Madsen v. R., [1997] 2 CTC 3091

Bonner T .CJ .:

The Appellant appeals from assessments of income tax for the 1984, 1985 and 1986 taxation years. All three appeals involve the deductibility of amounts claimed by the Appellant in his income tax returns as losses from the business of marketing speed-reading courses. The 1986 appeal raises an additional question, the deductibility of losses claimed by the Appellant from the business of publishing and distributing a publication called Enjoy Magazine (“Enjoy”).

The Minister of National Revenue (“Minister”) assessed tax on the basis that the Appellant was not entitled to the deductions claimed by virtue of paragraph 18(1)(a), section 67 and section 245 of the Income Tax Act (“Act”). It was the position of the Minister that the deductions were claimed in respect of operations or arrangements which were intended not to generate income but rather to create the illusion that business was carried on at a loss deductible for purposes of the income tax.

The general nature of the speed-reading scheme in which the Appellant participated is described in Reasons for Judgment of the Federal Court in Moloney v. J?. [1] and of this Court in Bendall v. 7?., [2] , to name only two. A company called Applied Research Limited (“Applied Research”) owned the copyright in a course of instruction in speed-reading. A firm of self-styled financial consultants and tax advisors, H.N. Thill and Associates, promoted the sale to taxpayers seeking a tax shelter of licences to sell the speed-reading course in territories located in the United States. For each such territory the licensee was to pay a licence fee of $100 and an “advance royalty” of $20,000. Another company, Omni Educational Marketing Corp., (“Omni”) held itself out to be prepared to market the courses on behalf of the licensees of Applied Research. Omni offered each licensee a cash performance bond of $17,500 in support of its promise to market the courses in the licensee’s territory. The arrangement was structured in such a way that the licensee was required to invest very little of his own cash. The cash bond payment to the licensee was to be made at the same time as the arrangement was entered into with the consequence that the licensee was able to use the bond money as part payment of the $20,100 payable to Applied Research for each territory. Thus, for each territory, the licensee was required to make a cash outlay of only $2,600. The scheme was based on an assumption that the entire $20,000 was deductible immediately as a business loss in computing income for tax purposes. There was no suggestion and no evidence whatever that any attempt was made to market speed-reading courses in any of the territories acquired by the Appellant under the scheme.

The findings or assumptions of fact upon which the Minister based the assessments in issue are pleaded in the Reply to the Amended Notice of Appeal. Those findings set out the details of this scheme with great particu- larity. The evidence did not establish that the findings were erroneous. One of them was as follows:

5. …

h) in participating in the Speed Read tax scheme the Appellant did not, at any relevant time carry on business either by himself or through others acting for him or on his behalf.

That finding was fully justified. Paragraph 18(1)(a) of the Act reads as follows:

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

That provision clearly prohibits the deduction of the component elements of the losses in question.

I do not overlook the argument of Counsel for the Appellant that the advance royalties and licence fees were expenses paid by the Appellant for the purpose of earning income, not from a business, but rather from property owned by him, namely, the speed-reading licences. Any attempt to determine whether the licences were a source of passive income analogous to rents, royalties and interest or a source of business income, that is to say income from a commercial enterprise must in the circumstances of this case be of a highly speculative nature. The licences were never exploited and there was no credible evidence to support a conclusion that the Appellant intended to exploit them either through Omni or otherwise. It is, in my view, futile to engage in speculation as to the amount of activity which might be required of a licence holder who seeks to derive income from his licence and, based on that speculation, to attempt to ascertain whether such income is from a source that is a business or a source that is a property. I say futile because, whatever the nature of the source, the Appellant did not seriously intend to use his licences as a source of income. Moreover the exercise is pointless for paragraph 18(1)(«) of the Act applies to the computation of income not only from business but also from property. I find that the Appellant’s testimony with regard to the possibility of earning income from the scheme was disingenuous. In my view the Appellant entered into the scheme because he sought tax relief, nothing more. Paragraph 18(1)(«) of the Act therefore prohibits the deductions in question.

The deduction sought by the Appellant in respect of the Enjoy scheme stands on the same footing. The Appellant acquired from Applied Research licences authorizing him to publish, distribute and market Enjoy within spe- cific territories. The fee for each licence was $500 which, according to a brochure promoting the scheme “entitles you as a business owner to write off certain business expenses against your total income”. One such expense, according to the brochure, “...is an advance royalty ($15,000 U.S.) that you are required to pay to the copyright holder, Applied...”. The Appellant then entered into an operating agreement with Plymouth Publications Inc. (“Plymouth”) to publish, distribute and market Enjoy in his territories. Plymouth agreed to pay to the Appellant 12.5¢ U.S. per copy of Enjoy distributed within the territories during the term of the operating agreement. As a guarantee of contractual performance, Plymouth executed and deposited a performance bond with yet another company, Federated Financial Corporation (“Federated”). The Appellant was required to pay only $500 per licence out of his own funds. The balance of the fee was borrowed from Federated by way of promissory note. In the event of non performance, the bond was to off set the promissory note. One inevitable result of the arrangements made, if all worked as obviously intended by the parties, was a substantial tax deduction at a modest cash cost. The other result, mentioned in the brochure which promoted the scheme, was “the potential of substantial revenues from national and retail advertising”. That result was not in any way inevitable. Although one edition of the magazine was apparently published it was not shown that Plymouth made any bona fide attempt to exploit the Appellant’s licences by distributing Enjoy in his territories. In my view the Enjoy scheme does not differ from the speed-reading scheme in any way material to the issue in this appeal. The deductions sought are prohibited by paragrah 18(l)(a) of the Act.

The Amended Notice of Appeal raises the question whether the initial assessment of tax for the Appellant’s 1986 taxation year was made “with all due dispatch” within the meaning of subsection 152(1) of the Act. The Appellant’s 1986 return was filed on or before April 30, 1987. The subsection 152(1) assessment was not made until May 1, 1990, three years and one day after filing. During that period the Minister investigated the deductibility of the Enjoy losses. I observe that the Appellant was advised by letter of July 29, 1987 (Exhibit R- 4 Tab 1) that such investigation was underway and was invited, if he wished that the 1986 return be processed without benefit of the deductions claimed with respect to Enjoy, to advise the Department of National Revenue. He doesn’t appear to have done so. The material in Exhibit R-4 indicates that the investigation proceeded without delay. In the circumstances I cannot find that the Minister failed to act with all due dispatch. In any event, the decision of the Federal Court of Appeal in Ginsberg v. R. [3] is authority for the proposition that the failure of the Minister to act with all due dispatch as required by subsection 152(1) of the Act does not deprive the Minister of the statutory power to issue an assessment.

The appeals from the assessments for the 1984, 1985 and 1986 taxation years will therefore be dismissed with costs.

The assessment for the 1989 taxation year was protective in nature. It was common ground that the inclusion in the Appellant’s income for 1989 of a receipt in respect of the performance bond could stand only if the Appellant was found to be entitled to the deductions claimed in 1986 in respect of Enjoy. In light of the outcome of the 1986 appeal the 1989 appeal will be allowed without costs and the assessment referred back to the Minister to delete the performance bond inclusion.

Appeal dismissed.