Citation: 2011 TCC 345
Date: 20110708
Docket: 2010-696(IT)G
BETWEEN:
VON REALTY LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Pizzitelli J.
[1]
The
issue to be decided in this matter is whether the sale of the Appellant’s
interest in land resulting in a gain of $844,366 is taxable as a capital gain
or income from business in its 2005 taxation year.
[2]
The
parties filed a Joint Partial Statement of Facts which confirms the following
facts; namely, that the Appellant was a private corporation and a taxable
Canadian corporation incorporated in British Columbia in 1977 with a business
address in Aurora,
Ontario. Mr. Patrick Harrison
was the sole shareholder at the relevant times and the Appellant had a taxation
year ending January 31. On July 30, 1996, the Appellant purchased a 6.75%
interest in an existing Joint Venture with three other parties, the sole asset
of which was land located in Kelowna, British Columbia (the “Property”) and on
February 24, 2001, the Joint Venture was reorganized and the Appellant ended up
with a one‑third interest in the Joint Venture in conjunction with two of
the other original parties. On September 23, 2004, being within the Appellant’s
2005 taxation year, the Appellant sold its interest in the Property and
realized its gain above, the amount of which is not in dispute.
[3]
The
Appellant filed its 2005 tax return on the basis the disposition of its
interest in the Property was a capital gain, and hence, included one-half of
the above gain into income as a taxable capital gain, being $422,183. The
Minister of National Revenue (the “Minister”) initially assessed the Appellant
as filed on May 2, 2005, but reassessed by Notice of Reassessment on January
30, 2009, by including the full amount of the gain as business income and
denying the taxable capital gain, having characterized the Property as
inventory instead of capital property. The Appellant filed a Notice of
Objection on April 29, 2009, and the Minister issued a Notice of Confirmation
on February 17, 2010, confirming its reassessment, resulting in the appeal
before us.
[4]
From
the evidence at trial, it is also not disputed that Mr. Patrick Harrison
graduated as a Kinesiologist in about 1981 and then moved with his wife,
a physiotherapist, to Kelowna, British Columbia, where his wife found work. It was
in Kelowna that the Harrisons
became friends with William Von Niessen and his wife, a local real estate agent
and developer who assisted them with the purchase of their first home in 1982.
Although the Harrisons moved back to Ontario in 1986, they remained friends with the Von Niessens
and got together during March and Christmas breaks, with Mr. Harrison
testifying they returned to British Columbia at least twice a year.
[5]
Mr. Harrison
was interested in assisting people in wheelchairs and started a corporation
named Special Health Systems Ltd. that grew into a manufacturer and distributor
of wheelchairs and medical equipment which became quite successful. The Harrisons,
through their holding corporation 1155805 Ontario Inc., sold their business in
1995 for about $6.6 million pursuant to an agreement in which Mr. Harrison was
required to give a two-year non–competition covenant and remain as an employee
for one year. His employment ended about September 1996, after which he
testified he spent time with this children to make up for the time lost with
them while he had dedicated his efforts to growing his business, played tennis,
took scuba diving and flying lessons, joined the board of directors of a non–profit
organization named Community Home Assistance for Seniors or CHAFE, assisted a
friend with the start-up of his business by driving a delivery truck for him
without pay and looked for and bought a cottage by the spring of 1997. In 1997,
the Harrisons planned for and took their two children, then aged 11 and 12 out of
school in the fall for a two-month trip to Australia and other destinations. While in
Australia, Mrs. Harrison expressed an interest in alpacas and upon their return
to Ontario, Mr. Harrison spent his time researching alpacas, travelling to
Western Canada to see alpaca farms and learn about their lodging and feed and
returning to Ontario to supervise the building of barns and fences on his
parents-in–law’s farm in order to establish an alpacas farming business with
his wife which operated from 1998 to 2006. Mr. Harrison testified farming was
his main occupation during this period and that apart from the purchase of his
home and cottage, he never dealt with real estate of any kind other than his
involvement with the Property to be discussed and I accept his testimony as
forthright and credible in this regard.
[6]
With
respect to the Property, there is no dispute that the Property was originally
owned by a Mr. Barry Brocklebank, who sold his interest to a joint venture
which included himself, R127 Enterprises Ltd. (“R127”), a corporation owned by
Gebhard Wager, and Pegasus Enterprises Ltd. (“Pegasus”), a corporation
owned by William Von Niessen, all of whom entered into a Joint Venture
Agreement dated August 17, 1990, to develop and sell the subdivided lots (the
“Joint Venture Agreement”). The above parties had a respective 50%, 25% and 25%
interest in the Joint Venture.
[7]
In
or about 1996, Mr. Harrison became aware from discussions with his friend,
William Von Niessen, that Mr. Von Niessen was having some cash flow
difficulties with some of his development projects including the Joint Venture
and Mr. Von Niessen inquired as to whether Mr. Harrison could loan him some
funds. After some time and repeated requests for a loan by Mr. Von Niessen, Mr.
Harrison agreed to loan his friend $250,000 for a return of $50,000, resulting
in a 25% net return. After seeking legal advice, it was agreed that Mr. Harrison would use a corporate
vehicle to loan Mr. Von Niessen’s company, Pegasus, the money and take
security. Since the Joint Venture Agreement prohibited any Joint Venture member
from encumbering the Property for its own loans, the structure used was that
Mr. Harrison purchased an inactive corporation owned by Mr. Von Niessen, which
was the Appellant, for the sum of $1.00 and flowed money from his corporation
1155805 Ontario Inc., which was flush with cash from the previous sale of
Special Health Systems Ltd., to the Appellant in order to fund the loan to
Pegasus, (later also used to make future loans or investments in the Joint
Venture). There is evidence that Mr. Harrison had to file nil tax return
filings to bring the Appellant up to date and I accept that the Appellant was
an inactive corporation at the time its shares were purchased by Mr. Harrison
for $1.00. The loans from 1155805 Ontario Inc. above and in turn the
Appellant’s subsequent loans to and investments in the Joint Venture were also
recorded in the financial statements of the Appellant. Pegasus, with the consent
of the other Joint Venture members, entered into an agreement with the
Appellant dated July 30, 1996, pursuant to which Pegasus transferred a 6.75%
interest in the Joint Venture to the Appellant under terms which included the
right to buy the interest back for $300,000 in Pegasus’ favour within a one‑year
period of time (the “6.75% Agreement”) as well as Pegasus retaining the right to
vote the entire 25% interest including the Appellant’s 6.75% and other terms
which will prove relevant in this matter and upon which the Appellant relies
upon to evidence its position that this acquisition of Property was as security
for the loan and not to engage in the business of the Joint Venture.
[8]
Mr. Harrison
testified, and his testimony was unchallenged by the Respondent, that from the
time of making the initial investment above, the day‑to‑day affairs
of the Joint Venture were run by Mr. Von Niessen and he had no involvement in
the Joint Venture other than to stay in touch with Mr. Von Niessen
once or twice a month, no more than he would have contacted Mr. Harrison
as a friend, according to Mr. Von Niessen’s testimony, and it was during such
conversations that Mr. Harrison became aware that things were not going well
and the City of Kelowna was only prepared to approve 36 lots of the 120 requested by the Joint
Venture. Mr.Harrison had no dealings with the City, nor even at this point had
met Mr. Brocklebank, the 50% owner. He did admit to having met Mr. Wager before
as he had lived next door to the Wagers at one point in Kelowna prior to his
involvement.
[9]
It
appears things continued to go poorly for the Joint Venture and that Mr. Brocklebank
was actively trying to sell his 50% interest to the City, which created
problems for the Joint Venture which had been faced with increasing demands
from the City for more parkland dedication from the Property. Mr. Brocklebank
also received a third party offer for his interest from a party who had not
even contacted the other Joint Venture members, prompting the other members to
become concerned and negotiate with Mr. Brocklebank for the sale of his
interest to them. As the other members had no available funds to effect the
purchase of Mr. Brocklebank’s interest, Mr. Harrison, who had been informed of
the difficulties, agreed to be the financier and fund the purchase price of Mr.
Brocklebank’s interest for $600,000 plus disbursements not to exceed $20,000.
[10]
Pursuant
to an agreement dated February 24, 2001, made between R127, Pegasus, the
Appellant and the three individual principals of these corporations (the “Second
Purchase Agreement”), the Appellant agreed to provide funds for the purchase of
Mr. Brocklebank’s 50% interest, which was to be paid back from mortgage
financing by the Joint Venture and afterwards the Appellant was to pay funds to
Pegasus and R127 totalling $295,000 in order to purchase a further interest in
the Joint Venture so as to end up, with the other two, as equal Joint Venture
members .The evidence is that the Joint Venture did not borrow against the
Property to repay the Appellant the funds it advanced to purchase Mr. Brocklebank’s
interest but that the Appellant still acquired the one-third interest. The
Second Purchase Agreement also contained terms obliging each of the three
members to carry on as equal partners and use the Property to secure the
financing needs of the Joint Venture unlike the earlier Joint Venture
Agreement. The parties also agreed to meet and agree on a revision to the
Joint Venture Agreement which was never done.
[11]
After
retaining municipal counsel to assist them in dealing with the City and being
unsuccessful, and having encountered difficulties with Mr. Wager who was
refusing to approve loan packages sought by the Joint Venture and who became
uncooperative, Pegasus and the Appellant finally agreed to sell their total two‑thirds’
interest to R127, Mr. Wager’s company, for $3.7 Million, resulting in the
disposition of the Appellant’s interest giving rise to this appeal.
Position of the Parties
[12]
The
Appellant takes the position that the disposition of his interest in the
Property should result in a capital gain as it is a capital property and the
Appellant’s interest in the Joint Venture was not an adventure or concern in
the nature of trade, and hence the Appellant was not in the business of property
development and sale. The Appellant’s main argument in support of its position
is that the Appellant acquired an interest in the Joint Venture initially as
security for a loan and then increased its interest in the Joint Venture to
protect its investment and never had any intention to be in the business of
property development via the Joint Venture nor had ever been in such business
either before or after its involvement in the Joint Venture. The Respondent
argues the opposite; that the Property is inventory and hence its disposition
by the Appellant gives rise to a full income inclusion under the Income Tax
Act of Canada (the “Act”) and that the Appellant had the
necessary intention to be in the business of property development, or at least
had the intention to sell the property for a profit if the development never
proceeded, simply because that was the stated purpose of the Joint Venture when
it agreed to become a member.
The Law
[13]
The
relevant provisions of the Act are set out below:
3 The
income of a taxpayer for a taxation year for the purposes of this Part is the
taxpayer’s income for the year determined by the following rules:
(a) determine the total of all
amounts each of which is the taxpayer’s income for the year (other than a
taxable capital gain from the disposition of a property) from a source inside
or outside Canada, including, without restricting the generality of the
foregoing, the taxpayer’s income for the year from each office, employment,
business and property,
(b) determine the amount, if
any, by which
(i) the
total of
(A) all
of the taxpayer’s taxable capital gains for the year from dispositions of
property other than listed personal property, and
(B) the
taxpayer’s taxable net gain for the year from dispositions of listed personal
property,
exceeds
(ii)
the amount, if any,
by which the taxpayer’s allowable capital losses for the year from dispositions
of property other than listed personal property exceed the taxpayer’s allowable
business investment losses for the year,
…
9(1) Subject to this Part, a taxpayer’s income for a taxation
year from a business or property is the taxpayer’s profit from that business or
property for the year.
…
38 For the purposes of this Act,
(a) subject to paragraphs (a.1) to (a.3),
a taxpayer’s taxable capital gain for a taxation year from the disposition of
any property is ½ of the taxpayer’s capital gain for the year from the
disposition of the property;
…
39(1) For the purposes of this Act,
(a) a taxpayer’s
capital gain for a taxation year from the disposition of any property is the
taxpayer’s gain for the year determined under this subdivision (to the extent
of the amount thereof that would not, if section 3 were read without reference
to the expression “other than a taxable capital gain from the disposition of a
property” in paragraph 3(a) and without reference to paragraph 3(b),
be included in computing the taxpayer’s income for the year or any other
taxation year) from the disposition of any property of the taxpayer other than
(i) eligible capital
property,
(i.1) an
object that the Canadian Cultural Property Export Review Board has determined
meets the criteria set out in paragraphs 29(3)(b) and (c) of the Cultural
Property Export and Import Act and that has been disposed of,
(A) in
the case of a gift to which subsection 118.1(5) applies, within the period
ending 36 months after the death of the taxpayer or, where written application
therefor has been made to the Minister by the taxpayer’s legal representative
within that period, within such longer period as the Minister considers
reasonable in the circumstances, and
(B) in any
other case, at any time,
to an institution or a public
authority in Canada that was, at the time of the disposition, designated under
subsection 32(2) of that Act either generally or for a specified purpose
related to that object,
(ii)
a Canadian resource
property,
(ii.1) a foreign resource property,
(ii.2) a property if the
disposition is a disposition to which subsection 142.4(4) or (5) or 142.5(1)
applies,
(iii) an insurance
policy, including a life insurance policy, except for that part of a life
insurance policy in respect of which a policyholder is deemed by paragraph
138.1(1)(e) to have an interest in a related segregated fund trust,
(iv) a timber resource property; or
(v) an interest of a beneficiary under a
qualifying environmental trust;
…
248(1) In this Act,
…
“business” includes a profession, calling, trade,
manufacture or undertaking of any kind whatever and, except for the purposes of
paragraph 18(2)(c),
section 54.2, subsection 95(1) and paragraph 110.6(14)(f), an adventure or concern in the
nature of trade but does not include an office or employment; …
Analysis
[14]
The
parties argued this matter primarily on the basis of whether or not the
acquisitions by the Appellant of its interest in the Joint Venture and hence
its Property constituted “an adventure or concern in the nature of trade” as
included in the definition of “business” in subsection 248(1) of the Act
above. There was no argument brought forth by either party that if the
transactions in question did not fall within the definition of a business that
they would not automatically be treated as capital property and in fact both
parties relied upon the Supreme Court of Canada decision in Friesen v.
Canada, [1995] 3 S.C.R. 103, which clearly acknowledges the dichotomy in
the Act between capital gains treatment and business income treatment of
property further reflected in the definitions of business, inventory and
capital gains above. In paragraph 28 of Friesen, Major J., writing
for the majority, stated:
28 … The Act defines two types of
property, one of which applies to each of these sources of revenue. Capital
property (as defined in s. 54(b)) creates a capital gain or loss upon
disposition. Inventory is property the cost or value of which is relevant to
the computation of business income. The Act thus creates a simple system which
recognizes only two broad categories of property. …
[15]
Although
“an adventure or concern in the nature of trade” is not defined in the Act,
established jurisprudence abounds on the subject and the leading case of Happy
Valley Farms Ltd. v. Her Majesty the Queen, 86 DTC 6421 (F.C.T.D.), which
adopted many of the tests set out in the earlier case of Minister of
National Revenue v. Taylor, 56 DTC 1125 (Exch. Ct.), spoke to the several
tests used by the Courts in determining the issue. Rouleau J. listed such tests
in paragraph 14 of Happy Valley Farms:
14 Several tests, many of them similar to those pronounced by the
Court in the Taylor case, have been used by the courts
in determining whether a gain is of an income or capital nature. These include:
1. The nature of the
property sold. Although virtually any form of property may be acquired to
be dealt in, those forms of property, such as manufactured articles, which are
generally the subject of trading only are rarely the subject of investment.
Property which does not yield to its owner an income or personal enjoyment
simply by virtue of its ownership is more likely to have been acquired for the
purpose of sale than property that does.
2. The length of period
of ownership. Generally, property meant to be dealt in is realized within a
short time after acquisition. Nevertheless, there are many exceptions to this
general rule.
3. The frequency or
number of other similar transactions by the taxpayer. If the same sort of
property has been sold in succession over a period of years or there are
several sales at about the same date, a presumption arises that there has been
dealing in respect of the property.
4. Work expended on or in
connection with the property realized. If effort is put into bringing the
property into a more marketable condition during the ownership of the taxpayer
or if special efforts are made to find or attract purchasers (such as the
opening of an office or advertising) there is some evidence of dealing in the
property.
5. The circumstances that
were responsible for the sale of the property. There may exist some
explanation, such as a sudden emergency or an opportunity calling for ready
money, that will preclude a finding that the plan of dealing in the property
was what caused the original purchase.
6. Motive. The motive of the
taxpayer is never irrelevant in any of these cases. The intention at the time
of acquiring an asset as inferred from surrounding circumstances and direct
evidence is one of the most important elements in determining whether a gain is
of a capital or income nature.
[16]
Counsel
for the Appellant argued that there were additional factors to consider from
her reading of the authorities and Interpretation Bulletin IT-218R and it is
clear that the decision in Happy Valley Farms and following decisions
require each case to be determined on its own facts and a consideration of all
the relevant facts and circumstances with no single factor necessarily being
determinative of the issue. Some of the factors she alluded to can be considered
in the broader context of the several factors of Happy Valley Farms and
others in addition thereto and reference will be made to those relevant factors
below. There is no doubt, however, that the intention of the taxpayer at the
time of acquiring an asset is the most important criteria to examine as Rouleau
J. confirmed in paragraph 15 of Happy Valley Farms:
15 While all of the above factors
have been considered by the courts, it is the last one, the question of motive
or intention which has been most developed. That, in addition to consideration
of the taxpayer’s whole course of conduct while in possession of the asset, is
what in the end generally influences the finding of the court.
[17]
Even
if a taxpayer has as his main intention the acquisition of an investment
property to produce investment income, a gain may be taxed as income under the
“secondary intention” test. In paragraph 16 of Happy Valley Farms,
Rouleau J. described this test as follows:
16 … This has meant, in some
cases, that even where it could be established that a taxpayer’s main intention
was investment, a gain on the sale of the asset would be held taxable as
income if the court believed that, at the time of acquisition, the taxpayer had
in mind the possibility of selling the asset if his investment project did not,
for whatever reason, materialize. …
[18]
The
parties in fact addressed the majority of their arguments to the intention
factor. It should be noted that while the Appellant spoke of the intention of
Patrick Harrison, the sole shareholder of the Appellant as being reflective of
the corporate Appellant’s intention, the Respondent argued that the intention
of Mr. Harrison is not the appropriate intention to consider but rather the
corporate Appellant’s intention is the one to consider and that it must be
inferred from the intention of the Joint Venture which it joined.
[19]
While
the intention of the Joint Venture is certainly one to consider as one of the
factors or circumstances in this matter, I must agree with counsel for the
Appellant that the Respondent is simply not correct in law to suggest the
intention of a corporate taxpayer’s management is not reflective of its
intention. In Bosa Bros. Construction Ltd. v. R., 96 DTC 6193
(F.C.T.D.), Nadon J., as he was then, restated the principles on relevant
intention with reference to the purchase of real estate investments, by
adopting those stated by Joyal J. in Marsted Holdings Ltd. et al. v. The
Queen, 86 DTC 6200 (F.C.T.D.) who in turn quoted Christie A.C.J. of the Tax
Court of Canada in Leonard Reeves Incorporated v. Minister of National
Revenue, 85 DTC 419 at 421 that:
… If the appellant is a corporation, the
relevant intentions to be attributed to it are those which the natural person
by whom it was managed and controlled had for it: …
[20]
The
intention of the Appellant’s sole President and shareholder, Mr. Patrick
Harrison, is the relevant intention to impute to the Appellant, just as would
be the intention of the Board of Directors, shareholders, controlling minds or
other persons found to be in control of a corporation for the purposes of the Act.
It is trite to say that it is only through the decisions and actions of such persons
that a corporate entity can express itself.
[21]
In
addressing the intention of the Appellant, the Court must have regard to the
time at which such intention must be scrutinized. In the sixth factor listed
above by Rouleau J. in Happy Valley Farms, the time was specifically
determined to be the time at which the asset was acquired. In the matter at
hand, there are in fact two acquisition dates; the first being July 30, 1996,
when the Appellant acquired a 6.75 % interest in the Joint Venture pursuant to
the 6.75% Agreement and February 24, 2001, being the time the Appellant
acquired a further interest in the Joint Venture pursuant to the Second
Purchase Agreement so as to raise his interest to one-third. In my view, each
acquisition must be analysed using the factors to determine whether such
acquisition constituted the acquisition of a capital property or inventory for
carrying on business, as intentions may indeed change between acquisitions of
interests in similar properties.
[22]
Since
the bulk of the parties’ arguments centered on the intention of the Appellant,
I propose to analyse the intention of the parties with respect to each
acquisition date above and will consider other factors in determining whether
the acquisition was an adventure or concern in the nature of trade while doing
so.
1. 6.75% Interest
[23]
There
is no doubt in my mind that the Appellant did not intend to acquire its initial
interest in the Property other than as security for a loan arrangement. The
evidence of the Appellant, corroborated by Mr. Von Niessen, clearly indicates
that Mr.Von Niessen approached Mr. Harrison for a loan and later repeated his
requests for same when not initially successful. Mr. Harrison obtained the
benefit of legal advice and it was decided that such a loan to a friend was
only wise if adequate security was given. As Mr. Von Niessen did not have the
ability to grant personal security and was prohibited by the terms of the Joint Venture
Agreement from encumbering his interest in the Joint Venture for personal
reasons without the unanimous consent of the other members, then the only
security available was the transfer of an interest in the Joint Venture held by
Mr. Von Niessen’s corporation, Pegasus. Mr. Harrison’s attorneys created a plan
whereby Mr. Harrison would acquire a British Columbia corporation to undertake the
transaction, which ended in the acquisition of the inactive Appellant by Mr. Harrison
to be used for such purpose, and the sum of $250,000 was advanced to Pegasus
who in turn transferred a 6.75% interest in the Joint Venture to the
Appellant.
[24]
The
Respondent argues that the documents submitted as evidence are the main
indicators of the Appellant’s intentions, and in this regard, I agree they are
certainly important. In my view, the 6.75% Agreement supports the position of
the Appellant. Notwithstanding that paragraph 3 of such agreement states that
both the Appellant and Mr. Harrison acknowledge having read the Joint Venture
Agreement and agree to be bound by it, which is a requirement of the
Joint Venture Agreement as a condition to the transfer of any interest,
the balance of such 6.75% Agreement clearly evidences the intention of all the
parties, including all the other members of the Joint Venture Agreement, that
the Appellant’s ownership in the Joint Venture was intended to be short lived.
Paragraph 2(c) of the agreement grants Pegasus the right to repurchase the
interest within one year at the Agreed Price of $300,000 representing the
initial $250,000 intended to be loaned and the agreed upon return of $50,000.
The Appellant itself, and not Pegasus, had the option of extending the
time for such repurchase option by one year pursuant to paragraph 2(d) of the
agreement, further evidencing its intention to make every attempt to not end up
with the property. It should be noted that paragraph 4 of the Agreement
contained the consent of the remaining Joint Venture members to the repurchase
by Pegasus of such interest without any further consent or approval and thus
waiving any right of refusal they otherwise had under the Joint Venture
Agreement.
[25]
Moreover,
I agree with the Appellant that the agreement was designed to keep the
Appellant out of the obligations and management of the Joint Venture as
Paragraph 2(a) exonerates the Appellant from any obligations to pay any
mortgage obligations pursuant to the existing mortgage registered against title
to the Property and paragraph 2(e) give Pegasus retention of voting rights over
the interest acquired.
[26]
The
terms of the 6.75% Agreement fully support the argument that the transaction
was designed to mimic a loan transaction giving security. However, other
factors support this position. Neither the Appellant, having been a dormant
corporation at the time of acquisition by Mr. Harrison, nor Mr. Harrison were
engaged in the business of real estate development. As is clear from the facts
above, Mr. Harrison was a Kinesiologist who went into the business of selling
wheelchairs and medical equipment followed by alpaca farming. Neither his
history nor education tie him to real estate development and the evidence is
clear that apart from his purchases of his homes and cottage he had not engaged
in the purchase of any other real estate interests either before or since the
acquisition of his interests in the Joint Venture. There are simply no other
similar transactions conducted by the Appellant or its principal.
[27]
It
is also clear that neither the Appellant nor its principal, Mr. Harrison,
expended any work in connection with the Property or Joint Venture until the
Appellant acquired its second interest. The evidence is that Mr. Harrison kept
in informal contact with Mr. Von Niessen as a friend and had no involvement in
the management of the Joint Venture nor in any decisions affecting it. The
evidence is that Mr. Harrison had not even met the main Joint Venture member,
Mr. Brocklebank, at the time of its acquisition or for some time after
until the time of acquiring a greater interest due to the sale of Mr.
Brocklebank’s 50% interest. In fact, Mr. Harrison was living in Ontario and busy with other
interests, including spending time with his children, travelling, taking scuba diving
and flying lessons and starting an alpaca farm, rather than be concerned with
the Joint Venture. All of these facts suggest he had no intention of being in
the business of real estate.
[28]
While
I agree with the Respondent that the nature of the property, a 60‑acre
undeveloped piece of vacant land, was not in its state usable for producing
investment income and that there was never any intention to develop it for such
purposes, and that the clear intention of the Joint Venture was to develop and
sell residential building lots, I do not agree this factor would be conclusive
as to support the Respondent’s position with respect to the initial
acquisition. The intention of the Appellant clearly trumps such
consideration as the Appellant in my view did not intend to have any ongoing
ownership of the Property, seeing it only as security for its loan made to
Pegasus. In Orzeck v. Minister of National Revenue, [1987] 2 C.T.C.
2318, a case relied upon by the Respondent, Tremblay J. of the Tax Court stated
at paragraph 37:
The principle criterion is the taxpayer’s
intention. In fact, all the other criteria serve only to aid in determining the
taxpayer’s intention.
[29]
The
intent of the Appellant was not to participate in the Joint Venture and this is
borne out by the reality of the circumstances surrounding his involvement in
the initial acquisition. His actions in not only playing a passive role but
effectively playing no real role at all in the ongoing decisions and management
of the Joint Venture, coupled by his lack of background, education or
experience in such business and the terms of the Agreement effectively
shielding him from such involvement or obligations support the oral evidence of
the Appellant’s principal and his credibility. While I agree with the
Respondent’s point that the case of Regal Heights Ltd. v. Minister of
National Revenue, [1960] S.C.R. 902, made it clear that “what actually
happened is more important than idealistic intentions which are not carried out,”
I do not agree with the Respondent’s position that what actually happened is
that the Appellant knowingly joined a Joint Venture engaged in the business of
real estate for the purpose of furthering that goal. As I said, what
actually happened is that the Property interest acquired was intended only as
security, a capital result.
[30]
In Van
Dongen v. R., 90 DTC 6633 (F.C.T.D.) relied upon by the Appellant, the
Federal Court - Trial Division denied the taxpayer a write down of inventory as
a deduction against income on the basis that the lands acquired by the taxpayer
from his sons were acquired to protect an investment in a loan made to the son
who could not repay the loan when due. The amount of the loan and interest due
exceeded the value of the lands acquired and the taxpayer had sought to write
off the difference. The Court denied his expense on the grounds the properties
acquired were not inventory and at paragraph 38, Cullen J. stated:
38 … It was obvious from the
plaintiff’s own evidence and that of his son Casey that there was no intention
by the plaintiff to resell the properties or otherwise deal with them in a
business-like manner. The properties held by the plaintiff were held to secure
a loan, and if the plaintiff got his money back at ten percent interest the
paper title would revert to the son or to a purchaser, and Casey would keep any
profit.
[31]
In
the case at hand, the 6.75% Agreement evidences the same intention by the
Appellant to give back title once he was repaid the initial $250,000 plus
agreed return of $50,000 for a total of $300,000 and contemplated it would
occur within a year or two. The evidence of both the Appellant and Mr. Von
Niessen support that view and the conduct of the Appellant in not getting
involved in the Joint Venture or voting or paying the outstanding Joint Venture
mortgage support the fact the Appellant had no intention and did not deal with
the Property interest in a business-like manner and accordingly was not engaged
in an adventure or concern in the nature of trade with respect to this first
acquisition of Property.
2. Acquisition of Balance of
Property Interest
[32]
On
February 24, 2001, the Appellant acquired a further interest in the Property so
as to give it a one-third interest in the Joint Venture. The circumstances
surrounding the purchase described above relate to the purchase of an existing
Joint Venture member’s 50% interest; namely that of one Mr. Brocklebank to
avoid him selling to a third party relatively unknown to the remaining members.
The interest was purchased pursuant to the Second Purchase Agreement above
mentioned.
[33]
The
Appellant argues the purchase was necessary to protect the Appellant’s existing
investment in the Joint Venture and that the Appellant had no other choice but to
make such further investment as it was the only one of the remaining Joint
Venture members that had the financial means to do so and by not doing so its
interest in the Property would be at risk since a new 50% owner, relatively
unknown to them, would make the ongoing Joint Venture plans uncertain.
[34]
The
Appellant relies on the cases of Farmer Construction Ltd. v. R., 84 DTC
6331 (F.C.T.D.) and R. v. Greenington Group Ltd., 79 DTC 5026 (F.C.T.D.),
as supporting its argument that property acquired to protect a loan or
investment did not result in creating an adventure or concern in the nature of
a trade. In Farmer Construction, an unpaid contractor purchased a single
use building it was hired to construct. The Court found in that case that, due
to the nature of the property being a single use building and the difficulties
in selling or renting it out, that the intention of the taxpayer was to
complete and operate the building until a buyer came along and that since possibility
of resale at that time was not feasible, the taxpayer was acquiring the asset to
reduce or possibly eliminate a substantial loss. In Greenington Group, a
general contractor involved in institutional construction had surplus funds and
had loaned funds to a developer for interim financing to enable the
construction of a golf course, swimming pool and parking lot on property owned
by the borrower and took mortgage security on the property. When the loan
defaulted and the borrower fought foreclosure actions the taxpayer arranged to
buy the property. The Court held that the intention of the taxpayer was not to
make a profit but to cut his losses and recover amounts due on the loan and
interest if possible and had no reason to expect to be able to sell the property
at a profit at that point. Accordingly, when an unsolicited offer presented
itself, he sold resulting in an unexpected profit.
[35]
In
both the above cases, the Court found that the taxpayer was protecting his
initial investment, whether it was unpaid contract amounts as in Farmer Construction
or unpaid loans as in Greenington Group consistent with the argument of
the Appellant that it was protecting its initial investment. However, in both
those cases, the Courts also found that at the time of acquisition the facts
and circumstances suggested the intention of both parties was to cut their
losses or recoup their initial investment and not make a profit as the
feasibility for doing so did not reasonably exist. In my view, the case at hand
differs from the above two cases in that I find the evidence supports the
position of the Respondent that the Appellant’s intention was to make a profit
and not just protect its investment or reduce its loss.
[36]
The
Second Purchase Agreement suggests the Appellant had wholeheartedly become an
equal partner in the venture. In the first paragraph of that document, the
parties agreed to restructure the Joint Venture so the parties had equal one-third
interests and states:
… to this day forward carry on as equal
partners, accepting that decisions required by the venture must be unanimous.
As equal partners, they agree to share the liability of financing the
development of the Joint Venture Property using the Joint Venture Property as
security, in contrast to the existing Joint Venture Agreement.
[37]
This
provision demonstrates that the Appellant was abandoning his earlier role of
not being involved in management and decision-making in favour of taking a
fully active role and the testimony of Mr. Von Niessen confirms that in fact
the Appellant was involved in all decisions and kept appraised of all matters
affecting the development. Unlike with his first purchase of interest,
the Appellant had learned a little from the experience and felt he had
something to contribute and his view were solicited by the other members or
sought by right of his one-third interest.
[38]
The
Appellant’s main argument is that the Appellant had no choice but to be
involved as it was the only one of the group with the means to fund the buyout
of Mr. Brocklebank’s 50% interest and thus avoid the imposition of an unknown
new member on them. The difficulty I have with this argument is that if the
Appellant was in such position and had, as it testified earlier, considered the
project to belong to the other members, why did it not just loan the monies to
the remaining members or joint venture and take back mortgage security on the
Joint Venture property for the loan and even the initial loan. It seems to
me the Appellant had other options to protect and even enhance its security but
did not explain why no such other options were considered.
[39]
Just
as confusing to me is why, if the Appellant was the only one with funds, did it
not acquire Mr. Brocklebank’s entire 50% interest which together with its 6.75%
existing interest would have given him control over the Joint Venture if
the protection of his interest was the intended goal? Instead, the Appellant
enters into an agreement whereby the parties agree to later secure financing to
not only pay him out but to cover the costs of the planned activities and any
associated carrying costs, suggesting he was agreeing to allow the Property to
fund the ongoing requirements of the Joint Venture. If the intention of the
Appellant was only to protect his investment, it seems inconsistent to advance
a further amount in excess of $600,000, being over twice his initial
investment, without taking hard security when he had the chance and agreeing to
allowing all the Property to stand as security to fund the further requirements
of the Joint Venture. The second last bullet of the Second Purchase Agreement
clearly states that :
The new financing will pay out the loan
from Von Realty to conclude the purchase of Brocklebank shares and leave a
residual working fund for the future activities toward approvals for
development.
[40]
Clearly,
the Appellant was not only interested in recovering its investment, it was
interested in the completion of the development and obviously the profit from
it.
[41]
Furthermore,
the Second Purchase Agreement has the Appellant agreeing to pay the sum of
$250,500 to R127 and $45,000 to Pegasus after all of the activities listed had
been completed, including amendment to the Joint Venture Agreement and the
securing of new financing for the Joint Venture to repay his $600,000 plus loan
and provide working capital. The Appellant thus committed to payment of another
$295,500 to the remaining members of the Joint Venture as part of his
acquisition of his one-third interest. Considering the third party offer
submitted to Mr. Brocklebank was for $550,000 plus a percentage of ultimate
profit from the Joint Venture and the parties negotiated to purchase his
interest for a clean $600,000, it stands to reason that if a 50% interest was
worth $600,000 to an arm’s length party then the whole Joint Venture interest
must have been worth about $1,200,000. The only logical reason a person would
agree to pay $295,500 for an additional 26.68% of the Joint Venture interest,
which is only a 5% discount based on a fair value of $1,200,000 for the whole,
is that the Appellant expected the Joint Venture would make a profit and it
did; a significant one on final sale of the property. The fact the Second
Purchase Agreement mentions no interest rate for the $620,000 loan portion also
suggests the Appellant was expecting to obtain a return on Joint Venture
profits rather than on the loan.
[42]
All
of the above points in my view to the Appellant having changed its intention
from the initial loan secured by an interest in the Property when it first
acquired a 6.75% interest to investing and committing as a full-fledged partner
in the Joint Venture whose sole purpose was to develop and sell vacant land as
building lots - land that had no real capacity to earn investment income.
While the Joint Venture Agreement refers to the sale of gravel and soil
from the lands, the evidence of Mr. Niessen was that this was only a
possibility and a standard provision in an agreement and that soil and gravel
must sometimes be purchased instead of sold in preparing the land so I
attribute no real intention to earn investment income from the project. In any
event, no such sale could occur until the parties cleared the land as part of
its development activities so any such sales would only be incidental to the
main purpose of earning business income. As I said earlier, the nature of the
property itself would generally suggest it could only be developed for profit
as it had no existing means of producing investment income and there were no
plans for it to do so.
[43]
There
is also evidence that, after the Appellant acquired his further interest,
further work was expended on the Property, not only by the greater involvement
by the Appellant’s principal, Mr. Harrison, but by the fact the members
retained a municipal lawyer to attempt to deal with the City of Kelowna’s
demands for the project in an attempt to further it along, albeit
unsuccessfully. This fact demonstrates the Appellant’s involvement in the
Joint Venture and its intention to see the project through as opposed to
encouraging a quick sale to recover or minimize the risk of loss.
[44]
Frankly,
the other factors pointed to by the Appellant’s counsel such as the length of
ownership, up to eight years for the first acquisition and three years for the
second as well as suggestion that its cash infusions into the Joint Venture
instead of financing and leveraging its investment like most developers would
allegedly do, are not in my view conclusive either way. The fact the Appellant
had the means to make a cash investment suggestive of making a capital
investment, is not more convincing in these circumstances than accepting that the
only reason it was asked to make an investment in the first place and later
given an equal position in the Joint Venture was because it had the financial
means to do so. As for the circumstances surrounding the ultimate sale of the
property, although the difficulties with R127 and Mr. Wager that eventually led
to the sale by the Appellant and Pegasus to R127 may not have been anticipated,
the evidence is that the parties negotiated the sale as part of a strategy
to either sell their interests or buy the others and I can give no weight to
the circumstances of the sale in deciding the nature of the Property.
Conclusion
[45]
For
the above reasons, I find that the initial 6.75% of the Appellant’s interest in
the Joint Venture was the acquisition of a capital property, and accordingly, I
find that 20.25% of the gain shall be treated as a capital gain while the
balance of the gain shall be treated as business income and direct the Minister
of National Revenue to reassess the taxation of the gain in such manner.
The Respondent shall be entitled to normal party and party costs in this
matter in accordance with the Tariff.
Signed at Ottawa, Canada, this 8th day of July 2011.
“F.J. Pizzitelli”
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