McDougall v. R., [1997] 3 C.T.C. 2927, 98 D.T.C. 1005

McArthur T.C.J.:

1 These appeals are from reassessments for the Appellant's 1987, 1988, 1989, 1990 and 1991 taxation years. They involve the disallowance by the Minister of National Revenue (the “Minister”) of expenses incurred by the Appellant from a consulting business the Appellant avows he conducts.

2 In computing his income from business in the 1987 through 1991 taxation years, the Appellant included business losses ranging from approximately $27,000 to $35,000. The Appellant subsequently reduced his claim and at trial it was agreed by the parties that the expenses reproduced in the chart below were incurred. It is not disputed that the Appellant carried on the activities described and incurred the expenses. The issue is whether these activities and services were performed solely in furtherance of the business of a company in which the Appellant was a sole shareholder, or were the services performed and the expenses incurred by the Appellant in the course of carrying on his own business?

• 1 Referred to as “Professional fees” in 1988.

  2 Referred to as “Meals and promotion” in 1989. The figures for meals are net of the non-deductible portions.

  3 My mathematical calculations of the totals differ in some instances from those presented to the Court.

3 For the reasons that follow I find that the services were performed and the expenses were incurred by the Appellant in the course of carrying on his own business.

4 The Appellant has been employed as a full-time professor of law at Osgoode Hall since 1986. Prior to 1985, he taught at Dalhousie University and Osgoode Hall law schools and performed some consulting services for fees in the oil and gas industry. He has an economics degree from Simon Fraser University, a law degree from Osgoode Hall and a Master's degree from Harvard University. I need not set out his qualifications in detail. It is sufficient to observe that he demonstrated that he was qualified to embark upon the business venture that he did in 1985.

5 In 1985, the Canadian Federal Government announced its intention to sell the troubled aircraft manufacturing company De Havilland of Canada Limited (“De Havilland”).

6 In that same year, together with John Shepherd who was then the chairman of Lee Instruments, the Appellant incorporated Rimgate Holdings Limited (“Rimgate”) for the purpose of acquiring De Havilland. The Appellant and John Shepherd through Rimgate attracted others with the financial credibility and aerospace experience to give presence to their endeavour. Rimgate was incorporated as a vehicle to attract others with substance for the attempted take-over of De Havilland. The Appellant did not have the wherewithal for such an undertaking, alone, he would not have been taken seriously. His role was to gather, in Rimgate, serious parties with the capability of financing and operating an aeroplane manufacturing company.

7 In May of 1985, Rimgate entered into a joint venture agreement with Versatile Corporation of British Columbia, wherein Versatile agreed to participate in part of the funding necessary for the take-over of De Havilland. Other interested parties became involved in Rimgate, including Fokker Aircraft of Amsterdam, the investment firm Nesbitt Thompson and several individuals with impressive credentials in the aerospace industry. The Appellant incurred expenses travelling frequently to Europe and other parts of the world.

8 It does not serve a purpose to set out in detail the impressive efforts made by the Appellant in assisting Rimgate in its monumental task. The Appellant's testimony was comprehensive and credible. The Appellant anticipated benefiting by obtaining consultant fees from Rimgate should it be successful. He did not envisage being compensated by retaining equity in Rimgate other than in a very minor way.

9 In early 1986, the Boeing Corporation, a giant United States based aerospace manufacturing company, took over De Havilland. Fokker, Versatile, Shepherd and others surrendered their shares in Rimgate to the Appellant, who then became the only shareholder. Rimgate retained a Board of Directors.

10 Shortly after, Rimgate became actively involved in an attempt to take over the Fairchild Aircraft Manufacturing Company of San Antonio, Texas (“Fairchild”). Again, Rimgate required the participation of other parties including Nesbitt Thompson and Aeritalia in the attempt to take-over Fairchild. Further expenses, including many trips to Italy and Texas, were expended by the Appellant to preserve his right to collect consulting fees from Rimgate. Ultimately, this take-over bid was unsuccessful.

11 In 1987, Rimgate made a second failed attempt to take over Fairchild with the support of Fokker, Nesbitt Thompson and others. In 1989, subsequent to this second aborted attempt to purchase Fairchild, Rimgate sued Fairchild for breach of contract and damages. Some of the legal expenses incurred in this action were funded by the Appellant. Recently the litigation was settled for approximately $600,000. These funds have yet to be distributed and are held by a Texas law firm pending the resolution of a dispute over legal fees. The Appellant anticipates that part of his fees and disbursements will be paid upon distribution of the settlement funds.

12 In 1989, Rimgate entered a contract for the right to market the Lear Jet. It had income and expenses from that venture. It had its own office which was separate from the Appellant's personal office and it filed its own income tax returns.

13 While the Appellant remained the sole shareholder of Rimgate, there was a Board of Directors to whom the Appellant reported from time to time. In a memorandum of December 1, 1988, the Appellant reported to “Directors and File” of Rimgate that the total consulting fees owing to him by Rimgate at that date was $576,500 in U.S. funds. The memorandum also states in part as follows:

Further to my report of my expenses personally absorbed in order to secure eventual payment of consulting fees owed by Rimgate and as specified in Rimgate Director Resolution noted in Corporate Minutes, I now indicate as requested consulting fees owing for the period ending 31.12.1987 (Fairchild Round 2).

My consulting rate has been previously agreed at $US 1200.00 per day plus an agreed bonus of $US 500 per day for all days in excess of 200 days...

14 A further memorandum from the Appellant to Rimgate's Board of Directors, and dated September 25, 1991, states under the heading Compensation:

Mine - agreed level of consultancy fees unpayable in short term and will have to be settled out as things improve in a way that still leaves room for continuing the business and meeting other obligations. Expenses to be repaid first and fees later on a lump sum basis spread over whatever time is appropriate.

15 A third undated memorandum, titled “Telephone Poll of Rimgate Board of Directors”, states that the Board of Directors of Rimgate resolved that the Appellant's per diem rate be reduced to $550.00 and that his expenses would be paid when funds were available.

16 In a memorandum from Tom McDougall (no relation to the Appellant) to the Board of Directors of Rimgate on the 25th of September 1991, he claimed consultancy fees from the company. I accept the authenticity and contents of these corporate resolutions.

17 As a general rule a corporation is a legal entity distinct from its shareholders.[FN1: <p><em>Salomon v. A. Salomon &amp; Co.</em>, [1897] A.C. 22 (U.K. H.L.).</p>] Only in rare circumstances will this principle be disregarded.[FN2: <p>See<em>Kosmopoulos v. Constitution Insurance Co.</em>, [1987] 1 S.C.R. 2 (S.C.C.)at 10-11, Wilson, J. writing for the majority (McIntyre, J. concurring).</p>] I find that the Appellant correctly regarded Rimgate as an entity separate and distinct from himself as the shareholder who owned it. Nonetheless, as a corporate person Rimgate required human persons to act on its behalf and the directors of Rimgate, including the Appellant, acted in this capacity. This fact, however, does not preclude the possibility that a personal business of the Appellant could contract with Rimgate to perform consulting services. One person may function in dual capacities.[FN3: <p><em>Lee v. Lee's Air Farming Ltd.</em>(1960), [1961] A.C. 12 (New Zealand P.C.)at 26,<em>Salomon v. A. Salomon &amp; Co.</em>, [1897] A.C. 22 (U.K. H.L.)at 51.</p>]

18 Both counsel referred me to the judgment of Christie, A.C.J., in Coulter v. Minister of National Revenue (1985), 86 D.T.C. 1048 (T.C.C.). Coulter involved appeals for the 1980 and 1981 taxation years. Judge Christie quoted at length from Lee v. Lee's Air Farming Ltd., supra. With regard to the 1980 taxation year, Judge Christie did not think that on the facts before him a contract of employment could have been formed between the company and its shareholder because the shareholder did not believe such a contract was possible and so could not have had the intention to form a contract. In reassessing, however, the Minister assumed that an employment contract did in fact exist and reassessed the Appellant on the basis of one of the terms of the contract. Christie, A.C.J. therefore disposed of the appeal on the supposition that there was an employment contract. However, with regard to determining the terms of the contract he said at 2057:

I believe that where it is expressly or impliedly alleged in cases of the kind under appeal that a taxpayer having a relationship to a company similar to that which existed between the appellant and Coulter Copper & Brass Ltd. was acting as its agent in negotiating a verbal contract of employment with him, convincing confirmatory proof of some kind should be forthcoming to establish the terms of the contract relied on in making deductions in the computation of income. In the absence of special circumstances, which I am unable at present to foresee, I would not in such a case regard the oral testimony of an interested party alone to be a sufficient basis upon which to interfere with an assessment or reassessment by the Minister. In the case at hand there is neither special circumstances not [sic] convincing confirmatory proof.

19 In the circumstances of the present appeal, Rimgate was a corporate body separate and apart from the Appellant. The Appellant entered into an oral contract with Rimgate whereby he would perform consulting services and fund the legal costs arising from a lawsuit. The Appellant did not act alone. There was a board of directors. This fact alone would serve to distinguish Coulter from the matter before me. In any event, the corporate resolutions, portions of which are reproduced above, confirm the existence and terms of these agreements. As I stated above, I accept the Appellant's testimony and the authenticity and contents of these documents.

20 In Mastri v. R. (Fed. C.A.), Mr. Justice Robertson (MacGuigan and McDonald, JJ.A. concurring) recently affirmed the correctness of the analysis in Tonn v. R. (1995), 96 D.T.C. 6001 (Fed. C.A.). In his reasons for judgment he clarified the approach to the determination of whether a taxpayer held a reasonable expectation of profit. At page 6 he said:

First, it was decided in Moldowan[ Moldowan v. Minister of National Revenue, [1978] 1 S.C.R. 480] that in order to have a source of income a taxpayer must have a reasonable expectation of profit. Second, “whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts” (supra at 485-86). If as a matter of fact a taxpayer is found not to have a reasonable expectation of profit then there is no source of income and, therefore, no basis upon which the taxpayer is able to calculate a rental loss.

21 He continued in his analysis of Tonn and reproduced at page 7 the following passages from that judgment:

The Moldowan test, therefore is a useful tool by which the tax-inappropriateness of an activity may be reasonably inferred when other, more direct forms of evidence are lacking. Consequently, when the circumstances do not admit of any suspicion that a business loss was made for a personal or non-business motive, the test should be applied sparingly and with a latitude favouring the taxpayer, whose business judgment may have been less than competent.

...I otherwise agree that the Moldowan test should be applied sparingly where a taxpayer's “business judgment” is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable. However, where circumstances suggest that a personal or other-than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect.

22 With regard to these passages he then observed at pages 7 and 8:

The reference to the Moldowan test being applied “sparingly” is not intended as a rule of law, but as a common-sense guideline for the judges of the Tax Court. In other words, the term “sparingly” was meant to convey the understanding that in cases, for example, where there is no personal element the judge should apply the reasonable expectation of profit test less assiduously than he or she might do if such a factor were present. It is in this sense that the Court in Tonn cautioned against “second-guessing” the business decisions of taxpayers.

In summary, the decision of this Court in Tonn does not purport to alter the law as stated in Moldowan. Tonn simply affirms the common-sense understanding that it is not the place of the courts to second-guess the business acumen of a taxpayer whose commercial venture turns out to be less profitable than anticipated.

23 The Federal Court of Appeal also recently confirmed that the legal analysis in Tonn was not intended to be restricted to cases involving rental losses but meant to apply generally to all commercial endeavours: Mohammad v. R. (Fed. C.A.) per Robertson, J.A. (MacGuigan and McDonald, JJ.A. concurring), at pages 11 and 12.

24 In Tonn, Linden, J.A. (Strayer and McDonald, JJ.A. concurring) observed at page 6005 that s. 9(1), by defining business income as profit, implicitly authorizes the deduction of legitimate expenses. However, only expenses incurred as relevant and working expenses of some process of income earning are deductible. With regard to s. 18(1)(a), he said that the reference to income must be read as a reference to net income, or profit, in light of s. 9(1). To be deductible according to paragraph 18(1)(a), an expense must have been incurred with the subjective intention of producing profit.

25 I believe that the Appellant engaged in consulting activities for the purpose of earning income from a business and that the Appellant had a reasonable expectation of profit. An element of personal enjoyment was not the dominant, motivating force in the Appellant's decision to conduct a business. I find that the primary motive of the Appellant was a desire for profit. This profit intention was not unreasonable. The taxpayer was a highly educated person with experience in the consulting field. He made impressive and organized efforts in assisting Rimgate in his capacity as a consultant. The lack of profit cannot be attributed to a lack of time or effort spent on the part of the Appellant in carrying on the business. The fact that profit failed to materialize in the relevant period is not alone determinative. It is not the position of this Court to second guess the business judgment of the Appellant. In fact, presently $600,000 is held in trust for Rimgate and its creditors, including the Appellant.

26 I find that the Appellant operated a business. He acted as a consultant to Rimgate and funded a lawsuit. In so doing he incurred expenses with the intention of producing income from a business or property. The expenses the Appellant incurred and subsequently sought to deduct from income as business losses in his 1987 through 1991 taxation years were incurred by him while carrying on his business. I accept his evidence and the documentation supports these findings.

27 The appeal from the assessments for the 1987 to 1991 taxation years is allowed and the assessments are referred back to the Minister of National Revenue for reassessment to permit the taxpayer to deduct the business losses agreed to respecting the expenses incurred in his consulting business. The Appellant is entitled to his costs.