T-189-77
Nahum Gelber (Plaintiff)
v.
The Queen (Defendant)
Trial Division, Walsh J.—Montreal, October 21;
Ottawa, October 27, 1980.
Income tax — Capital cost allowance — Purchase and
leaseback agreement — Purchase by plaintiff in 1972 of
interest in film for total price of $38,333.33: $8,333.33 paid on
account in 1972 and $30,000 paid in 1973 — Plaintiff to
receive annual rental guaranteed up to the minimum of
$30,000 by the end of the agreement — Plaintiff to receive also
interest from bonds pledged to secure rental — Capital cost
allowance based on $38,333.33 claimed by plaintiff for his
1972 taxation year — Reassessment by defendant based on
$8,333.33 — Whether actual cost to plaintiff of his investment
is $38,333.33 or $8,333.33, the amount at risk according to
defendant — Appeals allowed — Income Tax Act, R.S.C.
1952, c. 148 as amended, ss. 67, 245(1).
Mandel v. The Queen [1977] 1 F.C. 673 confirmed by
[1979] 1 F.C. 560, distinguished. Lipper v. The Queen 79
DTC 5246, distinguished.
INCOME tax appeal.
COUNSEL:
R. S. Litvack for plaintiff.
P. Plourde and J.-P. Fortin, Q.C. for
defendant.
SOLICITORS:
Chait, Salomon, Gelber, Reis, Bronstein, Lit-
vack, Echenberg & Lipper, Montreal, for
plaintiff.
Deputy Attorney General of Canada for
defendant.
The following are the reasons for judgment
rendered in English by
WALSH J.: This action was heard together with
actions bearing Nos. T-1438-77 and T-1439-77
between the same parties, the issues being identi
cal save that they concern reassessments concern
ing the 1972, 1973 and 1974 taxation years respec
tively. As the statement of claim set out and
evidence disclosed, on December 28, 1972, plain
tiff entered into a letter agreement with Interconti-
nental Leisure Industries Ltd. (hereinafter called
"Intercontinental") pursuant to which he agreed
to purchase a 4 1/6% interest in a certain feature
film entitled "Mother's Day" for and in consider
ation of a total price of $38,333.33 on account of
which he paid upon execution of the agreement the
sum of $8,333.33, obliging himself to pay to Inter
continental the additional sum of $30,000 upon
fulfilment by Intercontinental of certain obliga
tions assumed by it under the terms of the agree
ment. These conditions were fulfilled and plaintiff
paid the additional $30,000 to Intercontinental
during the taxation year 1973. Under the terms of
the agreement Intercontinental agreed to lease
back the film from plaintiff (and other undivided
owners thereof) for a term of fifteen years ter
minating on December 31, 1988, in consideration
of an annual rental equal to 4 1/6% of 92% of the
gross revenues received by Intercontinental from
any source arising from the exploitation of the
film, it being agreed that in any event the mini
mum rental revenue to be paid by Intercontinental
to the taxpayer on or before December 31, 1983,
would be $30,000. Furthermore, Intercontinental
pledged in favour of plaintiff certain Government
of Canada Bonds to guarantee the payment of the
rental payable by Intercontinental to plaintiff
under the terms of the agreement.
Evidence disclosed that the only rental revenue
received was the sum of $124.58 in October 1974,
$1,917 in January 1975 and a further sum of $9.14
in January 1975 for a total of $2,050.72. In addi
tion the agreement provided however that plaintiff
was to receive the interest on the bonds pledged to
secure the rental and in fact did receive in Septem-
ber 1973 $875.24, in March 1974 $875.26, and in
September 1974 $832.50 with further similar
amounts making a total of $12,573 as of October
20, 1980.
It is plaintiffs contention that the capital cost to
him of 4 1/6% undivided interest in the film
entitled "Mother's Day" was $38,333.33 and not
$8,333.33 as claimed by the Minister and that, in
calculating his taxable income for the taxation
year 1972 he was entitled to deduct 60% of the
said capital cost pursuant to the provisions of the
Income Tax Act, R.S.C. 1952, c. 148, and Regula
tions thereunder.
Defendant concedes that the agreement pro
vided for the pledge of $30,000 secured by Govern
ment of Canada Bonds as a "rental guarantee".
For his 1972 taxation year plaintiff claimed a
capital cost allowance of $23,000 computed on the
basis that his capital cost on the said film was
$38,333.33. Defendant reassessed him on the basis
that the capital cost was $8,333.33, this being the
amount that he had in fact invested and put at
risk. She contended that to permit the capital cost
allowance to be claimed by plaintiff on the basis
that the capital cost of the film was $38,333.33 is
not reasonable in the circumstances and would
unduly or artificially reduce his income. At no
time during the taxation years in question was
plaintiff engaged directly or otherwise in a motion
picture business. In his 1973 taxation year plain
tiff, having reduced the capital cost of the film to
him to $15,333.33 as a result of the $23,000
capital cost allowance claimed in 1972, claimed
60% of this amount or $9,200, while the Minister
having allowed only $5,000 capital cost allowance
in 1972 on the basis of the capital cost of the film
being $8,333.33 allowed only $2,000, on the re
maining capital cost of $3,333.33. In his 1974
taxation year plaintiff claimed that the unde-
preciated capital cost remaining to him was
$6,133.33 while the Minister contended it was
$1,333.33. The figures in plaintiffs 1974 tax
returns and the reassessment by the Minister are
difficult to reconcile. In his return, for reasons
undisclosed he claims capital cost allowance of
100% of $6,133.33 with respect to "Mother's Day"
and the reassessment adds back the sum of
$5,333.33. This was apparently based on the Min
ister's calculation which would allow 60% of
$1,333.33 or $800. Moreover plaintiff shows his
income from the investment as $1,607.76. If we
add the sums of $875.26 and $832.50 as his inter
est on the bonds in 1974 this would total
$1,707.76, an even $100 more. Possibly there has
been an error in addition. Furthermore the rental
revenue of $124.58 for the film should also have
been shown which would bring the total to
$1,832.34 rather than $1,607.76. Mr. Gelber in
testifying could not explain the discrepancy and
his accountant was not present to give evidence. I
merely call attention to these matters in the inter
est of accuracy, although they do not affect the
principal issue in the present case which is whether
the actual cost to Mr. Gelber of his investment was
$38,333.33 as he contends or $8,333.33 which was
the amount at risk according to the Minister's
contention.
Certainly as it is plaintiffs contention that the
$30,000 which he is assured of receiving by
December 31, 1983 less whatever amounts he has
received in the interval for film rental constitutes
income and not a return of capital he must, to be
consistent, include all such receipts in income and
be taxed on same, while similarly defendant
cannot tax same as income while at the same time
contending that they constitute an assured refund
of capital so that his net outlay cannot have
exceeded $8,333.33. The evidence as to how these
receipts have been treated is far from satisfactory.
It has already been pointed out in plaintiffs 1974
tax return that the income from the film invest
ment was declared at $1,607.76 but the only
income from rental of the film was $124.58 and
even the interest from the bonds which is shown as
additional rental in the schedule filed as an exhibit
at trial amounted to $1,707.76. While the interest
received from the pledged bonds is indicated in the
agreement as "additional rental" it appears to me
to be something separate and distinct from revenue
received from the actual rental of the film guaran
teed up to a minimum of $30,000. In any event
this interest would certainly have to be declared as
income and evidently it was in 1974 although in a
somewhat incorrect amount which apparently did
not include the actual rental revenue of $124.58.
In the 1973 tax return of Mr. Gelber no income is
shown from the "Mother's Day" film investment
although from the schedule produced at trial it
appears that $875.24 was received in September
1973 as interest from the pledged bonds. This of
course may have appeared in the item $926.99
shown as Canadian interest income but there is no
evidence to support this so this is mere speculation.
Unfortunately plaintiffs 1975 tax return is not
before the Court and that is the only year in which
any substantial revenue was received from the film
rental, so there is no way of determining how this
revenue was treated in his tax return for that year.
For its part defendant in its reassessment for the
1974 tax year merely shows an increase of
$5,333.33 as an adjustment of the capital cost
allowance claimed on the film without allowing
any credit for the $1,607.76 shown as interest
income from it. As counsel for defendant conceded
it cannot have it both ways, but possibly is making
the same distinction, which I am inclined to do,
between interest received on bonds pledged as
security and income from actual rental of the film
and considering that the former is not income
arising from rental of the film. In any event the
manner in which either plaintiff or defendant
treated receipts from the rental of the film in 1973
and 1974, while of interest, is not binding on the
Court in reaching a conclusion on the matter at
issue.
Provision is made in the agreement between
Intercontinental and purchasers such as plaintiff
herein of an interest in the film that they can
borrow from the bank for financing the acquisition
in which case Intercontinental will hypothecate to
the Royal Bank of Canada the bonds which would
be otherwise pledged and will guarantee the loan
to the extent of not less than 78% of the purchase
price payable. It is suggested in the proposal that
the purchasers will then be able to deduct from
income interest paid on the bank loan. Whether or
not Mr. Gelber took advantage of this is not
indicated and in any event it does not appear to
affect the issue. Paragraph 4 of the purchase and
leaseback agreement reads in part as follows:
In the case of bonds pledged with the undersigned pursuant
to paragraph 2 above, all interest on such bonds shall be
retained by the undersigned as additional rental .... The inter
est so paid or credited shall not be applied in reduction of the
rental guarantee.
It is for this reason that I. conclude that the
interest received from the bonds has nothing to do
with the guarantee of a minimum rental of
$30,000 by December 31, 1983, or whether any
sums received, whether from the rental of the film
or from the eventual payment of the balance over
and above the sums received as rental up to the
amount of $30,000 on December 31, 1983, are
received as income or as a return of capital.
Mr. Gelber was undoubtedly aware of the tax
advantages of the agreement, being a well-
informed and experienced corporation lawyer, but
an awareness of tax advantages is not synonymous
with an intention to evade taxation. It is trite law
to state that a taxpayer is entitled to take advan
tage of any of the provisions of the Income Tax
Act and Regulations which are to his advantage in
order to minimize his taxation. The present deal
was particularly attractive for Mr. Gelber since
with an outlay of $38,333.33 he was assured of
getting at least $30,000 back eventually, without
losing interest on $30,000 of the sum he had
invested in the meanwhile. His maximum possible
loss was therefore $8,333.33 and there was always
the possibility (although in the film industry some
what remote) that the film might prove highly
profitable so that he would make a profit from this
investment. One of Mr. Gelber's partners wrote a
memo to him and others who might be interested
in the film on December 22, 1972, reading in part:
To understand this film deal properly, I think you have to look
at it as an investment and not strictly as a tax shelter. In other
words, if you were to receive total rental income of
$23,000.00,' being the amount of each unit, at the 50% rate,
you would be paying $11,500.00 in income tax, or approximate
ly the amount of the accumulated depreciation for the five-year
period shown on the attached schedule. In addition, there would
be certain bank charges that run at a net figure after tax
considerations of about $234.00 a year; however, if the film
were to make money, then the benefits would be real.
Mr. Gelber testified that bonds were worth at
the time they were pledged $31,583 but had a face
value of $38,900 and were left with him pursuant
to the terms of the agreement. This security was to
be reduced as rental payments were received.
Bonds with a face value of $1,900 have since been
returned. Bonds with a face value of $37,000 all
coming due on December 31, 1983 remain
pledged, and it is evident that at that date Inter
continental will pay whatever difference is still due
between rental payments and the $30,000 in order
to get back the bonds with a face value of $37,000.
Mr. Gelber actually invested $38.333.33.
He projected a return of $48,000 over an
11-year period on his investment 2 and since only
$8,333.33 were at risk considered that the dangers
on the downside were minimal. Defendant's coun
sel points out that a return of $48,000 on an
investment of over $38,000 after 11 years is cer
tainly not attractive from the investment point of
view and but for the taxation advantages he could
undoubtedly have made better use of his money.
Mr. Gelber admitted that one of the inducements
was the guaranteed provision of $30,000 by the
pledge of the bonds saving him from investigating
the credit of the vendors in order to accept their
personal guarantee. He went into the project con
sidering it as an investment with little risk on the
downside rather than strictly speaking as a tax
shelter. No rental revenue from the film whatso
ever has been received since 1975.
As it was pointed out by plaintiff's counsel in
argument Mr. Gelber did not purchase the bonds;
they were merely pledged to him, so it cannot be
said that $30,000 of the purchase price was paid
by him to acquire the bonds.
Defendant's counsel contends that if the matter
is looked at as an investment not of $38,333.33 but
of $8,333.33 then the estimated return of $48,000,
(if $30,000 capital is included) or some $10,000
over the original investment over a 10-year period
would be much more realistic. Reliance is placed
inter alia on section 67 of the Act which reads:
67. In computing income, no deduction shall be made in
respect of an outlay or expense in respect of which any amount
is otherwise deductible under this Act, except to the extent that
the outlay or expense was reasonable in the circumstances.
I do not find on the evidence before me that the
outlay of $38,333.33 was unreasonable. The fact
that the risk on the downside was minimized by
2 His manner of calculating this was not indicated, but
projecting bond interest forward to December 31, 1983 from
his schedule of October 20, 1980 would indicate total interest
income from the bonds of approximately $19,000, if no more
had been released as a result of additional rental received from
the film. Possibly when Mr. Gelber talks of "return" on his
investment he is not talking of income return but of the total he
would get back including the capital of $30,000 and the interest
on the bonds, and not bringing film revenues into his
calculations.
the guarantee of a return on the investment of at
least $30,000 plus bond interest equivalent to in
terest which would have been earned on $30,000 of
the original investment indicates that the outlay or
expense was reasonable.
The Minister also invokes section 245(1) of the
Act which reads as follows:
245. (1) In computing income for the purposes of this Act,
no deduction may be made in respect of a disbursement or
expense made or incurred in respect of a transaction or opera
tion that, if allowed, would unduly or artificially reduce the
income.
There is no sham involved in this transaction as far
as can be seen from the documentation and it
would require something more than an imputation
of motive to consider that it was a transaction
entered into by Mr. Gelber to artificially reduce
his income. Defendant argues that it was extraor
dinary that Intercontinental should have been will
ing to put $30,000 at risk in the form of an income
guarantee in order to obtain a net investment of
$8,333.33 and that it would have been simpler had
Mr. Gelber just put up the $8,333.33 at risk in the
hope that the rental income from the film would
cover it rather than to put up $38,333.33 with a
guarantee that $30,000 of it would not be at risk.
However the Act does not use the term "real
amount at risk" which constantly appears in
defendant's argument but merely the term "capital
cost to the taxpayer" and the evidence is undisput
ed that plaintiff did outlay $38,333.33 in cash as
capital cost. While defendant argues that by
increasing the figure from $8,333.33 to
$38,333.33, of which plaintiff was sure of getting
back $30,000, the deal was made attractive since
capital cost allowance was then claimed by him on
the larger figure, and this is undoubtedly so, the
defendant appears to have failed to establish that
the $30,000 was a commitment to return part of
the purchase price rather than a mere guarantee of
assured income of this amount so as to make the
proposition more attractive. When the balance on
December 31, 1983 is paid the amount received by
plaintiff at that time has to be declared as income
and taxed as such.
While defendant's counsel cited a number of
cases most of them are the so-called "sham" cases
which appear to have no application here. Not
only were the agreements validly entered into but
it is not disputed that the parties here were acting
at arm's length. The two most pertinent cases are
those dealing directly with film investments and
both can clearly be distinguished. In the case of
Mandel v. The Queen [1977] 1 F.C. 673 con
firmed in appeal [1979] 1 F.C. 560 the appellant
and others had made a down payment on a film
and agreed to pay the balance out of the proceeds
of distribution. They claimed capital cost allow
ance on the whole purchase price including the
balance which was not paid, being a contingent
liability. It was held that the transaction was not a
sham since there always existed the possibility that
the film might eventually produce income, but that
capital cost allowance could only be claimed for
the taxation year in question on the amount actu
ally paid in that year. The balance constituted a
contingent liability and could only be used for
capital cost allowance purposes when and if it was
paid. In the case of Lipper v. The Queen 79 DTC
5246 (Mr. Lipper incidentally being one of Mr.
Gelber's partners) the situation was somewhat
similar. Mr. Lipper did not have the same deal as
Mr. Gelber had and the case dealt with a different
film in a different taxation year. In that case as in
the Mandel case part of the purchase price was
paid in cash with the greater amount to be payable
out of future earnings of the film from time to
time. There was a limited partnership with only
one general partner, being a company which had
no assets. The taxpayer could lose no more than
the amount of his original investment if no profit
resulted from the film, and only the general part
ner would be liable for the debt. No profit ever did
result. The taxpayer was only allowed to claim his
actual $5,000 investment, not the $11,243 being
his share of the partnership, for capital cost allow
ance calculations. It was held that the very large
sum provided for in deferred payments had no true
business purpose and was simply a tax evasion
scheme. Here again the case dealt with a contin
gent liability to pay the balance of capital cost out
of future film profits. The deferred payment was
grossly and artificially exaggerated and wholly
unrelated to the value of the film. Neither the
vendor nor the purchaser expected the price to be
paid. In the present case there was no contingent
liability contracted by Mr. Gelber. He had made
his payment in cash. He undoubtedly was aware of
the tax advantages and the deal was undoubtedly
an attractive one for him. The risk was compara
tively slight and there was always some hope that
the film might prove profitable. Evidence indicated
that it had good actors and actresses in it. To
equate guaranteed income with a refund of capital
as defendant does, is to deliberately ignore the
written agreement. While undoubtedly plaintiff
was better off from a capital cost allowance point
of view by paying $38,333.33 with guaranteed
income return of $30,000 than he would have been
by paying $8,333.33 outright it must be remem
bered that he had to wait 11 years to obtain full
payment of this guaranteed income. The interest
received on the bonds in the meanwhile was merely
what he might have received otherwise by invest
ing the $30,000, quite probably to better advan
tage than in Government bonds, and it was clearly
the guaranteed income feature plus the tax advan
tages which attracted him. This however in my
view is not sufficient to consider that it was a
transaction entered into with no proper business
purposes which would have the effect of artificially
reducing income pursuant to section 245(1) of the
Act. The appeals for all three years are therefore
maintained and the tax returns of plaintiff for
each of the years 1972, 1973 and 1974 are referred
back to the Minister for reassessment pursuant to
these reasons with costs, only one set of costs being
allowed since all three cases were heard simultane
ously.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.