Sidney John Becker v. Her Majesty the Queen, [1981] CTC 184

Marceau, J:—In filing his tax return for the 1976 taxation year, relying on sections 3 and 9, on paragraph 18(1 )(a) and on section 111 of the Income Tax Act (SC 1970-71-72, c 63, as amended), the plaintiff claimed a deduction of $434,276.55—part of which was to be carried back and applied to the preceding year—with respect to a business loss allegedly sustained by him during the year. The deduction was disallowed, and the reassessments issued accordingly were later confirmed by the Minister, on the ground that the loss sustained by the taxpayer was not a business loss but a capital loss within the meaning of paragraph 38(b) of the Act, as a consequence of which a maximum deduction of $1,000 for each of the two years was allowable in accordance with the provisions of subparagraph 3(e)(ii). This is an appeal directly to this Court from the confirmed reassessments.

There is no dispute as to the amount of the loss or as to the time when it was incurred; the issue is the so often raised one of the nature of the loss for the purposes of the Income Tax Act: was the loss on account of business or of capital? The question of course can only be determined on the basis of the facts of the case; they can be briefly stated as follows.

The plaintiff, a Montrealer, graduated from McGill University with a mechanical engineering diploma in 1938, and soon joined the company his father had founded in 1918, JJ Becker Inc, then a plumbing and heating contracting firm. Except for an interval of a few years during the war, between 1940 and 1944, he remained completely involved in the family business until 1963. For many years, he had been owner and president of the company which under his management had evolved into a large and sophisticated mechanical work enterprise with over 100 full time employees, including draftmen, designers and engineers, capable of undertaking major construction projects in all their technical aspects. But, in the early 60’s, he had started thinking that “the future for me in the contracting business was not the way I wanted to go’’, and he had come to the decision to try and sell his company. In 1963, he disposed of his entire interest in the company.

It is at this time, when the question of “where do I go from here’’ (examination for discovery, p 15), was on his mind, that the plaintiff, then aged 47, became aware through his auditor that a lumber company, located in Newcastle, New Brunswick, could be the subject of an interesting deal. The company was called British Canadian Pitwood Ltd (to which I will refer hereinafter, for convenience, as BCP Ltd). It had been in business since 1938 operating a mill, first specializing in the export of pulp and pitwood an later becoming involved in the sale of green wood, mostly to the United Kingdom market. Mr Cleland, the owner of the company, had mechanized his operation in 1961, which had required the borrowing of large sums of money, and in the following winter a fire had broken out destroying the installation without the insurance policy proceeds being sufficient to cover the whole loss. The mill had been rebuilt but then the bank had refused to renew the company’s line of credit. Faced with no working capital and no machinery, Mr Cleland had been forced to resort, for the sawing of his logs of which he had ample reserve, to jobbers who could provide the machinery and manpower. BCP Ltd was therefore in 1963, when the plaintiff first heard about it, in a very precarious financial situation and its owner could hardly refuse to consider a valuable deal.

Such a deal immediately appealed to the entrepreneur’s instinct of the plaintiff. On the one hand, the company had, it seemed, a “tremendous potential” in view of its location and its access to a steady supply of logs. On the other hand, through various previous business contacts, the plaintiff had become very much interested in the lumber industry. One of his customers, a manufacturer of vans, coils and air conditioning equipment, had put on the market a special patented type of lumber “dry kiln” (a “kiln” being a sort of a large drying room in which heated air is circulated through the lumber to dry it properly and prevent it from warping and twisting after being manufactured and used), and his company had on various occasions been hired to make designs for the installation of the equipment. The plaintiff had been led to wonder why the whole process involved in the preparation of lumber for manufacturing use was divided in practice and done at different locations, with the manufacturers being forced themselves to take care of the necessary drying of the wood, which involved much manipulation, transportation and costs that could otherwise be avoided, and he had devised a plan to integrate the various operations required to bring the raw material to a finished product right at the site of the sawmill. The possibility to put into practice his idea was presenting itself in what appeared to be an ideal context.

The takeover was soon realized. On December 23, 1963, the plaintiff acquired 90% of the shares in BCP Ltd for $1 and other considerations, the latter being the payment of the company’s liabilities up to an amount of $160,000. Mr Cleland remained the holder of the balance of the shares and accepted to provide the on-site management in exchange for a salary and 10% of the profits.

The renovation started immediately and in spite of the fact that Mr Cleland unfortunately died suddenly in the middle of 1974, the implementation of the “integration concept” was put forward. A new building was erected for the kilns and the processing material; the additions required to put the whole operation indoor were installed; the head office was transferred to Montreal; a new trade mark was registered; a marketing programme to attract customers and open up a market for finished wood parts was set up. In 1968, the renovated integrated plant was in full operation; a profit was realized for the year. In 1969, however, some difficulties loomed out on the horizon: the company’s main furnisher of logs, Fraser Companies Ltd, started to show reluctance in providing it with adequate supplies. The following year, the difficulties took clearer shape with the coming into power of a conservative government with less cooperative policies towards the operation of the sawmills. Finally, when Fraser Companies Ltd sold their mill to an American Corporation which refused to follow its predecessor’s policies, the difficulties became quite real: the supply of logs began to shrink. Between 1969 and 1976, BCP Ltd’s production kept declining because of lack of raw material and naturally its financial situation became more and more precarious. In 1976, the Industrial Development Bank to which the company was indebted lost faith in the future of the enterprise and decided to exercise upon its securities, placing the assets up for sale. BCP Ltd’s operation had ceased to exist.

From 1963 to 1976, apart from the $160,000 of the company’s debt he had agreed to pay as a consideration for the acquisition of the shares (which amount was later converted into preferred shares), the plaintiff had guaranteed advances made to BCP Ltd and had made himself interestbearing loans to the company with a view to providing it with the money required to implement its innovation programme and improve its working capital. With the collapse of the operation, it became evident to the plaintiff that he would never be reimbursed. It is the aggregate amount of the advances so made and loans so guaranteed, an amount as indicated above of $434,276.55, that the plaintiff treated, in his 1976 tax return, as business loss deductible from his income.

These are, broadly stated, the main facts on the basis of which the question raised by this appeal must be determined.

The plaintiff raises two grounds of appeal against the Minister’s assumptions that the advances and loans guarantees were not made in the course of carrying on a business and were on account of capital. They are set forth in paragraphs 3, 4 and 5 of his declaration:

3. The purpose of plaintiff in acquiring the shares of British Canadian Pitwood, in making loans to it and in guaranteeing loans made by third parties to the company, was to utilize the company to develop a prototype lumber mill and to sell the company at a profit.

4. It was also plaintiff’s intention that the prototype lumber mill serves as a pilot project in demonstrating the value of various engineering techniques applicable to the forest industry.

5. In demonstrating the value of various engineering techniques applicable to the forest industry, plaintiff also expected to enhance his reputation as a professional engineer with the direct result of increasing his income.

The two grounds are not contradictory, but, of course, they must be dealt with separately since they imply different reasoning and require different approaches to the facts of the case.

1—The submission in support of the first ground of appeal may be put simply as follows. It is well established, it is said, that, as a result of the inclusion of the term “adventure or concern in nature of trade’’ in the definition of business as used in sections 3 and 9 of the Act, a single transaction, however isolated it was and whatever its subject matter was, may be characterized as a business venture for the purposes of the Income Tax Act. The subject matter of the transaction here was the acquisition of the shares and the advances made to the company to renovate its plant, and it is this whole transaction that must be considered. Now, goes on the argument, the principles to be applied in order to determine whether a particular transaction was entered into in the course of an adventure in nature of trade or whether it was entered into as an investment have been laid down in various cases Starting with MNR v Taylor, [1956] CTC 189; 56 DTC 1125. What must be considered is the intention of the taxpayer when he entered into the transaction: if that intention was to make a profit from the resale of the property acquired, the transaction is to be treated as an “adventure in nature of trade’’. The intention of the plaintiff here, it is contented, can be drawn from his testimony: when he purchased the company and lent it money, his intention was to put into practice the new concept he had devised for the operation of a sawmill, to prove its profit earning capacity, and then to sell it. The plaintiff was established in Montreal, he had other concerns in Montreal and he did not envisage his moving from Montreal and settling down in Newcastle. His idea was not to keep the operation beyond the time required to build it up, make it profitable and attract a buyer. If we accept the plaintiff’s testimony, concludes counsel, and there is no reason to disbelieve it, the transaction must be seen as having been “an adventure in nature of trade”, in like manner as those comparable transactions found to have been trading operations in some previous cases, especially MNR v Freud, [1968] CTC 438; 68 DTC 5279.

The reasoning may appear attractive but it falls short of convincing me. Its weakness lies in the use of the word “intention” without proper qualification. When it is said that the intention of the taxpayer when entering into an isolated transaction may give the operation the essential ingredient of a business venture for the purposes of the Income Tax Act, the intention referred to is the motivating intention, the immediate and prevailing purpose or at least one of the immediate and dominant purposes for which the act is done. I accept the plaintiff’s statement that it was his intention to transform the company, make it profitable and eventually sell it at a profit. But the intention of eventually disposing of the company at a profit was not, insofar as I can appreciate the situation, the motivating factor or one of the motivating factors that led him to invest into BCP Ltd. The plaintiff’s personality, his entrepreneurial skill and desire, and his whole course of conduct following the acquisition appear to me inconsistent with the view that his immediate purpose was to speculate. The statement of Martland, J in Irrigation Industries Ltd v MNR, [1962] CTC 215; 62 DTC 1131, applies here perfectly:

In my opinion, a person who puts money into a business enterprise by the purchase of the shares of the company on an isolated occasion, and not as part of his regular business, cannot be said to have engaged in an adventure in the nature of trade merely because the purchase was speculative in that, at the time, he did not intend to hold the shares indefinitely but intended, if possible, to sell them at a profit as soon as he reasonably could. I think that there must be a clearer indication of trade than this before it can be said that there has been adventure and adventure in the nature of trade.

I see no such clear “indication of trade” in the circumstances of this case contrary to what was seen in MNR v Freud (referred to above), the Supreme Court decision specifically relied on by counsel. In the Freud case, the lending of money to a company set up by the taxpayer was the subject matter of the transaction which had to be characterized. The taxpayer had conceived the idea of developing a special type of small car for which he thought there should be a market and he had organized the company for the purpose of developing and promoting his invention. Two passages of the reasons for judgment given by Pigeon, J for the Court should be sufficient for my purpose: the first is at 443 [5282]:

It is, of course, obvious that a loan made by a person who is not in the business of lending money is ordinarily to be considered as an investment. It is only under quite exceptional or unusual circumstances that such an operation should be considered as a speculation. However, the circumstances of the present case are quite unusual and exceptional. It is an undeniable fact that, at the outset, the operation embarked upon was an adventure in the nature of trade. It is equally clear that the character of the venture itself remained the same until it ended up in a total loss.

and the second one at 444 [5283]:

In the present case as we have seen, the basic venture was not the development of a sports car with a view to the making of a profit by going into the business of selling cars but with a view to a profit on selling the prototype. Therefore, the venture, from its inception, was not for the purpose of deriving income from an investment but for the purpose of making a profit on the resale which is characteristic of a venture in the nature of trade. Nothing indicates that the character of the operation had changed when the outlays under consideration were made.

I do not think it is necessary for me to show any further and insist upon the view that the factual situation in that case was clearly distinguishable from that in the present case.

The plaintiff has not convinced me that, when he purchased the company and later made advances to it in order to implement a transformation of its operations, he was embarking upon an operation that can be characterized as an adventure in nature of trade for the purpose of the Act.

2—The second ground of appeal will not require very lengthy remarks. Is is clear to me that it can no more succeed than the first one. In fact, although it was the only ground alleged in the original notice of objection to the assessments, counsel for the plaintiff did not insist upon it before me.

The contention is that the loss was a current expense of the plaintiff incurred for the purpose of demonstrating the value of engineering techniques applicable to the forest industry, with a view to enhancing the plaintiff’s reputation as a professional engineer and thereby increasing his income. To give a mere Starting point to a reasoning capable of supporting such a submission, it would be necessary, it seems to me, to be able to draw from the evidence that the plaintiff was already in or at least intended to enter into the business of a general practitioner in mechanical engineering or of a consultant in engineering techniques applicable to the forest industry. The evidence is to the contrary. The plaintiff has never, either before or after the transaction, practised as a consulting engineer nor has he ever done any work as a consulant to the lumber industry. Moreover, as I see it, the new “integrated concept” devised by the plaintiff for his sawmill had a lot to do with organizational and managerial skills as well as marketing abilities, but certainly not very much with engineering know-how. The contention is, to me, simply untenable.

It follows from the foregoing that the assumption of the Minister to the effect that the loss of $434,276.55 sustained by the plaintiff in 1976 in the circumstances above described was a capital loss remains unassailed. None of the grounds raised in support of the contention that the assumption was wrong has any merit. The action will therefore be dismissed.