Nahum Gelber v. Her Majesty the Queen, [1980] CTC 505, [1980] DTC 6369

Walsh, J:—This action was heard together with actions bearing Nos T-1438-77 and T-1439-77 between the same parties, the issues being identical save that they concern reassessments concerning the 1972, 1973 and 1974 taxation years respectively. As the statement of claims set out and evidence disclosed, on December 28, 1972, plaintiff entered into a letter agreement with Intercontinental Leisure Industries Ltd (hereinafter called “Intercontinental”) pursuant to which he agreed to purchase a 4 /2% interest in a certain feature film entitled “Mother’s Day” for and in consideration of a total price of $38,333.33 on account of which he paid upon execution of the agreement the sum of $8,333.33, obliging himself to pay to Intercontinental the additional sum of $30,000 upon fulfillment by Intercontinental of certain obligations assumed by it under the terms of the agreement. These conditions were fulfilled and plaintiff paid the additional $30,000 to Intercontinental during the taxation year 1973. Under the terms of the agreement Intercontinental agreed to lease back the film from plaintiff (and other undivided owners thereof) for a term of 15 years terminating on December 31, 1988, in consideration of an annual rental equal to 4 1/6% of 92% of the gross revenues received by Intercontinental from any source arising from the exploitation of the film, it being agreed that in any event the minimum rental revenue to be paid by Intercontinental to the taxpayer on or before December 31, 1983, would be $30,000. Furthermore Intercontinental pledged in favour of plaintiff certain Government of Canada Bonds to guarantee the payment of the rental payable by Intercontinental to plaintiff under the terms of the agreement.

Evidence disclosed that the only rental revenue received was the sum of $124.58 in October 1974, $1,917 in January 1975 and a further sum of $9.14 in January 1975 for a total of $2,050.72. In addition the agreement provided however the plaintiff was to receive the interest on the bonds pledged to secure the rental and in fact did receive in September 1973 $875.24, in March 1974 $875.26, and in September 1974 $832.50 with further similar amounts making a total of $12,573 as of October 20, 1980.

It is plaintiff’s contention that the capital cost to him of 4 1/6% undivided interest in the film entitled “Mother’s Day” was $38,333.33 and not $8,333.33 as claimed by the Minister and that, in calculation his taxable income for the taxation year 1972 he was entitled to deduct 60% of the said capital cost pursuant to the provisions of the Income Tax Act and regulations thereunder.

Defendant concedes that the agreement provided for the pledge of $30,000 secured by Government of Canada Bonds as a “rental guarantee”. For his 1972 taxation year plaintiff claimed a capital cost allowance of $23,000 computed on the basis that his capital cost on the said film was $38,333.33. Defendant reassessed him on the basis that the capital cost was $8,333.33, this being the amount that he had in fact invested and put at risk. She contended that to permit the capital cost allowance to be claimed by plaintiff on the basis that the capital cost of the film was $38,333.33 is not reasonable in the circumstance and would unduly or artificially reduce his income. At no time during the taxation years in’ question was plaintiff engaged directly or otherwise in a motion picture business. In his 1973 taxation year plaintiff, having reduced the capital cost of the film to him to $15,333.33 as a result of the $23,000 capital cost allowance claimed in 1972, claimed 60% of this amount or $9,200, while the Minister having allowed only $5,000 capital cost allowance in 1972 on the basis of the capital cost of the film being $8,333.33. In his 1974 taxation year plaintiff claimed that the undepreciated capital cost remaining to him was $6,133.33 while the Minister contended it was $1,333.33. The figures in plaintiff’s 1974 tax returns and the reassessment by the Minister are difficult to reconcile. In his return, for reasons undisclosed he claims capital cost allowance of 100% of $6,133.33 with respect to “Mother’s Day” and the reassessment adds back the sum of $5,333.33. This was apparently based on the Minister’s calculation which would allow 60% of $1,333.33 or $800. Moreover plaintiff shows his income from the investments as $1,607.76. If we add the sums of $875.26 and $832.50 as his interest on the bonds in 1974 this would total $1,707.76, an even $100 more. Possibly there has been an error in addition. Furthermore the rental revenue of $124.58 for the film should also have been shown which would bring the total of $1,832.34 rather than $1,607.76. Mr Gelber in testifying could not explain the discrepancy and his accountant was not present to give evidence. I merely call attention to these matters in the interest of accuracy, although they do not affect the principal issue in the present case which is whether the actual cost to Mr Gelber of his investment was $38,333.33 as he contends or $8,333.33 which was the amount at risk according to the Minister’s contention.

Certainly as it is plaintiff’s contention that the $30,000 which he is assured of receiving by December 31, 1983 less whatever amounts he has received in the interval for film rental constitutes income and not a return of capital he must, to be consistent include all such receipts in income and be taxed on same, while similarly defendant cannot tax same as income while at the same time contending that they constitute an assured refund of capital so that his net outlay cannot have exceeded $8,333.33. The evidence as to how these receipts have been treated is far from satisfactory. It has already been pointed out in plaintiff’s 1974 tax return that the income from the film investment was declared at $1,607.76 but the only income from rental of the film was $124.58 and even the interest from the bonds which is shown as additional rental in the schedule filed as an exhibit at trial amounted to $1,707.76. While the interest received from the pledged bonds is indicated in the agreement as “additional rental’’ it appears to me to be something separate and distinct from revenue received from the actual rental of the film guaranteed up to a minimum of $30,000. In any event this interest would certainly have to be declared as income and evidently it was in 1974 although in a somewhat incorrect amount which apparently did not include the actual rental revenue of $124.58. In the 1973 tax return of Mr Gelber no income is shown from the “Mother’s Day” film investment although from the schedule produced at trial it appears that $875.24 was received in September 1973 as interest from the pledged bonds. This of course may have appeared in the item $926.99 shown as Canadian interest income but there is no evidence to support this so this is mere speculation. Unfortunately plaintiff’s 1975 tax return is not before the Court and that is the only year in which any substantial revenue was received from the film rental, so there is no way of determining how this revenue was treated in his tax return for that year.

For its part defendant in its reassessment for the 1974 tax year merely shows an increase of $5,333.33 as an adjustment of the capital cost allowance claimed on the film without allowing any credit for the $1,607.76 shown as interest income from it. As counsel for defendant conceded it cannot have it both ways, but possibly is making the same distinction, which I am inclined to do, between interest received on bonds pledged as security and income from actual rental of the film and considering that the former is not income arising from rental of the film. In any event the manner in which either plaintiff or defendant treated receipts from the rental of the film in 1973 and 1974, while of interest, is not binding on the Court in reaching a conclusion on the matter at issue.

Provision is made in the agreement between Intercontinental and purchasers such as plaintiff herein of an interest in the film that they can borrow from the bank for financing the acquisition in which case Intercontinental will hypothecate to the Royal Bank of Canada the bonds which would be otherwise pledged and will guarantee the loan to the extent of not less than 78% of the purchase price payable. It is suggested in the proposal that the purchasers will then be able to deduct from income interest paid on the bank loan. Whether or not Mr Gelber took advantage of this is not indicated and in any event it does not appear to affect the issue. Paragraph 4 of the purchase and leaseback agreement reads in part as follows:

In the case of bonds pledged while the undersigned pursuant to paragraph 2 above, all interest on such bonds shall be retained by the undesigned as additional rental. . . . The interest so paid or credited shall not be applied in reduction of the rental guarantee.

It is for this reason that I conclude that the interest received from the bonds has nothing to do with the guarantee of a minimum rental of $30,000 by December 31, 1983, or whether any sums received, whether from the rental of the film or from the eventual payment of the balance over and above the sums received as rental up to the amount of $30,000 on December 31,1983, are received as income or as a return of capital.

Mr Gelber was undoubtedly aware of the tax advantages of the agreement, being a well-informed and experienced corporation lawyer, but an awareness of tax advantages is not synonymous with an intention to evade taxation. It is trite law to state that a taxpapyer is entitled to take advantage of any of the provisions of the Income Tax Act and Regulations which are to his advantage in order to minimize his taxation. The present deal was particularly attractive for Mr Gelber since with an outlay of $38,333.33 he was assured of getting at least $30,000 back eventually, without losing interest on $30,000 of the sum he had invested in the meanwhile. His maximum possible loss was therefore $8,333.33 and there was always the possibility (although in the film industry somewhat remote) that the film might prove highly profitable so that he would make a profit from this investment. One of Mr Gelber’s partners wrote a memo to him and others who might be interested in the film on December 22, 1972, reading in part:

To understand this film deal properly, I think you have to look at it as an investment and not strictly as a tax shelter. In other words, if you were to receive total rental income of $23,000,* [1] being the amount of each unit, at the 50% rate, you would be paying $11,500 in income tax, or approximately the amount of the accumulated depreciation for the five-year period shown on the attached schedule. In addition, there would be certain bank charges that run at a net figure after tax considerations of about $234.00 a year; however, if the film were to make money, then the benefits would be real.

Mr Gelber testified that bonds were worth at the time they were pledged $31,583 but had a face value of $38,900 and were left with him pursuant to the terms of the agreement. This security was to be reduced as rental payments were received. Bonds with a face value of $1,900 have since been returned. Bonds with a face value of $37,000 all coming due on December 31, 1983 remain pledged, and it is evident that at that date Intercontinental will pay whatever difference is still due between rental payments and the $30,000 in order to get back the bonds with a fact value of $37,000.

He projected a return of $48,000 over an 11 year period on his investment! [2] and since only $8,333.33 were at risk considered that the dangers on the downside were minimal. Defendant’s counsel points out that a return of $48,000 on an investment of over $38,000 after 11 years is certainly not attractive from the investment point of view and but for the taxation advantages he could undoubtedly have made better use of his money. Mr Gelber admitted that one of the inducements was the guaranteed provision of $30,000 by the pledge of the bonds saving him from investigating the credit of the vendors in order to accept their personal guarantee. He went into the project considering it as an investment with little risk on the downside rather than strictly speaking as a tax shelter. No rental revenue from the film whatsoever has been received since 1975.

As it was pointed out by plaintiff’s counsel in argument Mr Gelber did not purchase the bonds; they were merely pledged to him, so it cannot be said that $30,000 of the purchase price was paid by him to acquire the bonds.

Defendant’s counsel contends that if the matter is looked at as an investment not of $38,333.33 but of $8,333.33 than the estimated return of $48,000, (if $30,000 capital is included) or some $10,000 over the original investment over a 10 year period would be much more realistic. Reliance is placed inter alia on section 67 of the Act which reads:

In computing income, no deduction shall be made in respect of an outlay or expense in respect of which any amount is otherwise deductible under this Act, except to the extent that the outlay or expense was reasonable in the circumstances.

I do not find on the evidence before me that the outlay of $38,333.33 was unreasonable. The fact that the risk on the downside was minimized by the guarantee of a return on the investment of at least $30,000 plus bond interest equivalent to interest which would have been earned on $30,000 of the original investment indicates that the outlay or expense was unreasonable.

The Minister also invokes subsection 245(1) of the Act which reads as follows:

(1) In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

There is no sham involved in this transaction as far as can be seen from the documentation and it would require something more than an imputation of motive to consider that it was a transaction entered into by Mr Gelber to ar- tifically reduce his income. Defendant argues that it was extraordinary that Intercontinental should have been willing to put $30,000 at risk in the form of an income guarantee in order to obtain a net investment of $8,333.33 and that it would have been simpler had Mr Gelber just put up the $8,333.33 at risk in the hope that the rental income from the film would cover it rather than to put up $38,333.33 with a guarantee that $30,000 of it would not be at risk. However the Act does not use the term “real amount at risk’’ which constantly appears in defendant’s argument but merely the term “capital cost to the taxpayer’’ and the evidence is undisputed that plaintiff did outlay $38,333.33 in cash as capital cost. While defendant argues that by increasing the figure from $8,333.33 to $38,333.33, of which plaintiff was sure of getting back $30,000, the deal was made attractive since capital cost allowance was then claimed by him on the larger figure, and this is undoubtedly so, the defendant appears to have failed to establish that the $30,000 was a commitment to return part of the purchase price rather than a mere guarantee of assured income of this amount so as to make the proposition more attractive. When the balance on December 31, 1983 is paid the amount received by plaintiff at that time has to be declared as income and taxed as such.

While defendant’s counsel cited a number of cases most of them are the so-called “sham” cases which appear to have no application here. Not only were the agreements validly entered into but it is not disputed that the parties here were acting at arms length. The two most pertinent cases are those dealing directly with film investments and both can clearly be distinguished. In the case of Lawrence H Mandel v Her Majesty The Queen, [1976] CTC 545; 76 DTC 6316 confirmed in appeal [1978] CTC 780; 78 DTC 6518 the appellant and others had made a downpayment on a film and agreed to pay the balance out of the proceeds of distribution. They claimed capital cost allowance on the whole purchase price including the balance which was not paid, being a contingent liability. It was held that the transaction was not a sham since there always existed the possibility that the film might eventually produce income, but that capital cost allowance could only be claimed for the taxation year in question on the amount actually paid in that year. The balance constituted a contingent liability and could only be used for capital cost allowance purposes when and if it was paid. In the case of C Ralph Lipper v Her Majesty The Queen, [1979] CTC 316; 79 DTC 5246 (Mr Lipper incidentially being one of Mr Gelber’s partners) the situation was somewhat similar. Mr Lipper did not have the same deal as Mr Gelber had and the case dealt with a different film in a different taxation year. In that case as in the Mandel case part of the purchase price was paid in cash with the greater amount to be payable out of future earnings of the film from time to time. There was a limited partnership with only one general partner, being a company which had no assets. The taxpayer could lose no more than the amount of his original investment if no profit resulted from the film, and only the general partner would be liable for the debt. No profit ever did result. The taxpayer was only allowed to claim his actual $5,000 investment, not the $11,243 being his share of the partnership, for capital cost allowance calculations. It was held that the very large sum provided for in deferred payments had no true business purpose and was simply a tax evasion scheme. Here again the case dealt with a contingent liability to pay the balance of capital cost out of future film profits. The deferred payment was grossly and artificially exaggerated and wholly unrelated to the value of the film. Neither the vendor nor the purchaser expected the price to be paid. In the present case there was no contingent liability contracted by Mr Gelber. He had made his payment in cash. He undoubtedly was aware of the tax advantages and the deal was undoubtedly an attractive one for him. The risk was comparatively slight and there was always some hope that the film might prove profitable. Evidence indicated that it had good actors and actresses in it. To equate guaranteed income with a refund of capital as defendant does, is to deliberately ignore the written agreement. While undoubtedly plaintiff was better off from a cpaital cost allowance point of view by paying $38,333.33 with guaranteed income return of $30,000 than he would have been paying $8,333.33 outright it must be remembered that he had to wait 11 years to obtain full payment of this guaranteed income. The interest received on the bonds in the meanwhile was merely what he might have received otherwise by investing the $30,000, quite probably to better advantage than in Government bonds, and it was clearly the guaranteed income feature plus the tax advantages which attracted him. This however in my view is not sufficient to consider that it was transaction entered into with no proper business purposes which would have the effect of artificially reducing income pursuant to subsection 245(1) of the Act. The appeals for all three years are therefore maintained and the tax returns of plaintiff for each of the years 1972,1973 and 1974 are referred back to the Minister for reassessment pursuant to these reasons with costs, only one set of costs being allowed since all three cases were heard simultaneously.