41,910.19
Less: Proceeds received	2,000.00	$39,919,19
Add: Payments made:		685.00
		$40,595,19

The appellant earned management fees with respect to the development of the Belleville property.

Evidence

In general the evidence and testimony provided were designed to support the facts alleged by the appellant. The main dispute, however, centred on the interpretation to be placed upon those facts — there appeared little doubt that the appellant had done at least some professional work on the building; that he had put up certain term deposits as a guarantee; and lost the amount in question in the process.

Argument

In essence, the proposition of the appellant is that a businessmantaxpayer who loans funds to an already existing business debtor, and thereby becomes a creditor for an even greater amount, does so as part of his business activity in order to collect the original business accounts receivable. Therefore, the proposition follows that in the event of loss, the loan should be a deductible expense. All the testimony supported the view that the appellant had either left Wenfair or agreed to do so at the time the guarantee was provided. There was no evidence or testimony leading to a conclusion that he had done so in order to ensure the completion of the project and derive his gain from the sale of the building by Wenfair. In the words of counsel for the appellant:

Again I say it wasn't to keep a business, it wasn’t to sell a business, it wasn't to provide anything for Mr Feher’s enduring benefit. It was simply a risk amount in the hope and expectation that he would recoup his $40,000 fee.

Counsel for the appellant quoted extensively from MNR v Henry J Freud, [1968] CTC 438, 68 DTC 5279, and also cited the following:

D J MacDonald Sales Limited v MNP, 16 Tax ABC 49; 62 DTC 208;

George H Steer v MNP, [1965] CTC 181; 65 DTC 5115;

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

Donald Preston McLaws v MNP, [1972] CTC 165; 72 DTC 6149;

Her Majesty the Queen v FH Jones Tobacco Sales Co. Ltd., [1973] CTC 784; 73 DTC 5577;

H Griffiths Company Limited v MNP, [1975] CTC 2120; 75 DTC 97;

Her Majesty the Queen v H Griffiths Company Limited, [1976] CTC 454; 76 DTC 6261.

Counsel for the respondent cited the following case:

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

Findings

As I read the above citations, there are only two situations upon which the appellant could possibly rely — Macdonald (supra) and Jones (supra). The distinctions in MacDonald (supra) are obvious — the debtor and the creditors were unrelated, and the presiding Member noted “the patricular circumstances of this case”. In light of the more recent decisions I would be reluctant to accept the decision in MacDonald (supra) and concluded that the “sole purpose (of the guarantee) was to increase its sales, and hence its profits, and this moreover is what did happen . . . (p 792). In the instant case, there is no indication that the appellant anticipated further business as an architect with Wenfair. His only purpose for making the guarantee was (according to his evidence) to collect an already outstanding accounts receivable — considerably different than Jones (supra). Conversely, Chaffey (supra) cited by the respondent dealt with a situation considerably more in favour of that appellant’s claim than the instant case, and Chaffey was not successful in the appeal.

At the date the appellant provided the guarantee, he incurred only a contingent liability — no funds had actually changed hands. At the date the guarantee was exercised by the bank, he assumed the position of the bank (stood in its shoes) up to the extent of the amount so paid. As I see it, that brought into existence for the appellant an asset of enduring benefit — he became a creditor of Wenfair and, as such, had some legal position, no matter how limited. The fact that his claim as a creditor with respect to the “guarantee” funds provided, was of little practical value is not pertinent. The claim as a creditor for the “guaranteed” funds was separate and distinct from any claim he might have had with respect to his professional fees. The narrow area so clearly defined in Freud (supra), which permitted the learned judge to allow that appeal, provides no comfort for this appellant as the argument has been proposed at this hearing. In Freud (supra), the sole purpose of the loans provided to the company by the appellant was to complete the work of the company — the development and production of a prototype automobile to sell. The only purpose of the company, according to the evidence, was to produce and sell that prototype — there was never any intention to use the prototype as an investment from which to earn operating revenue. The prototype was inventory, not an investment. The loans in question in that case can be regarded (in a very simplistic way) as merely the provision of funds for the acquisition of inventory to sell — a purely trading purpose as seen by the learned judge.

It is interesting to note that the evidence in this current matter shows many similarities — the building under construction by Wenfair was to be sold — not retained and rented as an investment. However, this appellant eschewed the “completion of the project” purpose similar to Freud (supra) (although referenced as an alternative in the notice of appeal), and related the guarantee to the architect’s fees — quite a different perspective.

The two amounts involved in this appeal — the professional fees and the payment under the guarantee have not been related in a way providing a basis for the appellant’s contention. That interrelationship (fees and guarantee) might be argued had the bank accepted as a form of guarantee from the appellant the assignment of his accounts receivable from Wenfair — but that was not the situation portrayed at the hearing. Further, the appellant has not demonstrated in what manner a loan to a third party (Wenfair) to keep it solvent, should be considered as a deductible expense in relation to the architectural business when it is less than certain that a similar loan made to the architectural business for the same purpose would be so deductible. In the final result, it is difficult for a creditor to support as a deductible non-capital business expense an amount used for capital purposes by a debtor, particularly when the parties are not dealing at arm’s length.

Decision

The appeal is dismissed.

Appeal dismissed.