Date: 20021104
Docket: 2001-4479-IT-I
BETWEEN:
DWIGHT LEWIS DARLING,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
For the Appellant: The Appellant himself
Counsel for the Respondent: Tony Chambers
____________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at
Kingston, Ontario, on September 20, 2002)
McArthur J.
[1] The issue in this appeal is whether the Appellant may deduct the amount of $10,737 in computing his 1999 income pursuant to paragraph 18(1)(a) of the Income Tax Act which reads:
18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of
(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;
In satisfaction of a judgment, a Notice of Garnishment issued by the Ontario Court General Division in the amount of about $265,000 dated June 1998 resulted in a garnishee order being sent to Century 21 Townsend Limited with respect to the Appellant. The amount of $10,737, pursuant to the order, was paid. The Appellant was his only witness and Robert Meihan, an appeals officer who completed the audit for Revenue Canada, gave evidence for the Respondent.
[2] For the most part, the facts are not in dispute. The Appellant is a real estate broker and agent in the Brockville area. During the relevant period, at least in 1990 and 1991, he was working for Dwight L. Darling Real Estate Limited. His position is that damages he paid in 1999 were to earn income from a partnership that had been dissolved in 1991.
[3] The thrust of the Respondent's position is that the Appellant had no source of income from which he could deduct his payments made towards satisfying the judgment.
[4] The Appellant, his brother, David Darling, and Anthony Leeder, referred to as the managers, entered into a real estate investment with 19 partners. In accordance with an agreement dated February 14, 1990, a total of 30 limited partners would each invest $15,000, and the funds would be used to purchase a 41.8 acre parcel of land in Brockville. It was anticipated that income would be generated by renting a three-bedroom house on the property and developing the remaining acreage as a Christmas tree plantation and future real estate development. It was the partners' understanding, apart from the three managers, that the property would not be purchased until all 30 shares in the partnership were sold and the advanced funds would be held in a bank account earning interest at 10% until all shares were sold.
[5] In the event that the required 30 shares were not sold, the $15,000 investment would be returned to each partner, with interest. In this regard, I refer to the partnership agreement and to the judgment of Mr. Justice Cosgrove of the Ontario Court General Division. However, the managers purchased the property after only 19 shares were sold, and a $250,000 mortgage was granted back to the vendor. The assumptions of fact in the Reply to the Notice of Appeal referred to a $295,000 mortgage, as does the judgment of Cosgrove J. I do not think anything falls on it, but the documents filed indicate a registered mortgage in the amount of $250,000, as does the land transfer tax affidavit attached to the transfer of land. Again, this discrepancy has no relevance. Funds from the shares sold were used to make payments on the mortgage, but the property was repossessed after about a year by the mortgagee vendor.
[6] Some of the relevant provisions in the partnership agreement include paragraph 3 to the effect that "there shall be 30 limited partners". I note that the Appellant did not contribute $15,000 as did the 19 partners. Paragraph 8 stated "projected income from the partnership is set out in Schedule C" which schedule projects income of approximately $60,000 after 10 years, which was to be divided amongst 30 partners. Paragraph 13 provides that "the managers shall receive a 10% interest in the property and all business developments that result from this venture". And paragraph 20 sates that "at the end of each fiscal year, the net profits or losses of the partnership for such year shall be allocated to the partners in proportion to the number of shares of partnership each partner owns".
[7] The Appellant stated, inter alia, in his Notice of Appeal:
... The damages I have to pay are directly related to the failure of the Partnership Agreement. Although the Appeal Court said I was in breach of trust, I still had nothing to do with the management of it and therefore had nothing to do with its failure. This is a direct failed real estate transaction expense. Now I'm paying the investors back their principal plus interest income.
The judgment of Cosgrove J. that was confirmed by the Ontario Court of Appeal found that the failure was as a result of a breach of trust by the Appellant and David Darling. I accept that version. The Appellant was involved in two previous and similar partnerships that did not live up to their projections or expectations. Shortly after the purchase, the Appellant made an unsuccessful application to have the house on one acre of land severed from the 42-acre parcel. He had a conditional offer to sell the severed parcel for $110,000, which of course fell through.
[8] The Respondent's counsel indicated that the Appellant probably declared his prorated share of the rental income from the property in his 1991 income tax return, and the evidence in this regard is contained in Exhibit R-3. The contributing partners sued the managing partners, seeking a refund of their investment money after they lost the property and their investment. In a judgment in favour of the contributing partners, Cosgrove J. found in March 1996 that the Appellant and his brother, David, were liable in fraudulently misleading the Plaintiff investors.
[9] In 1998, the Ontario Court of Appeal upheld the judgment of Cosgrove J., but referred to the Appellant's actions as breach of trust, and not as being fraudulently misleading. This distinguishes the Appellant's actions from that of the taxpayer in Poulin v. the Queen, 96 DTC 6477, wherein the taxpayer, a real estate agent, was required to pay damages as a result of his fraudulent activities. It places the Appellant more in the situation of the taxpayer in McNeil v. The Queen, [2000] 2 CTC 304. This does not assist the Appellant if he cannot establish that the payment toward the judgment was incurred for the purpose of producing income from a business or property pursuant to paragraph 18(1)(a) of the Act.
[10] In McNeil, Rothstein J. stated that as a result of the Supreme Court of Canada decision in 65302 B.C. Limited v. Canada, 99 DTC 5799, fines and penalties incurred for the purpose of gaining or producing income are deductible expenses under paragraph 18(1)(a), provided of course, the criteria in that section are met. In McNeil, the Court found that the judgment for damages was paid by the taxpayer for the business purposes of keeping his client. The Court also found that the right to deduct damages as an expense arises in the year the damage award is made and not in the year in which the events giving rise to the damages took place. Reading from the headnote in the McNeil decision:
At common law a taxpayer is entitled to deduct an expense when it is incurred, and an expense is incurred when a taxpayer has an absolute and unconditional obligation to pay an amount. The appellant's liability to pay damages was ascertained and became absolute and unconditional obligation when the judgment of the British Columbia Supreme Court was issued. The right to deduct such damages as an expense under paragraph 18(1)(a) arose at that time in 1994.
[11] The issue narrows down to whether the Appellant had a source of income from which to deduct the damage payments. The Appellant had an interest in an income-producing property from 1990 to 1991 when the property and business reverted back to the vendor to satisfy his mortgage back. After 1991, there was no longer a business or a property or a partnership; all was lost. The obligation to pay damages arising from his breach of trust was finalized in May 1998 when the Ontario Court of Appeal dismissed the Appellant's appeal of Justice Cosgrove's decision. At that time, his source of income from the partnership, or business or property was long gone; there was no source of income in the 1999 taxation year from which he could deduct the judgment payment. His 1999 payment was as a result of a garnishee and not made to earn income.
[12] The Appellant referred to a letter from his accountant to the tax centre dated February 15, 2001 which reads in part as follows:
It is my understanding that the court-awarded damages are deductible for income tax purposes provided they meet certain criteria. I believe the damages awarded meet these criteria. The timing of the deduction may be at issue. That is to say should the amount of $265,104.55 be deducted in the year the taxpayer is determined to have an absolute and unconditional obligation to pay it, 1998 or is it deductible in the year payment is made? 1998, 1999 and subsequent years. Once the deductibility of the damages has been established, we would like to pursue the issue of timing further.
CCRA bulletin IT-467R outlines requirement for the deductibility of damages in computing income. I would put forward the following comments in respect to the tests listed in this bulletin.
In Mr. Darling's case, the damages were awarded as a result of not fulfilling the terms of contract in a real estate development venture. As a general partner in the proposal, Mr. Darling, a real estate broker and sales representative, received or expected to receive significant commission income from the real estate transactions. The limited partners expected to earn income from the operation of a Christmas tree farm initially and then from the subsequent development and sale of the property.
...
The bulletin states "where the amount of damages is determined by a court, the payment of such an amount would be considered reasonable in the circumstances for the purpose of section 67.
Based on the information obtained from IT-467R and summarized details I read with respect to the tax court case McNeil, 2000 DTC 6211, I believe these court-awarded damages to be deductible by my client.
[13] I do not believe the author's logic survives close scrutiny. While the Appellant is a real estate broker and sales representative, in 1999, he was an employee of Century 21 Townsend Limited. Apparently, he receives employment income from that corporation. It was not a partner of the 1990 and 1991 venture, and the judgment for damages did not involve it or the Appellant's earlier corporation, Dwight Darling Real Estate Limited.
[14] The limited partners anticipated to earn income from the property and rental business, but that did not exist in 1998 when the damages were awarded or in 1999 when the Appellant was forced to make a payment. As stated, the McNeil case does not assist the Appellant because the expenditure in 1999 was not made for the purpose of earning income. The expenditure was made because there was a judgment against the Appellant for breach of trust that had happened seven years before his salary or commission owing to him by a corporation was garnisheed.
[15] For the above reasons, the appeal is dismissed.
Signed at Ottawa, Canada, this 4th day of November, 2002
|
"C.H. McArthur" |
J.T.C.C.
COURT FILE NO.: 2001-4479(IT)I
STYLE OF CAUSE: Dwight Lewis Darling and
Her Majesty the Queen
PLACE OF HEARING: Kingston, Ontario
DATE OF HEARING: September 18, 2002
REASONS FOR JUDGMENT BY: The Honourable Judge C.H. McArthur
DATE OF JUDGMENT: September 24, 2002
APPEARANCES:
For the Appellant: The Appellant himself
Counsel for the Respondent: Tony Chambers
COUNSEL OF RECORD:
For the Appellant:
Name: n/a
Firm: n/a
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada