Jack Dichter Developments LTD v. Minister of National Revenue, [1979] CTC 2706, 79 DTC 608

M J Bonner:—This is an appeal from an assessment of income tax for the appellant’s 1975 taxation year. The respondent, on assessing, disallowed the deduction of the sum of $63,200 claimed as a reserve for doubtful debts and included in computing the appellant’s income the sum of $80,038, being the gain realized by the appellant on the sale of an interest in a shopping centre.

I shall deal first with the doubtful debt issue. The appellant claimed that for several years it had carried on the business of a money-lender. In its 1975 fiscal year it loaned $79,000 to Yankel Ranch & Development Ltd (hereinafter called “Yankel”). The latter was in the business of purchasing, breeding and selling exotic cattle. Yankel lost money and was unable to repay.

The respondent’s position was that the loan was not made in the ordinary course of business and that no part of the ordinary business of the appellant was the lending of money, and thus that the deduction was not permitted by paragraph 20(1)(l) of the Income Tax Act. The respondent observed that the loans made by the appellant to Yankel were non-arm’s length transactions and that the lender and borrower were both controlled by the same individual, Jack Dichter. The points characterized as observations were pleaded as assumptions made by the respondent on assessment, but, whether taken together or separately, neither is necessarily fatal to the claim made by the appellant. The respondent did not suggest that the quantum of the reserve claimed was not reasonable. It was not suggested by the appellant that the decrease in the value of its receivables from Yankel was a current cost or deductible otherwise than by virtue of paragraph 20(1 )(l). Thus, the issues to be decided are whether the loans in question were made in the ordinary course of business and whether any part of the ordinary business of the appellant was the lending of money.

Evidence was given by Jack Dichter, President of the appellant. He stated that the appellant was incorporated in 1970 to “receive income” from Diet Plan and to invest the same in loans. Diet Plan was, I gather, some sort of a profit-making enterprise involving promotion of a weight control program. Before the formation of the appellant Mr Dichter held another company which made mortgage loans. The appellant itself made loans to borrowers referred to Mr Dichter by his lawyer and by his bank manager. Evidence was also given by H W Johnson, the appellant’s auditor. He stated that it was the appellant’s practice to invest its funds in term deposits with its bank and to use the deposits as collateral security for bank loans, the proceeds of which were reloaned by the appellant. The appellant’s objects were introduced in evidence. One was “‘to negotiate loans, to lend money and to deal in mortgages, bonds, obligations, securities and other investments”. Mr Johnson identified the appellant’s financial statements for each fiscal period from 1971 to 1975. Those statements indicated that the appellant earned interest income. The sources of the interest income were term deposits and two second mortgage loans made by the appellant. On the evidence it seems clear that part of the ordinary business of the appellant was the lending of money.

The question whether the loans were made in the ordinary course of business is more difficult. The following advances were made to Yankel:

In each case the appellant received interest-bearing promissory notes.

Mr Dichter had become interested in Simmenthal cattle. He formed Yankel in the spring of 1974. During the spring and summer of that year the company purchased cattle with a view to holding its first sale at the end of October. Yankel had expended large amounts of money for the purchases and for feed and trucking. It was, I gather, indebted to the bank for overdrafts. The bank pressed Mr Dichter for payment of the amount owed by Yankel and the loans in question were made. It seems clear that at the time the loans were made there was no reason to expect that Yankel would be unable to repay. I reach that conclusion not only from Mr Dichter’s statements as to the state of his mind, but also from his conduct in causing Yankel to purchase cattle as late as September of 1974. The sale in October was disastrous. As Mr Dichter put it, “we were wiped out”. Prices paid for Simmenthal animals fell and did not subsequently recover. Yankel became unable to pay.

Early in 1975, after the end of the appellant’s 1975 taxation year, the appellant made a further loan of $25,000 to Yankel to assist it in meeting demands made by its creditors. Mr Dichter stated that when the final advance was made he still had great hopes for the Simmenthal venture, despited the poor results at the sale.

Some meaning must be given to the adjective “ordinary” in subparagraph 20(1 )(l)(ii). It cannot be suggested that every loan made with the expectation that it will be repaid is made in the ordinary course of business, even in the case of a company whose corporate objects include the one quoted previously. Before making the loans in question the appellant had made term deposits, three loans on the security of second mortgages and one loan to two persons named Reykdal and Brassard. Mr Dichter stated that the latter was made in connection with his first venture into cattle. I cannot conclude that the appellant’s activities prior to the advance of the funds to Yankel were such that it can be said that the Yankel advances fell into any pattern which can be described as the ordianry course of the appellant’s business.

Evidence was given as to a number of loans made by the appellant in the fiscal years 1978 and 1979. It does not assist the appellant. It was not shown that the later loans were made consistently with any course or pattern of business conduct commenced earlier.

The appellant relied on the decision of the Federal Court of Canada in Her Majesty the Queen v E V Keith Enterprises Ltd, [1976] CTC 21; 76 DTC 6018. In that case Mahoney, J found at p 24 (p 6020):

The defendant had established over the years a pattern of both loaning money and carrying deferred balances to accommodate persons and companies doing business with the operating entities through which its construction and other activities were carried on. It had, on previous occasions given, the accommodation to the individual principals of the actual business connection.

No similar finding of fact can be made on the evidence adduced in this appeal. The appeal therefore must fail on the first issue.

I turn next to the shopping centre issue. Early in 1973 Mr Dichter received a telephone call from Larry Reykdal, a real estate agent. Mr Reykdal invited Mr Dichter to join with him in the purchase from Dot Investments Ltd (hereinafter called “Dot”) of a one-half interest in an Edmonton shopping centre known as the Dickensfield Shopping Centre. At that time construction of the shopping centre had either just started, or was about to start. In March of 1973 the appellant and Reykdal Investments Ltd (hereinafter called “Investments”) entered into an agreement with Dot to purchase a one-half interest in the shopping centre for a consideration of $100,000, plus the assumption of one-half of a mortgage indebtedness of $950,000. Mr Dichter examined a list of tenants, both anticipated and committed, and a calculation of expected revenues from the shopping centre operation. Mr Dichter raised the $100,000 required by the appellant and Investments by bank loan. The mall building was substantially completed and the first tenant moved in in July of 1973. An “official opening” took place in October of 1973.

Mr Dichter’s evidence was that in purchasing an interest in the shopping centre he sought “an investment in a security that would grow with me”. He contacted prospective tenants and followed construction activities closely.

In the fall of 1973 two verbal offers and one written offer were made for the purchase of the Dickensfield Shopping Centre. Mr Dichter testified that he refused to entertain them. One of the offers was for a purchase price of $1,500,000. Mr Dichter stated that he felt that if the shopping centre was worth that much money to someone else, it was worth that much to him. It may be noted that the offer contained a condition as to occupancy which could not be met.

Dot was a company controlled by a Mr Koch. Mr Dichter testified that the construction of the Dickensfield Shopping Centre was carried on by another company controlled by Mr Koch. The sole responsibility for control and management of the Dickensfield Shopping Centre rested with Dot. In January of 1974 Mr Koch, who through one of his companies was involved in the construction of another shopping centre at North Battleford known as the Frontier Shopping Centre, ran into severe financial difficulties. Some work remained to be done on the Dickensfield Shopping Centre. The parking lot was not paved and other interior work was incomplete. Dot had collected rent from tenants of the Dickensfield Shopping Centre and had not turned over the share belonging to the appellant and Investments. Mr Dichter testified that he and Mr Reykdal therefore “had to” help Mr Koch and accept a proposal made for the sale by Dot to the appellant and Investments of Dot’s remaining one-half interest in the Dickensfield Shopping Centre.

By agreement dated January 30, 1974, Investments and the appellant each bought an undivided one-half interest in Dot’s remaining one-half interest in the Dickensfield Shopping Centre. The purchase price for that one- half interest was $675,000, payable as to $200,000 in cash on closing and, as to the remainder, by assumption of Dot’s liability under the existing first mortgage. Mr Dichter testified that before this purchase was made one-half interest of the appellant and Investments produced revenues which exceeded carrying costs. The purchase of the second half was financed by borrowing $250,000 on the security of a short term second mortgage, bearing interest at 14% per annum. After the second mortgage was arranged, Mr Reykdal explored longer term financing, but apparently lenders found revenues to be insufficient.

Mr Dichter stated that following the January purchase with its attendant increased debt loan the appellant and Investments “could scrape by” based on a 100% occupancy level. That level was not reached until late in 1974. At the time of the second purchase from Dot the occupancy rate was 85%. Subsequently, revenues declined still further due to unsatisfactory tenants and the second mortgage fell into default. In June of 1974 solicitors for the second mortgagee demanded repayment and threatened foreclosure. On July 10, 1974, the appellant and Investments sold the Dickensfield Shopping Centre, realizing the profit in question.

On January 22,1974, Mr Reykdal borrowed $150,000 from his bank and invested the funds in a guaranteed investment certificate. The certificate was deposited as security for a guarantee given by Mr Reykdal on behalf of Investments and the appellant. The guarantee was given as security for the performance by Dot of its obligations to the mortgagee of the Frontier Shopping Centre. It was required in order to induce the mortgage to advance funds to Dot. In consideration the appellant and Investments received an option to purchase the Frontier Shopping Centre.

It is difficult to accept as complete the explanation given by Mr Dichter for entry into the January of 1974 purchase from Dot. The agreement governing the purchase contained covenants by Dot to complete construction work on unleased areas and to pay monthly amounts in respect of certain leases until the lessees commenced to pay rent. It did not contain any provision for a hold-back of any part of the purchase price pending performance by Dot of its obligations. If Dot were as unreliable in discharging its obligations to account for revenues and in failing to complete the Dickensfield Shopping Centre as was alleged, it would seem most unlikely that the appellant and Investments would agree to purchase without some provision for hold-back. Furthermore, the purchase was made five days after the giving of the guarantee, an act which seems rather odd in light of Dot’s alleged unreliability. I am not persuaded that the appellant had to purchase from Dot in January of 1974.

In my view the Dickensfield Shopping Centre venture was, on the balance of probabilities, speculative. It was not suggested that the first acquisition could or should be viewed in a different light than the second. The second was Clearly speculative and, having taken place only a short time after the first, tends to indicate that the first may well be of a similar nature. I cannot accept the submission that the swift resale was necessitated by unpredictable and unforeseen events and was not planned from the outset. The initial acquisition was financed by borrowed money. The second purchase was also financed by borrowed money. The second borrowing was on a short term basis. It as not suggested that the first borrowing was arranged on a long term basis. It was apparent to the appellant in January of 1974 that revenues would not equal expenditures, at least for some time. It was not suggested that the appellant and Investments were capable of meeting a shortfall. The acquisition of the option on the Frontier Shopping Centre was not said to have been made with investment in view. It was not suggested that either the appellant or Investments had the means or intention of acquiring an interest in that property and holding it as a source of income. Mr Dichter’s statements of subjective intent must be weighed with the whole course of conduct of the appellant which is at least as consistent with a speculation as with an investment. The assessment has therefore not been shown to be wrong. The appeal must therefore be dismissed.

Appeal dismissed.