Tax Court of Canada Judgments

Date: 20021015

Docket: 1999-3797-IT-G

BETWEEN:

BRUCE AGNEW,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent,

AND BETWEEN:

1999-3798(IT)G

CLAYTON WATTERS,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

O'Connor, J.T.C.C.

[1]            These appeals were selected by counsel for the Appellants and counsel for the Respondent as representative of approximately 138 essentially identical investment situations. The outcome of these appeals may govern all situations.

[2]            The appeals were heard, for the most part, on common evidence. Certain facts however, were peculiar to each individual. Most importantly the due diligence efforts in investigating the investment were extensive for Watters and considerably less for Agnew. Further, Watters, as did many investors, eventually placed the investment (then represented by a share in a corporation) in his RRSP whereas Agnew did not. Also for Agnew the years in question are 1994 and 1995 and for Watters the years in question are 1992, 1993 and 1994. Also, Watters' investment was in Bovine I and Agnew's investment is in Bovine VI but this is not material as all the Bovines had essentially the same structure.

[3]            The Appellants and the other investors became interested in a scheme involving the following players and facts:

(a)            A prominent London, Ontario lawyer, William Kennedy ("Kennedy") in early 1992 conceived or learned of an idea involving the implantation of frozen cattle embryos in host cows resulting later in the birth of calves having the same favourable features as the cattle whose embryos were used. Further details of the process appear below. Matters were initiated by Mr. Deno DeLellis a very persuasive salesman. He was instrumental in drawing up the Operating Memorandum ("OM") which describes how the plan would work. The OM referred to the various steps and master agreements to be executed. Mr. DeLellis, at first with AIC Investment Planning Ltd., later joined AIC Berkshire Group ("AIC"), a national financial organization which was a registered securities dealer. The investments in the Bovines were made through AIC.

(b)            A family named Coles, being a well-known group of farmers in the London, Ontario area, were to physically handle the operations in Canada through a corporation named Asil Inc. The national audit firm of Ernst & Young provided cash projections, vetted the OM and did the accounting and some auditing. Also some public meetings were held, where the well known investment counsellor, Brian Costello discussed and promoted the plan.

(c)            If an investor wished to borrow the money to make the investment ($20,000) or as matters progressed ($22,000), National Trust was prepared to lend the desired amount on the basis of some security. Many of the sales of the investment were made through the instrumentality of Mr. DeLellis.

(d)            Further details of the investments are as follows:

[4]            The concept originally conceived by Mr. Kennedy in 1992 involved the importation into Canada from Italy of frozen embryos of a very special breed of cattle known as Piedmontese. The particular feature of these cattle is that their meat generated only one half of the fat or cholesterol of normal cattle and it was thought that this breed would appeal to health conscious Canadian consumers. Six limited Bovine partnerships were set up, each limited to 25 limited partners. The reason for the six partnerships is that the Ontario Securities Act provides for an exemption from filing a prospectus in situations such as this where the number of investors is limited to 25. In that case only an OM is required.

[5]            The limited partnerships were known as Bovine I, II, III, IV, V and VI. There is very little difference in the structure of each of the limited partnerships except that in the first five the investment was $20,000 and in Bovine VI the investment was $22,000. If all six Bovines were fully subscribed that would have involved 150 people (6 x 25) but Bovine VI was not fully subscribed to and consequently the total number of investors was only 138.

[6]            The responsibility of the Coles' family was to provide all of the farm services. They would arrange for the obtaining of cattle "host dams" in Canada. They would arrange for the implant of the frozen embryos. They would arrange for the veterinarians and the care of the animals when birthing and over-all care generally until a final sale of the calf produced by the frozen embryo. The "host dam" cows were provided principally by the Coles on a rental basis.

[7]            When an investor wrote a cheque for $20,000 or $22,000, it was sent through AIC.

[8]            The OM provides the following objects namely that the offering was for:

(a)            the purpose of carrying on the business of providing frozen embryos, transplanting, bringing those embryos from Italy, arrange for the transfer of the embryos into the host cows, raising, indexing, exhibiting and selling full-blooded Piedmontese cattle, and

(b)            to provide an opportunity for income.

[9]            The issues that arise are whether the investors are entitled to take restricted farm losses, whether an investment can eventually be placed in an investor's RRSP and thirdly can the investor deduct the interest on the monies borrowed from National Trust to make the $20,000 or $22,000 investments.

[10]          The main determinant behind all of the issues was at first thought to be whether a business was being carried on with a reasonable expectation of profit. Was there a source of income? The decision of the Supreme Court of Canada in Stewart v. Canada, [2002] S.C.J. No. 46, discussed below, altered that approach somewhat.

[11]          The overall plan set forth in the OM does not contemplate any profits for the limited partners. It contemplates that when a herd is ready for sale, the limited partnership concerned was to transfer that herd and other assets, embryos, etc. to a limited corporation in exchange for a share in that corporation for each investor. The sale was to be made at fair market value and it was contemplated that if there was going to be a contribution to an RRSP it would be the share of the corporation owned by a particular investor that would be contributed.

[12]          The following extracts from pages 009 to 045 of the OM for Bovine I describe the plan more completely:

Payment on Closing of Offering:	$20,000.00 by cash or certified cheque
General Partner:	Middlesex Perth Bovine I Management Inc.
Promoter:	Piemontese London Ltd.
Manager of the Herd:	Middlesex Perth Bovine I Management Inc.
Agent:	Piemontese London Ltd.
Escrow Agent:	Jeffery Associates

Generation of Cash Flow and Income

The Cash Flow and Income of the Limited Partnership shall be generated by the sale of the Herd.

Distributable Cash	Distributable Cash of the Limited Partnership distributed in respect of each fiscal year shall be as follows:
	1.         100% thereof to the Limited Partners, until such time as the Limited Partners receive Distributable Cash equal on a cumulative basis to 100% of their Net Capital Investments or $20,000.00;
	2.         thereafter, 75% to the Limited Partners, and 25% to the General Partner.

Asset Transfer & Dissolution of the Limited Partnership:	On or about January 15th, 1994, the Limited Partnership will transfer all of the Herd and other assets to Middlesex Perth Bovine I Inc. (the "Corporation") in consideration of the Corporation issuing Shares to the Limited Partnership and assuming all of the Liabilities of the Limited Partnership (the "Asset Transfer"). Within sixty (60) days of the Asset Transfer, the Limited Partnership will be dissolved and the shares of the corporation will be allocated to the Partners in accordance with the provisions respecting distribution of Distributable Cash.
Eligibility for RRSP:	It is expected that the shares of the Corporation will be eligible investments for RRSP purposes...
Corporation	The Corporation intends to liquidate its assets in its first fiscal year following completion of the Asset Transfer, and pay dividends to the shareholders and purchase the shares for cancellation with the net proceeds received from the liquidation.
Canadian Federal Income Tax Aspects of the Offering:	The Limited Partnership will use the cash method of computing income for income tax purposes, and anticipates that there will be losses available to holders of Interests in 1992 and 1993. Interest expense incurred on money borrowed to acquire an Interest is generally deductible for income tax purposes, and should be taken into account in determining a taxpayer's income or loss from the Partnership. In certain circumstances, the Tax Act restricts the deductibility from other sources of income of a taxpayer's share of losses from a farming business.
	It is expected that any capital gain arising on the disposition of shares in the Corporation to an RRSP will be eligible for the enhanced $500,000.00 capital gains exemption on shares of qualified small business corporation. A Limited Partner's ability to claim the capital gains exemption will be affected by the cumulative net investment loss account of the Limited Partner. The principal Canadian federal income tax consequences to prospective Limited Partners of holding and disposing of Interests pursuant to this Offering Memorandum are set out under the heading entitled "Income Tax Aspects of the Investment" which has been prepared by Ernst & Young, Chartered Accountants.

Closing:	The General Partner shall initially close this Offering on June 30th, 1992, .... closings completed upon receipt of twenty (20) subscriptions and twenty-five (25) subscriptions, respectively, provided that the twenty-five (25) subscriptions are received on or before December 31st, 1992.
Management Agreement:	The General Partner will act as Manager of the Herd. The General Partner shall retain such professional advisors and such expertise as it deems necessary to assist it in performing its management duties and its duties to rent the Host Dams and provide board and care for the Herd.

THE INVESTMENT

The objectives of the investment offered by this Offering are to provide to investors the benefit of limited liability while at the same time providing an opportunity for earning income through the sale of the Herd.

THE LIMITED PARTNERSHIP

The Limited Partnership was formed as a limited partnership under the firm name and style of "Middlesex Perth Bovine I Limited Partnership" pursuant to a limited partnership agreement entered into between Middlesex Perth Bovine I Management Inc. and the Initial Limited Partner. The Limited Partnership was registered under the Limited Partnerships Act (Ontario) (the "Act") on the 25th day of February 1992.

THE HERD

The Limited Partnership will purchase two hundred (200) full blood Piedmontese frozen embryos to be implanted in host dams for the purpose of producing a herd of full blood Piedmontese cattle which will be raised with the host dams to the weaning age of approximately two hundred (200) days. For the period of one hundred and eighty (180) days following weaning, the Herd will be raised, indexed, shown and sold at any time or times considered by the General Partner to be in the best interests of the Limited Partnership. It is the intention of the General Partner to sell the entire Herd within the one hundred and eighty (180) day period following weaning. The frozen embryos will be purchased from various breeders of Piedmontese cattle located in Italy, Canada and/or the United States through the General Partner. The frozen embryos will be implanted by a person or persons chosen by the General Partner as having experience in the field of embryo transplantation. The success rate from the implantation of bovine embryos varies greatly. Although an average rate of success is about fifty-five (55%) per cent, with proper care and management high rates of between seventy-five (75%) per cent and eighty (80%) per cent are achievable. For the purpose of this Offering, a success rate of seventy (70%) percent has been used.

At the time of subscription, each investor will be required to execute and deliver a Subscription Agreement to Jeffrey Associates, who shall act as the Escrow Agent on behalf of the Limited Partnership, for each interest being acquired.

The subscription price of twenty thousand ($20,000.00) Dollars shall be paid by cash or certified cheque payable to Jeffery Associates, in Trust, as Escrow Agent on or before the closing of the Offering.

On the date of closing, the Escrow Agent will deliver all Subscription Agreements, cash and certified cheques to the General Partner.

It is expected that the proceeds from the sale of the Interests in the aggregate amount of $500,000.00 will be applied in the following manner:

(a)            $80,000.00 will be used by the Limited Partnership to acquire and implant the frozen embryos;

(b)            $210,000.00 will be used for purposes of prepaid rental of the Host Dams and the Herd from embryo transfer until weaning;

(c)            $31,500.00 will be used for purposes of prepaid board and care of the Herd from weaning until sale;

(d)            $35,000.00 will be used for purposes of prepaid management of the Limited Partnership and reporting to the Limited Partners from embryo transfer until sale;

(e)            $80,000.00 will be paid for the fees and costs associated with this Offering;

(f)             $63,500.00 will be deposited in an interest-bearing account for working capital purposes, including, but not limited to, registration, bloodtyping and insurance.

	Amount	Per Interest
Frozen Embryos (including implant fees)	$ 80,000.00	$ 3,200.00
Prepaid Host Dam Rental	$210,000.00	$ 8,400.00
Prepaid Board and Care	$ 31,500.00	$ 1,260.00
Management Fees	$35,000.00	$1,4000.00
Fees and Costs of Issue Summary
Costs of issue	$ 30,000.00	$ 1,200.00
Sales Commissions (2)	$ 50,000.00	$ 2,000.00
Working Capital	$ 63,500.00	$ 2,540.00
	___________	__________
TOTAL COST	$500,000.00	$20,000.00

The Limited Partnership was formed on the 26th day of February 1992, and shall continue until the 31st day of December 2001, unless previously terminated in accordance with the provisions of the Limited Partnership Agreement. It may be renewed by the vote of holders of at least two-thirds of the outstanding Interests for such term or terms as may be specified thereby.

The fiscal year of the Limited Partnership shall end on the 30th day of December in each year. The auditors of the Limited Partnership shall be Ernst & Young, Chartered Accountants, or another qualified auditor, as determined by the General Partner.

It is expected that the shares of the corporation will be eligible investments under the Income Tax Act (the "Act") for registered retirement savings plans.

The corporation intends to liquidate its assets in its first fiscal year following completion of the asset transfer and pay dividends to the shareholders and purchase the shares for cancellation with the net proceeds received from the liquidation.

Investors who acquire one or more interests will become Limited Partners of the Limited Partnership and will be required to include in income their share of the income or loss of the Limited Partnership for the fiscal period of the Limited Partnership ending in the Limited Partner's taxation year.

The General Partner has applied to Revenue Canada for a Tax Shelter identification number with respect to this Offering and will provide information with respect to this number to Limited Partners upon receipt.

INTEREST EXPENSE ON MONEY BORROWED TO ACQUIRE INTEREST

Generally any interest expense incurred on money borrowed to acquire an Interest is deductible for income tax purposes. However, any interest expense incurred by a partner on money borrowed to purchase an interest in a partnership must be taken into account in computing the partner's income or loss from the partnership. Accordingly, any interest expense incurred personally by a Limited Partner in relation to the acquisition of an Interest that has the effect of increasing or creating a farming loss of the Limited Partner may not be currently deductible, with the non-deductible portion becoming part of the Limited Partner's restricted farm loss. The restricted farm loss rules are explained below under the heading "Losses of a Limited Partner".

Generally a partner's share of the loss of a partnership is deductible in computing his taxable income against all sources of income. However the Tax Act contains special rules whose effect is to restrict the deductibility of farm losses by a person whose chief source of income is neither farming nor a combination of farming and some other source of income. In such cases the maximum amount of farming losses that can be deducted against other sources of income is limited to the lesser of:

(a)            the farming losses for the year; and

(b)            $2,500.00 plus the lesser of:

(i)             one-half of the amount by which the farming losses exceed $2,500.00; and

(ii)            $6,250.00.

Where a partnership carries on a farming business, Revenue Canada has stated in a published Interpretation Bulletin that it considers these restrictions to apply separately to each partner of the partnership. The amount of such losses that are not deductible against other income in the year may be carried back three years and carried forward ten years as restricted farm losses. Restricted farm losses are only deductible to the extent of a taxpayer's farming income earned in a year. Limited Partners whose chief source of income is not farming or a combination of farming and some other source of income may be restricted in deducting their share of the farming losses, if any, from the Limited Partnership as discussed above.

Any income or loss for tax purposes realized or incurred by the corporation are those of the corporation and cannot be allocated to its shareholders. Income... will be realized by the shareholders in the form of dividends from the corporation.

On the purchase for cancellation of the shares, the corporation is deemed to have paid, and the shareholders are deemed to have received, a dividend for income tax purposes equal to the amount it pays in excess of the paid-up-capital of the shares. The paid-up-capital of share received on tax-deferred transfer of assets, as described above, is equal to the aggregate of the agreed amounts, less the amount of any liabilities assumed and other non-share consideration paid by the corporation.

The following is a list of all material contracts relating to the Limited Partnership which have been or will be entered into on or before the date of closing:

(a)            the Agency Agreement;

(b)            the Escrow Agreement;

(c)            the Limited Partnership Agreement;

(d)            the Board and Care Agreement;

(e)            the Piedmontese Sales Agreement;

(f)             the Management Agreement;

(g)            the Asset Transfer Agreement; and

(h)            the Subscription Agreement.

[13]          Eventually all of the six corporations amalgamated to form one corporation, Aosta Piedmontese Ltd.

[14]          Over time matters appeared to be progressing but certain persons, principally, Kennedy, DeLellis and Coles began to misappropriate funds to themselves or relatives. The total misappropriation amounted to approximately one million dollars.

[15]          The fact of the misappropriations was brought to the attention of AIC. They brought in an outside manager, a firm called Promiteer, who took over the business from Kennedy and Coles and started managing the herd. Promiteer brought in a Mr. Roy Hains, a Chartered Accountant and a former partner of Price Waterhouse. He filed a report describing how the misappropriations were effected and how much money was repatriated (approximately one-half of a million dollars). Further at this stage the plan was changed to go long term and build up the herd. However, in February, 2000 due to the misappropriations and other adversities the operation was forced to shut down.

SUBMISSIONS OF THE APPELLANTS

[16]          The basic position of the investors is that they made a legitimate investment, relying on well-known parties such as the following:

Kennedy, a well-known London lawyer from a wealthy family

Brian Costello

The Coles family, who were well-know local ranchers

Ernst & Young, a well-known national accounting firm

National Trust Company which was providing financing services

AIC, a well-known securities dealer

DeLellis, a high earning securities dealer employed by AIC

To a certain extent they made their own due diligence and notwithstanding the fact that they did and were entitled to structure matters to achieve tax savings, nevertheless, there was an expectation of profit and the business was being carried on. Although at first losses were contemplated the plan was long term and future dividends were contemplated.

[17]          It is also the position of the Appellants and the investors, that had it not been for the misappropriations of large sums of money they realistically expected to have profits at the end of the day.

[18]          It is further the position of the Appellants and the investors that since there was no personal benefit or element to them such as you have in many tax driven schemes such as horse farms and villas and matters of that nature, it follows that there must have been some kind of business being carried on. See discussion of the Stewart case later.

[19]          The Appellants believed that the concept was a good one because of the health benefits of this particular brand of low fat beef of the Piedmontese breed, there would be a strong and profitable market in Canada for the product.

[20]          The Appellants refer to the purposes in the OM, namely:

(a)           to carry on the business of acquiring frozen embryos, producing by embryo transfer, raising, indexing, exhibiting and selling full blood Piedmontese cattle; and

(b)           to provide an opportunity for income.

[21]          The Appellants also refer to the detailed spending plan for the proceeds, tax advice and services of Ernst & Young all as set out in the OM and the general complexity and extensiveness of the OM supplemented by the eight material contracts mentioned above.

[22]          Counsel for the Appellants adds that the structure was a seamless series of transactions which was timed and phased so as to operate in a tax efficient manner. All of the steps from beginning to end were contemplated and pre-planned in the OM and were carried through under the supervision of Ernst & Young and various third party solicitors whose reports on the rollover transactions were filed at trial. Ernst & Young duly completed and filed on behalf of each taxpayer the section 85 rollover forms with elected values in accordance with the criteria of section 85.

[23]          Counsel adds as follows:

Ernst & Young acted as auditors for Bovines I and II in the first year and as accountants thereafter. The following financial statements were

reviewed at trial:

(1)            audited financial statement for Bovine I December 31, 1992. In terms of business activity Ernst & Young reports on:

(a)           cash in bank;

(b)           accounts receivable;

(c)           stock of embryos;

(d)           prepaid expenses;

(e)           accounts payable;

(f)            accrued liabilities.

The partnership was duly registered with Revenue Canada and granted tax shelter number TS05323499 and operated within the tax shelter guidelines. Ernst & Young certified a net farming loss for income tax purposes of $15,000 per unit which each partner could utilize subject to the restrictions in the Income Tax Act ("Act").

The activities reported on by Ernst & Young in their various audited and unaudited financial statements when taken together demonstrate and describe what must be described as a business and in fact the business contemplated by the OM and the projections. Embryos were bought and paid for. Embryos were implanted. Administrative expenses were incurred. Some calves were born and sold and the usual and customary banking activities were carried on. Financial statements and tax returns and elections were prepared and filed.

[24]          Counsel for the Appellants points out that at trial Suzanne Walker, the witness for Canada Customs and Revenue Agency ("CCRA") was taken meticulously through the OM which enumerates and describes the eight material contracts. She further was taken to each of the eight material contracts and she confirmed that each of those contracts was correctly described in the brief descriptions in the OM and each material contract carried out the objectives described in the short descriptions in the OMs. Any taxpayer who took the trouble to read the eight material contracts only would have found confirmation that the contracts which should exist did exist.

[25]          On the issue of due diligence counsel notes the response made to Ms. Walker and CCRA by the Appellant, Watters. Exhibit A-l, Tab 2. In answer to the question as to what he did to understand the proposal he replied that after reading and highlighting the lengthy OM he contacted for further information:

1.             Canadian Livestock Records Corporation, Ottawa

2.             Canadian Association of Piedmontese, Yorkton, Saskatchewan

3.             Western Ontario Breeders Inc., Woodstock

4.              Ministry of Agriculture and Food, St. Thomas

5.             Local livestock owners and managers in Elgin County where he lived.

[26]          In answer to the proposition that any tax shelter should justify itself as an investment without regard to tax savings Watters set out his calculation based on a selling price which he had learned was $5,000 for males and $6,500 for females which yielded a return of $32,200 (and possibly more) on his initial investment of $20,000.

[27]          Notwithstanding the reports and responses received from all 25 investors including representations from their accountants and lawyers and notwithstanding the securities background of the sale, CCRA persisted in the theory that Mr. Watters as an individual should have made more or better inquiries. At trial Dr. Betteridge ("Betteridge"), the only expert produced by CCRA, agreed that all of the places where Watters applied for information were appropriate places. He stated that if he had been asked about the 70% rate considered by Bovine I or indeed the 50% rate considered by Bovine VI he probably would have stated that his best number would be 60% but that there were no guarantees. It is submitted that if Watters had contacted Betteridge for advice, the conclusion would have been no different.

[28]          Highlighting the seriousness of the misappropriations proceedings before the Ontario Securities Commission ("OSC") resulted in a decision on the matter April 9, 1997 as a result of which it determined improper conduct on the sale of the Bovine limited partnerships and misrepresentation and the receipt of unlawful commissions. The Ontario Securities Commission ruled that DeLellis and Kennedy would be barred for life from having securities licences.

[29]          In each year the auditors certified that the conditions of RRSP qualification continued. See for example Tab 13 of Exhibit A-1 being the sample letter from Ernst & Young to AIC as to qualification for RRSP purposes. It was part of the project and plan that investors would transfer their Bovine shares to their RRSP at values determined by Ernst & Young based upon the actual results of the Ernst & Young audits. Ernst & Young prepared a number of detailed projections - by way of example - a projection at Tab 5 of Exhibit A-1 dated January 18, 1993 directed to AIC and DeLellis. The time line shows the rollover to a corporation and dissolution of the companies and shows a cash flow on various scenarios including in one case a cash distribution of $23,351 per unit and a net return to investor after tax of $7,767 in 1993 and $15,835 in 1994.

[30]          These projections were given to AIC and DeLellis to be utilized in the marketing process and were relied on by the investors in making their investment decision.

[31]          It is important to stress that these units were marketed through a well-known investment dealer and supported by Ernst & Young. The position of the taxpayers will be that AIC/Berkshire bore the substantial part of the due diligence obligations and that it was not for each investor to become an expert in Italian cattle.

[32]          While the proponents at all times represented that the project would be a money maker because of the inherent qualities of Piedmontese beef and the potential market in Canada for the product, the business model did not include any enticements to buyers such as free trips, free use of vacation homes, or even free meat. This was not one of those cases where a loss becomes inevitable because, for example, the taxpayer gets to use the vacation villa for the prime part of the year and then rents it out for the balance of the year for an amount of money which will not cover the mortgage interest and thus guarantee a loss. The Bovine projects were marketed solely as an opportunity to invest in a new Canadian business which would provide a healthful new product and would generate income.

[33]          After the investors learned of the misappropriations they got advice from experts in the farming field including George Earley whose report is filed and who gave expert evidence in this action. Mr. Earley reported positively on the quality of the product from a genetic point of view and has given his opinion that, absent a massive fraud and theft of the assets of the businesses, the business model was a good one and was viable.

[34]          Mr. Earley gave the opinion that based upon his expert knowledge of embryo transplantation in Canada the 70% success rate provided for in Bovine I OM was attainable. He gave a detailed calculation supported by records of actual sales of Piedmontese cows in Canada and the U.S. at the time at which the animals were to be available for sale which established conclusively that there would have been a profit but for the destruction of the businesses by the diversion of one million dollars. He showed how the operating cushion for each Bovine partnership was ample for it's legitimate purposes but could not possibly withstand a massive theft. Mr. Earley gave evidence that the Piedmontese concept is becoming established in Canada and that transplantation is commonplace.

[35]          After the taxpayers took over the control of their business they obtained the assistance of the Wilmeth Ranch and embarked upon a long term process of building up a herd. That process is described in the Revised Middlesex Perth Business Plan of 1996 - see Hains report, Tab 1; Mr. Hains had arranged for some of the wrongdoers to pay $283,000 which is referred to as "repatriated cash". The concept was to utilize embryos in storage and females in order to build up a herd of 150. At that point the annual production of calves could be sold, generating sufficient revenue to begin to return capital to the shareholders.

[36]          Mr. Hains negotiated with Kennedy for a payment on behalf of the investors but Kennedy went bankrupt instead. Hains negotiated with Ernst & Young and they refused payment. He negotiated with AIC and they made a payment by way of a loan of $250,000 of their mutual fund interest free and established a legal fund of $75,000.

[37]          Ultimately the herd was transferred to the Wilmeth Ranch in Texas. There are a number of reports of visits after that time where representatives of the Board of Directors attended in Texas and reported to the shareholders on the state of the herd. The herd was lost due to the combined effect of:

(a)           drought;

(b)           lightening strikes;

(c)           loco weed poisioning; and

(d)           loss of value of the Canadian dollar.

The business finally ended in February, 2000.

[38]          It was a fundamental aspect of the proposal that no borrowed monies would be required. The OM provided at page 16 that the partnerships would not borrow from banks and there was no vendor financing involved. In each case the investor put up $20,000 of tax paid cash. Having paid his $20,000 the investor was in a position where he expected to get back more than $20,000 so that he would have a profit.

[39]          The OM provides at page 16:

It is not contemplated that the limited partnership will enter into arrangements directly to borrow funds from a bank or other lending institution, it being the present intention of the general partner to manage the Herd assets of the partnership to generate proceeds sufficient to sustain the working capital requirements of the limited partnership of the Herd.

[40]          The OM also provided for mortality insurance on the limited partnership's herd. This is a factor in the evidence of Mr. Earley.

[41]          On being led through the portions of the OM which describe the herd and the Piedmontese product Dr. Betteridge agreed that the document was accurate from a scientific point of view and that it was fair and factually correct in every regard.

[42]          The taxpayers have submitted a large volume of evidence through Mr. Hains and including the decision of the Ontario Securities Commission which focus on a bringing to light of activities of the various parties involved in the wrongdoing. The Crown argues this evidence is not relevant on the issue of reasonable expectation of profit and that the reasonable expectation of profit decision must be made at the time the investments are made and the cheques are written. These events occur of course over a period of time in respect of the various Bovine partnerships.

[43]          The purpose of this evidence has been to demonstrate the cause for the collapse of the business as being the defalcations even though the taxpayers do not bear the burden of establishing that cause because they do not have to prove, on a before-investment basis, a guarantee of profit but only a reasonable expectation of profit. The taxpayers have gone the extra step of proving the cause of death of the business by way of establishing that the business was otherwise viable. Indeed, Dr. Betteridge agreed that there was a real upside potential in this product in Canada in the recent and continuing health conscious climate.

[44]          It is difficult to imagine what an ordinary taxpayer who was contemplating investing $20,000 through a registered dealer pursuant to an OM developed by Ernst & Young could reasonably have been expected to do by way of due diligence more than what Watters or Agnew have done. When measured against the investigations or inquiries undertaken by taxpayers in the decided cases the investigations and inquiries by Watters and Agnew are extremely thorough. Given the fact that under the securities legislation the taxpayer was separated from Kennedy before making his investment, he was entitled to rely on AIC with whom he was dealing.

[45]          It is the position of each taxpayer that:

1.             This was a cash investment with no vendor financing.

2.             There was no motivation other than to make a profit return on the investment. There is no personal benefit as that concept has been developed by the case law.

3.             Each investor made appropriate due diligence inquiries in the circumstances.

4.             Each investor was entitled to rely on due diligence having been done by AIC and Ernst & Young.

5.             The business was viable except for the unforeseen defalcation by the manager and his associates.

6.             These defalcations were not foreseeable and beyond the control of the taxpayers.

7.             But for the defalcations the business would have made a profit. See the evidence of Mr. Earley. Ms. Walker admitted that without the one million dollars the businesses could not succeed and failure became inevitable after the defalcations.

8.             The monies borrowed were borrowed to gain a profit. In this regard Counsel refers to the letter of Watters to CCRA and the evidence of both Watters and Agnew. There was no requirement in the transaction that the taxpayer borrow money. While CCRA alleges that it was inherent in the transaction that there was 100% financing, the concept of 100% in these cases refers to vendor financing and not a situation where a taxpayer borrows on his home to fund the investment. Ms. Walker of CCRA admitted that in her job in Tax Avoidance she is familiar with the usual case where the financing is provided by the vendor and repayment is contingent on success, or is foregiveable in certain circumstances or is indeed guaranteed by the proponent. The Bovine investors paid 100% cash in advance even in cases where they borrowed that money from third parties against existing assets.

9.             In each case the investment qualified for RRSP purposes.

10.           There was a business which existed and operated as demonstrated the Ernst & Young financial statements, cash flows and other documentation.

11.           The transactions, at the individual, partnership and corporate levels as well as after transfer to RRSP were a single transaction contemplated by the OM and should not artifically be subdivided into their various planned steps.

12.           The transactions were fully and completely documented in advance in the OM and the material contracts.

13.           The farming losses are bona fide.

THE LAW

[46]          The primary issue to be determined is whether the taxpayers in making their investments in the Bovine projects had, when they invested, a reasonable expectation of profit.

[47]          The analysis on the issue of reasonable expectation of profit must commence with a factual background which highlights the factors in this investment which are to be compared to factors in investments in the decided cases and the developing case law.

[48]          The primary factors in this investment are:

(a)            The investors are from the Middlesex County area and surrounding farming community and are investing in a farm related project to be carried on in their community by way of a new Canadian business enterprise.

(b)            Each investor paid $20,000 or $22,000 in cash on day one. There was no unpaid balance secured by vendor financing. In fact the OM provides that there will be no borrowing by the business.

(c)            There is no contingent forgiveness of unpaid balance.

(d)            The budgets and cash flows had been carefully and at great expense prepared by Ernst & Young (see opinion of Hains tab 4, 8, 9, 10, 14).

(e)            The budgets contained contingency reserves sufficient to cover in any eventuality the costs of registration, blood typing and mortality insurance.

(f)             The proponent was a well-known, local lawyer and municipal politician and member of a highly placed and noted family.

(g)            Third party financing at 100% was available through National Trust upon the security of the taxpayer's home or other assets.

(h)            The principal involved in marketing in five of the six cases was AIC/Berkshire, a well-known and highly regarded investment company.

(i)             The proposal was supported by a tax opinion from Ernst & Young.

(j)             Ernst & Young were to and did engineer the various legal steps of the section 85 rollover, the generation of the restricted farm loss and the verification of the appropriateness of RRSP and the valuation for RRSP (see opinion of Hains tab 13).

(k)            The sales effort started with advertisement in the London Free Press leading to the public meeting at the London Convention Centre or high school with a nationally known figure in the investment community - Brian Costello.

(l)             The salesman DeLellis was an apparently successful investment advisor.

(m)           The technology relating to the embryo transplant process was well established. In fact Mr. Earley had previously accomplished the same process of frozen embryo transfer with Belgian Blue cattle. Dr. Betteridge confirmed that this is a 30 year old process and talked about 22,000 transfers per year.

(n)            The Piedmontese breed was known in the agricultural community and the health conscious climate in Canada seemed to be supportive of the introduction and distribution of the product.

(o)            The farming aspects were to be handled by the Coles family who were well known farmers.

(p)            In each case the taxpayer in buying a partnership unit from AIC was entitled to and did assume that AIC and it's staff had carried out the requisite due diligence prior to proceeding with the offering. The Ontario Securities Commission regulations mandate that the investor deal directly with AIC.

(q)            In each case the taxpayer in buying a partnership unit was entitled to and did assume that Ernst & Young and it's staff had carried out the requisite due diligence in the projection process and in acting as auditor properly reviewed the results of operation of the businesses (see opinion of Hains Tab 11).

(r)             Ernst & Young participated openly in the marketing of the partnership units as demonstrated by their billings (see opinion of Hains Tab 3).

(s)            Ernst & Young opined positively on the reasonable expectation of profit issue (see opinion of Hains Tab 6) and thus supported after the fact the advice and opinion in the planning stages of the project that there would be a reasonable expectation of profit barring unforeseen circumstances.

(t)             There was absolutely no personal element here: no free meat or condos.

[49]          This court has considered a number of situations in which CCRA has alleged that the taxpayer did not have a reasonable expectation of profit.

[50]          In Dr. B. Clare Baker v. The Minister of National Revenue, 87 DTC 566 (T.C.C.), Dr. Baker purchased a semi-detached house in Florida as an income-producing investment. The real estate agent assured him he would be able to rent out the property and his accountant told him he would need 30 weeks rent a year to make money. There were losses and a title problem that cost $15,000. The Minister disallowed the rental losses. The Court found the taxpayer had a reasonable expectation of profit and had reason to believe his investment was viable. A minimum of 30 weeks rental was not excessive and the fact that the rentals did not materialize could not be imputed to Dr. Baker.

[51]          It should be noted that Dr. Baker relied on the advice of the very realtor who was selling to him and spoke to his accountant before investing $80,000.

[52]          The Bovine cases are much stronger in that the Bovine partners had:

(a)            the benefit of the strong fiduciary due diligence obligations of AIC;

(b)            the comfort of the Ernst & Young projections on the OM.

[53]          The court stated at 568 in discussing Moldowan v. Canada, [1978] 1 S.C.R. 480on reasonable expectation of profit:

I understand this to mean that a reasonable expectation of profit exists where given all the facts pertinent to a venture it could, within a realistic time...yield a profit barring abnormal circumstances.... In other words, is the venture as structured and normally operated capable of generating a profit?

[54]          Abnormal circumstances for Dr. Baker would be a hurricane knocking down his house. Abnormal circumstances for the Bovine investors involved a complex fraud perpetrated by Kennedy, Coles and DeLellis as unravelled by Roy Hains years later. Neither of these events would diminish the reasonable expectation of profit.

[55]          The issue was dealt with by the Federal Court of Appeal in Tonn v. R., [1996] 1 C.T.C. 205 (Fed. C.A.). The taxpayers bought a residential property in Scarborough with an intention of profit. They had losses for three years which they deducted and which the Minister rejected. The Tax Court of Canada found for the Minister and the Federal Court of Appeal reversed the Tax Court of Canada.

[56]          As developed in Tonn, there are 2 types of cases:

1.              Those in which the impugned activity had a strong personal element, and

2.              Those in which the impugned activity had no personal element.

[57]          Where there was no suspicion that the loss was incurred for a personal or non-business motive the objective test in Moldowan should be applied sparingly and with a latitude favouring the taxpayer. The primary use of Moldowan as an objective test should be the prevention of inappropriate reductions in tax and not as a vehicle for the wholesale judicial second-guessing of business judgments. Since Tonn's rental was neither a hobby nor personal, his expectation, even though too optimistic, was not unreasonable.

[58]          At pages 209-214 in Tonn inclusive the Court lays out the relevant legal principles relevant to deductibility in the Act. See for example at page 210 the basic analysis that flows from subsection 9(1) that defines income from a business or property as the profit from the business or property. This establishes that income is a net concept because profit means the excess of revenues over expenses. Profits are achieved only after expenses are deducted.

[59]          At page 219 in Tonn:

but do the Act's purposes suggest that deductions of losses from bona fide businesses be disallowed solely because the taxpayer made a bad judgment call? I do not think so. The tax system has every interest in investigating the bona fides of the taxpayer's dealings in certain situations but it should not discourage or penalize honest but erroneous business decisions. The tax system does not tax on the basis of a taxpayer's business acumen with deductions extended to the wise and withheld from the foolish...

It seems to me that for most cases where the department desires to challenge the reasonableness of the taxpayer's transactions, they need simply refer to section 67. This section provides that an expense may be deducted only to the extent that it is reasonable in the circumstances. They need not resort to the more heavy handed Moldowan test.

[78]          At page 220 the court reviews the personal element cases:

• horse farm

• Hawaii and Florida condo rental

• ski chalet rental

• yacht operation

• dog kennel operation

[61]          In these cases any desire for profit is no more than a pious wish or a fanciful dream.

[62]          In the Bovine cases, the evidence of Hains and the audited and unaudited financial statements from Ernst & Young and Mr. Bernhart establish that there was a business for some years. There was also improper activity on the part of certain principals but clearly there was a business. In any event, the improper activities of the wrongdoers post-dated the decision to invest and the time when reasonable expectation of profit is relevant.

[63]          In Allen v. Canada, [2000] F.C.J. No. 1651 (C.A.) Appellant invested in a rental property with a very small initial cash payment. The Minister argued Allen had no reasonable expectation of profit because of his significant borrowing for a 25 year amortization. The Court found:

the investment was clearly long-term and bona fide with the expectation that in the fullness of time the debt would be paid down and ultimately paid off and the Appellants would have a lasting investment.

[64]          This is not one of those cases where the purpose of an investment was to get a capital gain. Federal Court dismissed Crown's appeal.

[65]          Paragraph 9:

... It is unnecessary to address the question as to whether the unreasonable expectation of profit test applies at the limited partnership rather than at the partner's level... At paragraph 13 the Respondent's investment in this viable and profitable business was devoid of personal interest and the business was genuine.

[66]          In the Bovine case there was no personal interest, there was a business and on all the evidence - especially the Ernst & Young projections - a profitable one.

[67]          Paragraph 14:

The Appellants position in these proceedings would extend the application of the "no reasonable expectation of profit" doctrine to the individual partners for their involvement in a partnership which, in all respects, carries on a profitable business. This position postulates that as a result of the Respondents financial arrangements the partnership in which the Respondent invested did not carry on a business and was not a source of income but only for the amount of the interest losses exceeding the income produced by the business. The learned Tax Court judge was of the view that "this was wrong as a matter of logic, law and common sense". We agree with him.

[68]          The Appellants in the case at bar adopt the position that this is a single if multi-phased transaction amounting, when considered in its entirety as an investment with a view to profit.

SUBMISSIONS OF THE RESPONDENT

[69]          I shall attempt to paraphrase and summarize Respondent's counsel's submissions given orally at the hearing of these appeals.

[70]          The Respondent contends there was no active business with a reasonable expectation of profit. There were no profits at the partnership level and profits were only anticipated at the stage when the herd had been transferred under a section 85 rollover to the corporations and it would be the corporations who would sell the herd and hopefully realize profits.

[71]          The submissions of counsel for the Appellants have to a large extent been based on paper, on the documents that exist, the OM, the eight material contracts in support.

[72]          The factual problem is that these documents exist only for the scheme to be properly papered up, and that they were never intended to be acted upon.

[73]          Mrs. Walker told us that as soon as the general partner got money, in fact on the first day it was some five subscriptions of $100,000 the general partner sends it within days, not to Jeffery & Associates but the bulk of it goes to Asil, the Coles company which managed the cattle.

[74]          There were never 140 births. The proceeds in no event were never used as stated in the OM. Roughly one-third of the subscription amounts were diverted and they were diverted right from the beginning until the end.

[75]          It is the activities of the promoters that, as we know, it's the manner in which they acted that is going to be of far greater assistance to the court than what they wrote they would do.

[76]          The OM and the other paper ought not to be relied upon.

[77]          The OM says that there will be a closing date of June 30th, 1992. Watters, the last subscriber, bought his on December 31st 1992.

[78]          The notion of any importance being attached to what the documents say ought to be largely dismissed and probably entirely thrown out.

[79]          On the subject matter of due diligence Mr. Watters read and reread the OM. Mr. Agnew never did until well after a period of time, well after he had paid for and taken out the subscription in Bovine VI. So certainly the two gentlemen are not in the same position, vis a vis the attention that they paid to the OM. Agnew just did not look at it, did not ask to see it. He only saw it many many months later after it had become obvious that the scheme was failing.

[80]          Mr. Watters' first determination was that he was not going to invest in Bovine. That was Watters' evidence. His investigation had led him to the conclusion that this was not a good investment. Now why he went ahead and made it after that, even he was unable to tell us.

[81]          There is a severe and serious distinction between the limited partnership and the company. And that there is going to have to be an assessment made of the limited partnership via the limited partners, and we have to recognize that there is a separate entity, the corporation, which also files a tax return. One can not regard this whole operation that is determined in the OM as a continuum, that is not so. There are some clear differences in the players, in the entities that are involved. There is no way that we can get around that.

[82]          The involvement of Promitere, Hains, Thiessen, Lawson has no relevance whatsoever to the issues that have been placed before this court. Their involvement is at a point in time where there is an abject failure of this whole operation.

[83]          The investors were not in a position to rely on the due diligence that had been undertaken by others. The OM itself says that there has been no due diligence by anyone. That is the information that the investors themselves get. How can it be argued in any way that despite the clear statement to that effect, in the OM, that we can obtain any assurance that there was some due diligence done and that the investors could look to Ernst & Young or that they could look to AIC.

[84]          Tab 8 of Exhibit A-1 is not of much assistance because of course it is the financial statements as at December 31st, 1992, which of course would have been prepared in 1993. And by then all of the 25 subscriptions of Bovine I had closed. So it is not on the basis of this document that any of the investors made their investment decision.

[85]          There is no evidence that Ernst & Young did any due diligence.

[86]          Exhibit R-21 has been placed before the Court. This is the Statement of Claim filed with the Superior Court of Justice of Ontario on October 15, 1999. And then it was amended on July 13, 2000. This is the Statement of Claim where the plaintiffs are the various named investors and which include Mr. Agnew and Mr. Watters.

[87]          Paragraph 18 of the Claim says that the representations by Ernst & Young were made negligently, misrepresented the true financial position of the Limited Partnerships, and failed to make sufficient enquiries concerning the appropriateness of the financial projections and proposed use of the funds. Proper enquiries should have disclosed problems with the proposed expenses.

[88]          It failed to conduct sufficient enquiries about the reasonableness of the business when it gave financial and tax advice to investors. Proper enquiries should have disclosed problems in the business and the advice rested on a faulty basis.

[89]          Despite what the OM says about the 70% success rate, the raising of whatever the number is going to be of the animals that are going to be born as a result of this process, the risks associated with any farming activity, the resale of these animals at some particular point in time, and the likelihood of success just doesn't appear to be a quality investment.

[90]          Inevitably, unfortunately in these Limited Partnership Agreements, what carries the investment decision are the tax advantages as opposed to exactly as in this case a concentration and a valuation of the business operation, the business risks and the business profits. There is no projection of business income in the OM and that would be a reasonable part of such an OM.

[91]          There can be no doubt that in law a Bovine I Limited Partnership is one legal entity and it has certain rights and it has certain obligations, and with regard to the Act its profit and losses are going to be reported to CCRA and to the government by the Limited Partners. That is its role. That is how a Limited Partnership operates. If you choose to invest in the vehicle, accept the rules that accompany that vehicle.

[92]          What we do know is that on January 15, 1994, the limited partnership is going to transfer the herd to the corporation, take back from the corporation 25 shares, distribute those shares to the 25 Limited Partners and dissolve itself. And up to this point in time, the plan for the Limited Partnership is that it is not going to make any money, it is only going to provide losses, which losses are going to be flowed through to the individual investors.

[93]          So that by the very nature, as articulated in the seminal document, the OM, it is planned and indeed it is subsequently executed that the limited partnership is not in existence to make a profit. How much more basic can we be to be able to establish as a matter of fact, as a finding of fact, as a conclusion of fact that there was no reasonable expectation of profit in the Limited Partnership. We are told that it is only there to obtain the losses and the loss advantages flowing back to the Limited Partners.

[94]          It is a dead easy finding on the facts that the Limited Partnership had no reasonable expectation of profit. It was not intended to.

[95]          But what counsel for the Appellant states is that you have got to spin back the profitability that the OM says is going to exist later on in the corporation after the herd has been disposed of and that that profit and that expectation of profit somehow or another is going to be spun back to the Limited Partnership to satisfy the fiscal test of reasonable expectation of profit in a legal entity that's operating a business.

[96]          In the paragraph of the OM entitled "Losses of a Limited Partner" we read:

"Generally a partner's share of the loss of a partnership is deductible in computing his taxable income against all sources of income..."

[97]          And then reference to the special rules about restricted farm loss.

[98]          And in opposition to that let's look at what the OM tells about what's going to happen by way of tax treatment of losses or profit to the corporation. At page 39 in the second full paragraph the OM says:

"Any income or loss for tax purposes realized or incurred by the Corporation are those of the Corporation and cannot be allocated to its shareholders..."

[99]          I suppose this is part of the inarticulate language that Mr. Hains spoke about when he said it does not make sense, but we can figure it out.

"...Income will be realized by the shareholders in the form of dividends from the corporation."

[100]        Fair enough. If there are any profits from the corporation, taxes will be paid at the corporate level and the shareholders are going to get their share of those profits by way of dividends.

[101]        This plan involved separate entities, the Limited Partners and their association in a Limited Partnership, dealing with a partnership and the corporation. And what the plan suggests, and is exactly what happened, is that the losses would be collected and maintained by the Limited Partnership, flown through to the Limited Partners, the herd would be transferred and the profit, if any, would be distributed by way of dividends by the corporation.

[102]        Despite the intentions as are set out in the OM, the reality is that at the moment of the rollover there were no young cattle that had been born. What the corporation was receiving from the Limited Partnership on the rollover was 41 embryos which, eventually became 23 live births.

[103]        Counsel submitted that 21 young cattle at that point in time, given the resources of the company, the lack of experience of the handlers in the care and the feeding and attention of those 23 young cattle, indeed the defalcation that has clearly occurred by this time was such that the only conclusion on the facts that the court can find is that that business did not have a reasonable expectation of profit, and therefore was not a qualifying business. It was not a business.

[104]        Turning to the case law we have divided our approach into three. So we are going to deal first of all with the question of partnership generally, the question of reasonable expectation of profit and finally limited partnerships.

[105]        In Backman v.Canada, [2001] 1 S.C.R. 367 the Supreme Court of Canada, dealing with the notion of a view to profit, says this:

"A determination of whether there exists a 'view to profit' requires an enquiry into the intention of the parties entering into the alleged partnership. At the outset it is important to distinguish between motivation and intention."

[106]        And at the next page the Court acknowledges that the tax motivation does not derogate, does not necessarily take away from the validity of the transaction, but goes on to say the question at this stage is whether the taxpayer can establish an intention to make a profit, whether or not he was motivated by tax considerations.

[107]        At paragraph 23 we note that a taxpayer can be saved by demonstrating that there was an ancillary profit-making purpose.

[108]        At the bottom of the page, paragraph 25, the Supreme Court states:

"In other words, to ascertain the existence of a partnership, the courts must enquire into whether the objective documentary evidence and the surrounding facts, including what the parties actually did, are consistent with the subjective intention to carry on a business in common with a view to profit."

[109]        Based upon the evidence, both the oral evidence of the witness and the documentary evidence and all of the surrounding facts, it is submitted that the Limited Partnership did not intend to carry on business with a view to profit.

[110]        In Robinson (Trustee of) v. The Queen, 98 DTC 6065 at paragraph 11. The situation that arises here has to do with a passive partner. And what the Court says is that the Appellant relied on a line of cases in which it was held that a person is just as much a partner for tax purposes although he or she be a silent or passive partner.

[111]        The Court notes later:

"That being said, these provisions must be viewed in the context of the statute as a whole particularly section 3 and the definitions of partnership and person in section 1. These provisions in my view appear clearly to contemplate that all of the partners of the limited partnership carried on the business of the partnership."

[112]        In paragraph 17, and dealing with the fact that the Appellant took no part in the management of the business and that what flows from that does not mean that it and the other Limited Partners did not carry on the business in conjunction with the General Partner in that year, in effect, the Limited Partners are bound by the intent and the motivation of the General Partner. If there is no business for the General Partner there can be no business for the Limited Partners and it is not their hope that is going to inject any notion of business if there is no business for the General Partner.

[113]        And the cases tell us is it is the General Partner and the conduct of the General Partner that will characterize the profit as being a business income or capital gain, i.e., whether a business is being carried on.

[114]        In Nichols v. Canada, 1997 T.C.J. No. 88, Rowe, T.C.J., at page 24, cites, with approval, the following words of Hamlyn J. in Watson v. Canada, [1995] 2 C.T.C 2460:

"Computation of loss from a business

Section 3 of the Act sets out the rules to determine a taxpayer's income. A business loss is taken into account by virtue of paragraph 3(d) which states that any positive amount determined under paragraph 3(c) is reduced by "the aggregate of all amounts each of which is his loss for the year from ...business."

The provisions of the Act that apply to the computation of a loss from a business are those that apply to the computation of income from a business, or in the words of subsection 9(2):

9(2)          a taxpayer's loss for a taxation year from a business or property is the amount of his loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source...

The general provision of the act for calculating business income (and therefore a business loss) is subsection 9(1) which states that:

9(1)          a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.

In calculating this profit (or loss) paragraph 18(1)(a) stipulates that no deduction shall be made in respect of:

18(1)(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property.

Even if an outlay or expense is made for that purpose, it still is subject to the general limitation of section 67 that:

no deduction shall be made in respect of an outlay or expense ... except to the extent that the outlay or expense was reasonable in the circumstances.

For the taxation year in issue, the version of subsection 245(1) that applied also disallowed deductions made:

in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

Meaning of business

In any event, a loss from a business presupposes that there is a business. Subsection 248(1) gives an extended definition of "business" as including

a profession, calling, trade, manufacture or undertaking of any kind whatever and...an adventure or concern in the nature of trade...

However, in this case, it is the ordinary meaning of "business" which is relevant. In Moloney, supra, it was noted at pages C.T.C. 227-28, D.T.C. 6570 that for an activity to be a business it must produce income in its own right and not merely from applying the Act:

While it is trite law that a taxpayer may so arrange his business as to attract the lease possible tax, it is equally clear in our view that the reduction of his own tax cannot by itself be a taxpayer's business for the purpose of the Income Tax Act. To put the matter another way, for an activity to qualify as a "business" the expenses of which are deductible under paragraph 18(1)(a), it must not only be one engaged in by the taxpayer with a reasonable expectation of profit, but that profit must be anticipated to flow from the activity itself rather than exclusively from the provisions of the taxing statute.

----------------

More recently, in Bendall v. Canada, [1995] 2 C.T.C. 2172 (T.C.C.), this Court addressed the meaning of business. Judge Bonner wrote:

The issue here is whether the appellant carried on a "business" within the meaning of the Income Tax Act. That word is to be given its ordinary meaning and that meaning does not include a tax avoidance scheme which is nothing more than a pale imitation of a business. The appellant was not involved in a commercial activity either directly or through Omni as his agent. The objective evidence regarding the manner in which the scheme operated and the actions and inaction o the parties point clearly to a conclusion that both the appellant and the promoters of the scheme were indifferent to the marketing of the speed reading course and to the earning of profits from that activity. There can be no doubt that what was sought was a tax deduction which would result in a refund part of which was to go to enrich the promoters of this scheme and the remainder of which was to go to the appellant. I disbelieve the appellant's testimony as to his subjective intention. As noted in Symes, E.C. v. Canada, [1993] 4 S.C.R. 695, [1994] 1 C.T.C. 40, 94 D.T.C. 6001, per Iacobucci J., at page 736 (C.T.C. 58; D.T.C. 6014):

----------------

As in other areas of law where purpose or intention behind actions is to be ascertained, it must not be supposed that in responding to this question, courts will be guided only by a taxpayer's statements, ex post facto or otherwise, as to the subjective purpose of a particular expenditure. Courts will, instead, look for objective manifestations of purpose, and purpose is ultimately a question of fact to be decided with due regard for all of the circumstances.

In my view the deduction of the component elements of the "losses" is prohibited by paragraph 18(1)(a) of the Act.

The ratio of the decision of the Court of Appeal in Moloney is contained in the following passage at page 6571:

In our view the judgment under appeal is based on the trial judge's findings of fact, notably that the appellant never intended to carry on the business of marketing the speed reading course himself or through Omni, that neither the appellant nor Omni had the means or the ability to do so, and that the sole purpose of the scheme was to obtain tax refunds and nothing else.

That decision is none the less applicable despite the absence in this case of evidence showing the "circularity and simultaneity of the transactions between the related companies". The essential facts in this case and in Moloney are the same. I will therefore dismiss the appeals with costs."

Then, having reviewed the jurisprudence, Hamlyn, J.T.C.C. continued as follows:

"Analysis

The appellants primarily bought a tax reduction scheme. The assertion that an investment of $500 would provide retirement or future income does not stand the test of reality. The appellants did nothing other than sign documents and pay the license fee. No investigation took place by them, no research was conducted by them, no business plan was developed by them and certainly they made no efforts to operate a business.

[115]        Counsel cites further authorities to the effect that inappropriate tax avoidance will not work.

[116]        Counsel submitted further that in order to deduct its expenses, a limited partnership must incur those expenses for the purpose of gaining or producing income from the business allegedly operated by the partnership (see paragraph 18(1)(a) of the Act).

[117]        The Supreme Court of Canada has provided the Tax Court with the reasonable expectation of profit test as a vehicle by which a court may consider the deductibility of expenses for the purposes of the Act. This test considers:

(a)            background and training of the taxpayer;

(b)            profit and loss history of the enterprise;

(c)            the taxpayer's intended course of action; and

(d)            the capability of the venture to produce a profit after deducting Capital Cost Allowance.

[118]        A limited partnership whose intended course of action is to divest itself of all its revenue-generating assets before any revenue could be generated according to its business plan and the actual operation of the business clearly is not created for the purpose of gaining or producing income from that business.

[119]        The Tax Court must consider what motive exists for the creation of the partnership entity. In the face of a non-business motive, such as, the generation of tax benefits alone, the Tax Court of Canada will be required to apply the reasonable expectation of profit test most assiduously.

[120]        In this case, before any revenue could be generated by the planned liquidation of the herd, the limited partnership's only asset, the herd had been transferred to a corporation in order that the Corporation capture any revenue that might be generated. The distribution of income of that Corporation rested solely in the discretion of the Corporation's Board of Directors.

[121]        Further, the shares of this corporation at the time of this sale had long since left the hands of the limited partnership as it had been dissolved in the sixty days following the asset transfer to the Corporation. At that point in time, the shares were held in the self-directed Registered Retirement Savings Plans of a number of different taxpayers.

[122]        From its inception, the partnership was devoid of any profit making intention and capability.

ANALYSIS AND DECISION

[123]        In my opinion the appeals are to be allowed with costs for the following principal reasons:

(1)            There was clearly a commercial activity being carried on. Embryos were being bought, imported and transferred into host cows with a view to producing calves having the same meat quality as that of the donors of the embryos. Were it not for the defalcations the bulk of the evidence is that the plan would have succeeded.

(2)            There was an operating farm where activities took place. The activities may not have been, on the grand scale contemplated in the OM but there is no doubt the activities were carried out.

(3)            The investors relied on the personalities involved namely, the lawyer Kennedy, who had a good reputation, Ernst & Young, the Coles, the putting forth of the plan by Costello, a well-known investment counsellor, the involvement of AIC. Although the involvement of these various entities and persons may not have been as extensive as it should have been it appears however that the investors were impressed by the persons involved. It is also a fact that at least Watters carried out extensive research on the concept and made inquiries of several bodies which even Betteridge stated were the correct bodies to review. Watters apparently decided that, at first, he did not like the investment but consequently he changed his mind and went ahead with it.

(4)            The Appellants paid for their investment with their own monies. Even though the monies were borrowed from National Trust Company they were borrowed on the security which the Appellants placed on their homes or some other assets. Thus, effectively, they were putting up their own assets/cash to make the investment.

(5)            The operation was to be carried out without any financing by the partnership or the corporations later involved.

(6)            The plan was carried out over a long term, was extensive and thorough and included eight material contracts. It attracted 135 investors. It was not "fly by night".

(7)           It is well established that a desire to obtain a tax advantage or loss does not automatically stigmatize the investment and thus render it simply as a tax evasion scheme even though a business is contemplated.

(8)            Most importantly there was no personal benefit or element involved in the investment. In Stewart v. Canada, [2002] S.C.J. No. 46, a decision of the Supreme Court of Canada issued after the hearing of these appeals, a thorough analysis is made of the concept of reasonable expectation of profit.

In a word, the following is stated at paragraph 53:

We emphasize that this "pursuit of profit" source test will only require analysis in situations where there is some personal or hobby element to the activity in question. With respect, in our view, courts have erred in the past in applying the REOP test to activities such as law practices and restaurants where there exists no such personal element: see, for example, Landry, supra; Sirois, supra; Engler v. the Queen, 94 D.T.C. 6280 (F.C.). Where the nature of an activity is clearly commercial, there is no need to analyze the taxpayer's business decisions. Such endeavours necessarily involve the pursuit of profit. As such, a source of income by definition exists, and there is no need to take the inquiry any further.

[124]        The decision of the Supreme Court of Canada in Stewart was also applied in the Supreme Court decision in Walls v. Canada, [2002] S.C.J. No. 47. It should be noted that although these two decisions and a decision of the Federal Court of Appeal were released only after the hearing of the cases at bar as was the Federal Court of Appeal ruling in Stanley Witkin v. Canada, [2002] F.C.A. 174. Counsel for both parties subsequently made submissions on those later decisions.

[125]        The decision in Witken does not deal with the reasonable expectation of profit test but held that since a partnership was not proven the alleged partner involved could not deduct losses and the appeal was dismissed. I do not think the outcome of that case bears significantly on the outcome of the current appeals.

[126]        The investment changed in form from one of initial limited partnerships where losses were incurred to the later structure where corporations were formed and assets were transferred by the partnerships to the corporations and shares in the corporations were issued to the former partners and the limited partnership was dissolved shortly thereafter. I do not believe that a change of structure that was contemplated in the initial OM is sufficient to destroy the initial concept of a business source and a profit. Even though the operation is carried out at different stages by different entities it is one continuous plan which considering there was no personal element was a source of business. Moreover, although no profits were contemplated immediately for the limited partners, it was planned they were to receive dividends in due course on the corporate shares they received in exchange for the partnerships' assets.

[127]        Consequently for all the foregoing reasons the appeals are allowed with costs.

Signed at Ottawa, Canada, this 15th day of October, 2002.

"T. O'Connor"

J.T.C.C.

COURT FILE NO.:                                                 1999-3797(IT)G and 1999-3798(IT)G

STYLE OF CAUSE:                                               Bruce Agnew v. The Queen

                                                                                                Clayton Watters v. The Queen

PLACE OF HEARING:                                         London, Ontario

DATE OF HEARING:                                           May 6, 2002

REASONS FOR JUDGMENT BY:      The Honourable Judge T. O'Connor

DATE OF JUDGMENT:                                       October 15, 2002

APPEARANCES:

Counsel for the Appellant: Arthur M. Barat and Avril A. Farlam

Counsel for the Respondent:              Roger LeClaire and Boyd Aitken

COUNSEL OF RECORD:

For the Appellant:                

Name:                               

Firm:                 

For the Respondent:                             Morris Rosenberg

                                                                                Deputy Attorney General of Canada

                                                                                                Ottawa, Canada

1999-3798(IT)G

BETWEEN:

CLAYTON WATTERS,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeals heard together by the Honourable Judge Terrence O'Connor with the appeals of Bruce Agnew (1999-3797(IT)G) on May 6, 2002, and following,

at London, Ontario, as supplemented by a telephone conference call,

held on November 4, 2002

Appearances

Counsel for the Appellant: Arthur M. Barat and Avril A. Farlam

Counsel for the Respondent:              Roger LeClaire and Boyd Aitken

AMENDED JUDGMENT

                Whereas this Court issued a Judgment dated October 15, 2002;

Wherein the appeals from the reassessments made under the Income Tax Act (the "Act") for the 1992, 1993 and 1994 taxation years were allowed, with costs;   

And whereas counsel for both parties requested amendments to said Judgement to clarify certain points;

                This Court amends the said Judgment to add the following:

                The said judgment applies with respect to all of Bovines I through VI not outstanding that Bovine VI was not fully subscribed to and its activities were not as extensive as Bovines I through V.                

                The shares of the corporations involved in Bovines I through V were qualified investments for Registered Retirement Savings Plans ("R.R.S.P.'s") as contemplated in paragraph 146(1) of the Act. Further, in 1994 at the time of the rollover of the assets of all the Limited Partnerships and at the time of any contributions to R.R.S.P.'s the shares of all the said corporations had a value of $9,568 as contended by counsel for the Appellant and not $20,000 as originally claimed nor $4,360 as contended by counsel for the Respondent.

                                Signed at Ottawa, Canada, this 9th day of December, 2002.

"T. O'Connor"

J.T.C.C.

               

1999-3797(IT)G

BETWEEN:

BRUCE AGNEW,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeals heard together with the appeals of Clayton Watters (1999-3798(IT)G) on May 6, 2002, and following, at London, Ontario,

by the Honourable Judge Terrence O'Connor

Appearances

Counsel for the Appellant: Arthur M. Barat and Avril A. Farlam

Counsel for the Respondent:              Roger LeClaire and Boyd Aitken

JUDGMENT

                The appeals from the reassessments made under the Income Tax Act for the 1994 and 1995 taxation years are allowed, with costs, and the matters are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.

Signed at Ottawa, Canada, this 15th day of October, 2002.

"T. O'Connor"

J.T.C.C.

1999-3798(IT)G

BETWEEN:

CLAYTON WATTERS,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeals heard together with the appeals of Bruce Agnew (1999-3797(IT)G)

on May 6, 2002, and following, at London, Ontario,

by the Honourable Judge Terrence O'Connor

Appearances

Counsel for the Appellant: Arthur M. Barat and Avril A. Farlam

Counsel for the Respondent:              Roger LeClaire and Boyd Aitken

JUDGMENT

                The appeals from the reassessments made under the Income Tax Act for the 1992, 1993 and 1994 taxation years are allowed, with costs, and the matters are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.

Signed at Ottawa, Canada, this 15th day of October, 2002.

"T. O'Connor"

J.T.C.C.