Paul Morello and Gerald Morello v. Minister of National Revenue, [1993] 2 CTC 2357

Christie, A.C.T.C.C.J.:— The year under review in both appeals is 1984. They arise out of similar transactions and the facts relevant to the determination of them are the same. It was agreed by the litigants that only the appeal of Paul Morello would be heard and that the disposition of this appeal would govern the disposition of Gerald Morello’s appeal. In these reasons a reference to "the appellant” is a reference to Paul Morello.

In the notice of appeal and the reply thereto allegations and counterallegations were made about whether an election had been made under subsection 39(4) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") with reference to a Canadian security. The appellant abandoned his position in this regard at the commencement of the trial. The remaining issue is simply whether the profit realized on the disposition of a promissory note is business income or a capital gain.

Mr. Frederick Turack, C.A. is the accountant for both the appellant and Canadian Solifuels Inc. ("Solifuels"). His testimony is that the corporation is involved solely in research and the development of products. Its principal product is a furnace that will burn material such as wood chips, peat, garbage. It will also burn highly toxic compounds like PCBs. The furnace has been under experimentation since 1983. Solifuels needed financing to continue its work and consulted Turack. In the late summer of 1984 the appellant became knowledgeable about Solifuels through Turack. This led to an agreement in writing being made by them on October 26, 1984. In summary this occurred under the agreement:

1. Solifuels sold a promissory note with a face value of $216,000 payable on demand without interest to the appellant for $240,000.

2. The closing took place on October 26, 1984, at the offices of a law firm.

3. At the closing Solifuels delivered the promissory note to the appellant and received a certified cheque for $240,000.

4. The appellant thereupon presented the promissory note to Solifuels for redemption and received a certified cheque for $216,000.

5. Solifuels made a designation under subsection 194(4) of the Act which states that the amount designated is $240,000. [1]

6. All of these transactions took place at the same place on the same day. [2]

By operation of subsection 127.3(6) of the Act the appellant is deemed to have acquired the $216,000 promissory note at a cost to him equal to the amount by which [the amount] he paid for it ($240,000) exceeds 50 per cent of the amount designated under subsection 194(4), i.e., 50 per cent of $240,000, or $120,000. The deemed cost is $120,000 and the profit on disposition of the note is $216,000 — $120,000 = $96,000.

What followed is set out in paragraphs 4 and 5 of the notice of appeal. They read:

4. The appellant invested the proceeds of disposition of $216,000 into shares of a corporation registered as a small business development corporation pursuant to the provisions of the Small Business Development Corporation Act (Ontario) which corporation (the"SBDC") acquired shares in Solifuels.

5. The appellant, through a holding company, continues to hold the shares of the SBDC to the present time.

The corporation referred to in paragraph 4 is 596471 Ontario Ltd., shares of which were issued to the appellant in consideration of the $216,000. [3] The evidence does not establish precisely when the $216,000 was invested in shares of this numbered company. There is nothing regarding such an investment in the agreement of October 26, 1984, between Solifuels and the appellant nor is there anything therein about 596471 Ontario Ltd. acquiring shares of Solifuels.

In his return of income for 1984 the appellant reported a taxable capital gain of 50 per cent of $96,000, or $48,000.

I will leave aside for the moment the investment of the $216,000 by the appellant in shares of 596471 Ontario Ltd. and the latter's purchase of shares in Solifuels. In my opinion the profit of $96,000 realized by the appellant on the redemption of the promissory note for $216,000 issued by Solifuels is not a capital gain.

I regard the disposition of this appeal as settled by The Queen v. Loewen, [1993] 1 C.T.C. 212, 93 D.T.C. 5109 (F.C.T.D.). [4] In Loewen, the appellant on July 16, 1984, made an agreement with Dynaflex Industries Ltd. ("Dynaflex") to purchase from it a scientific research tax credit debenture with a face value of $140,000 for $200,000. The debenture was redeemable on demand for $140,000. It was also agreed that at the closing the debenture would be delivered to the appellant who would pay the $200,000 by delivering a cheque for $24,000 and a promissory note for Dynaflex for $176,000. This note was payable in two instalments: $24,000 on or before September 30, 1984, and the balance on or before December 31, 1984. It bore interest at 19.091 per cent per annum. Dynaflex undertook to make a designation of $200,000 under subsection 194(4) or the Act.

The debenture for $140,000 was issued with interest at 24 per cent per annum and delivered the same day to the appellant. In August 1984 Dynaflex made the designation of $200,000 under subsection 194(4). The payments on the appellant's promissory note to Dynaflex were made. The interest was waived. On January 2, 1985, the appellant called for the redemption of the debenture and he was paid $140,000. Again the interest was waived. Applying subsection 127.3(6), the profit on the disposition of the debenture was $40,000. In dismissing the appeal Mr. Justice Dubé said at page 221 (D.T.C. 5115):

. . . the plaintiff’s appeal is allowed on the basis that the defendant's gain from the disposition of the SRTC debenture gave rise to income from a business on the grounds that the transaction was an adventure in the nature of trade.

I am unable to find any difference in substance between the facts in Loewen and those in this appeal relevant to the question whether the profit in each case was business income or a capital gain. Indeed, in the present case the facts, if anything, point even more to an adventure in the nature of trade. For example, in the case at hand all of the transactions relevant to realizing the profit took place on the same day while in Loewen they occurred over a period of six months.

It was emphasized by Mr. Turack that all of the steps from the appellant acquiring the $216,000 promissory note from Solifuels to the acquisition of shares in Solifuels by 596471 Ontario Ltd. was a single interrelated commercial scheme. The first step would not have been undertaken in the absence of the expectation of the fulfilment of the last step. Assuming that is so I cannot, with respect, understand how the legal nature for tax purposes of the profit in the hands of the appellant on the disposition of the promissory note he purchased from Solifuels can be determined with reference to the fact that he chose to invest the profit in shares of 596471 Ontario Ltd. which, in turn, invested in shares of Solifuels.

Over the years a number of tests or guidelines have been judicially established to assist in determining the issue of business income versus capital gain in trading cases. But the manner in which the profit in issue in those cases was disposed of by the person who realized it, whether by investment or otherwise, is not one of them to the best of my knowledge. Nor does it, in my opinion, qualify as such.

The appeal is dismissed.

Appeal dismissed.