http://decision.tcc-cci.gc.ca/site/tcc-cci/decisions/en/item/31181/index.do 
Drouin v. The Queen[1] (May 3, 2013) involved deductions claimed by the appellant in connection with his acquisition of a computer software franchise:
[1] This is an appeal from a reassessment, notice of which is dated August 27, 2009, for the 2008 taxation year (the reassessment), whereby the Canada Revenue Agency (the CRA) denied $85,875.33 in deductions that the appellant had claimed as capital cost allowance, eligible capital property and interest in respect of the purchase of a franchise authorizing him to market computer software.
Background
[2] Prospector Networks International Inc. (PIN) was a company based in Barbados. The appellant submits that PIN carried on a business that developed software for business markets in North America and elsewhere (“the software”).
[3] The software consists of the following:
(i) Solutions Prospector: a software package designed to help salespeople identify prospective clients;
(ii) Mail it Safe: software designed to secure and track e-mail to help lawyers, health care professionals, public agencies and others who regularly send and receive confidential information;
(iii) CashOnTime: a software package designed to help financial officers and collection agents track accounts receivable and payments.
[4] PIN granted licences (in 2003 and 2004) and franchises (from 2005 to 2008) that, according to the appellant, allowed the licensees and franchisees (collectively, “the franchisees”) to use and market the software and any products derived from the software.
[5] According to the appellant, PIN also offered to market the software on the franchisees’ behalf under contracts of mandate with PIN’s subsidiaries and associated businesses.
[6] The appellant is a software engineer.
[7] In 2007, the appellant bought a franchise and signed an agency agreement with a subsidiary of PIN. Under the terms of this mandate, the subsidiary undertook to operate the appellant’s franchise. I should immediately note that the respondent submits that this agency agreement is a sham. The appellant bought the franchise on the advice of his financial planner.
[8] The purchase price of the franchise in 2007 was $200,000: $10,000 for the franchise rights and $190,000 for the Solutions Prospector and Mail it Safe software. The appellant gave the franchisor a five-year full recourse promissory note bearing interest at a rate of 7.5% per annum. The respondent submits that this promissory note is a sham.
[9] The contracts signed in 2007 (i.e., the franchise agreement and the agency agreement) were replaced with new contracts in 2008. The cost of the franchise was raised by $30,000 in 2008. When he bought his franchise in 2008, the appellant gave the franchisor a ten-year full recourse promissory note bearing interest at the rate of 4% per annum. The respondent submits that the 2008 agency agreement and promissory note, too, are shams.
[10] Any dealings that the appellant had with PIN, the agent or any of PIN’s affiliated companies were at arm’s length.
The Crown alleged that there was never any business, that the agreements were shams and that the property acquired had no value:
[11] The respondent’s position: The CRA’s position is that the appellant bought the franchise solely for the purpose of obtaining tax deductions. This position is based on the following arguments.
(A) Argument I – There was no business
[12] First, the CRA submits that the deductions were not made for the purpose of gaining or producing income, because at no time during the relevant period did the appellant intend to carry on a business or in fact carry on a business, nor for that matter did Network Prospector or MarketX Services Inc. intend to carry on a business or in fact carry on a business on behalf of the appellant. See the Reply to the Notice of Appeal (the Reply) at subparagraph 26(l). See also the Reply at paragraphs 28, 29 and 36 to 38. See also the Reply at subparagraphs 25(o), (p) and (r), where the CRA alleges that the appellant never intended to draw income from his business.
(B) Argument II – The sham
[13] Second, the CRA submits that the full recourse promissory note and the agency agreement constituted [translation] “shams” (see the Reply at subparagraphs 26(l), (m), (p), (x), (y), (z), (aa) and (bb) and at paragraphs 32 and 34).
(C) Argument III – The unreasonable price
[14] Finally, the CRA submits that the [translation] “fair market value of the franchise and the rights attached to it was nil” (see the Reply, subparagraph 25(s)). The CRA further submits that [translation] “the fair market value of a franchise of Prospector International Networks Inc. was very low, if not nil” (see the Reply, subparagraph 26(cc)).
Issue
[15] The issue in this case is the following: Was the appellant carrying on a business in the year 2008? This issue also raises the following questions:
(a) Did the full recourse promissory note and the agency and management agreement constitute shams?
(b) Did the appellant pay a reasonable price for his franchise?
This was an extremely lengthy and hard fought case:
[20] The hearing lasted a total of 30 days, from January 23, 2012, to May 10, 2012. The appellant filed approximately 785 exhibits, totalling around 13,000 pages. The respondent filed 161 exhibits.
The Reasons for Judgment run to 283 paragraphs.
In what might be regarded as an uncommon outcome in this type of case the court accepted the taxpayer’s position and allowed his appeal:
[263] In conclusion, the evidence shows the following:
(i) The appellant acquired his franchise in order to earn a business income. It is clear that the appellant did not purchase the franchise as a hobby or other personal pursuit. Even if tax considerations were a prime motivation for his acquiring the franchise, they do not result in the appellant’s business venture not existing.
(ii) The intention of the appellant’s agent was to market the software on behalf of the appellant (and the other franchisees). The information given to the franchisees in updates and at franchisee meetings reveal that marketing efforts were made on their behalf.
(iii) The appellant (and the other franchisee witnesses) were under the obligation to pay the promissory note on the maturity date.
In my opinion, the Minister erred in concluding that, because of the commercial failure of PIN (and its affiliate companies) and of the franchises; and the testimonies of the appellant, Mr. Duhamel and the franchisee witnesses, which were ambiguous, confusing, incorrect and incomprehensible at times and, on occasion, even contradictory; the parties had devised an elaborate stratagem (to be implemented over several years) to give the impression that they were operating a business when the only activity they actually engaged in (still according to the Minister) was that of obtaining tax refunds.
…
[266] The present case is distinguishable from
Moloney in that the evidence has shown that, over the years, a subsidiary of PIN had marketed the software to prestigious, well-known Canadian clients in order to create a storefront, a strategy that was described as being common and key by expert Mr. Ouellet and which would have made it possible to do business with value-added resellers in the United States, in accordance with the company’s initial strategy. A great deal of money was invested in the development and marketing of the software, whereas in
Moloney, the transactions between the related companies were circular and simultaneous, meaning that no capital or credit was engaged by anyone in the so-called business.
[267] I also note that in
Moloney, Canadian sales were not considered, since the licensee’s territory was in the United States. In the case at bar, it has been shown that the Canadian sales were of particular interest to the franchisees.
[268] Moreover, contrary to
Moloney, the evidence in the case at bar showed the appellant’s intention to market, with the help of an agent, the software and to generate a profit from the software. As the evidence has shown, the appellant had two goals, one, to take advantage of tax deductions and to profit from the sale of software or the potential acquisition of the company.
[269] In
Moloney, the taxpayer also did not have to spend any of his own money and did not take a financial risk. In the case at bar, the appellant had already spent $52,000 of his own money, a sum that was not refundable under any condition, and agreed unconditionally to pay his full recourse promissory note on the maturity date.
[270] The present case can also be distinguished from
Bendall. In
Bendall, the taxpayer had participated in a similar operation as that in
Moloney, with the exception that the related companies did not engage in circular and simultaneous transactions. Justice Bonner came to the conclusion that the appellant’s agent was not carrying on a business, while, in the case at bar, a PIN subsidiary was working on building a storefront. Justice Bonner further stated in his judgment that it was impossible to conclude that the taxpayers seriously expected the agent to market the speed reading courses. In the case at bar, not only were market and sales efforts undertaken, but also Network told the franchisees that it had done a great deal to market the software. In addition, the decision of the taxpayer in
Bendall to make a new investment two years later, even though he had not achieved any sales, does not apply to the appellant who bought only one franchise.
[271] The appellant’s situation is also distinguishable from the situation in
Madell. In
Madell, the judge reached the conclusion that the taxpayer could not realize a profit from his investment because he was required to return the entire revenues the sales generated. In the case at bar, the agreements provided the appellant with royalties.
[272] Lastly, in
St-Laurent, the Court noted that if the facts had been different—if, for example, the appellant had attended meetings, consulted the business plan and examined the objectives—the outcome could have been different. Nothing in the evidence, apart from the taxpayer’s vague and unsubstantiated allegations, showed that the taxpayer was pursuing profit.
[273] For all of these reasons, the appeal is allowed, with costs.
Comment: It is not unlikely that this case will end up in the Federal Court of Appeal (and, possibly, the Supreme Court of Canada). On the face of it, however, it would seem that the Crown may have an uphill battle since the evidentiary record is so rich and the Tax Court’s decision appears to be replete with findings of fact arising out of that evidentiary record.
[1] 2013 TCC 139.