Karst v. R., [1999] 4 CTC 2041 (Informal Procedure)

Beaubier T.C.J.:

This appeal pursuant to the Informal Procedure was heard at Calgary, Alberta on June 9, 1999. The Appellant testified and called Neil Macaulay, manager, special debts, Alberta Opportunity Company, and Terry Zurow- ski, C.A., of Calgary to testify on behalf of the Appellant. No witnesses were called by the Respondent.

The Appellant has appealed the disallowance of a business investment loss and a deduction of legal fees for the year 1994. Paragraphs 1 to 7, inclusive, of the Reply read:

1. The only allegations of fact in the Notice of Appeal are set out in division “C” of the Notice of Appeal. The Deputy Attorney General denies that the Appellant has provided proof, to the standard required by the Income Tax Act (the (“Ac/”):

a) that the Appellant invested $70,000 in Quikstep Ladders Inc. (“Quickstep”),

b) that Quikstep earned business income, and

C) that the Appellant took legal steps to recover the money invested and incurred additional legal expenses not exceeding $12,350.

2. The Minister of National Revenue (the “Minister”) initially assessed the Appellant for the 1994 year by Notice dated May 1, 1995.

3, In computing income for the 1994 taxation year, the Appellant claimed

the amount of $65,670 as a business investment loss (“BIL”) in respect of a shareholder loan made to Quickstep.

4. The Appellant, through his representative’s letter dated July 18, 1996, requested that the BIL be increased to $71,397 to reflect an increase in legal fees of $5,727, which were previously unclaimed.

5. In reassessing the Appellant for the 1994 taxation year, the Minister disallowed the revised claim for a BIL in the amount of $71,397, which included the increased claim for $5,727 in legal fees.

6. The Appellant objected to the reassessment and the Minister issued a Notification of Confirmation stating that the Appellant did not have a BIL of $72,293. (It should be noted that this amount is stated in error and should be $71,397 as stated in paragraph 4 above).

7. In so reassessing the Appellant, the Minister relied on, inter alia, the following assumptions:

a) The Appellant did not verify that any funds were loaned to Quickstep.

b) If the Appellant did loan funds to Quickstep, which is not admitted but is expressly denied, it has not been verified that the Appellant received or was to receive interest from the funds loaned.

c) Quickstep was not a small business corporation within the meaning of the provisions of the Act as it did not have active business income from its assets.

d) Quickstep has never filed income tax returns.

e) The Appellant has not proven that the debt owing, if any, by Quickstep became a bad debt in the 1994 taxation year.

f) The Appellant is not a shareholder in Quickstep.

g) The 100% shareholder in Quickstep is 363411 Alberta Ltd. (“363411”).

h) The Appellant is the 100% shareholder of 343411.

1) The Appellant has not submitted documentation to support legal fees of $12,350.

j) The alleged legal fees of $12,350 account for a portion of the BIL claimed by the Appellant in the 1994 taxation year.

k) The Appellant has failed to establish that he incurred a capital loss with respect to a debt owing, if any, to Quickstep during the 1994 taxation year.

Assumptions 7(a), (b), (d), (f), (h) and (j) were established as true by the evidence.

The evidence is that in 1987, as a result of work with the Israeli Defence Force, the Appellant thought of the idea for a light collapsible ladder. In 1989 he discussed this with Patrick Chao and they formed a partnership to develop the ladder. Soon their costs amounted to $109,091, one half of which Mr. Chao invested. Mr. Chao’s corporation also proceeded to obtain patents on the ladder at that time.

The Appellant acquired 100% of 363411 before March 28, 1989 (Exhibit R-3) and continues to own 363411 to this day. Before the end of 1989 388060 Alberta Ltd. (“388060”) was formed and Patrick Chao and 363411 each owned 50% of it (Exhibit R-1). 388060 changed its name to Quikstep Ladder Inc. before December 14, 1990 and by the end of its 1990 fiscal year the shareholdings were:

There is no accepted evidence that Mr. Karst ever owned any shares of Quikstep. He testified that 363411 owned its Quikstep shares for him, but no trust agreement or any other document was placed in evidence to verify that. Mr. Zurowski reviewed Exhibit A-12, a draft March 31, 1990 financial statement of Quikstep, which refers to shareholders’ loans of $131,581 which he confirmed included the $109,091 already described. Mr. Zurowski testified that these were loans of shareholders and no one else. Part of Exhibit A-12 contains statements to June 30, 1990 which enlarge the shareholders’ loans to a total of $179,985.

Mr. Zurowski’s testimony was buttressed by Exhibit A-6 which was reviewed by him. It is a law firm’s letter to Mr. Karst dated February 20, 1991 which asks him to verify the amount of the shareholder loan in question and whether it is owed to Mr. Karst or to 363411 as described in an attached Statement of Claim.

Paragraph 1 of the Statement of Claim by Mr. Karst and 363411 against Quikstep and others states that 363411 is a shareholder in Quikstep. Draft paragraph 11 questions the amount of the loan and the name of the lender. Mr. Karst and 363411 caused the Statement of Claim to be issued but Mr. Karst never testified as to what the final draft of the Statement of Claim stated in paragraph 11.

In early 1990 Quikstep hired a Chief Operating Officer and AOC invested $250,000 in Quikstep. AOC later increased this to a total of $270,000. In June, 1990, Mr. Karst was released by Quikstep and escorted out of its premises whereupon he launched the lawsuit described in Exhibit A-6 in early 1991.

Mr. Karst testified that by December 1991 Quikstep had produced 3,000 ladders and closed its doors. Except for a small amount recovered by AOC, the remaining investments in Quikstep were not recovered by its investors and lenders.

On the evidence led by the Appellant, any money he had used to begin the ladder business was invested in 363411 when he formed it. He had 363411 become the shareholder of Quikstep because of his concern that Israeli authorities might litigate against Quikstep if it discovered that Mr. Karst had got the idea of the ladder from them and in turn Mr. Karst or Quikstep had profited from it.

The unanimous shareholders’ agreement dated February 16, 1999 (Exhibit A-4) confirms the finding that 363411 and not Mr. Karst, was the shareholder in Quikstep. Mr. Zurowski’s testimony established that 363411 then owned the loans in question in Quikstep.

For these reasons, the Court finds that Mr. Karst was never a shareholder of Quikstep. Mr. Karst admitted that 363411 was merely a holding company and had no active business at any time. For this reason, Mr. Karst is not entitled to a business investment loss in 1994.

At best, Mr. Karst established roughly that he spent $4,564 in legal fees in the lawsuit described in Exhibit A-6. However, he did not prove when he spent this sum. For this reason, and the reasons already described, he is not entitled to deduct the legal fees.

The appeal is dismissed in its entirety.

Appeal dismissed.