Colbert v. The Queen, 94 DTC 6620, [1994] 2 CTC 345 (FCTD)

Wetston J.:— This is an appeal from the judgments of the Tax Court dismissing the plaintiffs’ appeals from the assessments of the Minister for the 1984 and 1985 taxation years. The proceedings now before this Court are in the nature of de novo appeals. This case involves the application of the replacement property rules under section 44 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the "Act") to the plaintiffs’ disposition in 1984 and acquisition in 1985 of farm properties.

The plaintiffs, Joan and Robert Colbert, were the owners of a chicken farm. In september 1981, on the advice of their accountant, the plaintiffs decided to incorporate 492758 Ontario Ltd. They were primarily concerned about accident claims which could arise from the periodic employment of summer students to do additional work on the farm. At all material times the plaintiffs were the sole shareholders, officers and directors of the company. Upon incorporation of the company, all the equipment and vehicles used on the chicken farm were transferred to the corporation pursuant to section 85 of the Act. The purchase and sale agreement which conveyed these assets to the corporation indicates that the goodwill of the business was also transferred to the company. During the entire period in question the land and the chicken quota remained in the hands of the plaintiffs.

On January 5, 1984 the farm was sold and the plaintiffs included the capital gain from this disposition in computing their 1984 income. In 1985, a new farm was purchased in partnership with a third party and the chicken farming business was continued. However, the plaintiffs were not personally involved in the day to day operations of the second farm. For both the 1984 and 1985 taxation years, the plaintiffs elected under subsections 13(4) and 44(1) of the Income Tax Act to treat the farm sold in 1984 as a ''former business property" and the farm purchased in 1985 as a “replacement property" within the meaning of subsection 248(1). The election was made to treat the assets of the new farm as replacement properties in order to defer the tax payable on the capital gain and the recaptured capital cost allowance with respect to the farm property disposed of in 1984.

The Minister reassessed the plaintiffs’ return and disallowed the election under subsections 13(4) and 44(1) of the Act for both the 1984 and 1985 taxation years. The Minister treated the first farm as a “rental property" within the meaning of subsection 248(1) of the Act.

The primary issue in this appeal is whether the farm disposed of in 1984 is a former business property as defined by subsection 248(1) of the Act. A former business property does not generally include a rental property.

248(1) “former business property" of a taxpayer means a capital property that was used by him primarily for the purpose of gaining or producing income from a business, and that was real property or an interest therein of the taxpayer, but does not include

(a) a rental property of the taxpayer.. .

and for the purposes of this definition, "rental property" of a taxpayer means real property owned by the taxpayer, whether jointly with another person or otherwise, if the property was used by the taxpayer in the taxation year in respect of which the expression is being applied principally for the purpose of gaining or producing gross revenue that is rent, but for greater certainty, does not include a property leased by the taxpayer to a lessee, in the ordinary course of the taxpayer's business of selling goods or rendering services, under an agreement by which the lessee undertakes to use the property to carry on the business of selling or promoting the sale of the taxpayer's goods or services.

In confirming the Minister's reassessment, the Tax Court concluded that the first farm held by the Colberts was a rental property. Further, it was found that the chickens were the property of the corporation (the lessee) and therefore, no agreement, implied or otherwise, could be said to exist whereby the lessee had undertaken to carry on the business of selling the taxpayer's goods or services.

In my view, the disposition of this appeal turns on the question of whether, as required by the definition of former business property in subsection 248(1), the land and the chicken quota were used by the plaintiffs in the business of farming so as to entitle them to the deferral in subsections 13(4) and 44(1). The plaintiffs argue that they carried on the chicken farming business in conjunction with the corporation. Much emphasis was placed on the fact that the taxpayers at all times remained the owners of the land and the chicken quota, assets without which the farming business could not be operated. It was submitted that both the corporation and the taxpayers contributed assets to the business and that therefore, the taxpayers remained in the business of farming even after the incorporation. The defendant submits that the business was transferred to the corporation in October 1981 and from that point on, the farming business was carried on solely by the company and the Colberts were merely employees. Essentially, the defendant's position is based upon the consequences which he argues must necessarily follow from the interjection of a corporate vehicle to carry on the chicken farming business. According to this submission, given the presence of the corporation, the plaintiffs cannot now ask that the corporate veil be lifted in order to give them the benefit of the provisions which would allow them a deferral of recaptured capital cost allowance and capital gains. The defendant relies on jurisprudence which directs that those who have chosen to take advantage of the benefits of incorporation must bear the corresponding burdens; Constitution Insurance Co. of Canada v. Kosmopoulos, [1987] 1 S.C.R. 2, 34 D.L.R. (4th) 208 at page 10 (D.L.R. 213-14); Lachappelle v. M.N.R., [1990] 2 C.T.C. 2396, 90 D.T.C. 1876 at page 2401 (D.T.C. 1879) (T.C.C.); Laframboise v. M.N.R., [1992] 2 C.T.C. 2690, 92 D.T.C. 2299 at page 2699 (D.T.C. 2305) (T.C.C.).

Since Salomon v. Salomon & Co., [1897] A.C. 22, it has been a well settled principle of company law that the mere holding of all the shares of a corporation does not lead to the conclusion that the business carried on by the company is the business of the shareholder. Therefore, one must start from the presumption that generally when a company is incorporated to carry on a business, the business becomes that of the company and the shareholder cannot claim that business as his or her own. However, it has also been recognized that the relationship between a company and a shareholder can be such to constitute the company as an agent of the shareholder; Constitution Insurance Co., supra, at page 10 (D.L.R. 213), Denison Mines Ltd. v. M.N.R., [1971] C.T.C. 640, 71 D.T.C. 5375 at page 660 (D.T.C. 5388) (F.C.T.D.); Gramophone & Typewriter Ltd. v. Stanley, [1908] 2 K.B. 89. When such circumstances exist, the business carried on by the company can in reality be said to be that of the shareholder. Whether an express or implied agency relationship has been established is a question of fact to be determined on the specific circumstances of each case, Clarkson v. Zhelka, [1967] 2 O.R. 565 at 578 (H.C.).

The Colberts at all times remained the owners of the land and the quota, assets which were necessary to the operation of the chicken farm. Had the land and the quota been transferred to the corporation along with the goodwill, equipment and vehicles there would be no doubt that the plaintiffs would not be entitled to the deferral they seek as they could not be said to have used the property in the course of their own business. However, the ownership of part of the business assets by the shareholders complicates matters. Therefore, the question to be answered is whether on the facts of this case, the company was a mere agent in carrying out the plaintiffs’ chicken farming business.

Counsel for the plaintiffs did not argue that the company was an agent of the Colberts. Rather, it was submitted that the company and the Colberts were jointly engaged in the business. There was no express partnership or joint venture agreement between the plaintiffs and the company to jointly carry out the business. Rather, the plaintiffs ask the Court to infer that such an arrangement existed. I now turn to the evidence to determine if an agency or partnership relationship can be established.

Mr. Colbert testified that nothing with respect to the daily operation of the farm significantly changed after the introduction of the company. In his mind, he carried on the operations as he always had. Both before and after the incorporation in 1981, the hatchery invoiced him personally for the chicks. Invoices were entered into evidence to demonstrate that other expenses such as heat, light and feed were also billed to Mr. Colbert personally. However, after 1981, these expenses were paid for by cheque drawn from the company's account. It would appear that throughout the period in question the mortgage payments and land taxes were paid for directly by the plaintiffs. However, the financial statements indicate that the marketing board fees associated with the quota were paid by the corporation.

The objects clause in the articles of incorporation of 492758 Ontario Ltd. indicates that the company was incorporated for the purpose of carrying on the business of farming and agriculture. The objects clause must be viewed in conjunction with the October 1981 purchase and sale agreement which transferred the goodwill of the business and the right to represent the purchaser (the corporation) as carrying on the business. The fact that the company bought the chickens and paid all the operating expenses of the farming operation, is also indicative of an intention to transfer the business to the corporation.

The accounting evidence sheds further light on the business relationship between the plaintiffs and the corporation and the uestion of who was carrying on the business. Mr. Robert Welsh, who also testified during the proceedings, was the plaintiffs’ chartered accountant during the relevant time period. He testified that prior to the incorporation of the company the entire net income of the farming business was reported as personal income by the taxpayers. After the corporation was formed, the entire net income of the corporation was split between Robert and Joan Colbert, leaving the company with little or no income. These amounts were reported by the taxpayers as employment income and rental income on the Colberts’ individual tax returns. Mr. Welsh described the company as being a conduit through which all the earnings flowed to the taxpayers. In 1982 and 1983, the company paid out $39,060 and $39,898 in salary respectively. No salary was paid out in 1984, the year of disposition. In that same year, the plaintiffs reported farming income which consisted primarily of the proceeds from the sale of the farm.

The fact that the company retained no significant earnings but rather acted as a "conduit" by filtering its income to the Colberts is not a sufficient basis on which to find that the Colberts were actually carrying on the business. They both received salary which was reported as on their tax returns as employment income and Mr. Colbert reported further amounts he received from the corporation as rental income. I cannot accept Mr. Colbert's testimony that nothing changed after the incorporation. While Mr. Colbert may have been performing the same functions on the farm, he was doing so in a different capacity, that of a salaried employee, not an independent sole proprietor. A decision was made to draw salary from the company; therefore, the amounts reported as employment income cannot be said to be income generated from a business.

With respect to the amounts reported on Mr. Colbert's returns as rental income, the plaintiffs emphasized that there was no formal document which leased or assigned these assets to the corporation. However, an unexecuted, draft lease between the corporation and the plaintiffs with respect to the quota was entered into evidence and Mr. Colbert admitted that inquiries had been made regarding the assignment of the quota to the corporation. While these plans may not have been formally completed, this indicates an intention to lease the quota. Further, despite the lack of a formal lease agreement, the financial statements contain a footnote which states that the farm buildings and the quota were leased to the corporation as of October 1981.

The treatment of the expenses relating to the land and the quota provides further evidence that the corporation used the land and the quota from the date of its incorporation until 1984 to operate the business of producing chickens. Mr. Welsh confirmed that in 1982 and 1983, expense items relative to the land, buildings and quota, were recorded on the books of the company as rental expenses. These amounts then flowed to Mr. Colbert and were recorded in a statement of rental income. In 1982 and 1983, the company paid out $41,647 and $43,635 in "rent" respectively. This was .not done for the 1984 taxation year because the expenses were so minimal due to the disposition of the farm early in the year. In 1984, the farm did not reimburse the Colberts for expenses relating to the land. These expenses remained on the company's books and were not captioned as rental expenses. The use of the term rent to describe this reimbursement to the taxpayers, was in the opinion of Mr. Welsh, the only term that could be used to describe the payment in accordance with generally accepted accounting principles.

The plaintiffs emphasised that under the marketing board rules, a company or individual could not sell chickens unless they were the holder of a quota. Mr. Frank Fortuna, the Quota Supervisor for the Ontario Chicken Producers Marketing Board, gave evidence which confirmed this. The policy of the Board is to fix and allot quotas to persons who are beneficial owners of the premises upon which the chickens are being produced. A deed of land must be filed as evidence of beneficial ownership. Therefore, Robert and Joan Colbert were listed as the quota holders. Quota holders must apply to the Board to produce and market chickens and are obliged to report to the Board each time chickens are actually marketed. With respect to the quota held by the Colberts, Mr. Fortuna testified that no one other than the Colberts reported to the Board.Mr. Fortuna further testified that it is the policy of the Board that the chickens are produced and marketed by the holder of the quota, although he confirmed that the Board allows for the least of quotas in which case, the lessee becomes the producer.

As noted above, the evidence is not straightforward. The evidence as to the exact nature of the relationship between the parties is conflicting. However, on balance there is insufficient evidence upon which to find that the Colberts were engaged in the business of farming. After the incorporation, they arranged to receive salary from the company and thereby became employees. While the absence of a formal lease document makes it difficult to find conclusively that the land and the quota were leased to the corporation, the conduct of the plaintiffs and the accounting statements appear to indicate that the corporation used the land and the quota and paid the Colberts "rent" to compensate them for this use. It is difficult to describe such a payment as anything other than rental income. In any event, in my view, the corporation, not the Colberts, was using the land and the quota to generate business income. The Colberts, who were the eventual recipients of this income, received it as employment and rental income. Further, I cannot conclude that the corporation was a mere agent of the Colberts or that there was an implied agreement to jointly carry out the business.

In conclusion, the farm was not used by the plaintiffs to generate income from the business of farming and, therefore, does not fall within the definition of former business property in subsection 248(1) of the Act. Given this finding, it is not necessary to determine whether the second property was a replacement property within the meaning of subsection 13(4.1).

For the above reasons, the appeals are dismissed.

Appeals dismissed.