Grouchy v. The Queen, 90 DTC 6267, [1990] 1 CTC 375 (FCTD)

Martin, J.:—The taxpayer plaintiff, Frank Grouchy, appeals the reassessment of his income for his 1981 and 1982 taxation years whereby certain income for those years, which had been claimed as being on capital account, was characterized by the Minister of National Revenue as being on income account and therefore taxable in full rather than at the 50 per cent preferred capital gain rate.

The amounts involved arise as a result of the purchase and sale by the partnership of the plaintiff and his brother-in-law Harold Ryan, G.R. Holdings, of 14 townhouses in St. John’s, Newfoundland, during the two-month period between October 31, 1980 and December 29, 1980. The properties were purchased by the partnership on October 31, 1980 for $348,000 and sold on December 29, 1980 for $427,000 {these amounts and the others referred to herein are approximate) for a gain to the partnership of some $79,000.

The plaintiff, who gave evidence at the trial, is the owner-manager of an automobile parts, tire and supply business in St. John's known as Grouchy's Ltd. He has carried on this business for a number of years prior to forming his partnership with Harold Ryan in 1980 and has been fairly successful, so much so that he thought he would like to retire in about ten years' time when he reached the age of 55.

He said that for several years prior to forming the partnership with Ryan he had been thinking in investing in rental real estate in St. John’s with a view to building up a rental income for his retirement. At the time he was considering this venture he had excess cash and his automotive business had been and was moderately successful.

Harold Ryan was chosen as a partner because of his knowledge of the construction business and of the quality of rental properties. The plaintiff, for his part, thought he brought to the partnership a better business sense and, perhaps, a better credit rating.

Ryan brought to the plaintiff's attention, at about the time they agreed to form the partnership, the possibility of the purchase of the 14 townhouses to which reference has already been made. The houses had been constructed in 1974 by Modern Developers Ltd., a company in which Ryan held a minority interest. All of the houses were mortgaged to Central and Eastern Trust Company and all, in October of 1980, were tenant occupied.

In addition to Ryan's recommendation to purchase the property, Grouchy was given a document prepared by somebody at Modern Developers Ltd. which showed the municipal number of each townhouse, the outstanding balance of the principal amount of the mortgage, the name of the tenant, the monthly rental and the amount of the monthly mortgage payment.

In summary this document, which along with Ryan's recommendation and the age of the townhouses convinced Grouchy that their acquisition would be a good investment, showed the outstanding principal balance on the mortgages to be $238,000, the monthly rental income to be $4000 and the monthly mortgage payments, which included amounts sufficient to cover municipal taxation, to be $3000. Given that information and the asking price of $448,000 Grouchy agreed to accept Ryan's recommendation and the partnership purchased the properties on December 29, 1980, having entered into an agreement to do so on December 10, 1980.

At the trial Grouchy, not unexpectedly, said that at the time of the purchase of the townhouses it was not his intention to sell them but rather he had bought them as an investment with the intention of building up a rental property portfolio.

Counsel for the defendant points out that the sale, just a few weeks after the purchase and in the absence of any proof that Grouchy's original intention to hold the property as an investment had been frustrated, supports the contention that the plaintiff must have bought with the primary or at least secondary intention of selling the properties if the price was right. Furthermore she points out that the sale was made to the first person who offered to buy them and it appeared that the only restriction the plaintiff had on selling the property was in obtaining the “right price". She says the fact that the sale was voluntary and not forced tends to support the contention that the original intention in acquiring the houses was to sell them at a profit as soon as a satisfactory one could be obtained.

As well counsel for the defendant points to the plaintiff's partner Ryan, whose business is admittedly dealing in real estate, as an indication that the plaintiff had thrown in his lot with Ryan and was, in partnership with him, carrying on the business of dealing in real estate. She points to what she indicates to be the plaintiff's minor personal investment of $2600 in the $348,000 purchase price as being more consistent with a real estate dealing scheme than investment. In further support of her contention that a subsequent sale rather than an investment was the purpose of the purchase she points to the lack of any long-term projection of income and expenses prior to the acquisition of the properties.

In support of her submissions counsel for the defendant has cited, among other cases, the 1978 Tax Review Board case of Danchak v. M.N.R., [1978] C.T.C. 3049; 78 D.T.C. 1770, in which a partnership between the manager of a firm engaged in the construction business and a corporate dealer in land acquired property which it subsequently resold after it had received an unsolicited offer to purchase it. In that case the Board found that the sale by the taxpayer was a sale in the course of an adventure in the nature of trade and that the resulting profit was income from a business.

Although that case bears some similarity to the present one, the unsolicited offer resulting in the subsequent sale, the rapid acceptance of that offer, the expressed intention to hold the property acquired as a rental income property, and the partnership aspect, there are significant differences. Unlike the plaintiff in this case, the plaintiff in Danchak was a person relatively sophisticated in matters relating to the purchase and sale of land and the venture was in a field closely related to the taxpayer's ordinary earning pursuits.

In the present case the 1980 purchase was the first time the plaintiff had acquired real estate either for investment or resale and, irrespective of which purpose the real estate was acquired, neither purpose had any relationship to the plaintiff's ordinary means of earning his living in the automotive parts trade.

I agree that more formal projections of income and expenses over a longer period of time would have lent more credence to the plaintiff's claim that he intended the acquisition as an investment rather than as inventory for business. However, given the information which the plaintiff had, I cannot find that it was inconsistent with his expressed intention. He says he thought that real estate in St. John's would be a secure investment. There were 14 townhouses, all rented with the rental payments exceeding the mortgage payments and municipal taxes by about $1000 a month. He was mistaken about the maturity dates of the mortgages but had he addressed his mind to the actual facts rather than to the mistaken surmise that the mortgages would not have to be renewed for a period of about five years from the date of the purchase, it would not have been unreasonable for him, in my view, to conclude that the mortgage company would be prepared to renew the mortgages.

I give little weight to the defendant's suggestion that the plaintiff invested only $2600 of his own money into the project. He invested the further amount of $55,000 which he borrowed from the bank and for which he, and not some non-recourse-shell-of-a-company, was personally liable. Furthermore he was personally liable, as a partner, for the full amount of the outstanding principal amounts due under the mortgages the repayment of which the partnership had assumed at the time of the purchase. That represents, to me at least, a substantial personal investment because he was personally liable for at least one half of the full purchase price. It may be technically correct to say that he had invested only $2600 of his own money but in my view it is misleading.

Counsel for the defendant is right when she points to the quick resale as tending to show an original intention to acquire for the purpose of selling rather than for an investment but it is not conclusive. Nor is it conclusive of such an intention if at the time of the purchase of the property the plaintiff considered the possibility of a future sale. In order to bring the gain on the sale into income as opposed to capital there would have to have been, at the time of the acquisition of the property, the primary intention of selling or the intention of selling it must have been one of the motivating factors leading to the purchase, sometimes called the secondary intention.

The fact that a taxpayer admits at the time he acquired the property he knew that he would resell it immediately after the acquisition if he were offered a sufficiently high price would not of itself change the transaction from a capital one to an adventure in the nature of trade.

This distinction was made quite clearly by Noël, J. in Racine et al v. M.N.R., [1965] C.T.C. 150; 65 D.T.C. 5098 at 5103, when he wrote the following:

. . . It is not, in fact, sufficient to find merely that if a purchaser had stopped to think at the moment of the purchase, he would be obliged to admit that if at the conclusion of the purchase an attractive offer were made to him he would resell it, for every person buying a house for his family, a painting for his house, machinery for his business or a building for his factory would be obliged to admit, if this person were honest and if the transaction were not based exclusively on a sentimental attachment, that if he were offered a sufficiently high price a moment after the purchase, he would resell. Thus, it appears that the fact alone that a person buying a property with the aim of using it as capital could be induced to resell it if a sufficiently high price were offered to him is not sufficient to change an acquisition of capital into an adventure in the nature of trade. In fact, this is not what must be understood by a “secondary intention" if one wants to utilize this term.

To give to a transaction whichjnvolves 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.

which was approved by Walsh, J. of this Court in Pierce Investment Corp. v. M.N.R., [1974] C.T.C. 825; 74 D.T.C. 6608 at 6612.

As opposed to what inferences may be drawn from the quick sale in this case, which might not support the plaintiff's expressed intention, there is the fact that the partnership took no steps to initiate the sale. It was an unsolicited offer to purchase the property by one Edward Hearn which initiated the activity resulting in the sale. Granted the actual price was stated by the plaintiff but this, in my view, was just another way of stating what Noël, J. observed was a “sufficiently high price” which, if offered the moment after the property was purchased, would cause the plaintiff to resell, and is not either conclusive or even sufficient to change an acquisition of capital into an adventure in the nature of trade.

The defendant has alleged that Ryan had extensive dealings in real estate development and sales and was familiar with the real estate business. Assuming that to be true it would indicate that Ryan would have some difficulty in persuading anyone that his portion of the partnership gain should be on capital account. Ryan's business was dealing in real estate and, prima facie, a profit on a real estate transaction would be on income account. Indeed the defendant introduced evidence that Ryan had told a Department of National Revenue tax auditor that the townhouses had been acquired from Modern Developers Ltd. with a view to renting them for a year and then selling them when the time was right.

Counsel for the defendant did not explain how this evidence was admissible or, if admissible, how it would be relevant to the plaintiff's intention when the townhouses were acquired. Assuming its admissibility it would only tend to show what Ryan's intention was at the time of the acquisition and not, in my view, what the plaintiff's intention was. Because there was nothing in the evidence which convinced me that Ryan's intention at the time of the acquisition of the townhouses should be attributed to the plaintiff I find the evidence of Ryan's intention irrelevant.

Counsel for the defendant suggested that Ryan's intentions should be attributed to the plaintiff because, if I understand her submission correctly, Ryan was the plaintiff's alter ego and he was, in effect, exercising the plaintiff's judgment for him. She is correct when she says that the plaintiff relied and relied heavily upon Ryan's recommendations for the acquisition of partnership real estate. However the plaintiff did not rely on Ryan's recommendations exclusively nor did he accept all of his recommendations. In fact on one of the occasions when the partnership acquired property it relied upon the plaintiff's advice. As counsel for the plaintiff said his client and his chequebook did not blindly follow Ryan's advice. In my view the evidence discloses that the plaintiff listened to Ryan's advice and then exercised his independent judgment on whether or not a given property would be acquired. The fact that Ryan's advice was accepted more often than it was rejected does not lead me to the conclusion that the plaintiff had abandoned his investment intentions and substituted those of Ryan.

Although the taxpayer's expressed intention at the time of the acquisition of the property is not conclusive of that intention it does not have to be completely ignored. Granted that there would be no trial if his intention was not that which he has said it was, but some weight, beyond its mere expression, should be given to it when one finds, as in this case I have found, the taxpayer to be an open, frank and credible witness. Counsel for the defendant aid, quite properly, point to inconsistencies in his discovery evidence and his evidence at trial but those inconsistencies were, in my view, of a relatively insignificant nature and no more than one would expect from an honest witness giving evidence of events and recollections of intentions which occurred years earlier. The plaintiff said, and I believe him, that it was his intention to acquire the townhouses as part of a real estate rental investment portfolio. He said, and once again I believe him, that he had no intention of selling the townhouses at the time they were acquired.

I am cautioned not to accept too uncritically expressions of intention but rather to see what inferences may be drawn from the taxpayer's actions. In this respect, and it is most significant in this case, I have had regard to the real estate dealings of the partnership from the time of its inception in 1980 to the time of the trial. During that entire period there were a total of five transactions in which the partnership acquired real estate with the last one being in 1984. More importantly, during the entire period, there was only one transaction in which the partnership sold real estate and that was the single transaction in December of 1980 in which the 14 townhouses were sold.

More than any other factor I have been influenced by the partnership's subsequent dealings in real estate. These subsequent dealings have convinced me of the truth of the plaintiff's evidence that his intention has always been to acquire real estate as an investment with a view to building up a real estate rental portfolio.

The one sale which the partnership made in 1980 I regard as an exception to the partnership's established practice and as one which the motivation for or the intention to make did not exist at the time of the purchase of the townhouses in 1980.

Counsel for the plaintiff, in his submissions, made a rather technical argument based upon the burden of proof and why, in his view, the assumptions of fact made by the Minister were insufficient to place any burden of proof on the plaintiff and, because of their vagueness, they would be insufficient to support the assessment made by the Minister. I found his argument intriguing but, given the view I have taken of the evidence, I do not find it necessary to make any decision on the basis of that argument. That is to say I am satisfied that the plaintiff's evidence of his intention at the time of the acquisition of the townhouses Is accurate.

For the foregoing reasons I have concluded that the plaintiff's appeal should be allowed with costs. Therefore, pursuant to paragraph 337(2)(b) of the Federal Court Rules, counsel for the plaintiff is directed to prepare a draft of the formal judgment and to submit the same to counsel for the defendant for approval as to its form and then to me for review and, if accepted, for entry.

Appeal allowed.