Ralph Brady v. Minister of National Revenue, [1980] CTC 2234, 80 DTC 1222

The Chairman:—This is an appeal of Mr Ralph Brady from income tax assessments in respect of the 1969, 1970, 1971, 1972 and 1973 taxation years.

In assessing the appellant the Minister found that the appellant had failed to include the following amounts in computing his income:

The Minister added the above amounts to the appellant’s income for each of the taxation years respectively and imposed a penalty of $250.84 for the appellant’s omission in not reporting income in the amount of $6,500 for the 1969 taxation year.

In computing his income for the 1972 and 1973 taxation years the appellant sought to deduct as interest expenses the amounts of $5,615 and $3,817 respectively. The Minister disallowed the amounts so claimed. At the hearing, by way of amendment of the respondent’s reply, an amount of $6,089 also claimed by the appellant in the 1971 taxation years as interest expenses was also disallowed.

In 1972 and 1973 the appellant reported income of $389.55 and $16,914.67 respectively, as taxable capital gain resulting from the sale of shares of Ark Explorations Limited in those years; the Minister included in the appellant’s income the amounts of $11,027.86 and $59,722.21 received by the appellant in the 1972 and 1973 taxation years as taxable income derived from the sale of shares of Ark Explorations Limited.

Summary of Facts

The appellant, a resident of Port Lambton Ontario, had been for many years engaged in the oil and gas business. In order to diversify his business activities the appellant formed a company under the name of Castaway Inn Limited (hereinafter referred to as “Castaway”) to operate a motel, a restaurant and a yacht club, which were operated and financed by the appellant.

In the late 60’s and early 70’s the appellant who owned the land and building on which Castaway was operating spent considerable time in administering the Inn. Substantial sums of money were required for necessary improvements to the buildings and as working capital for the business. To meet the financial requirements the appellant borrowed some of the necessary finances from the banks and also provided monies from his own personal financial resources. The improvements made to Castaway Inn Limited by the appellant were therefore in the nature of leasehold improvements. When the assets of Castaway and the Yacht Club were sold in 1973, the appellant was still personally liable for loans made by the bank to Castaway, which he had personally guaranteed.

While still operating Castaway the appellant also engaged in the business of locating and leasing land for oil and gas operations, in which he had formerly been engaged. However, by means of an alleged oral agreement between Angelus Petroleums (1965) Limited (hereinafter referred to as “Angelus”) and Castaway, the latter became the vehicle through which the appellant financed his gas and oil activities. It is alleged that the services performed by the appellant to Angelus from 1969 to 1972 were paid for by Angelus to Castaway by the transfer of Angelus shares to Castaway.

In 1971, Ark Explorations Limited, (hereinafter referred to as “Ark”) was incorporated (with 3, 000,000 common shares npv) at the instigation of the appellant for the purpose of searching for oil and gas and participating in Similar ventures with other companies.

In 1971 Ark acquired all the assets of Pure Copper Explorations Limited (“Pure Copper”) for about $42,000. Ark financed the acquisition by assuming liabilities of Pure Copper in the amount of $13,720 and issued 1,020,005 common shares for distribution to shareholders of Pure Copper. Of the 1,020,005 common shares issued 675,000 shares were in escrow. Although it was not made clear as to how much of the appellant’s own capital went into the venture, all the transactions were arranged by the appellant.

The appellant personally acquired from Galbay Investments Limited, 94,000 shares in Pure Copper at a price of 2.4¢ a share and 257,500 escrowed shares of Pure Copper for $6,000. These shares were then exchanged on a share for share basis for escrowed shares of Ark and thus the appellant came into possession of 257,500 escrowed shares of Ark. In September, 1971 the appellant extended his holdings in Ark by acquiring an additional 65,000 common shares at 10¢ per share.

In October, 1971, in its prospectus Ark offered 500,000 common shares for sale to the public at the best market price but not less than 22 /aC per share to be paid to Ark. A second offer for the sale of 545,000 shares was made by certain shareholders of Ark which was also included in the prospectus. However these latter shares could only be sold to the public after the 500,000 treasury shares offered by Ark had been subscribed for.

In April, 1972 the appellant, under the second offer contained in the prospectus, sold his 65,000 common shares in Ark and reported a taxable capital gain of $389.55.

In October, 1972 the appellant purchased 250,000 escrowed shares of Ark from Mr Frank Rawlings. One month later 112,800 of these shares were released from escrow and the appellant sold 96,700 shares to a third party. The appellant reported a taxable capital gain of $16,914.67 on the disposition of the said shares.

The Issue

The issue in this appeal can be divided into three categories:

(a) Who was the recipient of the income for services rendered by the appellant to Angelus during the taxation years 1969 to 1972?

(b) Are the interest expenses claimed by the appellant totalling $6,089 for 1971; $5,615 for 1972 and $3,817 for 1973 deductible?

(c) Was the acquisition by the appellant in 1971 of 65,000 shares of Ark and a further acquisition of 250,000 of Ark shares in 1972 and their subsequent disposition capital transactions?

Finding of Facts

I shall deal first with the question of who received payment for the services rendered to Angelus in the period of 1969 to 1972. It is the appellant’s contention that because of an alleged restrictive covenant whereby the appellant promised in 1965 not to engage in the business of ac- qu i ri ng oil wells, his activities in the oil exploration business during the pertinent years should be considered as that of Castaway’s and that the payment for services rendered were made to Castaway and not to the appellant.

It seems clear from the evidence that although the appellant did administer the Castaway business during the pertinent taxation years, he also devoted considerable time in the oil exploration business with which he was thoroughly familiar. It is through his personal knowledge and his competence in the oil exploration business and not in his capacity of administrator of the Castaway Inn, that the appellant rendered services to Angélus. I can see of no way the Castaway corporation, which was in a totally different field of activities, could possibly have been of service to Angelus, an oil exploration company. The services rendered to Angelus were rendered by the appellant personally and whether or not it suited the purpose of the appellant to let it appear that the services were rendered by Castaway, Castaway did not nor could it render the services for which Angelus paid. Notwithstanding the possible existence of a restrictive covenant which prohibited the appellant from engaging in an oil acquisition enterprise, the evidence clearly shows that the appellant was so engaged. It is very difficult to understand why Angelus would have entered into a contractural partnership with Castaway Inn Limited, but it is very easy to understand its acceptance of services which the appellant himself could render because of his experience in the oil and gas exploration fields.

This fact is confirmed by a Board of Directors’ resolution of Angelus in March, 1969 whereby the appellant personally, and not Castaway, was asked to perform services for Angelus because of the experience in and knowledge of the oil exploration field. Under such circumstances it is impossible to conclude that the payments made by Angelus for services rendered by the appellant personally could have been paid to and received by anyone else but the appellant. With reference to the payments made by Angelus, the original T-4 slips were subsequently amended whereby Castaway was substituted for the appellant as recipient of the shares which Angelus transferred for services received from the appellant (Exhibit A-12 and A-13). The shares were then transferred to the appellant, who debited the cost against the appellant’s advance account with Castaway. The whole procedure of utilizing Castaway as a front for the appellant’s activities in oil explorations appears to me to be highly artificial and does not reflect the true substance of transactions.

I hold therefore that the amounts of $6,500, $13,500, $13,500 and $4,500 in each of the years 1969,1970,1971 and 1972 respectively were income to the appellant and that the penalty of $250.84 imposed on the appellant for omitting to report income in the amount of $6,500 for the 1969 taxation year was justified.

The second point in issue is the disallowance of interest expenses in the amounts of $6,089 in 1971; $5,615 in 1972 and $3,817 in 1973. The appellant admitted that Castaway Inn Limited was in financial difficulties and needed funding for capital improvement and for working capital. It is the appellant’s contention that since he did not use the money in any of his other business ventures, the capital borrowed by him was used directly or indirectly to improve Castaway’s potential to earn income for the appellant.

It would appear that the respondent in assessing the appellant considered this fact and allowed the interest payments on money borrowed to finance capital improvements. However, the respondent disallowed interest payment on funds used to pay off Castaway’s existing liabilities or to increase its working capital, on the grounds that pursuant to paragraph 18(1)(a) of the Income Tax Act, such borrowings were incurred for the benefit of Castaway Limited and were not borrowed or used by the appellant for the purpose of gaining or producing income from his personal business.

In support of his position counsel for the respondent cited the case of John A Matheson v Her Majesty The Queen, [1974] CTC 186; 74 DTC 6176, in which the Federal Court, Trial Division stated:

The interest expense claimed by the Plaintiff and disallowed by the Minister was not paid or incurred in respect of borrowed money used to earn income from the Plaintiff’s business or property and the reassessments are accordingly sustained.

I find that the conclusion in the Matheson case is applicable to the facts of this appeal and that the interest payments in keeping with the provisions of paragraph 18(1)(a) were properly disallowed by the Minister.

The last point in issue is the taxability of the profits realized by the appellant on his various transactions in shares of Ark Exploration. It is the appellant’s contention that his holdings of shares in Ark were an investment and that the profits earned on their disposal was capital in nature. The appellant cited the case of Irrigation Industries Ltd v MNR, [1962] CTC 215; 62 DTC 1131. Mr Justice Martland stated in his judgment that corporate shares are not in themselves articles of commerce and that their acquisition is a well recognized method of investing capital in a business enterprise.

However I agree with counsel for the respondent in not interpreting Mr Justice Martland’s words as implying that all sales of shares should be considered as being outside the scope of a commercial transaction which can produce taxable income. The shares of Ark and the manner in which they were transacted appear to me to be highly speculative and are not the kind of shares one would acquire as a long-term investment, to which I believe Mr Justice Martland referred. The evidence is that the appellant was an insider in the transactions and played a prominent role in moving the shares. The appellant’s activities were not unlike that of a broker and much more in keeping with that of a trader in shares than that of a person who is seeking to make a long-term investment. The price that the appellant may have paid for the shares though not irrelevant to the issue cannot in my view be considered as a meaningful indication of the appellant’s intention in acquiring the shares. The fact that the appellant gave valid consideration for the shares he originally acquired in Ark does not necessarily lead to the conclusion that they were acquired as an investment. On the basis of the evidence I find that the appellant’s basic concern, his attitude and the manner the Ark shares were acquired and disposed of by him are highly indicative of a speculative intent. The appellant has not succeeded in establishing to the satisfaction of the Board that his intent in acquiring the said shares was for investment purposes. I must conclude, therefore, that the profits realized by the appellant from the disposition of the shares in the amounts of $11,027.86 and $59,722.21 in the 1972 and 1973 taxation years respectively were properly added to the appellant’s income for those years.

For the reasons set out above the appeal must be dismissed.

Appeal dismissed.