Ellaman Holdings Inc. v. Minister of National Revenue, [1987] 2 CTC 2162, 87 DTC 480

Sarchuk, T.C.J.: —Ellaman Holdings Inc. (Ellaman) appeals with respect to a reassessment of tax for its 1980 taxation year. The appellant is a corporation incorporated under the laws of the Province of Ontario. It contends that in the 1980 taxation year its business activities consisted of two separate components, the first being the sale of stationery and supplies to schools and commercial institutions, which business was carried on under the trade name Canadian Envelope & Stationery House, and the second being a mortgage brokerage business.

In computing its income for the 1980 taxation year, the appellant deducted, pursuant to the provisions of subsection 125(1) of the Income Tax Act, an amount of $46,464 as a loss from an active business, that being from its mortgage business, and further claimed as a deduction from income the amount of $97,010 in respect of a reserve for doubtful debts within the meaning of paragraph 20(1)(l) of the Income Tax Act.

The respondent in reassessing tax to the appellant for the 1980 taxation year disallowed the loss of $46,464 in the computation of the appellant's income from an active business and attributed such loss to the Canadian investment income of the appellant. Furthermore, the respondent disallowed the deduction of $97,010 sought by the appellant as a reserve for doubtful debts.

A short summary of the nature of Ellaman's business is warranted. The appellant was incorporated July 4,1978 with a fiscal period ending June 30. Mr. Emanuel Scheinman (Scheinman) was at all material times the sole shareholder and president. Since 1935 Scheinman had carried on a stationery jobbing business as a sole proprietorship under the business name of Canadian Envelope. Over the years the business developed and from approximately 1950 Canadian Envelope quoted only on school board tenders and such larger commercial purchasers as Hydro and City of Toronto. It maintained an office and warehouse on Queen Street in Toronto until 1968 when those premises were sold and the offices were relocated in Schein- man's residence. On June 30, 1978 the appellant purchased from Scheinman the business of Canadian Envelope, which business continued to be operated from Scheinman's residence. Concurrently Ellaman purchased 16 mortgages of the aggregate face value of $845,688 from Scheinman. Eight of these mortgages are the subject matter of this appeal.

Scheinman testified that throughout the years he made personal investments in mortgages utilizing the profits earned by the stationery business and other funds. In this activity he was involved with a Toronto lawyer Mr. Manning H. Roebuck (Roebuck). It was his custom to investigate the properties in the company of Roebuck. He also examined the financial statements where applicable to determine what amount of money the owners themselves had invested. He alleged that it was on the basis of his own investigations that he decided whether or not to lend money on the strength of a mortgage.

An analysis of the mortgages acquired by the appellant from Scheinman, and in particular the eight which form the basis for the claimed deductions, discloses a number of similarities. In each case Scheinman was but one of a number of investors who acquired an interest in a second mortgage. In each case the mortgage was arranged by Roebuck. A borrower would approach Roebuck who would then endeavour to find a sufficient number of individuals interested in that investment. Having found such investors Roebuck would then act as trustee for those individuals. The mortgage was taken in his name as trustee and he was responsible for the administration of the mortgage, the collection of the payments and the distribution of the proceeds to the various investors. When a problem arose it was Roebuck's responsibility to look into it and to resolve it. Furthermore in each instance Roebuck personally guaranteed, in writing, the payment of principal and interest to each investor.

According to the evidence, this had been the practice almost invariably followed by Scheinman in the years immediately preceding the purchase of the portfolio by the appellant. No changes in this practice appear to have been contemplated by Ellaman following the purchase and as matters turned out no further investments were made by Ellaman.

The eight mortgages sold by Scheinman to Ellaman were in good standing at the time of the sale. In the early summer of 1979 they began to go into default. Scheinman maintained that he spent considerable time attempting to determine whether or not any recovery could be made. He testified that he met with accountants and Roebuck to investigate and discuss the possibility of recovery. Just when these meetings took place is unclear.

Roebuck testified as to the ultimate disposition of each of the mortgages. There was no recovery on five of the eight mortgages. Several were lost to the first mortgagee. Several law suits were commenced but in two instances further action against the mortgagors was considered to be pointless. In two cases settlements amounting to 49 cents on the dollar were eventually negotiated and in another instance there was an 80 per cent recovery. Roebuck expressed the view that the mortgages were uncollectible in the appellant's 1980 taxation year, that is as at July 30, 1980.

Mr. Scheinman testified that Roebuck was a business colleague and friend. He stated that the appellant took no steps whatsoever to require Roebuck to honour his guarantee and conceded that the close relationship between them was one of the reasons why such steps were not taken. With respect to the personal guarantees given, Roebuck admitted that after the various mortgages began to go into default in the late summer of 1979 a number of investors commenced legal proceedings against him. Some eventually obtained judgments. Ellaman did not take any action itself, nor did it participate in any of the other suits launched.

With respect to payment on these judgments Roebuck testified:

Q. And have you been able to satisfy those judgments?

A. Well, as I got in fees, as I went along, and as I was able to collect a little money here or there, I made sure that the elderly women and the widows got their money back as quickly as I possibly could give them, and I believe I satisfied about 80 per cent of the people that put their life savings with Manning Roebuck, that got it back. The richer people didn't get it back.

One must assume that Ellaman was one of the “richer people” not considered eligible to receive any payment.

At some point of time following the defaults legal proceedings were instituted by Roebuck on behalf of the investors against several mortgagors on their covenants. Roebuck carried on these actions until December 3, 1981 when by way of a court order he was removed as trustee with respect to at least two of the mortgages in issue. The evidence of Scheinman and Roebuck regarding the status of remaining mortgages was not particularly clear but it does appear that legal proceedings were pursued either by Roebuck or others and judgments obtained. The settlements previously referred to were not finalized until 1984.

I am not at all satisfied that the mortgages in issue can properly be characterized as "bad debts" as that term is used in paragraph 20(1)(i) [sic] of the Income Tax Act.

The Income Tax Act does not define a bad debt. A debt is generally recognized to be bad when it has been proven uncollectible in the year. It has been said that a bad debt is a debt which the creditor, after having personally considered the relevant factors in so far as they are applicable to each particular debt, honestly and reasonably determines to be uncollectible at the end of the fiscal year when the determination is required to be made. To accept the evidence of an individual asserting the existence of a bad debt, the court must be convinced from that evidence that the taxpayer

in question has acted honestly and on sound general principles: Geoffrey Hogan v. M.N.R., 15 Tax A.B.C. 1; 56 D.T.C. 183; Leonidas Roy v. M.N.R., 20 Tax A.B.C. 385; 58 D.T.C. 676.

It is appropriate at this point to comment on certain evidence elicited from Roebuck and Scheinman which, in my view, seriously casts doubt on their assertions.

On December 15, 1979 an agreement was entered into by Roebuck and Scheinman (Ex. R-3). On the face of it this was an agreement by Roebuck to sell to Scheinman an undivided 20 per cent interest in an apartment complex located in Florida for the sum of $200,000. On January 9, 1980 Roebuck and Scheinman executed a warranty deed by virtue of which Roebuck, in consideration of the sum of $200,000, conveyed his undivided 20 per cent interest in the Florida property to Scheinman. On that same date a cheque in the amount of $200,000 drawn on the account of Ellaman Holdings Inc. was paid to Roebuck. Also on the same date Scheinman executed a promissory note in favour of Manning H. Roebuck, trustee, in the sum of $200,000. With respect to these transactions Scheinman testified:

BY MR. TEMPLETON:

Q. And you were explaining this cheque?

A. My relationship with this property is only as a trustee.

Q. I'm sorry — your relationship with the property . . .?

A. Is as a trustee.

Q. As a trustee for whom? That shouldn't be a difficult question, Sir.

A. The fact of it is, I honestly don't know.

HIS HONOUR: I'm sorry?

THE WITNESS: I’m advising Manny Roebuck about it, what is going on down there; he knows what's going on down there.

BY MR. TEMPLETON:

Q. You're a trustee, but you don't know who you're a trustee for?

A. Not exactly. He asked me to take this property over as a trustee.

Q. I see. Well, why would you be paying him $200,000 — giving him a promissory note for $200,000 — if you're just taking it over as a trustee?

Sir, this is a fairly significant amount of money, $200,000. You're giving a person a promise to pay $200,000. Surely the facts surrounding that promise to pay cannot be that remote?

A. Well now, what is your question again?

Q. The question is — question one: why are you giving Manny Roebuck a promissory note for $200,000?

A. That was in 1980?

Q. Yes. Was it not for money Manny Roebuck gave you — $200,000 that he gave you?

A. It must have been if I gave him a promissory note.

Q. Now there's a cheque for $200,000 to Manny Roebuck. What's that for?

A. That was what I used in order to have this trusteeship, whatever you term the thing, in this Canterbury property.

Scheinman's testimony does little to explain this peculiar transaction.

Roebuck was also cross-examined about these events. It would be most difficult to summarize the extended and convoluted explanation offered by him. It included an allegation that the promissory note was "never used"; that the "note was of no value and should have been torn up" and that "the agreement (Ex. R-3) never took effect. He (Scheinman) just held it as trustee for them (Roebuck family trusts). The deal never went through. He (Scheinman) didn't like the property." It was Roebuck's evidence that even though this agreement was “signed and sealed" the transaction never took place.

His explanations with respect to the source of the funds and the alleged family trusts were as follows:

Q. In late 1979, December 1979 or early 1980, you made an interest-free loan to Mr. Scheinman in the amount of about $200,000?

A. Not that I remember, no.

Q. I'm showing you a copy of a document, Exhibit R-1. It's a promissory note from Mr. Scheinman in the amount of $200,000.

A. There's some property in the States, if I remember correctly, that's what it is.

HIS HONOUR: There's some property in the States?

THE WITNESS: Yes. That I held as trustee, as I took all mortgages as trustee, on behalf of the family trust, my brother's trust and the family trust, my sisters trust.

HIS HONOUR: On behalf of your family’s trust?

THE WITNESS: My brother's family trust, my family trust, and my sisters family trust.

And they became dissatisfied, because they also lost money on my investments during that time, and they wanted the property taken out of my name as trustee, so they wanted Mr. Scheinman, who they had a lot of confidence in, to take over, because they always found him very honest, and he decided to take it over. But as I believe, if my recollection serves me correctly, it’s rather hard to remember these things — I had about $200,000 invested in it to the trust, which I loaned the trust in order to carry that property, and I wanted my $200,000 back, so the family says, in view of the fact I owe them a lot of money that they lost, "I'll give you a note for it”, and they authorized Scheinman to give me the note.

They then turned around and said: “No, we won't give you the note”, and they put Mr. Scheinman in funds of $200,000 to give me a cheque to pay me out my investment, and that money went into my general account to pay my debts at that time.

Q. And the source of those funds was from the family trust?

A. The family trust, yes.

Q. So the family trust gave Mr. Scheinman $200,000?

A. Yes. To keep the record straight, I had $200,000 in it, and I wanted my $200,000 back, because I needed the money to pay my debts.

THE WITNESS: They put Mr. Scheinman in funds of $200,000 as trustee, to give it to me to pay my debts. They owed me. They owed it to me and I used it to pay my debts.

BY MR. TEMPLETON:

Q. Why would the family trust benefit Mr. Scheinman $200,000?

A. They didn't benefit him. He was only the trustee, and I wanted my $200,000 back from them, and they co-operated and they gave him the $200,000 to give to me.

Q. And he got the property?

A. He hasn't got the property, it belongs to the family trust. It's money owed to me. He's only the bare trustee.

Q. Well, if he's only a bare trustee, why is he paying you $200,000?

A. He didn't pay it. He got the money from the family trust to give to me.

Q. Why didn't the family trust pay it to you?

A. Because they wanted me off the hook there. They wanted me to sign off and I wanted my money back, I needed the money.

Although Roebuck received a cheque in the sum of $200,000 drawn on the account of Ellaman, no evidence was adduced substantiating the payment to Scheinman (or to Ellaman) of the sum of $200,000 by the trust as alleged by Roebuck. Nor is there any evidence that Scheinman was indeed a bare trustee of the property transferred to him by Roebuck.

With respect to the sale agreement of December 15, 1979 (Ex. R-3) Roebuck stated:

A. It never took effect. He just held it as trustee for them. The deal never went through. He didn't like the property.

Q. Your evidence is indicating that even though that document is signed and apparently sealed, it never took place?

A. That's right.

One might wonder how Scheinman's dislike of the property would be relevant if he were only a trustee, holding the land for some other person.

In so far as the Warranty Deed (Ex. R-4) was concerned the following exchange took place between counsel and Roebuck:

Q. All right. I'm showing you another copy of another document called a Warranty Deed. It says: "This indenture made this 9th day of January, 1980 by and between Manning Harold Roebuck . . .” — that's you?

A. That's right — as trustee.

Q. It doesn't say ”. . . as trustee", does it, on this document?

A. No, but I am trustee. The books will show that the money came from the States.

No such evidence was adduced. There is no reference in Exhibits R-3 and R-4 to Roebuck's alleged trusteeship, nor in fact do these documents support the assertions that Scheinman acquired the property as trustee. It should be noted that Roebuck is a lawyer by profession and was the person responsible for drafting the two documents, each of which describes his interest in the property sold to Scheinman as an “undivided 20% interest".

The appellant Ellaman was involved in some fashion in this transaction. No explanation of its involvement was offered. These events took place during the same period of time that Ellaman's co-investors were pressing Roebuck for some payment on his guarantees, actions in which Ellaman chose not to participate for whatever reason.

It is not necessary to speculate as to the real purpose of these transactions. It is sufficient to state that the explanations advanced by Scheinman and Roebuck were, to put it simply, implausible. Scheinman's failure to recollect the details of the Florida transaction was, in the circumstances, unreasonable. Roebuck for his part was not a credible witness. He was less than forthright in his responses and his answers were all too often evasive and in my view deliberately imprecise. His general demeanour throughout was such as to suggest untruthfulness.

The nature of the relationship between Scheinman and Roebuck casts substantial doubt upon the appellant's contention that it carefully assessed the circumstances and reasonably concluded that it would not be worthwhile to take any action to recover its losses from Roebuck on his personal guarantee, and puts into serious question the basis upon which the appellant made the “bad debt” determination in the taxation year in issue.

In this appeal it was also necessary for the appellant to establish that the debts in issue arose from loans made in the ordinary course of the appellant's business and that part of its ordinary business includes the lending of money. It was contended on behalf of the appellant that the acquisition of the 16 mortgages from Scheinman was consistent with the objects for which it was incorporated which provided, inter alia, that it has the right to buy, sell and deal in mortgages. It was further contended that had it not been for a sudden change in market conditions, the appellant would have continued to buy, sell and deal in mortgages.

The respondent for his part contends that the holding of mortgages by the appellant did not constitute the carrying on of the business of money lending or a business of any other kind, with the consequence that any loss suffered as a result of such holding is not to be deducted in the computation of income from an active business within the meaning of subsection 125(1) of the Income Tax Act. Furthermore, the respondent contended that the appellant did not carry on the business of money lending in the relevant taxation year, and accordingly no amount in respect of a reserve for doubtful debts within the meaning of paragraph 20(1)(l) of the Income Tax Act may be deducted in computing the appellant's income for the 1980 taxation year.

In determining the nature of the appellant's activities its course of conduct over an extended period of time is, in the usual course, relevant. In the case at bar such evidence is not available because prior to June 30, 1978 the mortgage portfolio belonged to Scheinman. On the other hand, there was absolutely no change in the manner in which the mortgage portfolio was managed by Scheinman and in such circumstances Scheinman's activities prior to the "roll-over" are a factor which may be considered in determining whether it can be concluded that Ellaman was carrying on the business of money lending. In fact counsel for the appellant adduced a good deal of evidence from Scheinman as to his management of the mortgage portfolio in prior years in an effort to support Ellaman's position on this issue.

On the evidence before me I have concluded that Scheinman's activities cannot be categorized as a money lending business. In Litchfield v. Dreyfus, [1906] 1 K.B. 584 at 589 Farwell, J. said:

But not every man who lends money at interest carries on the business of money lending. Speaking generally, a man who carries on a money lending business is one who is ready and willing to lend to all and sundry, provided that they are from his point of view eligible . . . it is a question of fact in each case.

In all instances the mortgages held by Scheinman in the years immediately preceding the “roll-over” were participations in mortgages, the trustee and broker of which was Roebuck, a close friend of Scheinman. The appraisal of properties and the initial evaluation of risk with respect to each investment as well as the search for new investors was done by Roebuck. The mortgages were personally guaranteed by Roebuck. The usual source of moneys to finance Scheinman's purchase of these participation mortgages was profit from Scheinman's envelope business. There was no evidence of purchasing mortgages at a discount; there was no evidence that mortgages were offered to Scheinman by real estate agents or that he solicited such offers. In my view the manner in which Scheinman attended to his mortgage portfolio was consistent with the investment of surplus funds to derive income from property. There is nothing in the evidence to justify a conclusion that Scheinman was carrying on business as a money lender.

This conclusion per se does not necessarily lead to a finding that Ellaman was not carrying on the business of money lending. It is but one factor to be considered. As previously noted there was no change whatsoever in the nature of the transactions after the “roll-over” of the mortgage portfolio to Ellaman. No new activity took place and no steps were taken by Ellaman to hold itself out as a money lender ready to lend to eligible borrowers. While that may have been, in part, the result of an unfavourable economic climate, that hardly seems to be the entire reason. The evidence discloses that the mortgagors, with one exception, did not commence to default on their payments until the period April to August 1979. In fact Scheinman testified that it was in the late summer of 1979, as he recalled, "when a lot of these mortgages went into default”. The absence of any lending activity in the first year following the acquisition of the mortgage portfolio cannot be solely attributed to the events of 1979 as suggested by the appellant. The appellant, in my view, did not conduct its management of this portfolio as a money lending would. It did not have any commercial organization and it was not licenced or listed as a money lender. Nothing in the evidence justifies a conclusion that the appellant was carrying on business as a money lender.

I am aware that a distinction must be made between a business activity carried on by an individual and one carried on by a corporation. If a corporation carries on the business for which it was formed it creates a presumption that the profits derived from those activities were profits derived from the business. Canadian Marconi Company v. The Queen, [1986] 2 S.C.R. 552; [1986] 2 C.T.C. 465. That presumption, however, is rebuttable and on the facts in this case has been rebutted. Let me add that I find it difficult to accept that an activity carried on by an individual, which bears none of the hallmarks of a business, becomes a business by the simple expedience of incorporation and roll-over. In any event in this appeal there is no factual basis upon which I could find that the appellant was carrying on the business of money lending.

In the alternative, counsel for the appellant submitted that the appellant is and was engaged, through the principal officer of the company, Scheinman, in the business of investing. Counsel argued that even if the Court were to find on the facts that the appellant was not engaged in the business of money lending, the evidence supported a finding that it was engaged in the investment business, a business authorized by the provisions of its articles of incorporation. In support counsel cited M.N.R. v. Kelvingrove Investments Ltd., [1974] C.T.C. 450; 74 D.T.C. 6357.

The subject of the "corporate presumption" was recently reviewed by the Supreme Court of Canada. In Canadian Marconi Company v. The Queen, supra, Wilson, J. considered the distinction between income from a business and income from property. In the course of her judgment she stated at 528-31 (C.T.C. 468-70):

It is frequently stated in both the English and Canadian case law that there is in the case of a corporate taxpayer a rebuttable presumption that income received from or generated by an activity done in pursuit of an object set out in the corporation's constating documents is income from a business.

The existence of the presumption was also noted by Locke, J. in Western Leaseholds Ltd. v. Minister of National Revenue, [1960] S.C.R. 10 and it has been applied in many subsequent cases: see, for example, Queen & Metcalfe Carpark Ltd. v. Minister of National Revenue, [1973] C.T.C. 810, 74 D.T.C. 6007 (F.C.T.D.), aff’d [1976] C.T.C. xvi (F.C.A.); Fontaine Watch Co. v. Minister of National Revenue, 60 D.T.C. 535 (T.A.B.); M.R.T. Investments Ltd. v. The Queen, [1976] 1 F.C. 126, 75 D.T.C. 5224, aff'd 76 D.T.C. 6158 (F.C.A.). Indeed, although strictly speaking not relevant to the disposition of this appeal, it is interesting to note that Revenue Canada itself affirms the existence of the rebuttable presumption: see Interpretation Bulletin IT-73R3, paragraph 2. The case law thus provides ample support for the existence of the presumption and, in my view, rightly so. An inference that income is from a business seems to be an eminently logical one to draw when a company derives income from a business activity in which it is expressly empowered to engage.

As I have indicated, the presumption that income earned by a corporate taxpayer in the exercise of its duly authorized objects is income from a business is rebuttable. For example, in Sutton Lumber and Trading Co. v. Minister of National Revenue, [1953] 2 S.C.R. 77, the appellant successfully rebutted the presumption and in Burri v. The Queen, 85 D.T.C. 5287 (F.C.T.D.), Strayer J., although questioning the existence of the presumption (pp. 5289-90), held that if such existed it was rebutted on the facts before him. The question whether particular income is income from a business or property remains a question of fact in every case. However, the fact that a particular taxpayer is a corporation is a very relevant matter to be considered because of the existence of the presumption and its implications in terms of the evidentiary burden resting on the appellant.

Madam Justice Wilson noted that the characterization of income as income from a business or income from property must be made from an examination of the taxpayer's whole course of conduct viewed in the light of Surrounding circumstances. In following this method she noted that courts have examined the number of transactions, their volume, their frequency, the turnover of the investments and the nature of the investments themselves.

I have considered all of the evidence before me. There was, in my view, minimal activity involved in acquiring the investments, and as I noted earlier in these reasons there were no other transactions after the appellant acquired the mortgage portfolio. There were no employees involved other than Scheinman and, on the face of it, it would appear as though very little of his time was required.

With respect to "the corporate presumption" Strayer, J. stated in Burri v. The Queen, [1985] 2 C.T.C. 42 at 46; 85 D.T.C. 5287 at 5289:

But it must be noted that these statements do not purport to hold that a corporation can never have income other than income from a business. They speak only of a presumption or a prima facie indication that a corporation's income is business income.

In the appeal before me the only factor supportive of the appellant's position is the existence of the power to "make an investment of any kind” included as one of the objects enumerated in its articles of incorporation. The existence of this power does not by itself afford evidence that the appellant was carrying on the business of investment. The history of its activities, brief though it was, and the manner in which this appellant and its principal before it went about earning revenue from the mortgage portfolio is not in the least conclusive of the carrying on of a business. The appellant, in my view, has failed to show that the assessment was one which ought not to have been made. The appeal is dismissed.

Appeal dismissed.