Geropoulos v. R., [1998] 3 CTC 2384

Sarchuk T.C.J.:

These are appeals by John Geropoulos (the Appellant) from assessments of tax with respect to his 1989, 1990 and 1992 taxation years. At all relevant times, the Appellant was a 25% shareholder of Landrex Woodstock Centre Inc. (Woodstock). In 1988, the Appellant loaned the sum of $103,035 to Woodstock. He incurred a loss in that amount on the loan during 1992 and pursuant to subsection 50(1) of the Income Tax Act (the Act) disposed of the loan for nil proceeds. Pursuant to paragraphs 39(1 )(c) and 38(1 )(c) of the Act, he reported this as a business investment loss (BIL) and claimed an allowable business investment loss (ABIL) of $77,276.25. The Appellant also sought to carry a non-capital loss back to his 1990 and 1989 taxation years. The Minister disallowed the BIL (and the loss carryback) on the basis that not all or substantially all of the assets of Woodstock were used in an active business. The issue in these appeals is whether the loan made by the Appellant to Woodstock, a Canadian-controlled private corporation, is a business investment loss within the meaning of paragraph 39(1)(c) of the Act.

Evidence on behalf of the Appellant was adduced from Thomas Edward Raymond Butcher (Butcher), a lawyer, a large part of whose practice involved real estate principally from the perspective of the public offering of real estate based activities. He was also one of three equal shareholders in Landrex Homes Inc. (Landrex) which was in the house building business since 1985. [1] In the course of Landrex’s activities, Butcher and his associates were exposed to various real estate opportunities which would be presented to them by real estate brokers. One such opportunity involved an 18-acre parcel of land situate at the corner of Highways 401 and 59, near the City of Woodstock. The site was interesting and in due course, Landrex determined, without having decided exactly what to do with the property, to proceed with its acquisition. Woodstock was incorporated to pursue the project. [2] It now became necessary to arrange for some initial funding for the deposit and other activities that would occur in the near future. As a result, Butcher approached the Appellant and his brother, Peter, with respect to their possible involvement. Both had previously invested in house-building ventures with Landrex. They agreed to participate in the project, became shareholders of Woodstock, and agreed to lend the amount of approximately $200,000 to it. [3]

An offer to purchase was made on October 18, 1987 and was accepted the following day. [4] The purchase price was $1,700,000 with a deposit of $85,000. The offer was conditional on Woodstock obtaining the appropriate variation to have the entire 18-acre parcel rezoned for commercial use. The agreement also obliged Woodstock to appeal any rejection by the municipal authority to the Ontario Municipal Board (OMB). It was also stipulated that a denial by OMB of such an appeal rendered the offer null and void.

When the agreement was concluded and the application for an amendment to the Official Plan was being processed, Woodstock began to put its mind to developing the property. R.D. Butcher met with David Blandford and John Topping, principal shareholders in Enterprise Property Group (Woodstock) Limited (Enterprise), which managed commercial properties, including shopping centres, and presented the Woodstock property to them. They, in turn, made a proposal to Sears Canada Inc. (Sears), a retailer with whom they were involved through other business, to occupy space in a regional shopping centre which would be constructed on the Woodstock property. Sears was agreeable and was prepared to commit to take space if and when that centre was built.

Blandford and Topping (through Enterprise) and Woodstock then agreed to develop the project and to equally share the expenses. To this end, on February 6, 1989, an agreement was concluded with Sears regarding the rental of space in the proposed centre. [5] Discussions regarding the project were also held with various other retailers as well as with planners, traffic consultants, architects and lawyers.

There was substantial opposition to the proposed zoning changes. Butcher testified that a number of presentations were made to Council and to the planning committee of the City of Woodstock. Public meetings were held and other public relations steps were taken. After considerable effort, the necessary approvals were obtained from the committee. As Butcher recalls, the planning committee for the next level of government also approved the rezoning. Final approval was still required from the Regional Council and at that stage, the proposal was rejected. As required by the agreement of purchase and sale, an appeal was launched to the OMB. According to Butcher, the expenses incurred to this point were in the neighbourhood of $425,000 and it was understood that substantially greater costs would be incurred in connection with the OMB hearing. They had been advised that expert witnesses and legal counsel would have to be retained and that given the opposition, they should anticipate a very long hearing. Woodstock/Enterprise did not have the necessary funds with which to finance further expenses and therefore, an effort was made to “find some deep pockets to become partners”.

On June 1, 1991, an agreement was executed between Enterprise, Woodstock and Armcorp 4-23 Ltd. (Armcorp) [6] (the Co-Owners) for the purpose of completing the acquisition of the property and the construction and management of the shopping centre. This agreement certified that Woodstock and Enterprise had incurred costs of $425,000 which were to constitute their initial contribution. Armcorp was to provide an equal amount and subsequent amounts would be contributed equally. Armcorp also agreed to pay a management fee to Woodstock and Enterprise. It was also agreed that once the property was rezoned, the project would be restructured to permit Sears to acquire a one-third interest therein and the Co-Owners would collectively hold two-thirds through a restructured joint venture (Revised Venture). [7] As a result of the structuring, Armcorp would have an 85% interest in the Revised Venture and Woodstock/Enterprise the remaining 15%. Furthermore, at the time of such restructuring the lands were to be revalued at the highest possible value acceptable to Sears (market value) which market value would then be paid to the Co-Owners in their respective Co-Ownership proportions. [8] At all relevant times, the venture was to be controlled by Armcorp. In addition, Woodstock and Enterprise were also entitled, following lease-up, to elect to sell their interest in the Revised Venture to Armcorp. [9]

On April 30, 1992, Woodstock learned that the appeal to the OMB was unsuccessful and that an adverse award of substantial costs had been made against it. Woodstock had no significant assets left and the effect of this decision was to render it insolvent. [10] The project, needless to say, was abandoned. The loan made by the Appellant to Woodstock was determined by him to be a bad debt, leading to the claimed ABIL as previously noted.

It is the Appellant’s position that the loan in question was a business investment loss pursuant to paragraph 39(1)(c) of the Act because all the relevant statutory criteria were satisfied, i.e. the Appellant had loaned money to a small business corporation, the loan became a bad debt in 1992 which was a capital loss, and there was no possibility that the corporation would again commence business.

The Respondent does not dispute that the Appellant advanced the sum of $103,035 by way of loan to Woodstock, or that the debt became a bad debt in the 1992 taxation year. However, she takes the position that Woodstock never carried on an active business or alternatively, that the business carried on by it was a specified investment business.

Conclusion

A BIL is defined by paragraph 39(1 )(c) as a loss that is a capital loss realized on a disposition of a debt owing by a small business corporation. In these appeals, the disposition was a deemed disposition of a bad debt from an insolvent corporation, i.e. Woodstock. A “small business corporation” is defined in subsection 248(1) of the Act as follows:

248 (1) In this Act,

“small business corporation” at any particular time means a particular corporation that is a Canadian-controlled private corporation all or substantially all of the fair market value of the assets of which at that time was attributable to assets that were

(a) used in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it,

The issue in these appeals is whether Woodstock carried on an “active business” at the relevant time. Subsection 248(1) of the Act defines the term as follows:

“active business”, in relation to any business carried on by a taxpayer resident in Canada, means any business carried on by the taxpayer other than a specified investment business or a personal services business;

The Respondent’s contention is that Woodstock never carried on an active business and that its activities were nothing more than steps “taken to acquire a business, to get a business enterprise or entity put in place”. It was further contended that no business as such materialized since Woodstock became insolvent when its plans failed to come to fruition.

In my view, this position is not well-founded. The rationale for the distinction in the Act between an “active business” and “specified investment business” was identified by Sobier J. of this Court in Lake Superior Investments Ltd. v. Minister of National Revenue^ [11] as follows:

… The text writers give us some insight as to why there was a change in dealing with active business income and investment income, and how this came about. David Phillip Jones in 1982, 30 Canadian Tax Journal, said at page 5:

In a series of cases, however, the courts effectively eliminated the idea of passive business and held that virtually any business constituted an active business. The purpose of the ‘specified investment income’ amendment, therefore, was to make certain that income from the business of renting property did not generally constitute active business income, but rather was assimilated to investment income, thereby effectively reversing the jurisprudence on this point. (emphasis added) [12]

As was observed by Mr. Justice Urie in King George Hotels Ltd. v. R.: [13]

Before disposing of the appeal I think it should be stressed that whether a business is an active or inactive one is, as earlier pointed out on the authority of the Rockmore case, supra, one of fact dependent on circumstances of each case. That being so, it is neither possible nor or desirable to lay down any rule or principle applicable to every case. It cannot be said, therefore, in my view, that income from “other than an active business” necessarily means that derived from a business “is in an absolute state of suspension” or one “devoid of any quantum of business activity” as has been said in earlier decisions in the Trial Division. In any given case, the business may be of that kind but whether or not it is, is not necessarily determinative of the issue, the resolution of which depends on the fact finder’s view of the true nature of the business based on the facts in the particular case. The quantum of activity may well vary from case to case but still it is necessary for the Court to weigh all of the evidence to characterize the quality of the particular business.

On the evidence, it is clear that Woodstock was in the land development business. Its activities were directed to the acquisition of property for that purpose. Substantial efforts were made and costs incurred with respect to the rezoning; discussions were held with planners, architects and traffic consultants. Woodstock had assets, liabilities, it actively sought out busi- nesses for the proposed centre and in fact, secured an agreement with Sears to become involved as a partner and prime tenant. Such activities are all part of the business of land development. The nature and quantum of these activities were, for obvious reasons, different than those of many other businesses but, nonetheless, constitute an active business.

I have also concluded that the Respondent’s position that Woodstock carried on a specified investment business cannot be sustained. The definition of “specified investment business” is set out in paragraph 125(7)(e) of the Act and reads in part as follows:

125(7) In this section,

(e) “specified investment business” carried on by a corporation in a taxation year means a business ... the principal purpose of which is to derive income from property (including interest, dividends, rents or royalties) unless...

First, the Butchers and Kuiken were actively involved in the development of land and the construction of residential properties for resale. The Appellant and his brother were also involved in several of these projects. There is no history that any of the shareholders in Woodstock had ever derived income from rentals or any other form of property.

Second, it is evident that Woodstock did not have the financial capability to finance any portion of the cost of the development of a regional shopping centre, nor did it ever intend to do so. Accordingly, in 1991 an investor, Armcorp, was brought in. The nature of the Co-Owners agreement entered into at that time is of substantial significance, in particular the manner in which the joint venture was to be restructured upon approval of the rezoning. Specifically, the proposed Revised Venture diluted Woodstock’s interest in the project, but also enabled it to have its share of the market value calculated and paid out from the proceeds of interim financing. [14] All of this is consistent with Woodstock’s position that it had no desire to be a landlord in a shopping complex and was not becoming involved in the purchase and development of the property as a long-term investment.

Butcher also testified that the buyout provision in the Co-Owners agreement was specifically designed to provide an exit mechanism for Wood- stock. [15] This matter was regarded by it as fundamental to the revised agreement. As Butcher noted: “We were very much in a minority position, and so we negotiated this technique for converting our equity into cash”.

Butcher was quite specific in his testimony that a long-term involvement was not what Woodstock was looking for. In his words:

Our intention was to develop, get some money, and go on and do something else, develop another property, or build some houses, or do something else, which accounts for this arrangement that we arrived at with the Chrysler Pension Fund.

So we got back our investment. We got back the enhanced value that resulted from our having made the investment engaged in this activity. And we retained a 15% ongoing interest. It was something that we thought would be a valuable asset which would at that point have cost us nothing. ^ [16]

His testimony was not contradicted or questioned in any material aspect.

While it is a fact that the Co-Owners agreement speaks of holding the project for investment purposes, Butcher’s testimony, which I accept, clearly negates that intention vis à vis Woodstock. I observe further that it is inappropriate to attribute the same intentions to each of the joint venturers as appears to have been done by the Respondent. On the evidence, it is clear that Woodstock’s intention was as Butcher said: “to develop, to get some money, and to go on and do something else, develop another property” and that any potential that this development had to provide Woodstock with rental income was entirely subordinate.

On balance, I am satisfied that Woodstock was carrying on an active business. The appeals are allowed with costs to the Appellant, to be taxed.

Appeal allowed.