Jacques Lagasse v. Minister of National Revenue, [1978] CTC 2587, [1978] DTC 1430

Guy Tremblay [TRANSLATION]:—This case was heard in Sherbrooke, Quebec on February 9, 1977.

It must be determined whether the respondent was justified in not allowing certain expenses claimed by the appellant in respect of the taxation years 1969, 1970 and 1971.

These expenses were claimed as representation expenses, as interest paid pursuant to endorsements for three companies, in one of which the appellant was not a shareholder, or as business losses.

2. Burden of Proof

The appellant has the burden of proving that the respondent’s assessments are unjustified. This burden of proof is based not on a particular section of the Income Tax Act but on several judicial decisions, including the judgment of the Supreme Court in R IV S Johnston v MNR, ([1948] CTC 195); 3 DTC 1182.

3. Representation Expenses: $15,030.89

3.1 The appellant claimed certain expenses for 1969, 1970 and 1971 as representation expenses and these were disallowed in part, as shown below:

3.2 According to the evidence the appellant was a member of the Chamber of Notaries of Quebec during these years and had an office in Sherbrooke. He practised’ his profession with two other notaries, Mr René Lagassé and Mr Claude Gagnon, who worked for him on a fee basis. There was no partnership between them. Furthermore, the appellant was required to be responsible for all the representation expenses. The representation expenses paid by Mr René Lagassé and Mr Claude Gagnon, for which they were reimbursed by the appellant, were claimed by the latter on his tax returns.

3.3 In the document filed as Exhibit A-1 the appellant gave a list of 21 companies, including seven insurance companies, five oil companies and four banks, for which the appellant had drawn up almost all the contracts relating to transactions concluded in the Sherbrooke region since 1945, including the years in question.

3.4 Most of the head offices of the companies listed were situated in Montreal. For the purpose of his work the appellant had to spend 70 days at Montreal in 1969, 53 days in 1970 and 55 days in 1971. He further contended to have made other journeys for the same purpose to Quebec City, Trois-Rivières, Ottawa and the United States during the same years.

3.5 During the years in question, one-half of the appellant’s clients were situated outside Sherbrooke.

3.6 The representation expenses claimed consist to a large extent of travelling expenses, as appears from the documents filed as Exhibits A-2, A-3 and A-4 for each of the years in question.

3.7 The representation expenses may be broken down as follows for each of the years:

3.8 The Board noted among the exhibits filed a letter from the Chamber of Notaries of Quebec dated June 4, 1973, stating that the appellant took part in the International Congress “du Notariat latin” at Montevideo, Uruguay in 1969; the Annual Meeting of the Canadian Bar Association in 1970; the congress of the International Union of Latin Notaries in Athens, Greece and the Annual Meeting of the Canadian Bar Association at Banff in 1971.

3.9 It appears from the appellant’s tax returns for the years in question that he received the following gross professional fees:

1969: $115,578.17

1970: $108,018.82

1971: $135,735.59

3.10 Among the exhibits filed at the hearing the respondent noted the sums of $480.41 and $587.99 for the appellant’s stay at Pinehurst, North Carolina, where there is a well-known golf club. According to the appellant, a number of his clients go there at certain times of the year and transactions were concluded there following these meetings.

Decision on the representation expenses

3.11 In view of the testimony of the appellant and the exhibits filed:

Whereas the expenses consist for the most part of travelling expenses;

In view of the quantum of the professional fees earned by the appellant;

In view of the burden of proof rests on the appellant;

The Board feels that the appellant has discharged the burden of proof, and that the said expenses have been satisfactorily proven and are reasonable in the circumstances. The amounts claimed as representation expenses in the appellant’s tax returns for 1969, 1970 and 1971 are therefore allowed.

4. The interest of $4,202.70 paid to Smith Investment Corp Ltd in 1970, following an endorsement in favour of Les Entreprises Massawippi Inc

4.1 The facts relating to this interest were well summarized in part by the appellant in his pleadings:

(Translation)

In 1964 Messrs Rosaire Gagnon, René Lagassé and the appellant were shareholders of Hollywood Development Inc, a corporation established for the purpose of purchasing and reselling land, of which the principal asset was a vacant lot situated on Bourque Boulevard near Sherbrooke, the purchase price of which was $18,000. It should be noted that Mr Rosaire Gagnon held fifty per cent of the shares issued, whereas Mr René Lagassé and the appellant each held twenty-five per cent. In December 1964 another corporation, Les Entreprises Massawippi Inc, the shareholders of which were Messrs Pierre Légaré, Rosaire Gagnon, J L Pomer- leau et al, had expressed the intention of acquiring the Pleasant View Hotel in North Hatley. Since part of the selling price of the hotel was to be paid by the transfer of certain plots of land, the directors of Les Entreprises Massawippi Inc suggested to Hollywood Development Inc that it should acquire the lot situated at Bourque Boulevard for $70,000, which would produce a substantial profit for Hollywood Development Inc. However, in order to conclude these various transactions; Les Entreprises Massawippi Inc needed to borrow $55,000. A lender was found, namely, Smith Investment Corp Ltd, but before making the loan it laid down certain conditions, in particular that Mr Rosaire Gagnon and the appellant would become joint and several sureties to guarantee payment of the obligation signed by Les Entreprises Massawippi Inc. So as to conclude the transactions and enable Hollywood Development Inc, Messrs Jacques Lagassé and Rosaire Gagnon undertook jointly and severally to guarantee repayment of the debt to Les Entreprises Massawippi Inc.

4.2 The sale of the lot took place and Hollywood Development Inc theoretically made a profit of $52,000 (70-18 = 52).

In fact, however, the sum of $70,000 was never paid, and it seems that the debtor was content to pay the interest. As at January 31, 1966 the sum of $70,000 was still owing, as appears in the financial statement of Hollywood Development Inc prepared by the accountants Maheu Noel et Cie and filed as Exhibit A-9. The debt to Smith Investment Corp Ltd does not seem to have been paid off with any greater speed, since a capital balance of $38,133.95 still remained to be paid as December 20, 1969.

4.3 When Les Entreprises Massawippi Inc became bankrupt in 1967 the creditor, Smith Investment Corp Ltd took possession of the Pleasant View Hotel in North Hatley, presumably still retaining the surety given by the appellant and Rosaire Gagnon. The hotel subsequently passed through various hands and the last owners became bankrupt in 1969.

In January 1970 the appellant paid $19,066.98, that is, one-half of the principal debt of $38,133.95.

During the hearing this sum of $19,066.98 was claimed as a capital loss by the appellant. In his argument however, he subsequently renounced this claim. The respondent admitted that the sum of $4,202.70 had been paid as interest by the appellant during 1970. The latter claimed this amount as an expense incurred for the purpose of gaining income.

4.4 The statutory provisions involved in this claim are paragraphs 12(1)(a) and 11 (1 )(c) of the old Act:

12. (1) In computing income, no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer.

11. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 12, the following amounts may be deducted in computing the income of a taxpayer for a taxation year:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire an interest in a life insurance policy), or

(ii) an amount payable for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy).

Do the facts proven in the case at bar meet the conditions laid down in subparagraph 11 (1 )(c)(i)?

4.5 The Board must reply in the negative. In order for interest to be allowed as a deduction, it must first be paid on a sum borrowed by the taxpayer. In the case at bar it was not the appellant who borrowed the money, but Les Entreprises Massawippi Inc. The appellant did not pay the interest under an obligation resulting from money he himself had borrowed, but under a guarantee which he had given.

In his argument counsel for the appellant referred to D P McLaws V MNR, [1972] CTC 165; 72 DTC 6149, and drew a distinction between the guarantee or simple surety which the taxpayer had undertaken in the aforementioned case and the joint surety which the taxpayer in the case at bar had undertaken.

Counsel for the appellant maintained that in the case at bar the appellant was liable to perform the obligation not only upon the default of the debtor, “who must previously be discussed”, as in the case of a simple surety, within the meaning of article 1941 of the Civil Code of the province of Quebec: the appellant could even be compelled to the performance of the obligation independently of the debtor company and the other joint and several sureties, and performance by him would discharge the others toward the creditor in accordance with Article 1103 of the Civil Code of the Province of Quebec.

The appellant argued that this distinction would: place the joint surety on the same footing as the debtor-borrower and would thus allow him to deduct the interest.

The Board feels that this distinction does not alter the fact that the money was not borrowed by the appellant, either as a simple or a joint and several surety, but by another person, Les Entreprises Massawippi Inc.

In the aforementioned McLaws the Supreme Court based its decision, inter alia, on the argument made by Viscount Dunedin in the English case of The Commissioners of Inland Revenue v Sir H C. Holder, Bart and J A Holder (1932), TC 540, at 564:

It is true that he pays a sum which pays all interest due by the person to whom the advance is made, but his debt is his debt under the guarantee, not a debt in respect of the advance made to him.

However, in this English case cited by the appellant, part of the guarantees had been given jointly and severally by the defendants.

Thus, since one of the conditions of paragraph 11 (1)(c) is not met, the Board has no alternative but to dismiss the appeal concerning the interest paid to Smith Investment Corp Ltd.

4.6 Is it possible that the amount of interest which is not deductible under paragraph 11(1)(c) may be deductible under another section? Yes, it may be deductible under paragraph 12(1 )(a), but first on con- dition that it is part of a total amount (capital and interest) left unpaid by the debtor, that is, Les Entreprises Massawippi Inc, and that the surety has paid. Second, the total amount paid must be an expense incurred by the appellant for the purpose of gaining or producing income from property or a business of the taxpayer.

4.6.1 The first condition is met. It was proven that the amounts (capital and interest) were paid by the appellant in his capacity as surety.

4.6.2 In order to answer the question as to whether the second condition was met, it must be asked whether the type of risk taken by the appellant may be considered a business, or at least an adventure or concern in the nature of trade, so that the expense could be regarded as having been incurred for the purpose of making a profit. The loss of $19,066.98, equal to the capital which the appellant himself claimed in advance as a capital loss, was subsequently excluded from the case at bar.

If this was in fact a capital loss, then it is quite clear that paragraph 12(1)(a) cannot apply and that the interest on this capital may not be deducted from his income.

Furthermore, the Board is not bound by the appellant’s claim that -he believed that this was a capital loss, or that he did not claim the capital as an expense incurred for the purpose of earning income. If the Board were to reach this conclusion after studying the question, it would have to allow at least the part which was claimed, that is, $4,202.70.

Let us reconsider the facts. The appellant, a notary, acted as surety for a loan of $55,000 obtained by Les Entreprises Massawippi Inc, in which he was not a shareholder, to enable it to purchase a hotel, the property of a third person. On that occasion, the borrowing company purchased a lot from Hollywood Development Inc, in which the appellant owns fifty per cent of the shares. The price of $70,000 was not paid to the vendors company at the time of the sale, even though it was stated in the contract that the selling company received fair and valid consideration. It was hoped that payment would be made. The sum of $70,000 was never paid. The appellant’s hopes of earning personal income lay in the potential dividends from Hollywood Development Inc.

The Board finds the connection between the surety given and the possibility of the appellant’s earning income too remote and not sufficiently direct. Furthermore, the appellant does not have a personal business of making loans and giving sureties. The appellant’s business is a learned profession, that of notary. Though he is often asked to draw up loan and surety contracts in his profession, this does not in itself constitute a personal loan business for him. At least, this was not shown by the evidence.

5. The interest of $2,516.44 paid for Karol Shoes Inc in 1970, pursuant to an endorsement

5.1 The facts proven concerning these interest amounts are well summarized in the appellant’s pleading:

(Translation)

Messrs André Trottier, Pierre Legaré and the taxpayer were shareholders and directors of Chaussures Karol Shoes Inc, a corporation whose major activity was the manufacturing of shoes. As part of the corporation’s operations it had to make certain purchases of leather and other goods from various suppliers. Before forwarding the goods these persons, that is, the two companies, Bennett of Chambly and Solpa of St-Jérôme, required Messrs André Trottier, Pierre Légaré and the appellant to guarantee jointly and severally payment for the goods. These three persons did in fact guarantee payment by the corporation, and in 1970 were then called upon to discharge the debts due to Bennett and Solpa, even though they had transferred their interests. These debts included, inter alia, interest in the amount of $2,516.44, which the appellant paid and claimed as a deduction in computing his income for the 1970 taxation year: it was, however, not allowed by the Minister.

5.2 The paragraphs involved are paragraphs 12(1)(a) and (b) and subparagraphs 11 (1 )(c)(i) and (ii), cited above.

It should be noted that only the interest was claimed. This cannot be allowed under paragraph 11(1)(c). This was not interest paid on money borrowed by the appellant (subparagraph 11 (1 )(c)(i)), or on an amount payable for property acquired by the appellant (subparagraph 11(1)(c)(ii)). The property was in fact acquired by Karol Shoes Inc and not by the appellant.

Even though the sum of $2,516.44 may not be deducted as interest under paragraph 11(1)(c) of the old Income Tax Act, the appellant nonetheless paid interest of $2,516.44 in accordance with his surety. However, this sum, together with a capital sum, made up a total which was not shown in the evidence. This total, which was left unpaid by Karol Shoes Inc, was the object of the performance of the surety.

It remains to be ascertained whether the total, including the $2,516.44, may be allowed as a deduction under paragraph 12(1)(a).

After studying the facts listed above, the Board has reached the conclusion that the expense resulting from the surety was not incurred “for the purpose of gaining or producing income from property or a business of the taxpayer’’ within the meaning of paragraph 12(1 )(a).

The hoped-for dividend was of course income from property, but was too remote in the case at bar. Even if evidence had been adduced of dividends issued in the past by Karol Shoes Inc, would this be sufficient? The company is a person independent of the shareholder. The appellant’s personal business does not receive regular income from the company, as was the case in Philippe Ewart, a judgment rendered recently by the Board. The appellant, an engineer, drew professional fees for certain contracts performed by his company, and for substantial amounts.

The Board held that the losses incurred by the appellant as a result of the loan he made to his company in respect of these contracts and of the surety for their performance of the said contracts were allowable in computing his income.

Similar decisions were rendered in cases where companies had become sureties for suppliers:

D J MacDonald Sales Limited v MNR, 16 Tax ABC 49: 56 DTC 481;

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

In the case at bar no evidence was adduced to show that there was a connection as direct as those in the aforementioned cases between the expenses incurred and the personal income of the appellant, who is a notary and not a shoe merchant.

Counsel for the respondent cited the following cases, most of which confirm the principles on which the Board based its decision in the case at bar:

(1) William Russell Beaty v MNR, 19 Tax ABC 452; 58 DTC 435;

(2) No 235 v MNR, 12 Tax ABC 207; 55 DTC 123;

(3) D J MacDonald Sales Limited v MNR, 16 Tax ABC 49; 56 DTC 481;

(4) Robert Graham Hamilton Me Leigh : v MNR, 9 Tax ABC 278; 53 DTC 437;

(5) Benjamin Baril v MNR, 39 Tax ABC 406; 65 DTC 753;

(6) Minas Basin Pulp & Power Co Ltd v MNR, [1969] Tax ABC 11; 69 DTC 62;

(7) Robert K Weill v MNR, [1969] Tax ABC 1049; 69 DTC 374;

(8) Donald Preston McLaws v MNR, [1972] CTC 165; 72 DTC 6149;

(9) Belton Lumber Co Ltd v MNR, [1972] CTC 2065; 72 DTC 1076.

The Board also considered the various cases summarized by Dubé J of the Federal Court of Canada in The Queen v H Griffiths Company Limited, [1976] CTC 454; 76 DTC 6261. The Board feels it is’ worthwhile to give these summaries here, as it did in the recent decision in Philippe Ewart’.

1. In D J MacDonald Sales Limited v MNR, 16 Tax ABC 49; 56 DTC 481, the Tax. Appeal Board held that the payment of a guaranteed’ note of one of its suppliers in order to ensure a continuing source of supply was incurred for the purpose of producing income, thus deductible. The supplier was not a subsidiary.

2. In Her Majesty the Queen v F H Jones Tobacco Sales Co Ltd, [1973] CTC 784; 73 DTC 5577, the Federal Court found that the payment of a guaranteed loan in favour of the company’s largest customer in exchange for the customer’s undertaking to buy tobacco from it was an operating loss incurred for the purpose of producing income, thus deductible. Noël ACJ said courts were inclined to consider “not so much the legal aspect of the transaction, but rather the practical and commercial aspects”.

3. In Heap & Partners (Nfld) Limited v MNR, 42 Tax ABC 278; 66 DTC 772, the Tax Appeal Board decided that payments made by the parent company to cover guaranteed loans to its subsidiary were made for producing income and were deductible. The Berman case [infra] was quoted as the authority for that decision.

4. In L Berman & Co Ltd v MNR, [1961] CTC 237; 61 DTC 1150, the Exchequer Court held that the voluntary payment of debts incurred by its Subsidiary to suppliers was deductible because it was advantageous for the parent company to maintain the goodwill of its suppliers.

5. In MNR v George H Steer, [1967] SCR 34; [1966] CTC 731; 66 DTC 5481, the Supreme Court of Canada allowed an appeal from the Exchequer Court and held that. repayment of a guaranteed loan for the drilling of three wells was a deferred loan. Judson, J said that “the guarantee meant that at some time the respondent might have to step into the bank’s shoes to this extent”. The loss was held to be a loss of capital and the deduction thereof prohibited.

6. In Algoma Central Railway v MNR [1967] 2 Ex CR 88; [1967] CTC 130; 67 DTC 5091, the Exchequer Court held that the sum paid by a railway for a survey of the volume of traffic in an unpopulated area was deductible as a current business expense. Jackett, P, as he then was, said the “usual test” whether such a payment is one made on account of capital is “was it made with a view of bringing into existence an advantage for the enduring benefit of the appellant’s business?” In a footnote at page 95 [137, 5095] he referred to the Canada Safeway case [infra] and remarked: “There can be expenditures that, in a broad sense, are made to improve the position of the business and that, nevertheless, do not escape the prohibition in section 12(1)(a).”

7. In Canada Safeway Limited v MNR, [1957] SCR 717; [1957] CTC 335; 57 DTC 1239, the issue before the Supreme Court of Canada reduced itself to the meaning of the phrase in paragraph 5(1 )(b) of the Income War Tax Act, RSC 1927 c 97, as amended ss 4, 5 and 6 “borrowed capital used in the business to earn the income” which in turn depends on the scope of the words “used in the business”. Rand, J said that “in the circumstances before us, the interposition of a new and distinct capacity as shareholder breaks the continuity of the company’s act as being in its own business” and further down “the business of the subsidiary is not that of the company”.

8. In DWS Corporation v MNR, [1968] 2 Ex CR 44; [1968] CTC 65; 66 DTC 5045, Thurlow, J of the Exchequer Court, now ACJ of the Federal Court, relied on the Canada Safeway decision [supra] to hold that the borrowed money was not used for the purpose of earning income from the appellant’s business within the meaning of the Act.

9. In Minas Basin Pulp & Power Company, Limited v MNR, [1969] Tax ABC 11; 69 DTC 62, the Tax Appeal Board held that payment made on a guarantee on behalf of a subsidiary could not in any way increase the income receivable from the business of the appellant itself, thus not deductible. The subsidiary was not wholly owned and there was no intertwining of the business operations.

10. In Stewart & Morrison Limited v MNR, [1974] SCR 477; [1972] CTC 73; 72 DTC 6049, the Supreme Court of Canada held that money supplied by the parent company to an American subsidiary which it “masterminded”, through a bank loan, in a losing cause, was an outlay of a Capital nature and not deductible. Judson, J said the Court was not concerned with “what the result would have been if the appellant taxpayer had chosen to open its own branch office in New York. . It financed a subsidiary and lost its money.”

Judson, J said the Berman case [supra] was not in point, because in that case “the taxpayer made voluntary payments to strangers, ie, the suppliers of its subsidiary, for the purpose of protecting its own goodwill”. He concluded at page 479 [74, 6050]:

The learned trial judge has correctly characterized these dealings between the parent company and its American subsidiary. The parent company provided working capital to its subsidiary by way of loans. These loans were the only working capital the American subsidiary ever had with the exception of the sum of $1,000 invested by Stewart & Morrison Limited for the acquisition of all of the issued share capital of its subsidiary. The money was lost and the losses were capital losses to Stewart & Morrison Limited. The deduction of these losses has been rightly found to be prohibited by paragraph 12(1 )(b) of the Income Tax Act.

In The Queen v H Griffiths Company Limited, where all these precedents were cited, the Federal Court refused to allow the taxpayer’s expense, as appears in the summary of facts and the decision at [1977] 1 FC 476; [1976] CTC 454; 30 DTC 6261:

Defendant established a subsidiary mainly to obtain the sheet metal Capability which it needed to compete in the field of mechanical contracting. The subsidiary, while an ‘‘operating arm’’, was a separate entity. In order to obtain ‘‘working capital”, loans were arranged. Griffiths personally guaranteed one for $50,000, and defendant, the other, for $75,000. Upon the bankruptcy of the subsidiary, defendant reimbursed the bank the $75,000 and sought to deduct this amount under paragraph 12(1 )(a) of the Income Tax Act as an expense incurred for the purpose of producing income. The Minister assumed that the sum was not an outlay or expense, but was overturned by the Tax Review Board.

Held, allowing the appeal, this type of loan has been held to be a ‘‘deferred loan”, as the parent might some day have to ‘‘step into the bank’s shoes”. The payment by the parent was not made voluntarily to maintain the goodwill of strangers, but to satisfy a legal obligation. Such outlay was made ‘‘with a view of bringing into existence an advantage for the enduring benefit” of defendant’s business. The establishment of the subsidiary was to ensure an adequate supply of sheet metal, a distinct advantage. The guarantee was effected to provide working capital so that the benefit could continue; the establishment of the subsidiary was no “passing fancy”. The repayment was thus a capital outlay and not deductible under subsection 12(1).

It should be noted that in the case at bar the appellant was an individual, whereas in the aforementioned cases the appellants were companies.

6. The loss of $9,300 in Imprimerie Yamaska Ltée, as the result of an endorsement

6.1 According to the facts submitted in evidence Imprimerie Yamaska Limitée was established in 1953. The appellant held forty-nine per cent of the shares.

In 1965 the company borrowed $59,300 to purchase machinery. The lender required the endorsement of the appellant, who in fact undertook jointly and severally with the company to repay the debt, as appears in a note dated June 21, 1967, filed as Exhibit A-23. In 1969 the company became bankrupt. The appellant was obliged to pay the sum of $9,300 on May 13, 1969, as appears from the documents filed in evidence as Exhibit A-24.

6.2 The appellant deducted the sum of $9,300 in computing his net income for 1970. The respondent refused to allow this deduction.

6.3 The facts are similar to those in the case of Karol Shoes Inc and our conclusions can not be any different. The sum of $9,300 paid by the appellant as surety for Imprimerie Yamaska Limitée must be refused as a deduction in computing the appellant’s personal income.

6.4 The Board considered the possibility of the appellant’s having an endorsement business, since on three occasions, namely in the cases of Les Entreprises Massawippi Inc, Karol Shoes Inc and Imprimerie Yamaska Limitée, the appellant endorsed companies. However, the Board must reject this possibility, since the connection between the surety and the possibility of the appellant’s earning income is too remote.

7. Business losses in Laminatex Enr

7.1 The facts alleged by the appellant in his written argument provide a good summary of the facts which were proven:

(Translation)

During 1967 the appellant was a partner, in a company with one Mr Doré, in Laminatex Enr, a registered partnership the head office of which was situated in Montreal North and which had as its principal aim the lamination of plastic objects. In order to operate, the company had acquired a laminating machine at a cost of $15,000, the price of which was to be paid in instalments extending into 1969. In fact, the appellant’s role in the company was that of a silent partner, whereas Mr Doré was responsible for the management of the company. It appears that the latter neglected to look after the company’s business and omitted to warn. the taxpayer of the situation, since, on July 17, 1967, a writ of summons was issued by the Provincial Court at Montreal at the request of a supplier and in August of the same year there was an ex parte inscription and judgment was rendered by default ordering the company to pay the sum of $89.30. In November 1967, since the creditor had obtained judgment he attempted to have the machine sold, and it was in fact sold in the same month by judicial sale for the sum of $550. Not until December of the same year did the taxpayer learn what had happened and, suspecting fraud, he immediately notified his counsel, who, in December 1967, sent a default notice to the bailiff, holding him liable for having acted illegally in this matter. Finally, on May 2, 1970 the whole matter was settled and the Provincial Court in Montreal sent the balance of the sale price, that is, $411.98, to the appellant. It should be noted that no legal proceedings were brought in this matter, and that the settlement was reached only after various internal negotiations between counsel for the appellant and the bailiff. In the meantime, however, the taxpayer continued to be responsible for the current expenditures of the company; thus in 1969 he made various payments in the amount of $8,637, $1,721.01 of which was interest paid to the Royal Bank of Canada and $4,137 represented amounts paid for the machinery. The taxpayer deducted this sum in computing his income for 1969, although this was not allowed by the Minister.

7.2 Moreover, the evidence was that under the contract filed as Exhibits A-12 and A-13 the machine was purchased at a cost of $15,794. This was a contract of purchase and not a rental contract. The contract was signed on June 25, 1965. According to Exhibit A-14, the last payment was made on September 15, 1969. It appears in the contract itself that the parties thereto are General Binding Corporation (Canada) Ltd and the appellant himself. The signature is, moreover, “Laminatex Enr per Jacques Lagassé”.

7.3 The appellant claimed a terminal loss of $15,382.02. Whereas no depreciation was claimed, the appellant would normally be entitled to claim a loss of this kind. In Exhibit A-15, which contains the operating statements of Laminatex Enr for the years ending December 31, 1968 and 1969, however, the following appears under the item “Rental of machinery’’:

1968: $5,624.61

1969: $4,137.00

After the appellant filed his tax return for 1969, the respondent adjusted the net income by adding additional income of $8,637 under the item “Loss by Laminatex Enr’’. This sum consisted of the following amounts:

During the hearing the winding-up costs in the amount of $2,778.99 were not proven.

7.4 Whereas the contract filed with the Board is a contract of purchase and not a rental contract, whereas the appellant has since 1965 claimed as rental expenses the. amounts paid for the purchase price instead of claiming the capital cost allowance, as he should normally have done, and whereas the appellant is now claiming a terminal loss, this creates a delicate problem.

After a close study of Exhibit A-13 the Board found, however, that in the contract there occur the words, written above a blank space:

(Translation)

For AC use only

Furthermore, the following was added to the contract:

(Translation)

You will soon receive from IAC complete details of the arrangements we have made for you to facilitate this purchase, including the place where you should send your payment, if you make your payments by mail. If you wish to make your payment in person, you can use the local IAC branch or the one that is most convenient for you.

The Board concludes from this that the purchase of the laminating machine was financed by Industrial Acceptance Corporation Limited. Since IAC retained the ownership of the machinery until it was. completely paid for, as is customary in such cases, no capital cost allowance was Claimed at that time because the appellant was not the owner.

Rather, the amount of the payments made to IAC was deducted as rental. The fact that no capital cost allowance was claimed seems to meet the requirements of the Act and the Regulations, since it is necessary to be the owner of a property to claim depreciation. Considering the payment as a current expenditure at that time seems a sound accounting practice.

Furthermore, the fact that the respondent accepted this procedure confirms that this approach is possible.

The Board does not believe that the appellant may now change his mind and seek to take advantage of the capital cost allowance system, after having benefited from the system for deducting payments for the machinery. The system applied since the machinery was purchased must be continued.

7.5 According to the respondent, the rental payment in 1969 and the interest must be of a capital nature since the operations of Laminatex Enr had ceased in 1967.

Can the fact that the business had not been operating since 1967 have any effect on an expense incurred in 1969 for the same business? This argument cannot be accepted. According to the evidence, the appellant continued to pay the expenses of Laminatex Enr until 1969.

Is a business truly closed down if all its debts continue to be paid? Why should the payments not form part of the general losses of the business? Is the receipt of accounts receivable regarded as business losses, after the business is closed down, a capital gain? No. This gain forms part of the income of the business and is taxable, just as an expense is allowed as a deduction if it was incurred for the purpose of gaining or producing income from property or business of the taxpayer in accordance with paragraph 12(1 )(a).

7.6 Laminatex Enr was not a company in which the legal entity is independent of the shareholder. It was a personal business of the appellant, and all its operations were directly connected with the appellant’s personal income.

7.7 The Board therefore accepts the sum of $4,137 and $1,721.01 as allowable deductions.

8. Conclusion

The appeal is allowed in part. The assessments involved are referred back to the respondent for re-examination and reassessment in accordance with the reasons for judgment.

Appeal allowed in part.