The Chairman (orally: December 13, 1974):
1 This is an appeal by Doral Investment Corporation against reassessments of the Minister of National Revenue for the 1970 and 1971 taxation years. The point at issue is whether or not a loss claimed by the appellant in the amount of $175,000, approximately, is deductible in the year 1970 or whether it is really a repayment, or the result of a repayment, of capital to this company by or on behalf of Mr Max Schuchmann.
2 The facts are that three principals, Mr Schuchmann, Mr Shefner, and Mr Milner, in 1965 or thereabouts, purchased some 7,000 square feet of land in an area in the northeast section of Montreal known as Ville d'Anjou, and entered into two agreements, R-4 and R-1, R-1 being an agreement between East End Development Corp (sometimes hereinafter referred to as “East End”), the vehicle that they chose to develop and sell the land in Ville d'Anjou, and Doral Investment Corporation, a company that was controlled by Mr Schuchmann. Each of the other two principals had corporate vehicles of their own that they used in this transaction, and it was in uncontradicted evidence that none of the parties cared which vehicle actually put the money into the business.
3 Further uncontradicted evidence is that of a man by the name of Jack Iny, who was a real estate agent in the area in which the land was situated and who was selling almost exclusively in that area. He indicated that from his experience, by the end of 1967 and throughout 1968, business was quite active and in part of 1969 business was fair but towards the end of 1969 difficulties arose. Much has been made of what has been commonly referred to as the FLQ crisis of 1970 and the alleged political instability of Quebec in the latter part of 1969 and 1970, but the fact remains that, notwithstanding these headline-producing instances, Ville d'Anjou had its own problems in that it was being investigated, or its mayor and town planner were being investigated, for some alleged mishandling of the municipal powers that they had. If one looks at the financial statements of East End, one sees that the revenues went down in 1970, and the statement as of September 13, 1970, being the year end of that company, shows sales of $19,000 whereas the previous year had shown sales of $1,264,000. In the year 1968 the company shows sales from its land of $1,120,000. So one cannot escape the conclusion that, for whatever reasons, the property in Ville d'Anjou became a liability rather than an asset for the purpose for which it had been purchased, and I think it is a fair inference to draw from the evidence that all three principals were traders as the term is known in real estate and that their avowed intention on purchasing the land was to buy it for development and sale to builders for a profit.
4 The tenor of both respondent's Exhibit I and respondent's Exhibit 4 is that Schuchmann, regardless of what company may have been his corporate vehicle in the formation of the three-man corporation, was to have the control of the operations of East End Development Corp and Doral was to be paid a management fee of 5 per cent of each piece of land sold, regardless of how the sale took place, but in no instance was it to receive less than $10,000 for its services, the said services being performed by Mr Schuchmann in each year. In each case, it was a long-term agreement, for, I think, 15 years. In the years from December 1966 to April 1970, management fees were received from East End by the appellant in this case, totalling $147,354.55. The evidence of the company's accountant, Mr Bratt, is that these items were taken into income in the years in which they were received. The uncontradicted evidence also is that over a period of time, starting in April of 1967, $4,000 was loaned by the appellant to East End and, in July 1967, $10,000 was loaned, and these sums were repaid within the year. But in January of 1968, the appellant made a loan to East End in the amount of $178,500 and this loan subsequently was increased to some $218,000.
5 It is clear from the evidence that the money was paid to East End as a means of repaying Mr Schuchmann the moneys that he had ad vanced on account of Doral to the East End project. Mr Schuchmann has said in his evidence that he put money in because Doral at that particular time did not have the funds available and, at the time that the main amount of which we are talking was loaned by the appellant to East End, Doral was at the peak of its earning capacity, as it later turned out, with the East End Development Corporation. But, in my view there is no weight of evidence that, at that time, the difficulty that followed could have been foreseen. I have the evidence of a qualified professional accountant, which has not been challenged, in which he says that, in each of the years that he reviewed the financial statements of East End with respect to whether or not a write-off or a reserve should be set up with respect to the appellant's loans to that company, he was satisfied that it followed sound accounting principles and practice to show them at 100 cents on the dollar. As I have said the fiscal period of East End ended September 30th whereas Doral's year end was December 30th in each year, and suddenly Mr Bratt was faced with this tremendous drop in sales from over a million dollars to some $19,000, or whatever the figure was, and he says that, again following sound accounting principles and practice, he wrote the full amount of the loss off. I think it is interesting to note that a great deal has been made of the fact that the land was carried on the balance sheet of East End for at least another two years, although it was quite evident that it had no value. The reason that it was carried was that legal title remained in the East End group until a year following the tax sale. When land has been purchased at a tax sale, the legally registered owner has a period of 12 months in which to repay the taxes plus, I think the evidence was, interest or some other terminology, at 10 per cent to make up for the prospective purchaser having had his money tied up for that period of time.
6 It is clear that Doral, at the time it made this substantial advance to East End in January 1968, had, according to the evidence that has been adduced, every reason to believe that a substantial and large income- producing future lay ahead as a result of its connection with East End. All that suddenly changed, and the company wrote off the debt which, as has been pointed out, did not appear on the balance sheet of Doral until 1968. I think the evidence also substantiates that it was not necessary to show the loan as a specific loan to a specific person, individual or company until that period in time.
7 It has bothered me to some extent as to whether or not the advance was clearly a capital advance by Doral to East End Development Corporation. I have the belief that the money that each of the partners was required to advance in equal amounts as set out in the agreement of October 21, 1965, represented payments on capital account, but Doral was a separate operating entity, with a separate contract with East End, and what East End did with the moneys loaned to it by Doral cannot, in my view, change the character of the transaction that took place, basically, in January 1968, which again was the date of the $178,500 loan.
8 In my opinion it would be grossly unrealistic,—I hesitate to use the term unfair because fairness connotes or denotes equity, which should not carry any great weight in interpreting fiscal statutes—but I cannot see how one could logically come to the conclusion that a company that had $147,000 in taxable income and had advanced funds at a time when that income showed every probability of continuing, should not be allowed to deduct the loss when some unforeseen difficulties arose and the East End Development Corp land transaction collapsed.
9 I think, on all the evidence, I must come to the conclusion that it was an arm's-length transaction in which the loan was made (and there is no contradiction in the evidence to indicate that it was not in fact made), and that it was made with the intention of providing financing on the understanding that it would continue to earn this substantial income, and therefore could in no way be classed as a capital advance. I should say, in passing, that the Crown also raised the question of whether the matter was ultra vires. I think the supplementary letters patent were probably issued some time before the pleadings of the respondent were drawn but after the file had been reviewed. However, in my mind, it would make no difference, in so far as the Income Tax Act is concerned, whether what Doral did was within its company charter if in fact it did do as I have found.
10 There is also the question of why the land was carried on the books and what effect, if any, that had. In my view it was purely a bookkeeping entry and no matter how long it was carried on the books of the company, or at what value it was carried, such an entry could not possibly change the character of what took place because, from the time that the taxes were in arrears until the present date, there is no evidence to show that the land had any value. In each of the years that it was carried, there were losses in excess of $200,000, as I recall, and in substance never has Doral received any payment on this loan subsequent to December of 1970. Although some payments appear to have been made in 1971 to some individuals, no one was able to give evidence as to at what point in the fiscal year these payments were made, and I cannot attach any weight to them whatsoever.
11 On all the evidence I must allow the appeal and, although it is of little solace to you, Mr Schneiderman, I thank you both for the manner in which you presented your cases. It is always a pleasure to come to Montreal and receive the benefit of effort that has been put into this case today, even though I must say that it is perhaps the most difficult town or city to come to to hear cases because not only are the situations complicated and the cases well-prepared, but I also seem to have to keep the participants at arm's length. So I thank you for your assistance. The appeal will be allowed and the assessment vacated.
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