Deputy Minister of Revenue (Quebec) v. Lipson, [1979] CTC 247, [1979] 1 S.C.R. 833

Pigeon, J:—This appeal is from a decision of the Court of Appeal of Quebec, [1976] CA 28, which affirmed in part only a judgment of the Provincial Court setting aside a provincial income tax reassessment of respondent for 1966.

With a few other persons, respondent had a company incorporated under the laws of Ontario for the purpose of operating a seventy apartment building in Ottawa. This building was not ready for occupation until November 1, 1961. At that time, market conditions were such that financial results were not as expected, and for the first six months there was a deficit of $50,877.32.

In order to enable the company to honour its obligations, in particular interest and capital payments on mortgages totalling $725,000, the nine shareholders formed what they called a syndicate, in which their respective shares corresponded to the number of shares each held in the capital stock of the company. At the same time they entered into a contract by which they leased the building owned by the company, although the latter was to continue to administer it for the account of the syndicate. As tenants the members of the syndicate undertook to pay all the operating costs, taxes, insurance premiums and so on, together with a rental of $34,700 per annum plus five per cent of gross rentals from tenants of apartments over $60,000 per annum. This lease was made for three years commencing May 1, 1962, with an option to renew for two more years on notice given three months before expiry of the first three years. The members of the syndicate took up this option, and the lease lasted five years.

In his provincial income tax return for 1966, respondent claimed the deduction of his share of the loss suffered by the syndicate in that year. This deduction was disallowed by the assessment in issue, and he appealed to the Provincial Court. In his judgment, Judge Dussault made the following observations respecting what might be expected from the arrangement concluded between the company and its shareholders, otherwise known as the syndicate:

[TRANSLATION] From all of the foregoing it must be concluded that the minimum income anticipated as almost certain was about $151,000 (testimony of Mr Ruby, P 126).

The monetary obligations assumed by the partners are contained in clauses 3, 4 and 5 of the lease and could be estimated approximately as follows, on the date the lease was signed and on the basis of the first six months of operation:

(1) Annual rental of	bv	$34,700.00
plus 5 per cent of gross income over $60,000
5 per cent of about $90,000		4,500.00
(Testimony of Mr Ruby, p 122)
(2) All direct or indirect operating expenses. These expenses
are broken down in Exhibit R-2, for the period November 1,
1961 to April 30, 1962, and total $58,483.08 for six months of
operation. The partners were therefore correct in anticipating
that these expenses would total annually about $58,483.08 x
2—		116,966.16
Total estimated value of annual monetary obligations
assumed by the partners under the lease		156,166.16

It should however be noted that the items “advertising, $3,528.93”, “commission rentals, $1,867.57” and ‘‘organization expenses, $981.88”, totalling $6,378.38, did not appear likely to continue for more than a year. In addition, according to Mr Ruby, the rentals seemed low for this type of building and could be increased (Mr Ruby, p 122).

However, the projections made regarding the prompt renting of vacant apartments by the syndicate were not realized in any of the taxation years 1963, 1964, 1965 and 1966, and this, plus increases in taxes ($15,000 according to Mr Lipson’s testimony, p 28) and in anticipated expenses, resulted in a sizable deficit for each of these taxation years.

The loss sustained by the syndicate was as follows (as stated in the opinion of Dube, JA):

As noted in the judgment of the Provincial Court, the company realized profits in 1971 only.

Why was this onerous contract made by respondent and the other members of the syndicate? Like the Provincial Court, I will first quote the following answer which respondent himself gave at the hearing:

Q Mr Lipson, what was the purpose of this lease that was entered into as of May first (1st), nineteen sixty-two (1962)?

A Well, by that time, the building had been completed, the initial results of renters were substantially disappointing, and, based on the first annual statement that was prepared—it was just a part of the year—we could see that certainly over a short term—perhaps six (6) months, perhaps another year—we would be having more problems in renting up fully than we had initially in our starting projections had anticipated, and this was discussed again with our lawyers, and accountants, and we were advised to take advantage of the situation where, since, if there was going to be a loss of this sort, that at least, by putting the building into our own hands as owner—as tenants, that we could, if this loss over the short period did materialize, as now began to appear, that we would at least be able to take advantage of this loss against some of our other income.

Respondent added in cross-examination (as quoted by Dube, JA in the Court of Appeal):

Well, we still had our firm belief that this was going to be a successful venture, and as I think I explained earlier, the only reason for moving into a syndicate was to take advantage of what, for a short term, was going to look like tax excess of payment because of losses incurred until we turned it around.

Turning now to the reason why the Provincial Court nonetheless allowed the deduction of the loss suffered by the shareholders of the company, as members of the syndicate leasing its building:

[TRANSLATION] It appears, from the evidence of the applicant and the other partners heard, that this lease was signed in good faith on the advice of experts. These witnesses all testified on oath that on the date the lease was signed, May 1,1962, they had no reason to think that the syndicate would not realize a profit during its anticipated life from three to five years. The evidence of these partners regarding the leasing of the apartments was corroborated by Mr Brownlea, a real estate broker, residing and practising in Ottawa for many years. This evidence was not contradicted.

The syndicate signed with Rideau Terrace Apartment Limited a contract which by its very nature is a current commercial operation, and constitutes an adventure in the nature of trade within the meaning of the Provincial Income Tax Act. There is nothing artificial about this contract as such.

It is true that in their budgetary forecasts the members of the syndicate proved to be very poor prophets. It is a fact that during its five years of existence the syndicate accumulated annual deficits ranging from $50,000 to about $100,000; but it is also true that during the same period Rideau Terrace Apartment Limited made no profit either.

Is this a sufficient reason to set aside the evidence of the expert witness Brownlea and the members of the syndicate, by taxing them with bad faith? The Court does not think so, any more than, for the same reason, section 163 of the Provincial Income Tax Act should be applied here.

In the Court of Appeal Dube, JA, while expressly approving this reasoning, nevertheless held that a part of the loss corresponding to the rental was not deductible, and observed in this regard:

[TRANSLATION] . . . in my opinion the partners, if they wanted to benefit from the advantages of their method of doing business, through a syndicate, should not at the same time try to get the best of both worlds and benefit also from the advantages they may derive from a limited company: at present the partners have assumed responsibility for all the expenses of the company, and deducted these expenses from their other income; however, they are paying the company an annual rental of $34,700, plus five per cent of the rentals from leases, over $60,000; in so doing, they are getting a double benefit.

This rental for the lease might be reasonable if the company in question were composed of persons other than the partners, but these are the same individuals who are seeking a double benefit: the evidence shows that, with this rental, the company was able during the years that the business was operated by the syndicate to enrich itself by about a hundred thousand dollars.

I am therefore of the opinion that the rental which the partners chose to pay the company in which they were shareholders cannot be allowed as a deduction for tax purposes, since they benefited from these amounts as shareholders in the company owning the building.

In my view one must go further: it is the entire loss which is not deductible, because it was not an expense incurred for the purpose of gaining income. Section 15 of the Provincial Income Tax Act (RSQ 1964, c 69) provides:

No deduction shall be permitted in respect of

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

5. Subject to the other provisions of this act, income for a taxation year from a business or property is the profit therefrom for that year.

It is perfectly clear from these provisions that, in order for an expense to be admissible as a deduction from a taxpayer’s income, it must have been incurred in order to make a profit. It is not enough that the expense was incurred in order to obtain gross income, as counsel argued at the hearing. By virtue of section 5, to gain income means to yield a profit. In the case at bar, there is no basis for finding that in renewing the lease for the last two years the members of the syndicate expected to make a profit. The only evidence submitted was as to the expectations they had on signing the lease, but these expectations were not realized, and the factors which caused the losses in the first three years were still present when the lease was renewed. No one therefore could imagine that a loss would not be incurred. It is accordingly clear that the sole reason for the renewal was that stated by the respondent: to create a deductible loss by means of a disadvantageous contract, instead of advancing capital. The actual purpose of the operation was not to make a profit but to put money into the company by incurring a loss to its benefit.

This is quite a different situation from that of the taxpayer in MNR v H J Freud, [1969] SCR 75; [1968] CTC 438; 68 DTC 5279, which was cited by Dubé, J A and by Dussault, J. In that case, there was a risky venture in the construction of a sports car. If it had succeeded it would have been profitable; it did not matter that the risks may have been poorly evaluated: the taxpayer was seeking a profit, not a loss, and furthermore it was not, as here, a contract made by persons not dealing at arm’s length.

Additionally, I strongly doubt that the evidence of the situation at the origin of the lease justified the conclusion arrived at in the courts below. The question was not whether the rental was reasonable, but whether the contract as a whole was really made for the purpose of making a profit. In other words, the true question was: did the members of the syndicate expect in executing the lease to make a profit proportionate to the risk of loss they were assuming? The most optimistic calculations of the real estate brokers hardly succeeded in showing it would be possible to break even. Could the members of the syndicate reasonably have been expected to enter into such a contract if they had not been shareholders? Some indication of the terms a third party may exact for taking over a losing business may be found in the decision of this Court in MNR v J N Sissons, [1969] SCR 507; [1969] CTC 184; 69 DTC 5152. There is therefore a great deal to be said in support of the decision of the Tax Appeal Board, J Lipson v MNR, [1972] CTC 2270; 72 DTC 1222, regarding respondent’s federal income tax for the years 1964 to 1967, a decision based essentially on a provision of the federal Act identical with section 15(a) of the provincial statute.

In the circumstances, I find it unnecessary to consider the other points raised by appellant, and the many cases cited by either side. The conclusion on the appeal obviously makes it unnecessary to discuss repondent’s cross-appeal seeking restoration of the judgment at trial.

For these reasons I would allow the appeal, reverse the decision of the Court of Appeal and of the Provincial Court, restore the assessment of respondent for 1966 and dismiss the cross-appeal, the whole with costs except that in accordance with the terms on which leave to appeal was granted appellant will have to pay the costs on the application and on the appeal.