Riviera Hotel Co. Ltd. v. The Queen, 82 DTC 6045, [1982] CTC 30 (FCTD)

Addy, J:—The Minister of National Revenue disallowed the plaintiff’s refundable dividend tax credit on hand for the taxation year 1973 which was claimed at $94,366.90 allowing only the sum of $250.99. The plaintiff appeals against this determination.

In 1973, it had paid a taxable dividend of $100,000 which would entitle it to claim a refund of one-third of the dividend or $33,333. There was also an appeal against the similar reduction of claimed refundable tax dividend on hand for the years 1972 and 1974, but, as no dividend was paid during those years, the plaintiff agreed with the defendant’s submission at trial that the appeal should be quashed for those years on the grounds that there is no basis under the Act for an appeal unless such a refund entitlement exists.

As to 1973, there is no dispute as to the method of determining the amount of refund or as to the amount itself, but only as to whether or not the amount which the plaintiff claims to have correctly determined as “Canadian investment income” falls within the meaning of that expression as provided for in paragraph 129(4)(a) of the Act. This enactment at the time in issue read as follows:

(4) In subsection (3),

(a) “Canadian investment income” of a corporation for a taxation year means the amount, if any, by which the aggregate of

(i) the amount, if any, by which the aggregate of such of the corporation’s taxable capital gains for the year from dispositions of property as may reasonably be considered to be income from sources in Canada exceeds the aggregate of such of the corporation’s allowable capital losses for the year from dispositions of property as may reasonably be considered to be losses from sources in Canada,

(ii) all amounts each of which is the corporation’s income for the year (other than exempt income or any dividend the amount of which was deductible under section 112 from its income for the year) from a source in Canada that is a property, determined, for greater certainty, after deducting all outlays and expenses deductible in computing the corporation’s income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning the income from that property,

(iii) all amounts each of which is the corporation’s income for the year (other than exempt income) from a source in Canada that is a business other than an active business, determined, for greater certainty, after deducting all outlays and expenses deductible in computing the corporation’s income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning the income from that business,

exceeds the aggregate of amounts each of which is a loss of the corporation for the year from a source in Canada that is a property or business other than an active business; and

The plaintiff submits that the income derived from the sale of two of its properties, from the sale of some sand and also interest income in 1973 all constitute “Canadian investment income” as defined in section 129. It submits also that, with respect to the two sales of lands, the gains therefrom during that year were either capital gain from dispositions of property, alternatively, “income from a source in Canada” that is, a business other than an “active business”. It submits further that, in either case, the income must be included as part of Canadian investment income pursuant to subparagraphs 129(4)(a)(i) or (iii) respectively.

As to the sale of sand and the interest income from other sources which comprise term deposits and agreements for sale, it submits that they constitute Canadian investment income pursuant to subparagraph 129(4)(a)(ii), as income from a source in Canada that is property or, alternatively, under subparagraph 129(4)(a)(iii) from a source in Canada, that is, a business other than an active business.

The plaintiff corporation is privately held and was incorporated in the Province of Alberta in 1959. The objects of the plaintiff include all aspects of a hotel business and other businesses. One of the objects authorizes the company to “purchase, lease or otherwise acquire, sell or otherwise dispose of any lands necessary or convenient for the purposes of the Company”. There is, however, no specific provision authorizing the company to carry on the real estate business nor to engage in the servicing, subdivision or development of real estate.

Shortly after its incorporation the plaintiff acquired a site and built a hotel on it in the City of Edmonton. The Hotel was expanded thereafter by the addition of 100 rooms, a banquet room and other facilities. The hotel, known as the “Riviera Hotel”, was located at a prime intersection south of the City of Edmonton and en route to and from the International Airport. It developed into a very successful operation requiring about 130 to 140 full-time employees in the 1973 taxation year and offered all of the services normally associated with a large hotel such as dining room, cocktail lounge, beer parlour, conference facilities and the like. Some services, namely the lounge and restaurant service, were provided by an associated corporation, Michael’s Fine Foods Ltd, which was eventually merged with the plaintiff. Fifty per cent of the issued shares of the plaintiff are owned by Mr and Mrs Larry Superstein, both residents of the United States, and fifty per cent are owned by Max Superstein, resident of Canada. The day-to-day affairs of the plaintiff and financial matters concerning the Company were attended to by a manager and the shareholders did not take an active role in the day-to-day operations of the Company.

The following is a summary of the properties acquired and sold by the plaintiff since its incorporation to date of trial:

This appeal, in so far as the gains realized from 1973 sales of property are concerned, relates to the sale of some 9.2 acres of the Dykes property to Canadian Tire Corporation and to the sale of the Inglewood property (refer to items 1 and 2 above).

There was evidence to the effect that the original six acres of the Dykes property purchased in 1961 (item 1) and the Inglewood property purchased in 1962 (item 2), were acquired as potential hotel sites. No planning, however, was carried out and no steps whatsoever were taken to develop them as such. There appears to have been at the time of purchase a collateral intention regarding the possible future use of those lands for hotel purposes.

It appears that the only work done in conjunction with the Dykes property (item 1 above), from which the Canadian Tire parcel was taken, was the partitioning of the 20 acres sold to Green in 1967 and the replotting by the City of Edmonton of some 9 acres for a sale to it in 1971. The evidence also establishes that all the plaintiff did was to execute the required documents for the replot, the work having been carried out at the City’s expense. The Canadian Tire parcel was never offered for sale: its disposition resulted from an unsolicited offer.

The Inglewood property (item 2 above) was required by the City of Edmonton for highway expansion and was purchased by the City for that purpose. Had it not been sold, the City would, in all probability, have expropriated it.

Turning now to the other parcels of land, the Mullback property (item 4 above), some nine years after its acquisition, was subdivided and serviced prior to sale by the plaintiff, except for two five-acre commercial sites which were retained from the subdivision for development as a shopping centre and one of which sites was in fact thereafter sold. The lands, though subdivided, were sold in one transaction. I attach no significance, as I was invited to do by counsel for the plaintiff, to the fact that the actual work of subdividing and servicing was not done by the employees of the plaintiff but by other parties hired by it for that purpose. (See ESG Holdings Ltd v Her Majesty The Queen [1976] CTC 295; 76 DTC 6158.

The remaining properties which have been disposed of, were sold in their Original state without having been subdivided or improved. Except for the Henderson farm, the plaintiff merely paid the annual municipal taxes and the amounts due from time to time on the unpaid balances of purchase price. They were never listed with agents nor advertised for sale. As to the Henderson farm, it was rented by the plaintiff and soil was also sold from lands owned by the plaintiff. The Henderson property apparently comprised large quantities of commercially valuable lands.

With regard to the sale of lands, the plaintiff claims that the profit realized is either a capital gain (subparagraph 129(4)(a)(i) supra) or income from a non-active business (subparagraph 129(4)(a)(Hi) supra). The defendant, on the other hand, contends that it is income and not a capital gain and, further, that it is income from an “active business” referred to in the last- mentioned subsection and is, therefore, not to be considered as investment income under paragraph 129(4)(a).

The first question to be decided is whether the gain from the sale of lands is capital gain or income from a business, whether it be active or non-active.

The following facts are pertinent: the number of parcels purchased, the number of sales, the fact that the taxpayer reported in its 1972, 1973 and 1974 income tax returns that it had no capital gains and that no amended return was ever filed, the fact that the lands were described therein as part of an inventory of lands, and also the fact that in the letters patent the objects of the company included the purchase, rental and sale of lands. None of these factors are conclusive in themselves but they all negate the probability of a finding that the profits realized were in the nature of a capital gain. I attach particular weight in the present case to the fact that a contrary finding would contradict the specific declarations in the above-mentioned tax returns to the effect there were no capital gains realized during those years. It is true, as stated by my brother Walsh, J in MRT Investments Limited et al v Her Majesty The Queen, [1975] CTC 354; 75 DTC 5224, that what really must be considered is the true nature of the activities and not merely the particular designation which the taxpayer chooses to attach to them. However, where, as in the present case, the taxpayer, by attaching a particular designation, is in effect making a declaration against his interest and where it is most probably not a mere slip or inadvertent error but rather a statement made with full knowledge of the facts and prepared by a business or accounting expert, there exists at least an obligation on the taxpayer to explain how they occurred and why effect should not be given to the statements contained in the tax returns and the financial statements forming part thereof. This is particularly pertinent in the case at Bar as the above statements and others in these returns to which I shall refer later relate to the two main issues which must be decided and as the only witness called on behalf of the plaintiff was the president of a firm of financial management consultants which had been employed in that capacity by the plaintiff company for some twelve years (ie since 1969). Previous to that, the same person had been employed by the firm of auditors who were acting for the plaintiff.

The witness stated that the 1971, 1972 and 1973 returns were signed by one of the owners of the company and that the 1974 and 1975 returns were signed by himself on behalf of the plaintiff. Substantially the same statements regarding the nature of the entries and of the business were contained in all of the reports and the witness, under cross-examination, conceded that it was only recently that he had come to the conclusion that the description of the nature of the company’s business was inaccurate, notwithstanding his expertise in financial and business matters.

With regard to the buying, leasing and selling of lands being included in the objects of the company, it is of some importance to note the principle that, where the type of activity engaged in is that contemplated in the letters patent of either a public or a private company, although not conclusive evidence, this might well constitute prima facie evidence that, or at least, an indication that the profit derived from the activity is from the ordinary business of the company (see Anderson Logging Co. v The King, [1917-27] CTC 198; 52 DTC 1209, and The Queen & Metcalfe Carpark Ltd v MNR, [1973] CTC 810.

I find no difficulty in coming to the conclusion on the above evidence that the profit was not a capital gain but resulted from a source that was a business which might be either active or inactive. The latter point now remains to be determined.

Although active business income is now defined, there was no statutory definition of the expression in 1973. One must therefore look at the decided cases. The leading cases are the following: MRT Investments Limited et al v Her Majesty The Queen, supra; the appeal of this last-mentioned case cited as Her Majesty The Queen v Rockmore Investments Ltd, [1976] CTC 291; 76 DTC 1324; Her Majesty The Queen v Cadboro Bay Holdings Ltd, [1977] CTC 186; 77 DTC 5115; and King George Hotels Ltd v Her Majesty The Queen, [1981] CTC 490; 81 DTC 5362, which was an appeal from the Tax Review Board decision reported in [1979] CTC 2794. In the Morbane case, relying on the reaffirmation by the Court of Appeal in the King George Hotels case, supra, of the principles previously laid down by it in the Rockmore case, I concluded that the statement in the Cadboro case to the effect that any business activity whatsoever of a private corporation in Canada would constitute an “active business” is not to be applied as a general principle. The Court of Appeal has, on these two occasions, refused to lay down any general rule or legal standard as to what might constitute the required elements of an active business and has held that each case must be considered on its particular facts and that the trial judge must examine all of the circumstances pertaining to the extent of the activity existing at the relevant time.

In considering the summary of land purchases and sales, supra, in addition to the numbers, dates and nature of the transactions as well as the other real estate activities already commented upon, the following observations are worthy of note: the Canadian Tire property (item 1), or at least part of it, was held for approximately twelve years before being disposed of and the Inglewood property was held for some eleven years. Up until 1973, lands were being acquired. Thereafter, there were no acquisitions but the majority of the lands were disposed of. The Dykes property was acquired in three separate parcels at different times and was resold on three separate occasions in three different parcels.

There is no doubt that, by far, the bulk of the time was spent by the owners and their employees in carrying on the hotel business, and comparatively speaking, little time was spent in dealing with real estate. The witness called by the plaintiff estimated approximately two weeks per year for one man and that not more than two employees or officers of the plaintiff spent any time or effort in administering or dealing with the properties. There was, however, no direct evidence or any satisfactory evidence for that matter as to the actual amount of time spent by the local owner in administering the lands during 1973. In the final analysis, it appears that only approximately 2% of the administrative time and effort of the plaintiff’s officers and employees was required for that purpose. The comparison between the two undertakings of the plaintiff is, however, of no great significance, having regard to the small amount of time one would normally spend in operating a business of buying and selling large tracts of raw land, even if that business were a very active one, as compared to the time and effort required to carry Out an undertaking as labour-intensive as a hotel business. There was no separate office nor apparently any separate administrative installation for the land purchases and sales portions of the plaintiff’s business.

Although there is evidence that none of the properties were sold through an agent, or listed for sale, we find in the 1973 tax return an expense listed as $35,812 for commissions paid. The witness offered an explanation that this might well be a finder’s fee paid to the nephew of the owner but no firm evidence was produced. The statements and declarations found in the income tax returns are also relevant to the issue of whether the business was an active one. Furthermore, as I have previously commented, because of the probability that they were not made inadvertently but only made following due consideration and professional advice and constitute statements against interest, they are of particular importance in the case at Bar. On examining the income tax returns of the plaintiff, we find that for the years 1971, 1972 and 1973 the returns were signed by one Max Superstein, the Canadian owner of a 50% interest in the plaintiff Company and the nature of the plaintiff’s business during those years was described therein as “hotel and real estate”. The 1974 and 1975 returns were signed by the financial and business consultant for the plaintiff who testified at trial. In its 1974 return the same description was used as for the previous years and in its 1975 return, the business was described as “hotel and servicing land for resale”.

The lands in the returns of 1973 and 1974 were described as forming part of an “inventory of land”. This, of course, is evidence which might tend to establish that the taxpayer considered that it was holding the lands listed in its inventory for the express purpose of resale at all times. In 1973, the inventory amounted to some $1,244,000 and that inventory, together with the amounts due under agreement for sales accounts, amounted to approximately one-half of the total assets of the company. Both in 1973 and 1974 the revenue from other sources (the main one being land sales) exceeded the revenue from the hotel business.

Although 1973 is the only year under appeal and the Court must determine whether the sales of land were part of an active business carried on by the taxpayer during that year, sales and other activities subsequent thereto are nevertheless relevant in determining the overall intent of the taxpayer with regard to its land holdings.

On the whole of the evidence, I conclude that the income derived from the sale of lands in 1973 was from an active business source within the meaning of those words as used in subparagraph 129(4)(a)(iii). Since the income does not otherwise qualify as Canadian investment income under paragraph 129(4)(a), the amount must be taxable as ordinary income.

As to the sale of soil, the income for that activity was $1,853 in 1972 and $2,500 in 1973. The sales increased dramatically and by 1977 and 1978 the income had reached $200,000 net. I find no difficulty in characterizing the $2,500 net received from sale of soil for the Henderson property as revenue from an active business in 1973. The plaintiff has also failed to establish that the interest income for 1973 was not intrinsically linked to an active business. I cannot see how, under the circumstances of this case, either of these last two sources could qualify under subparagraph 129(4)(a)(ii) as income from a source that is property. This has not been established.

For the above reasons the action will be dismissed with costs.