Makuz v. The Queen

Makuz v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2006-07-12
Neutral citation
2006 TCC 263
File numbers
96-1882(IT)G, 96‑1883(IT)G, 96-2512(IT)G, 96‑3944(IT)G, 96‑3949(IT)G, 96‑3952(IT)G, 96-4031(IT)G, 96-4038(IT)G, 97-981(IT)G, 97-982(IT)G, 97-983(IT)G, 97-984(IT)G, 97-985(IT)G, 97-986(IT)G, 97-987(IT)G, 97-988(IT)G
Judges and Taxing Officers
Donald G.H. Bowman
Subjects
Income Tax Act
Notes
Decision Content
Citation: 2006TCC263
Date: 20060712
Dockets: 96-1882(IT)G; 96‑1883(IT)G; 96-2512(IT)G; 96‑3944(IT)G; 96‑3949(IT)G; 96‑3952(IT)G; 96-4031(IT)G; 96-4038(IT)G;
97-981(IT)G; 97-982(IT)G; 97-983(IT)G; 97-984(IT)G;
97-985(IT)G; 97-986(IT)G; 97-987(IT)G; 97-988(IT)G
BETWEEN:
ALEX R. MAKUZ, WILLIAM O.S. BALLARD,
MICHAEL COHL, CHARLES CSAK,
JAMES MOLYNEUX, EDWARD BOBOT,
ADEL MARCO, PETER PESCE,
EDEN HOLDINGS LTD.,
WATER’S EDGE VILLAGE ESTATES LTD.,
SANDSPIT HOLDINGS LTD.,
WATER’S
EDGE
VILLAGE
ESTATES (PHASE II) LTD.,
TWIN OAKS VILLAGE ESTATES LTD.,
JAMES S. DUNCAN, ANTHONY R. YOUNG,
J. DUNCAN HOLDINGS LTD.,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Bowman, C.J.
[1] These appeals were heard together on common evidence. The evidence in nine of the appeals was heard in
Victoria ,
British Columbia and the evidence in seven of the appeals was heard in
Toronto ,
Ontario
. In general, the appeals that were heard in
Victoria were by residents of
British Columbia
. The appeals that were heard in
Toronto were by residents of
Ontario
. The appeals heard in
Victoria
were the following: Eden Holdings Ltd., (“Eden”), 97‑981(IT)G; Water’s Edge Village Estates Ltd., (“Water’s Edge”), 97‑982(IT)G; Sandspit Holdings Ltd., (“Sandspit”), 97‑983(IT)G; Water’s Edge Village Estates (Phase II) Ltd., (“Water’s Edge II), 97‑984(IT)G; Twin Oaks Village Estates Ltd., (“Twin Oaks”), 97‑985(IT)G; James S. Duncan, (“Duncan”), 97‑986(IT)G; Anthony R. Young, (“Young”) 97-987(IT)G and J. Duncan Holdings Ltd., (“Duncan Holdings”), 97‑988(IT)G.
[2] The Toronto appeals were: Alex R. Makuz, (“Makuz”), 96-1882(IT)G; William O.S. Ballard, (“Ballard”), 96-1883(IT)G; Michael Cohl, (“Cohl”), 96‑2512(IT)G; Charles Csak, (“Csak”), 96-3944(IT)G; James Molyneux, (“Molyneux”), 96‑3949(IT)G; Edward Bobot, (“Bobot”), 96‑3952(IT)G; Adel Marco, (“Marco”), 96‑4031(IT)G and Peter Pesce, (“Pesce”), 96‑4038(IT)G. The one exception was that Ballard gave his evidence in
Victoria
, B.C.
[3] Crown counsel for the
Victoria
appeals were Mr. Robert Carvalho and Mr. Gavin Laird. Crown counsel for the
Toronto
appeals were Ms. Patricia Lee and Mr. Eric Noble. Counsel for all of the appellants was Mr. George Cadman. The argument in all appeals was heard in
Toronto
.
[4] The issue in all of the appeals is the same for all of the appellants. It is whether a loss in a partnership, in which the appellants claimed to have an interest, is deductible by the appellants in computing their income in the years 1988, 1989, 1990 and 1991. The parties agreed on certain facts and their agreement is attached as Schedule A.
[5] The question of the loss from this particular partnership has been before this court and the Federal Court of Appeal. In Witkin v. The Queen, Beaubier J. ([1998] 3 C.T.C. 2869]) dismissed the appeals and the Federal Court of Appeal ([2002] 3 C.T.C. 184) affirmed his judgment on different grounds.
[6] The facts are complicated and they include a multiplicity of transactions. A number of corporations and three partnerships are involved. The principle of income tax law that is relied upon is that when a person becomes a partner in a partnership before the end of the partnership’s fiscal period, that person’s pro rata share of the partnership’s income or loss is to be determined at the end of the partnership’s fiscal period. The principle is not in doubt, but its application to the facts here is disputed.
[7] In a nutshell, here is the problem. Partnership A had a fiscal period ending December 31, 1987. Partnership B had a fiscal period ending March 31, 1988. Partnership B acquired a partnership interest in Partnership A on December 31, 1987. Partnership A sustained a loss before the end of its fiscal period that ended on December 31, 1987. Therefore, Partnership B’s share of that loss should enter into the computation of its income or loss for the period ending March 31, 1988. The appellants’ position is that they acquired partnership interests in Partnership B before March 31, 1988. Therefore they claimed their proportionate share of the loss of Partnership B.
[8] The Minister of National Revenue denied the loss claimed by the appellants’ citing artificiality and sham and alleging that the appellants were not really buying a partnership interest with the intent of earning income but were in reality simply buying a loss and a tax write-off and not a genuine investment. The respondent relies, in addition, upon old section 245 of the Income Tax Act. The appellants state that they were aware of the existence of the tax write-off but that their purpose was to acquire an investment in the real estate market in
Texas
.
[9] A more detailed outline of the facts follows and is shown diagramatically on Schedule B. The facts are taken substantially from the notices of appeal and on paper, at least, seem to be supported by the documentation. The Claridge Associates (“CA”) was a general partnership founded on November 20, 1979 under
Texas
law. Its fiscal year-end was December 31. Its original partners were Belcourt Construction Company Ltd. (“Belcourt”) and Realty Properties Multi‑Storey Inc. (“RPMSI”), a
Texas
corporation. Subsequently, Soza Marine Service Limited (“Soza”) acquired an interest so that by the end of 1986 Soza and Belcourt had a 50% interest in CA and RPMSI had 50%. On October 9, 1987, Multi-Storey Investments, Inc. (“MSI”) acquired Soza’s and Belcourt’s 50% interest.
[10] CA built a luxury residential condominium apartment complex in
Dallas
known as The Claridge. On December 30, 1987, CA owned approximately 79 condominium units in The Claridge. Claridge Holdings No. 2 (“CH2”) was a general partnership formed under
Texas
law. On December 31, 1987, its partners were RPMSI and Strauss Investment Construction Corp. (“SICC”), a
Texas
corporation. Claridge Holdings No. 1 (“CH1”) was a general partnership formed under
Texas
law whose original partners were Strauss Investments Realty Corp. (“SIRC”) and Strauss Investment Management Company (“SIMC”). The fiscal year-end of CH1 was March 31.
[11] On December 31, 1987, CH1 purchased a 49.5% interest in CA from each of MSI and RPMSI for US $20.00. Also, on December 31, 1987, CA sold an 85% interest in the 79 units to CH2. The consideration was the assumption by CH2 of US $23,000,000 of specific liabilities of CA and 85% of all other indebtedness of CA.
[12] By letter agreement dated March 7, 1988, SIMC and SIRC, in consideration of US $20.00, granted CMF Enterprises Ltd. (“CMF"), an
Ontario
corporation, an option to acquire 99% of the partnership interests in CH1.
[13] On March 28, 1988, in consideration of the payment of amounts which I shall set out in more detail below CMF assigned to the appellants the right to acquire varying percentages of the partnership interests. For example, Ballard paid $95,357.97 for the right to acquire 4.03% of the partnership interest in CH1. Molyneux (through CMF Investments) acquired the right to acquire 5.41% of the partnership interests in CH1 for $127,120.93. Twin Oaks paid $47,669.98 for a right to acquire 2.02%. Young paid $15,890.33 to acquire 0.67% of the partnership interest of CH1. It works out to somewhere between $23,400 and $23,700 for the right to acquire 1% of the partnership interests. For the sake of simplicity I shall treat the cost of acquiring a 1% partnership interest in CH1 as US $23,500.
[14] On the same day, March 28, 1988, the appellants exercised their options and paid SIMC and SIRC a nominal amount to acquire the respective partnership interests in respect of which they held options. For example, Ballard paid US $4.03 to acquire a 4.03% interest in CH1. Molyneaux paid US $5.41 to acquire a 5.41% interest, Young paid US $0.67 for 0.67% interest and Twin Oaks paid US $2.02 for a 2.02% interest.
[15] On March 30, 1988, MSI contributed to CA a Promissory Note (“PN”). The notice of appeal states that the PN was in the amount of approximately US $64,000,000. It is difficult to tell from the note itself how much it is for. The indebtedness under the note (which is dated March 30, 1988, and is signed by Richard C. Strauss and is in favour of MSI), is said to be equal to the difference between certain indebtedness of CA to the Chase Manhattan Bank and the Morgan Guaranty Trust Company of New York and $17,705,350.
[16] If the figure of US $64,000,000 in the notice of appeal is accepted, it would mean that the indebtedness of CA to the two financial institutions would be in excess of $81,000,000.
[17] On March 31, 1988, after the acquisition of the partnership interests, the appellants contributed capital to CHI in proportion to the percentage interest acquired. For example, Ballard, with a 4.03% interest, contributed US $54,657; Molyneux, with a 5.4% interest, contributed US $72,874; Young, with a 0.67% interest contributed US $9,109 and Twin Oaks, with a 2.02% interest, contributed US $27,328. This works out, with variance of no more than US $100, to a contribution of about US $13,500 for each one percent partnership interest in CH1 acquired.
[18] Also, on March 31, 1988, CH1 contributed US $1,342,000 to CA. This amount is the aggregate of the contributions made by the appellants to CH1. Also, on March 31, 1988, the “Carried Interest Agreement” was entered into between CA, MSI, CH2 and Richard Strauss. Under that agreement, CA transferred to CH2 the remaining 15% interest in the Claridge units, US $1,342,000 of cash and the PN. CH2 assumed the remaining first‑mortgage liabilities of CA and MSI agreed to convey to CA a 5.4% beneficial interest in the Claridge units if, as and when, it acquired them.
[19] Some time between March 31, 1988 and before September 13, 1988, Wasco Properties Inc., (“Wasco”) a
Delaware
corporation, acquired the Claridge units from CH2, then MSI acquired them from Wasco and on September 9, 1988, MSI conveyed 5.4% interest of the units to CA.
[20] In 1988, 1989, 1990 and 1991, the appellants claimed the share of CH1’s losses (which were CA’s losses) equal to their proportionate interest in the partnership CH1. For example, in 1988, Ballard, with a 4.03% interest claimed $1,763,855; Twin Oaks with a 2.02% interest claimed $884,116; Young, with a .67% interest claimed $293,246. In summary then, Ballard in 1988 claimed a loss of $1,763,855 and his cost of the partnership interest was the aggregate $95,357.97 (cost of option paid to CMF), $4.03 (cost of the 4.03% partnership interest) and $54,657, (capital contribution to CH1) for a total of $150,019.
[21] The cost to Twin Oaks of its 2.02% interest was $47,669.98, plus $2.02 plus $27,328, total $75,000, and this gave Twin Oaks access to a loss of $884,116.
[22] The cost of Young of buying into the pool of losses was $15,890.33 plus $0.67 plus $9,109 for a total of $25,003 and he claimed $293,246.
[23] The result was that for a total outlay of about US $3,730,000, the appellants were given access to a pool of losses totalling Cnd. $43,200,000.
[24] If one looks at these numbers, and at the remarkable discrepancy between what was paid and the losses claimed, it is difficult to believe that the access to the losses was not the predominant, if not the sole motivation for the investment. For example, if we look at Ballard (and I pick him simply as an illustration), for an outlay of $150,000 he got a tax loss of $1,763,855 in the first year as well as a further loss of about $33,000 in the following years. This is even better than the prospect held out to the appellants in the promotional material. The U.S. Real Estate Investment Overview that was given to the investors reads as follows:
The Claridge is an exclusive 97 unit high-rise, situated in one of the city’s most prestigious locations. The property was assembled in 1979 and the building was constructed over a three year period to March, 1985, at an accumulated cost in excess of $70 million. To December 31, 1987, 22 units have been sold. Due to declining
Texas
real estate values in recent years, the estimated fair market value of the remaining unsold units approximates $23 million.
CMF Enterprises Ltd., has obtained an option to purchase the undivided interest in the Claridge by acquiring all of the partnership interests in Claridge Holdings No. 1. CMF has also negotiated an agreement whereby the existing partners in the project will contribute capital to fund the existing debt in excess of fair market value of the project.
Income Tax Considerations
CMF Enterprises Ltd. commenced negotiations with the Strauss Group, owners of the Claridge partnership, at the beginning of December, 1987. By December 27, the percentage of interest and the price had been negotiated. On December 30, in an effort to further enhance the deal, and isolate the excess debt from future partners, CMF requested that the Strauss Group undertake to reorganize their ownership structure. The following steps were taken prior to year end:
• The partnership owning the property was acquired by a second partnership with a February 1988 year end.
• 85% of the property was sold for debt at fair market value to a third partnership.
Under the existing agreement with the Strauss Group, Canadian investors owning the second partnership will be allocated substantially all of the partnership loss incurred in the Claridge Associates partnership for the operating year ended December 31, 1987, which is estimated to be $27 - $30 million U.S. Based on a minimum investment of $150,000 Canadian, the pro rata allocation of loss would approximate $1,250,000 Canadian as a minimum.
[25] Mr. Ballard, for an expenditure of $150,000, claimed $1,763,855 in 1988. Even assuming the $150,000 was not deductible, the tax value of $1,763,855, assuming a marginal rate of 52% was about $917,000, for a return of about 600%.
[26] The appellants, through CH1, ended up with 99% of a loss of about $43,000,000 but only a contingent interest in 5.4% of the unsold condominiums.
[27] I have traced the complex series of transactions beginning with the creation of CA, the construction of the Claridge with the large losses and 79 unsold units through to the final transactions whereby MSI transferred 5.4% of the units some time after March 31, 1988. It is important to determine just what the appellants were getting when they paid an aggregate of approximately US $37,220 for each 1% partnership interest of CH1.
[28] Considering that the transactions were all pre-orchestrated, the appellants were buying on March 28, 1988 into a partnership which in two days would be stripped of all of its assets and be left with nothing but a promise by MSI to convey 5.4% of the Claridge units to it if, as and when it acquired them.
[29] The appellants were getting the prospect of a large tax write‑off in respect of a loss that it was certain had already occurred plus a chance, a possibility, or a hope of getting a 5.4% interest in 79 unsold condominiums. We know what the losses were worth if they could successfully be used by the appellants — the tax value of a write-off of over $40,000,000. What was an uncertain chance of getting 5.4% of 79 unsold condominium units worth? The promotional material says that the unsold 79 units had a fair market value (“fmv”) of about US $23,000,000. Without deciding whether the figure is correct, 5.4% of $23,000,000 is $1,242,000.
[30] The appellants were paying an aggregate of US $3,700,000. If the losses were not the principal motivation for buying into the partnership it is hard to imagine why they would pay $3,700,000 for a 5.4% interest in 79 [1] unsold units with a value of about $1,200,000. This value would have to be discounted by some indeterminate factor considering that on March 28, 1988, CA1 had only a chance of receiving the 5.4% of the units.
[31] I shall deal briefly with certain aspects of the evidence. The first is the stated intentions of the appellants. This occupied a great deal of the time at trial.
[32] The answers to the question why the appellants invested in the Claridge varied. Some said they relied upon their advisors such as the accounting firm of Eng, Rozon & Floor or Mr. Perkins of the law firm of Perkins, Kenney & Ballard or the accounting firm of Cooper, Millson and Foster (“CMF”). I will outline briefly the evidence of the appellants but I should preface the outline with the caveat that statements of subjective intention about the reasons for entering into a transaction are considerably less persuasive than the objective facts and circumstances surrounding the transaction. Without suggesting that there was any conscious dishonesty in a person’s statements of subjective intention, they tend to be unreliable because they are influenced by many extraneous factors. What actually happens is often a more reliable indication of a taxpayer’s purpose.
[33] This is consistent with what was said by the Federal Court of Appeal in The Queen v. Allan McLarty, 2006 FCA 152 at paragraphs 27 and 28.
[27] The court below suggested a novel approach to the question of whether a taxpayer has purchased seismic data for the purpose of exploration as required by paragraph 66.1(6)(a) of the Act. Because the respondent was an individual who had entered an agreement that stipulated that exploration for oil and gas would occur, the TCC indicated that it was unnecessary to look beyond the respondent’s purpose in obtaining the Data, as evinced by his testimony and his reliance on the Memorandum. In other words, objective evidence of a connection between data purchase and actual exploration work was not legally relevant in cases such as that before it. This finding of law is subject to a correctness standard of review. See e.g. Housen v. Nikolaisen, 2002 SCC 33 [“Housen”] at para. 36.
[28] The TCC admitted that its approach to considering whether the statutory purpose test was met departed from the prior jurisprudence. In Global Communications and Petro-Canada, the courts looked at what was actually done to the land or with the seismic data. In my respectful opinion, the TCC’s departure from the prior case law was unjustified. The jurisprudence of this court does not suggest that the statutory purpose test varies with the taxpayer’s identity. Instead, it indicates that the court must always examine either what was actually done or what was planned to be done with the seismic data.
[34] A further reason for treating statements of intention with some caution is that, as will be apparent from the outline that follows, there is no consistency in the stated intentions of the appellants in making the investment. We have here what is stated to be a partnership with an interest in a partnership that owns a condominium apartment complex. It would be anomalous if the tax consequences to the individual investor in the partnership were to vary from investor to investor depending on his or her reasons for joining the partnership.
[35] Mr. James Duncan was involved, along with Mr. Anthony Young, in a number of corporations which are appellants – Twin Oaks, Water’s Edge and Water’s Edge II. They invested personally as well as through those corporations and Mr. Duncan’s personal corporation, Duncan Holdings. Together, through a company, Swiftsure Developments Ltd., they participated in many real estate developments. They heard of the Claridge investment through their accountant, Mr.
Eng.
Mr. Duncan invested before he went down to inspect the Claridge building. He stated that he and Mr. Young had wanted to get into the
United States
real estate market.
[36] He did not recall being briefed about the tax advantages of the investment and stated that the potential tax effect did not influence his decision to proceed with the investment. Since Mr. Eng was promoting the scheme among his clients it is odd that the significant potential tax advantages were not forcibly brought to Mr. Duncan’s attention in such a way that he would remember them. Indeed, in the memorandum of February 25, 1988 from Mr. Eng to Mr. Duncan and Mr. Young, the following appears on the first page.
We formally communicate to you as follows:
1. The investment package came to us from CMF Enterprises Ltd. via Jim Hutton.
2. CMF Enterprises Ltd. has requested Eng, Rozon +& Floor and/or Camus Management Corporation to act as “facilitator” in their search for qualified investors.
3. We are introducing the package to you on the basis that your group is a group of qualified investors – being developers and sophisticated investors and whose main business is in the real estate development field.
4. The investment:
a) The product is a completed 97 suite luxury condominium located in
Dallas ,
Texas
.
b) Total investment available is approximately $4.5 million cash.
c) The investors will participate in all future profits (operating and capital) subject to all risks and rewards associated with real estate development and investment.
d) A side benefit of the investment is the current tax losses accruing to the investors. The total such benefits is estimated to be $38 million (from the investment of approximately $4.5 million cash).
e) Suggested amounts for the Young/Duncan Group:
1) Cash investment of $720,000.
2) Tax loss allocation approximately $6 million.
3) Ownership: Approximately 15%.
5. Based on the above suggested investment by the Young/Duncan Group, we hereby formally advise you that we have agreed to accept a professional fee of 1% of the tax loss (approximately $60,000) from CMF Enterprises Ltd. based on completion of the transaction (instead of 2% from yourselves as previously agreed).
[37] This material was before all of the investors. It formed part of a larger package which was contained in Exhibit R‑1 entitled “Promotional Material”.
[38] Mr. Eden has been associated for many years with Mr. Duncan and Tony Young in real estate development. He testified that he decided to invest in the Claridge project because Mr. Eng recommended it to him. He was aware as well that Mr. Duncan and Mr. Young were investing in it.
[39] Mr. Eden did not recall seeing the profit projections which formed part of the promotional material. Apart from the recommendation by Mr. Eng, Mr. Eden had no recollection of any details of the Claridge investment. He admitted to being aware of the tax advantage but said he was mainly interested in the investment as something on which he could make a good return. Mr. Eden invested $25,000 and claimed a write-off of $293,246 in 1988 and small amounts in 1989 and 1990.
[40] Mr. Young, with Mr. Duncan and Mr. Eden, has been active in real estate development. It appeared from his testimony that originally the Young/Duncan group, including their various companies, originally (on March 3, 1988) invested a total of $825,000 in the project and then about a week later (March 11, 1988) they reduced their total investment to $425,000. Mr. Young invested $25,000 and claimed a tax loss in 1988 of $293,246. Water’s Edge II invested a total of $200,000 and claimed a write-off in 1988 of $2,354,724.
[41] Mr. Young seems to have been somewhat more actively involved in considering the advisability of the investment than the others in the group. He stated that he knew of the tax advantage but his main interest was to get into the real estate market in the
United States
. He stated that he believed that he would still have gone ahead with the Claridge investment even without the tax advantage. He is an astute businessman. I find it hard to believe that someone of his obvious business acumen would have invested in such a questionable project without the incentive of the enormous tax advantage.
[42] Mr. Young also described a parcel of 16 acres near
Dallas
owned by CH1. That parcel was bought apparently before the Claridge building was sold in 1990. It has not been developed and has been sitting idle and unoccupied for about 16 years.
[43] Mr. Young was clear in his testimony that he was well aware of the tax losses that would be allocated to him and to the companies in which he had an interest as the result of the investment in the Claridge project.
[44] Mr. Young seems to have relied entirely on his accountants Eng, Rozon & Floor, who were certainly aware of the enormous potential write-off of the loss incurred by CA prior to the investors’ involvement in the project, as compared to highly questionable chance of their ever making any money from a turnaround in the Dallas real estate market. When a taxpayer disavows any significant knowledge of the details of an investment and bases the decision solely on the recommendation of his or her professional advisor, the knowledge of and purpose for the investment must be found in the minds of the professional advisor and attributed to the investor. I think that as a matter of commercial reality what the Eng firm was promoting was essentially a sale of the losses that had been incurred by CA.
[45] Mr. William Ballard is a lawyer by training but has never practised. He describes himself as an investor. He has had extensive experience in developing real estate. He also was very active in the entertainment business. His partner, Mr. Perkins, told him about the Claridge investment based on material he obtained from an accountant, Alex Makuz, who is one of the appellants in these cases. Mr. Ballard believes that he must have looked at the promotional material. He stated that he spoke to Mr. Perkins on a number of occasions and that one of the factors that influenced his decision to buy into the Claridge project was the high calibre of the people who were looking at it. Mr. Ballard did not know what cash flow calculations were made by Mr. Perkins.
[46] Mr. Perkins’ testimony was that he saw the Claridge building and was impressed with the quality of its construction. He thought it was grossly undervalued in the depressed state of the
Dallas
real estate market. He recommended the investment to his clients, Mr. Ballard and Mr. Cohl. He described the transaction as “tax assisted”, a term that in the circumstances I find euphemistic. Mr. Perkins was very knowledgeable about the tax aspects of the investments. For example, he knew that one effect of buying the 16 acre parcel of land was to keep the partnership alive and avoid an income inclusion to the partners on the windup of the partnership in which they had a negative ACB. Mr. Perkins was the person upon whom a number of the investors relied for advice on both the advisability of the investment and the legal structure. Most of them seemed very uncertain or even confused about the structure of the transaction. I was hoping Mr. Perkins would shed some light on the legal structure but he was almost as vague as the investors. I have had to piece together from different sources the way I think the deal was structured. Fortunately, even if I got some of the details wrong, it does not detract from the broad outline or from the question of principle involved here.
[47] Mr. Cohl is a producer of musical performances and has had a business association with Mr. Ballard for many years. As was the case with Mr. Ballard, Mr. Cohl was introduced to the Claridge project by Mr. Perkins and he relied on Mr. Perkins’ recommendations.
[48] Mr. Cohl was aware of the tax advantage but saw it as a “tax delay”. At pages 96-97 of the February 6, 2006 transcript the following appears:
Q. I take it from what you’ve told us earlier, you were aware that there was a potential tax benefit to this transaction.
A. Tax delay.
Q. Tax delay.
A. It’s still my understanding that that’s really what – well, that’s my –
HIS HONOUR: Sir, I don’t understand the term “tax delay.”
THE APPELLANT: Ultimately, the way “Perky” always explained it to me, was you don’t have to pay the tax this year, but eventually all tax shelters collapse and you’d have to pay the tax. So you don’t have to pay it, say, in year one, but you end up having to pay it perhaps in year four or five. It’s not that you get off the tax forever. That was never my understanding. Whether that’s right or not, that was my understanding, so that it was kind of a – like I said, it’s a tax delay more than a not have to pay it.
Q. And that was your understanding as you went into this deal.
A. That’s still my understanding.
Q. Okay.
HIS HONOUR: You mean like films.
THE APPELLANT: Yeah, absolutely.
[49] Mr. Cohl’s understanding is probably correct if one is dealing with capital cost allowance (“cca”) on films. If the film is sold at a profit there may be a recapture of cca. However, if you claim losses there is no recapture. The one possible exception to this is where the loss is the result of an inventory write down and the inventory recovers its value and is sold. I doubt this is what Mr. Cohl was thinking about. Mr. Cohl saw it as a high risk investment but reasoned that all his business ventures concerning films are high risk. He seems to have gone into the deal blindly and solely on Mr. Perkins’ advice. He seemed ready and able to roll the dice for $150,000 and that is exactly what he did.
[50] Mr. Peter Pesce is the president of a family owned coffee company. He was introduced to the Claridge investment by CMF, chartered accountants, whose partners were also the shareholders of CMF Enterprises, which had acquired the option on the partnership’s interests in CH1 which they were selling as part of their promotion of the Claridge investment.
[51] Mr. Pesce invested in the project because of his confidence in CMF and because of the reputation of some of the other investors such as Ballard and Cohl. He stated that he did not have any recollection of the tax advantage of the Claridge investment and that he was not thinking of it when he was selling his coffee company. I must say I find it passing strange that a person who is selling a company for several million dollars with substantial tax to pay as a result would have no recollection of the fact that an investment of $150,000 would yield a tax write-off of about $1,250,000.
[52] Mr. Marco is an engineer by training. He has had extensive experience in real estate development throughout the world. His practice was to find a real estate project, develop it and bring other investors in. His accountants were CMF. He described generally the real estate market in the 1980s. He did not do separate calculations because he relied upon CMF, his accountants and John Campbell of Miller Thomson, his counsel. He was aware of the tax loss but stated that he was looking at the value of the building. He thought they were getting a building worth $23 million.
[53] He stated that he did not do any mathematical calculations. If he had he would have found that the appellants were paying about $3,700,000 for a chance of getting a 5.4% interest in 79 unsold apartments. Assuming the $23 million value to be correct, what they were paying for was a chance of getting something with a problematical value no greater than $1,200,000 plus a tax write-off of over $40,000,000. It is true he did refer to some interesting figures such as $700,000 per unit, which he thought might be sold in two years or so. Like Mr. Cohl, he stated that he saw the loss as something that would be recovered.
[54] I question the correctness of this understanding where, as here, we are dealing with a loss that does not arise from a claim for cca. Nonetheless, in a rather vague sort of way that seems to be the way he saw it, despite the fact that none of the material stated that there would be recapture. The very comprehensive opinion of the
Toronto
firm of solicitors, Miller Thomson, Sedgwick, Lewis and Healy which was given to CMF Enterprises Ltd. on March 30, 1988, and which was available to the investors does not mention that they would recapture in the sense in which it seems Mr. Cohl and Mr. Marco understood the term.
[55] Mr. Marco identified a letter dated April 4, 1988, sent to the investors by CMF Enterprises Ltd. reporting on the closing (Exhibit A‑5). I am reproducing it in full because it summarizes fairly succinctly the situation immediately following March 31, 1988:
Dear Claridge Holdings No. 1 Partners:
We are pleased to report on the closing of our real estate investment in the Claridge. Pre-closing proceedings commenced at approximately 8:30 am on Wednesday March 30, and final documents were signed, executed and completed by 9:00 pm on Thursday March 31. A complete report and copies of the closing documentation will be delivered to you at a later date.
Generally, the closing went well and according to the pre-determined agenda. As of the date of our investment, the Strauss Group had still not finalized the second mortgage arrangements for the Claridge but was working closely with its principle lending candidate towards obtaining a commitment. The prospects look promising. Based on verbal discussions with Wasco in
New York
, the Strauss Group believes that Wasco will either grant a formal extension of the foreclosure proceedings or work with the Strauss Group on an informal basis until the financing has been arranged. This is as we anticipated. The Strauss Group did have a complete financing package committed in September of 1987 to re-structure the project, but did not proceed at the request of Wasco. We therefore expected that Wasco would be lenient in its approach to the potential foreclosure this time around if the Strauss Group was experiencing delays in obtaining the necessary commitment.
On a more positive front, the Strauss Group has five condominiums under contract of sale over the next few months, with one unit selling for $600,000 cash scheduled for closing within the next two weeks.
As you are aware, in the event that satisfactory financing cannot be obtained for the Claridge, and in the event that Wasco does follow through with foreclosure, the Strauss Group must transfer to us a net profits interest in a partnership which owns a four story commercial building known as the
Equitable
Bank
Building
. At the closing, and in order to provide further incentive to finalize the financing on the Claridge, we negotiated that $250,000 be immediately placed into an escrow account by the Strauss Group with Johnson & Swanson for up to six months. In the event of foreclosure by Wasco, and in the event that financing is obtained any time subsequent to that and Claridge Holdings No. 2 or an affiliate of the Strauss Group re-acquires the Claridge, then we will acquire our 5.4% direct interest and the funds will be released back to the Strauss Group. In the event that financing is not obtained, then the funds will be released to us.
We feel that these conditions, which were negotiated at the closing, will extend the time window available to re-acquire the Claridge as well as increase our protection against another Strauss entity other than Claridge Holdings No. 2 re-acquiring the property and not being obligated to give us the 5.4% interest. In summary, we feel that we have strengthened our position vis a vis obtaining the property interest in any eventuality. However, we would like to mention that the entire closing was very amicable and the Strauss Group has indicated that they are looking forward to working together with us as partners in the Claridge.
We will be providing all partners with complete financial statements for the fiscal year ending March 31, 1988 for Claridge Holdings No. 1. These statements and copies of the closing documentation and legal reporting letters will be available in due course.
Should you have any questions in the interim, please do not hesitate to call.
Yours truly,
CMF ENTERPRISES LTD.
J.D. Millson
[56] This letter demonstrates in my view the true economic reality of the situation. The 5.4% profit interest that CH1 had indirectly in the building was far from guaranteed. It was contingent upon financing arrangements being completed. Even if the acquisition of the 5.4% interest in the building were certain, the value was less than the amount paid. A fmv of $23 million was mentioned in the promotional material. 5.4% of that is about $1,200,000 – substantially less than the aggregate paid by the investors. Even if we were to accept that a couple of apartments were being sold for $600,000 each, as Mr. Marco stated, this would still work out to only $47,400,000 if all 79 units were sold at that figure. 5.4% would be $2,559,600. The aggregate amount paid by the investors was about $3,700,000. In fact the building was sold in 1990. Mr. Marco stated that as minority partners (5.4%) they had no say in the decision to sell. The investors realized nothing from the sale in 1990.
[57] Mr. Marco was cross-examined at some length by Ms. Lee on the projections in Exhibit R‑1, Tab 3. It seemed fairly obvious that Mr. Marco had not given a great deal of thought to the projections. Regardless of these projections the best case scenario would be that CH1 ended up with 5.4% of the profits from the sale of 79 units (or 74 or 75 depending on who was doing the counting). The fmv was said to be $23,000,000 but even if one takes the units as being instantly saleable at $700,000 each, (a wildly unrealistic hypothesis) for a total of about $47,400,000, 5.4% of that total is $2,986,200 and from that there must be deducted the expenses and carrying costs. One might well ask, what rational business person would pay $3,700,000 for a chance to realize a gross return of at best about $2,900,000, less expenses? The answer is obvious − only if that rational businessman was getting in addition a tax write‑off of $40,000,000.
[58] Mr. Marco paid a total of $150,000 and claimed in 1988 a non-capital loss of $1,716,342, some of which would be available to be carried back to earlier years and forwards to later years. The most optimistic projection would yield him gross income of about $70,000, for a loss of $80,000 ($150,000 minus $70,000) according to questions I put to him at the end of his testimony. Another erroneous notion that came out of those questions was the idea that he would get his $150,000 back as capital after earning the profit of $70,000. That amount disappeared into the project and, try as I will, I cannot make it reappear.
[59] The projections are all over the lot and the ideas of recapture of loss and return of capital are erroneous. In most cases these considerations would be significant but here they are not because obviously the predominant feature of the investment was the tax benefit.
[60] The next witness was Edward Bobot, a chartered accountant. From 1985 to 1989 or 1990, he was a partner in the accounting firm CMF. He became involved in the CH1 investment in reliance on Jim Millson. He seems to have done a minimal amount of independent investigation. He had no recollection of any of the documents that were put before the investors, or signed by them. Apart from being influenced by the fact that other members of CMF were investing in CH1 he was also impressed by the fact that one of CMF’s partners, Mr. Marco was also investing. The predominant reason for Mr. Bobot’s investing seems to have been that as a junior member of the firm he was subjected to a certain amount of pressure by the other partners to join. His investment in CH1 was through another partnership, CMF Investments of which the other partners of CMF were partners. CMC Investments had a 5.41% interest in CH1. He claimed a loss of $260,463 in 1988 in respect of his interest in CH1. His knowledge of the investment was very limited. He invested because the other partners in CMF were doing so and his contribution was made by amounts taken from his draws as a partner