Date:
20021104
Docket:
2001-4479-IT-I
BETWEEN:
DWIGHT LEWIS
DARLING,
Appellant,
and
HER MAJESTY
THE QUEEN,
Respondent.
____________________________________________________________________
For the
Appellant: The Appellant himself
Counsel for
the Respondent: Tony Chambers
____________________________________________________________________
Reasons
for Judgment
(Delivered
orally from the Bench at
Kingston,
Ontario, on September 20, 2002)
McArthur
J.
[1]
The issue in this appeal is whether the
Appellant may deduct the amount of $10,737 in computing his 1999
income pursuant to paragraph 18(1)(a) of the Income Tax
Act which reads:
18(1) In computing
the income of a taxpayer from a business or property 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 the business or property;
In satisfaction of a
judgment, a Notice of Garnishment issued by the Ontario Court
General Division in the amount of about $265,000 dated June 1998
resulted in a garnishee order being sent to Century 21 Townsend
Limited with respect to the Appellant. The amount of $10,737,
pursuant to the order, was paid. The Appellant was his only
witness and Robert Meihan, an appeals officer who completed the
audit for Revenue Canada, gave evidence for the
Respondent.
[2]
For the most part, the facts are not in dispute. The Appellant is a real estate broker and agent in
the Brockville area. During the relevant period, at least in 1990
and 1991, he was working for Dwight L. Darling Real Estate
Limited. His position is that damages he paid in 1999 were to
earn income from a partnership that had been dissolved in
1991.
[3]
The thrust of the Respondent's position is
that the Appellant had no source of income from which he could
deduct his payments made towards satisfying the
judgment.
[4]
The Appellant, his brother, David Darling, and
Anthony Leeder, referred to as the managers, entered into a real
estate investment with 19 partners. In accordance with an
agreement dated February 14, 1990, a total of 30 limited
partners would each invest $15,000, and the funds would be used
to purchase a 41.8 acre parcel of land in Brockville. It was
anticipated that income would be generated by renting a
three-bedroom house on the property and developing the remaining
acreage as a Christmas tree plantation and future real estate
development. It was the partners' understanding, apart from
the three managers, that the property would not be purchased
until all 30 shares in the partnership were sold and the advanced
funds would be held in a bank account earning interest at 10%
until all shares were sold.
[5]
In the event that the required 30 shares were
not sold, the $15,000 investment would be returned to each
partner, with interest. In this regard, I refer to the
partnership agreement and to the judgment of Mr. Justice Cosgrove
of the Ontario Court General Division. However, the managers
purchased the property after only 19 shares were sold, and a
$250,000 mortgage was granted back to the vendor. The assumptions
of fact in the Reply to the Notice of Appeal referred to a
$295,000 mortgage, as does the judgment of Cosgrove J. I do not
think anything falls on it, but the documents filed indicate a
registered mortgage in the amount of $250,000, as does the land
transfer tax affidavit attached to the transfer of land. Again,
this discrepancy has no relevance. Funds from the shares sold
were used to make payments on the mortgage, but the property was
repossessed after about a year by the mortgagee
vendor.
[6]
Some of the relevant provisions in the
partnership agreement include paragraph 3 to the effect that
"there shall be 30 limited partners". I note that the
Appellant did not contribute $15,000 as did the 19 partners.
Paragraph 8 stated "projected income from the partnership is
set out in Schedule C" which schedule projects income of
approximately $60,000 after 10 years, which was to be divided
amongst 30 partners. Paragraph 13 provides that "the
managers shall receive a 10% interest in the property and all
business developments that result from this venture". And
paragraph 20 sates that "at the end of each fiscal year, the
net profits or losses of the partnership for such year shall be
allocated to the partners in proportion to the number of shares
of partnership each partner owns".
[7]
The Appellant stated, inter alia, in
his Notice of Appeal:
...
The damages I have to pay are directly related to the failure of
the Partnership Agreement. Although the Appeal Court said I was
in breach of trust, I still had nothing to do with the management
of it and therefore had nothing to do with its failure. This is a
direct failed real estate transaction expense. Now I'm paying
the investors back their principal plus interest
income.
The judgment of
Cosgrove J. that was confirmed by the Ontario Court of Appeal
found that the failure was as a result of a breach of trust by
the Appellant and David Darling. I accept that version. The
Appellant was involved in two previous and similar partnerships
that did not live up to their projections or expectations.
Shortly after the purchase, the Appellant made an unsuccessful
application to have the house on one acre of land severed from
the 42-acre parcel. He had a conditional offer to sell the
severed parcel for $110,000, which of course fell
through.
[8]
The Respondent's counsel indicated that
the Appellant probably declared his prorated share of the rental
income from the property in his 1991 income tax return, and the
evidence in this regard is contained in Exhibit R-3. The
contributing partners sued the managing partners, seeking a
refund of their investment money after they lost the property and
their investment. In a judgment in favour of the contributing
partners, Cosgrove J. found in March 1996 that the Appellant and
his brother, David, were liable in fraudulently misleading the
Plaintiff investors.
[9]
In 1998, the Ontario Court of Appeal
upheld the judgment of Cosgrove J., but referred to the
Appellant's actions as breach of trust, and not as being
fraudulently misleading. This distinguishes the Appellant's
actions from that of the taxpayer in Poulin v. the Queen,
96 DTC 6477, wherein the taxpayer, a real estate agent, was
required to pay damages as a result of his fraudulent activities.
It places the Appellant more in the situation of the taxpayer in
McNeil v. The Queen, [2000] 2 CTC 304. This does not
assist the Appellant if he cannot establish that the payment
toward the judgment was incurred for the purpose of producing
income from a business or property pursuant to paragraph
18(1)(a) of the Act.
[10]
In McNeil, Rothstein J. stated that as
a result of the Supreme Court of Canada decision in 65302 B.C.
Limited v. Canada, 99 DTC 5799, fines and penalties
incurred for the purpose of gaining or producing income are
deductible expenses under paragraph 18(1)(a), provided of
course, the criteria in that section are met. In McNeil,
the Court found that the judgment for damages was paid by the
taxpayer for the business purposes of keeping his client. The
Court also found that the right to deduct damages as an expense
arises in the year the damage award is made and not in the year
in which the events giving rise to the damages took place.
Reading from the headnote in the McNeil
decision:
At common
law a taxpayer is entitled to deduct an expense when it is
incurred, and an expense is incurred when a taxpayer has an
absolute and unconditional obligation to pay an amount. The
appellant's liability to pay damages was ascertained and
became absolute and unconditional obligation when the judgment of
the British Columbia Supreme Court was issued. The right to
deduct such damages as an expense under paragraph 18(1)(a)
arose at that time in 1994.
[11]
The issue narrows down to whether the
Appellant had a source of income from which to deduct the damage
payments. The Appellant had an interest in an income-producing
property from 1990 to 1991 when the property and business
reverted back to the vendor to satisfy his mortgage back. After
1991, there was no longer a business or a property or a
partnership; all was lost. The obligation to pay damages arising
from his breach of trust was finalized in May 1998 when the
Ontario Court of Appeal dismissed the Appellant's appeal of
Justice Cosgrove's decision. At that time, his source of
income from the partnership, or business or property was long
gone; there was no source of income in the 1999 taxation year
from which he could deduct the judgment payment. His 1999 payment
was as a result of a garnishee and not made to earn
income.
[12]
The Appellant referred to a letter from his
accountant to the tax centre dated February 15, 2001 which reads
in part as follows:
It is my
understanding that the court-awarded damages are deductible for
income tax purposes provided they meet certain criteria. I
believe the damages awarded meet these criteria. The timing of
the deduction may be at issue. That is to say should the amount
of $265,104.55 be deducted in the year the taxpayer is determined
to have an absolute and unconditional obligation to pay it, 1998
or is it deductible in the year payment is made? 1998, 1999 and
subsequent years. Once the deductibility of the damages has been
established, we would like to pursue the issue of timing
further.
CCRA
bulletin IT-467R outlines requirement for the deductibility of
damages in computing income. I would put forward the following
comments in respect to the tests listed in this
bulletin.
In Mr.
Darling's case, the damages were awarded as a result of not
fulfilling the terms of contract in a real estate development
venture. As a general partner in the proposal, Mr. Darling, a
real estate broker and sales representative, received or expected
to receive significant commission income from the real estate
transactions. The limited partners expected to earn income from
the operation of a Christmas tree farm initially and then from
the subsequent development and sale of the property.
...
The
bulletin states "where the amount of damages is determined
by a court, the payment of such an amount would be considered
reasonable in the circumstances for the purpose of section
67.
Based on
the information obtained from IT-467R and summarized details I
read with respect to the tax court case McNeil, 2000 DTC
6211, I believe these court-awarded damages to be deductible by
my client.
[13]
I do not believe the author's logic
survives close scrutiny. While the Appellant is a real estate
broker and sales representative, in 1999, he was an employee of
Century 21 Townsend Limited. Apparently, he receives employment
income from that corporation. It was not a partner of the 1990
and 1991 venture, and the judgment for damages did not involve it
or the Appellant's earlier corporation, Dwight Darling Real
Estate Limited.
[14]
The limited partners anticipated
to earn income from the property and rental business, but that
did not exist in 1998 when the damages were awarded or in 1999
when the Appellant was forced to make a payment. As stated, the
McNeil case does not assist the Appellant because the
expenditure in 1999 was not made for the purpose of earning
income. The expenditure was made because there was a judgment
against the Appellant for breach of trust that had happened seven
years before his salary or commission owing to him by a
corporation was garnisheed.
[15]
For the above reasons, the appeal
is dismissed.
Signed at
Ottawa, Canada, this 4th day of November, 2002
J.T.C.C.
COURT FILE
NO.:
2001-4479(IT)I
STYLE OF
CAUSE:
Dwight Lewis Darling and
Her Majesty the Queen
PLACE OF
HEARING:
Kingston, Ontario
DATE OF
HEARING:
September 18, 2002
REASONS FOR
JUDGMENT BY: The Honourable Judge C.H.
McArthur
DATE OF
JUDGMENT:
September 24, 2002
APPEARANCES:
For the
Appellant:
The Appellant himself
Counsel
for the
Respondent:
Tony Chambers
COUNSEL OF
RECORD:
For the
Appellant:
Name:
n/a
Firm:
n/a
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
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