George Sher v. Minister of National Revenue, [1978] CTC 2486, [1978] DTC 1356

Delmer E Taylor:—There are two issues arising from income tax assessments: the first, in which the Minister of National Revenue disallowed $4,541.97 and $4,728.24 of the amounts claimed as expenses during the years 1971 and 1972 respectively; and the second the further disallowance of a $40,500 loss on the sale of corporate stock shares, claimed as a deduction from income in the year 1972. The appellant relied, inter alia, on the provisions of section 3, paragraph 12(1 )(a) and subsection 12(2) of the Income Tax Act, RSC 1952, c 148, as amended, as it read in its application to the appellant’s 1971 taxation year, and on the provisions of section 3, subsection 9(2), paragraph 18(1 )(a) and section 67 of the Income Tax Act, RSC 1952, c 148, as amended by section 1, SC 1970-71-72, c 63, as it read in its application to the appellant’s 1972 taxation year. The respondent relied, inter alia, on paragraphs 12(1)(a) and 12(1)(h) of the Income Tax Act, RSC 1952, c 148, as amended, as it applied to the 1971 taxation year and on paragraphs 18(1 )(a), 18(1 )(h), 39(1)(b) and 40(1 )(b) of the Income Tax Act, SC 1970-71-72, c 63 as it applied to the 1972 taxation year and on subsection 26(3) of the Income Tax Application Rules.

Facts

At all material times the appellant was a securities sales representative and a director of the stock brokerage firm of Grant Johnston Limited (hereinafter referred to as “Johnston” or “the Company”), a member of the Montreal, Toronto and Canadian stock exchanges. Johnston was a wholly-owned subsidiary of Grant Johnston Holdings Limited (hereinafter referred to as “Johnston Holdings’’) in which the appellant, in 1969 and 1970, purchased 3,000 common shares at a total cost of $40,500. In 1972 Johnston found itself in financial. difficulties and Johnston Holdings agreed to sell all of the issued and outstanding shares of Johnston to C J Hodgson & Co Inc, another brokerage firm. At the same time the appellant agreed to sell his shares in the capital stock of Johnston Holdings for the nominal consideration of $1.

Contentions

The position of the appellant was that:

—he was, in the relevant taxation years, a freelance securities sales representative and that the amounts incurred by him for certain automobile, sales promotion and entertainment, advertising, general office and travel expenses were for the purpose of gaining or producing income from his business, and that the said expenses were reasonable in the circumstances;

—the shares were purchased by him in the course of his business operations for the purpose of entitling him to greater access to commercially useful information and to earn income in excess of that normally received by securities sales representatives. As a result, the loss suffered by him was properly included in calculating his loss from a business and in calculating his income for his 1972 taxation year pursuant to section 3 of the Act.

The respondent contended that:

—of the total amounts which the appellant sought to deduct in respect of business expenses, the amounts of $4,541.97 in 1971 and $4,728.24 in 1972, if incurred, were not incurred for the purpose of gaining or producing income from the appellant’s business;

—the shares of Johnston Holdings at a total cost of $40,500 were not acquired for the purpose of gaining or producing income from a business but were rather acquired with a view to retaining the same as an investment:

—the appellant’s loss from the disposal of said shares was on Capital account.

Evidence

The appellant, in giving evidence, stated that although the expenses disallowed, $4,541.97 and $4,728.24, (a portion only of the total claimed for the years in question) were not supported by vouchers, they were reasonable, and had been the type of expenditure for which it was Often difficult to obtain proper receipts.

In dealing with the second item (the $40,500 loss) his basic position was that he was an independent contractor servicing clients who had stayed with him in several brokerage firms over many years, but that he was not a trader in investment securities himself. His acquisition of stock in Johnston Holdings had been to permit him to be a director providing commission rates on his sales of 40% or 50% rather than the regular sales commissions of 33 /3%, and to allow him access to company records and meetings, thereby better to serve his clients and protect their interests. When Johnston Holdings did encounter financial difficulties he was instrumental in transferring his clients’ business (amounting to some 2 million dollars of securities) to a banking institution. He now is associated with another brokerage firm, in which he has some $10,000 invested in subordinated loans, and he also receives regular financial and corporate information. His clientèle has remained with him during this change to: a different brokerage firm.

Argument

Counsel for the appellant referred to an extract from Canadian Securities Law Reports, Part X1, March 1974, entitled “Financial Contribution of Partners and Directors of Member Firms, Member Corporations and Affiliated Companies’’, and also used as support the cases of Brien A Hornby v Minister of National Revenue, [1972] CTC 2539; 72 DTC 1476, and Margaret Ann F rappier v Minister of National Revenue, [1976] CTC 85; 76 DTC 6066:

With regard to the disallowed expenses he argued that although the action of the Minister could be understood since no vouchers were available, nevertheless the appellant had met the sole onus upon him to establish, at least by his uncontradicted evidence, that such expenditures had been made, and that they were for the purpose of earning his income.

On the second issue, counsel essentially proposed that the purchase of the company stock had been in the nature of a necessary extension of his regular income earning activity—as an independent contractor salesman of securities. The stock in Johnston Holdings should be viewed in the same way as “the purchase of accounts receivable” (any potential settlement) noted in Frappier (supra) at [1976] CTC 89; 76 DTC 6068, respectively. The salient point in Hornby (supra) for counsel, was that the designation as a trader in securities attributed to the appellant in that case, was not vital to the favourable decision given, but rather the advantages he acquired as a result of owning the capital stock were important. This should support the appellant’s case in the matter now before the Board.

Counsel for the respondent did not make reference to any particular case law, other than to disagree with the points raised from Hornby and Frappier (supra) particularly noting that the deciding factor in favour of the appellant in Hornby (supra) was that he himself was a trader in securities—completely different in the instant case. He agreed that the acquisition of the company stock in this appeal may not have been an investment for dividends or even long term increase in value, but it was an asset of an enduring nature providing the appellant with certain advantages and benefits, and assured additional commission income. The issue of the disallowed expenses, in his view, left the Board unable to allow the amounts since there had been no physical evidence presented in support of them.

Findings

First, on the issue of the disallowed expenses of $4,541.97 and $4,728.24, the Board does not consider the verbal evidence of the taxpayer as sufficient to alter the Minister’s assessment, even though the appellant’s general description of his activities and efforts resulting in the claimed expenses, indicated some business relevance. At the same time the Board notes that other than arbitrarily, there appears no basis for the allowance of some portion of the same type of expenses by the Minister, for which receipts were not submitted either. This is of particular note since the taxpayer had, on filing his returns, reduced his “Sales Promotion and Entertainment” expenses by 30% for “personal use” to cover, according to his own testimony, the meals, etc he personally consumed at business meetings—an unusual and notable gesture indeed.

On the major issue (the $40,500 loss) the Board accepts without question that the appellant was a “trader”—in the sense described by his counsel—a commission salesman of investment securities. That, however, is not synonymous with being a trader in securities in his own right, and that he was not, by his own evidence. The effort of counsel by reference to case law, to extrapolate the requirements of one form of endeavour into the exigencies of the other, however commendable, is not persuasive. I find the Hornby case (supra) dependent. to such a degree on the acknowledged securities trading of the appellant there, that it has no application here. In Frappier (supra) I read nothing which would lead me to conclude that in holding that the amount paid by the appellant to reimburse her client for their losses, claimed and eventually allowed as a “business expense” in that case, would have been regarded in the same way had it been a claim for her own losses as a result of the bankruptcy of the company.

At the same time I have reservations that the Minister has met very directly the overall posture adopted by counsel for the appellant, that the only onus for the appellant was to establish that the $40,500 had not been for a capital outlay, and this he had done, in his opinion, by virtue of the argument that the receipt of dividends was not the motivation for the purchase. It appeared to me that counsel for the appellant, in this proposition, and counsel for the respondent in his counter argument left some rather nebulous area in between a property acquired as inventory therefore to be used for trading purposes, and a property acquired as an investment to be held for the return to be gained from the holding thereof. Although there may be a wide variety of circumstances, under which “property” is acquired, and on the scrutiny and interpretation of these circumstances will depend a determination of its nature, I am unaware that the Income Tax Act or the legislative record leaves open some ill-defined third option. In a decision of this Board, Arthur J Thomas v MNR, [1977] CTC 2227; 77 DTC 171, a matter not unlike the one at hand was examined and decided in favour of the taxpayer. A review of that decision may set the framework for the instant case. The point at issue there was whether interest should be a deductible expense when paid by the taxpayer on bank loans, the proceeds of which were invested in a stock brokerage firm—rather similar to this situation before the Board. Some closing remarks from the Thomas decision at paces 174 and 2231 respectively would be in order:

The appellant’s present investment in McEwen would appear to be well in excess of the total of the borrowed funds and the rewards were substantial and immediate—some $90.000 in salary in 1974 alone. The Board also accepts the appellants verbal explanation regarding the company policy at McEwen—to remunerate the security sales agents by salary and commission rather than by dividends. Taken in conjunction with his statements that he needed to be a shareholder to operate as a stockbroker, the investment must be regarded as having been made for a property acquired for the purpose of gaining or producing income.

The point made in the above decision is that the appellant (Thomas) made the outlay of funds (up to $60,000) for a property acquired for the purpose of gaining or producing income. It had been the Minister’s contention in that case that evidence had not been provided that a property had been acquired, and with that the Board disagreed. The same situation obtains in the instant case—property was acquired, not only a minority interest in Company shares but the rights to increased commission earnings attached thereto. The ownership of the stock conveyed this right on him under Company policy—and provided for the appellant retaining a much larger share of his earnings as commission on sales—sales he would be making in any event. That may well be described as showing characteristics of an “enduring nature”

—certainly the very essence of any capital acquisition. The appellant in this case also acquired a similar capital asset for his investment of $40,500.

While the interest charges related to the acquisition of the capital asset in the Thomas case (supra) were held to be deductible, it does not follow that the cost of the capital asset itself should be deductible. This is the point at issue in this appeal, and is quite a different matter.

Decision

The appeal is dismissed.

Appeal dismissed.