Frank R Crawley v. Minister of National Revenue, [1979] CTC 2014, 79 DTC 33

The Chairman:—The appeals of Frank R Crawley are from assessments dated August 15, 1975, whereby the Minister of National Revenue added to the appellant’s income for the 1970 taxation year an amount of $15,000 claimed as a loss for a film called ‘‘Gimme Shelter”, and also disallowed an amount of $21,000 claimed as a loss for the same film in the 1971 taxation year. By notice of assessment dated October 30, 1975, the Minister added to the appellant’s 1972 income, reported capital gains in the amount of $1,231; disallowed the loss claimed re “Gimme Shelter” in the amount of $8,400; disallowed an amount claimed as a loss in a film entitled “Luck of Ginger Coffey” and also disallowed an amount of $12,400 claimed as a loss on a film entitled “Everest Symphony”. By notice of assessment dated August 15,1975, the Minister disallowed the amounts of $3,360, $19,233 and $401 claimed as losses in respect of films “Gimme Shelter”, “Everest Symphony” and “Luck of Ginger Coffey” respectively. (Exhibit R-1).

Issue

Basically the issue in these appeals is the deductibility or otherwise of an amount of $50,000 advanced to Film Canada Presentations Limited (hereinafter referred to as “Film Canada”) by the appellant and an amount of $75,000 paid by the appellant pursuant to his endorsement of a Security Pacific National Bank guarantee. The two questions the Board must decide are whether the amounts claimed by the appellant were expenses incurred to gain income from a property or business or whether they were loans; and secondly, whether or not the advances were capital in nature.

The Evidence

The appellant has been in the film industry for over forty years and has made between 2,500 and 3,000 films. Crawley Films began in 1938 as a partnership between the appellant and his wife. In October of 1946 the company was incorporated and became known as Crawley Films Limited. At that time Crawley Films produced but did not distribute films. (Exhibit A-1 — Federal Charter, Supplementary Letters Patent and Registration).

In the late 1930’s the appellant was the producer, under contract, of several films for the National Film Board, in a series called “Canada Carries On”.

A picture story appearing in the Television and Motion Picture Review of May 1955 describing Crawley Films and how films were produced was filed as Exhibit A-2. In giving evidence the appellant explained that the film industry has three main branches: a) Tourist films, promotion films, merchandising films; b) Television commercials; c) Entertainment films.

The first two categories are contract films presenting no financial problems as to their production. The third category, the entertainment films, do present financial difficulties and risks from the very start. Problems arise because the options on novels, the cost of the screen play and the cost of making the feature films, which the traditional lending institutions consider too risky to finance, must be financed otherwise.

In the circumstances it is necessary in order to appreciate the nature of the transactions subject of these appeals, to examine the background of each of the pertinent films as described by the appellant, which was not contradicted by the respondent.

“The Luck of Ginger Coffey” was the first feature film made by the appellant and in order to produce it, the appellant went into partnership with one Walter Reed Sterling of New York. The appellant borrowed from the Royal Bank, against personal securities, an amount of $200,000, to enable him to operate as a producer of feature films. He then bought the novel “The Luck of Ginger Coffey” from Brian Moore and had a proper screen play written at a cost of some $25,000. As executive producer of the film he hired a director, a production manager and crew and the film was made and released in New York. Walter Reed Sterling, the appellant’s partner, subsequently lost his money and would not pay the returns on the film to the appellant who now personally owns the film.

Since 1964 the film was shown on the United States television network, it was sold to CBC and has been resold to City-TV Toronto. The appellant has since received somewhat more than the original cost for the film.

The film “Gimme Shelter’’ came about at a time when Crawley Films, through the appellant, was seeking to get into the film distribution business. Prior to that time Crawley Films was engaged in the production of some of the films produced by the appellant as executive producer. Two shareholders of Film Canada, Mr Poolman and Mr Fry, sought the appellant’s financial assistance in acquiring the distribution rights for “Gimme Shelter’’. (Film Canada’s bank—the Canadian Imperial Bank of Commerce—being unwilling to make any further advances). The rights were held by Mr Leonard Holzer in New York who was asking $50,000 for the Canadian distribution of “Gimme Shelter’’. The appellant paid $25,000 in December 1970 and $25,000 in January 1971, under conditions set out in an Agreement dated December 21st, 1970. (Exhibit A-3).

On December, 16,1970 a Direction was issued by Film Canada to Premier Operating Corporation Limited to pay all film rentals earned by “Gimme Shelter’’ to F R Crawley. (Exhibit A-4).

On December 28, 1971, Film Canada made an assignment in bankruptcy and a notice from the Trustees in bankruptcy showed the appellant as a creditor in the amount of $100,000. (Exhibit A-5).

The distribution rights of “Gimme Shelter”, acquired by Film Canada, lapsed pursuant to a bankruptcy clause in the Agreement. (Exhibit A-3). The appellant however made an agreement with Mr Holzer to renew the distribution rights for $15,000. The appellant advanced $15,000 to Crawley Films Limited and the corporation acquired the distribution rights of “Gimme Shelter” for Canada. On June 30, 1972, a further agreement was entered into between Crawley Films Limited and Leonard Holzer extending the time of the licence re “Gimme Shelter” for 10 years. (Exhibit A-6).

Mr Poolman was also the sole shareholder of another company known as Production Canada Express Limited and had bid against Crawley Films for a film and lost the bid. Mr Poolman hired a cameraman and shot the picture. When the picture was finished, Mr Poolman’s liabilities were such that he locked the negative footage in a food locker, unprocessed. The appellant, with Mr Poolman’s consent, had the film processed to see what was on the film. On processing the film it was found that the cameraman who had shot the picture and had not been paid for his work had taken as compensation considerable footage of a leading rock singer Janis Joplin who died subsequently and on whose life a film is now being produced by 20th Century Fox.

The appellant redeemed the film footage for the cameraman, processed it and found he had 10,000 feet of film on Janis Joplin and decided to produce a feature film on his own, by agreement with Maclean-Hunter Limited and the estate of Production Canada Express Limited. The appellant sought out and dealt with some fourteen holders of Janis Joplin footage in Europe and the United States and obtained synchronisation rights as well as rights to the songs in a feature film which was produced at Crawley Films at a cost of $400,000 and which eventually was nominated for an Academy Award.

The appellant was also involved in the making of “The Man Who Skied Down Everest”. The appellant had learned through friends that there was a Japanese film called “Everest Symphony” for sale. The film dealt with a Japanese who in 1970 skied down Mount Everest. However, after speaking to the man who actually skied down Mount Everest and having spoken to Ishahara Productions who owned the film, the appellant took an option on the film. At that time the appellant was president and majority shareholder of Canamco Ltd in California and through Canamco an option on all the footage of “Everest Symphony” was taken for $75,000 with a down payment of $7,500.

Security Pacific National Bank would not advance money to Canamco because it had no assets so the appellant had to endorse the loan personally. When the note became due Crawley Films put up the $75,000 and redeemed the note.

The film “Everest Symphony” was edited and considerable addition made to it by the appellant and released as “The Man Who Skied Down Everest”.

Problems arose between the appellant and his two partners in Canamco Ltd as to the partition of the money when the film was released. The matter was settled pursuant to an arbitration opinion as set out in Exhibit A-7.

In the pertinent taxation years Crawley Films had also acquired the rights to make a screen play from a novel called “The Strange One”, written by Fred Bosworth in 1958 who allegedly has now been paid $42,500. (Exhibit A-8—Cheque for $900 to Fred Bosworth). It is alleged that personal advances were used in reference to financing such projected feature films because they are considered by lending institutions as being too unproductive. Other personal cheques in connection with expenses of the preparatory work in the production of “The Strange One” were produced as Exhibit A-9 and one in connection with the film rights of another novel called “Settlers of the Marsh” for an amount of $1,000.

The evidence established to the satisfaction of the Board that the principal occupation of the appellant for many years was that of film producer and that he was so engaged during the pertinent taxation years.

The nature of the film industry, the intangibles from which feature entertainment films originate, the financial outlays that must be expended before a film can begin to be realized and the heavy financial risks taken before knowing what success the film will have, have been set out for the benefit of the Board by the appellant and confirmed by Mr Gulkin, a film producer who was called as a witness.

On the basis of this evidence the Board can properly conclude that the problems and risks involved in the production of feature films have caused the lending institutions to be more apprehensive in advancing monies for the production of feature films than they would otherwise be.

However, notwithstanding the general background of feature film production which is noted, the Board must decide the nature of specific transactions.

The first transaction in question is the advance made by the appellant of $50,000 to Film Canada.

The evidence is that the amount was advanced in two payments of $25,000 each, one in December 1970 and the other in January of 1971 pursuant to an Agreement between the appellant and Film Canada dated December 21, 1970. (Exhibit A-3).

It is clear from the Agreement and from the appellant’s testimony that the purpose of the advance was to permit Film Canada, whose principal shareholders were Mr Poolman and Mr Fry, to acquire the distribution rights of “Gimme Shelter” from Mr Leonard Holzer of New York. Regardless of what the appellant’s ultimate purpose may have been in signing the Agreement, the advance was not made so that the appellant personally or that Crawley Films could obtain the distribution rights. The Agreement “in form” is that of a loan of $50,000 @ 9% interest with a $5,000 bonus repayable to the appellant and guaranteed by promissory notes. The agreement also provided for the repayment to the appellant of $31,618.71 owed the appellant by Mr Fry for which a promissory note was also issued. The repayment of both these amounts ($50,000 and $31,618.71 plus interest) was specifically provided for in the Agreement and in the Direction (Exhibit A-4). Exhibit A-3, inter alia, reads as follows:

(6) .. . The Company has made arrangements with Premier Operating Corporation Limited and with Cinecity Theatre to pay all film rentals due to it by Cinecity Theatre to Crawley. (Copy of direction and acknowledgment effecting same attached and marked ‘C’ hereto). Crawley agrees to deposit these film rentals into a special account with the Canadian Imperial Bank of Commerce, 100 University Avenue, Toronto. The film rentals earned during the first week of the showing of Gimme Shelter at Cinecity will be paid by Crawley to the Company for its general purposes. The Company and Crawley acknowledge that the sum of $2,680 of such amount will be repaid forthwith to Poolman by the Company on account of monies advanced by Poolman to the Company on short term. The balance of film rentals received after the first week from Cinecity and with respect to other engagements for the picture in Metropolitan Toronto shall be paid to Crawley for deposit in the special account and are to be credited to the loan account of the Company with Crawley.

(7) All contracts relating to the picture shall be subject to the approval of Crawley. Such contracts shall at the option of Crawley stipulate that film rentals payable to Film Canada by virtue of such contracts shall be paid into the said special account with the Canadian Imperial Bank of Commerce as mentioned in paragraph 6 hereof. With respect to any engagement of the picture other than Cinecity or other theatre in Metropolitan Toronto, Crawley shall upon receipt of any film rentals for such engagements pay to the Company 25% of such film rentals, which the Company shall use for its general corporate purposes. The remaining 75% of such film rentals shall be paid out of the said special account to Crawley and be credited against the loan account of the Company with Crawley.

(8) All payments to Crawley remaining in the said special account as set out in paragraph 6 hereof shall be credited to the loan account of the Company with Crawley, by virtue of this Agreement. First the cash advances with interest and bonus as mentioned in paragraph 1, 2, 3 and 4 hereof shall be repaid to Crawley out of this special account. Out of the balance Crawley shall be repaid on account of the indebtedness of $31,618.71 with interest as accrued as set out in paragraph 5 hereof.

(9) As soon as all monies owing to Crawley by virtue of the promissory notes given to Crawley as aforesaid and by virtue of the indebtedness assumed by the Company as herein set forth, and on account of any interest due to Crawley as accrued on the said promissory notes and on the indebtedness herein assumed have been repaid to Crawley, any balance remaining in the said special account shall be paid to the Company.

The substance of the Agreement as well as its form is, in my view, that of a loan repayable to the appellant through the film rentals earned by “Gimme Shelter’. The appellant had no direct interest in the distribution rights of the film other than the payments on his loan which would cease once the loan had been repaid.

The nature of the advance of $50,000 by the appellant to enable Film Canada to acquire the distribution rights for ‘‘Gimme Shelter” is quite different from the payment of $15,000 by Crawley Films (through the appellant its principal shareholder) for the said distribution rights which had expired with the assignment in bankruptcy of Film Canada. In the latter transaction the appellant might well be said to have incurred expenses for the purpose of earning income from Crawley Films in the distribution of “Gimme Shelter”.

The second transaction to be determined is the appellant’s payment of an amount of $75,000 to the Security Pacific National Bank for the redemption of a note in that amount. The appellant was the majority shareholder of Canamco and having secured the loan, the Security Pacific National Bank advanced Canamco $75,000 for the purchase of the film “Everest Symphony”. The appellant in remaking the film acted in the capacity of executive producer and director and was paid between $50,000 and $60,000 for his work on the film “The Man Who Skied Down Everest”.

On May 17,1973, Security Pacific National Bank addressed the following letter to Mr F R Crawley:

Mr F R Crawley

Crawley Films Limited

19 Fairmont

Ottawa, Canada K1Y 3B5

Re: Can Am Ltd

Dear Mr Crawley:

As you are aware Can Am’s promissory note in the amount of US $75,000 matures on May 30, 1973.

Please arrange for payment of US $75,000 plus accrued interest in the amount of US $1,801.03 to be in my hands on or before the due date.

Thank you.

Very truly yours,

(Signature)

AB:ls Anthony Bill

Assistant Vice President

The appellant redeemed the note by paying $75,000 which was charged to the appellant’s drawing account (or credited to the appellant’s loan account) with Crawley Films. The book entry was made on February 28, 1974 and some question arose as to whether the amount was paid in 1973 pursuant to the letter from Security Pacific National Bank or in February of 1974.1 accept the appellant’s statement that the payment was made in 1973 but February 28 is Crawley Films’ fiscal year end and the February 1974 entry reflected the 1973 payment. (Exhibit R-2).

On the release of the film in the United States some difficulty arose as to the distribution of income from the film to the shareholders of Canamco which was settled by arbitration. (Exhibit A-7). The letter of arbitration reads in part:

F R Crawley, President

Crawley Films Limited

409 King Street, West

Toronto, Ontario M5V 1K1

Canada

Re: Canamco Arbitration

Dear Budge:

I enclose a copy of the arbitration opinion and award and of Mr Ziffren’s letter. In summary, the arbitrators made the following award:

1. Crawley Films and Crawley are entitled to recoup their costs of production of $494,450;

2. Canamco is indebted to Crawley Films and Crawley for advances of working capital of $60,111;

3. Crawley Films is entitled to 50% of the net profits of the picture;

4. Crawley Films and Crawley are entitled to interest of $77,980 as of December

31, 1976 with interest running thereafter at 7% on the sum of $362,191;

I have no difficulty in this instance in accepting that the $75,000 paid by the appellant to Security Pacific National Bank and charged to the appellant’s loan account in Crawley Films’ books were expenses incurred by the appellant for earning money from his business as executive producer and from Crawley Films as a distributor for the film.

It seems clear from the evidence that in the business of producing feature films, that outlays for the purchase of novels, scripts, distribution rights, etc cannot be considered as capital assets, not only because their “enduring quality’’ is uncertain but more importantly and irrespective of the nature which might normally be attributed to these items, the use made of them by the producer is that of stock-in-trade and are commercial items, necessary in the exercise of the business of feature film production. In the circumstances no capital cost allowances, capital gains or losses can be claimed in respect of these outlays.

Conclusion

On the basis of the facts in these appeals, I conclude that the appellant in the pertinent taxation years was in the business of producing and distributing feature films and had to make substantial outlays in order to earn income from the production of the films.

In determining whether the amounts claimed by the appellant were expenses incurred for the purpose of earning income from a business it is necessary to establish a direct and demonstrable relationship between the advance and the income earned from the business.

Although I am satisfied that this relationship existed in the films referred to in the notices of assessment, the appellant did not establish such a relationship in respect of his advance of $50,000 to Film Canada. There is no direct relationship between the appellant’s advance to Film Canada and income earned by the appellant from his business as producer of feature films. All that the appellant received was interest on his loan. Since the appellant was not in the business of loaning money even the interest received cannot be considered as income from the appellant’s business of producing films within the meaning of paragraph 12(1 )(a) of the Income Tax Act, SC 1970-71-72, c 63, as amended.

Decision

The appeals are allowed and the matter referred back to the respondent for reconsideration and reassessment on the basis that the appellant was engaged in the business of producing feature films and that all of the advances referred to in the assessments, save one, were expenses incurred by the appellant for the purpose of earning income from his business and are deductible. The Board, however, holds that none of the amounts in issue in these appeals are capital in nature and that no capital cost allowances, capital losses or capital gains can be claimed by the appellant. The Board holds further that the advance made by the appellant in the amount of $50,000 to Film Canada, pursuant to an Agreement dated December 21, 1970, was by way of loan and was not an expense incurred by the appellant for the purpose of earning income from his business within the meaning of paragraph 12(1)(a) of the Income Tax Act and that the relief sought in respect of these last two issues cannot be granted.

Appeal allowed in part.