Date: 20000907
Docket: 1999-3681-IT-I
BETWEEN:
DEREK LABELL,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Lamarre, J.T.C.C.
[1] This is an appeal, filed under the informal procedure, from a determination of a loss made by the Minister of National Revenue ("Minister") under the Income Tax Act ("Act"), whereby the Minister determined to be nil the appellant's loss for the 1994 taxation year. Originally, the appellant had claimed, in filing his 1994 tax return, a business investment loss in the amount of $22,104, of which $16,578 was claimed as an allowable business investment loss ("ABIL").
[2] In support of his determination, the Minister relied upon the following assumptions of fact found in paragraph 6 of the Reply to the Notice of Appeal:
a) for the 1994 taxation year, the Appellant declared an amount of $22,104 as Business Investment loss from "Multichange Foreign Exchange Limited Partnership"; and consequently, claimed a deduction in the amount of $16,578 as ABIL;
b) "Multichange Foreign Exchange Limited Partnership" was not a Canadian-controlled private corporation;
c) the Auditor mentioned that the head office of "Multichange Foreign Exchange Limited Partnership" was located in United States of America;
d) "Multichange Foreign Exchange Limited Partnership" was not a small business corporation;
e) "Multichange Foreign Exchange Limited Partnership" was a "limited partnership"; thus, it was not legally considered a corporation, that is to say, it was not legally considered a person;
f) as well, the vouchers submitted by the Appellant were not valid for a Capital loss;
g) consequently, the amount of $16,578 ($22,104 x 75%) claimed by the Appellant as ABIL in the Appellant's 1994 taxation year, was disallowed by the Minister;
h) furthermore, as the loan was a non-interest bearing, the amount of $22,104 was not considered as Capital loss by the Minister.
[3] At the hearing, the appellant admitted that he could not claim an ABIL according to the terms of the Act but he still claims that he should be allowed a capital loss.
[4] It was disclosed in evidence that the appellant invested an amount of $2,000 in Multichange International Limited Partnership ("limited partnership") as a limited partner at the time that limited partnership was registered in the province of Quebec on March 15, 1993 (Exhibits R-2 and A-2). Ms. Diane Schrenk, the other limited partner, invested $10,000. An American corporation called Multichange International Foreign Exchange, which was incorporated in the state of Delaware in United States ("Multichange Corporation") on March 10, 1993 (Exhibit R-1), acted as the general partner and was represented by Mr. Bernard Van der Stichele, a financial consultant. Mr. Van der Stichele also invested $2,000 in the limited partnership.
[5] The objectives behind the creation of the limited partnership are stated as follows in the "Déclaration de société en commandite" filed as Exhibit R-2:
Les objectifs de la COMMANDITE sont d'acheter et d'installer des systèmes mécaniques d'opération, contrôlés du logiciel par ordinateur pour faire l'échange de devises étrangères, ainsi pour la dissémination de l'information sur le prix coûtant des transactions et sur leur valeur, et d'exploiter commercialement des bureaux de change.
[6] According to the appellant's testimony, which is summarized in a letter sent by the appellant to counsel for the respondent on July 6, 2000 (Exhibit R-7), the limited partnership was set up to operate foreign currency exchange retail outlets and to sell and distribute automated currency exchange vending machines throughout North America. The limited partnership dealt with a German manufacturer by the name of Hess.
[7] The limited partnership opened its first retail operation in Decarie Square in Montreal (with one vending machine and two counters providing regular service). According to the appellant, the representative of the limited partnership had to go to Germany in order to secure with the manufacturer the limited partnership's rights with respect to the machines to be sold. The appellant also stated that the limited partnership wanted to be the only business in Canada to operate retail outlets dispensing foreign currencies through vending machines. According to the appellant, to achieve this purpose, large amounts of cash were required to purchase the machines, to stock them with cash in many different currencies, to travel, to hire staff, to train several technicians to maintain the machines, etc.
[8] To obtain those large sums of money, the limited partnership asked the appellant to meet with people in the industry and find investors. The appellant met with Mr. Murray Pezim in Vancouver, who at the time had several companies listed on the Vancouver Stock Exchange, and with other investors, to convince them to inject additional working capital into the limited partnership. He was however unsuccessful.
[9] Furthermore, the appellant testified that an opportunity came up in Frankfurt, Germany, to acquire and administrate a carriage trade portfolio management company that Multichange Corporation had known from previous business dealings. In Frankfurt, the appellant and other people travelling with him were introduced to a group of hotel travel agents who were interested in the concept of installing vending machines in their travel businesses. All this led to a trip to Nice, France, to meet with one executive of that group for the purpose of discussing the matter and then to Madrid to meet the chairman of the group.
[10] The $22,377.59 claimed by the appellant as a capital loss represents an amount of $20,377.59 loaned to the limited partnership by way of advances and the amount of $2,000 of capital invested by him when the limited partnership was registered. The appellant filed vouchers proving those advances. The vouchers consist mainly of telephone, taxi, hotel, car rental and gas bills, and airplane tickets. Most of these bills were paid with American Express credit cards.
[11] According to the appellant, the limited partnership was forced to cease its operations in early 1994 due to financial difficulties. This is corroborated by two letters signed by Mr. Van der Stichele (who testified to the same effect) on March 31, 1994. The first states that the entire initial capital ($14,000) invested in the limited partnership was lost during the first nine months of operation of the limited partnership (from March to December 1993) (Exhibit R-10). The second is to the effect that an amount of $20,377.59 was owed to the appellant on December 31, 1993 (Exhibit R-5). According to Exhibit R-10, the limited partnership incurred additional liabilities of approximately $200,000.
[12] The Minister refused to accept the loss on the basis that the appellant did not present adequate vouchers and on the basis that the loan did not bear any interest. The respondent is also of the view that the limited partnership to which the advances were made did not use the borrowed funds in order to produce income from a business.
[13] The respondent is of the view that the statement of earnings of the limited partnership for the period ending December 31, 1993, which shows a loan payable to the appellant of $22,377.59, is not reliable. Indeed, the provision for bad debts claimed as expenses is higher than the income declared. On the other hand, the respondent relies on the same document to say that with a loss shown of $362,688, it is not reasonable to believe that the limited partnership authorized the appellant to advance that amount of money ($20,377.59) and not reasonable for the appellant to claim that the funds were used in order to produce income.
[14] The respondent also referred to a memorandum of agreement between the limited partnership and the general partner drafted on March 12, 1993, but not signed, whereby the limited partners secured the services of the general partner for a monthly fee of $12,000. The respondent claims that those consulting fees were completely unreasonable if one takes into account the loss declared in the statement of earnings.
[15] The respondent also filed computerized forms showing the appellant's reported income from 1988 through 1995. According to those sheets, the appellant never reported more than $2,500 per year and reported very low income in the years 1991 through 1994. The respondent is skeptical as to the source of the funds presumably advanced by the appellant to the limited partnership.
[16] After having analyzed the evidence, I am satisfied that the limited partnership operated a business in 1993. It had a place of business in Decarie Square and was operating one vending machine and two counters. The appellant has also demonstrated that he originally invested $2,000 in working capital in the limited partnership. The evidence disclosed as well that the limited partnership tried to find investors in Western Canada and in Europe and to secure its rights with the manufacturer of the vending machines. I therefore see no basis for concluding that the amounts claimed as expenses by the appellant were not disbursed in order to raise income for and from the limited partnership.
[17] It is obvious that the Minister first refused the ABIL without having analyzed the expenses as such. In a letter addressed to the appellant by the Office Examination Section on January 25, 1996 (Exhibit R-8), the appellant was asked to provide all the information concerning the unrecoverable loans. The appellant sent a confirmation of the amount owed signed by Mr. Van der Stichele (Exhibit R-5). He also sent a copy of the unit value of his interest in the limited partnership (Exhibit A-2).
[18] The vouchers do not seem to have been specifically required by Revenue Canada at that time. At the appeal level, Ms. Lucie Allaire, appeals officer, asked the appellant's accountant for a copy of a loan agreement between the appellant and the limited partnership and a copy of the partnership agreement by which the limited partnership was constituted. No references to the vouchers were specifically made and the appellant and his accountant were under the impression that Revenue Canada already had the documentation required.
[19] The vouchers were submitted by the appellant at the first hearing and I accepted the respondent's request for an adjournment to allow the respondent time to analyze those vouchers. At the second hearing, counsel asked a few questions concerning the vouchers but, upon reflection, it is my view that counsel did not succeed in challenging them. It is true that the appellant reported low income in 1994 and previous years. However, the fact is that the expenses incurred were real. There is no doubt about that if we look at Exhibits R-6 and R-7. The next step is therefore to determine if they were incurred for the benefit of the limited partnership or for personal reasons. Some of those expenses might be personal (for example the phone calls in Montreal, which represent, however, a very low amount). Some of the expenses pointed out by counsel for the respondent are not in the name of the appellant or any partner of the limited partnership (for example two plane tickets in the names of Verron and Zhivcov costing $781.50 and $782.75 respectively). (See Exhibit R-6 at page 29.)
[20] Apart from those few items, I have no reason to believe, having heard the appellant's and Mr. Van der Stichele's testimony, that the expenses in question were personal expenditures of the appellant.
[21] As was said by Robertson J. A. of the Federal Court of Appeal in Easton v. The Queen, [1998] 2 F.C. 44 at page 55:
As a general proposition, it is safe to conclude that an advance or outlay made by a shareholder to or on behalf of the corporation will be treated as a loan extended for the purpose of providing that corporation with working capital. In the event the loan is not repaid the loss is deemed to be of a capital nature for one of two reasons. Either the loan was given to generate a stream of income for the taxpayer, as is characteristic of an investment, or it was given to enable the corporation to carry on its business such that the shareholder would secure an enduring benefit in the form of dividends or an increase in share value. As the law presumes that shares are acquired for investment purposes it seems only too reasonable to presume that a loss arising from an advance or outlay made by a shareholder is also on capital account.
[22] Although the controversial statement of earnings for the period ending December 31, 1993 (Exhibit A-1) shows a significant loss, this was for the first and only year of operation. It is conceivable that the appellant did not realize the extent of the loss during the 1993 taxation year, which was the year in which he advanced all the money. Ms. Schrenk, the other limited partner, had invested $10,000 and the limited partnership had started operating a business in Decarie Square in Montreal. As early as 1994, the limited partnership ceased its operations due to financial difficulties. In those circumstances, I will give the benefit of the doubt to the appellant. I am ready to accept that he advanced the money to enable the limited partnership to carry on its business and that he hoped to secure a benefit thereby through an increase in the value of his interest in the partnership.
[23] For these reasons, I am therefore of the view that the appellant is entitled to a capital loss for the amounts advanced to the limited partnership, with the exception of the few items specified above. I would therefore reduce the capital loss claimed by an aggregate amount of $2,000.
[24] The appeal is therefore allowed, without costs, and the assessment is referred back to the Minister for reconsideration and reassessment on the basis that the appellant is entitled to a capital loss of $20,104 for the 1994 taxation year.
Signed at Ottawa, Canada, this 7th day of September 2000.
"Lucie Lamarre"
J.T.C.C.