The Assistant Chairman:—These are the appeals of Albert J A Reid from assessments of the appellant’s 1966 and 1967 taxation years which were heard at Toronto on January 26, 30 and 31, 1973.
Counsel for the appellant considered that the appeal for the 1967 taxation year was invalid because it was from a nil assessment for that year, and asked that it be quashed. However, both counsel had apparently agreed that it would be necessary to discuss the facts which took place in 1967 and conceivably might affect the appellant’s 1966 tax assessment. This discussion was permitted. The Board feels, however, that it would have been more satisfactory to have had the opportunity of hearing arguments on the merits of the appellant’s appeal from his 1967 assessment as well as those from his 1966 assessment, and the Board questions whether a nil assessment in a taxation year necessarily precludes it from being appealed.
In this appeal counsel for the appellant contends that his liability to pay $200,000 was the result of an expense incurred in 1967 for the purpose of earning income from his business or, alternatively, that an amount of $235,000 constituted a bad debt or a general business expense incurred by the appellant in 1967 for the purpose of earning income from his business. Counsel further concluded that if the deduction of either of these amounts were allowed, a loss would be created in the appellant’s 1967 taxation year which could be carried back and deducted from his business income for 1966.
Counsel for the respondent contended that the amount of $200,000 or the amount of $235,000 is not deductible in computing the appellant’s income for 1967 because
(1) the amounts were not outlays or expenses incurred for the purpose of gaining income from a business;
(2) these amounts were not debts that became bad or doubtful in 1967 and they had not been included in computing the appellant’s income for the 1966 or 1967 taxation year;
(3) these amounts were not debts arising from loans made in the Ordinary course of business by the appellant and the appellant's ordinary business was not that of lending money;
(4) these amounts were not related to a business operated by the appellant but to the appellant’s employment with the company, and any permissible deduction would be limited to the amount of commissions received by the appellant during the 1967 taxation year which was already allowed;
(5) this alleged loss suffered by the appellant during the 1967 taxation year was not incurred from a business operated by the appellant but was incurred with respect to the appellant’s employment with Waite, Reid and Company Limited and therefore cannot be carried back to the 1966 taxation year.
The facts of the case are as follows:
The appellant in 1959 established the firm of Adams, Reid Limited which was engaged in the underwriting and promotion of issues of stock. In 1961 the appellant, who was vice-president and owner of 40% of the shares of the company, took in Mr Waite on Mr Adams’s retirement from business and continued the firm as a brokerage house trading on the Toronto Stock Exchange under the name of Waite, Reid and Company Limited in which the appellant owned over 50% of the shares.
In 1966 the appellant was president of Waite, Reid and Company Limited and was also president and principal shareholder of Ken-Al Enterprises Limited, an underwriting company. The appellant further owned 50% of the issued capital stock of Welbay Securities Limited, another underwriting company. The appellant’s activities in the trading, the promoting, and sale of securities were carried out through these three companies.
In the pertinent years the appellant derived income from the business of trading sales of securities in the following way:
(a) commissions from Waite, Reid and Company Limited;
(b) profits from trading in securities in Waite, Reid and Company Limited;
(c) profits from trading of securities by Ken-Al Enterprises Limited and Welbay Securities Limited;
(d) a salary from Waite, Reid and Company Limited as administrator and manager for that company.
From evidence heard, customers would approach the appellant with a project. The promotion and the sale of securities on the project would be carried out by Waite, Reid and Company Limited but the underwriting would be done by either Ken-Al Enterprises Limited or by Welbay Securities Limited. When customers lacked sufficient finances to put their project on the market, the appellant’s policy was to loan the customers the necessary finances out of his personal funds and charge the amount so loaned as an advance to Waite, Reid and Company Limited. No interest was charged on the loans which were usually short-term loans as the revenues envisaged by the appellant were from the commission and the profits earned from trading in the eventual securities.
Pursuant to a Toronto Stock Exchange regulation, a subordination agreement for these loans was entered into on November 1, 1966, whereby Albert J A Reid, as creditor of Waite, Reid and Company Limited, agreed to postpone the payment and satisfaction of the debt owing to him by Waite, Reid and Company Limited until all the general creditors of Waite, Reid and Company Limited had been fully paid (Exhibit A-8).
The appellant, who was president and manager of Waite, Reid and Company Limited, also acted as salesman of Waite, Reid and Company Limited and received a 50% commission from the Toronto branch of the company, and a 3373% commission for the business he brought to the branches of the company in other cities, whereas the other salesmen of the company received only 337s%.
The appellant had instituted a company policy whereby the salesmen were liable and responsible to the company for the payments of their respective customers’ deficit accounts (Exhibit A-6). An agreement to this effect was signed by some of the salesmen and although not all the salesmen had signed such an agreement, all the salesmen, including the appellant, were held responsible for the payment of their customers’ deficit accounts. Salesmen’s customers’ bad debts were deducted from the commissions earned by the salesmen at the end of each year.
In July 1967 Waite, Reid and Company Limited was petitioned into bankruptcy and at that time it would appear that the appellant, as a salesman, had accumulated a liability to Waite, Reid and Company Limited of $200,000 from unpaid accounts of the appellant’s customers and for which the appellant had no counter-balancing commission income.
The appellant had, however, by means of subordinated loans advanced $235,000 to Waite, Reid and Company Limited in order to enable the company to extend credit to customers whose business the appellant sought to transact through that company.
The trustee in bankruptcy, in attempting to collect the outstanding accounts owing to Waite, Reid and Company Limited, advised the appellant on April 26, 1968 (Exhibit A-7) of the appellant’s $200,000 liability to Waite, Reid and Company Limited under the indemnity clause to which the appellant was subjected. The appellant resisted because he contended that he had a counter-claim of $235,000 owing to him by Waite, Reid and Company Limited as subordinated loans made to the company. This issue was finally settled with the trustee on February 7, 1972 (Exhibit A-9) by an agreement in which the appellant’s $235,000 credit in Waite, Reid and Company Limited was offset against his liabilities to that company.
The basic point in issue is whether the amount of $200,000 and/or the amount of $235,000 is deductible in computing the appellant’s income for 1967, and whether a consequential loss could be carried back and deducted from the appellant’s business income for 1966. Because of the difference in the nature and source of the appellant’s $200,000 liability and $235,000 credit with Waite, Reid and Company Limited, I propose to deal with each separately.
It is important, in my view, to distinguish clearly between the appellant’s various sources of income. Since the appellant was the majority shareholder of Waite, Reid and Company Limited, he received income from his share of the company’s profits, as manager of the company he received a salary, and as salesman for the company he received a commission. These three sources of income indicate three separate and distinct activities of the appellant within that company.
Counsel for the appellant contends that these three activities in Waite, Reid and Company Limited, as well as those in Ken-Al Enterprises Limited and Welbay Securities Limited in which the appellant was a shareholder, was one overall scheme of the appellant’s operations for the promotion and trading of securities and that these incorporated companies were merely the legally required vehicles by which the appellant could carry out his personal brokerage business.
From this premise, counsel concludes that the appellant’s liability to pay $200,000 was an expense incurred in 1967 and the $235,000 was a bad debt or general expense incurred in 1967 by the appellant in earning income in his overall activities or business as a broker independently of Waite, Reid and Company Limited, and that the loss created by the deduction of either of these amounts for the 1967 taxation year should be carried back to 1966 and deducted from income derived from the appellant’s overall business as a broker, again independently of Waite, Reid and Company Limited.
This point of view is certainly not confirmed by the financial statements attached to the appellant’s return. Notwithstanding that the ap- pellant considers his activities as one scheme of operations or an overall personal brokerage business independent of his companies, the appellant could not nor did he, in fact, operate in a vacuum and the companies were not only vehicles to carry out the appellant’s brokerage business—they were separate legal entities which, for tax purposes, operated their individual businesses. For whatever reason Waite, Reid and Company Limited or any other companies may have been incorporated by the appellant, they acquired a legal entity which cannot be ignored and the companies, as well as the shareholders and officers, are subject to the basic commercial and business laws and practices. in this instance the identity of the company, and that of the principal shareholder, cannot be interchanged at will to suit a particular purpose. Nor can the activities of the principal shareholder, that of the manager, or that of the salesman in Waite, Reid and Company Limited, which were carried out by the appellant, be fused together and considered as part of an overall business independent of Waite, Reid and Company Limited.
In claiming that the $200,000 liability was an expenditure made for the purpose of earning income for the appellant’s overall brokerage activities, he is ignoring completely the corporate structure of Waite, Reid and Company Limited which held, and was responsible for, the securities which were sold, not by the appellant, but by Waite, Reid and Company Limited. As principal shareholder, the appellant could realize an income from profits of the company on the sale of shares but, in earning his commission income, the appellant was merely promoting the sale of securities owned by Waite, Reid and Company Limited and, as such, he was acting as any other salesman employed by that company.
Just as it would be unthinkable to hold that the appellant’s salary as manager of Waite, Reid and Company Limited was income from the appellant’s overall brokerage business, and not income from an office or employment in Waite, Reid and Company Limited, it is as difficult to hold that the appellant’s commission income as a salesman for Waite, Reid and Company Limited was not income from employment but from the appellant’s overall brokerage business. The fact that the appellant was president of Waite, Reid and Company Limited, the fact that he established for himself and received a 50% commission on sales of shares to his customers when other salesmen received 331/3%, and the fact that he voluntarily assumed the responsibility for his personal customers’ unpaid accounts does not, in any way, alter the nature of his activities as a salesman for Waite, Reid and Company Limited. His relationship with the company in that capacity was identical to that of any of the other salesmen and the source of his income from commissions was, in my opinion, from employment and not from a business.
Since the appellant’s $200,000 liability arises because of the unpaid accounts of the appellant’s customers and for which the appellant in his capacity as a salesman was liable to Waite, Reid and Company Limited as an accessory to his employment as a salesman, it cannot be held that the eventual loss to the appellant was a business loss any more than a similar loss by any other salesman could be considered a business loss.
The appellant’s $200,000 liability could not, in my view, even be considered as a deductible item from the appellant’s commission income in 1967 because such a loss is not included in the type of expenses that are deductible from commission income pursuant to subsection 11(6) of the Income Tax Act. In any event, the resulting loss. could not be carried back to the previous year.
In my opinion, whether the appellant was liable for the $200,000 in 1967, whether the debt became doubtful or bad in that year, whether its calculation was on a cash or accrual basis, and whether, or when, subrogation took place, is not material for the purposes of this appeal because the liability, the debt or the loss of the $200,000 did not Originate from moneys expended by the appellant for the purpose of gaining income from a business, but arose because of an indemnity clause which was an accessory to the appellant’s employment activities as salesman for Waite, Reid and Company Limited and therefore cannot be deducted as a business loss pursuant to paragraph 12(1)(a) of the Income Tax Act.
The $235,000 credit claimed by the appellant in 1967 arose by way of subordinated loans made by the appellant to Waite, Reid and Company Limited in his capacity as principal shareholder of the company.
It is important to note that the appellant advanced moneys to Waite, Reid and Company Limited, and it is the company and not the appellant who extended credit to its customers. These loans made by the company to its customers might conceivably be considered as expenditures made by the company for the purpose of earning income from a business, but the advances made by the appellant to Waite, Reid and Company Limited cannot by any standard be considered as general expenses incurred by the appellant for the purpose of earning income from a business. They can only be described as a shareholder’s loan to the company in order to provide it with the running capital necessary for the operation of its business and, as such, the advances must be considered as capital investment by the appellant.
Just as the appellant cannot be considered as operating an overall brokerage business independently of the companies incorporated for that purpose, the appellant cannot be considered as carrying on a loaning business independently of Waite, Reid and Company Limited because there is nothing in the evidence which indicates that the appellant made any loans other than to Waite, Reid and Company Limited in which the appellant is the principal shareholder. Paragraphs 11 (1)(e) and 11 (1 )(f) of the Income Tax Act are not applicable, and the $235,000 subordinated loans made by the appellant to Waite, Reid and Company Limited cannot be considered as doubtful or bad debts because they did not arise from loans made in the ordinary course of the appellant’s business and no part of the appellant’s ordinary business is the lending of money.
In my opinion, the basic issue to be decided in this appeal on which the applicablity of supporting arguments depends is simply the deductibility or otherwise of either or both of the losses of $200,000 and $235,000 in the appellant’s 1967 taxation year and the possibility of a carry-back of such losses to his 1965 taxation year.
A careful review of the facts and an analysis of the source of these losses have led me to conclude that the appellant’s liability to pay $200,000 was not due to expenses incurred in 1967 for the purpose of earning income from his business; that the amount of $235,000 was neither a bad debt nor a general business expense incurred by the appellant in 1967 for the purpose of earning income from his business; that neither of these losses are deductible in the 1967 taxation year and therefore no resulting loss was incurred by the appellant in the 1967 taxation year which could be legally carried back to the appellant’s 1966 taxation year presently under appeal.
Counsel for the appellant stated that the Minister had agreed to allow, by way of reassessment, deductions relative to certain items in the appellant’s 1966 return and, with the consent of counsel for the respondent, asked that, whatever the outcome of the present appeal, the matter be referred back to the Minister for reassessment. The appeal from the appellant’s 1967 assessment having been quashed, the appeal for the 1966 taxation year is allowed in part and the matter referred back to the Minister for reconsideration and reassessment of certain specific items in the appellant’s 1966 taxation year, but as to all other issues the appeal is dismissed.
Appeal allowed in part.