Pierre-Gilles Laframboise v. Minister of National Revenue, [1992] 2 CTC 2692, [1992] 1 CTC 2494, [1992] DTC 2155

P.R. Dussault, T.C.CJ.:—These appeals are from reassessments for the appellant's 1986 and 1987 taxation years. In submitting his returns for 1986 and 1987 the appellant claimed, inter alia, a deduction of $5,616 for 1986 as rental expense for a home office and a business loss of $100,160 for a bad debt owed to him by a corporation named Satelcom Inc. ("Satelcom"). For 1987 the appellant claimed to carry over the balance of this loss not deducted in 1986, namely an amount of $13,533.61. By a reassessment in a notice dated June 20, 1989 for the appellant's 1986 taxation year, the respondent disallowed deduction of the rental expense claimed and considered the appellant's loss as a loss on a business investment only half of which was deductible from his other income, that is up to the sum of $50,080. By a reassessment in a notice dated August 1, 1989 the respondent disallowed the carryover of the balance of the loss claimed by the appellant for his 1987 taxation year.

In assessing the appellant for the years at issue the respondent relied on the following assumptions of fact set out in paragraphs 4(a) to (n) of the reply to the notice of appeal:

(a) the appellant is a practising lawyer;

(b) the appellant shares his fees with the law firm Pouliot, Mercure, which makes available to him all necessary administrative services:

office space, secretarial, accounting and collection services, and so on;

(c) the appellants place of business is his office located in the premises of the firm Pouliot, Mercure;

(d) the appellant did not establish that a second office in his house was actually used or was reasonable, or that the expenses were reasonable;

(e) the appellant's home office is maintained principally as a convenience and it was not shown that the cost of maintaining the house was incurred for the purpose of earning income;

(f) during his 1986 taxation year the appellant held 18 per cent of the shares in the company Yocar Inc.;

(g) the company Yocar Inc. in turn held 33 1/3 per cent of the shares in the company Satelcom Inc.;

(h) on or about February 6, 1986 the appellant stood surety with the Bank of Nova Scotia for loans made by the latter to Satelcom Inc.;

(i) to guarantee his commitments, the appellant gave the bank personal term deposits or Treasury bills as a collateral guarantee;

(j) when Satelcom Inc. could not pay its bank loans, the Bank of Nova Scotia cashed the term deposits given as security and the interest accumulated on those term deposits, amounting to $100,160;

(k) sometime in December 1986, Satelcom Inc. ceased operations and undertook an ordered liquidation of its inventory, which was completed in June 1987;

(l) 50 per cent of the appellant's loss of $100,160 is deductible, since it is a business investment loss;

(m) the appellant was not engaged in an adventure in the nature of trade;

(n) the appellant accordingly had no loss other than a capital one to be carried over to his 1987 taxation year.

[Translation.]

Office expenses

I will first deal with the expenses of maintaining the home office. The appellant was the only witness heard by the Court. He is a lawyer by profession and explained that he began practising law in 1975 with a clientele consisting of business people in the Cartierville area, north of the city of Montreal. In 1984 he joined a downtown Montreal law firm while continuing to work for himself, and kept an office at home so he could continue to provide on-the-spot service to his original clients. As he simply had an administrative agreement with the firm, whose offices were located in the downtown area, the appellant submitted that in Toronto in 1985. According to the appellant, the fact of obtaining an exclusive distributor's licence for the sophisticated Sony equipment and the sales potential of such equipment in remote areas offered a unique opportunity for those involved to set up a business quickly, operate it for a year or two, long enough to make it viable, and resell it at a considerable profit as soon as specific results contained in financial statements could show possible buyers the growth potential of the business. In legal terms, the three men decided to use the Satelcom Company, which was already in existence and of which Roger Lachaine had till then been the sole shareholder, to operate the new business. It was therefore agreed that each of those concerned would hold one-third of the shares. The appellant, who said that in view of his profession he wished to place himself at a greater distance from the risks inherent in such an undertaking, acquired his one-third interest of the Satelcom shares through a company controlled by his wife, involved in presenting fashion shows for various institutions, and known as Yocar Inc. (" Yocar"). The purchase price of one-third of the Satelcom shares by Yocar was set at about $50. However the appellant, who held only an 18 per cent share in Yocar, was given a purchase option on the Satelcom shares bought by Yocar amounting to $1. In financial terms, the Satelcom shareholders anticipated that they would not themselves have to invest money in the new business. They expected that the necessary financing to purchase the Sony Tokyo equipment would be through letters of credit their distributors would obtain from their respective banks, which could be used by Satelcom to obtain delivery of the equipment from Sony Tokyo in Canada.

Following what the appellant himself described as "not very in-depth market studies”, negotiations were begun with Sony Tokyo for an exclusive distributorship over a five-year period of 1,000 DBS sets a year at the rate of two orders of 500 each. At the same time Satelcom, which had found an Ontario distributor specializing in the sale of similar products, a company known as DCA, was also trying to obtain from Sony-Tokyo at this distributor's request exclusive rights of sale for a two year period to a combination of Sony equipment, "as a unit”, namely the DBS equipment, a television set and a VCR recording and reproduction system. Although the need to obtain prior approval from Sony Canada for this second undertaking delayed the signature of the agreement between Satelcom and Sony-Tokyo, it was agreed to order the first 500 DBS sets. However, as the DCA distributor was unable to obtain letters of credit from its bank before the DBS sets were delivered in Canada, Satelcom had to use its own bank to get a letter of credit in favour of Sony-Tokyo to cover the delivery of the first 500 DBS sets in Canada. As Satelcom had no working capital, the bank asked for personal guarantees from the principals as a condition of issuing this letter of credit to Sony-Tokyo. This is when the appellant was required to give the banks certain instruments as security, including the certificates of deposit and Treasury bills mentioned above. The letter of credit made out to Sony-Tokyo by Satelcom's bank was in fact to be offset by a letter of credit from the DCA bank to Satelcom as soon as the equipment was delivered in Canada, and this was done.

The same procedure was used for the second order of 500 more DBS sets. However, because of a number of problems, due in particular to the fact that the sets were not selling as well as expected, that they were sold mainly in remote areas which did not have cable service and installation and after-sale service costs in those areas were quite high, the DCA distributor never took delivery of this second order of 500 sets, for which Satelcom was finally responsible. The second letter of credit in favour of Satelcom was therefore never issued by DCA's bank. As a result, Satelcom had to incur additional expense to take delivery of and itself sell the sets for which it became responsible, which in addition had technical defects. With the aid of loans from the principals, Satelcom was finally able to sell all these sets in 1987. However, in 1986 the bank realized on the security given by the appellant in return for issuing the second letter of credit in favour of Sony-Tokyo. As it had no liquid funds, Satelcom could not reimburse the appellant and hence the $100,160 loss suffered by the latter during the year 1986.

In his testimony the appellant, who said he had never intended to abandon the practice of law, stated that he only became involved in this matter with the other two principals intending to make a quick, sizeable profit of about $1,000,000 by reselling the business after a short period of operating it, if all went well. He said that it was essentially a short-term concern in the nature of trade, and he never contemplated continuing to be personally involved in the Operating of such a business over the long term. Moreover, he stated that during 1986 efforts were made not only to get the business started but also to contact possible buyers who might have been interested once it was a going concern.

Appellant's position

Counsel for the appellant maintained that the latter's involvement in Satelcom should be seen essentially as an adventure or concern in the nature of trade. Counsel said that by purchasing the Satelcom shares through Yocar the appellant was not in any way seeking to obtain a source of income from Satelcom's activities, but a profit by the quick resale of his interest as soon as the Satelcom business had demonstrated its profitability. In this connection, counsel emphasized that the appellant's actions were intended not only to ensure a market and a distribution network for the sets but also to obtain potential buyers for the ongoing business, the principal asset of which was the exclusive distribution licence to be given for the DBS sets by Sony Tokyo. Counsel further argued that the fact the appellant acquired his interest in Satelcom indirectly through Yocar is irrelevant to the outcome of the case. In his submission, the appellant was only seeking to use an existing corporate structure to protect himself personally from possible actions on account of his profession. In short, he said, the use of Yocar was only a convenient way of operating, since in spite of this it was the appellant's personal money that was used, not money belonging to Satelcom or to Yocar. In conclusion, counsel for the appellant considered that if matters had gone well the profit made would certainly have been treated as a business income for the appellant and not as a capital gain. In the same way, he said, the loss incurred by the appellant should be regarded as a business loss, not as a capital loss. Counsel for the appellant based his arguments primarily on the Supreme Court of Canada judgment in M.N.R. v. Freud, [1968] C.T.C. 438, 68 D.T.C. 5279, the facts in which he said were similar to those in the instant case. Further, to establish that the money spent by a taxpayer in connection with a concern in the nature of trade in which he is engaged should be treated as business losses, he referred to the following decisions:

Cull v. The Queen, [1987] 2 C.T.C. 63, 87 D.T.C. 5322;

Becker v. The Queen, [1983] C.T.C. 11, 83 D.T.C. 5032;

Stewart & Morrison Ltd. v. M.N.R., [1972] C.T.C. 73, 72 D.T.C. 6049;

N.D.L. Nouvelles Distributrices Ltée v. M.N.R., [1986] 1 C.T.C. 2153, 86 D.T.C. 1089;

W. Green Holdings Ltd. v. M.N.R., [1990] 2 C.T.C. 2068, 90 D.T.C. 1605.

Respondent's position

Counsel for the respondent argued that counsel for the appellants argument based on the corresponding treatment of a profit and loss resulting from a concern in the nature of trade is not really applicable in the circumstances. He said that although the appellant held an option to purchase the Satelcom shares held by Yocar, that option was not exercised so that as the appellant was not directly a shareholder in Satelcom he could not have been personally taxed on profit resulting from sale of the Satelcom shares. Accordingly, he said, the interposition of Yocar raised a question as to whether the results of the concern in the nature of trade in which the appellant said he was involved could be attributed to him personally, if everything had gone as expected. He therefore argued that what the appellant is asking is for the corporate veil to be lifted, which cannot be done in the circumstances since it is the appellant himself who used this structure to obtain every possible advantage and minimize risks. In his submission, therefore, the facts in the instant case must be distinguished from those in Freud, supra. Alternatively, if I understand his argument correctly, counsel for the respondent maintained that if Satelcom had really been able to set up its structure of operations, what it would have had to sell would have been its good will, which considered as an eligible capital asset would have been taxed at a 50 per cent, not 100 per cent, rate. The fact that the respondent allowed a 50 per cent deduction for the losses by considering them as business investment losses would therefore seem, counsel submitted, to be the most appropriate treatment in the circumstances. In support of his argument that the loss was a capital loss, and specifically in the circumstances a business investment loss, counsel for the respondent referred to the following decisions:

Stewart & Morrison Ltd. v. M.N.R., supra;

McKinley v. M.N.R., [1974] C.T.C. 170, 74 D.T.C. 6138;

Pierce Investments Corp. v. The Queen, [1974] C.T.C. 825, 74 D.T.C. 6688;

Isaac Meisels Investments Ltd. v. The Queen, [1985] 1 C.T.C. 9, 85 D.T.C. 5029;

Dumas v. M.N.R., [1989] 1 C.T.C. 52, 89 D.T.C. 5004;

K.J. Beamish Construction Co. v. M.N.R., [1990] 2 C.T.C. 2199, 90 D.T.C. 1584;

Lachapelle v. M.N.R., [1990] 2 C.T.C. 2396, 90 D.T.C. 1876;

Hill v. M.N.R., [1991] 2 C.T.C. 2356, 91 D.T.C. 1094.

Analysis

Before discussing the appropriate fiscal treatment of the loss of $100,160 sustained by the appellant in 1986, the matter must be placed in its proper perspective. Though it may have been recognized that the rules for determining the characteristics of a gain or loss from the disposition of property are similar at the outset to those for determining the characteristics of a gain or loss resulting from a loan or surety (reported sub nom. Lachapelle v. M.N.R., [1990] 2 C.T.C. 2396, 90 D.T.C. 1876, at page 2399 (D.T.C. 1878), I think it is important to distinguish these different situations, as the Associate Chief Judge of this Court did in K.J. Beamish Construction Co., supra. I think it is important to do this in order to reconcile, so far as possible, several decisions which might otherwise seem contradictory.

The Court does not have to determine here the characteristics of a gain or loss resulting from the disposal of shares in the capital stock of Satelcom or Yocar, but rather those from the loss resulting from the Bank's decision to reimburse itself for the advances made to Satelcom from the security provided by the appellant, and as a result of the inability of the latter, who was then subrogated in the Bank's rights, to obtain payment of his debt from Satelcom.

It is the Supreme Court of Canada's judgment in M.N.R. v. Steer, [1967] S.C.R. 34, [1966] C.T.C. 731, 66 D.T.C. 5481, which first approved the principle that a loss sustained by a taxpayer was a capital loss.

When the taxpayer's business is not making loans or providing securities, several decisions have in one way or another approved this principle that losses suffered from loans made or securities given to provide working capital were capital losses and not business losses. This was the decision, inter alia, in Steward & Morrison Ltd., supra, N.M. Tilley Realty Ltd. v. M.N.R., [1984] C.T.C. 2387, 84 D.T.C. 1343, Issac Meisels Investments Ltd., supra, K.J. Beamish Construction Co., supra, Lachapelle, supra, and Hill, supra. Referring to the Supreme Court's judgment in Stewart & Morrison Ltd., supra, Judge Brulé of this Court said in Lachapelle, supra, at page 2402 (D.T.C. 1880):

A similar view has been advanced in this Court in N.M. Tilley Realty Ltd. v. M.N.R., 84 D.T.C. 1343. Sarchuk T.C.J., relying on Algoma Central Railway v. M.N.R., [1967] C.T.C. 130, 67 D.T.C. 5091, held that loans and guarantees given by the appellant to a related company were outlays on account of capital and not business losses because they were given to provide working capital to the company. As in Meisels, the Court pointed out that no direct connection could be drawn between these outlays and the earnings of business income.

Although a loss arising on a guarantee or a loan is normally characterized as a loss on account of capital, such losses may constitute business losses if the loan or guarantee is given in the ordinary course of the taxpayer's business for the purpose of earning an ongoing and increasing income stream.

Similarly, in Hill, supra, dealing with payments made by a taxpayer to a bank in execution of securities provided for money advanced to a company named Horaceville, in which the taxpayer was a shareholder and director, Judge Bonner of this Court said the following at page 2359 (D.T.C. 10%) :

The short answer to all of this is that the claim made by the bank was based on guarantees given by the appellant of the indebtedness of Horaceville. Those guarantees were not shown to have been given in the course of a business or adventure in the nature of trade involving the provision of guarantees for reward. There was no evidence that any such business existed. This is a case in which a claim for payment was made under a guarantee given by a shareholder to a bank to induce it to advance the capital required by the shareholder's company to carry on its business. Such a payment, when made, is an outlay of capital. [2]

It is true that in some decisions losses suffered on loans or securities have been classified on a less technical basis and deduction of all the losses sustained as business losses has been approved in situations where there was a direct and necessary connection between the fact of making the loans or giving the security and that of earning or preserving income from a business of property when that business or property belonged to the taxpayer himself. In this regard reference may be made to the decisions in D.J. MacDonald Sales v. M.N.R. (1956), 16 Tax A.B.C. 49, 56 D.T.C. 481, FH. Jones Tobacco Sales Co. v. M.N.R., [1972] C.T.C. 2433, 72 D.T.C. 1355, The Queen v. Lavigueur, [1973] C.T.C. 773,73 D.T.C. 5538 and Panda Realty Ltd. v. M.N.R., [1986] 1 C.T.C. 2417, 86 D.T.C. 1266. These decisions are of no assistance to the appellant here since, in the instant case, the securities were given not so that the appellant himself could earn business income but in order that Satelcom could do so.

Another line of authority appears to have been established as a consequence of the Supreme Court of Canada's judgment in Freud, supra, by which losses resulting from loans made or security provided for advances to a corporation were treated as business losses when it proved that the taxpayer who made these loans or provided the security held shares in the capital stock of a corporation not as an investment but as a concern in the nature of trade. A number of decisions, in particular in Becker, supra, and Cull, supra, referred to by counsel for the appellant, have in fact established the classification of losses suffered as the result of a concern in the nature of trade in which a taxpayer became involved by purchasing a corporation's capital stock. Referring again to Lachapelle, supra, I take the liberty of quoting part of Judge Brulé's analysis commenting as follows on these two decisions, and on others which have adopted the same approach at pages 2403-04 (D.T.C. 1880-81):

In Becker, losses incurred on shares, loans and guarantees given by the taxpayer to a corporation he controlled were held to be fully deductible business losses. However, there are clear differences between this case and the case at bar. For example, the Court in Becker established that the taxpayer purchased the shares with the intent to resell them at a profit after he had turned the company around. In short, the taxpayer was engaged in an “adventure in the nature of trade”. The loss on the loans and the guarantee were also fully deductible business losses because they were incidental to the taxpayer's business (that being the undertaking to purchase and sell the business at a profit).

The Becker case tends to undermine rather than support the appellant's position. First, the taxpayer in Becker did not claim to be engaged in the underlying business of the corporation. Second, the taxpayer clearly undertook to buy and sell the business; he never intended to recoup his investment by establishing an ongoing operation. In fact, Kato, supra; Leslie v. M.N.R., [1986] 1 C.T.C. 2209, 86 D.T.C. 1152; and M.N.R. v. Taylor, [1956] C.T.C. 189, 56 D.T.C. 1125 (all cited by the appellant in argument) were also decided on this same principle. In each of these cases, the taxpayer's gain or loss was characterized on the basis that the taxpayer had intended to sell his shares.

For a situation where an appellant had no intention of selling his shares at the time that he acquired them see the Federal Court of Appeal decision in Guy Dumas v. M.N.R., [1989] 1 C.T.C. 52, 89 D.T.C. 5004.

Cull is both a difficult decision to explain and distinguish, partly because Madame Justice Reid gave a broad interpretation to the Freud case and partly because the decision suggests that the business of the corporation was also the business of the taxpayer/shareholder. However, the decision is fully justified on the basis that the taxpayer acquired the shares not as an investment, but as a trading asset. The Court said at page 68 (D.T.C. 5325):

In my view the Freud case is directly applicable to the present situation. The shares in the hands of the partnership were not, as the defendant claims, merely of the usual and normal investment character. They were acquired for the purpose of acquiring an interest in the lands under option and in the development project, for the purpose of making a profit therefrom, either by Simlac selling its assets or by the shareholders selling their shares.

As the taxpayer was engaged in an adventure in the nature of trade, advances made to the corporation in the form of loans and loan guarantees were also fully deductible. Unlike the present appeal, Cull dealt with an isolated transaction in one piece of land and not with an ongoing business. Further, as the taxpayer intended to divest himself of his interest in the undertaking from the outset, Cull is not as closely analogous with the case at bar as the appellant has suggested.

In Cull, the Court tended to overlook the separate existence of the corporation. This would violate the basic principle of a separate corporate personality as established in the leading English case of Salomon v. Salomon & Co., [1897] A.C.

22. The subject as well covered by Christie, A.C.J., in the case of K.]. Beamish Construction Co. v. M.N.R., [1990] 2 C.T.C. 2199, 90 D.T.C. 1584. In reviewing this separate corporate entity and it being regarded in law as a legal entity with a personality of its own and quite distinct from its shareholders he quotes Pigeon, J. in the Supreme Court of Canada case of Appleby v. M.N.R., [1975] 2 S.C.R. 805, [1974] C.T.C. 693, 74 D.T.C. 6514 at 813 (C.T.C. 698, D.T.C. 6517) as follows:

Ever since Salomon v. Salomon & Co., it has been accepted that although the shares of a limited company may be beneficially owned by the same person who also manages it, its business is nevertheless in law that of a distinct entity, a legal person having its own rights and obligations. The Income Tax Act unmistakably implies that this rule holds good for tax purposes.

As counsel for the appellant's main argument is that the loss was sustained in connection with a concern in the nature of trade in which the appellant was personally involved despite the intermediary of Yocar, it is worth restating the rule that the existence of a corporation cannot be ignored so as to benefit the taxpayer when he has himself used this structure because it was advantageous to him at the time. Reference may be made in this regard to the Supreme Court of Canada judgment in Kosmopoulos v. Constitution Insurance Inc., [1987] 1 S.C.R. 2, 34 D.L.R. (4th) 208, in which Wilson, J. said at page 10 (S.C.R.) :

As a general rule a corporation is a legal entity distinct from its shareholders: Solomon v. Solomon & Co., [1897] A.C. 22 (H.L.) The law on when a court may disregard this principle by “ lifting the corporate veil” and regarding the company as a mere "agent" or" puppet" of its controlling shareholder or parent corporation follows no consistent principle. The best that can be said is that the "separate entities” principle is not enforced when it would yield a result “too flagrantly opposed to justice, convenience or the interests of the Revenue": L.C.B. Gower, Modem Company Law (4th ed. 1979), at page 112.

There is a persuasive argument that “those who have chosen the benefits of incorporation must bear the corresponding burdens, so that if the veil is to be lifted at all that should only be done in the interests of third parties who would otherwise suffer as a result of that choice": Cower, supra, at page 138.

Citing these remarks in Lachapelle, supra, at page 2402 (D.T.C. 1879), Judge Brulé of this Court adds the following comment by Prof. Bruce Welling in his text Corporate Law in Canada—The Governing Principles (1984), at page 140:

It is still common in Canada to see judges speaking, obiter, of "piercing the corporate veil" despite warnings from high authority that this is not a permissible practice. Perhaps this terminology can now be laid to rest as the C.B.C.A. type of statutes have come into force in most Canadian jurisdictions. We now are in a situation whereby most corporate statutes specifically state that corporations have the rights of natural persons and also provide that the issue of a certificate of incorporation is to be taken as conclusive evidence that the corporation has come into existence. It therefore seems clearly arguable on a statutory basis, as well as through refinance on Solomon's case, that judges simply do not nave the power to ignore the separate existence of a corporation in the name of some unarticulated notion of justice and fair play.

Accordingly, it does not seem proper based on the foregoing to accept the argument that the appellant himself was personally involved in a concern in the nature of trade when the shares of the capital stock of Satelcom were purchased by Yocar and not by himself, despite the fact that he held an option to purchase it for one dollar. Whatever might have been the eventual result of the sale of the shares of the capital stock of Satelcom, a capital gain or business income, it would probably have been taxed in the hands of the owner of the shares, namely Yocar. I cannot ignore the existence of Yocar and lift the corporate veil. Further, no evidence was presented that Yocar was the appellant's nominee. Accordingly, I cannot ascribe the Yocar concern in the nature of trade to the appellant. As to the option held by the appellant, it was not exercised and one cannot claim to ascribe legal consequences to a transaction which was not completed. The approach taken in Freud, supra, Becker, supra, and Cull, supra, therefore cannot be followed in the instant case. As the loss sustained by the appellant cannot be treated as a wholly deductible business loss, the respondent was right to treat it as a business investment loss.

The appeal is therefore allowed as to the deduction of the expenses of the home office in 1986. The appellant is not entitled to any other relief for 1986 and 1987.

As the appellant was largely unsuccessful on his appeal for 1986, no costs are awarded.

Appeal allowed in part.