Date: 20080715
Docket: A-545-06
Citation: 2008 FCA 238
CORAM: LINDEN J.A.
SHARLOW
J.A.
TRUDEL
J.A.
BETWEEN:
KEVIN WEAVER and JENNIFER
WEAVER
Appellants
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
SHARLOW J.A.
[1]
The
issue in this appeal is whether the appellants Kevin Weaver and Jennifer Weaver
are entitled to the “enhanced” capital gain deduction under subsection
110.6(2.1) of the Income Tax Act, R.S.C. 1985, c. 1 (5th
Supp.), as it read in 1998, in respect of the capital gain they realized on the
sale of shares of Songhees Retirement Park Ltd. (“SRP”). The Weavers are
entitled to that deduction if, at the time of the disposition of the shares,
all or substantially all of the fair market value of the assets of SRP was
attributable to assets used principally in an active business carried on by SRP.
Justice Beaubier of the Tax Court of Canada concluded that this condition was
not met (2006 TCC 566). The issue in this appeal is whether Justice Beaubier’s
conclusion is correct.
Facts
[2]
SRP
is a Canadian controlled private corporation with a fiscal year ending on
October 31. Until sometime in 1998, Kevin Weaver and Jennifer Weaver each owned
25% of the shares of SRP The remainder of the shares of SRP were owned by Bob
Malcolm. In 1993, SRP commenced the development of certain land as a retirement
community consisting of manufactured homes on leased lots. As the land was
located on the New Songhees Indian Reserve, SRP could not obtain title to the
land. Instead, it entered into a lease (the “headlease”) with the Government of
Canada, acting on behalf of the members of the Songhees Band who were in lawful
possession of the land.
[3]
The
term of the headlease was 49 years, commencing on November 1, 1993 and ending
on October 31, 2042. The rent payable under the headlease was $90,000 per year
for the first five years of the term, and “fair market rent”, as determined by
the Minister, for each succeeding five year period during the term. The fair
market rent for the second five year period of the headlease (November 1, 1998
to October 31, 2003) was approximately $99,000 per year.
[4]
The
terms of the headlease permitted the creation of lots on the leased land which
could be sublet for a term ending one day before the end of the term of the
headlease. Rent payable under each sublease consisted of “basic rent”, plus an
additional amount reflecting the sublessee’s proportionate share of the
operating costs of the community. The basic rent was set initially at an amount
that would ensure a spread between SRP’s expected rental revenues and the rent
it was required to pay under the headlease for the first five years, assuming
all of the lots were sublet. In addition, the sublease provided that the basic
rent would increase by the same percentage as the increase in the rent payable
under the headlease. That provision ensured that SRP’s expected rental revenue
would increase as its rent expense increased. It also ensured that the spread
between SRP’s expected rental revenue and its rental expense would grow with
each rental increase.
[5]
SRP
developed 95 lots on the leased land, of which 93 were leased to individuals
who purchased manufactured homes from SRP for the lots. The last lot was leased
and the last home sold at some point in the first three months of 1998. The
evidence of Mr. Weaver is that, for each manufactured home sold, SRP provided a
one year warranty for finishes and materials, and a five year structural
warranty. Until Mr. Weaver ceased being actively involved with SRP in November
of 1998, he coordinated the activities of SRP in connection with the
warranties. From his evidence, it appears that the one year warranty was the
most time consuming.
[6]
SRP
purchased two other land development properties, referred to as “Selwyn” and
“Grafton”. The Grafton property was sold in October of 1998 for approximately
$315,000, and the Selwyn property was sold in November of 1998 for $500,000. SRP
also acquired some publicly traded securities, the value of which is not enough
to be of concern in this appeal.
[7]
At
some point, disagreements arose between the Weavers and Mr. Malcolm. In
November of 1998, Mr. Weaver withdrew from active participation in the company.
SRP engaged Equitex Management as its agent to provide maintenance and other
services for the retirement community for a fee.
[8]
On
an unspecified date in September of 1998, Mr. Malcolm agreed to buy from the
Weavers their shares of SRP for a price equal to one half of the value of the
property of SRP. That agreement was not put into writing. When the agreement
was reached, SRP owned Selwyn and Grafton, as well as its interests in the
headlease and the subleases.
[9]
The
terms of the agreement governing the sale of the shares of SRP to Mr. Malcolm
are set out in a document that was apparently signed on December 10, 1998. The
purchase price of the shares is stated as $400,000 plus one-half of the value
of the publicly traded securities owned by SRP on December 10, 1998. By that
date, SRP had sold Selwyn and Grafton, so that the value of SRP at that time
would have been based primarily on the value of SRP’s interest in the headlease
and the subleases. According to an expert report submitted to the Tax Court,
the fair market value of SRP’s interests in the headlease and the subleases was
$902,000 (based on the anticipated rents and assuming a capitalization factor
of 14%).
[10]
The
proceeds of disposition received by each of the Weavers for their shares of SRP,
as reported in their income tax returns for 1998, was approximately $214,500.
For each of them, the adjusted cost base of the shares was $100,000 and the
costs of disposition were $500. As a result, for each of the Weavers, the
capital gain on the disposition of the shares was approximately $114,000. The
inclusion rate in 1998 was 75%, so the taxable capital gain for each of them
was approximately $85,500, before taking into account any deduction under
paragraph 110.6 (2.1) of the Income Tax Act. If they were eligible for
that deduction, their taxable capital gain would be zero.
Discussion
[11]
The
entitlement of the Weavers to the enhanced capital gains deduction in respect
of the disposition of their shares of SRP depends on the combined operation of
a number of complex provisions of the Income Tax Act. As this case does
not involve a disputed point of statutory interpretation, it is not necessary
to quote those provisions at length. A summary of the effect of each of the
relevant provisions will suffice.
Date of disposition
[12]
First
it is necessary to resolve the threshold issue, the date of the disposition of
the shares of SRP, because the correct application of the statutory provisions
depends on that determination. Justice Beaubier, agreeing with the Minister,
concluded that the date of the disposition of the shares was December 10, 1998.
The Weavers argue that the disposition occurred in September of 1998, when they
reached an oral agreement to sell the shares to Mr. Malcolm for an agreed price.
[13]
It
is possible, as a matter of law, for the beneficial ownership of property to be
transferred by means of an oral agreement, and it is also possible for the
transfer of the beneficial ownership of property to precede the transfer of legal
title (see, for example, Lysaght v. Edwards (1876), 2 Ch. D. 499, Martin
Commercial Fueling Inc. v. Virtanen (1997), 144 D.L.R. (4th) 290
(B.C.C.A.)). When that occurs, the disposition of the property for income tax
purposes is generally the earlier date.
[14]
The
issue in this case is whether there is evidence of an agreement in September of
1998 that had the effect of passing beneficial ownership of the shares of SRP at
that time. The Weavers rely on the oral evidence of Kevin Weaver and Mr.
Malcolm, who both say that they agreed in September of 1998 that the shares would
be sold for a price determined as one-half of the value of the assets of SRP. However,
there is no evidence that they agreed on a date for the valuation.
[15]
The
evidence contradicting the position of the Weavers is the written agreement
dated December 10, 1998, which states that the sale occurred on December 10,
1998, and also contains a representation by the Weavers that they were the
beneficial owners of the shares on December 10, 1998. In addition, the
statement of agreed facts submitted to the Tax Court states that the shares
were sold on December 10, 1998, and that the Weavers were the beneficial owners
of the shares for the 24 month period prior to December 10, 1998. In my view, given
this record, Justice Beaubier made no error in concluding that the disposition of
the shares occurred on December 10, 1998.
Entitlement to deduction
claimed
[16]
I
turn now to the statutory provisions that must be applied to determine the
entitlement of the Weavers to the deduction claimed. Subsection 110.6(2.1) of
the Income Tax Act permits a reduction in the capital gain realized by
the Weavers if the shares met the definition of “qualified small business
corporation share” on the date of their disposition. The question is whether
the shares of SRP met that definition on December 10, 1998.
[17]
The
phrase “qualified small business corporation share” is defined in subsection
110.6(1) of the Income Tax Act. The definition contains a number of
tests that must be met, but for the purposes of this appeal, only one of those
conditions is relevant. The key condition is that, “at the determination time”,
SRP must have met the definition of “small business corporation”. In the
context of this case, the determination time is the date of the disposition of
the shares of SRP, which is December 10, 1998.
[18]
The
phrase “small business corporation” is defined in subsection 248(1) of the Income
Tax Act. The definition is complex. For the purposes of this case it is sufficient
to say that SRP would meet that definition if, on December 10, 1998, all or
substantially all of the fair market value of the assets of SRP was attributable
to assets that were used principally in an “active business” carried on by SRP.
I note parenthetically that the Minister generally accepts, as a rule of thumb,
that the word “principally” signifies more than 50%, and that the phrase “all or
substantially all” signifies 90% or more. In this case, all parties were
content to use these guidelines.
[19]
The
characterization of a business as “active” has long been used as a means of
providing preferential tax treatment of various kinds. As a result there is a
great deal of jurisprudence on the meaning of the phrase “active business”. In Canada
v. Rockmore Investments Ltd., [1976] 2 F.C. 428, this Court held that the
question of whether a business was “active” was a question of fact, to be
determined by the nature and degree of the activity required to generate the
revenue of the business. In that case, a business incorporated to invest in
mortgages was held to be carrying on an active business. Similarly, in Canadian
Marconi v. R., [1986] 2 S.C.R. 522, the Supreme Court of Canada held that
the active management of a portfolio of securities obtained with the proceeds
of sale of a division of the corporation was an active business. These cases and
others adopted a meaning of “active business” that was so broad that there was
very little a corporation might do that would not comprise the carrying on of
an active business.
[20]
Parliament
apparently was concerned that the broad interpretation of “active business”
adopted by this Court and the Supreme Court of Canada could mean that corporations
earning passive investment income would obtain the tax advantages intended for
businesses whose income was the result of a higher level of activity. To meet
that concern, the Income Tax Act was amended to add the definition of
the phrase “active business” in subsection 248(1) and subsection 125(7) of the Income
Tax Act to mean, inter alia, any business carried on by a taxpayer
except a business falling within the definition of “specified investment
business” (see Lerric Investments Corp. v. Canada (C.A.), [2001] 2 F.C.
608, and Baker v. Canada, 2005 FCA 185). At the same time, the phrase “specified
investment business” was defined to mean a business, the principal purpose of
which is to derive income from property, including interest, dividends, rents
and royalties (subject to a number of exceptions that are not relevant to this
case).
[21]
The
Minister argues that the business of SRP at the relevant time (that is, on
December 10, 1998) met the definition of “specified investment business” and
therefore was not an active business. I summarize the Minister’s reasoning as
follows. On December 10, 1998, the assets of SRP consisted of its interests in
the headlease and the subleases, a small amount of cash and a few publicly
traded securities. Given the relative value of those assets as summarized
above, SRP’s interests in the headlease and the subleases comprised all or
substantially all of the fair market value of the assets of SRP. On December
10, 1998, those assets were used to derive rental income, and only rental
income. Therefore the business of SRP met the definition of “specified
investment business”.
[22]
The
Weavers do not dispute the facts asserted by the Minister, but they dispute the
conclusion. I summarize their argument as follows. The interest of SRP in the
headlease and the subleases are the foundational assets from which SRP derived
income from its land development business for its 1993 to 1998 fiscal years,
which was an active business. By December 10, 1998, that active business was
not completely at an end because SRP had continuing obligations under the
warranties given to purchasers of the manufactured homes. The continued
existence of those warranties on the manufactured homes is enough to establish
that the purpose of the business of SRP, as of December 10, 1998, was still
that of a land developer rather than an investor in rental properties. Therefore,
on that date the business of SRP was still an active business and had not
become a specified investment business.
[23]
Justice
Beaubier noted that, by December 10, 1998, the obligations of SRP under the subleases
were the responsibility of Equitex Management, which was retained as the agent
of SRP to manage the retirement community on SRP’s behalf. It is not clear
whether he intended that observation to be a reason for rejecting the Weavers’
argument. In my view, that would not be a sound basis for concluding that the
business of SRP was not an active business. An active business is no less
active merely because it is carried on by an agent: E.S.G. Holdings Ltd. v.
Canada, [1976] C.T.C. 295, 76 D.T.C. 6158 (F.C.A.).
[24]
However,
Justice Beaubier also noted that, by December 10, 1998, the income of SRP
consisted entirely of rent. As I understand his reasons, that was the principal
basis for rejecting the Weavers’ argument. In my view, Justice Beaubier reached
the correct conclusion on this point.
[25]
The
definition of “specified investment business” does not ask about the general
nature of the business of a corporation, or the degree of activity or passivity
actually required by that business. Rather, it asks about the legal character
of the income that the business is intended principally to earn. If on the
relevant date the legal character of that income is rent, for example, then the
business meets the definition unless once of the statutory exceptions applies
(none of those exceptions is relevant in this case).
[26]
As
explained above, in determining whether the business of SRP met the definition
of “specified investment business” on December 10, 1998, the key question is
whether the principal purpose of that business at that time was to derive
income from property (such as rent). It is not relevant that SRP carried on an
active business before that time. The fact is that on December 10, 1998, almost
all of the income of SRP was rent, and almost all of the property of SRP was property
that generated and could generate only rental income. Indeed, the terms of the
headlease and sublease, which had terms running to October 31, 2042, were
structured to result in a steady, and steadily growing, stream of rental income.
Except for minor amounts of cash and securities, SRP had no property that was
capable of resulting in any kind of income other than rent. The warranties
existed, but they were obligations of SRP. They could produce only costs, not
income. There is no evidence of any plans or prospects for SRP that could
possibly cause SRP to earn any kind of income other than rent.
[27]
In
my view, it would not be reasonable on these facts to conclude that the
principal purpose of the business of SRP, on December 10, 1998, was to derive
anything other than rental income. It follows that the business of SRP on that
date was a “specified investment business”, and therefore it was not an active
business. The inescapable conclusion is that the Weavers are not entitled to the
capital gains deduction in respect of the capital gain on the disposition of
their shares of SRP.
[28]
I
have not ignored the argument of the Weavers based on the definition in
subsection 129(4) of the Income Tax Act which states that the income or
loss of a corporation for a taxation year from a source that is a property
“does not include the income or loss from any property that is incident to or
pertains to an active business carried on by it”. I agree with the Minister
that this definition applies only for the purposes of section 129 (dividend
refunds to private corporations). More importantly, however, it does not
address the issue in this case. Perhaps there was a time when it could be said
that SRP’s interests in the headlease and subleases were properties that were
incidental to or that pertained to an active business carried on by SRP. However,
that was no longer the case on December 10, 1998.
Conclusion
[29]
I
would dismiss this appeal with costs.
“I
agree.
A.M. Linden J.A.”
“I
agree.
Johanne Trudel J.A.
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