Paul F McDonald v. Minister of National Revenue, 79 DTC 814, [1979] CTC 3000

Delmer E Taylor:—This is an appeal heard in the City of Toronto, Ontario, on September 20, 1979, against an income tax assessment in which the Minister of National Revenue disallowed an amount of $387,562 claimed by the taxpayer in filing his 1972 income tax return as “a loss for the year from an office, employment, business or property”. After review and examination, the relevant amount at issue in this appeal is $238,963. In assessing the appellant, the respondent relied, inter alia, upon paragraph 3(d), subsection 9(2), paragraphs 18(1)(a) and 18(1)(b) of the Income Tax Act, SC 1970-71-72, c 63, as amended.

Background

In 1965, the appellant purchased a controlling interest in Grant Johnston & Co Limited (hereinafter referred to as “Grant” or “the Company”), a firm engaged in the stock brokerage business. Subsequent corporate name changes and reorganizations resulted in the fact that this appeal concerns a company Grant Johnston Limited but this is irrelevant to the material issue at hand.

Commencing in 1970, the appellant purchased additional shares of “Grant” at an additional cost of $238,964. In 1972, the appellant sold all of his shares in “Grant” to an arm’s length purchaser for the sum of $1.

Contentions

It was contended by the appellant that he did not purchase the shares as an investment, but rather had as an operating motivation, their resale at a profit. The respondent asserted that the appellant had purchased the shares as an investment.

Evidence

The appellant described the difficult economic conditions which developed in the years 1970, 1971 and 1972 which resulted in the acquisition of the shares at issue. His testimony left no doubt that his purpose in the purchases was “to hold the business together” until he was able “to turn it around” hopefully in two or three years. His efforts to re-establish the Company on a sound financial basis had not been successful, the ensuing sale developed and the loss realized. He outlined the substantial income he had enjoyed from the Company during the years 1966 and 1969, and even into 1970 when business had gone very well. Up until the year 1968 he had been the majority shareholder, reduced this by sales to colleagues, but recovered the majority position in 1972 after the share acquisition in question.

Agrument

Counsel for the appellant proposed two approaches to establish the case—first, that the share acquisition was for the purpose of preserving the business (the corporation “Grant”) thereby maintaining the flow of income to the appellant; and second, (as noted earlier) the appellant could have used the stock acquired for future sales to colleagues at a profit when he had turned the business around. In support of the first proposition, counsel noted the recent decision of this Board in Terence T Malone v MNR, [1979] CTC 2619; 79 DTC 540, wherein the loan advances made by the appellant to a stock brokerage company he controlled, were allowed as an expense of producing income. In support of his second contention, counsel referred the Board to Her Majesty the Queen v George H Garneau, [1977] CTC 288; 77 DTC 5190, a case which he asserted had great similarity to the matter before the Board.

Findings

The Board notes that in Malone (supra), the appellant had earlier invested some $80,000 in the capital stock of his company, which he did not claim as an expense, and further that the separate $139,500 amount allowed at the Tax Review Board level, was comprised of funds advanced directly to the company. According to counsel, the instant appeal meets the same criteria since in the “review and examination” portion of that decision noted earlier, the appellant modified his claim from $387,562 to $238,963 to eliminate the “original” investment in the company in the early 1960’s, leaving only the “second” investment amount at issue in this appeal. It would appear that counsel equates the loan of funds to the company in Malone (supra) to the purchase of equity capital from third parties in the instant appeal. I fail to see that such a comparison is realistic and, irrespective of the decision in Malone (supra), the circumstances of this instant appeal would not even meet the criteria there noted on pp 542 and 2622 respectively:

(2) One of (a) trading asset which compared to the first one, was not permanent capital, but funds earned and rolled back into the company. (Italics mine).

If this appellant is to succeed, it must be on the basis of the second argument—that he could have sold the shares acquired at a profit to future colleagues.

Turning to this second argument, and the Garneau (supra) reference, it was counsel’s view that it was on ‘‘all fours” with the instant matter, and it was noted that counsel had a particular acquaintance with the Garneau matter (supra) from which he could draw such a conclusion. There are however, significant comments therein which, in my view, assisted the learned justice in coming to his conclusion and overcoming the substantial obstacles in the path of the appellant, so succintly phrased at pp 291 and 292 and 5192 respectively:

... In claiming that the loss he sustained ought to be considered a loss from an employment or business under the Income Tax Act on the ground that the transaction had been ‘‘an adventure or concern in the nature of trade” (subsection 248(1)), not only is the defendant trying to disprove facts regularly assumed by the Minister when making the assessment* [2] but his contention goes against what can be accepted as being “normal” and readily believable. A man does not normally purchase shares in a new company he is himself setting up with others and with which he will remain employed as a speculative venture", the fact that the man is a broker, and the company a brokerage company does not make any difference as the operation cannot but be seen as being isolated and unconnected with his usual trading operations.

... It is well settled that, under exceptional and unusual circumstances, an isolated venture can be considered as a business and the acquisition of shares in a company may be a trading operation!. [1] In my view, the circumstances surrounding the transaction involved here are quite exceptional and unusual and the in- ferences flowing therefrom induce me to believe the defendant’s contention that he did not purchase the shares as an investment but for the main purpose of making a profit on the resale.

... He himself testified that he was afraid of having to share in the costs of an inevitable winding-up if the firm were to be left without sufficient capital. It can also he assumed that he was reluctant in resigning himself to such a professional setback, even though it was never suggested that his decision could have been made for the purpose of retaining his employment. (Italics mine).

These circumstances, which I believe were “exceptional and unusual” in Garneau (supra) and not to be found in this matter, are:

(1) there was no indication either at the time of Garneau’s original involvement with the group or at the time of the investment at issue in that appeal that the business itself was in difficulty.

(2) the turn of events requiring the investment resulted from a policy decision at the senior ownership and management level, simply the withdrawal of the main base of capital support, not supplied by Garneau.

(3) there was to be formed a “new company” which would carry with it “its background of experience, goodwill and extensive connections in the main trading centres”, (pp 291 and 5192 respectively)

(4) the investment was one time and one time only—not several different stock acquisitions under differing circumstances and over a period of time.

(5) his analysis of the business at the time of his investment showed good prospects for capital stock value improvement—at least in the short term.

(6) there is no indication that any efforts were proceeding within the group to sell, merge or amalgamate the operation with another stock broker. It was “buy in” or leave for Garneau.

(7) the new operation did prove to be successful, at least immediately after formation of the new company.

(8) “at the time the company was doing well, the defendant was actively exploring the possibility of resale and soliciting offers in an effort to complete a deal”, (pp 292 and 5192 respectively).

(9) His initial experience having been so disturbing, unexpected and unsavoury, it is quite conceivable that he would attempt to get out as quickly as he could, with a profit to recompense him for his own lost business if possible, and eliminate the risk of his experience recurring.

Under the circumstances detailed above, particularly points 7, 8 and 9, Marceau, J reached the conclusion that “the possibility of reselling his shares at a profit in the near future was the main motivating reason why the defendant agreed to purchase them in the first place”. It would appear to me that the learned justice reached that conclusion, based on the view that the defendant Garneau, finding himself in a most difficult situation, made a conscious decision to extricate himself by a program of investing substantially in the new venture, maintaining it operational, enhancing its profit picture and attractiveness to an investor, and quickly selling out.

Conclusion

There was no indication in the testimony of Mr McDonald that similar conditions or prospects existed either for Grant or for this appellant. I would accept that when (and if) the operation of Grant again became successful, perhaps in two or three years, he might have revived the practice he had followed in earlier years—to provide a method of participation in the capital stock of Grant by some of his senior colleagues and employees. However there is no evidence and, to his substantial credit, Mr McDonald did not so allege that in the acquisiton of the capital stock his major motivation was to sell that stock at a profit.

Decision

The appeal is dismissed.

Appeal dismissed.