Marvin C Holland v. Minister of National Revenue, [1980] CTC 2487, 80 DTC 1452

D E Taylor:—This is an appeal heard in the City of Edmonton, Alberta, on March 21, 1980, against an income tax assessment dated August 20, 1976, in which the Minister of National Revenue disallowed an amount of $22,184.16 claimed in the year 1974 as a business income loss. In so assessing, the respondent relied, inter alia, upon paragraph 18(1)(b) and subparagraph 40(2)(g)(ii) of the Income Tax Act, SC 1970-71-72, c 63, as amended.

History

The appellant is a businessman presently living in Victoria, British Columbia, but during at least a portion of the time material, was living in Edmonton. He was the owner of several nationally-known companies engaged in the clothing business from which he received a substantial salary. He also owned rental property with an undepreciated value of $105,000 in 1974, from which he derived gross rental income of $32,400 and, further, he had investment income of $1,946. The relevant amount of $22,184.16 was inden- tified in the 1974 income tax return filed by the appellant in the following way:

The “business loss’’ of $20,159 consisted of two amounts: that associated with a Mr Duke for $19,659, and that against a Mr Wright for $500.

Contentions

In his notice of appeal, the appellant asserted that:

— In 1974, he and Allen E Duke were operating a business venture in relation to imported European antiques.

—The profits from such a venture were to be divided equally with Duke.

— Duke was to do the buying and selling.

— He (the appellant) arranged two letters of credit for the purpose of purchasing antiques in Europe which became part of the inventory of the business venture.

—As antiques were purchased by Duke, sums were drawn on these letters of credit in order to pay for the antiques so purchased.

— Drawings on the aforementioned letters of credit were as follows:

—The business venture was unsuccessful and the appellant suffered a business loss in the amount of $22,184.16.

— In conjunction with various business activities he expended in 1974 $2,025.16 in relation to business promotion.

—The business enterprise operated by the appellant and Mr Duke personally was for the purpose of gaining or producing income.

—The expenditures incurred pursuant to the letters of credit issued were for the purpose of purchasing inventory for the business venture and for the purpose of gaining or producing income from a business.

—The losses suffered were business losses and properly deductible.

—The business promotion expenses incurred by the appellant in 1974 were for the purpose of gaining or producing income and are properly allowable as a deduction to the appellant.

For the respondent:

—The advances to Duke and Wright were personal loans, not made for the purpose of earning income, hence not deductible as either business or capital losses.

—The travel expenditures claimed were neither shown to have been laid out to earn income from a business or a property of the appellant nor do they qualify for deduction as either salesman’s or employee’s travel expenses.

Evidence

The appellant testified that Duke had been one of his valued employees for six or seven years in Edmonton, had wanted to leave Holland’s employ and go into the auction business himself, and in fact had done so in April 1973, calling it “Dukes Auction Gallery Ltd’’. Duke had suggested to and arranged with the appellant the process described in the notice of appeal in which they would have a business separate from the auction gallery, but using the facilities of the auction gallery for storage, display and sales—Duke receiving the regular auctioneer’s commissions on the items involved. A pamphlet headed “ANTIQUES—DUKES AUCTION GALLERY LTD—Auctioneers: Al Duke, Bud Haynes’’ was entered as Exhibit A-1. Also submitted by the appellant were photostatic copies of two cheques—one dated December 20, 1974 for $6,000 in his favour, apparently made out by Duke, and with a notation ‘‘Special Account’’ written on it (Exhibit A-2), and another also in favour of the appellant dated February 7,1975 for an amount of $4,250 also made out apparently by Duke, on an account (as indicated thereon in writing) “Duke’s Auction Service”. It was the evidence of Mr Holland that the first cheque had been returned to him NSF, and when he had met Duke, he was informed the Income Tax Department had taken the funds out of the ‘‘special account” for some of Duke’s own income tax liability. The cheque for $4,250 was to be partial recovery of the $6,000 NSF cheque, but it was also NSF. A document (Exhibit A-4), purportedly signed by Duke, was also entered by the appellant over the strong reservation of counsel for the respondent:

in the Province of Alberta, Businessman

do solemnly declare that

1. On or about the year 1974 I was carrying on business as Duke’s Auction Gallery in Edmonton, Alberta.

2. During this time, in addition to my above-mentioned business I entered into a joint venture with Marvin C Holland to import certain and various antiques from Europe for re-sale in Canada.

3. This venture with Mr Holland was financially successful and as a direct result Mr Holland suffered a business loss from my records of $19,962.15.

4. I make this statement voluntarily as it truly represents the business venture entered into with Mr Holland at the time.

AND I make this solemn declaration conscientiously believing it to be true and knowing that it is of the same force and effect as if made under oath and by virtue of “The Canada Evidence Act”.

DECLARED before me at the City )
of Edmonton,	)
in the Province of Alberta,	)	(Sgd) A E Duke
this 25th day of November,	)
1976.	)
(Signature)
A Commissioner for Oaths in and
for the Province of Alberta

The following particular portion from the appellant’s evidence is quoted for later reference:

Q. I show you a brochure entitled “Antiques, Dukes Auction Gallery”, can you describe what that is? A. This is the program of the first container that came over from England, and I believe that the sale took place, I think it was either August or September, 1974. I attended that auction, it was very well handled; I have our cost and selling price. As the evening progressed, it was very successful.

Q. The cost that you just mentioned came out of this $40,000 line of credit for the antiques, is that correct? A. Oh yes.

MR JONES: Mr Chairman, may I introduce this? Any objections?

(BROCHURE OF AUCTION PROGRAM MARKED AS EXHIBIT NUMBER A-1)

MR JONES:

Q. Were you in any way associated with Dukes Auction Galleries Ltd? A. I had none whatsoever.

Q. Did you ever contribute any capital to Dukes Auction Galleries? A. None whatsoever.

Q. After this first auction which you say you attended and was successful— A. Yes.

It is also noted for the records that in the notice of objection of the appelant filed with Revenue Canada on August 26, 1976, the following details were provided with regard to expenses Claimed:

STATEMENT OF FACTS AND REASONS

Business Promotion Expenses $2,025.16

In 1974 I was Chief Executive Officer of MARV HOLLAND SALES LTD, HOMACO MFG CO LTD and I was starting a third company to purchase rental products from the first two companies. The third company “Cl Services” is now operating successfully.

My business interests are varied and require a reasonable amount of travelling.

This travelling and promotion expense is necessary to produce the large income on which I pay taxes.

In cross-examination counsel for the respondent obtained the agreement of the appellant that the $500 claim for business loss related to Wright was in fact a personal loan, and should not be claimed. Further, a substantial examination of the travelling and promotion vouchers presented to support the appellant’s claim for $2,025.16 showed that there was at best tenuous relationship between these claims and any purpose to produce income (whether in the alleged antique business or any other), and in many instances there was no relationship whatsoever. The appellant agreed that many of these claims should also be deleted. Photostatic copies of the following three cancelled cheques were submitted by counsel for the respondent through the appellant (Exhibit R-1). All were in favour of the appellant, made out on cheques specifically printed for “Duke’s Auction Gallery Ltd—Special Accounts”, signed by Duke alone, on an Edmonton bank, and negotiated by the appellant at a bank in Victoria, British Columbia:

It was the testimony of the appellant that the net “business loss” claim related to Duke in the amount of $19,659 resulted from the bank credit of $40,000 for Duke noted above, a further $5,000 which the appellant had provided to Duke at a later date, less the $25,000 above and less some minor recovery or credits amounting to $341.

Argument

For the appellant:

We are in a situation of applying what I believe is basically uncontroverted evidence, particularly in relation to the $19,000, and whether or not this should be allowed as a business deduction.

The classic case, of course, of British Insulated and Helsby Cables Ltd is the test of what is a capital deduction, which is the Department’s position. If it isn’t business, it is capital. Of course, the operative words in the British Insulated case are that you are to bring into existence an asset or advantage for the enduring benefit of a trade.

I submit... that there is nothing of that type at all, there is no enduring benefit. Here we have the uncontroverted testimony of Mr Holland to the effect that these monies were used for the purchase of inventory. The inventory was bought and sold. That is the classic in my submission . . . type of business expense one has in any business.

I will only allude to one . . . Sigma Explorations Ltd v The Queen, [1975] CTC 215, . . . at page 223:

“Here, the circumstances that both outlays in question turned out to be economically unsound does not prevent their deduction if they were in fact and law laid out for the purpose of gaining or producing income.

In my opinion the funds expended were not made with a view of bringing into existence an advantage for the enduring benefit of the plaintiff’s business. From a practical and commercial point of view, the plaintiff’s intention or “view” was to bring into inventory information which it reasonably expected to market quickly and produce revenue or income.”

Mr Holland, I suggest, his course of conduct was that of a reasonable businessman in those circumstances. This was a new business to him, he attended the first auction; it seemed to be going all right; he trusted the man, because the man had worked with him for, I’ve forgotten how many years, certainly many years, but he had no reason to suppose that anything other than the normal business situation should exist. He took an interest in how things were going as he was periodically here in Edmonton and was Satisfied that things were going all right. ... The (approximately) $2,000 expenses, I suggest ... you are basically going to have to decide what you feel is reasonable in the circumstances. You have had testimony from Mr Holland, and again uncontradicted, that he did on behalf of the antique business, if I can call it that, have some expenditures. He said he went to Seattle, he also of course has testified that he had been back to Edmonton and had gone up and just talked to Mr Duke as to how things were going, so I believe reasonably, there would be expenses. The questions is, how much? Was it $2,000 and whatever the amount is, or was it something less? That, of course, is your decision to make. You have all kinds of authority saying that unvouchered expenses should be viewed with suspicion, but then you have to weigh against that, as to whether or not you believe Mr Holland and, in your mind, find it reasonable that in these circumstances expenses would be made. I suggest to you that it is reasonable, and then of course you have to come up with the amount. So, your problem is one, I suggest, of credibility of Mr Holland and I suggest to you that he has been a very very believable witness . . .

For the respondent:

. . . the first question is, how much are we talking about . . ., if it turns on credibility, there is documented proof for the $40,000, $40,292,and there is no proof whatever, other than Mr Holland’s word for the extra $5,000 that he claims. So, if you believe Mr Holland that he is out that extra $5,000, then the overall loss is $19,292 which, in my submission . . . should be on account of capital however, not a business loss.

. . . we have $290 worth of vouchers, some of which are personal, in support of a $2,000 claim and the Minister, as I said, disallowed it on two reasons: one, there was no evidence of any business and secondly, there was no support for the expenditures.

. . . Mr Duke was entrusted with this money and he did make repayments which indicates to me a loan. Mr Holland had no control and, as a matter of fact, I think the evidence shows that he wasn't really that certain that all the money had been spent legitimately for legitimate purposes of this so-called venture. Mr Duke didn't seem to really have to account for very much except for any profits which apparently were non-existent and he had to repay the money. Now to me, that points to a loan, not to anything else. It was not Mr Holland who wrote cheques when the custom’s invoices came in; it was Mr Duke who had absolutely full control of that money, it was given to him . . . Did it buy inventory in Mr Holland’s business, did it buy inventory for the partnership, or did it buy inventory for Mr Duke’s business? And I suggest to you, only if you can find (so) on the evidence, that this was entirely and absolutely Mr Holland’s business, could he even make a claim to money lost in a business, if it purchased inventory. If it was a joint venture between Holland and Duke, or if it was Mr Duke’s business, then I suggest to you . . . that it was a one-time injection of capital in the amount of $40,000 or $45,000, and whatever Mr Duke did with it, is totally irrelevant.

Findings

I would first note that the essence of the Minister’s assessment on the “business loss” aspect is that the amounts claimed were not made for the purpose of gaining or producing income, whether capital or current outlays. On the other hand, counsel for the appellant argued, as I see it, that since the outlays “did not bring into existence an asset of an enduring nature” (in his view, barred under paragraph 18(1)(b) of the Act), the only other alternative was that they were “business losses” deductible under paragraph 18(1 )(a) of the Act:

. . . in summary, I say that as far as the $19,000 is concerned, all the evidence that you have before you indicates a business expense and, based on the authorities which I have given you, should not be classified as capital.

In my view, the argument of counsel for the appellant must meet directly the challenge presented by the Minister’s assessment: “that the outlay was not made for the purpose of producing income”, and this is not accomplished simply by defining the outlay as a “business loss”. Paragraph 18(1 )(a) of the Act does not deal with “business losses” as contrasted with “capital losses” under paragraph 18(1)(b). A “business loss”, as this must be defined for purposes of section 18(1 )(a) of the Act, obviously would arise when the outlay or expense claimed resulted from the fact that it had been made for the purpose of producing income. That, however, would in itself only meet the general limitation for all expenses claimed explicit in paragraph 18(1)(a)—it would not determine that the outlay was on current or on capital account. If on capital account, it would still be subject to the provisions of paragarph 18(1 )(b) of the Act, and deductible only to the extent so permitted therein. I would make reference to the recent case of William A Johnson v MNR, [1980] CTC 2471.

Taking the component parts of the amounts appealed in order, the Board notes as follows:

Wright—$500: The appellant has agreed that the amount should not have been claimed—it was personal. Therefore, that amount will not be allowed.

Travelling—$2,025.16: A substantial portion of any claim for this amount disintegrated under the cross-examination of counsel for the respondent, and I respectfully decline the invitation to apportion it in some manner to give the appellant a partial benefit. It is evident at least that much of it was personal—consequently it will be allowed. The Board also notes the variance in explanations provided for the claims at the Objection stage, and at this Appeal stage.

Duke—$19,659: To whatever degree the appellant might claim his oral testimony should be accepted, it would be clouded by the result in the two items noted immediately above. The physical evidence (exhibits, etc) is interpreted by the appellant to mean that he made available to Duke some $45,000, to be spent by Duke for the acquisition of antiques at his own discretion, without restraint, control or monitoring. The antiques were to be shipped to Duke’s place of business where he (Duke) separately operated an auction business under a limited liability corporation (Duke Auction) in which Holland again had no interest, restraint, control or monitoring. The recovery of Holland’s $45,000 (leaving aside for the moment the critical question of whether it was a personal loan or a business investment) was to be effected by selling the antiques through the vehicle of Dukes Auction, the proceeds to be retained by Duke again under his sole control, and the profits to be split equally between them. All this, from a businessman with Substantial experience and resources.

In the Board’s view, the only physical evidence to indicate that even such a loose arrangement existed at all is the affidavit from Duke (Exhibit A-4) which the Board is not prepared to accept as proof under these circumstances. Particularly this is so when the limited information regarding Duke’s whereabouts given at the hearing would indicate that he works in Edmonton and might have been brought forward by the appellant as a witness. The Board has no evidence upon which to base a conclusion that whatever funds were provided to Duke, such funds had anything to do with any business venture in which the appellant participated, let alone to the exclusion of the Minister’s assertion that the funds represented a personal loan.

Further, in my view, there is a serious gap in the evidence which deals with the chronology of the transactions, as I understand them to have transpired according to the testimony of Holland. The funds (at least the first $40,000) were drawn upon by Duke (allegedly for the purchase of antiques) during the period December 14, 1973 to February 11, 1974 (See appellant’s contentions quoted earlier); the first sale (attended by the appellant) took place in August or September, 1974. Yet Duke had returned to the appellant at least two substantial cheques from the Special Account on May 9, 1974 ($17,000) and on May 28, 1974 ($5,000). There is nothing available to the Board to explain how the above $22,000 in May 1974 could have come from the first sale of the antiques which did not occur until several months later. Indeed, since only 50% of profit was to be returned to Holland and the other 50% would go to Duke, it would be a reasonable conclusion that before the first sale, there had been at least a $44,000 profit, if I understand correctly.

Summary

The appellant has not met the requirements of the Minister to establish that the deductions claimed had a direct relationship to any business venture entered into by the appellant for the purpose of producing a profit. Therefore, they would not meet the prerequisite conditions in paragraph 18(1)(a) of the Act applicable to any deduction claimed. Accordingly, it is unnecessary for the Board to consider the argument of counsel for the appellant that the outlay could not be ‘’capital” because nothing of “enduring benefit” had been brought into existence—an argument which, in any event, would need to pass the appropriate tests described in William A Johnson (supra).

Decision

The appeal is dismissed.

Appeal dismissed.