Terence T Malone v. Minister of National Revenue, [1979] CTC 2619, 79 DTC 540

Roland St-Onge:—The appeal of Mr Terence T Malone came before me on April 4, 1979, at the City of Toronto, Ontario and the issue is whether the appellant is entitled to deduct a business loss in the amount of $139,500 in his 1971 taxation year.

The undisputed facts are as follows:

(1) The appellant was president of Malone Lynch Securities Limited (hereinafter sometimes referred to as Malone Lynch) as well as a substantial shareholder thereof. Malone Lynch was a stock brokerage company.

(2) The appellant, at all material times, was employed as a salesman for the company and was paid partially in salary and partially in commissions.

(3) The appellant had been making subordinated loans to Malone Lynch, his employer, in which he was a shareholder, in order to enable the company to maintain its working capital position.

(4) In 1971, Malone Lynch went bankrupt and the appellant suffered a loss of $139,500 as a result of his employer’s failure to repay the said sum.

The respondent contended that the appellant did not suffer a business loss within the meaning of paragraph 12(1)(a) of the Income Tax Act, RSC 1952, c 148, as amended, and consequently the said loss was disallowed.

At the hearing, the appellant testified as follows: In 1964, he became a shareholder of Robertson, Malone & Co Limited by investing $10,000 therein. By 1967, the appellant had invested $60,000 in common shares and became the president of the company. In 1970, there was a merger to create a new company, Malone Lynch Securities Limited, a stock brokerage company and the appellant’s interest therein was 23%

In 1968, the appellant took control of the company but he was still acting as a commissioned salesman. His salary was nominal but, at the end of each year, instead of keeping the money in the company, the profit was shared amongst the shareholders and every year the appellant paid substantial tax thereon as appears in Exhibit A-7, as follows:

INCOME AND TAXES PAID FOR PERIOD 1964-1971

Salary/ Bonuses Commissions Other Total Income Taxes Paid Salary/

1964	$ - $18,873 $ - $18,873 $ 5,438
1965		16,227	—	16,227	3,655
1966	—	14,564	220	14,784	2,980
1967	478	21,680	(1,060)	21,097	5,918
1968	14,463	46,748	2,428	63,629	27,241
1969	71,443	18,000	(926)	88,516	42,574
1970	18,913	60,500	1,264	80,677	37,728
1971	43,801	10,500	1,581	55,882	22,125

From time to time, the appellant made several short-term loans to the company in order to comply with the Toronto Stock Exchange requirements. Malone Lynch had to maintain its working capital position at a certain level and the appellant’s contribution to this working capital went up to $139,500 on March 31, 1971.

In 1971, the appellant went bankrupt because one of its share salesman bought a substantial amount of shares in an oil company at $2 each. The said shares went down to $0.35 and, because the salesman could not pay, the liability was transferred to the company’s account, which used its total working capital.

The shareholders could not come up with further funds within a period of three days and the Toronto Stock Exchange put the company in bankruptcy.

Consequently, the appellant incurred two kinds of losses:

(1) $80,000 investment in preferred shares;

(2) $139,500 short-term advances to the company.

The appellant explained that it was common practice for a small business like his to distribute the earnings at the end of every year; that their shareholders never received any dividends; that the money he received from the company went back to it after paying the income tax thereon; that the money he advanced to the company was not an investment, but working capital in order to stay in business; and that it would be ridiculous to believe that an employee would advance this kind of money to an employer.

The agent for the appellant argued that, according to the rules of the Securities Commission, a taxpayer must be a registered salesman to sell securities, which in the appellant’s case involved two kinds of advances: investment in preferred shares, and short term loans, so that large amounts of profit could be earned.

Then, he referred the Board to the following cases:

MNR v Freud, [1968] CTC 438; 68 DTC 5279;

Margaret Ann F rappier v The Queen, [1976] CTC 85; 76 DTC 6066;

The Queen v F H Jones Tobacco Sales Co Ltd, [1973] CTC 784; 73 DTC 5577;

Mossport Park Limited v MNR, [1977] CTC 2397; 77 DIC 264;

Arthur J Thomas v MNR, [1977] CTC 2227; 77 DTC 171.

He also argued that the appellant wore four different hats:

(1) as employee, his salary was nominal;

(2) as shareholder, he did not receive any dividends;

(3) as commissioned salesman, substantial commission received; and

(4) as a businessman, he was required to maintain the company’s working capital position in order to stay in business.

He also stated that it would be ridiculous for an employee to advance that kind of money to an employer when the shareholders were not even getting any dividends; that an ordinary commissioned salesman, instead of advancing this kind of money, would move to another employer; that if the appellant advanced substantial sums of his money and borrowed money, his intention was to stay in business and generate substantial profits.

He stated that the appellant incurred two kinds of losses:

(1) an unclaimed investment loss of $80,000, and

(2) one of trading asset which compared to the first one, was not permanent capital, but funds earned and rolled back into the company.

Counsel for respondent referred the Board to two cases:

Reid (A J A) v MNR, [1973] CTC 2073; 73 DTC 69, and Charles Chaffey v MNR, [1978] CTC 253; 78 DTC 6176.

Then he argued that the appellant was not in the money-lending business, but only an employee of the company and, as such, he could not claim as business losses the money he advanced to his company. It was an investment and consequently a non-deductible loss of capital. If the investment goes bad, he says, one loses capital. Similarly, if a property which generated rental income is destroyed by fire, the owner incurred an undeductible loss of capital.

He terminated his argument by saying that, in the case at bar, the appellant earned employment income and there was no section in the Income Tax Act to provide for that kind of loss.

The Board believes that the case at bar is not as simple as presented by counsel for respondent. The appellant was not an ordinary salesman who advanced money to a company, but a very special one. He was the backbone of his company and, without him, the company had no existence. Furthermore, this company was kept in existence to allow the appellant to generate substantial profit (from 1967 to 1971—some $310,000) because the appellant could not have been in this kind of business without resorting to Malone Lynch, the use of which as a mere vehicle was born out of necessity. In fact an individual, to do this kind of business, has to be incorporated. For this reason, I dare to say that the appellant was not an ordinary salesman employed by a company, but a very special one.

The appellant never pretended that he was in the money-lending business, but according to the evidence, taken as a whole, he was in the profit-making business. His intention was to earn substantial profit and he did so by buying and selling stock for clients and the best way to do it was to use Malone Lynch.

The evidence has revealed that the method employed by the appellant was the most efficient and appropriate way to earn considerable profits. The advances he made to his company became an integral part of his current profit-making activities and there is no doubt that these advances were made as a businessman intending to continue in business and in accordance with the ordinary principles of commercial trading or well-accepted principles in the practice of the stock market business.

The fact that it was a necessity to have a company to be very efficient in this kind of business is corroborated by the facts enunciated in the Frappier decision as well as in the Thomas decision and I quote at p 2231:

The Board also accepts the appellant’s verbal explanation regarding the company policy at McEwen—to remunerate the security sales agents by salary and commission rather than by dividends. Taken in conjunction with his statements that he needed to be a shareholder to operate as a stockbroker, the investment must be regarded as having been made for a property acquired for the purpose of gaining or producing income.

The Reid decision is distinguishable on the facts, although the principles enunciated therein are usually the right ones to say that the loss belonged to the company, but in the case at Bar, the company has a lesser importance and should not be the focus to decide the nature of the losses. Herein the Board prefers to rely on the principles enunciated in the Freud decision and more particularly, at p 443:

Assuming that the whole amount should properly be considered as a debt due by the company, this does not necessarily imply that the outlay was an investment. Obligations to pay money can be trading assets just like other things (Scott v MNR, [1963] SCR 223 [[1963] CTC 176; 63 DTC 1121]; MNR v Maclnnes, [1963] SCR 299 [[1963] CTC 311; 63 DTC 1203]; MNR v Curlett, [1967] SCR 280 [[1967] CTC 62; 67 DTC 5058]). It is true that in those cases the conclusion that the acquisition of mortgages at a discount was a speculation, not an investment, rests upon a consideration of the large number of operations of a similar nature that were effected. But, on account of the definition of ‘business’, this is not the only basis on which this conclusion can be reached. As previously pointed out, a single venture in the nature of trade is a business for the purposes of the Income Tax Act ‘as well in the case of an individual as of a company’.

It is, of course, obvious that a loan made by a person who is not in the business of lending money is ordinarily to be considered as an investment. It is only under quite exceptional or unusual circumstances that such an operation should be considered as a speculation. However, the circumstances of the present case are quite unusual and exceptional. It is an undeniable fact that, at the outset, the operation embarked upon was an adventure in the nature of trade. It is equally clear that the character of the venture itself remained the same until it ended up in a total loss. Under those circumstances, the outlay made by respondent in the last year, when the speculative nature of the undertaking was even more marked than at the outset due to financial difficulties, cannot be considered as an investment. Whether it is considered as a payment in anticipation of shares to be issued or as an advance to be refunded if the venture was successful, it is clear that the monies were not invested to derive an income therefrom but in the hope of making a profit on the whole transaction.

And also at p 444:

In my view, the payments made by respondent could not properly be considered as an investment in the circumstances in which they were made. It was purely speculation. If a profit had been obtained it would have been taxable irrespective of the method adopted for realizing it. Such being the situation, these sums must be considered as outlays for gaining income from an adventure in the nature of trade, that is a business within the meaning of the Income Tax Act, and not as outlays or losses on account of capital.

Also in the Frappier decision at p 93, and I quote:

Here again there has been considerable jurisprudence. In the case of Canada Starch Company Limited v MNR, [1969] 1 Ex CR 96 [[1968] CTC 466; 68 DTC 5320], President Jackett, as he then was, had this question to consider, and after examining the jurisprudence said at p 105 (475, 5325):

in distinguishing between a capital payment and a payment on current account, in my view, regard must be had to the business and commercial realities of the matter.

In the case of L Berman & Co v MNR, [1961] CTC 237; 61 DTC 1150, former President Thorson of this Court also examined this question in the case of a payment made by a parent company to suppliers of a Toronto subsidiary whose operations had been closed, because it was anxious to continue doing business with the suppliers. At pp 247-248 the learned President states:

There is no doubt in my mind that the appellant made the payments in question as a business person intending to continue in business would reasonably do and that, consequently, they were made in accordance with the ordinary principles of business practice and I am unable to find any ground in paragraph 12(1)(a) for their exclusion.

Even if the appellant had not been legally bound to make the payments that did not prevent them from having been made in accordance with the ordinary principles of commercial trading. There is strong authority for this statement in Usher’s Wiltshire Brewery Limited v Bruce, [1915] AC 433. In that case the tenants of the appellants’ tied houses were by agreement bound to repair their houses and pay certain rates and taxes. They failed to do so. The appellants, though in no way legally or morally bound to do so, paid for these repairs and paid these rates and taxes. They did so, not as a matter of charity, but of commercial expediency, in order to avoid the loss of their tenants, and, consequently, the loss of the market for their beer, which they had acquired these houses for the purpose of affording. It was held that, although they were not legally or morally bound to make these payments, yet they were, in estimating the balance of the profits and gains of their business for the purposes of assessment of income tax, entitled to deduct all the sums so paid by them as expenses necessarily incurred for the purposes of their business.

And in British Insulated and Helsby Cables v Atherton, [1926] AC 205, Viscount Cave, LC, said, at p 211:

It was made clear in the above cited cases of Usher’s Wiltshire Brewery v Bruce, [1915] AC 433, and Smith v Incorporated Council of Law Reporting, [1914] 3 KB 674, that a sum of money expended, not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expedience, and, in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purpose of the trade.

On p 248 he also refers to the case of Cooke v Quick Shoe Repair Service, 30 TC 460, and Robert Addie & Sons Collieries Limited v CIR, [1924] SC 231-235, where similar findings were made.

Similar findings were also made by former Associate Chief Justice Noel in the case of The Queen v F H Jones Tobacco Sales Company Limited, [1973] FC 825 [[1973] CTC 784; 73 DTC 5577], in which he refers to the Supreme Court judgment in the case of MNR v Algoma Central Railway, [1968] SCR 447 [[1968] CTC 161; 68 DTC 5096], which confirmed judgment of Jackett, P in the same case reported in [1967] 2 Ex CR 88; [1967] CTC 130. He quotes at length from the judgment of Pigeon, J in the Supreme Court in the case of MNR v Freud, [1969] SCR 75 [[1968] CTC 438; 68 DTC 5279], at pp 81 to 84 in which he accepted as deductible moneys advanced to a company for the construction of a sports car prototype which were unfortunately used to no purpose since the venture did not succeed. At p 837, the learned former Associate Chief Justice states:

the loss sustained by defendant when it was called on to act as surety must be treated as an outlay made for the purpose of gaining or producing income in the operation of its business undertaking, and not as an outlay or loss on account of capital.

Later on the same page he states:

In effect defendant sought through this guarantee to ensure the continued growth of its sales to Tabacs Trans-Canada Ltée and at the same time to make certain that the latter would be able to proceed with large orders for tobacco made.

In the case of Aluminium Company of Canada Limited v Her Majesty The Queen, [1974] CTC 471; 74 DTC 6408, Heald, J states at 477(6413):

The authorities clearly indicate that an expenditure made as a ‘gift’ or as a matter of commercial morality will be allowed as a deduction in computing income. See Olympia Floor & Wall Tile (Quebec) Ltd v MNR, [1970] CTC 99; 70 DTC 6085 and Pigott Investments v The Queen, [1973] CTC 693; 73 DTC 5507 (above). Subject expenditure was made in the interests of commercial morality.

In the case of Olympia Floor and Wall Tile (Quebec) Ltd v MNR, [1970] Ex CR 274; [1970] CTC 99; 70 DTC 6085, referred to therein President Jackett followed the authority of Ried le Brewery Limited v MNR, [1939] SCR 253 [1938-39] CTC 312; 1 DTC 499-29, which allowed the deduction of amounts spent by breweries following the practice of treating frequenters of hotels and clubs by following this practice its sales would either be maintained or increased whereas if the practice were discontinued its sales would decrease. See also The Queen v R Lavigueur, [1973] CTC 773; 73 DTC 5538, in which loans made to tenants of a commercial building by the landlord to enable them to remain in business and continue occupancy of the leased premises were allowed as a deduction from income as expenses laid out to produce income.

I conclude that on the facts of this case the reimbursement of losses made to clients of plaintiff were made with a view to producing income according to the provisions of paragraph 12(1)(a)of the Act and were not a payment on account of capital by virtue of paragraph 12(1)(b).

In the light of these decisions, the Board decides that the advances were made with the view of producing income according to the provisions of paragraph 12(1)(a) of the Act and were not a payment on account of capital by virtue of paragraph 12(1)(b).

Consequently, the appeal is allowed.

Appeal allowed.