Date: 20000831
Docket: 98-2826-IT-I
BETWEEN:
JAMES F. DAVIDSON,
Appellant,
and
HER MAJESTY HE QUEEN,
Respondent,
AND BETWEEN:
98-2827-IT-I
AGNA DAVIDSON
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
___________________________________________________________________
For the Appellants: James F. Davidson
For the Respondent: François Bordeleau
___________________________________________________________________
Reasonsfor Judgment
(Delivered orally from the Bench on May 3, 2000, at Sudbury, Ontario)
Mogan J.T.C.C.
[1] The appeals of James and Agna Davidson who are husband and wife were heard together on common evidence. The years under appeal for James are 1994, 1995 and 1996 and for Agna are 1994 and 1995. The claim by Agna relates to certain credits like the goods and services tax credit, which is dependent upon either the family income or the income of the two Appellants as spouses. Therefore, the appeals of Agna will follow the result in the appeals of James. That was clarified with the parties at the beginning of the hearing. The Appellants have elected the informal procedure.
[2] The story behind these appeals really begins many years prior to 1994 which is the first year under appeal. In 1987, the Appellants incorporated 704770 Ontario Incorporated (the "numbered company") to purchase a motel in Pembroke, Ontario. It operated the motel for approximately two years. In 1989, the motel was sold and the numbered company took back a mortgage in the amount of approximately $190,000.
[3] Mr. Davidson then found a property in Smiths Falls, Ontario which looked like a good investment because it included a gas station, convenience store and car wash. The leases for those three enterprises appeared to be in good order and, accordingly, the Appellants caused the numbered company to purchase this property at 69 Lombard Street, Smiths Falls for a price of approximately $1,018,000. As Mr. Davidson explained in evidence, the value of the property was really dependent upon the leases for the gas station, convenience store and car wash, and the inherent value of the property was not one million dollars without those leases.
[4] The purchase transaction was completed on or about December 15, 1989 and the principal tenant was Congo Gas which I assume operated the gas station, convenience store and car wash. Unbeknownst to the Appellants, the gas station tenant was in dangerous financial circumstances at the time of the purchase. By January 1991, just thirteen or fourteen months after the purchase, the tenant went bankrupt and was unable to operate the gas station or keep up the lease payments. That event was a financial catastrophe for the numbered company because it had purchased the property and was dependent upon the rent from leases to pay the mortgage on the property.
[5] The Appellants and the numbered company attempted to find someone else to operate the gas station but, in that process, it came to light that there was an environmental hazard on the property. The details are not precise but I assume it related to the fact that there were underground tanks which stored gasoline or other petroleum products. It is a well known fact that if a tank of that character develops a leak, the surrounding land can be contaminated resulting in costly clean-up procedures. Once the Appellants knew about the environmental problem, it was almost impossible to find any person who would operate the gas station. I conclude from Mr. Davidson's evidence that the property was without a tenant from early 1991 right through to the latter part of 1992 with no lease payments coming in.
[6] With no lease payments, the numbered company could not service the mortgage. The mortgagee took proceedings against the property and, in the latter part of 1992, forced the sale of the property at a price in the range of $450,000 which of course caused a very substantial loss to the numbered company. Also, around 1990, 1991 or 1992, the person who purchased the Pembroke motel went bankrupt and was unable to continue the operation of the motel. The company suffered the loss of the vendor take back mortgage on the motel. And so there was a double financial catastrophe falling upon the numbered company which I would call a holding company for the Appellants.
[7] The Appellants concluded that there was some kind of professional negligence connected with the purchase of the Smiths Falls property. A legal action was commenced by the Appellants and the numbered company against three persons (i) Daniel Kimmel, who was a lawyer who represented them on the purchase of the property; (ii) Dennis Girard, a real estate agent who was connected with and advised them on the purchase of the property; and (iii) Canada Trust Company. I am not sure in what capacity Canada Trust was sued but it may have been the broker who employed Dennis Girard as the real estate agent or it may have been the listing broker. Also, I am not sure in what capacity the other parties were sued because there was not entered into evidence the statement of claim filed in the Ontario Court against those defendants. I do not know what specific damages were claimed against them. I note from the oral evidence of James Davidson that one of the heads of damages was lost salary in the range of approximately $270,000 representing about nine years of salary at $30,000 per year because he had not been paid any salary as the manager of the numbered company at any time from and after December 1989 when it purchased the Smiths Falls property.
[8] I assume there were other claims of damages like the capital loss suffered on the purchase price when the numbered company paid about $1,018,000 for the Smiths Falls property and it was sold for only about $450,000. I do not have a copy of the statements of defence filed on behalf of the various defendants and so I do not know what has been said by way of defence against the claims. This is unfortunate because those two documents (statement of claim and statement of defence) are important to the Appellants' appeals. The Appellants ought to have known that, coming to this Court claiming to deduct legal expenses connected with this lawsuit and certain ancillary expenses for the claims they have incurred in connection with the lawsuit. The lawsuit is the cornerstone of the Appellants' appeals but I do not have the pleadings and I cannot determine precisely what has been claimed against the defendants. I found the Appellant, James Davidson, to be a very believable witness. I have no doubt that when he was testifying, he was attempting to recollect and describe what the numbered company's claim was. He did describe a claim for $270,000 which I determined would have been at the rate of $30,000 per year for nine years since apparently the legal action was not commenced until 1997 and 1998, eight or nine years after the original purchase.
[9] The reason I am disappointed in not having the pleadings in the case before the Ontario Court is that I have some general principles of commercial law which most lawyers carry around as part of their legal equipment after they are qualified to practice law. I would have thought that a possible defence against the individual plaintiffs, if Mr. Davidson was claiming for lost wages or lost salary, was what lawyers would call no privity of contract between any of the defendants and James Davidson. None of the defendants was ever going to be an employer of James Davidson. They had different capacities. Mr. Kimmel was the lawyer acting for the corporate purchaser, the numbered company. Dennis Girard was a real estate agent and perhaps his primary professional connection was with the vendor. If Canada Trust was the broker, it is possible their client relationship was with the vendor, if it were the broker for whom Mr. Girard worked. It appears to me that none of the defendants was ever going to be an employer of James Davidson. I would think that if he was claiming damages in the lawsuit, one of the potential defences would be a lack of privity of contract between the named defendants and Mr. Davidson. If he has an action for lost salary or lost wages, it seems to me his only action is against his own company, the numbered company. That is only speculation on my part because I do not have the pleadings. While there is nothing wrong with making a claim for lost wages in an action like the one that has been described, in the absence of the pleadings and knowing specifically what was claimed and also, importantly, what defence is put up, it is difficult for me to say whether there was a reasonable cause of action or that this action was an attempt to collect salary or wages owing.
[10] I am inclined to the view that from what I have been told in evidence that the action is primarily for the loss of the property and the capital loss suffered when the buyer paid $1,018,000 for a property which may have been grossly overvalued. It may have been overvalued because of the negligence of some of the persons advising the buyer at the time, who was led to believe that everything was in place with respect to the credit rating of the vendor and the credit rating of the potential tenant.
[11] Also absent from evidence are the tax returns of the individual Appellants. Neither party (Appellants or Respondent) saw fit to put into evidence the income tax returns, particularly the returns of Mr. Davidson. I do not know what his sources of income were in 1994, 1995 and 1996 against which the expenses are deducted. He did say in response to one of my own questions that in the years under appeal, his income was derived mainly from pensions. Pensions as a source of income are very different from employment; so different that they are received in most cases after a period of employment. The amounts are deducted, however, as if they are claims against employment as a source of income. The Notice of Appeal begins by saying:
The legal and office expenses were incurred by myself in order for 704770 Ontario Inc. and myself to file a joint action to recover losses on the investment and the earned income of $30,000 per year for myself.
Apparently, that was the purpose of the claim and employment would be a source of income. Income from employment is described in section 5 of the Income Tax Act and, under section 8 of that Act, there is a very limited number of deductions which one can take and set off against employment income. The only one which I think relates to the claim made by the Appellant, James Davidson, is paragraph 8(1)(b) which states as follows:
8(1) In computing a taxpayer's income for a taxation year from an office or employment, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:
...
(b) amounts paid by the taxpayer in the year as or on account of legal expenses incurred by the taxpayer to collect or establish a right to salary or wages owed to the taxpayer by the employer or former employer of the taxpayer;
[12] The only person (and I use that word in the legalistic sense) who could be described as an employer, former employer or potential employer of James Davidson was the numbered company. That is the person to whom he claims he was looking to pay him $30,000 per year. Indeed, he went to the trouble of drafting an employment agreement between himself and his own company dated January 1, 1994 which is attached to his Notice of Appeal and which begins as follows:
James F. Davidson of the City of Kingston in the Province of Ontario accept the position of Manager at the yearly salary of $30,000 and will comply with the following terms and conditions.
There are four or five conditions, each two or three lines long, and attached to that is another page entitled Basic Function, which is to manage the day-to-day operations and functions of the company to ensure that the interests of the company are protected. Then there is a series of duties and responsibilities. I do not doubt that Mr. Davidson in good faith drafted and signed this contract but, in a sense, it is based on an expectation that the litigation against the named defendants will be successful and that some property will be restored to the numbered company which could then employ him in some capacity to manage its affairs. Until that expectation is fulfilled (and I am not saying that it is not a reasonable expectation) the numbered company does not and would not have any property. Without any property, the numbered company would not be in a position to employ any person because there would be no property for the person to manage.
[13] On the evidence before me and in the absence of the documents I have referred to, I do not see any ground on which it could be said that James Davidson or his wife has a cause of action against the named defendants for lost wages. Clearly, neither of the Appellants were ever going to be employed by the persons named as defendants in that legal action, Mr. Kimmel, the lawyer, Dennis Girard, the real estate agent, or Canada Trust. At most, James Davidson might have been employed by his company had it acquired a successful commercial property and had that commercial property produced the kind of profit that would have permitted a salary to Mr. Davidson. He lost out on that when the company lost its property. His cause of action, if any, for lost wages would be an action against the numbered company, which is like an action against himself because he and his wife are the only shareholders of the company.
[14] There is no such action going on. Therefore, I would hold that the legal fees in connection with the action against the named defendants, Kimmel, Girard and Canada Trust, are not deductible by the Appellant and his wife. They are more likely financing the litigation on behalf of the numbered company. The real plaintiff is the numbered company as the former registered owner of the Smiths Falls property but, without any assets, the numbered company cannot afford to conduct the litigation as former owner. What is happening here is that the shareholders of the numbered company are financing its litigation because, as the purchaser, it was the first party that suffered the most when the property was lost, particularly if it was lost as a consequence of actionable conduct by any of the named defendants. That result will be known only when the Ontario Court delivers its decision.
[15] Because the legal fees are not deductible by the Appellant (James Davidson), I would conclude that the other expenses identified in Schedule "A" to the Reply to the Notice of Appeal would also not be deductible because they are in the same realm. They are what I would call incidental and casual expenses incurred only in connection with pursuing the litigation against the named defendants. They are basically all litigation costs and because the litigation is not structured for the purpose of gaining and producing income for either of the Appellants, the amounts that were deducted in computing income for the years under appeal are not in law deductible. The assessments under appeal are well founded and ought to be sustained. I dismiss the appeals for all three years by the Appellant, James Davidson, and as a collateral matter dismiss the two years under appeal by his wife, Agna Davidson.
Signed at Ottawa, Canada, this 31st day of August, 2000.
"M.A. Mogan"
J.T.C.C.
COURT FILE NO.: 98-2826(IT)I and 98-2827(IT)I
STYLE OF CAUSE: James F. Davidson and Agna Davidson and
Her Majesty the Queen
PLACE OF HEARING: Sudbury, Ontario
DATE OF HEARING: May 3, 2000
REASONS FOR JUDGMENT BY: The Honourable Judge M.A. Mogan
DATE OF JUDGMENT: May 9, 2000
APPEARANCES:
For the Appellants: James F. Davidson
Counsel for the Respondent: François Bordeleau
COUNSEL OF RECORD:
For the Appellant:
Name: N/A
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada