Air Rock Drilling Co. v. R., [1999] 3 CTC 2001, 99 DTC 617

Mogan T . C.J.:

The appeals of Air Rock Drilling Co. Ltd. v. The Queen (96-1713

(11)G), Shelva Jean Desaulniers v. The Queen (96-1884 (1T)G) and Wallace Desaulniers v. The Queen (96-1885(lT)G) were heard together on common evidence. These three appeals are from assessments under the Income Tax Act. Because there are three different Appellants in three separate proceedings in this Court, I shall for convenience refer to Air Rock Drilling Co. Ltd. as “Air Rock”; refer to Shelva Jean Desaulniers as “Shelva”; and refer to Wallace Desaulniers as “Wallace”. Shelva and Wallace are wife and husband. All of the issued shares of Air Rock were owned by 554022 Ontario Ltd. (referred to herein as “022”). All of the issued shares of 022 were for the next two months would be in accordance with Jim Grant’s memo of April 16 referred to above. It appears that the directors were content to have CPI go into bankruptcy.

The last page of Exhibit R-54 is the minutes of a meeting of directors of CPI held on August 6, 1991 at which the directors agreed that the only solution for CPI was to make an assignment in bankruptcy. There is a significant time gap between the meeting of directors on April 17 and the next meeting on August 6, 1991 authorizing the bankruptcy. According to Wallace, that gap is explained by the fact that CPI was attempting in the intervening three and one-half months to obtain certain tax credits which could be obtained only if CPI had an operating status with at least a skeleton staff. Mr. Grant could not recall whether CPI had any activity after April 1991. I conclude that Mr. Grant spent most of his time at the Entrée Canada office on Queen Street in Ottawa; that he rarely visited the CPI plant at Kemptville which operated for more than 12 months and was only 45 minutes south of Ottawa; and that specific details were not important to him. He was the chief executive officer and chairman of CPI but, in evidence, he could not recall with precision any important facts with respect to its short operational life.

The Respondent has admitted in the pleadings that each of Air Rock, Wallace and Shelva was dealing at arm’s length with CPI at all relevant times; and that CPI was a “small business corporation” within the meaning of the Income Tax Act. The three Appellants have alleged that each was dealing at arm’s length with NPC and that NPC was also a “small business corporation” within the meaning of the Act. Those allegations are not admitted in the pleadings but I have concluded that each Appellant was dealing at arm’s length with NPC and that NPC was a small business corporation. I rely on the following uncontradicted evidence of Wallace: (i) he and Shelva were persuaded by Herb Gee to invest $242,000 personally in NPC;

(ii) the amounts paid are proved in Exhibit A-39; (iii) Wallace and Shelva caused Air Rock to invest $202,350 in NPC; (iv) the investment in NPC was a method of obtaining scientific research tax credits (SRTC) and also an opportunity to participate in big profits from the manufacture and sale of Polyol; (v) Herb Gee disappeared and Wallace and Shelva were left on their own to locate, take possession of, and transport the Polyol equipment from Nova Scotia to the Air Rock yard in Ontario; and (vi) Wallace did not know what happened to the money which he and Shelva ($242,000) and Air Rock ($202,350) invested in NPC.

If Wallace and Shelva and Air Rock had controlled NPC, they would know what happened to their money. Also, on a balance of probabilities, NPC was a small business corporation used by Herb Gee (and perhaps others) to sell the idea of easy tax credits and big profits to persons like Wallace and Shelva. In the mind of Herb Gee, NPC may have been the “Brooklyn Bridge” but, in the minds of Wallace and Shelva, NPC was a bona fide business venture.

There is no dispute concerning the amounts of money passing between any one of the Appellants and either CPI or NPC. Barbara Scott identified a schedule (Exhibit A-61) which summarized the amounts of money advanced to or for NPC and CPI by Air Rock. In her mind and on the books of Air Rock, she merged NPC and CPI as if it were a single Polyol venture to which Air Rock had advanced money. The amounts set out in Exhibit A- 61 may be summarized as follows:

Fiscal Period Amount Paid To Repayment Net Investment

May 31, 1988 $ 25,000 NPC $ 25,000 May 31, 1989 177,350 NPC 177,350

Subtotal $202.350

May 31. 1990 272,737 CPI 65,000 207,737

May 31, 1991 289,977 CPI 8,000 281,977

May 31, 1992 167,057 CPI 46,279 120,778

Total $932,121 $119,279 $812,842

Notes:

1 Research & Development tax credit transferred by trustee in bankruptcy.

CPI made an assignment in bankruptcy at the end of December 1991. Upon or prior to that assignment, Air Rock used its mortgage to take possession of the Kemptville plant. Also, Air Rock used its security interest under the Personal Property Security Act to take possession of the Polyol equipment. The value of the Kemptville plant and the value of the Polyol equipment do not appear in the column “repayment” in the above table but those values are a factor in the reassessments which are under appeal. Lastly, the amount of $242,000 advanced to NPC by Wallace and Shelva personally is in addition to the amounts advanced by Air Rock shown in the above table.

The Issues

I can now describe the issues in these appeals in greater detail and will consider Air Rock first. A “business investment loss” is defined in paragraph 39(1 )(c) of the Act and, in summary, is a capital loss resulting from an investment in the shares of a small business corporation or resulting from a loan to such a corporation. An “allowable business investment loss” (“ABIL”) is defined in paragraph 38(c) as 75% of a business investment loss. Although an ABIL is a capital loss, it is deductible in computing income under paragraph 3(d) of the Act. For its fiscal period ending May 31, 1991, Air Rock claimed a business investment loss of $200,000 and deducted an ABIL of $150,000. For its fiscal period ending May 31, 1992, Air Rock claimed a business investment of $287,842 and deducted an ABIL of $215,882. Those losses were claimed with respect to the money advanced to NPC and CPI by Air Rock.

Barbara Scott described the circumstances in which she caused Air Rock to claim the business investment losses of $200,000 and $287,842. All of the money advanced by Air Rock to NPC and CPI she debited to a single Polyol Venture account in the books of Air Rock. Although Wallace could not provide Ms. Scott with much detail concerning CPI, she was satisfied in November 1991 (just before filing Air Rock’s 1991 income tax return) that the value of Air Rock’s investment in the Polyol Venture was greatly overstated on the books of Air Rock. She therefore decided to claim an arbitrary amount of $200,000 as a business investment loss. By the time she filed Air Rock’s 1992 income tax return, CPI was already bankrupt. She therefore computed the 1992 business investment loss as follows:

By notices of reassessment dated December 19, 1994, the Minister of National Revenue disallowed in full the deduction of the ABILs for 1991 and 1992 and, apparently, a carryover of such losses to 1993. Air Rock served Notices of Objection for all three years. The Minister confirmed the reassessments and stated in the Notice of Confirmation:

The capital loss claimed as a deduction from income was not in respect of the disposition of a debt or other right to receive an amount that was acquired by you for the purpose of gaining or producing income from a business or property or as consideration for the disposition of capital property to a person with whom you were dealing at arms length within the meaning of subparagraph 40(2)(g)(ii) of the Act; accordingly, for the purpose of section 3 of the Act you had no allowable capital loss within the meaning of paragraph 38(b) and therefore you had no Allowable Business Investment Loss within the meaning of paragraph 38(c) of the Act.

Air Rock has appealed with respect to its taxation years 1991, 1992 and 1993 and claims the deduction of the ABILs as reported for 1991 and 1992; and alternatively, the deduction of its full ABIL in its 1992 taxation year when CPI became insolvent and ceased operations.

The issues with respect to Wallace and Shelva are more complex. In their Notices of Appeal, Wallace and Shelva make the following statements of fact:

8. During 1987 and 1988, Mr. and Mrs. Desaulniers wrote cheques from their joint bank accounts to Vincent Murphy, Herbert Gee and National Polyoil, all to enable equipment and machinery to be purchased for the business of National Polyoil to be conducted. The total amounts so paid by Mr. and Mrs. Desaulniers aggregated $242,000, which amounts were so paid roughly equally between the two of them.

9. The business of National Polyoil never started other than the conduct of some preliminary research and development activity. As the result, a combination of Mr. and Mrs. Desaulniers and Air Rock, all of whom had advanced funds, owned equipment, technology, machinery and research and development rights for a business intended to be carried on by National Polyoils, but which had not in fact been so carried on.

10. In 1989, the assets referred to in paragraph 9 were transferred by a combination of Mr. and Mrs. Desaulniers and Air Rock to Canadian Polyols International Inc. (“CPI”) in an arms length transaction. There was no formal agreement of purchase and sale.

11. In the books and records of CPI, shares were issued to Mr. Desaulniers only for the assets referred to in paragraphs 9 and 10 above, and the issued shares were shown on such books as having a value of $421,000.

The above statements of fact are admitted by the Respondent and form the basis of the assessments against Wallace and Shelva. By notices of reas sessment dated February 29, 1996, the Minister of National Revenue made the following decisions with respect to Wallace and Shelva:

(a) for the 1990 taxation year, the Minister added to Wallace’s reported income the amount of $196,830 as a shareholder benefit; and the Minister did the same with respect to Shelva;

(b) for the 1991 taxation year, the Minister allowed to Wallace a business investment loss of $310,500 with a resulting loss carryback to 1990; and the Minister did the same with respect to Shelva.

The Minister computed the 1990 shareholder benefit as follows: (i) the Polyol equipment was acquired by Air Rock, Wallace and Shelva in 1989 as a result of their investments in NPC in the following proportions:

Air Rock	$202,350	-	46%
Wallace	$121,000	-	27%
Shelva	$121,000	-	27%

(ii) in exchange for the transfer of the Polyol equipment, CPI issued 610,145 shares to Wallace and Shelva in February 1990 representing a value of $421,000 at 69¢ per share;

(111) Air Rock did not receive any shares of CPI for its 46% interest in the Polyol equipment and so Air Rock conferred a benefit on Wallace and Shelva in the amount of $193,660 being 46% of $421,000;

(iv) that benefit was allocated $96,830 to Wallace and $96,830 to Shelva:

(v) Air Rock paid $200,000 to CPI in 1990 for which it should have received 289,855 shares at 69¢ per share;

(vi) those 289,855 shares were issued to Wallace and Shelva (being the remainder of the 900,000 shares);

(vii) Air Rock conferred a benefit on Wallace and Shelva in the amount of $200,000;

(viii) that benefit was allocated $100,000 to Wallace and $100,000 to Shelva;

(ix) the total 1990 shareholder benefit to each of Wallace and Shelva was

The business investments loss which the Minister allowed to Wallace and Shelva for 1991 is dependent in part upon the amount of the shareholder benefit as computed in paragraph 34 above. The Minister assumed that the 900,000 shares of CPI issued to Wallace and Shelva had no value at the end of 1991 because CPI made an assignment in bankruptcy in Decem- ber 1991. Therefore, the Minister determined the adjusted cost base (ACB) of Wallace’s 450,000 shares in CPI and the amount of Wallace’s deemed loss under section 50 of the Act in the following manner:

The Decision Concerning Wallace and Shelva

Considering whether Wallace and Shelva received a shareholder benefit in 1990, I am faced with some important and undisputed facts. First, the attempt to manufacture Polyol in NPC and later in CPI was a financial disaster from beginning to end. Wallace and Shelva did not recover any of the $242,000 which they personally advanced to NPC in 1987 and 1988. Air Rock paid out cash in the net amount of $812,842 to NPC and CPI (see table in paragraph 26 above) and recovered no cash with respect to that amount but only the Kemptville plant site (estimated value $200,000) and the Polyol equipment (estimated value not more than $275,000). In other words, Wallace and Shelva have personally lost $242,000 and Air Rock has lost at least $337,000.

Second, the CPI venture (I hesitate to call it a business because it had no sales) lost money from the moment it commenced in the early part of 1990 until it closed down in the spring or summer of 1991. The venture was kept alive in the fall of 1990 only because Air Rock made injections of cash in the aggregate amount of $176,000 (see paragraph 17 above). The CPI financial statements for the year ending December 31, 1990 (Exhibit A-55) show nil revenue, expenses of $889,078, and a deficit of $1,003,867. With no revenue coming in and only expenses going out, the deficit was growing month-by-month through 1990 and was depleting the shareholders’ capital.

Third, Wallace and Shelva as the indirect shareholders of Air Rock did not perceive or experience or enjoy any tangible or intangible benefit from the money ($812,842 including 46% of the cost of the Polyol equipment) which Air Rock invested in NPC and CPI even if a portion of that money paid for CPI shares which were issued in their names. Wallace and Shelva did not have the use of a luxury yacht or condominium in a palm tree ha- ven! They could only watch with dismay as CPI consumed and depleted the investments of all shareholders.

And fourth, the collapse of CPI was swift. On February 12, 1990, a shareholders agreement (Exhibit R-31) was signed among persons who were investing more than $1,500,000. Fourteen months later on April 16, 1991, Mr. Grant was reporting to the directors (Exhibit A-57) that CPI was insolvent and would likely become bankrupt. Some obstacles should have been obvious from the start. There was no operating business transferred to CPI, no established manufacturing process, no quality product and no list of loyal customers. CPI was truly starting from scratch. Also, among the investors and directors, there was no one with a real passion for the process and the product, no inventor, no entrepreneurial manager who had spent a long time working the process and was determined to see it succeed. Mr. Grant, the chief executive officer, was not in regular attendance at the Kemptville plant. If the CPI venture was to succeed, it would do so in the hands of hired help.

When a shareholder benefit is assessed under the Income Tax Act and then appealed to this Court, the credibility of the shareholder is often an important factor. Wallace is an intelligent and successful businessman with only limited (Grade 9) formal education. I found him to be a totally credible witness. His answers to all questions were straight and candid in the context that he has very limited knowledge of corporate matters and procedures. I believe him when he stated (i) that he was not involved in any way in the record-keeping of CPI (minute book, share register, financial statements, etc.); (ii) that it was not his idea to issue the 900,000 shares of CPI to him and Shelva excluding Air Rock; and (iii) that he thought the shareholdings in CPI would all be straightened out when CPI went public. It is highly unlikely that Wallace would have understood that 900,000 shares of CPI were issued in the names of him and Shelva for a total consideration of $621,000 but paid in part by Air Rock ($193,660 in the value of the Polyol equipment plus $200,000 in cash). Similarly, he would not have realized that, by the issue of such shares, Air Rock might have conferred a benefit on him and Shelva. He was too busy operating the well-drilling business of Air Rock and worrying about the survival of the Polyol enterprise in CPI.

The documents in evidence indicate that the investors subscribed for CPI shares at 69^ per share in February 1990. That subscription price does not prove the fair market value of CPI shares at that time because CPI was a private corporation and the transfer of all its shares was restricted by the shareholders agreement (Exhibit R-31). In particular, the 69¢ subscription price does not prove the fair market value of shares issued to Wallace and Shelva and Mr. Richardson (Jarco) because their shares were subject to a voting trust under Article 13 of the shareholders agreement. It appears that all shares of the two largest shareholders (the Desaulniers and Mr. Richardson) were required to be placed in a voting trust to ensure that those shares would be voted “to go public” at the appropriate time.

I am satisfied that the record-keeping of CPI was sloppy and inaccurate. The table in paragraph 17 above shows how seven cheques, all from Air Rock, were recorded as having been deposited by “Wally” or “W. Desaulnier” (name misspelled). Mr. Grant acknowledged more than once that he used the names Wallace, Shelva, Desaulniers and Air Rock interchangeably. This is borne out in his minutes of directors’ meetings and his letters (Exhibits R-43, A-52 and A-54). Details did not seem important to Mr. Grant. I believe Wallace when he states that he did not ask that shares of CPI be issued to him and Shelva, excluding Air Rock. I believe Ms. Scott when she states that Wallace told her that the shareholdings in CPI would be straightened out when it went public.

Having regard to the rapid decline in the fortunes of CPI, I conclude that all parties involved in its administration (directors and officers) were more concerned with the day-to-day survival of the enterprise than with any corporate record-keeping. In the midst of the financial turmoil surrounding CPI, if Wallace and Shelva had thought about the large amounts of money flowing from Air Rock to CPI and the issue of CPI shares in their names alone, they would have known that they held a significant portion of the CPI shares on behalf of Air Rock. In the business life of CPI, from February 1990 to September 1990 when Air Rock became the only source of operating capital, Wallace and Shelva did not have time to be concerned with the rather abstract idea of whether some of the shares issued in their names should have been issued to Air Rock.

In the case of Chopp v. R. (1995), 95 D.T.C. 527 (T.C.C.), I was required to consider whether the taxpayer had received a shareholder benefit as the result of a bookkeeping error. When allowing the appeal, I made the following statement at page 532:

…] think a benefit may be conferred within the meaning of subsection 15(1) without any intent or actual knowledge on the part of the shareholder or the corporation if the circumstances are such that the shareholder or corporation ought to have known that a benefit was conferred and did nothing to reverse the benefit if it was not intended. I am thinking of relative amounts. If there is a genuine bookkeeping error with respect to a particular amount, and that amount is truly significant relative to a corporation’s revenue or its expenses or a balance in the shareholder loan account, a court may conclude that the error should have been caught by some person among the corporate employees or shareholders or outside auditors. ...

Considering the rapid decline and final bankruptcy of CPI, I cannot find any circumstances which would lead me to conclude that Wallace or Shelva or Air Rock ought to have known that a benefit was conferred when the 900,000 shares of CPI were issued in the names of Wallace and Shelva alone. The decision of this Court in Chopp was upheld by the Federal Court of Appeal, (1997), 98 D.T.C. 6014 (Fed. C.A.).

In the extraordinary circumstances of these appeals, I find that all shares of CPI issued in the names of Wallace and Shelva were held by them on behalf of themselves and Air Rock in whatever portions were equitable. They did not receive any shareholder benefit just because 900,000 CPI shares were issued in their names when more than half of the consideration for those shares came from Air Rock. And even if they had received such a shareholder benefit, the value of the benefit would be minimal because, having regard to the fact that CPI never at any time had any customers or an operating business, the value of the issued CPI shares in February 1990 was substantially less than the subscription price of 69¢. That subscription price was based on the hopes and dreams of a few investors but not tested by the realities of the market place.

The assessment of a shareholder benefit under subsection 246(1) or 15(1) of the Income Tax Act must be based on at least an element of common sense. There must be a benefit, tangible or intangible, which the shareholder in fact perceived or experienced or enjoyed or which any reasonable person in the shoes of the shareholder would perceive or experience or enjoy. In my opinion, the shareholder benefit assessed against Wallace and Shelva for 1990 was not based on common sense. There was no benefit which they, or any reasonable person standing in their shoes, could perceive or experience or enjoy on February 12, 1990 when the 900,000 shares of CPI were issued in their names. When the shareholder benefit was finally reassessed in February, 1996, it should have been obvious to Revenue Canada that Wallace and Shelva had not received any financial advantage or personal enjoyment upon the issue of the CPI shares in their names; and that all parties (Wallace and Shelva and Air Rock) had suffered significant financial losses.

Wallace and Shelva had told Barbara Scott in 1990 and 1991 that the Air Rock investment in the Polyol Venture (as she recorded it in the books and records of Air Rock) would be straightened out and accurately recorded when CPI went public. CPI went bankrupt instead of going public. In the minds of Wallace and Shelva, it never became necessary to allocate the 900,000 shares of CPI as between them and Air Rock even though they knew that Air Rock had contributed the lion’s share of the capital to CPI. I found Barbara Scott to be a totally credible witness, particularly when she said that Wallace could not explain to her what was happening to the large amounts of money which Air Rock was advancing to CPI. Wallace had a blind faith in the Polyol process and history proved that his faith was not well-founded.

On a theoretical basis, it could be said Wallace and Shelva each suffered a small business investment loss in 1990 computed as follows:

The amount is not significant and they looked on all advances to NPC and CPI as one venture. Therefore, I would grant them a business investment loss of $121,000 in 1991 rather than allocate $7,330 of that amount to 1990. If Wallace and Shelva and Revenue Canada are in agreement, however, the loss could be so allocated.

I will allow the appeals of Wallace and Shelva for the 1990 taxation year on the basis that they did not receive a shareholder benefit from Air Rock or CPI in that year. For the 1991 taxation year, I will allow to each of Wallace and Shelva a business investment loss on the basis that 1991 was the year when their original advances to NPC were finally lost. Wallace had a business investment loss of $121,000 in 1991. So did Shelva.

The Decision Concerning Air Rock

When deciding to allow the appeals of Wallace and Shelva, I made a finding that all shares of CPI issued in their names were held by them on behalf of themselves and Air Rock in whatever portions were equitable. As a consequence of that finding, Air Rock was indirectly but equitably a shareholder of CPI. If the Polyol venture had been successful, and if CPI had become a public corporation, Wallace and Shelva would have had to owned by Wallace and Shelva with Wallace owning 153 shares and Shelva owning 152 shares. Wallace and Shelva reside at Jasper, a small rural community near Smiths Falls, Ontario.

In 1987 and 1988, Wallace and Shelva became interested in a particular enterprise owned by National Polyols Corporation (“NPC”). At various times, Wallace and Shelva and Air Rock advanced money to NPC. Because the business of NPC never started, other than the conduct of some research and development activity, certain equipment which had been acquired by or for NPC was seized by Wallace in 1989; brought to the Air Rock yard at Jasper; and later transferred to Canadian Polyols International Inc. (“CPI”). Air Rock made further advances of money to CPI to maintain the equipment. The parties agree that CPI was a “small business corporation” within the meaning of the Income Tax Act. The Appellants claim in their pleadings that NPC was also a small business corporation but that claim was not admitted by the Respondent.

The issues in these appeals are described in greater detail below but, broadly speaking, Air Rock deducted an allowable business investment loss (“ABIL”) in 1991 and 1992 but the Minister of National Revenue disallowed the ABIL; the Minister added to the reported incomes of Wallace and Shelva for 1990 a significant amount as a shareholder benefit under subsection 246(1) or subsection 15(1) of the Income Tax Act; and the Minister granted to Wallace and Shelva for 1991 a business investment loss. Air Rock claims an ABIL in 1991 and 1992. Wallace and Shelva claim that they had no shareholder benefit in 1990; and they dispute the amount of their business investment loss in 1991.

Air Rock carries on the business of drilling fresh water wells in Eastern Ontario between Brockville and Smiths Falls and from Ottawa to Kingston. Air Rock was incorporated in 1972 and has been a successful operating company. Wallace is responsible for the equipment and for field work getting the drilling job completed. Shelva is responsible for the administrative work in the Air Rock office. Wallace and Shelva were introduced to NPC through two men named Herb Gee and Vincent Murphy. Wallace had met Herb Gee in the mid-1980s through the purchase of some mutual funds and later, around 1987 or 1988, Herb Gee presented to Wallace the concept of investing in a corporation which would be involved with the production of Polyol. The corporation was NPC.

In evidence, Wallace gave the following brief non-technical description of Polyol. The idea was to take any natural vegetable oil (like canola oil) or allocate as between themselves and Air Rock the shares of CPI issued in their names. Barbara Scott recorded in the books of Air Rock all advances to NPC and CPI as loans to one entity which she called the Polyol Venture. Therefore, at the time of the CPI bankruptcy, Air Rock showed on its books a large loan receivable from CPI.

The recording of that loan has a bearing on whether Air Rock can claim a business investment loss in 1991 or 1992. The Respondent argues that Air Rock was not entitled to a business investment loss because (i) Air Rock was not a shareholder of CPI; (ii) the loans from Air Rock to CPI did not bear interest; and (iii) the loans to CPI were not acquired by Air Rock for the purpose of gaining or producing income within the meaning of subparagraph 40(2)(g)(ii) of the Act. I have concluded that Air Rock was an indirect but equitable shareholder of CPI. In Business Art Inc. v. Minister of National Revenue (1986), 86 D.T.C. 1842 (T.C.C.), the question was whether an interest-free loan from a shareholder was a loan acquired for the purpose of earning income. When deciding that question in the taxpayer’s favour, Rip J. stated at page 1848:

However, even if no interest was chargeable I do not believe that would be fatal to the appellant’s alternate submission. The fact that there may have been no interest attached to the debts in question is not relevant in deciding whether they were acquired for the purpose of gaining or producing income. See The Queen v. Lalande and Watelle. 84 D.T.C. 6159 at page 6164. It is not uncommon for a shareholder to lend money without interest and without security to the corporation since he anticipates that the loans will assist the corporation to earn income and to pay him income by way of dividends; the loan is made for the purpose of earning income from a property. Although the shareholder is a creditor of the corporation when he advances money to the corporation the shareholder does not see his advance of money to the corporation and his subscription for shares of the corporation as separate investments in two watertight compartments; rather he sees his money entering two compartments which open up into a single compartment for the use of the corporation. Purchasing shares and advancing money to a corporation are two ways of making an investment in the corporation. This is a sensible interpretation.

Similarly a shareholder of a corporation who may have incorporated a corporation for the purpose of acquiring product at a low cost and so reduce its own costs may advance money without interest to the corporation to enable the corporation to operate as intended; in this example even if the shareholder is not making loans for the purpose of producing income from its business, by having reduced costs, the loan is being made to earn income from property, that is, to receive dividends on the shares it owns in the corporation. It is not unusual for a person to invest in a corporation by subscribing for share capital and lending money without interest; as far as he is concerned the shares and his loans consti- tute a single investment and if later on, he is called on to advance further funds without interest he is only increasing his investment. I cannot subscribe to the theory that in such an example the non-interest bearing loans were not incurred for the purpose of earning income from property; if the loans were not advanced the corporation may have become bankrupt and the shares may have become worthless. Clearly the loans were made to earn income from property, that is, to place the corporation in a position where it will be successful and pay dividends.

I would apply the decision in Business Art and conclude that, because Air Rock was an equitable shareholder of CPI, the loans from Air Rock to CPI were acquired for the purpose of gaining or producing income from property. It is important to recall that Wallace and Shelva and Air Rock were all at arm’s length with CPI. Having regard to the fact that Wallace and Shelva, through 022, own indirectly all of the shares of Air Rock, and were substantial shareholders of CPI, I am inclined to the view that Air Rock’s loans to CPI were acquired for the purpose of gaining or producing income from property even if Air Rock were not a direct or equitable shareholder of CPI. This is the way new businesses are financed in the real world.

Having concluded that Air Rock’s loans to CPI were for the purpose of gaining or producing income within the meaning of subparagraph 40(2)(g)(ii), I find that Air Rock incurred a business investment loss on the bankruptcy of CPI. For the purpose of computing the amount of the business investment loss, it does not matter whether the money flowing from Air Rock to CPI (plus the value of Air Rock’s interest in the Polyol equipment) was consideration for shares or an ordinary loan. According to a schedule provided by the Respondent’s counsel in argument, the Minister performed separation computations with respect to Air Rock’s advances to NPC and CPI. The Minister determined that Air Rock suffered a loss of $$8,690 in 1989 computed as follows:

The Polyol equipment was not transferred to CPI until sometime between December 1989 and February 1990 during Air Rock’s 1990 fiscal period (ending May 31). I think that Air Rock’s loss on advances to NPC was $8,690 but incurred in the company’s 1990 taxation year. As the 1990 taxation year is not under appeal, the application of that loss may be statute- barred.

The Minister’s schedule excludes from Air Rock’s advances to CPI the amounts of $200,000 plus $193,660 which the Minister regarded as shareholder benefits. Having decided that there were no shareholder benefits, I will compute Air Rock’s business investment loss by adapting Exhibit A-61 and recognizing certain property recovered by Air Rock as follows:

In the above computation, the Minister had deducted the $50,000 mortgage credit from the net advances in 1991 but I treat it as a global credit. The value of the Polyol equipment upon the bankruptcy of CPI is more difficult to determine. Barbara Scott said that Wallace had an offer of $270,000 (US funds) from which she deducted a commission of $50,000 (US funds) to arrive at a value of $275,000 (Canadian funds). See paragraph 29 above. I would not deduct the sales commission for valuation purposes but would simply estimate the value at $300,000 (Canadian) in the absence of any expert evidence as to value. The amount of $300,000 could become the cost to Air Rock against which a later loss or gain would be determined upon the disposition of the Polyol equiment.

In my opinion, Air Rock incurred a business investment loss of $454,152 upon the bankruptcy of CPI. That bankruptcy did not occur until after May 31, 1991. Therefore, I conclude that Air Rock did not incur a business investment loss of $200,000 in its 1991 taxation year but it did incur a business investment loss of $454,152 in its 1992 taxation year. I will dismiss Air Rock’s appeal for 1991 but will allow its appeal for 1992 to permit the deduction of a business investment loss in the amount of $454,152.

At the end of the hearing, counsel made submissions as to costs. The three appeals are allowed with costs subject to the following conditions. The dismissal of Air Rock’s appeal for 1991 is not a factor in costs because the loss claimed in that year is simply deferred to 1992. Air Rock is entitled to costs as if it were the only Appellant but I will not allow any costs with respect to the so-called expert evidence of Mr. Mason because his evidence was extraneous or irrelevant. Wallace is entitled to costs in the fixed amount of $500. Shelva is entitled to costs in the fixed amount of $500.

Appeals allowed.