Clearwater Well Drilling Limited and Jennifer Fried v. Her Majesty the Queen, [1994] 1 CTC 2018, 94 DTC 1001

Rip, J.T.C.C.:— Clearwater Well Drilling Ltd. ("Clearwater") appealed income tax assessments for its 1984 to 1987 taxation years inclusive. At the same time its only shareholder, Jennifer Fried ("Fried"), appealed her income tax assessments for 1984 to 1987 taxation years inclusive. The Minister of National Revenue ("Minister") had assessed both taxpayers on related matters and the appeals of both parties were heard on common evidence. After the evidence of the appellants was complete the appellants and counsel for the respondent consented to judgment on all issues except one.

The remaining issue before me is to determine whether a loss of $15,210 suffered by Clearwater in 1987 was on account of income or capital.

In 1985 James Thrones ("Thrones") worked as a carpenter primarily in the house construction trade in Nova Scotia. He had eight or nine years' experience and Fried had engaged him to build a horse arena on her farm. At the same time he built a home for himself. Fried described him as a "very good carpenter who could build from sketches".

Thrones wanted to build homes himself. He had always been employed by others. He incorporated Red Oaks Construction Ltd. ("Red Oaks"). He did not know the reason he incorporated Red Oaks but thought" it was the way to go".

Thrones informed Fried that he wanted to build a house on speculation. They discussed what type of house he would build and agreed the house would be similar to the house he built for himself. Thus, Thrones explained, they knew the cost of the proposed house. He described the house as a "split entry, having an area of 1342 square feet on the main level”. The style was Georgian with brick on the front. It contained steel pillars.

Thrones asked Fried to help finance construction of the house. He required working capital before he could receive any mortgage advance. Fried, explained Thrones, would advance "money on the assumption we would split the profits”. Fried would get back what she put into the building of the house and the profits from the sale would be divided equally. Thrones would pay no interest on the money.

Both Fried and Thrones "took for granted" they would make a profit on the transaction.

Fried testified that she and Thrones drove around the area where Thrones had indicated he wanted to build. They saw two subdivisions under construction at the time. Single family houses on the subdivisions were being sold for between $100,000. and $125,000. They discussed in what subdivision the house would be built, having regard to the quality of the proposed house and other homes being put up in the area. They agreed to build in a subdivision which, although zoned for two-family residences, at the time had only three singlefamily residences and no two-family residences. They thought the house in this subdivision would be "most marketable", said Fried.

Fried met with her lawyer and he prepared an agreement ("agreement"), dated July 20, 1985, between Clearwater and Thrones personally. She agreed to assist Thrones because she "thought it would be a good opportunity. . .to make extra money. . .Thrones wanted me to put money up front and he'd get a mortgage for the rest". She testified Clearwater advanced the funds since she wanted to expand the company's business. Under the terms of the agreement, amongst other things;

(a) Clearwater was to advance to Thrones $10,000 on execution of the agreement to build a house; the $10,000 would be repaid on the sale of property;

(b) profit was defined to mean the proceeds from the sale of "the premises by Thrones less the cost and expense of discharging any property registered encumbrance on the property, less the payout of any other loan relating to the premises, less real estate commission, if any, less fees and conventional adjustments on closing”;

(c) the parties acknowledged that the agreement or any part of it "does not create, constitute or contemplate a partnership or joint venture in any form whatsoever";

(d) Clearwater agreed "to co-sign” the loan required "to secure. . . financing. . .";

Fried testified in her view the $10,000 was not a loan because "we both had risk". Clearwater's goal in entering the transaction was to gain a profit on the sale of the property.

Red Oaks was not a party to the agreement. There was no evidence who was the registered or beneficial owner of the property, although the municipality sent its tax assessment notice to both Thrones and Fried.

Thrones stated that the clause in the agreement deeming his relationship with Fried not a partnership or joint venture was included because she “wanted no liability if anything went wrong with construction”. Fried testified to the same effect when queried as to the reason for the clause.

Construction of the house began in June, 1985 and was completed November, 1985. During construction Fried frequently visited the site and discussed matters with Thrones, she declared. The house was for sale during construction but was not sold until late in 1986. The reason for the late sale, according to Thrones, was that" it was too much house for the subdivision. Once the house started to be built, two-family units took over the subdivision”. Neither Fried nor Thrones had foreseen this eventuality. In Thrones' view the house was" too high class and high quality”.

The original asking price of the house was $129,900. "with the possibility of going down to" $125,000. The house was sold for $112,000.

Clearwater advanced more than the $10,000 called for in the agreement. In fact, after advancing the $10,000 to Red Oaks on July 22, 1985, Clearwater made further advances to Thrones of $25,250 on August 30 and of $22,000 to Red Oaks on October 23. Thrones repaid the amounts of $25,630, $6,300 and $8,290 on or about October 15, November 5,1986 and January 9,1987 respectively. Red Oaks repaid $2,200 on or about March 5, 1986.

Once the house was sold and the proceeds of sale were accounted for, Fried did not take any action against Thrones (or Red Oaks) to recover any money because "he put in lots of time and effort and didn't make anything".

Counsel stated that Clearwater entered the transaction to help build the house, sell it and share the profits. Fried wanted Clearwater to expand its business and caused the corporation to advance funds to Thrones. Because costs were known — a similar house nearby had been built — Thrones and Fried were convinced the transaction would be profitable. This was, in counsel's view, a venture in the nature of trade.

The relationship between Clearwater and Thrones was not one of lender or borrower, as appears to be indicated in the agreement, counsel stressed. The money would be repaid out of the proceeds of sale before the profits were to be determined and distributed. No interest accrued on the advances. That the agreement stated the relationship was not to be construed as a joint venture or partnership does not screen the real situation. When Thrones required additional funds, Clearwater advanced the funds, although not required to do so by the agreement. When the proceeds of sale were insufficient to repay fully the appellant, both the appellant and Thrones walked away from the project since in their view the venture was ended.

Counsel for the Minister questioned the investigations and arrangements made by Fried and Thrones prior to building. Hence the possibility of profit was vague, she suggested. I do not share her concern that such preparatory work was not as detailed or complete as a sophisticated developer may have performed. One must consider the situation of the parties involved — their background, experience, education — as well as the amount of money to be put at risk.

The Minister’s counsel said the agreement speaks for itself. Thrones was looking for working capital and the appellant supplied him with capital.

In counsel for the respondent's view the agreement contemplated the appellant's activity was limited to that of an investor. She also suggested that if anyone, it was Fried, not Clearwater, who was engaged in the building of the house with Thrones: Fried and Thrones discussed the site and the details of construction and the land appeared to be owned by them. Clearwater only advanced capital and its loss was on account of capital.

I agree with Clearwater's counsel that the loss on advances it made were from a venture in the nature of trade. I do not put much weight on the agreement itself, in particular the acknowledgement by the parties that the agreement does not create a partnership or joint venture. The agreement, although executed by the parties in good faith, was not followed strictly by them. Thrones did not hesitate to call on Clearwater for additional funds and the appellant honoured his request. Fried acted as officer of the appellant in her dealings with Thrones and Red Oaks, whichever person who was constructing the house. There is no evidence to consider Fried was a builder. The discussions between Fried and Thrones with respect to what and where to build were of persons acting in concert to build rather than that of a simple investor and builder. The willingness of Clearwater to advance money during construction, as needed, demonstrates Clearwater had a proprietary interest in the project. As I see the transaction Clearwater had the money, Thrones had the know-how and together they agreed to build for resale, a classic venture in the nature of trade. The loss was incurred by Clearwater on account of income.

Therefore with respect to Clearwater, the appeals for 1984 to 1986 will be allowed only to delete the assessments of penalties, and the appeal for 1987 will be allowed only to delete the penalty, as consented to by the parties, and to allow the appellant to deduct the loss of $15,210 in computing its income for the year.

Mrs. Fried's appeals from assessments for 1984 to 1987 also will be allowed, on consent, but only to delete the penalties assessed.

Counsel for all the parties agreed that no costs are to be awarded.

Appeal allowed.