Wayne D Rudolph v. Minister of National Revenue, [1977] CTC 2288

Roland St-Onge (orally: May 19, 1977):—The appeal of Wayne D Rudolph came before me on May 17, 1977 at the City of Edmonton, Alberta, and it is with respect to a reassessment for his 1972 taxation year in which the Minister of National Revenue disallowed as deductions several amounts claimed by the taxpayer as losses from a business and from property under sections 3, 4, 10, 18 and 40 of the Income Tax Act, RSC 1952, c 148, as amended by section 1 of SC 1970-71-72, c 63, and sections 3, 4, 12 and 27 of the same Act, RSC 1952, c 148, prior to the amendments as it read in 1970.

In his notice of appeal, the appellant alleged the following facts:

1. On May 12, 1970 the appellant determined to go into business as an art dealer, and for that purpose acquired, in one transaction, an inventory for the business of 23 framed paintings, 33 unframed paintings, and 11 frames at a cost of some $5,000.00.

2. It was the intention of the appellant that in due course the business would be sold to a company of which he would be a shareholder, and on May 29, 1970, the company was incorporated under the name of Varga Art & Frames Shop Ltd.

3. The business was never transferred to the company since, on July 2, 1970, the whole of the Appellant’s inventory referred to above was completely destroyed by fire.

4. The Appellant had insured the inventory against a fire loss, and expected to recover his loss from his insurers in due course. However, it was in 1972 finally determined that, because the inventory had been moved by the Appellant from the premises stipulated in the policy of insurance to different premises (those from which the Appellant, and, ultimately, his company, would sell the inventory with a view to profit) without the insurer approving those premises, that the insurer was not liable under the policy of insurance.

5. The taxpayer incurred legal costs and expenses of $2,692.57 in his endeavour to recover from the insurers the value of the inventory lost in the fire.

6. In filing his return of income for 1972, the Appellant claimed as losses from his art business the $5,000.00 for the inventory, and the legal costs and expenses referred to above.

7. In assessing the Appellant, the Minister appears to have assumed that the paintings were not inventory of the Appellant, but rather personal property, and disallowed the deduction claimed as being capital losses.

8. The Appellant states that the paintings and frames were acquired for the sole purpose of resale in the course of a business venture, which he states had a reasonable expectation of profit, and that the paintings and frames constituted inventory and that the loss of that inventory, as ultimately established in 1972, together with the legal fees and costs incurred by him in seeking to recover his loss, constituted a business loss in 1972.

9. The appellant further, in 1970, expended $450.00 toward the lease of premises from which to conduct the business of art dealers. It was in these premises that the fire which destroyed his inventory occurred.

10. Since his inventory was destroyed, the premises he leased were damaged, and it was determined in 1972 the insurers were not liable to pay for the loss because of a material change in risk due to the removal of the inventory to the premises aforesaid, the appellant resolved in 1972 to discontinue the business, and included the $450.00 rental payment as a deduction in his 1972 return.

11. The Minister disallowed the rental payment as a deduction, on the assumption that the paintings and frames were not inventory.

12. The appellant states that the rental payment was a properly deductible expense which he hoped, until 1972, to recover from the company that was to acquire the whole of the business, a prospect which, after the decision with respect to the liability of the insurers referred to above, ceased in 1972.

13. During 1969-1971 inclusive the appellant was shareholder and President of RUDOLPH FOODS LTD a body corporate carrying on the business of a pizza parlour under the name of Pizza Cabaret at Edmonton.

14. Rudolph Foods Ltd was indebted to Neon Products Ltd for $2,800.00 under a contract respecting the sign for the pizza parlour, an indebtedness personally guaranteed by the appellant and another shareholder. As the business became insolvent, the Appellant borrowed $1,800.00 from a bank on November 9, 1971, and discharged a portion of the indebtedness. The balance was borne by another shareholder. The appellant repaid the monies to the bank on September 12, 1972.

15. Rudolph Foods Ltd ceased operations and by 1972 it became clear it would not repay to the appellant the $1,800.00 advanced by him on its behalf. Accordingly, he claimed one-half of the advance as an allowable capital loss for his 1972 taxation year.

On the other hand the respondent claims that the appellant should not be allowed to deduct $9,142.57 as expenses from income on account of the paintings business, and $900 as an allowable capital loss, being one-half of an alleged capital loss on account of Rudolph Foods Ltd.

As to the paintings business, the respondent states that at no time was the appellant in the business of an art dealer, and if the paintings were acquired as inventory, any non-capital loss on account of inventory would be deductible in 1970 and not in 1972.

As to the $450 expended as rent, it was expended in 1970 and cannot be deductible in 1972.

As to the Rudolph Foods business, the respondent contends that any amount paid by the appellant to Neon Products Ltd was paid pursuant to his obligation under a contract dated April 30, 1970, and that the amount was expended in 1971, but not to earn income and, consequently, it should not be deductible in 1972.

The respondent further contends that any loss on such debt was not an allowable capital loss by virtue of subparagraph 40(2)(g)(ii) as the loss is deemed to be nil.

The basic facts in this appeal are that some 56 paintings valued at $18,515 were sold by Clara and David Varga to Wayne and Erica Rudolph for the sum of $3,250, according to an agreement for sale dated May 12, 1970 and filed as Exhibit A-1. On April 30, 1970 the Vargas had rented from Palace Montgomery Syndicate a location Situated at 11429-124th Street, at the City of Edmonton, for a term of one year, at a monthly instalment of $225.

After the purchase, the paintings were stored at the pizza shop Situated at 11729 Jasper Avenue, at the City of Edmonton. The appellant then, through his friend Mr Melbourne, arranged for a binder of fire insurance on the said paintings while they were located at 11729 Jasper Avenue.

On June 30, 1970 the paintings were removed by Mr and Mrs Varga from 11729 Jasper Avenue to the residential premises located at 11429- 124th Street.

On the night of July 2, 1970 a fire took place at 11429-124th Street, and the paintings were totally destroyed.

The insurance company having denied liability under the alleged policy of insurance, the Rudolphs, who at this time had represented themselves as the owners of the paintings, took action against the insurance company. The judgment was delivered at Edmonton on June 9, 1972 by Mr Justice S Lieberman, and the following is an extract of the said judgment at page 5 of Exhibit R-1:

. . . I do not accept Mr Rudolph’s explanation of his financial interest in the paintings. The obvious and inescapable inference from the evidence is that neither of the Plaintiffs had full title to, or ownership of the paintings, nor did they own them jointly with one another.

The failure to disclose the precise nature of their interest is fatal to the Plaintiffs and I refer to the case of Cu/p v Quebec Fire Insurance Company, [1962] ILR 265.

In addition, there was a change material to the risk. Davis v Hugh McKinnon Limited, [1972] 1 WWR 669.

Accordingly, the plaintiffs’ claim was dismissed as against all the defendants.

The appellant also filed a certificate of incorporation to show that a company was incorporated on May 25, 1970 under the name of Varga Art & Frames Shop Ltd. He specified that the four shareholders, being the two couples, would each hold 25% of the shares in the company. However, the business was never transferred to the company and the appellant and his wife advanced more than $3,250 to the business, viz $5,000 according to Exhibit A-1, Tab 4, detailed as follows:

According to this exhibit, it appears that the $5,000 was distributed by the solicitor who handled the incorporation of the company.

In addition to the $5,000, the appellant paid two months’ rent, being $450. As to the $1,450, is was supposed to go into the company’s account.

The appellant testified that he never bought any paintings for his own use and enjoyment, and that the ones under discussion were acquired to be transferred to Varga Art & Frames Shop Ltd.

As to the Rudolph Foods business, the appellant and his brother personally signed the contract with Neon Products of Canada Limited for a rental agreement because their company was not in very good financial standing. The first payments were made by the company but in the end, they had to pay Neon Products the $1,800. The appellant is claiming one-half thereof as a capital loss.

Upon cross-examination, the appellant stated that he and his wife had rental properties, that he knew the advantages of having a limited company, and that in fact his Rudolph Foods business was incorporated with his brother as one of the shareholders; that he was to operate his paintings business under a company name; that some of the money was paid as wages to the Vargas and that the paintings were held in trust for the company.

As to the Rudolph Foods business, he stated that he had lost between $20,000 and $30,000 by lending money to the company; that the company would have paid him for the sign if it had been doing well and that he let both companies fold.

Counsel for appellant argued that the paintings cannot be considered as the appellant’s personal property because they were acquired as inventory and not for his own use and enjoyment; that the litigation was a means to allow the appellant to continue his business; that the appellant’s claim was receivable until 1972, when he lost his action and consequently this loss is deductible in 1972.

As to the Rudolph Foods business, he argued that this sign was used by the company to produce income.

Counsel for respondent argued that the appellant was not in the business of selling paintings and consequently subsection 12(1) which mentions “. . . the income of a taxpayer for a taxation year as income from a business . . .” does not apply; that the paintings were not his since he held them in trust for the company. He also argued that any amount paid by the appellant to Neon Products Ltd was paid personally under his obligation of the contract of April 30, 1970 and was not expended to earn income for the appellant, and that he cannot claim this loss as a capital loss because the company was worth nothing on Valuation Day and nothing in 1972.

According to the evidence adduced, it is self-evident that the paintings did not belong to the appellant and, consequently, they cannot be considered as his inventory. Furthermore, the appellant was not personally in the business of selling paintings and the loss of such inventory cannot be attributed to him.

Furthermore, the litigation could not allow the appellant to recover the paintings and continue his business, since the said paintings were completely destroyed. The litigation was only a means to get back the money he had advanced either to the Vargas or to the company.

As to the $900 the appellant had to pay to Neon Products for the sign used by the company, this could be considered as a loan to the company because the company had no assets at that time, but a deficit of some $30,000 which was money due to the shareholders, and it appears that the appellant incurred a capital loss when he paid the $900 to Neon Products. Also, because this amount was paid on November 30, 1971, it cannot be considered a deductible capital loss since the Act did not allow the deductibility of such a loss at that time.

For these reasons, the appeal is dismissed.

Appeal dismissed.