Campeau v. MNR, 93 DTC 92, [1992] 2 CTC 2673, [1992] 2 CTC 2208, [1993] DTC 88 (TCC)

Couture, C.T.C.C.J.:—The assessments under appeal are dated December 8, 1983, for the 1980 and 1981 taxation years.

The appellant gave evidence, acting for himself, and stated the following facts:

In 1971 he was studying at the École des Hautes-Etudes Commerciales in Montreal, with the aim of obtaining a bachelor’s degree in business administration. After he married, he abandoned these courses and continued his studies in the evenings. Through the school's placement service, he found a job with the company Crédit Foncier, an institution which specialized in the mortgage loan business. He had no experience in that field, and his duties consisted in acting as an assistant to a professional appraiser in preparing appraisal reports, that is, doing the manual labour such as checking the measurements of buildings and noting down the information required by the appraiser for preparing his report. After a year and a half of this type of work, he was transferred to the company's documents section, work which required that he check the various documents needed for obtaining a mortgage loan, and where he stayed for only a few months.

Toward the end of 1972, he left his job to accept the position of manager of mortgage loans for a Toronto trust company which was opening a branch in Montreal. In the beginning, his work consisted in appraising single-family houses, despite the fact that he had no experience in that field, by his own admission, and approving or rejecting loan applications. After a year and a half of this type of work, the company, having expanded, increased its staff and he was put in charge of office administration.

In 1977, during a difficult economic situation, the trust company terminated its Quebec operations. While the appellant was still an employee of the company, he had nothing more to do. At that time, a group of mortgage brokers invited him to join them and take charge exclusively of the administration of their business, which position he accepted. The work of a mortgage broker is to act as an intermediary between real estate brokers and the financial institutions which handle this kind of loan.

In about 1979, he became manager of the mortgage loans division of the Bank of Montréal, which position he held until 1981.

The appellant explained that, since he started working, his ambition had been to acquire a real estate portfolio, but that he did not have the necessary capital to carry out such a plan.

In 1977, a real estate agent suggested that he purchase a 17-unit building. Still having no capital, he interested his brother-in-law and together they purchased the building in question. He reminds us that in 1977, because of the political situation that was prevailing at that time, property prices had dropped substantially so that numerous opportunities were available to people who wanted to invest in this kind of investment. He knew that the rule at lending institutions was to lend up to the lesser of 75 per cent of the cost or the value of the property. Properties were sold for much less than their market value because the owners were seeking to liquidate their investments. Because of this situation, he came up with a method of financing the purchase of the said building with a minimal capital outlay on their part.

The building was purchased in October, 1977 by the brother-in- law’s wife and resold the same day to the husband at a much higher price. The cost was $155,000 and the appellant and his partner obtained a mortgage in the amount of $145,000, which required that they invest $5,000 in capital each. This mortgage was obtained from Crédit Foncier following an appraisal of the building by the company's appraisers.

Because the property was in the name of the brother-in-law, a counter-deed had been signed between the parties attesting that the appellant was the owner of half of the property.

This first adventure turned out to be relatively inexpensive for the appellant and his partner. For the last three months of 1977, the management showed a small profit of $742.64, that is the appellant's share. For 1978 the result was, in terms of his share, a loss of $1,338.70, which took into account the principal repayment on the mortgage. This first adventure seems to have served as a catalyst to motivate the appellant to get more involved in buying real estate.

He tells us that he was pleased with his 1977 experience, and decided in 1978 to take advantage of the economic situation and the financial scheme he had come up with to acquire other income properties. In September and October, he acquired two properties, again using the procedure he had followed in 1977, that is, using third parties, alone or with a partner.

The appellant explained that when a real estate agent offered him a property, he did a summary examination of the data relating to income and expenses set out in the listing document provided by the agent and if, by his estimates, he predicted that the transaction would be profitable he went ahead with the purchase. He asserted that he always relied on this information and that he made his decision on that basis.

In 1979 he acquired ten other properties between March and December, having a total value of $1,444,000, and obtained mortgages on those properties in the amount of $1,589,000, which gave him additional liquidity of about $145,000. All these mortgages were for a five-year term.

According to the figures provided by the appellant in 1979, he had accumulated a surplus of liquidity through his financing arrangements, amounting to $162,661. Unfortunately, his calculations when purchasing these properties turned out to be noticeably in error. Operating statements for 1979 were not filed, but according to the figures produced by the appellant his liquidity had fallen to $43,565.45, which indicates that the operations showed a substantial loss.

For the 1980 taxation year, the appellant claimed a deduction of $55,962 for operating losses in computing his income; that amount did not take into account a deduction for capital cost allowance and principal repayment on the mortgages. For 1981, the loss claimed, not including capital cost allowance or repayment of principal, was $75,585.46.

The appellant cites two reasons for these unfortunate results: the first, that the real estate agents were not honest in their representations to him with respect to the profitability of the properties, and the second attributable to the fact that the economic situation at the time was the cause of the loss of tenants for his buildings, and therefore of a noticeable reduction in his rental income.

Other events complicated the appellants financial situation. When his liquidity, created by the financial arrangements, was eliminated through operating expenses, the appellant had to go to his employer's bank to cover his operating deficits. On March 31, 1980, his bank account was overdrawn by $69,564, according to the bank documents filed. This line of credit was not authorized by the bank. The appellant tells us that he was still hoping that his financial situation would improve and that he would be able to get himself back afloat financially. Unfortunately for him, following an audit done by the bank's auditors, his unauthorized line of credit was discovered and he was instructed by his employer to repay the bank advances which he had been tacitly allowed to take. Having no financial resources available to him, his properties being mortgaged to their maximum, his only option was to sell them, which he did between September 1980 and the end of 1981, thereby realizing a profit of $62,182.90 and $155,539.97 for these taxation years.

The appellant submits that the properties he acquired between 1977 and 1979 constitute capital property, for which the proceeds of disposition resulted in capital gains, half of which is taxable. His arguments in support of this position are that his intentions at the outset were to build a real estate portfolio for himself and that circumstances led to his abandoning this plan. As noted above, he argued that his failure was due to the incorrect information as to the profitability of the properties received from the real estate agents at the time, complicated by the economic situation which made it difficult to rent his units, and finally the increase in interest rates, which rose from 8.25 per cent in June, 1977 to 15.75 per cent in March, 1980. According to him, these factors caused him to abort his plan to invest in real estate.

Counsel for the respondent argues that the appellant acquired the properties in question with the aim of reselling them and that the profit he realized is a profit from the operation of a business.

I am convinced that the facts clearly show that the appellant did not operate a business during the years 1979 to 1981, but what I must decide is whether his activities may have amounted to a concern in the nature of trade according to the provisions of the Act and to the case law.

In M.N.R. v. James A. Taylor, [1956] C.T.C. 189, 56 D.T.C. 1253, the President of the Exchequer Court of Canada, as it then was, carried out quite a complete examination of the factors which must be considered in order to establish whether a transaction involves the elements of an adventure in the nature of trade or disposition of an asset in the nature of capital. Drawing on a long line of cases in the English courts, he made the following remarks at page 210 (D.T.C. 1136):

The cases establish that the inclusion of the term“ adventure or concern in the nature of trade, in the definition of trade" in the United Kingdom Act substantially enlarged the ambit of the kind of transactions the profits from which were subject to income tax. In my opinion, the inclusion of the term in the definition of business” in the Canadian Act, quite apart from any judicial decisions, has had a similar effect in Canada. I am also of the view that it is not possible to determine the limits of the ambit of the term or lay down any single criterion for deciding whether a particular transaction was an adventure of trade for the answer in each case must depend on the facts and surrounding circumstances of the case. But while that is so it is possible to state with certainty some propositions of a negative nature.

At page 214 (D.T.C. 1139), he added:

In addition to the negative propositions established by the cases they also lay down positive guides. There is, in the first place, the general rule that the question whether a particular transaction is an adventure in the nature of trade depends on its character and surrounding circumstances and no single criterion can be formulated.

But there are some specific guides. One of these is that if the transaction is of the same kind and carried on in the same way as a transaction of an ordinary trader or dealer in property of the same kind as the subject matter of the transaction it may fairly be called an adventure in the nature of trade. The decisions of the Lord President in the Livingston case, supra, and the Rutledge case, supra, support this view. Put more simply, it may be said that if a person deals with the commodity purchased by him in the same way as a dealer in it would ordinarily do such a dealing is a trading adventure: vide Lord Radcliffe’s reasons for judgment in Edwards v. Bairstow, supra.

And there is the further established rule that the nature and quantity of the subject matter of the transaction may be such as to exclude the possibility that its sale was the realisation [sic] of an investment or otherwise of a capital nature or that it could have been disposed of otherwise than as a trade transaction: vide the reasons for judgment of Lord Sands in the Rutledge case, supra. And there is the statement of Lord Carmont in the Reinhold case, supra, that there are cases “where the commodity itself stamps the transaction as a trading venture”.

In another decision of that Court, Racine, Demers and Nolin v. M.N.R., [1965] 2 Ex. C.R. 338, [1965] C.T.C. 150, 65 D.T.C. 5098, the Honourable Mr. Justice Noël stated the following, with respect to an appellant's alleged intention, at page 349 (C.T.C. 159, D.T.C. 5103):

To give to a transaction which involves the acquisition of capital the double character of also being at the same time an adventure in the nature of trade, the purchaser must have in his mind, at the moment of the purchase, the possibility of reselling as an operating motivation for the acquisition; that is to say that he must have had in mind that upon a certain type of circumstances arising he had hopes of being able to resell it at a profit instead of using the thing purchased for purposes of capital. Generally speaking, a decision that such a motivation exists will have to be based on inferences flowing from circumstances surrounding the transaction rather than on direct evidence of what the purchaser had in mind.

[Emphasis added; Translation.]

In the decision of the Tax Appeal Board in Edward Dan Liersch v. M.N.R. (1960), 25 Tax A.B.C. 233, 60 D.T.C. 593, at page 234 (D.T.C. 594), R.S.W. Fordham, Q.C., makes the following comments:

At the hearing, the argument advanced by the appellant's counsel was that the said sum was a capital accretion in his client’s hands as, for one thing, he originally had intended to retain the building for the rents it would produce and had not planned to sell it. Be this as it may, it appears to me that the whole project was an adventure in the nature of trade, if ever there was one. The appellant had no financial resources whatever and was never in a position to pay for and maintain such a building as he managed to erect with money belonging to others.

[Emphasis added.]

There is an abundance of case law on the question of whether a transaction resulted in a capital gain or rather was in the nature of trade and the gain was thereby taxable. Certain general principles are derived from all these cases, but the one which must be noted is that the motive which led the taxpayer to get involved in the transaction in question must be inferred from all of the circumstances surrounding it.

In the situation under appeal, I have no doubt that the appellant may have aspired to create a real estate portfolio for himself, but in view of his admission that he did not have the necessary capital to attain this aspiration, attaining it was problematic, to say the least.

He was able to profit from a very specific political and economic situation which allowed him, using a rather well-designed scheme, to acquire a number of income properties in a very short period. Having no capital, the money available to him from the proceeds of the inflated mortgages had to be used not only to acquire the properties but also to cover operating expenses. This situation was apparent at the time of the first acquisition on Goyer Street in 1977, when the first full year of his operations ended in a deficit, his share of which was $1,338.70, none of which, according to the evidence, arose from capital cost allowance.

This initial experience should have alerted him to the fact that his modus operand/ presented serious financial risks in terms of the profitability of his acquisitions. Nonetheless, he persisted in 1978 and 1979, acquiring ten properties, again in the face of an adverse financial situation. From January to October 1979, according to the information contained in an exhibit filed by the appellant entitled "Bank's Prime Commercial Lending Rate”, the interest rate rose from 12 per cent to 15 per cent, and despite this substantial increase he continued his purchases, buying a property on October 5, 1979 and another on December 4 of that year. At that point he had been aware for a long time, in fact since 1978, that the management of his properties was showing an operating deficit which was growing, and given a progressively deteriorating economic situation he nonetheless persisted in his acquisitions.

In my view, this course of action had nothing in common with the action of an individual who is planning a long-term investment. The fact that he had no capital whatsoever and was covering operating deficits with money borrowed using a method that was at the very least abnormal in this type of transaction inevitably imply that in his heart of hearts the appellant must have been aware that his operating method, which involved serious risks according to the financial data in evidence, could not go on indefinitely in the circumstances and that, in the event that he was forced to terminate it, his only option in the absence of capital would be to liquidate.

It was erected on such fragile financial foundations that the slightest adverse economic pressure threatened to bring it down, and in fact this is what happened, as it was bound to do, within a relatively short time. Blaming the real estate brokers or the economic situation for his failure is merely to cite the remote causes which precipitated it. The primary cause was the fragility of the financial structure on which rested his real estate activities and which clearly signalled that the said activities were destined to have a relatively short lifespan.

When considered as a whole, the appellant's activities during the period between 1977 and 1981 are much more of the essence of real estate speculation, which was prompted by special and very specific economic circumstances, than of an attempt to carry out a capital project as he claims.

For these reasons, the appeals for the 1980 and 1981 taxation years are dismissed.

Appeals dismissed.