Allan Kleinfelder v. Minister of National Revenue, [1991] 1 CTC 2712, 91 DTC 913

Hamlyn, T.C.J.:—The appellant by way of notice of appeal with respect to his 1984 taxation year appeals their assessment by the respondent wherein the respondent disallowed $28,624.12 in business expenses in relation to an automobile venture, legal expenses and a condominium situated at 2125 Burtch Road, Kelowna, British Columbia.

The appellant's formal appeal was presented as follows:

Revenue Canada has disallowed the following items:

1. $12,156 as a deduction from income as a capital loss instead of as a business loss.

2. $14,963 inventory write-down from the real estate business.

3. $1,505 in legal fees with respect to the real estate business.

All of the above items are a deduction from income as business losses:

1. Loss on an automobile sales partnership business.

2. & 3. Losses from real estate operations.

All the items should be allowed as filed on my 1984 tax return.

The respondent's response was set forth as follows in the reply:

6. The Respondent submits that he properly disallowed the appellant's claim for a $12,156.12 deduction for a business loss in respect of the automobile venture as the Appellant was not in the business of buying and selling automobiles, and that any loss incurred by the Appellant was correctly reassessed as a capital loss; nor does the appellant meet the requirements of Subparagraph 20(1)(p)(ii) as he was not in the business of loaning money.

7. He submits that he properly disallowed the Appellant's claim for a $14,963 deduction for a business loss in respect of the Condominium, as the Appellant was not in the business of buying and selling property, and, as such, the Condominium was not" inventory" within the meaning of Subsection 248(1) of the Income Tax Act, and, therefore, there is no deduction available under Subsection 10(1) of the Income Tax Act.

8. He submits that he properly disallowed the Appellant's claim for a $1,505 deduction in respect of commission expenses as that amount was correctly characterized as on account of capital and was taken into account in the calculation of the 1985 disposition of the Condominium for the 1985 taxation year.

The following assumptions were accepted as common ground:

4. . . .

(a) the Appellant was at all material times to this action a real estate salesperson;

(b) in 1984, as originally assessed by the Respondent, the Appellant had taxable income of $8,840;

(c) upon reassessment of the Appellant's 1984 taxation year, the respondent disallowed the following amounts:

Automobile venture	$12,156.12
Condominium write down	$14,963.00
Commission expenses	$1,505.00
	$28,624.12

(g) the Appellant purchased a condominium located at 209—2125 Burtch Road in Kelowna, British Columbia, (the" Condominium") in 1981, and reported the cost of the Condominium on a capital cost allowance schedule, and prior to 1984, claimed capital cost allowance in respect thereto;

(h) in 1984 the Appellant claimed a $14,963 business loss with respect to the Condominium by writing down the cost of the condominium to its fair market value;

(I) in the 1985 taxation year, the Respondent allowed the said $1,505 legal fees as outlays of the disposition of the Condominium which was disposed of in 1985 by way of foreclosure; and . . .

The Condominium as Inventory and the Legal Expenses

The Appellant's Evidence

The appellant has been a real estate salesperson since 1978. He bought and sold several real estate properties in late 1980 and early 1981. Most of the properties were bought or sold through a corporation controlled by the appellant (he was the only shareholder and director). His evidence was that he used the corporation because of a lower rate of tax and because of limited liability. In the particular transaction before the Court he bought the property in his own name. The property was part of a condominium development. His primary purpose in buying the property was to obtain the real estate listing from the developer for all the other properties. The developer who also gave evidence affirmed the effect of this strategy. Indeed the appellant and his partner did succeed in selling all the properties that were sold in the development during that period of time. He did not list the specific property for sale as he felt such action would not show confidence in the development. He did however attempt to sell the property although these efforts were not successful. Eventually, the property was conveyed back to the developers' corporation in the course of a foreclosure action; in effect the appellant paid the developer to take the property off his hands so that the financial pressure on himself would be alleviated. The legal expenses of this transaction were $1,505

The taxpayer described the period of time in terms of the real estate business as one of speculative frenzy. The general feeling that prevailed was one of “if you did not participate you would be left behind”. The market weakened in 1981 and collapsed in 1982.

The taxpayer said that he did not have a knowledge of tax law and left the preparation of his return to his accountant. He said his accountant made the decisions in terms of the return and he simply signed and sent it in. He further said his level of tax knowledge has increased since the period of time in question; but, at that time he was not comfortable with tax and was not qualified to do his own return. He also advised the Court that it was his understanding at that time that any real estate transactions that he would be involved in because he was a real estate salesperson would not be eligible for capital gains consideration in relation to property transactions.

The position of the appellant as asserted by counsel was that the capital cost allowance claimed against the property in a prior year was a mistake.

Analysis of the Condominium and Legal Fees Transaction

It is clear that the appellant departed from his usual pattern of dealing with properties when he placed the condominium in his own name. It is also clear there was not an overt effort to sell the unit but a quiet effort to sell the unit i.e., it was not listed.

However, the taxpayer explained the reasons for dealing with the property in this manner were to ensure the development listing and to show confidence in the project.

The appellant also claimed capital cost allowance for the property in a prior year to the year in question. He also said he never claimed capital gains in terms of the other property transactions. His answers about certain accounting and tax matters were not strong. The conclusion drawn from viva voce evidence is that the appellant believed at all times during the period in question he was in the business of buying and selling real estate but he was not absolutely sure of the tax ramifications of his activities.

The condominium although dealt with in his own name was not unusual or isolated, that is, the asset was bought to resell and he did attempt to sell it. He thought he was entitled to deduct certain ” soft costs” but he did not believe he was able to deal with the transaction in terms of a capital gain or loss upon disposal. His historical pattern was to buy and sell properties. This activity complemented his regular economic activity of that of a real estate salesperson. As such it is concluded that in relation to the property before the Court the appellant was in the business of buying and selling property.

The appellant is entitled to the $14,963 deduction for business loss in respect of the condominium property because the appellant was in the business of buying and selling property such that the condominium was inventory within the meaning of section 248(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act") and the valuations of inventory property sections of the Act apply to the appellant.

The appellant is entitled to the $1,505 deduction for legal expenses in relation to the disposition of the condominium as this expense was expended for the purpose of gaining or producing income in the appellant's business of buying and selling property.

Automobile Venture

The Appellant's Evidence

The appellant knew a certain Mr. Gee who operated a men's clothing store in Kelowna, British Columbia. The appellant was a customer of Mr. Gee as well as a casual acquaintance. Mr. Gee told the appellant that he had acquired a used Mercedes automobile from an "estate" at a price that the appellant considered to be a bargain.

Mr. Gee advised the appellant that there were three other Mercedes that would be available from other "estates" in the near future for the sum of $36,000. Mr. Gee further advised he would like to purchase the automobiles but he did not have all the money.

The appellant and Mr. Gee then developed a proposal whereby the appellant would give Mr. Gee $18,000 and Mr. Gee would provide the balance. The automobiles would be purchased and the appellant would market the vehicles in the Kelowna area.

The proceeds would be divided in equal proportions.

The appellant then gave Mr. Gee the money without any documentation of any kind. A few days later after some contemplation the appellant re-attended upon Mr. Gee and asked for some documentation. A promissory note was issued by Mr. Gee to the appellant at no specified interest rate for $18,000.

The automobiles were never produced by Mr. Gee. Eventually Mr. Gee said he would return the money but at that point in time he did not have it. A new promissory note was issued for the $18,000 at a stated rate of interest of 18 per cent.

Mr. Gee paid back $5,000 in a lump sum and then a few smaller payments. Thereafter, Mr. Gee closed his men's clothing business and moved to Vancouver. A judgment was obtained against Mr. Gee on the default of the promissory note however Mr. Gee went bankrupt and the appellant received nothing more.

The issue before the Court is whether the appellant was engaged in the automobile business or engaged in the business of loaning money with respect to his transactions with Mr. Gee.

Analysis of the Automobile Venture

The appellant as previously found was a real estate salesperson. He had no automobile marketing experience. The whole proposal turned on the trust that the appellant had placed in Mr. Gee. The proposal never became a reality.

Cases cited to the Court by the appellant speak in terms of defalcations by employees, managing directors and others. In all cases businesses were established. In this case the business never commenced operation—the funds were simply misdirected.

In Cassidy's Ltd. v. M.N.R., [1990] 1 C.T.C. 2043; 89 D.T.C. 686, a case involving losses on defalcations by a senior employee, Rip, T.C.J. finds at page 2053 (D.T.C. 692): "The case law distinguishes not so much as to the level of the employee in the employer's hierarchy but how and at what stage in the income-earning process the money is stolen or embezzled.”

The transaction of buying the automobiles never took place, marketing never took place and the evidence about how the actual business was to be carried On was vague and imprecise. The infusion of capital by the appellant was to start the business but that business operation never started. The moneys were not expended by the partnership for the purpose of gaining or producing income in that, the other partner Mr. Gee misdirected the funds.

The capital expenditure by the appellant was not an outlay or expense for the purpose of gaining or producing income from the business in which the taxpayer was engaged.

The taxpayer was not engaged in the business of loaning money. The moneys were advanced to start a business that never started operation; the alleged partner misdirected the funds. The promissory note was issued by the alleged partner to give some assurance to the appellant for the capital moneys advanced and not as a business activity of loaning money.

Decision

The Condominium as Inventory

The appeal in relation to the $14,963 deduction fora business loss in respect of the condominium is allowed and referred back to the Minister for reconsideration and reassessment on the basis that the appellant was in the business of buying and selling property and, as such, the "condominium" was inventory within the meaning of subsection 248(1) of the Act and therefore the valuation of inventory property under subsection 10(1) of the Act applies to the appellant.

Legal Fees

The appeal in relation to the expended legal fees ($1,505) is allowed and is referred back to the Minister for reconsideration and reassessment on the basis that the fees were expended for the purpose of gaining income fiom a business within the meaning of section 18(1) of the Act.

Automobile Venture

The appeal in relation to the ” un recove red automobile venture" claimed as a deduction from income is dismissed.

As to costs, the appellant succeeding substantially in the appeal there will be an order for costs on a party-to-party basis.

Appeal allowed in part.