Roos v. The Queen, 94 DTC 1094, [1994] 1 CTC 2105 (TCC)

Bowman, J.T.C.C.:—These appeals are from reassessments for the appellants'1987, 1988 and 1989 taxation years. They are concerned with the computation of the profits realized by them on the sale of a number of building lots in Brighton, Ontario.

Two questions arise:

(a) Was the original purchase by them of a 39 acre parcel of land in Brighton the purchase of a capital property or was it, from the outset, part of a business or an adventure in the nature of trade?

(b) If the original purchase was on capital account at what point did a change of use take place, in effect converting the property from capital property to inventory?

Counsel for the appellants does not suggest that the property maintained its character as capital property throughout the years under appeal (McGuire v. M.N.R., [1956] C.T.C. 98, 56 D.T.C. 1042 (Ex. Ct.). It is common ground that by then the appellants were engaged in the business of subdividing and developing the property, and of selling lots. Mr. Menninga's position is, however, that a change of use, giving rise to a conversion to inventory, occurred in 1986. The effect of this under section 45 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") would be that the property would be deemed to have been disposed of at its fair market value at that time, giving rise to a capital gain in the appellants’ hands in 1986: a year that, as it happens, cannot be reassessed because it is statute-barred. If this position is correct the appellants' cost of the inventory of lots that were sold in 1987, 1988 and 1989 would be the fair market value at the date of the change of use.

The appellants, in filing their returns of income for 1986, 1987, 1988 and 1989 declared the profits realized on the sale of the lots as capital gains. The Minister appears to have allowed 1986 to become statute-barred, but he assessed 1987,1988 and 1989 on the basis that the entire transaction was, from the outset, a business or an adventure in the nature of trade and accordingly denied them the enhanced cost of inventory which would have resulted from a deemed disposition of capital property at a time prior to the date of sale.

At trial the Minister maintained this position and argued in the alternative that if there was a change of use for the purposes of section 45 of the Income Tax Act it occurred on October 19, 1984. Although this would give rise to a capital gain on the deemed disposition in a statute-barred year it would presumably be a smaller capital gain than would be the case if it occurred later since the fair market value closer to the date of sale would in all likelihood be greater. Accordingly the deemed cost of inventory under section 45 would, on the respondent's alternative position, be lower.

(a) Background

Mr. Richard Roos was born in Holland in 1939 and came to Canada in 1955. He studied geography and history at McMaster University and married his wife, Mrs. Nellie Roos, in 1966. They have three children. He has taught geography and urban planning in Brighton high school for many years. Mrs. Roos formerly taught public school. Prior to graduation Mr. Roos worked in tree nurseries and appears to have developed a considerable expertise in this area as well as in landscaping.

He and his wife purchased a home at 144 Ontario Street in Brighton and in the 1970s started in a small way to grow trees for sale. It takes about four to five years for small trees, called “liners”, to grow to a size suitable for sale. He rented from a neighbour an adjoining parcel of land, about an acre, for his nursery business. The nursery business was essentially a family affair, with both Mr. and Mrs. Roos and their children assisting.

His neighbour had given him an option to purchase the adjacent land for about $2,000. He let the option expire and the land changed hands after his neighbour's death. The new owner, one Seefeld, informed him that he would not recognize the option and would sell him the land for $25,000. Mr. Roos stated that he was not prepared to buy for such a figure, which he considered exorbitant, and that he would look elsewhere. In an act that was both highhanded and brutal, Seefeld, on September 6, 1979, peremptorily demanded that he "clear and vacate the land by September 31 [sic], 1979." Mr. Roos was thereby put in a desperate position. He was forced to transplant all of his trees to his own property. Somehow, he managed to meet Seefeld's wholly unreasonable deadline.

(b) The original purchase

He needed land for his nursery business and enlisted the aid of a Mrs. Poupart, a real estate agent. He told her that he needed land for his nursery business but he did not give her specific instructions either as to size or as to price. She found a couple of parcels. One was east of Brighton and was priced at $30,000. It was rejected because the soil was not suitable and would have required a large amount of sandy loam topsoil. Another one, on Highway 2 west of Brighton, was rejected because its frontage was too narrow, although it had between two and four acres.

Ultimately, in May of 1980 Mrs. Roos became aware of a parcel of 39 acres immediately across from their home on Ontario Street. She either saw the for sale sign herself or was told of it by Mrs. Poupart. The property was being sold under power of sale by a liquidator, the Clarkson Company, on behalf of the Royal Bank of Canada, and had formerly belonged to a developer. She called her husband at school and he came home. He took a shovel across the road and checked the suitability of the soil. He did not have time to walk the property, which was vacant and had not been cultivated for many years. As it subsequently turned out the back part was partly bush and partly swamp. He did not know what the zoning was and did not ask. Within four hours, after he came back from school in the afternoon, Mr. and Mrs. Roos signed an offer to purchase the land for $53,000, conditional only upon obtaining suitable financing. There is no evidence of any negotiation of the price.

Mr. and Mrs. Roos both explained their reasons for buying the property. It was immediately across from their existing home and was an ideal location for their nursery business. They both testified that the possibility of reselling all or any part of the property was not a motivating factor in the acquisition. Mrs. Roos was concerned about financing as they had to take out a $40,000 open mortgage at 15 per cent. Nonetheless, with Mr. Roos' salary and their own finances, they felt they could carry it, as they had no mortgage on their own home. They were well aware that 39 acres was more than they needed for their tree nursery but, given the location, which would enable them to carry on their business from their home they believed the opportunity was too good to miss.

It was suggested in cross-examination that they knew that they could sell the excess acreage and that this was a motivating factor in their decision to buy. They were not shaken in their denial and I accept their testimony. They were entirely credible witnesses. They testified that they would have bought the land if it had been only four acres. My conclusion from observing the appellants is that the additional land beyond that which they considered necessary for the nursery played no part whatever in their decision to buy. Indeed they bought it in spite of the excess acreage.

The respondent pleaded that the assessments were based upon the assumption that at the moment of purchase the appellants had in their minds the possibility of reselling as an operating motivation for the acquisition. This assumption has been thoroughly demolished. I base this conclusion not only upon the appellants' own testimony, which I accept, but upon a number of other circumstances. One is the speed with which they made an offer to purchase the land. They did not check the zoning, the topography, or anything other than the soil. They desperately needed land for the nursery. They were capable of handling the mortgage payments. The location was ideal. No steps whatever were taken until four years later to explore the possibility of selling any part of the property and that not until they were approached by third parties who enquired if they might be interested in selling some lots on Ontario Street. At that time they made some tentative and unsuccessful enquiries about selling lots but dia not pursue the idea until later. Mr. and Mrs. Roos had no idea that some years after they bought there would be a demand for lots on Ontario Street which was essentially still a county road in a small town. Indeed an expert town planner, Mr. Clarke, testified that in 1984 he prepared a report predicting that over the next ten years growth in Brighton would be, as he euphemistically described it, "stable". "Stagnant" would probably have been a better word. It is impossible to accept that a frugal and financially conservative high school teacher and tree farmer and his wife would mortgage their own home to buy, as part of a land speculation, a piece of property that a professional developer had been unable to develop or sell and which the bank was selling under its power of sale.

Counsel for the respondent suggested that whenever one purchases more land than is necessary to carry out a capital” purpose the excess must necessarily be inventory. There might be circumstances in which this is so (for example, rap ley v. M.N.R., [1984] C.T.C. 2676, 84 D.T.C. 1562), but it is not a principle of law (see, for example, Brampton Brick Ltd. v. M.N.R., [1963] C.T.C. 57, 63 D.T.C. 1033, per Thurlow, J. at page 6 (D.T.C. 1036)), and is not in accordance with common sense. It certainly is not the case here. The Rooses had no choice but to buy the entire 39 acres. They believed the liquidator would not agree to selling only a portion. If, after the sale they had immediately severed off enough for the nursery (and subsequent events would appear to indicate that they would not have been permitted to do so in any event) the sale would unquestionably have been on capital account. The acquisition of the excess was a necessary incident of the acquisition of property required for the nursery. The transaction was entirely on capital account. Their entire course of conduct is consistent with the acquisition of the entire 39 acres being a transaction on capital account. It is not consistent with the acquisition being part of a business or a speculation in land.

Counsel for the respondent agreed that the land used for the nursery— which ultimately expanded to about four acres—was capital in the appellants’ hands. From this position he argued that the fact that they did not immediately sell the excess proved that they had an intention from the outset to sell the surplus land later at a profit. I do not think that as a matter of logic or of common sense the conclusion follows from the premise.

(c) Subsequent events

The situation continued until some time in 1984. The Roos family operated and expanded the nursery until it covered about four acres. They made no effort to sell the excess lands but sometime in 1984 they were approached by a number of persons who enquired whether they might be interested in selling lots along Ontario Street, on which they had a frontage of about 882 feet.

Mr. Roos made some enquiries of the building inspector who told him that the municipality was not in favour of his selling lots along Ontario Street because it wanted the back part to be developed with internal roads. Mr. Roos then, on October 19, 1984, submitted to the town of Brighton a document called “Application for Plan of Subdivision”. This is purely an informal procedure designed to give the municipality an opportunity to make its views known if the owner proceeds with a formal application to the Ontario Ministry of Municipal Affairs and Housing. The one page document stated that the land covered by the application was about four acres. The application was not proceeded with and the $200 processing fee was not paid. The Rooses were concerned with the complications, risks and possible expense. As Mrs. Roos stated the prospect of obtaining a plan of subdivision, even for a few lots to enable them to sell to persons who wanted lots on Ontario Street, was abandoned almost as soon as the form was submitted because it was "scary". This is not exactly the reaction of a land developer.

After the abandonment of this notion the Rooses decided they would like to move across the street and put their home immediately next to their nursery operation. A number of considerations prompted this decision, including convenience, safety and efficiency of operation. For reasons that were not made very clear they seemed to believe it was either necessary or desirable that they obtain a severance of the land necessary for their home and nursery from the rest of the property. There was no legal requirement that they do so and they were again told that the municipality would not give them a severance. Mr. Clarke, the engineer and town planner, explained that the municipality did not want a number of accesses to individual homes on Ontario Street.

The municipality was, however, prepared to entertain the idea of a subdivision and on February 6, 1985 the county engineer wrote to Mr. Roos to this effect. On February 14,1985 Mr. Roos wrote to the county engineer expressing his objections to the municipality's rejection of his plan to proceed with severances rather than by way of a plan of subdivision. His objections were to no avail. On March 5,1985 he submitted, together with a cheque for $1,000, a further application to the town of Brighton for a plan of subdivision.

Although that document stated that the acreage of the subject lands was “about 39 acres total", when he appeared in May before the town council in support of his application he stated that he wanted approval for ten lots only, six on Ontario Street and four on a proposed new street. His proposal was approved in principle by the town council.

On June 12, 1985 he applied for approval under section 50 of the Planning Act to the Ministry of Municipal Affairs and Housing. His application was in respect of ten lots only.

In August of 1985 the Rooses sold their home and shortly thereafter moved to a newly constructed home across the street, on land adjacent to the nursery.

The draft plan of the proposed subdivision was approved on September 16, 1985, subject to a large number of conditions, including the registration of a subdivision agreement between the municipality and the owner.

In February of 1986 a sketch of Phase II, comprising lots 11-32 was prepared and was sent by the Planning Co-ordinator of the Town of Brighton by Mr. Paul J. Allore to Mr. Bob Clarke of Totten Sims Hubicki Associates Ltd., who were engineering and planning consultants retained by the town.

Throughout these documents lots 1-10 are described as Phase I. The remaining lots that were developed subsequently described as Phase II.

On February 21, 1986 a subdivision agreement covering 1.039 hectares, that is to say, the ten lots comprising Phase I, was signed by Mr. and Mrs. Roos, the Town of Brighton and the Brighton Public Utilities Commission.

On January 6, 1986 the Town of Brighton changed the zoning of the area comprising Phase I from D to R-1, thereby permitting the area to be used for single family dwellings. The subdivision plan for Phase I was registered on June 2, 1986. During the summer and fall of 1986 development on Phase I proceeded. According to notes on the draft plan relating to Phase II dated October 9,1986 (obviously made later) eight or nine lots in Phase I were sold in 1986 and, it appears, one was sold in 1987.

On October 14, 1986 the Rooses applied for approval under section 50 of the Planning Act for a plan of subdivision covering a further 48 lots to be included in Phase Il and on November 27, 1986 a similar application was submitted to the Town of Brighton. Draft plan approval was obtained on March 31, 1987. On April 20, 1987 the zoning was changed.

In fact the plan of subdivision for Phase II was registered in two stages, on June 29, 1987 in respect of 24 lots and, on March 23, 1988, in respect of the remaining 24 lots. These two stages of Phase II have since become designated as Phases II and III.

There is, evidently, a Phase IV in the offing but it seems to be stalled. It appears that some 15 lots were sold in 1987, 26 in 1988 and 9 in 1989.

Since I have concluded that the land was originally capital property in Mr. and Mrs. Roos' hands, and that a change of use took place at a later date, the question which must now be decided is: when did that change of use take place?

The effect of a change of use of property was discussed at some length by the House of Lords in Sharkey v. Wernher, [1955] 3 W.L.R. 671, [1955] 3 All E.R. 493. In that case Lady Wernher had a stud farm, which was a business and a racing stable, which was not, and was maintained for her own recreation. She removed five horses from the former to the latter. The House of Lords held that by that act she had effected a disposition of the horses and was obliged to bring their then fair market value into the determination of the profits from the stud farm.

The case was followed by Thurlow, J. (as he then was) in M.N.R. v. Frankel Corp., [1958] C.T.C. 314, 58 D.T.C. 1173 (Ex. Ct.) and distinguished by the Supreme Court of Canada in reversing his decision ([1959] S.C.R. 713, [1959]

C.T.C. 244, 59 D.T.C. 1161).

The English legislation contained nothing similar to section 45 of our act.

Paragraph 45(1)(a) of the Income Tax Act reads as follows:

45 (1) For the purposes of this subdivision the following rules apply:

(a) where a taxpayer,

(i) having acquired property for some other purpose, has commenced at a later time to use it for the purpose of gaining or producing income, or

(ii) having acquired property for the purpose of gaining or producing income, has commenced at a later time to use it for some other purpose,

he shall be deemed to have

(iii) disposed of it at that later time for proceeds equal to its fair market value at that later time, and

(iv) immediately thereafter reacquired it at a cost equal to that fair market value.

The time at which a change of use takes place for the purposes of section 45 is a question of fact depending on all of the circumstances.

Mr. LeBlanc contended that if I did not accept his argument that the property was inventory from the outset, the change of use took place on October 19, 1984 when Mr. Roos submitted the unofficial application to the Town of Brighton. I do not regard that as a "clear and unequivocal positive act implementing a change of intention . . . necessary to change the character of the land in question from a [capital] asset to a [trading] asset". (Edmund Peachey Ltd. v. The Queen, [1979] C.T.C. 51, 79 D.T.C. 5064 (F.C.A.) at page 55 (D.T.C. 5067), per Heald, J. See also Magilb Development Corp. v. The Queen, [1987] 1 C.T.C. 66, 87 D.T.C. 5012 (F.C.T.D.)). Mr. M.J. Bonner (now Judge Bonner), sitting as a member of the Tax Review Board, in Dawd v. M.N.R., [1981] C.T.C. 2999, 81 D.T.C. 888 at page 3003 (D.T.C. 891), held that the point at which the taxpayer

abandoned a course of action involving simple disposition of those parts of the land which he owned, and which were surplus, and to have embarked with Mr. Jones on the more complex process leading to the joint subdivision of the lands belonging to both.

fixed the time at which the development business commenced. On the facts before him he held that the turning point was the filing of certain plans. In this case the filing of a document with the Town of Brighton, a proceeding without statutory sanction or legal effect, and one that was immediately abandoned and that was, in any event, no more than a course of action which the appellants considered as a necessary alternative to severing a couple of lots is altogether too tentative and too equivocal to bring about the significant effect of converting what was clearly a capital property to inventory, and the concomitant tax consequence of a deemed disposition in 1984.

During the course of argument I suggested to Mr. Menninga that possibly the operative date for the change of use was the registration of the subdivision agreement and of the plan of subdivision, on the basis that at that point the appellants had given binding commitments and had taken a final irrevocable step prior to actual development that entitled them to accept offers to purchase. On reflection I think that point in time is too late. The step, at least in this case, that conforms most closely to the clear and unequivocal positive act" referred to by Mr. Justice Heald is the submission of the formal application to the Ministry of Municipal Affairs and Housing for a plan of subdivision. By this time they were fully committed to proceeding with the subdivision and had progressed far enough that their change of intention was evident from their affirmative acts.

Thus the change of use with respect to the 10 lots in Phase I took place on June 12, 1985 and, with respect to the 48 lots originally included in Phase II on October 14, 1986.

No evidence of fair market value was adduced, and quite properly so. It would have been premature to call evidence of fair market value until it was determined whether the land was originally capital in the appellants’ hands and, if so, whether a change of use took place, and when it did so. This is in accordance with the decision of the Tax Review Board in Dawd, supra.

The appeals will be allowed and the assessments referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with these reasons, on the basis that a change of use of the property in Phase I of the development took place on June 12, 1985 and of the property in Phase II (now Phases II and III) on October 14,1986, resulting, for the purposes of section 45 of the Income Tax Act, in a deemed disposition at the fair market value at those times of those properties and a deemed acquisition thereof, as inventory, by the appellants having a cost equal to that fair market value so determined. The appellants are entitled to their party-and-party costs. Only one counsel fee for both appellants is allowed.

Appeal allowed.