Jean-Camille Poulin v. Her Majesty the Queen, [1995] 1 CTC 2075

Garon J.T.C.C.:-These are appeals from reassessments dated June 8, 1990 made by the Minister of National Revenue for the 1984, 1985, 1986, 1987 and 1988 taxation years. In his reassessment for the 1987 taxation year, the Minister of National Revenue disallowed the $385,802 deduction claimed by the appellant as a business loss. In his assessments for the other taxation years in issue, that is, 1984, 1985, 1986 and 1988, the Minister of National Revenue disallowed the carryover to the other taxation years in issue of the part of the $385,802 loss which the appellant could not deduct in 1987, the year in which he incurred the loss. More specifically, the Minister of National Revenue disallowed the deductions claimed for noncapital losses for the taxation years mentioned in respect of those deductions, in the amounts indicated below:

$16,026 for year 1984

$29,838 for year 1985

$30,875 for year 1986

$81,196 for year 1988

At the start of the hearing of these appeals, the Court was informed that the appellant acknowledged the validity of the Minister of National Revenue’s assessment respecting the tax treatment of the gain realized by the appellant upon disposition in 1985 of two buildings, that is the 153 Brown Street in Cowansville and the 100 Sweet Street in Granby. The reassessment for the 1985 taxation year is therefore confirmed on this point.

The evidence showed that the appellant began in 1961 purchasing real estate properties, renovating them and reselling them. In 1963 or 1964, the appellant became a real estate agent and successively worked in that capacity for two brokerage firms. Later, that is, in 1976 or 1977, he began brokering real estate for his own account. Furthermore, the appellant took the necessary steps to establish two business corporations pursuant to the Quebec Companies Act, the first corporation called ’’Les Entreprises Tom- Lin Inc.", established by letters patent on March 10, 1969, and the second corporation called ’’Domaine Acrotère Inc.", incorporated by letters patent registered on September 12, 1973.

The appellant stated that he owned 100 per cent of the shares, or almost 100 per cent of the shares, of the capital stock of those two corporations. He was the chairman and director of those two corporations. At no time during the years in issue or during earlier or subsequent periods did the appellant receive remuneration in the form of salary from those two corporations; nor did he receive dividends from those corporations. It is provided in the instruments of incorporation of those two corporations that the objects for which those corporations were established include in particular the following:

To purchase, rent or otherwise acquire, own, administer, improve or contribute to improving real estate assets of all kinds and to sell, mortgage or otherwise dispose of those assets; to acquire building lands, to prepare them for construction, subdivide them into lots and improve and develop them in all ways; to purchase, rent, build or otherwise acquire, own, administer on the properties owned or administered by the company assets and rights to supply water, gas, electricity, energy, light and heating and sewer and drainage systems; to carry on any business for the purpose of achieving these ends; to carry out the operations of general contractors in the construction, demolition, repair of buildings of all kinds.

[Translation.]

Both of these corporations still carry on the activities for which they were incorporated. As appears from the income tax returns for the taxation years 1976 to 1988 inclusive, which were filed at the hearing of the instant appeals, the appellant’s income came from gains realized on the sale of real estate, from the rental of real estate, from commissions and certain other sources. A table summarizing the appellant’s income for the years 1976 to 1988 inclusive was filed at the hearing. That table (Exhibit A-6) is reproduced as a schedule to these reasons. The heading "Commissions” which appears in that table contains three components:

A. the commissions earned by the appellant as a broker when he acted for third parties;

B. the commissions earned by the appellant for services rendered to the aforementioned two real estate corporations Les Entreprises Tom-Lin Inc. and Domaine Acrotère Inc.; and

C. the commissions received by the appellant for his work in appraising the cost of buildings to be constructed.

In his income tax returns, the appellant considered his activities in the real estate field as constituting a single business.

In 1977, the appellant acted for Florian Dalpé and Jeanne-d’Arc Drouin-Dalpé (’’the Dalpés") as a broker in discussions which led to the closing of a real estate transaction that occurred on December 7, 1977. Some time later, the Dalpés brought an action in the Superior Court, District of Montreal, against the appellant, three other individuals and a business corporation called "Gestion Principale Montréal Limitée" ("Gestion"). The Registrar of the Montreal Registry Division and Prêts Québéco Inc. were third parties to that same action. The purpose of that action was to nullify the sale by the Dalpés to Gestion of two buildings and the sale by the latter corporation to the Dalpés of a second-rank mortgage claim representing the balance of the selling price owed to that corporation by a certain André Gosselin. That mortgage claim was on the property known as "Sherbrooke Towers", which the Gestion corporation had sold to Mr. Gosselin on July 7, 1977. In that action, the Dalpés alternatively requested that the defendants, including the appellant, be ordered to pay certain sums as damages if it were impossible to restore the parties to the action to the same state in which they were on December 7, 1977. This action proceeded to the end only in the case of the appellant. The Dalpés discontinued their action against one of the defendants before the trial started and settled out of court with the other defendants, including the Gestion corporation, either before or during the trial, the whole in accordance with what is related in the Superior Court judgment dated July 5, 1984. In that Superior Court judgment, the appellant was ordered to pay the sum of $163,952.76 plus interest at the legal rate as an indemnity pursuant to article 1056c of the Civil Code and costs. The Court also nullified the brokerage mandate given to the appellant by the Dalpés for the sale of the two buildings in question as well as the acknowledgement of a debt dated November 21, 1977, signed by the Dalpés for the appellant’s benefit. In its judgment of September 3, 1987, the Court of Appeal revised the amount to be paid by the appellant from $163,952.76 to $156,333.33 with interest starting on the date of service of the action, the additional indemnity provided by article 1056c of the Civil Code and costs in both Courts.

In two passages from this Superior Court judgment, the judge summarized the reasons for which the appellant had been held liable in the final analysis for damages in the amount of $156,333.33 plus interest, the additional indemnity of 1056c of the Civil Code and costs. Those passages read as follows:

For all these reasons, the Court concludes that the plaintiffs would never have signed the offer Exhibit P-1 and would never have completed the trans- action on December 7, 1977 without the false and fraudulent representations, positive, implicit and by omission, by the defendant Gestion (through its president, the defendant Lemaire) and by the defendant Poulin, particularly as regards the solvency of the building’s owner André Gosselin, the revenues from the building, the expenses, the number of vacant apartments, etc. The plaintiffs are therefore entitled to demand damages in full and complete compensation for their loss....

The plaintiffs therefore are well-founded to claim from the defendant Poulin one-third of $491,858.29, that is the sum of $163,952.76, for which the defendant Poulin must be accounted liable, in addition to interest and costs. His liability arises from articles 993 and 1710 of the Civil Code. He did not act with reasonable skill and all the care of a prudent administrator in the execution of his mandate. His scheme misled the plaintiffs. By his silence, he conspired in the fraudment schemes of the defendants Lemaire and Gestion. He certainly did not protect the interests of his clients the plaintiffs and did not competently perform his duty....

[Translation.]

The evidence showed that the appellant ultimately paid the total sum of $385,802 in discharge of all his obligations relating to his civil liability established by the courts. Incidentally, this total of $385,802 included an amount of $1,780.60 in respect of the services rendered by an attorney at the appellant’s request concerning a matter entirely separate from the issues in the action brought by the Dalpés against the appellant and the other four defendants.

It is also in evidence that the appellant surrendered his broker’s licence to the Service de courtage immobilier in May 1984, as witnessed by his letter of May 11, 1984. Since that time, he has not acted as a broker for anyone. He has however rendered services to the aforementioned two real estate companies of which he is the chairman, director and principal shareholder in the sale of buildings belonging to those corporations. In that capacity, the appellant received commissions from the two corporations in 1987 in the amounts indicated in Exhibit I-3.

Appellant’s claims

The appellant’s position was stated in particular in the notice of objection for the 1987 taxation year in the following terms:

This reassessment is without foundation in fact and in law because, for the taxation year in question, I am entitled to deduct from my income for the year the sum of $59,160 arising from a business loss of $385,802 which I incurred in 1987 pursuant to a judgment rendered by the Quebec Court of Appeal on September 3, 1987. The payment of that sum is related to a real estate agency mandate carried out in 1977 from which the judgment incidentally arises. In 1977, my commission income was calculated on a cash basis which justifies the deduction sought.

[Translation.]

Paragraphs 9 and 11 of the notice of appeal reveal other aspects of the appellant’s position. Those paragraphs are drafted as follows:

9. In 1977 and throughout the 1984, 1985, 1986, 1987 and 1988 taxation years, and since that time, the appellant has operated a business for real estate purposes and has reported business income therefrom pursuant to the Income Tax Act which was taxed by the respondent as such, the whole as will be demonstrated more fully at the hearing;

11. Even if the Court comes to the conclusion that although the Court of Appeal judgment was rendered in 1987, the obligation for the appellant to pay damages was retroactive to the date of the judgment rendered by the Superior Court, that is for 1984, the appellant is entitled to deduct and carry over the business loss of $385,802 considering that the appellant always operated a real estate business during the years in question, the whole as will be demonstrated more fully at the hearing.

[Translation.]

At the hearing, counsel for the appellant emphasized the point that the latter operated a single business in the real estate field recognized as such by tax authorities. She also added that that judgment for damages constituted a risk inherent in the exercise of the profession of broker. Lastly, counsel for the appellant relied on a decision of the Tax Appeal Board in Selig v. M.N.R. (1955), 30 Tax A.B.C. 437, 55 D.T.C. 46.

Claims of the respondent

In the notice of confirmation dated March 11, 1991, the Minister of National Revenue set forth the reasons in support of the assessment for the five years in issue in the instant appeal, as follows:

The Minister of National Revenue has considered the facts and reasons stated in your notice or notices of objection and hereby confirms the assessment(s) as made, pursuant to the provisions of the Income Tax Act, for the following reasons:

That the amount of $385,802 deducted from income for the 1987 taxation year did not constitute an outlay or expense which you incurred for the purpose of gaining or producing income within the meaning of paragraph 18( 1 )(a) of the Act because you were no longer operating the business at the time the obligation to pay those damages arose;

And that you did not have a non-capital loss for the 1987 taxation year which was deductible in computing your taxable income for the 1984, 1985, 1986 and 1988 taxation years pursuant to paragraph 111(1)(a) and paragraph 11 l(8)(b) of the Act.

[Translation.]

At paragraph 12 of the reply to the notice of appeal, the respondent clarified the position which the Minister of National Revenue had stated respecting the application of paragraph 18(1 )(a). That paragraph 12 reads as follows:

12. The respondent contends that the amount of $385,802 is not deductible by the appellant since that sum does not represent compensation made or incurred for the purpose of gaining or producing income from a business or property, the appellant, on May 11, 1984, having stopped operating the real estate brokerage business which gave rise to the proceeding.

[Translation.]

At the hearing, counsel for the respondent supported the point raised in paragraph 12 of the reply to the notice of appeal cited above by providing the additional information that the appellant’s brokerage business terminated when the appellant returned his broker’s licence to the Service de courtage immobilier. In support of this argument, he invoked the decision of Cullen J. of the Federal Court-Trial Division in Emerson v. The Queen, [1985] 1 C.T.C. 324, 85 D.T.C. 5236. That judgment was affirmed by the Federal Court of Appeal ([1986] 1 C.T.C. 422, 86 D.T.C. 6184).

Analysis

First of all, the possible application of paragraph 18(l)(b) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the ’’Act”) to the facts of the instant case was not raised in the reply to the notice of appeal. Counsel for the respondent only briefly mentioned that paragraph. in his argument. As another preliminary remark to my analysis, I would like to emphasize that, assuming the amount in issue were deductible, there was no objection to the part of that amount that could be deducted in computing the income for the 1987 taxation year or to the other fractions of that amount or to the other taxation years to which the carryback and carryforward could apply for the purposes of computing the appellant’s taxable income for those other taxation years.

It does not seem to me necessary to determine whether the appellant operated only one business in the real estate field which would have various facets, that is the purchase and sale of real estate properties, the rental of buildings, his work as a real estate broker and, lastly, his consulting work for the two business corporations which operated real estate businesses. It is known that the Income Tax Act requires income to be computed based on each source of income. See in particular sections 3 and 4 of the Income Tax Act. Accordingly, pursuant to that Act, the income from each business, for example, must be computed separately. If I were required to decide this issue, I would be inclined to believe that the appellant’s activities as a broker constituted a separate business and consequently a separate source of income. The taxpayer’s method of treating the income from his various activities related to the real estate field as arising from a single business does not seem to me a decisive factor in the least. In my view, the fact that the Minister of National Revenue allowed the appellant to proceed in this manner is not a conclusive factor either.

I shall now consider the respondent’s main argument that the amount of $385,802 paid by the appellant in 1987 is not deductible given that it cannot be considered a payment made for the purpose of gaining income from a business or property since the appellant stopped operating the real estate brokerage business in May 1984.

This argument cannot be accepted. It is possible to proceed by analogy: if the appellant had received a payment in 1987, for example, for services rendered in 1987 in his capacity as a broker (taking it for granted that the cash basis of accounting would apply in that case), [1] there is no doubt that that payment would have had to be included as business income in computing the appellant’s income, even if the appellant no longer actively carried on the business in question. In the above assumption, there is no doubt in my mind that the nature of that payment would not be altered merely by the passage of time. That payment would indisputably constitute business income. I do not see why it would be otherwise in the case of an expense which further would have been deductible if it had been made or incurred in a taxation year in which the taxpayer operated his business normally. Furthermore, it should not be forgotten that the event giving rise to the appellant’s civil liability occurred in 1977 when the appellant was operating that real estate brokerage business. The courts merely sanctioned, recognized or observed several years later the appellant’s civil liability for acts or omissions dating back to 1977.

In support of this argument, counsel for the respondent referred to the aforementioned decision in Emerson in which the existence of a source was found to be an essential condition for the deduction of interest under the authority of paragraph 20(1)(c). This judgment does not seem to me very useful for the purposes of the instant case as it applies in the narrow, restrictive context of paragraph 20(1 )(c), not in the broader, general context of paragraph 18(1 )(a) (and probably section 9) which governs the instant case. Furthermore, in my view, the aforementioned decision of the Tax Appeal Board in Selig clearly sets forth the applicable principles in a situation in which consideration had to be given to paragraph 12(l)(a) of the Income Tax Act of 1948, the text of which is, to all intents and pur- poses, identical to paragraph 18(1 )(a) of the present Act. In that case, the appellant, who had operated a scrap metal business, was disallowed a deduction for an amount which he had been ordered to pay by a court. That amount represented the value of copper bars which had been stolen by pedlars and sold to the taxpayer Selig, without the latter being at fault. The Minister of National Revenue had then disallowed the deduction of that amount on the ground that the appellant was not operating the business in the year in which he made the payment in question. Member Fisher wrote as follows at page 48 of the aforementioned decision:

Applying the principles set forth in the judgment in that case, which, although decided under the Income War Tax Act, is, in my opinion, equally applicable to the provisions of The 1948 Income Tax Act, it is my view that the liability here in question arose directly out of the normal trading operations of this taxpayer in the ordinary course of buying and selling scrap metals and that, accordingly, this was an expense in connection with a business of the taxpayer which, under ordinary circumstances and in the absence of any express prohibition in the legislation, would be allowable as a deduction for income tax purposes. Every dealer in scrap metals runs the risk, in the ordinary conduct of his business, of purchasing in good faith metals which may ultimately turn out to have been stolen property, with the result that the dealer will be held liable for their value less the amount which he paid for them.

It is my opinion, therefore, that if, after the purchase and sale of this scrap copper in 1946, it had been found in that year that the material was stolen, and the action had been taken and completed to judgment and payment of the $7,000 in question made, all in the year 1946, no question could have arisen that this amount was anything but an allowable deduction in determining the appellant’s taxable income. Is the situation altered, therefore, by reason of the fact that it was some time before the theft was discovered, action taken, judgment rendered, and payment made? Or by the fact that the appellant happens to be no longer actively engaged personally, as a sole proprietor, in the operation of the scrap dealing business in the year 1952? The liability was incurred personally by the appellant herein as sole proprietor of the business. It was not assumed by the limited company when it took over the business in 1947 for the simple reason that it was not even known to exist at that time. Nevertheless the court, in 1952, has found that the appellant, personally, was liable to make the payment of the $7,000 as a result of his personal business transactions. To the extent that he was so liable, it would appear that he was still in business until his business liabilities had all been settled once and for all.

Although the normal activities of the appellant’s brokerage business had been terminated when his broker’s permit was surrendered, I believe it may be argued that the appellant was acting in the context of the operation of his brokerage business by taking a certain number of measures to ensure his defence against the action brought against him (and other persons) by the Dalpés concerning, in particular, his professional activities as a broker and subsequently by instituting an appeal in the Quebec Court of Appeal from the trial court judgment in the same matter. Those actions were not common activities for a broker, but they undeniably concerned the opera- tion of his business. It should be noted that the action was brought against the appellant in the instant case in 1978 (given the file number of the Superior Court), thus well before the broker’s licence was surrendered by the appellant to the Service de courtage immobilier. The same approach would have to be adopted if, after surrendering his broker’s permit, the appellant had, for example, sued the Dalpés for the unpaid portion of his broker’s commission.

I also considered another issue which appeared to underlie certain observations by counsel for the respondent. I believe I understood that, in the respondent’s view, regardless of the question of the source, the payment of the sum of $385,802 did not constitute an outlay or an expense for the purpose of gaining or producing income within the meaning of paragraph 18(l)(a). The substance of that argument does not appear either in the notice of confirmation of the Minister of National Revenue or in the reply to the notice of appeal.

It is true that, in a certain sense, when a taxpayer pays a debt as part of the operation of his business, he does not foresee that he may realize an income from that transaction. This point of view appears particularly obvious if one considers certain rather extreme situations. For example, an employer who is required to pay an employee additional remuneration pursuant to a decision of a court or umpire that has adopted an interpretation, disputed by the employer, of a clause of a collective agreement or another type of contract is not actuated by an intention to earn an income when he makes that payment. The same is true if the payment is made to an employee by an employer when the latter discontinues the operation of the business in question or after the departure of an employee with whose services he was not satisfied. This very narrow interpretation of the exception which accompanies the prohibition established by paragraph 18(1 )(a) and which appears to have been suggested to me seems to me distinctly without foundation. I am rather of the view that the appropriate way to interpret paragraph 18(1)(a) in the case of the discharge of an obligation or debt requires one to ask whether that obligation or debt is related to the operation of a business or property or falls within the context of that operation. If the answer to that question is yes, the outlay or expense is deductible if, of course, other provisions of the Income Tax Act—including paragraph 18(l)(b)—do not prohibit that deduction. This same approach would have to be used if the issue of the deduction of the expense that here concerns us were considered in light of section 9 of the Act discussed below, and I believe one would come to the same conclusion on the subject of the deductibility of that expense.

There is no doubt in the instant case that the amount which the appellant paid to the Dalpés was to extinguish the obligation respecting the execution of the mandate which the latter had given him. The appellant’s liability arose from a contractual fault which he committed in performing the duties incumbent upon him pursuant to the contract entered into with the Dalpés. The following passage of the Superior Court judgment, affirmed in all its major aspects by the Quebec Court of Appeal, clearly indicates the origin of the appellant’s obligation to pay the amount in question. That passage is reproduced again for reasons of convenience:

His liability arises from articles 993 and 1710 of the Civil Code. He did not act with reasonable skill and all the care of a prudent administrator in the execution of his mandate.

[Translation.]

Counsel for the respondent suggested at one point during his argument, in response to a question by the Court, that the amount in issue paid by the appellant in 1987 could probably have been deductible if the appellant had committed only a simple error of good faith under his broker’s mandate for the Dalpés. Counsel for the respondent hastened to add, however, that, in the instant case, the Superior Court judgment had clearly stated that there had been ’’false and fraudulent representations, positive, implicit and by omission, by the defendant Gestion (through its president, the defendant Lemaire) and the defendant Poulin" affecting important aspects of the real estate transaction in which the appellant had taken part in his capacity as broker.

I do not believe that the issue of deductibility of this payment relies on the more or less serious nature of the contractual fault for which the appellant was found liable. This approach, in my view, would add an element of artificiality and arbitrariness in determining the deductibility of such a payment. The test that applies in my view simply comes down to the question whether the actions or omissions for which the appellant was blamed and which gave rise to a civil liability occurred in the context of the activities of the business which he was then operating. It should not be forgotten in the instant case that the courts ruled only on the appellant’s civil liability. The appellant’s criminal liability was not the subject of consideration by the courts. The situation could have been different, for example, if the appellant had been sentenced to a fine for his conduct in carrying out his broker’s mandate. Such was not the case, however.

In making the foregoing comments on the scope of paragraph 18(l)(a) of the Income Tax Act, I have not forgotten the observations made on behalf of the Federal Court of Appeal by Iacobucci J. when he was Chief Justice of the Federal Court in The Queen v. MerBan Capital Corp., [1989] 2 C.T.C. 246, 89 D.T.C. 5404 (F.C.A.) at page 256 (D.T.C. 5411):

At the outset, I believe it worthwhile to comment on the nature of paragraph 18(1)(a) of the Act upon which counsel for the respondents placed great emphasis in argument. Paragraph 18(1 )(a) is not, as counsel for the respondents appeared to argue, a provision which entitles a taxpayer to deduct an amount paid. Rather paragraph 18(1)(a), expressed in negative terms, limits the right to claim deductions; it does not authorize the right to deduct an amount since, as has been pointed out, such right must be found elsewhere in the Act (Harris, supra, note 15 to 189). Paragraph 18(1)(a) is one of the hurdles that an outlay has to go through to enjoy the status of deductibility under the Act; the paragraph does not confer the status of deductibility if its test is met.

The observations cited above seem to me to go beyond what was generally accepted. Some see in paragraph 18(1)(a) the existence of a positive test, stated implicitly, relating to the deductibility of certain expenses. In any case, it should be borne in mind that the issue in MerBan concerned the deduction of certain sums as interest and mainly concerned the application of paragraphs 21(1)(c) and 18(1 )(b) of the Act.

Having regard to the facts of the instant case, it is possible that the application of section 9 of the Income Tax Act should also be considered for the purposes of determining the appellant’s income gained from the business which he operated. This section 9 has been interpreted as generally permitting the deduction of operating expenses in accordance with generally accepted accounting and business practices. See the decisions of umpire Thorson in Daley v. M.N.R., [1950] C.T.C. 254, 50 D.T.C. 877 and The Royal Trust Co. v. M.N.R., [1957] C.T.C. 32, 57 D.T.C. 1055 (Ex. Ct.).

This argument was not raised at the hearing of these appeals and I shall add nothing further on this subject.

I therefore come to the conclusion that the amount of $385,802 is deductible in part in computing the appellant’s income for 1987, and the balance may be subject to a carryforward and carryback for the purposes of computing the appellant’s taxable income for the 1984, 1985, 1986 and 1988 taxation years. However, the amount of $1,780.60 must be subtracted from the amount of $385,802 as I have indicated above. The assessments in appeal must be amended accordingly.

As I have indicated above, the assessment of the Minister of National Revenue is confirmed with respect to the tax treatment of the gain realized in the sale of the two buildings mentioned at the start of these reasons.

For these reasons, the appeals are allowed, with costs, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis which I have stated above.

Appeals allowed.