Molony v. MNR, 90 DTC 1394, [1990] 1 CTC 2570 (TCC)

Christie, A.C.J.T.C.:—The matter in dispute is the deductibility of certain losses in computing the appellant's income. A number of years are involved.

The appellant is a management consultant but, as will be seen, he was otherwise engaged in prior years. He is 35 years of age. He went to school in Toronto and London, Ontario. He received his Bachelor of Arts from Western in 1976. He had part-time employment while in high school and in university and upon graduation from the latter he secured full-time employment with the Canadian Imperial Bank of Commerce ("the bank"). After a training program at a number of branch offices for some 21 months he spent 9 months in the Inspection and Audit Department at the head office of the bank. He was then assigned in 1978 to an important branch office at Bay and Richmond, Toronto, where he was designated a credit officer. He remained there until dismissed in 1982 for embezzlement. A measure of his success as a banker is that in September 1979 he was appointed Assistant Manager at that branch, the youngest person to receive this assignment. His primary responsibility related to the making of loans rather than to administration. During his time with the bank his salary increased from $10,000 to $35,000 per annum.

The appellant has a long history of gambling that relates back to his days as a student in grade school. It has involved diverse forms including poker; black jack; horse races; sporting events such as baseball, football, hockey and basketball; and trading in securities and commodities. His greatest losses were sustained playing baccarat and craps. This propensity lead to his first defalcation of bank funds in September 1980. What immediately precipitated this was that on an unspecified Tuesday in that month about $20,000 was due to a bookmaker for unsuccessful bets made on horse races. Two men attended at the appellant's office to collect. He persuaded them to leave with the assurance that he would have the funds within an hour. He managed this by means of a fictitious loan. He said that he intended to refund the money within days from anticipated winnings from more wagers. This was the first step in an accelerating series that, when terminated on April 27, 1982, with the arrest of the appellant, culminated in an insured loss to the bank in excess of $10,200,000. He was subsequently charged, convicted and sentenced to six years in prison. He was imprisoned from March 23, 1984 until May 1986 when he was released on parole. It is a condition of his parole that he shall not gamble or be in premises where there is gambling.

During the 19 months from September 1980 to April 1982 his attendance at casinos, latterly always in Atlantic City, increased from once a month to three times a week. The casino managers took special steps to facilitate the appellant in his gambling including providing private air transportation and making special banking arrangements for the transfer of funds from Toronto to Atlantic City. Between his duties of employment at the bank and his gambling the appellant was run ragged. All that was fraudulently appropriated plus all that could be spared from his salary went to gambling. Nothing was spent on material acquisitions. He spurned what he referred to as wine, women and song offered by casino management.

After he was released on parole he made a voluntary offer of some restitution and on August 19, 1986, he entered into an agreement in this regard with the “Underwriters at Lloyd's and Companies subscribing to Policy Nos. 79 ED 1126 and 79 ED 1127 issued to Canadian Imperial Bank of Commerce ('Insurers')." Under this agreement the appellant agreed to pay $100,000 (Cdn) to the insurers as full and final settlement on this basis: "Molony is to pay a minimum of $100 per month, together with 25% of his annual income in excess of $25,000 on a quarterly basis, until such time as the debt is satisfied." Accompanying this agreement is a promissory note of the same date for $100,000 without interest in favour of the Attorneys for the Insurers. Some $30,000 has been paid under this agreement. The source of all or most of the $30,000 is a portion of the royalties received by the appellant regarding a book published about his embezzlement of the bank's money and the related gambling. The rest of the royalties went for legal fees pertaining to the criminal proceedings and to the Canadian Foundation of Compulsive Gambling.

Two psychiatrists who qualified as experts gave evidence at the hearing on behalf of the respondent. First was Dr. Kilian B. Walsh, who had also testified at the trial of the accused on the charges under the Criminal Code. A report prepared by Dr. Walsh dated September 20, 1983, addressed to defence counsel in the criminal proceedings was placed in evidence. It was prepared following 12 consultations with the appellant each of which lasted at least one and one-half hours. It traced in some detail the appellant's history in relation to gambling. These extracts from it were read in evidence:

The key features of this illness (pathological gambling) are a chronic and progressive failure to resist impulses to gamble and gambling behaviour that compromises, disrupts, or damages personal, family, or vocational pursuits. Problems that arise as a consequence of gambling lead to more gambling.

Pathological gamblers see money as the cause and the solution to their gambling. Money for gambling may be obtained by forgery, embezzlement or fraud but typically is obtained in a nonviolent fashion. There is a conscious intent to return or repay the money. The disorder usually begins in adolescence. Some of the predisposing factors are: inappropriate parental discipline; exposure to gambling activities as an adolescent; a high family value on material and financial symbols; and lack of family emphasis on saving, planning and budgeting.

It is my opinion that Brian is a pathological gambler. This illness is best understood by looking at another addiction of which there is presently more public awareness—alcoholism. Intelligence plays no part where the addictive process is concerned. The ability to reason in the area of the addiction is defective. Just as the alcoholic against all reason is prepared to ruin his life and the lives of those close to him to satisfy his illness so also is the pathological gambler. Since money is the fuel of gambling irreparable financial harm with the ensuing emotional sequelae can be done in a matter of minutes, hours, days, weeks or years. Just as the social drinker finds alcoholism difficult to understand so also does the social gambler find the gambling addict difficult to understand.

The report also states: "He (Molony) is deeply involved in Gamblers' Anonymous and has reached a position of responsibility in one of their Toronto chapters."

Dr. Andrew I. Malcolm also testified. Like Dr. Walsh he was a witness at the appellant's trial on the criminal charges He was called by the Crown Attorney. A report dated October 4, 1989, prepared by Dr. Malcolm and addressed to counsel for the respondent, Mr. Erlichman, is an exhibit in these proceedings. It states that at the time of the appellant's trial on March 22 and 23, 1984, it was Dr. Malcolm's opinion that he suffered from an illness called pathological gambling. These passages are in the report:

Now Pathological Gambling is one of the Impulse Disorders. In this condition there is a failure to resist an impulse, drive, or temptation to perform some act that is harmful to the person or others. The evidence overwhelmingly supports the conclusion that Mr. Molony continued to gamble even though this behaviour was certain, in the end, to bring great grief upon his family, his girl friend, his colleagues at the bank, and himself. Secondly there is an increasing sense of tension and arousal immediately before committing the impulsive act; and this seems to be true of Mr. Molony as he laid down each successive bet. There was, furthermore, an experience of pleasure and gratification at the time of committing each act. In the Comprehensive Textbook of Psychiatry by Sadock and Kaplan it is noted that the act is what is called ego-syntonic, that is to say it is consonant with the immediate wish of the individual.

There is, thus, dyscontrol. The drive to seek the peculiar high sensation accorded only by the commission of the act is so strong that any inhibitory considerations are swept aside and the act is carried out. Such people have lost their sense of perspective. Their judgement which, in other situations, might be sound and wise, is seriously impaired when they are under the influence of the excitatory drive. And that is why pathological gamblers cannot abandon the game until their money is gone or the play is terminated by the operators. Gambling has been compared, in this respect, to the substance abuse disorders. In both conditions there is euphoria and an increasingly false perception of reality.

The gambler comes to rely on what can only be called magical thinking. He feels that his luck will change, that the very next throw of the dice will result in triumph, and that success is only his due after all the disappointment he has endured. But, of course, he loses far more often than he wins, and the sense of urgency and foolish hopefulness is only exaggerated by this fact. The gambler comes to believe that it is his ill luck that is the cause of all his troubles and that if he will only persist he will surely be rewarded. And this attitude, which is absolutely irrational, causes him to become a risk taker of constantly more absurd proportions. He becomes willing to take chances in complete defiance of any information and rational opinion in his own mind that his behaviour must be ill advised. It is, in fact, the extreme risk that creates the very excitement that drives and intensifies his obsession. And all of this is the very antithesis of the characteristics exhibited by a business man as he conducts his affairs.

After he was convicted in 1984 the appellant filed returns of income for 1980 and 1981. The amount reported for those years in respect of the embezzled funds as "other income” was $276,425 and $2,431,683 respectively. Losses were claimed as "other deductions" in the amounts of $287,690 and $2,444,524. In his 1982 return of income he reported the embezzled funds as "other income” of $7,509,000 and losses were claimed as "other deductions" of $7,515,041. In assessing the appellant's liability to tax on March 16, 1987 these deductions were disallowed by the respondent.

In his return of income for 1987 the appellant in calculating his taxable income sought to deduct a non-capital loss of $50,441. This was a loss carried forward from 1986 and pertained to the agreement with insurers and the $100,000 promissory note both dated August 19, 1986, previously referred to.

Two notices of appeal were filed in respect of these proceedings. The first was received by the registry on April 17, 1989. It states that in 1980, 1981 and 1982 the appellant carried on the business of gambling. The second notice of appeal was received by the registry on June 23, 1989. It relates only to 1987 and the non-capital loss of $50,441 carried forward from 1986. Again it is said that the appellant carried on the business of gambling in 1980, 1981 and 1982.

At the hearing the appellant's position was that the $50,441 was deductible even though only about $30,000 had been paid on the note on the basis that he was engaged in professional activities. His counsel said:

The only way in which we could ever be permitted to write off, as we did the $100,000.00 on an immediate footing, notwithstanding we did not pay it in that year, and therefore had the ability to carry it forward into the 1987 year, which is the relevant year, is, if I can establish the following:

1. I am in business, whatever that business is, gambling, embezzlement.

2. That in effect I am professional at what I do.

This is not just lawyers, or accountants who are considered as professional for income tax purposes. There are cases which address other not legally recognized professions as being professional for tax purposes. No case yet that speaks to embezzlement or gambling as attaining that professional status. But, if I can persuade you that in point of fact it is worthy of being considered professional for tax purposes, then under generally accepted accounting principles any professional, myself as a lawyer, are permitted to have my income approached on an accrual, not on a cash basis. That is what I have to do in order for the whole $100,000.00 to be treated in the way in which the taxpayer did in this case. I have to be a professional who is treating it on an accrual footing, it does not matter that I haven't paid it all yet, I am assuming liability.

Inter alia, counsel for the respondent argued with respect to the $50,441 that if it could be said that the appellant was in the gambling business, that business had ceased to exist long before the agreement was made and the promissory note issued. In the result there was no business in existence against which the $100,000 could be deducted when the debt was incurred. As already said, the appellant was arrested on April 27, 1982. He has not engaged in gambling since. In reply Mr. Wortzman relied on Selig v. M.N.R., [1955-56] 12 Tax A.B.C. 90; 55 D.T.C. 46. [1]

These secondary issues need be further addressed only if I conclude that the appellant was in the business of gambling in 1980, 1981 or 1982 within the meaning to be attributed to the word "business" in the context of these appeals. If such a business did not exist the dispute about the $50,441 is resolved in favour of the respondent.

The position of the respondent is that the funds wrongfully taken from the bank are employment income to the appellant under paragraph 6(1)(a) of the Income Tax Act.? [2] There was no real debate challenging this at the hearing. In The Queen v. Savage, [1983] C.T.C. 393; 83 D.T.C. 5409 (S.C.C.), Dickson, J. (later Chief Justice) speaking for the majority of the Court said with reference to paragraph 6(1)(a) at page 399 (D.T.C. 5414):

I agree with what was said by Evans J.A. in R. v. Poynton, [1972] 3 O.R. 727 at 738, speaking of benefits received or enjoyed in respect of, in the course of, or by virtue of an office or employment:

I do not believe the language to be restricted to benefits that are related to the office or employment in the sense that they represent a form of remuneration for services rendered. If it is a material acquisition which confers an economic benefit on the taxpayer and does not constitute an exemption, e.g. loan or gift, then it is within the all-embracing definition of s. 3.

The case cited by Mr. Justice Dickson is summed up in these words in Heggie v. M.N.R., [1985] 1 C.T.C. 2417; 85 D.T.C. 357 at 2423 (D.T.C. 361):

Poynton involved the prosecution of a former employee of Milne and Nicholls Limited, a general building contractor, for making false or deceptive statements in his income tax returns for 1967 and 1968 and wilfully evading payment of income taxes. This is what was before the Court for determination. In computing his income was the accused required to include

(i) moneys which he had stolen from his employer by way of obtaining kick- backs from sub-contractors of the employer; and

(ii) the value of certain benefits conferred on him by way of improvements to his residence which, by virtue of his fraudulent conduct, had been paid for by funds appropriated unlawfully from his employer?

The Court said yes. It was not suggested in Poynton that what the accused did was not in respect of or in the course of his employment. Obviously it was. The debate in the case revolved around an entirely different question, namely, whether stolen or embezzled funds can properly be regarded as income in the hands of the thief or embezzler under the Act. Funds of that kind are not the property of the thief or embezzler, but of his victim. The Court was of the view that nevertheless the funds could properly be regarded as income. The test is whether the thief or embezzler had in fact the actual use and enjoyment of the funds and it is not concerned with their ownership.

The substance of what follows has been said in many judicial pronouncements. In order for a taxpayer to be properly regarded as having been engaged in a business for purposes related to the Income Tax Act, it must be established that there was either profit from what he did or a reasonable expectation of profit. Whether such a reasonable expectation exists is to be determined by objective testing. Regardless of their profoundness, subjective expectations will not suffice.

There is no doubt that during the period 1980 to 1982 the appellant was a pathological gambler. That is the uncontradicted medical evidence and at the trial it was accepted by his counsel that he was so afflicted. Further, his illness was severe.

It strikes me that it is self-contradictory to speak of a pathological gambler being in the business of gambling. This activity impairs his intellect and his sense of perspective is lost. The impulse to go on regardless of the financial consequences is overwhelming. His attitude is irrational. Dr. Walsh says: “A (pathological) gambler comes to rely on what can only be called magical thinking.” All of these things place him on the road to certain financial ruin or, as in the case of the appellant, worse. I accept that at the relevant time the appellant believed or expected he would profit from his gambling, but when asked whether on reflection he regarded that belief or expectation to have been reasonable he said no.

My conclusion is that the appellant was not in the business of gambling in 1980, 1981 or 1982. It follows that these appeals fail and they are dismissed.

Appeals dismissed.