Thomas P McQuillan v. Minister of National Revenue, [1981] CTC 2657, 81 DTC 618

John B Goetz:—This is an appeal by the appellant with respect to his taxation years 1972, 1973, 1974, 1975 and 1976. The appellant claims he should have been allowed capital cost allowance commencing in his 1972 taxation year and ending in his 1976 taxation year on a certain movie film as claimed in his income tax returns from 1972 to 1976. He bases his claim on paragraph 20(1)(a) of the Income Tax Act and Class 18 Schedule II of the Income Tax Regulations.

In assessing the appellant, the respondent relied, inter alia, on sections 3, 9, 20 and 96 of the Income Tax Act, SC 1970-71-72, c 63, as amended, and upon Class 18 of section 1100 of the Income Tax Regulations and section 3 of The Limited Partnerships Act, RSO 1970, c 247. The respondent further alleges as a statement of fact that on August 15, 1972, the appellant and Pentacle VIII Productions Limited (hereinafter referred to as “Pentacle”) entered into a partnership agreement to produce a film entitled “Lies My Father Told Me”; and further that limited partners contributed $371,500 to the capitalization of the partnership of which the appellant contributed $50,000 for a 13.4589% interest in the partnership. The respondent further alleges that depreciable property, if acquired, was only acquired during the 1974 taxation year. Consequently, the sums of $76,395 and $41,701 were properly disallowed in the 1972 and 1973 taxation years pursuant to the provisions of paragraph 20(1 )(a) and subsection 96(1) of the Act. The respondent further alleges that if the total capital cost of the film to the limited partnership is more than $371,500, then the appellant’s share of the losses of the partnership should not exceed his capital contribution to the partnership during the relevant taxation years.

Facts

The appellant filed a very large number of documents composed mainly of agreements between various parties as well as financial statements of two different corporations: Pentacle statements from December 31, 1972 to 1980; and Pentimento Productions Limited (hereinafter referred to as “Penti- mento”) financial statements from 1974 to 1980 inclusive.

On August 15, 1972, a limited partnership agreement was entered into between Pentacle (the General Partner) and each person in Schedule “A” (the limited partners). There were 11 limited partners, one of whom was the appellant. Some of the terms of the agreement were:

2.3 The Limited Partners will not be liable for the debts of the Partnership beyond the amounts they contribute to the capital of the Partnership.

2.4 The General Partner will be responsible for the debts of the partnership.

As in Schedule A, the limited partners were to contribute the total sum of $371,500, of which the appellant contributed $50,000. Pentacle, according to its balance sheet as of December 31, 1972, sets out as a fixed cost for the motion picture film production of “Lies My Father Told Me” the sum of $946,027.34. According to Pentacle’s notes to financial statements for December 31, 1973:

3. The partnership signed an agreement on December 28, 1973 with Durham Productions Inc, in which Durham Productions Inc will loan $350,000 to the partnership to complete the film. (Italics mine.)

In the notes to financial statements of Pentacle for the period ending December 31, 1974, it is stated:

1. Partnership agreement

.. . Losses of the partnership are a charge against the partners in proportion to their respective capital contributions but are limited, in the case of the limited partners, to their respective capital contributions.

2. Accounting policy and presentation

No revenues have been earned to December 31, 1974 and all production costs incurred to this date have been capitalized. The cost of the film will be amortized as an expense in amounts equal to net distribution revenues received. . . .

3. Completion of film

By an agreement dated June 21, 1974 the partnership agreeed with the nominees of Pentimento Productions that Pentimento would assume responsibility for the cost of completion of the film estimated to be $350,000. .. .

In return for the assumption of the responsibility for the costs of completing the film, the partnership has agreed that Pentimento will receive the first $350,000 of the proceeds from any use of the film. (Italics mine.)

On September 7, 1972 there was an agreement entered into between Canadian Film Development Corporation and Famous Players Limited and Pentacle VIII Productions Limited, Limited Partnership, to produce “Lies My Father Told Me”. This agreement related to advances to Pentacle for the production of the film “Lies My Father Told Me” in the sum of $200,000 from Canadian Film Development Corporation and $25,000 from Famous Players. Pentacle (referred to as the “Producer”) agreed to invest $305,000 toward the production of the film. The terms of this agreement required that all moneys earned from the use of the film were to be applied in the following manner in order of priority:

(1) The Canadian Imperial Bank of Commerce up to the maximum of $100,000;

(2) The Canadian Development Corporation, Famous Players, the Producer and the completion guarantor, pro rata and pari passu, until all their advances pursuant to this agreement have been fully and finally reimbursed.

This agreement was later amended in April 1973 but has no effect on the basic facts involved.

On September 7, 1972, Pentacle entered into an agreement with Jan Kadar to produce the film. On November 1, 1973, Pentacle entered into a loan agreement with the Canadian Imperial Bank of Commerce for a loan in the aggregate of $200,000. Part of the terms of that agreement were as follows:

2. The Borrower shall use the proceeds of the Loans to finance the production of a film based on a screenplay written by Ted Allan and presently entitled “Lies My Father Told Me”.

3. .. . The Borrower (Pentacle) hereby covenants and agrees that all monies earned from the use of the Film .. . shall be applied firstly to indebtedness in respect of such advances and such interest thereon.

In this agreement the borrower (Pentacle) warranted that the limited partners had contributed at least $371,500 (Canadian) as capital and that Pentacle had received $200,000 from Canadian Film Development Corporation and the sum of $45,000 from Famous Players Limited. On page 4 of that agreement, it was further warranted that “production of the Film is now in progress’ and that it would be successfully completed out of the proceeds of the loans just referred to.

On April 18, 1974, an agreement was entered into by Arnold Schniffer and Arnold Issenman (The Nominees) and Pentacle VIII Productions Limited, among other things, to complete the film for distribution and release (the “work”). The Nominees agreed to provide an amount not exceeding $350,000 for the “work” and the payables. The Pentacle partnership agreed to pay into the Canadian Imperial Bank of Commerce in Toronto, any returns from the use of the film.

At this point in time it was recognized that there was further photography and “dubbing” to complete the production and post-production expenses totalling at least $280,000.

Columbia Picture Industry Inc, on March 25, 1975, wrote a letter which is in the form of a very long agreement addressed to Pentimento and to Pentacle wherein it is stated that Pentimento and Pentacle warranted and represented that they had substantially completed production of a coloured feature motion picture entitled “Lies My Father Told Me”. This document, in excess of 30 pages, gave Columbia, among other rights, the right to distribute, cut and re-edit the film.

On April 21, 1975, Pentacle wrote the limited partners advising that “the film is now being cutand should be in answer print form within afewdays.”.

By agreement dated April 13, 1973, between Canadian Film Development Corporation, Famous Players Limited and Pentacle VIII Productions Limited, Limited Partnership, to produce “Lies My Father Told Me”, an agreement was entered into whereby it was acknowledged that further advances of funds were required if the film was to be completed and, as a result, Famous Players advanced further sums of money for the completion of the film.

The appellant called as a witness one Carl Laywine who was a chartered accountant and acted for Pentacle. His evidence was extremely brief and he reiterated that in his view the film cost $946,027.44 and any loans were payable by the general partner (Pentacle). He stated that he had set up a capital cost schedule whereby the appellant would be able to claim a 60% capital cost allowance for the full year (1972) and forward. He mentioned that Columbia Pictures, in March 1981, remitted the sum of $419,000 in Canadian funds, which was paid to the Imperial Bank of Commerce and to other creditors. He agreed in cross-examination that Pentacle was to be paid in order to cover its debts from the proceeds of the film. He agreed that at the end of 1973 Pentacle was aware that they did not have sufficient funds to complete the film and consequently the arrangement with Pentimento.

Harry Gulkin, who was the film producer, stated that the photography was completed in November 1972, and that the film was of 125 minutes’ duration.

Jan Kadar, who was a director of a very high calibre, was very unhappy with this rough cut and would not allow the release of the film. Pentacle, having no further funds, then entered into the agreement with Pentimento referred to above.

As at December 31, 1972, the financial statements of Pentacle show the acquisition costs of the film were $946,027.34 and he set this figure up as a capital cost to be depreciated under Regulation 1100(1) Class 18, whereby “Property that is a motion picture film other than a television commercial message” can be appreciated at the rate of 60%. The accountant, as of December 31, 1972, set up a depreciation schedule for the limited partners on this basis.

In the limited partnership agreement it was clearly stated that the limited partners’ liability only extended to the amount of their individual capital contributions. Further, section 3 of chapter 237 of The Limited Partnerships Act of Ontario provides as follows:

3. General partners are jointly and severally responsible as general partners are by law, but limited partners are not liable for the debts of the partnership beyond the amounts by them contributed to the capital. (Italics mine.)

As stated above, paragraph 20(1 )(a) of the Act was relied upon by the appellant for the deduction claimed by him from 1972 to 1976 inclusive. Paragraph 20(1 )(a) reads as follows:

(1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(a) such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation;

The appellant stated that in Montreal, in December 1972, ten people viewed the film without sound, stating that the principal photography had been done but not all of it. He says: “It was not shown to the public, but there was a film.” If the appellant is to have the benefit of Regulation 1100(1) — giving him a 60% capital cost allowance on the film — it must be a motion picture film and I think that those words are quite clear that a motion picture film is something that is ready to be shown to the public. As of December 31, 1972, or in 1973, I do not feel that the appellant owned an interest in a motion picture film that could be termed a depreciable asset. Pentacle, on November 1, 1973, obtained a loan from the Canadian Imperial Bank of Commerce for the sum of $200,000 on the basis that the production of the film “is now in progress”. Further, on April 18, 1974, Pentacle entered into an agreement with Schniffer and Issenman, who were the nominees of Pentimento, for the purpose of doing additional work to complete the film. Further filming was required and the dubbing in of the music had to be done. The film was finally released for distribution in 1975.

I find that the motion picture film entitled “Lies My Father Told Me” was not completed until late 1974.

The limited partnership was established to complete the film and to do this they obtained, from Canadian Film Development Corporation, a loan in the sum of $200,000 and $25,000 from Famous Players. There were also other loans of $200,000 from the Imperial Bank of Commerce but repayment was to be made out of the proceeds of the film, which of course means that if the film made profits then the above amounts would be repaid.

In that all sums of loans advanced to Pentacle were to be repaid out of earnings, the capital cost as set out in the financial statements of Pentacle has to be tied to the actual capital contributions made by the limited partners and the balance of the loans payable was a liability contingent upon the film in fact earning profits. The obligations were then contingent upon the happening of an uncertain event and, if no profits are earned, the contingent liability does not become payable by the limited partnership.

The appellant’s only investment in the limited partnership was $50,000 and therefore his gain or loss is directly tied to that contribution as a capital investment in the limited partnership.

Counsel for the appellant cited the following cases:

Stef any k Estate v MNR, [1967] Tax ABC 834; 67 DTC 570;

MN Fl v Wardean Drilling Limited, [1969] CTC 265; 69 DTC 5194;

Her Majesty The Queen v Henuset Bros Ltd (No 1 ), [1977] CTC 227; 77 DTC 5169;

Gordon McKee v Her Majesty The Queen, [1977] CTC 491; 77 DTC 5345;

Lawrence H Mandel v Her Majesty The Queen, [1978] CTC 780; 78 DTC 5246;

C Ralph Lipper v Her Majesty The Queen, [1979] CTC 316; 79 DTC 5246;

Nahum Gelber v Her Majesty The Queen, [1980] CTC 505; 80 DTC 6359.

Counsel for the respondent cited the following cases:

Lawrence Mendel v Her Majesty The Queen, [1976] CTC 545; 76 DTC 6316;

[1978] CTC 780; 78 DTC 6518; [1980] CTC 130; 80 DTC 6148;

Gordon McKee v Her Majesty The Queen, [1977] CTC 491; 77 DTC 5345;

C Ralph Lipper v Her Majesty The Queen, [1979] CTC 316; 79 DTC 5246;

Nahum Gelber v Her Majesty The Queen, [1980] CTC 505; 80 DTC 6369.

I have perused the above-mentioned cases and I have reached my decision on the basis that the motion picture film entitled “Lies My Father Told Me” was not completed until the end of 1974. In any event, the appellant is entitled to claim capital cost allowance solely on the basis of his capital contribution to the limited partnership as assessed by the respondent.

For the above reasons, the appeal is dismissed.

Appeal dismissed.