Hughes v. The Queen, 84 DTC 6110, [1984] CTC 101 (FCTD)

Collier, J:—This is an appeal from a decision of the Tax Appeal Board. Only the 1974 taxation year is before the court.

The plaintiff purchased an eighteen-suite rental apartment building on January 26, 1973 for $235,000. On January 28, 1974, she obtained official approval for subdivision of the building into self-contained suites (strata title). The strata value, as of January 15, 1974, was appraised at $460,000. The plaintiff went on to convert, and sell suites.

The issue is set out in the statement of claim as follows:

8. The plaintiff filed her Tax Return for 1975 on the basis that the gain in value of the property from the date of acquisition to January 15, 1974 (at which time the prop- erty was valued at $460,000) was a capital gain and that the value in January, 1974 was the cost base upon which to calculate the income gain made in respect of the sale of each individual suite thereafter.

10. By Notice of Assessment, dated May 17, 1978, the Minister of National Revenue included additional amounts in the income of the plaintiff for the year ending December 31, 1975, on the basis that the whole of the gain made above the original acquisition should be taxed as an income gain.

and in paragraph 6 of the defence:

6. He admits the allegations of fact contained in paragraph 8 but he says that, if the property ever was capital in the hands of the plaintiff (which is not admitted but rather specifically denied), the conversion to inventory was at a date not later than July 15, 1973, and was at a fair market value not in excess of the actual cost of the property (regardless of date of conversion to inventory) rather than at the date and the value alleged by the plaintiff in the filing of her return of income for the year 1974.

I shall try to put the matter in other words.

The plaintiff says the purchase of the apartment building in January 1973 was on capital account. It was a pure investment. That sole intention and motivation did not change until strata title approval was given in January, 1974. At that time the suites became inventory, and were sold. Any gain between the time of purchase and January 15, 1974 was a capital gain. After that, any profit on individual suite sales fell into income.

The Minister of National Revenue contended the purchase of the apartment building, and its ultimate conversion to strata title units, was always motivated by an intention to turn the transaction into a profit; the gain was therefore chargeable to income. Not to taxable capital gain.

The plaintiff was born in 1941. Prior to August, 1972, she had lived in Toronto. She had held a real estate agent’s licence for fourteen months. She sold residential properties, which she described as in the “blue collar” range. She decided to move to Vancouver. She arrived August 5, 1972. She had hoped to sell real estate in British Columbia. She found she needed a licence in that province. She was unable to obtain one immediately.

She obtained employment with Deville Mortgage Corp Ltd. She took training as a sub-mortgage broker. She obtained her licence for that occupation in September, 1972. She earned $1,500 to $2,000 per month on a commission basis.

She became aware the apartment building, earlier referred to, was for sale. It was in the City of North Vancouver. On January 26, 1973 she made an offer of $235,000. It was accepted. Possession was to be delivered in April.

She was unable to assume the existing mortgages. That would have required a downpayment of $75,000. She did not have that kind of money. The interest rate on the existing first mortgage was 6 per cent; on the second mortgage, 12.5 per cent.

She obtained other financing: a first mortgage of $160,000 at 9/4 per cent for five years; a prepayment penalty provision was included. She had difficulty in obtaining a reasonable second mortgage. In order to complete the terms of the interim agreement, she was finally forced to agree to a second mortgage of $48,000 at 18 per cent for one year. The balance of the purchase price was made up of a promissory note for $30,000 payable to the vendors one year later.

Theoretically, the plaintiffs investment of personal funds appears to be $3,000. In actual fact, it was probably around $1,500.

The plaintiffs only other experience in ownership of property was, as I understood her evidence, the purchase and ultimate sale of three residences in Ontario.

Her evidence before me was that the purchase of the apartment building was purely for investment purposes. She intended to operate it as a landlord, obtaining income from rental. It was also to provide a home, in the sense of accommodation, for herself and her sister.

At the time of purchase, the plaintiff had a fiancé Richard Naylor. It was her intention he would act as caretaker/manager of the building. She intended to continue her own employment. She brought her sister from Toronto. That sister had worked for approximately seventeen years as a factory worker.

There is no doubt this transaction was, in retrospect, an improvident one on the part of the plaintiff. It was apparent from the outset that expenses, including the mortgage payments, would exceed revenue. The plaintiff hoped to reduce expenses. Without reviewing the evidence in detail, that hope never materialized.

The plaintiff left her employment as a sub-mortgage broker shortly after possession of the apartment building was obtained. She was unsuccessful in the remainder of 1973 in obtaining any really steady employment. It became apparent her fiancé was not capable of providing management or caretaker services. The relationship started to deteriorate in June or July of 1973. It culminated with the two parting company in December. The sister was unable to find employment in British Columbia until 1975.

On the plaintiffs own admission, by the end of June, 1973, she had no money, no job, problems with her fiancé, and her sister was out of work.

The plaintiff became aware, partly from what she had heard and partly on the advice of a friend, Karp, who also owned apartment buildings, the City of North Vancouver was considering a moratorium on self-owned or strata title conversion. Karp expressed the view rental apartments would never pay. The plaintiff wrote to the city on July 16, 1973, applying for permission to convert the building into strata title apartments.

The plaintiff said she really did not understand what strata title was all about. I do not accept that evidence. She may have known little about the technical aspects. But she did know this: if the application was approved, and if she went ahead, it meant selling the suites as individual units.

There were some problems with the plaintiffs application. The city at first refused to consider it. The plaintiff pursued the matter. Council reversed its decision. There were other matters that came up. They were ultimately resolved.

The plaintiff, I find, actively pursued this application for change to strata title. She wrote letters, sometimes with help from a friend (mostly the witness Devlin). She personally attended council meetings on August 20, 27, September 4, October 9 and December 17.

Regardless of all this, the plaintiff nevertheless testified she did not come to a final, irrevocable decision until approximately January 15, 1974.

I do not accept her evidence.

Counsel for the plaintiff characterized his client as naive and enthusiastic. I agree with the description enthusiastic. From my observation of the plaintiff, she was astute, not naive. I apply that characterization as far back as the initial purchase of the apartment building. I point to the following: Her superior at Deville Mortgage Corp Ltd reduced her commissions when she refused to sell the apartment building to him. But she held on to her job until the apartment sale was closed. Then she left. An office had been built in a portion of the apartment building. The plaintiff intended to start a mortgage brokerage business — Van-Surrey Investments — with a partner. She found the partner had “misrepresented” certain things. After three weeks she dissolved this arrangement.

I am satisfied the plaintiff intended to pursue the strata title scheme from the time she first made application to the city. It is obvious, and I am convinced it was obvious to her, the building could not be operated on a rental income basis. Her friend Karp had told her as much. I refer, as well, to the evidence given in respect of the suite rented by Mr and Mrs Dan. That couple had, at one time, owned the building. They had a nice suite. Mrs Dan, in late August, 1973, agreed the plaintiff could show the Dan suite. The plaintiff admitted she testified at the Tax Review Board that she was then considering selling the building. The purpose of showing the Dan suite was for sale, and appraisal purposes. At the trial before me, she said she had two options. She could show this suite to a prospective purchaser of the building, or to an appraiser who might wish to appraise the building for strata title purposes. She endeavoured, later in her testimony, to resile from that position. Her original testimony recorded, I find her true intention in respect of the future of the building.

Counsel for the Minister contended there was always a motivating intention, from the outset, on the part of the plaintiff to sell the apartment at a profit if the opportunity arose. The plaintiff, on the other hand, says her only motivating intention, at the time of purchase, was to operate the apartment as a rental investment.

The evidence and the inferences on this issue are finely balanced. The members of the Tax Review Board found against the plaintiff.

As Jackett, CJ said in Hiwako Investments Ltd v The Queen, [1978] CTC 378 at 383; 78 DTC 6281:

. . . an intention at the time of acquisition of an investment to sell it in the event that it does not prove profitable does not make the subsequent sale of the investment the completion of an “adventure or concern in the nature of trade”.

In Reicher v The Queen, [1975] CTC 659 at 660-661; 76 DTC 6001, Jackett, CJ had this to say:

At the trial, categorical evidence was given by the appellant that neither he nor his partners gave any thought to or considered acquiring the property “for the purpose of turning it into account, selling it at a profit” and that they did not “even advert to the possibility”; and he was not cross examined with reference to such evidence.

Such evidence is not, of course, conclusive. It must be considered with all the surrounding circumstances, and the Court must, based on such a consideration, reach a conclusion whether, on the balance of probability, the possibility of re-sale at a profit was one of the motivating considerations that entered into the decision to acquire the property in question.

On the evidence before me, and on a balance of probabilities, I find the plaintiffs only motivating intention in January 1973 was the acquisition of an investment.

That intention changed, however, by mid-July 1973, when the plaintiff made application for strata title. She was then in financial straits. It was at that stage, I find, the plaintiff intended to convert to inventory. All that followed was the putting of the scheme into effect.

The plaintiffs statement that she had not made up her mind until January of 1974 flies in the face of the evidence, and the inferences to be drawn from it.

The fact that a final appraisal and prospectus was not prepared until mid- Janury 1974 is not conclusive in favour of the plaintiff. Nor is the fact that the plaintiff was still accepting new tenants as late as December, 1973. It would have been financially disastrous to allow suites to remain vacant while the necessary legal, technical and other requirements for conversion to strata, and for approval, were being carried out.

To summarize, my findings are these:

1. The plaintiff, as of the date of acquisition (January 26, 1973) did not purchase the building as an adventure in the nature of trade. The inclusion of the gain on income account as of January 26, 1973 is varied.

2. The plaintiff, as of July 16, 1973, started to convert the apartments into inventory.

I do not know the exact consequences those findings will have on the Minister’s assessment.

I request counsel for the defendant to draw the formal pronouncement. Then submit it to counsel for the plaintiff for approval as to form. If the parties cannot agree, I will settle the formal judgment. If the parties can agree as to the disposition of the costs of this action, that direction can be included in the pronouncement. If either party wishes to make submissions on the pronouncement, or costs, arrangements can be made through the Registry.