Tax Court of Canada Judgments

Date: 20000301

Docket: 98-514-IT-G

BETWEEN:

WILLIAM H. JOHNSTON,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Bell, J.T.C.C.

ISSUES:

[1]1. Whether the Appellant, in his 1993 taxation year, suffered a non-capital loss in the amount of $57,000 arising from a "joint venture"; and

2. Whether in the absence of entitlement to a deduction of that amount as a non-capital loss, the Appellant is entitled to claim an allowable business investment loss in respect of same.

FACTS:

[2] I will outline a number of statements from the agreed facts and supplement it with viva voce evidence.

[3] The parties filed a Partial Statement of Agreed Facts. This was supplemented by the testimony of the Appellant and several other participants in "joint venture operations".

[4] One Wayne Sheldon Leard ("Leard") incorporated a number of corporations, two of which were WSL Sales Inc. ("WSL") and Wayne S. Leard Holdings Inc. ("Holdings"). Those two corporations perpetrated an elaborate scheme to defraud people who were willing to advance money to a large number of joint ventures.

[5] Leard, or one of the companies would have persons furnish a cheque in accordance with the terms of a joint venture agreement for which the co-venturer would receive a promissory note and a post-dated cheque. Within a relatively short period, such as thirty-five to forty-five days, a representative of Leard or his company would retrieve the post-dated cheque and give a cheque representing the return of the initial advance plus an additional sum to the co-venturer. Additional co-venturers were attracted on this basis. The monies received by Leard or his companies under the joint venture agreements were often used for his personal purposes and to pay previous co-venturers the return of their advance plus an additional sum.

[6] The fraudulent scheme employed by Leard and his companies was to convince people to invest in purchases of bankrupt or surplus merchandise to be re-sold in a short period of time for a profit. Ninety percent of these transactions did not, in fact, occur. Leard and his companies perpetrated the fraud by purchasing commodities, renting warehouses to store same, hiring employees, and selling commodities below purchase price in order to provide a facade to support, or lend credibility to, the fraudulent scheme. This "pyramid" scheme involved about 230 participants.

[7] The Appellant entered into five separate joint ventures with WSL in 1992. At no time did that company intend to fulfil any of its obligations under the agreements. No merchandise was in fact acquired in accordance with the terms of the fifth joint venture.[1] It is agreed that it is uncertain whether any merchandise was acquired pursuant to the first four joint venture agreements.

[8] The Appellant had no knowledge of the fraudulent scheme when making his fund contributions under the joint venture agreements. In respect of each of the first four joint ventures, the Appellant contributed a certain amount of money and received an amount a short time thereafter in excess of the contribution. The total sum received under those first four joint venture agreements, in excess of his contributions, was $31,460.

[9] Copies of the five joint venture agreements were filed with the Court. In each case, the agreement was between WSL and William Johnston. Those agreements provided respectively that WSL had experience in purchasing inventories in bulk and in reselling such inventory in bulk on a timely basis and that it and Johnson had agreed to form a venture for the purpose of purchasing and reselling such inventory. Pertinent portions of the fifth agreement, being representative, read as follows:

Purpose

WSL and the Co-Venturer hereby form a joint venture for the purpose of purchasing and then reselling inventory ... described below:

Purchase of wax paper

Loan

Each of the Co-Venturer and WSL agrees to fund the operations of the venture by loaning to the joint venture the amount set opposite their respective names on or before the date set forth below:

[10] There followed the amount of the loan and the date of same by both the co-venturer and WSL. Additional provisions of the Agreement are described below in connection with the promissory note given under the fifth joint venture.

[11] The document continued with a number of responsibilities and operations required of the co-venturer. It then set forth agreements of the co-venturer, namely, to assist WSL in developing the selling and marketing strategy, to assist WSL in generating sales leads and to consult with WSL from time to time in respect of all aspects of the joint venture business.

[12] The five joint venture agreements included the following:

Guarantee

Wayne S. Leard ... hereby guarantees that the Co-Venturer shall receive payment of his loan in full and in the event after distribution of the net revenues of the joint venture, the loan of the Co-Venturer has not been repaid in full, Leard shall promptly pay any deficiency. It is understood and agreed that Leard is guaranteeing repayment of the loan made by the Co-Venturer to the joint venture as a primary debtor and not as a surety.

[13] The following five agreements dealt with, in order, the purchase of aloe vera lotion, Tops N Trends, sewing machines, Raleigh products and finally, in the fifth venture, wax paper. The fifth joint venture was entered into by WSL Sales and the Appellant on December 14, 1992. It provided for the contribution of $57,000 by the Appellant. Whereas there was no contribution amount prescribed for WSL in this agreement, the amounts of WSL and the Appellant in each of the preceding four agreements were as follows:

May 20, 1992 agreement Co-venturer $25,000 loan

WSL $37,500 loan + taxes etc

July 5, 1992 agreement Co-venturer $30,000 loan

WSL $560,200 loan

August 28, 1992 agreement Co-venturer $35,000 loan

WSL $1,215,000 loan

October 13, 1992 agreement Co-venturer $50,000 loan

WSL $890,000 loan

December 14, 1992 agreement Co-venturer $57,000 loan

WSL $

[14] Leard and his companies were petitioned into bankruptcy in April, 1993, the scheme having fallen apart because of Leard's inability to raise the funds to continue paying investors in his pyramid schemes.

[15] The Trustee in Bankruptcy recovered amounts of money from investors who made gains in dealing with Leard or his companies and such amounts have been distributed to creditors.

[16] The Appellant, in computing income for his 1993 taxation year, claimed a business investment loss in the amount of $25,540 and deducted 75 percent thereof, namely, $19,155 as an allowable business investment loss ("ABIL") in respect of his fifth and final joint venture. The sum of $25,540 was arrived at by deducting $31,460, received as amounts in excess of his total contributions for the first four ventures, from the amount contributed by him, namely $57,000. The Minister of National Revenue ("Minister") disallowed the ABIL deduction and advised the Appellant that he had a capital loss in the amount of $25,540. The Appellant then filed a Notice of Objection for this 1993 taxation year claiming $25,540 as a business loss.

[17] In evidence, the Appellant stated that he had never been asked to assist WSL in any way in the joint ventures in which he was involved. He stated that his understanding of the splitting of profits was that he would receive 50 percent thereof and WSL would receive 50 percent. He never asked for financial reports. He stated that nothing during the entire period caused him to be suspicious. He said that he did not notice that no contribution was specified for WSL in the fifth joint venture agreement. He also said that his ultimate actual loss was $55,008 because he received, of the $57,000 advanced, the amount of $1,992 as a distribution. He also testified that he understood that Leard was, as set forth in the report of the Trustee in Bankruptcy, buying high and selling low and that that kind of activity could not produce profits. He said that he did not know what Tops N Trends were or whether they were acquired. He admitted that he knew nothing other than that he had been told that he might make money by investing with WSL Sales. He said he knew nothing about the activities conducted by Leard.

[18] Johnston also said that his understanding of the nature of the co-venture agreement was that he would put up a certain amount of money, that WSL would do the same and that he would receive a percentage of the profits. He stated further that if the goods weren't purchased:

Then I would receive my money back if the goods were not acquired.

[19] He said that he had been at WSL's warehouse on one occasion and saw camcorders, garbage bags, cutlery, exercise bikes, television sets and other merchandise that was coming and going. He also stated that he saw employees working there, bringing things in and shipping things out. He said that he substantially relied upon a friend of many years, Brian McDonnell, whom he described as a very astute businessman. He said that he felt that others would have done due diligence and named four people who were "well-known business people".

[20] The fifth joint venture agreement is shown as having been made as of the fourteenth day of December, 1992. The Appellant was given a promissory note which reads as follows:

PROMISSORY NOTE

$57,000

For value received the undersigned, WSL Sales Inc., for and on behalf of the joint venture (the "Joint Venture") referred to in the joint venture agreement (the "Joint Venture Agreement") made as of the 14^th day of Dec, 1992 between the undersigned and William Johnson (the "Holder") hereby promises to pay to the Holder the principal sum of Fifty Seven Thousand Dollars ($57,000) Dollars without interest thereon.

This promissory note is the promissory note referred to in clause 2 of the Joint Venture Agreement and accordingly is subject to the terms and conditions contained in the Joint Venture Agreement.

The principal sum of this promissory note shall be due and payable in accordance with the terms of the Joint Venture Agreement.

This promissory note may not be assigned by the Holder without the prior consent of the Joint Venture.

The undersigned for and on behalf of the Joint Venture hereby waives presentment for payment, demand, notice of dishonour, protest and notice of protest.

WSL SALES INC. for and on behalf of the

Joint Venture

By "Wayne Leard"         c/s

Duly Authorized Officer

[21] Clause 2 of the Joint Venture Agreement stated that:

All funds so advanced shall be made payable to WSL for and on behalf of the joint venture and WSL upon receipt of the funds shall hold such funds in trust for the joint venture and shall issue on behalf of the joint venture, a promissory note evidencing the advance of funds.

[22] One of the terms of the Joint Venture Agreement to which the promissory note was subject is paragraph 3 which reads as follows:

Term

The term of the joint venture shall be from date of signing this agreement until the date that the Inventory has been disposed of and the final distribution and report has been made by WSL to the Co-Venturer. It is anticipated that the term of the joint venture shall not exceed twelve months. If WSL has been unable to purchase the Inventory, WSL shall promptly return the funds received from the Co-Venturer and this agreement and the joint venture shall be at an end.

[23] Also produced to the Court in respect of the fifth joint venture agreement was a photocopy of a cheque from Wayne S. Leard Holdings Inc. dated January 23, 1993 to the Appellant for $57,000 "re: Wax Paper". The Appellant stated that he thought the wax paper wasn't purchased and that his money was being returned. He also stated that he did not take the cheque to the bank because Jack Asbury, who worked with Leard, asked the Appellant to hold the cheque for a couple of weeks as they were having financial problems. He stated that he later heard "that the wheels had fallen off the whole company" and that the cheque was invalid, he did not take it to the bank because he felt that there would be no funds to cover it.

[24] On cross-examination, the Appellant with respect to inventory, had the following exchange with Respondent's counsel:

Q. I understand, but you understand from the agreed facts that the parties have arrived at, after investigations and the like, that 90 percent of these joint venture agreements were productive of no inventory at all?

A. Yes. That's so stated in the -- yes.

Q. And you also understand that the remaining ten percent were used by Mr. Leard and his companies as, in effect, window dressing so that he might perpetrate the fraud. Isn't that the case?

A. Yes.

Q. And you understand as well that in many cases Mr. Leard would pay one joint venturer with the product that he had obtained from another joint venturer?

A. Yes.

Q. And you understand as well that Mr. Leard apparently paid amounts in excess of what he then sold product for?

A. It looks like it, yes.

Q. So he paid high and sold low, all to create the facade of a business activity?

A. It looks like that's the way it was happening.

Q. And you have no doubt that if a business were carried on in that way, that it could not be productive of profits could it?

A. It could not.

Q. And it could not also be productive of profits if Mr. Leard was continually using one joint venturer's advance to pay another, could it?

A. No, it couldn't.

Q. Eventually, he would run out of people that would be prepared to contribute to these joint venturers, isn't that the case?

A. I think that has happened.

[25] He stated that he had not investigated Leard or his companies very carefully, but that he relied on others.

[26] Here follows another portion of the exchange between Respondent's counsel and the Appellant:

Q. Were you provided with a statement from WSL as to what the Tops N Trends were?

A. No, I was not.

Q. You don't even know today what Tops N Trends are, do you?

A. No, I do not know.

[27] He then stated that he did not know whether they were acquired, that he was not given any financial statements setting out the profit on that joint venture, that he did not know whether the return received was referable to any business activity, that he did not know the price of the inventory, that he did not know the intended selling price of the inventory and that he knew nothing other than the fact that he had been told that he might make some money by investing with WSL. He said that he never put his mind to why WSL would enter into an agreement where it was contributing $560,000 and he was contributing $30,000 only and that the profits were to be shared on an equal basis. He said that he gave no thought to his potential contribution of effort to sales, that he had not asked Leard about that and that he was completely passive in regard to this joint venture. The Appellant then admitted that he was somewhat blinded by greed in his dealings with WSL.

[28] The Appellant acknowledged that the buying and selling of merchandise in the circumstances that existed would never have created a profit. With respect to the fifth joint venture under review the following exchange between Respondent's counsel and the Appellant took place:

Q. Now, there is a suggestion in your Notice of Appeal that there was a debt owed you by WSL in 1993 of $57,000?

A. Yes.

Q. How do you say that debt arose?

A. Well, I just gave them a cheque for $57,000 to purchase wax paper, which fell through.

Q. Well, you don't say that there was any wax paper that Mr. Leard or WSL ever intended to buy do you?

A. No, I don't know.

Q. So you gave Mr. Leard or his company $57,000 and they intended to pocket it?

A. I guess you could say that yes.

...

Q. ... At no time did you lend $57,000 to the company, did you? You loaned it to the joint venture, didn't you?

A. The joint venture, yes.

Q. And if there was a debt to the company it arose because of its failure to carry out the terms of the joint venture. I gather that's what you say?

A. Yes.

Q. So you would agree that you did not acquire that debt for the purpose of earning income?

[29] This question was met by an objection from Appellant's counsel on the basis that it was a legal conclusion.

[30] Appellant's counsel produced Brian McDonnell as a witness. He gave evidence concerning his due diligence in checking Leard and visiting the premises where Leard/WSL had assets of all kinds for sale with 25 or 30 employees being busy dealing with these assets.

[31] A Mr. Lacey, who gave evidence on behalf of the Appellant, among other things described the nature of the merchandise operation of Leard/WSL directed, obviously, to establishing the fact that it seemed legitimate.

[32] A Mr. Suchard gave similar evidence describing the locations where "every kind of inventory imaginable" was presented. His other evidence is not of assistance in the determination of the Appellant's issues.

[33] Respondent's counsel read into evidence certain portions of his examination of the Appellant. In that material, the Appellant said that he had made no enquiries as to why WSL was to contribute a different amount to the joint venture from his contribution and yet was to receive only 50 percent of the return. With respect to the aloe vera lotion joint venture, the Appellant said that he did not know what WSL was to contribute and was unable to say that any such lotion was purchased. He stated also that he had received no financial statements respecting the joint ventures. He said that he did not know whether there was ever a purchase of Tops N Trends and that he did not know what that presumed inventory was.

[34] The following exchange took place:

Q. So far as you know, Mr. Leard, through WSL, simply took your money?

A. Yes.

Q. And he could have done anything with it as far as you know?

A. Yes.

[35] The Appellant stated that he did not know what Raleigh products were purchased and, indeed, whether any were ever purchased. The Appellant also said that the wax paper transaction did not take place and this exchange respecting the fifth joint venture took place:

Q. I notice that in this case there is no reference to any contribution by WSL at all. Do you see that?

A. Yes, I do.

Q. Did you enter into this agreement on the basis that you were to provide $57,000 and WSL was to provide nothing?

A. I can't remember.

Q. Let me put it this way. Have you any information which would indicate that WSL had an obligation to make any contribution?

A. I'm not sure.

Q. Is this the full and complete agreement that was entered into in December of 1992?

A. Yes.

MR. GALWAY: To the best of our knowledge.

THE DEPONDENT: To the best of my knowledge it is

Q. ...Do you have any other source of information, and apart from the terms of the joint venture agreements themselves, in regard to this venture?

A. No, I don't.

...

Q. Do you have any knowledge of any business plan in respect of Leard or his companies?

A. No.

A. Were you provided with any prospectus in regard to your investment?

A. No.

[36] The Appellant then said that he did not know what it was going to cost to acquire the inventory, did not know the sale price, did not know whether Leard or his companies invested any money, didn't do any work as contemplated by the contract and did not know what enquiries others had made to satisfy themselves that Leard was reliable.

APPELLANT'S SUBMISSIONS:

[37] The Appellant claims entitlement to the deduction of a "business loss"[2] in the sum of $57,000 for his 1993 taxation year arising out of his fifth joint venture agreement with WSL. Alternatively, the Appellant seeks deduction of 75 percent of the sum of $57,000 as an allowable business investment loss under sections 38(c), 39(1)(c), 40(2)(g)(ii) and 50(1)(a) of the Income Tax Act ("Act").

[38] Respecting his first submission, Appellant's counsel submitted that the Appellant's activities were "an adventure or concern in the nature of trade" within the meaning of the description of "business" in section 248(1) of the Act. It reads as follows:

"business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever and ... an adventure or concern in the nature of trade but does not include an office or employment.

[39] He submitted that a single transaction may constitute an adventure or concern in the nature of trade and referred to Jake Friesen v. H.M.Q., 95 DTC 5551. In that case, the Appellant and others acquired a parcel of vacant land for the sole purpose of reselling it for a profit. When the property decreased in value, Friesen deducted the decline in value as a business loss relying on section 9, 10(1)[3] and 248(1) of the Act. The Supreme Court of Canada found that the venture was a "business" within the definition of that word, constituting an adventure in the nature of trade.

[40] Counsel then referred to the oft cited case of M.N.R. v. Taylor, 56 DTC 1125 in which the Exchequer Court of Canada enumerated tests for the determination of whether Taylor's purchase and sale of 1,500 tonnes of lead was an adventure or concern in the nature of trade. At 1137 Thorson, P. said:

I am also of the view that it is not possible to determine the limits of the ambit of the term or lay down any single criterion for deciding whether a particular transaction was an adventure in trade for the answer in each case must depend on the facts and surrounding circumstances of the case. But while that it so it is possible to state with certainty some propositions of a negative nature.

[41] He stated that it is the nature of the transaction, not its singleness or isolation, that is to be determined. He said at 1139 et seq:

... if the transaction is of the same kind and carried on in the same way as a transaction of an ordinary trader or dealer in property of the same kind as the subject matter of the transaction it may fairly be called an adventure in the nature of trade. ...

And there is the further established rule that the nature and quantity of the subject matter of the transaction may be such as to exclude the possibility that its sale was the realisation of an investment or otherwise of a capital nature or that it could have been disposed of otherwise than as a trade transaction.

[42] He also said that it is not essential that an organization be set up to carry a transaction into effect, and that a transaction being different from other activities of the taxpayer does not, of itself, exclude it from being an adventure in the nature or trade. He stated further that dealing with a commodity the same way as a dealer, is a relevant factor and that the nature and quantity of the subject matter of a transaction is also relevant.

[43] Counsel then referred to Friesen v. Canada [1995] T.C.J. No. 922 (T.T.C.). The Appellant became a real estate agent in 1948. In 1974 he began operating a land development business and was carrying it on at the date of the hearing. He had a history of dealing, as a principal, in real estate. In 1983 or 1984 he met a Terry Jacobs ("Jacobs") on a cruise. Jacobs sought money from Friesen to effect the sale of three of five houses he was buying in Seattle. Friesen went to Seattle, met a prospective purchaser of a house, and upon return to Winnipeg, sent Jacobs a cheque for $10,000. Later, having received a frantic telephone call from Jacobs respecting a difficulty with the property and having been informed by Jacobs that another $12,000 would enable him to effect the purchase of another property, the Appellant sent a cheque for that sum to Jacobs. Jacobs simply stole Friesen's money. The Tax Court found that Friesen made a joint venture with Jacobs with respect to the initial house, which venture extended to the second property. It concluded that the money was used in the course of business and the Court found that Friesen was entitled to a deduction.

[44] Appellant's counsel then referred to Kosowan v. Canada [1996] T.C.J. No. 683 in which this Court determined that money advanced by the Appellants for a questionable business venture that did not succeed were advanced for the purpose of obtaining a profit that was purely speculative. It stated that if a profit had been obtained that it would be taxable and that, accordingly, the sums advanced were considered as outlays for gaining income from an adventure in the nature of trade.

[45] Appellant's counsel then referred to Kleinfelder v. M.N.R., 91 DTC 913. In that case this Court found that monies advanced for the purchase and sale of automobiles and subsequently lost, the transaction never having taken place, were not deductible. Appellant's counsel, conceding that this case appeared not to be helpful to his cause, attempted to distinguish same by quoting this Court in support of his statement that there was "no formal agreement in place" and that "there was no real organizational structure in place to carry out the transaction. He sought to support his position by referring to the Court's words "vague and imprecise", found in the following portion of the Reasons for Judgment, at 916:

The transaction of buying the automobiles never took place, marketing never took place and the evidence about how the actual business was to be carried on was vague and imprecise. The infusion of capital by the Appellant was to start the business but that business operation never started. ... The monies were not expended by the partnership for the purpose of gaining or producing income in that, the other partner ... misdirected the funds.

[46] Appellant's counsel said:

The only other point, Your Honour, that I would like to make here is that my friends focussed on the fact, well, the joint venture didn't carry on business. Here, I am referring to paragraph 14 of my factum. The fact is the focus has to be not on the joint venture. The focus has to be on Mr. Johnston's intentions, Mr. Johnston's activities and whether there is some organizational structure in place to carry this thing through.

[47] His statement in his factum is:

It is submitted that the focus of the Court's analysis should centre on Mr. Johnston's actions and intentions, and the organizational structure in place, not on whether the joint venture was actually completed.

[48] Counsel then turned to a discussion of the concept of reasonable expectation of profit. He was addressing the Respondent's alternative submission that without a reasonable expectation of profit the Appellant could not be seen to have carried on business. For the reasons outlined below, I will not pursue his submissions in this regard.

[49] Finally, Appellant's counsel presented his alternative submission, namely, that the Appellant was entitled to a business investment loss as defined in section 39.

RESPONDENT'S SUBMISSIONS:

[50] Respondent's counsel referred to Moldowan v. R., 77 DTC 5213 and quoted from 5215 as follows:

Although originally disputed, it is now accepted that in order to have a "source of income" the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business: ...

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive.

[51] He then said that the above tests must apply and that what the taxpayer may feel or think is not an appropriate test. Counsel referred to Kleinfelder, supra, quoting the following portions, namely:

The transaction of buying the automobiles never took place, marketing never took place, and the evidence about how the business was to be carried on was vague and imprecise. The infusion of capital by the Appellant was to start the business but that business operation never started ...

[52] Counsel submitted that that was the situation with the present Appellant and went on to quote from Kleinfelder as follows:

... The monies were not expended by the partnership for the purpose of gaining or producing income in that the other partner Mr. Gee misdirected the funds.

The capital expenditure by the Appellant was not an outlay or an expense for the purpose of gaining or producing income from the business in which the taxpayer was engaged.

The taxpayer was not engaged in the business of loaning money. The monies were advanced to start a business that never started operation; the alleged partner misdirected the funds. The promissory note was issued by the alleged partner to give some assurance to the Appellant for the capital monies advanced and not as a business activity of loaning money.

[53] Counsel then referred to the agreement in the transaction giving rise to this appeal. He stated that the Appellant entered into this agreement in December, 1992, that he did not know what WSL's contribution was going to be[4], did not know what the cost of wax paper, the subject matter of the venture, would be, did not know whether there was an intended buyer, did not know the price at which the wax paper might be sold and did not know what expenses might be expected to be incurred in marketing the wax paper. He submitted, as in Kleinfelder, that capital was advanced but was not used to buy wax paper. He stated that no business was ever commenced by WSL and the Appellant as it related to wax paper but that the monies were taken from the Appellant and he was defrauded of same exactly as occurred in Kleinfelder. He referred to the underlying flaw in the agreement which a prudent person would have ascertained without much thought, namely the disproportionate contribution under other agreements with a 50 percent return to the Appellant. He submitted that, in effect, the Appellant did not inquire as to the reason for such disproportionate contributions, did not know whether any of the goods that were the subject of the joint venture agreements had ever been purchased, what their cost had been, what price they were to be sold at and what expenses would be incurred in relation to them. He stated that the Appellant had the right to obtain financial statements but never sought them. He further stated that the Appellant did not even know the nature of the inventory in the second and fourth joint ventures. He said that the Appellant did not provide assistance to the joint venture as contemplated by its terms and did not ask why he had been called upon so to do. He stated further that the Appellant did not consult with WSL from time to time as required by the terms of the contract. Counsel submitted that Johnston simply advanced the money and in a short period thereafter, received money. With respect to the joint venture giving rise to the loss of $57,000 he said:

... if you then look at the joint venture agreement dealing with the purchase of wax paper, how is it ever possible for Mr. Johnston to obtain a profit from having participated in that joint venture when the funds are never used to buy the very subject matter of the joint venture?

[54] Counsel then referred again to the Moldowan decision with reference to "an objective determination" and "the capability of the venture as capitalized to show a profit after charging capital cost allowance". He also referred to the absence of a "business plan", apparently in the Respondent's continued presentation in many cases, an important ingredient in determining whether a business existed.

[55] Finally, on this point, counsel said that the alleged partner misdirected the funds and the promissory note was issued "to an alleged partner to give some assurance to the Appellant for the capital monies and not as a business activity of loaning money". He concluded as follows:

In my submission, that ought to be the end of the matter when it comes to the question of a business loss. There was no activity which could be said constituted a business.

The fact that Mr. Leard was a skilful con artist does not change the underlying facts as they related to Mr. Johnston's involvement in the joint venture agreement of December 14, 1992. It may provide an explanation as to why Mr. Johnston has been defrauded, but it does not create a business undertaking that Mr. Johnston entered into on December 14 of 1992...

[56] Respondent's counsel then responded to the alternate position of the Appellant, namely that he was entitled to an allowable business investment loss if he failed in his submissions respecting a non-capital loss. He submitted that the Appellant did not dispose of a share of the capital stock of a small business corporation and that the funds advanced by the Appellant to the joint venture were advanced as a loan to the joint venture, not to a small business corporation. He said further that the Appellant did not dispose of a debt owing to the Appellant by a Canadian-controlled private corporation that was a small business corporation and if it did make such disposition the loss would be deemed to be nil unless the debt was "acquired for the purpose of gaining or producing income from a business or property". He said that the debt arose from the fact that the joint venture was not carried out and that the Appellant therefore had a right to the return of his monies. He submitted that there was security for that right by virtue of the promissory note but that the note did not provide for payment of interest. He concluded that when the Appellant acquired the debt, he did not acquire it for the purpose of earning income but simply had a right, because of fraud, to make a claim against WSL for return of those monies. Counsel also submitted that the Appellant did not invest, either by equity or debt, in WSL with a view to obtaining profits from its illegal activities. He said that a debt arose from the failure of WSL to carry out the terms of the agreement and that it was not, therefore, acquired by the Appellant to earn income.

ANALYSIS AND CONCLUSION:

[57] I have concluded that the Appellant was not engaged in the conduct of a "business" as that term is described in section 248 of the Act, namely:

"business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever and ... an adventure or concern in the nature of trade but does not include an office or employment.

The Appellant entered into five separate and distinct joint ventures, the fifth of which gave rise to the loss under examination in this appeal. The Partial Statement of Agreed Facts reads, in part, as follows:

At no time did WSL Sales intend to fulfil any of its obligations under any of the five joint venture agreements. While the five joint venture agreements contemplated the purchase and sale of certain merchandise, no merchandise was in fact acquired in accordance with the terms of the fifth joint venture and it is uncertain whether any merchandise was in fact acquired pursuant to the first four joint venture agreement (sic), or whether these transactions were part of the facade described in paragraph 4 above.

That facade was described as purchasing commodities, renting warehouses to store such commodities, hiring employees and selling commodities below purchase price in order to provide support to, or lend credibility to, the scheme. The Appellant advanced money "to the joint venture". No inventory was purchased. The Appellant made no enquiries about the acquisition, acquisition cost, sale cost or indeed with respect to any other aspect of the alleged venture. He had no knowledge of the contribution of WSL and made no enquiry of WSL about the absence from the agreement of any amount to be contributed by it. WSL did not conduct any business whatever with respect to wax paper but simply took monies from the Appellant and ultimately defrauded him as it did others. The Appellant did not seek financial statements from WSL and provided no assistance to the joint venture and made no enquiries as to why he was not called upon to do so. Although there is no such legal entity as a joint venture, the "venture" in this case was one in name only with absolutely no business activity giving it any status or legitimacy.

[58] I do not accept the submissions of Appellant's counsel that the Appellant was involved in an "undertaking of any kind whatever". In the decision of Friesen in this Court, the Appellant, who lost money to a fraud artist, had been a real estate agent and was operating a land development business when he decided to participate in the prospective purchase of real property in Seattle and in respect of which he lost the funds advanced. In Friesen (S.C.C.), the Appellant had actually, together with others, acquired a parcel of vacant land for the purpose of resale at a profit. No similar condition exists in this case. Indeed, the Kleinfelder decision, in my opinion, was not only correct on its facts but is supportive of my conclusion here. The purchase of automobiles never took place, marketing never took place and no business operation was commenced. No wax paper was purchased, no marketing of same took place and no business respecting same was commenced. I come to this conclusion relying on the facts and with no reference to or reliance upon Respondent counsel's submissions regarding no reasonable expectation of profit which has, in my opinion, nothing to do with the determination of whether a business existed in this case.

[59] I agree with the Appellant's submission that he is entitled to an allowable business investment loss. Section 38(c) provides that:

a taxpayer's allowable business investment loss for a taxation year from the disposition of any property is ¾ of his business investment loss for the year from the disposition of that property.

Section 39(1)(c) provides that:

a taxpayer's business investment loss ... from the disposition of any property is the amount ... by which his capital loss for the year from a disposition ... to which subsection 50(1) applies ...of any property that is ... a debt owing to the taxpayer by a Canadian-controlled private corporation ... that is a small business corporation ...

Section 50(1)(a) provides that where:

a debt owing to a taxpayer at the end of a taxation year ... is established by him to have become a bad debt in the year ... the taxpayer shall be deemed to have disposed of the debt ... at the end of the year for proceeds equal to nil ...

Section 40(2)(g)(ii) provides that:

a loss from the disposition of a debt ... unless the debt ... was acquired by the taxpayer for the purpose of gaining or producing income from a business or property ... is nil.

[60] Although the agreement in question provided for a loan by the Appellant "to the joint venture" the money was advanced to WSL "for and on behalf of the joint venture". The Appellant is the only party of the two parties to the Venture who advanced monies and it was advanced to the other party. The agreement provided for the issue of a promissory note by WSL evidencing the advance of funds and provided further if WSL was unable to purchase the inventory, it would promptly return the funds to the Appellant. The promissory note made and delivered by WSL referred to the joint venture agreement and set forth that it was subject to the terms and conditions and provided that it was payable in accordance with the terms of that agreement. I conclude that the debt so acquired by the Appellant from WSL upon the loan of $57,000 was acquired for the purpose of gaining or producing income from a "business or a property". He had had four previous joint venture experiences with WSL, each of which produced a return greater than his advance. My conclusion that he was not carrying on business is not inconsistent with this determination, it being present to his mind that he was advancing the sum of $57,000 for the purpose of gaining or producing income. It matters not whether the income was to come from business or property. If the income from the Appellant's four previous ventures was income from a business it follows that a loss from the fifth venture should be a business loss. I have decided that it was not. If, however, the income from the previous ventures was income from property the loss from the fifth venture, identical in form, must be a loss from property and accordingly, a capital loss.

[61] To qualify as a "business investment loss" in 1993 the Appellant must have a capital loss on the deemed disposition of a debt which became bad in that year. The Respondent's Amended Reply to the Notice of Appeal reads in part:

In assessing the Appellant for the 1993 taxation year, the Minister of National Revenue ... disallowed the deduction of the ABIL and advised the Appellant that he has a capital loss in the amount of $25,540.

In his submission, Respondent's counsel did not dispute the existence of a capital loss. Rather, he tried to convince the Court that the debt giving rise to the loss was not WSL's debt, that WSL was not a "small business corporation" within the meaning of section 39(1)(c) and that the debt was not acquired to earn income, with the result that the Appellant's loss would be deemed under section 40(2)(g)(ii) to be nil. The Respondent admitted in the Reply to the Notice of Appeal that WSL was a Canadian-controlled private corporation. I must determine whether it was a "small business corporation" as required by that section. The term "small business corporation" is defined in section 248 of the Act as

a Canadian-controlled private corporation all or substantially all of the fair market value of the assets of which were used principally in an active business carried on primarily in Canada by it.

[62] The term "active business", also defined in section 248, means any business carried on by a taxpayer other than a specified investment business or personal services business. It is clear that WSL's activities did not constitute a "specified investment business" or a "personal services business". I accept the submissions of Appellant's counsel that WSL was in the active business of defrauding. The fact that such activities were criminal does not prevent them from being characterized as a "business" for income tax purposes.[5] During the period in question WSL had employees, premises, warehouses and inventory and was engaged in buying and selling merchandise. It also had money, albeit advances from persons entering joint ventures. These assets were used to perpetrate fraud on those persons. I conclude, therefore, that WSL was using its assets in the business of enticing and defrauding co-venturers. I am satisfied from the foregoing that WSL was a small business corporation owing a debt to the Appellant which debt was acquired for the purpose of gaining or producing income from a business or property. I am also satisfied that such debt was deemed to have been disposed of in 1993 for proceeds equal to nil, thus constituting a business investment loss within the meaning of section 39(1)(c) of the Act.

[63] Accordingly, the Appellant's first submission that the loss suffered in respect of the fifth joint venture was a deductible non-capital loss fails. His alternative submission that he was entitled, in respect of the loss, to an allowable business investment loss under section 3 and the above noted provisions, succeeds.

[64] The appeal is allowed with costs.

Signed at Ottawa, Canada this 1^st day of March, 2000.

"Bell"

J.T.C.C.

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