Philip W Johnston v. Minister of National Revenue, [1983] CTC 2517, 83 DTC 456

D E Taylor:—This is an appeal heard in Toronto, Ontario, on May 16, 1983 against income tax assessments for the years 1974 and 1975 in which the Minister of National Revenue disallowed certain amounts claimed by the appellant as “business losses”. It should be noted that the original notice of appeal dealt only with the year 1974, and only one of the amounts at issue. But on agreement between the parties at the hearing, at the request of counsel for the appellant the matter was extended to include the year 1975 and the second amount at issue, based on the fact that the Minister, in filing the reply to the notice of appeal, had dealt with both amounts and was prepared to proceed with 1975.

The issue is identical in both situations — whether two amounts of $25,000 each advanced or guaranteed by the appellant in connection with the proposed production of movie or television films were business or investment losses. The first of these amounts was the appellant’s 25% share of a $100,000 bank loan guarantee made in 1972 in connection with a matter referred to at the hearing as the film “I Never Promised You A Rose Garden” (hereinafter called “Rose Garden”), which amount ($25,000) he repaid personally in 1975. The second issue was an amount of $25,000 advanced to Michael Jacot Productions Inc. (“Jacot Inc.”), allegedly in connection with the production of a series based on the life of the pirate Captain Morgan (hereinafter referred to as “Captain Morgan”).

With regard to “Rose Garden”, the appellant contended that “the property rights in the novel of the same name were taken with the clear intention of immediately selling them for profit”, and therefore “the venture was one in the nature of trade”. For “Captain Morgan”, the position was that the appellant and Mr Jacot (of Jacot Inc) set out to produce the series but were unable to complete the venture due to lack of interest by the TV networks.

The Minister contended that, for “Rose Garden”, the appellant did not intend to produce or distribute the film (if completed), nor did he intend for a profit to sell the rights to the film. With respect to “Captain Morgan”, the Minister contended that the appellant had simply provided Jacot Inc with a loan of funds (not as part of a business, but as an investment).

Mr Jacot testified regarding the efforts of the appellant and himself to sell the “Captain Morgan” idea and the proposed production to US distribution interests — primarily Columbia Broadcasting Systems (CBS). The funds (including a like amount from Jacot Inc) had been spent in pre-production and travelling. Those efforts had not been successful. Jacot’s understanding of the arrangement was that profits would be divided on a 50/50 basis with the appellant — if there had been profits. Mr Jacot filed with the Board an affidavit, the critical phrase from which in my opinion reads:

In or about the year 1974, one Philip Johnston, of the City of Toronto, in the Municipality of Metropolitan Toronto, did invest the sum of $25,000.00 in Michael Jacot Productions Inc., which sum was to be used for the scripting and pre- production of a proposed television program entitled “Captain Morgan’’.

Mr Johnston, in dealing with the “Captain Morgan” issue, noted that he had repaid the bank loan portion of his investment in 1974, and that is the reason that he deducted it in making out his tax return for that year. He had not attempted to claim directly against either Jacot Inc or Mr Jacot because neither was financially capable of paying him and, in any event, he regarded it as a business, not an investment loss. With regard to “Rose Garden”, Mr Johnston filed with the Board an agreement dated August 10, 1972 (Exhibit A-3) between himself and three others, detailing the arrangements for the acquisition by a corporation known as Motion Picture Investment and Management Limited (“M.P.I.M.”) of the rights and title to “Rose Garden” (referred to as “The Property”). The agreement noted also that the four “partners” agreed to the obligation of the $100,000 above for the rights. It is the appellant’s one-quarter share of that liability, eventually paid to the bank in 1975, which is at issue in this appeal. Exhibit A-3 is reproduced in its entirety:

Exhibit A-3

APPENDIX “A”

Auust 10,1972

Motion Picture Investments

and Management Limited,

c/o Zimmerman & Winters,

199 Bay Street,

Toronto 116, Ontario.

Dear Sirs:

We understand that Motion Picture Investment and Management Limited (‘MPIM’) a corporation incorporated under the laws of the Province of Ontario has the opportunity of purchasing the right, title and interest of Columbia Pictures in a certain novel entitled “I Never Promised You A Rose Garden” written by Joanne Greenberg and a screenplay based upon the said novel written by Lewis John Carlino, said novel and screenplay being hereinafter referred to as the “Property”.

We understand that MPIM intends to produce a motion picture based on the Property.

We understand that as partial consideration for acquiring the right, title and interest in the Property, MPIM must pay $100,000 upon the execution and delivery of the contract of purchase and sale of the Property between MPIM and Columbia Pictures.

In consideration of each of us receiving 1% of the producer’s share in the profits of the motion picture to be produced based upon the Property we each agree to execute a promissory note with the Canadian Imperial Bank of Commerce in the principal amount of $100,000 to be used for the purpose of acquiring the rights, title and interest in the Property. We further agree to execute a contract of purchase and sale of the Property with Columbia Pictures. Any monies raised by MPIM for the financing of the production of the motion picture to be based upon the Property will be used firstly to purchase the Property from the undersigned and we covenant and agree to deliver the Property to MPIM upon the discharge of the debt in the amount of $100,000 plus interest with the Canadian Imperial Bank of Commerce. We further agree not to sell, assign or transfer the right, title and interest in the Property to any individual or corporation other than MPIM.

It is understood and agreed by us that Canavest House Limited shall have the exclusive right to raise the necessary monies to produce the motion picture based upon the Property on behalf of MPIM for a period of sixty days following the execution and delivery of a formal agreement between MPIM and Canavest House Limited setting out the roles of MPIM and Canavest House Limited and the profit participation of each in the proposed motion picture.

MPIM shall have the exclusive right to produce the motion picture based upon the Property and we agree to hold the Property in escrow on behalf of MPIM until MPIM repays the loan of $100,000 to the Canadian Imperial Bank of Commerce, or February 28, 1973, whichever is the earlier.

If the foregoing is in accordance with the understanding between MPIM and ourselves, kindly sign the second copy of this letter as an acknowledgement of same.

Yours very truly,

SIGNED, SEALED AND DELIVERED

in the presence of: )

)

(Signature)	)	(Signature)
	)
Witness	)	George Vilim
	)
	)
(Signature)	)	(Signature)
	)
Witness	)	Gordon Ball
	)
	)
(Signature)	)	(Signature)
	)
Witness	)	Terry Dene
	)
	)
(Signature)	)	(Signature)
Witness	)	Philip Johnston
	)
	)

AGREED AND ACKNOWLEDGED this 30th day of August, 1974.

Motion Picture Investments and Management Ltd.,

(Signature)

Terry Dene, President.

I would simply comment on the odd situation which portrays Exhibit A-3 as being prepared in 1972 but signed by MPIM in 1974. Counsel for the respondent also commented on this point but it was not pursued at length.

The appellant noted that he had no proprietary interest in MPIM but, at the time, he provided legal services to the company. Another document (Exhibit A-4) (from Columbia Pictures, Hollywood, California) was filed in which the cost of the transfer of the said rights to “Rose Garden” are shown at $250,000, of which the $100,000 above was to be the first payment. The cost also included an obligation to Columbia for 12 /2% of the net profits from the film. At least one phrase from Exhibit A-4 is critical to my understanding of this matter:

Notwithstanding any of the provisions of this agreement to the contrary you hereby expressly acknowledge and agree that if you shall default in the payment of any moneys provided to be paid in Subdivision (a) of Paragraph 6 hereof all of the right, title and interest hereby transferred and assigned to you shall revert to the undersigned and you shall have no further right, title or interest in, to or with respect to the Property nor shall you have the right to recover any amount theretofore paid by you pursuant hereto.

Exhibit A-4 is signed individually by the four parties who also signed the $100,000 bank loan and Exhibit A-3 above, but there is no reference in Exhibit A-4 to “MPIM”. In the end result, the further payments required after the initial $100,000 were not made; efforts to arrange necessary financing failed, the $100,000 was never recovered from Columbia, and this appeal ensued.

Testimony was also given by Mr Johnston regarding some of his more successful involvement in the motion picture industry subsequent to the years under appeal. As I follow that testimony, it is not relevant to the issue before the Board — he was either receiving his remuneration in these later years for consulting services rendered by way of a percentage of the earnings of certain films, or he was simply an investor receiving his proportionate share of returns.

As I see it, the position of the appellant relative to the “Captain Morgan” issue is untenable. There is no evidence of any business arrangement between Mr Johnston and Jacot Inc, the recipient of the $25,000 advanced by him, and Mr Jacot’s testimony that there was some kind of 50/50 profit- sharing arrangement between them does not suffice. While Mr Jacot might have had the technical expertise to produce the series, it is clear he did not have the financial capability to do so. There is no indication that Mr Johnston had the technical expertise to produce or market the film, and he also lacked the financial backing to do so. The logical conclusion, in my view, is that the appellant made a loan to Jacot Inc from which he might expect interest income as on an investment. He may have had a verbal arrangement with Mr Jacot with respect to acquisition of some of the capital stock of Jacot Inc from which he could have only expected dividend income again on an investment. The limited activity of the appellant related to the prospect of interesting CBS in the production is just as easily understood as that of an investor making some attempt to salvage his investment, rather than that of a businessman actively pursuing a business goal. From any perspective, the loss of the $25,000 is on capital account.

With regard to “Rose Garden”, it was the main argument of counsel for the appellant that the intention of Mr Johnston and the three other participants was to make a profit by selling (or transferring) the property in the proposed film to MPIM — that they were only holding it “in escrow” for MPIM until MPIM paid off the bank loan. Counsel also noted that the only involvement of Mr Johnston (as one of the four participants under Exhibits A-3 and A-4) was to provide “short term financing” (the $100,000) for which the participants were to receive the “1% of the Producer’s share” noted above from Exhibit A-3. The appellant’s contention is that this was a venture in the nature of trade — a business — that the 1% return from MPIM was the potential source of earning to which he can point.

Neither the prospective role for MPIM nor its ability to carry out any task such as that described for it in Exhibit A-3 (supra) has been clearly defined for the Board. Nevertheless, the “bona tides” of Exhibit A-3 was not challenged by the Minister and it must be accepted by the Board although there are some conflicting elements within the document. The four partners did acquire the property in their own right and names (originally by Exhibit A- 4), and they did not assert that they had either the intention or the expectation to produce the film themselves. Since Exhibit A-4 relates to the year 1972, and Exhibit A-3 allegedly relates to the same year, this particular appellant’s expertise in the production and distribution of films was not greater in 1972 than it was two years later when the “Captain Morgan” episode began. As I see it, these four participants had only one avenue to pursue, and that was disposition of the property, and only one direction for such disposition — to MPIM. When that failed, their scheme failed, and they lost their money. I recognize that the four partners’ rights to transfer or sell the property were strictly circumscribed by Exhibit A-4, but the Minister has not contended that such sale or transfer to MPIM was impractical or impossible. I can only assume that in the event of such a sale to MPIM, MPIM would have taken over the balance of the obligation to Columbia.

It is interesting to consider what might have been the position of the respondent if the proposed sale to MPIM had gone through as intended. It is quite possible to believe that the Minister would have regarded the 1% return to the appellant as a gain or profit from the sale of a property — a return on the disposition of an asset acquired for the sole purpose of sale — a business purpose clearly. The appellant under that theoretical set of circumstances might attempt to argue the merits of considering the gain as on capital account — the disposition of a capital property, but it is highly unlikely that the Minister would have been easily so persuaded — given the known existence and validity of Exhibit A-3, which the Minister could then interpret precisely as the appellant is doing now.

The Board is persuaded that the testimony and evidence support the contention of counsel for the appellant that the loss of the amount paid to Columbia by the appellant ($25,000) was on income account, and should be considered a business loss. It is the Board’s understanding that the appellant claimed this as a loss in the year 1975, and may have some desire, even some right, to consider it as a loss related to a different taxation year. However, that point was not argued before the Board at the hearing.

The decision of the Board, therefore, is that the portion of the appeal on the loss incurred by the taxpayer with regard to the “Rose Garden” film is allowed as claimed in the year 1975, but the portion of the appeal for the loss related to the “Captain Morgan” issue is dismissed. The matter is referred back to the respondent for reconsideration and reassessment in accordance with the foregoing reasons for decision.

Appeal allowed in part.