Hebert v. The Queen, 86 DTC 6543, [1987] 1 CTC 6, [1986] 2 CTC 123 (FCTD)

Rouleau, J. [Translation]:—This is an appeal pursuant to section 172 of the Income Tax Act, S.C. 1970-71-72, c. 63, as amended, against a decision of the Tax Review Board (now the Tax Court of Canada) which dismissed the taxpayer's appeal in respect of assessments made by the Minister of National Revenue for 1976, 1977 and 1978. The Minister added to the plaintiff’s income profits from the sale of seven buildings during the years in question. These profits had been reported by the taxpayer as a capital gain.

It thus falls to me to determine whether the profits from the sale of these buildings are business income, as the Minister held, or are a capital gain as the taxpayer maintained.

The taxpayer's activities from 1971 onwards can be summarized in tabular form as follows:

The evidence established that the plaintiff built his apartments himself: he was the foreman. Moreover, this was his only occupation throughout these years. Though he was a carpenter by trade, he did not work for any other building contractor. His greatest wish was to be in a position in which he could live on his rental income. To attain this objective, the taxpayer at various times (see preceding table) purchased land on which he himself built apartment buildings which he rented as soon as construction was complete. In the mid-seventies, therefore, he had a number of apartments rented. However, because of mortgages and excessively low rentals, his net annual income was not sufficient to completely support him. The only way

*Still Mr. Hébert’s property.

he could manage was to build other more costly apartments which would bring in more money. To do this, however, he lacked the necessary capital, and so he financed his new construction by selling his older and smaller buildings. l now reproduce certain passages from the examination-in-chief of Mr. Hébert, which clearly illustrate the constraints he had to face and the means he used to deal with them. The passages are taken specifically from pages 18-23 of the transcript, dealing in particular with the building located at 1920 rue Lavallée.

Q. What did you intend when you purchased the land?

A. To build an apartment building.

Q. When did you begin construction?

A. In the fall, right away, right after that, as soon as I had the building permits.

Q. And approximately when did the construction end?

A. Sometime in the following spring.

Q. Did you put it up for rent?

A. As soon as work was finished.

Q. During or after the construction, but before putting it up for rent, did you try to sell this building?

A. No, I did not try to sell it.

Q. Did you receive offers to purchase this building from time to time?

A. For that one .. . while it was being built? No. But later . . . you always get offers for a building under construction, there is always someone in the market who goes around looking for buildings that can be bought cheaply.

Q. When you built that building, Mr. Hébert, did you think you would be able to get sufficient rental income from it to live on?

A. No, no, no, what can you get with a mortgage? The annual return is almost nothing, it is a question of . . . a question of a few dollars a year from it, perhaps $1,000 or $1,200 left per annum per house.

Q. So did you think it would be necessary to sell that building?

A. No, not for the . . . no, no, not at that time.

Q. Then how did you think you could get sufficient rental income?

A. Well . . . by building others.

Q. Why did you sell it?

A. I sold it because at a certain point, when you start with nothing, you cannot always . . . you cannot carry a heap of apartments, a whole lot of apartments, if you don’t have the necessary cash. The banks lend — they don’t lend at 100% they lend at 70%.

And a little further on:

Q. Why did you decide to sell this building and not others you owned at the time?

A. Because this was a single house, and it was the oldest one of the lot.

Q. The oldest one — does that mean in terms of profitability? — more or less profitable?

A. Less, less profitable in terms of price — the price of an apartment was lower in that house than in the new houses. In the houses . .. the other houses I had . . . which I built at the same time, the apartments were more modern, and could be rented for a higher rental than this house, which was on its own.

Q. When you speak of the price of an apartment, you mean the rental from it?

A. Yes, yes, that’s right.

Q. So you sold it in 1976: what did you do with the proceeds of disposition from that sale?

A. I reinvested the money in other newer, more modern buildings closer together.

The key argument of counsel for the plaintiff is that the latter never built these apartment buildings for the purpose of reselling immediately at a profit. He sold some of his buildings so that he could acquire a larger number of more costly apartments that would bring in a higher rental income. In the submission of his counsel, the taxpayer simply upgraded his investment portfolio. Counsel for the defendant was of the view that at the time the plaintiff built the buildings he had a secondary, if not primary, intent of selling the said buildings for residential purposes at a profit.

I echo what others have already said in concluding that the answer to the case at bar turns essentially on a question of fact. Each case must therefore be assessed in light of its particular circumstances, and the many court decisions cited on either side in support of the arguments of counsel in my opinion have only a persuasive authority. No two situations are in fact identical. In Roy M. Power v. The Queen (a judgment not reported in French, dated October 9, 1975, No. T-3376-74 of the Federal Court record, reported in English at [1975] C.T.C. 580; 75 D.T.C. 5388), Addy, J. stated:

All issues must be determined by a careful consideration of all of the relevant evidence both direct and circumstantial. In any particular case, a specific piece of evidence might, by reason of the surrounding circumstances of that case, necessarily possess great probative value while, in another case, evidence to the same effect might carry little or no weight. The Court must also bear in mind that facts often speak louder than words and that free acts are very good [sic] indication of what a person really intends and overt acts and their results constitute an excellent means of deciding what the intention actually was. In the same manner, other circumstances, which are not the result of any particular action of the person at the time and place in question, might also be of considerable help in deciding the issue of intention.

Having said that, it is nevertheless often difficult to distinguish between a Capital gain and business income. As Thorson, P. of the Exchequer Court properly noted in John Cragg v. M.N.R., [1952] Ex. C. R. 40, at 46; [1951] C.T.C. 322 at 327:

The question in each case is what is the proper deduction to be drawn from the taxpayer's whole course of conduct viewed in the light of all the circumstances. [Emphasis added.]

In examining the “taxpayer's whole course of conduct", various courts have considered the following factors:

(a) the number and repetition of similar transactions by the taxpayer,* [1]

(b) the circumstances surrounding disposal of the property, [2] + and

(c) the intent or motivation of the taxpayer at the time the property was purchased.:t [3]

These factors, sometimes objective and sometimes subjective, are not an exhaustive list. There are others, though these are the ones most frequently used. One must also be careful not to arrive at any final conclusion as to the nature of the transaction based on only one of these factors. The taxpayer's course of conduct must be viewed as a whole. Accordingly, applying these factors to the case before the Court, I arrive at the following results.

First, as to the number and repetition of similar transactions by the taxpayer, the evidence was that he needed only two transactions to sell the seven buildings and has sold no others since 1978. The evidence further established that since 1980 Mr. Hébert has been receiving from these other rental buildings, and from those he was able to construct after disposing of the buildings on rues Lavallée and Lamarre, rental income which he himself said in his examination was adequate. One might at first conclude from these two observations that a limited number of transactions (not to say an isolated or unusual transaction by the taxpayer) necessarily means that the benefit was a capital gain, and conversely be forced to conclude that a large number of transactions denoted an intention to carry on a business for profit. Unfortunately it is not that simple, since as Lord Clyde observed with striking imagery in The Balgownie Land Trust Ltd. v. C.I.R. (1929), 14 T.C. 684 at 691:

A single plunge may be enough provided it is shown to the satisfaction of the Court that the plunge is made in the waters of trade.

As can be seen, this factor taken by itself must be treated with caution.

Turning now to the circumstances surrounding disposition of the buildings, many of these were cited by the taxpayer. I need only mention the poor “quality” of tenants, namely persons who were not working or were on welfare, which made the collection of rent difficult, whether the area was suited for residential buildings, the unduly low rents and, most importantly, his lack of capital to finance the project on rue Séguin.

Finally, with regard to the intent or motivation of the taxpayer at the time he purchased the property, this is generally recognized to be the most significant factor, though one could not arrive at any final conclusion about the nature of the transaction based simply on the testimony of the party principally concerned as to his intent when he purchased the property.* [4] The conduct and activities of the taxpayer must also be consistent with this stated intention. [5] The evidence in the case at bar was that the taxpayer reinvested the proceeds of disposing of the buildings on rues Lavallée and Lamarre in the rue Séguin project.

As I pointed out earlier, these factors cannot be conclusive by themselves. However, when I look at the results as a whole I can only conclude that the taxpayer was not engaged in a business, and accordingly that the proceeds of disposition of the buildings were indeed a capital gain.

To find further support for the view that this was actually a capital gain, I looked closely at the extensive list of cases submitted by the parties both to the Tax Review Board and to this Court, cases which though only having a persuasive authority value had some resemblance to the case at bar.

First, The Queen v. Grant Kyllo, a judgment not reported in French, dated May 19, 1976, No. T-1334-75 of the record of the Federal Court of Canada (reported in English only at [1976] C.T.C. 409; 76 D.T.C. 6235); I reproduce, with some deletions, the facts as reported by my brother Collier J. (at 3-7):

In 1964 the defendant embarked on a course of dealings with the object of providing his own pension or retirement plan. The essence of it was to purchase interests in apartment buildings. The apartments would be an investment, with the rental income from the suites the security for his later years.

In 1964 his personal assets were the family home, a car and shares in Block Bros Industries Limited [the real estate agency for which he was working] worth $10,000. In that year he and the manager (Sawatsky) of another Block Bros office joined together to purchase a 20-suite apartment block in the Marpole area of Vancouver. This was described as the Montcalm property. The defendant put in approximately $1,000 of his own cash plus the legal costs of the transaction. The purchase of the building was essentially financed through first, second and third mortgages. The property was purchased from a Block Bros company. In November of the following year the defendant bought out his partner’s interest. Sawatsky had found a larger apartment block in which he wanted to invest; he also wanted to be on his own. The Montcalm property was managed by another Block Bros company which was in the business of property management. The defendant paid a management fee. The Montcalm property eventually progressed into a financial position where it was just paying its own way.

In 1966 the two Block brothers were personally building a brand new apartment block (27 suites) in the Marpole area. It was known as the Jordanaire. It was a much better and newer building than the Montcalm property and, of course, had more suites. Arthur Block indicated an interest in selling his one-half interest. The defendant made an offer of purchase which was accepted. He paid Arthur Block by transferring to him his shares in the public company, and by obtaining a second mortgage on the property. His cash equity outlay was approximately $10,000. Once Jordanaire was fully rented it began to show a small return. Jordanaire was not managed by a Block Bros company but by the defendant. He did not charge for his services.

The defendant sold the Montcalm property in the spring of the same year. He said, and I accept his evidence, he did not feel he could afford both it and the Jordanaire property. He sustained a loss of approximately $8,000 on the sale of the Montcalm building. He did not for tax purposes claim the loss as a deduction against income.

In 1967 a salesman drew his attention to another apartment building in Burnaby, BC. It was on Imperial Avenue, had 18 suites, and had been listed for sale through Block Bros. The defendant, because of his association and friendship with Henry Block, drew it to his attention. The two decided to buy. They did not make a thorough investigation. They relied primarily on the recommendation of the real estate salesman. Once the transaction was completed it was found a great deal of renovation would have to be done. The cost, when balanced against potential income, was unrealistic. After holding it for 60 days, they were able to sell it, using the services of the Block Bros organization. The defendant realized, on this transaction, a profit of $1,667. He was subsequently assessed by the Minister of National Revenue for tax on that gain, He did not appeal the assessment. He felt the legal costs of disputing it would probably be more than the amount involved.

His purpose in buying an interest in the Imperial Avenue property was to increase his holdings of rental suites and so provide a greater income for his later years. I accept his evidence as to that purpose.

In February of 1968 the defendant was given an opportunity to acquire an interest in a new apartment building to be built near the Central Park area in Burnaby. The other principal was, once more, Henry Block. This building was ultimately named the Kay-Jean. It had 48 suites. The defendant was to have an interest of 10/48 (10 out of the 48 suites). Henry Block held the other 38/48 interest. The estimated cost of construction was approximately $480,000. The construction was carried out through a Block Bros company. As it neared completion, the costs had risen approximately $100,000 over estimate. The defendant was required to put up $40,000 more than he had anticipated. To raise the additional funds he obtained a second mortgage on Kay-Jean and sold his interest in Jordanaire. That sale was made to a purchaser introduced by Henry Block. The sale of the defendant’s interest in Jordanaire realized, as I have earlier recounted, $47,181. Part of the proceeds were put into the purchase of his interest in Kay-Jean.

The defendant testified that if the costs in Kay-Jean had not increased he would not have disposed of his interest in Jordanaire. He said, and I accept his evidence, his purpose in acquiring an interest in Kay-Jean was to increase his investment in rental suites. It was part of his long-term plan of acquiring a sufficient number, either in one particular property or in more than one property, to provide security for later years.

In December of 1969 he was given the opportunity to participate with Henry Block in the acquisition of an even larger apartment unit, the El Rancho. There are actually three separate buildings in this complex. It has 132 suites and is located near the Lougheed Mall in Burnaby. The defendant was originally to hold a 21% interest. Henry Block was to have the remainder. The defendant required approximately $110,000 as a “down payment”.

In the meantime he had acquired further shares in the Block Bros public company. To finance his 21% interest in El Rancho he proposed to sell all his other interests including Kay-Jean and his Block Bros shares. He sold his interest in Kay-Jean through the services of Block Bros. He was unable at the time of committing himself to El Rancho to sell his Block Bros shares. An underwriting was taking place. He was advised by one of the Block brothers he was probably not permitted to sell his shares because of insider trading regulations.

When he was able to sell them, their market value had dropped considerably. He was forced to obtain further financing through second and third mortgages and to sign a note for $10,000. He put up, in respect of El Rancho, $30,000 to $40,000 cash, part of which came from the sale of the Kay-Jean property. Because of his financing problems he was compelled to reduce his interest in the El Rancho purchase from 21% to 15%.

The defendant said his purpose in getting into El Rancho was again to increase (for practical purposes) his quantitative holding of suites for income purposes, particularly in later years. El Rancho was a much larger complex than he had been in before. He wanted to consolidate and get into a larger operation such as this one. To do so he had to realize his other assets, including his interest in Kay-Jean. I accept his evidence and his intention as sworn to. It is consistent with his whole course of dealings starting in 1964.

At the time of trial, the defendant still holds his interest in El Rancho. There have been financial problems since the acquisition. He has had to take certain economic steps to retain his interest. But he has not sold. [Emphasis added.]

Before concluding, Collier, J. summarized the arguments of the parties in two short paragraphs, at 7 and 8. These arguments should be reproduced here, since they coincide in almost all respects with those of the case at bar.

Counsel for the defendant [Mr Kyllo] contends these five purchases and four sales over a period of five years were not with the intention of realizing a profit when an opportunity arose. He submits that they were all part of an investment scheme in rental income producing suites. The object was to acquire interests in more and better suites to provide larger and more assured future income; the fact some gains were made in the progression is incidental. I accept and agree with those submissions.

Counsel for the plaintiff urged the gains realized on the way to the defendant’s professed ultimate goal ought to be treated as trading or income gains; that the defendant throughout the period 1964 to 1969 had gone into the business activity of buying, holding, and disposing of apartment buildings; that everything was done, in some way, through Block Bros, an organization obviously in the business of, among other things, trading in real property.

Collier, J}. concluded as follows, at 8:

The defendant’s actions in endeavouring to create an upward progression in the apartment interests he acquired were, to my mind, much more consistent with an overall investment purpose than a mere trading purpose. In his employment he had no pension plan or retirement benefits scheme, as are found in many businesses today. It is true the interests he acquired commencing in 1964 were not held for long periods. But the dispositions were made only when the opportunity of improving upwards, or of acquiring a larger total interest, arose. In the case of Jordanaire part, at least, of the gain was immediately put into a new investment in the portfolio. In the case of Kay-Jean all of the gain was used to invest in El Rancho. [Emphasis added.]

This is the case which most resembles the case before the Court. The taxpayers’ intent or motivation was the same in both cases: increasing the number of apartments they owned as a means of increasing their rental income. It should also be noted that the proceeds of disposition of the buildings were used in both cases to finance the projects that followed.

The second case is that of Samuel Y. S. Lee v. M.N.R., reported at [1978] C.T.C. 2192; 78 D.T.C. 1152. This decision is as significant as the first, since as in Kyllo it deals with sales of property for the purpose of upgrading the taxpayer's real estate investment portfolio. I reproduce here the headnote of the decision.

The taxpayers, husband and wife, bought 12 real properties and sold 9 between the years 1969 to 1974. Some of these properties were held for less than 6 months before being resold. In re-assessing the taxpayers in their 1973 and 1974 taxation years the Minister assessed the profits realized on the transactions occurring in those years as income. The taxpayers appealed arguing that the properties had been purchased as an investment and that the numerous transactions were made to improve their portfolio. The taxpayers also cited the wife’s poor health and differences between them as reasons for some of the sales. Therefore, they contended they were not in the business of buying and selling real properties and that, accordingly, the profits realized on the 1973 and 1974 transactions were capital gains.

Held: The appeal was allowed. The conduct of the taxpayers throughout substantiated their claim that their goal was a rental investment portfolio. The taxpayers’ intention was not to turn the units to a profitable account at the earliest opportunity but rather to acquire better rental property.

Though this case does not have the importance of the first, I again note nevertheless the presence of the factor of progression toward more costly apartments which are more profitable. Further, what is striking in the latter case is that the taxpayers Lee sold 75 per cent of all the properties they owned, and in some cases these properties were sold less than six months after being purchased. In Mr. Hébert's case, the properties in question were held by him on an average of five years before being sold.

I now come to Joseph C. Williams v. M.N.R., reported at [1983] C.T.C. 2207; 83 D.T.C. 186, the headnote of which reads as follows:

The taxpayer real estate broker decided to build an apartment building as an investment to produce a steady source of income and for that purpose purchased land in conjunction with the owner of his employer company who had the necessary development expertise. When the municipality imposed a development levy and would not permit the proper zoning to the partners, the taxpayer reluctantly joined in granting an option on the land and received proceeds of disposition when the option was exercised. The Minister assessed the proceeds as income and the taxpayer appealed to the Tax Review Board.

The Member of the Tax Review Board found, at 2209 (D.T.C. 188), that:

[T]he Appellant’s whole course of conduct is consistent with the existence, as asserted, at the time of purchase of an exclusive intention of erecting an apartment building as an investment.

I recognize that the subject matter of the transaction is raw land and that there is some connection between the Appellant’s ordinary occupation and the transaction in question. However, those factors are not conclusive. The evidence establishes, on the balance of probabilities, that the land was purchased or a first step in a process intended to lead to the creation of a capital asset and not with a view to turning it to account for profit.

What is significant in this decision is that there was a connection between the subject-matter of the transaction (buildings) and the taxpayer’s occupation (real estate broker), and the Board, in my view correctly, held that this connection was not conclusive. In a similar way, the fact that Mr. Hébert is a carpenter and sold some of his buildings is also not conclusive. It may be noted that in Grant Kyllo (supra) there was also a very close connection between the subject-matter of the transaction and the taxpayer's employment. Without further particulars, this is only one factor to be considered among others. At all events, if Mr. Hébert had intended to speculate, why did he wait five years after constructing the buildings to sell them? What prompted the sale in the Williams case was that municipal zoning regulations made it impossible to build. Here, it was chiefly the taxpayer's lack of his own capital.

Finally, I conclude with Diamond Developments Ltd. v. M.N.R., [1984] C.T.C. 2992; 84 D.T.C. 1811, in which the headnote of the decision states:

The taxpayer corporation was engaged in the business of developing land and apartments for rental and then sale. With respect to the particular transaction in issue, the taxpayer purchased the land in 1969, completed the construction of an apartment building in 1972 and, after renting the apartments in the intervening years, sold the property in 1979. A decision had been made by the director in 1973 to convert the building to a condominium but this decision was not implemented. The sale was the result of an unsolicited offer and a need by the taxpayer at the time for a substantial amount of cash. The taxpayer reported its profit on the sale as a Capital gain. The Minister assessed it as income and the taxpayer appealed to the Tax Court of Canada.

Bonner, T.C.J. of the Tax Court of Canada found, at 2994 (D.T.C. 1813), that:

In trading cases the nature of the property sold and the length of time for which it was held are factors of considerable weight. Thus, a revenue generating asset such as this apartment building held for a significant period of time such as seven years will ordinarily be seen to be a capital asset, but another factor of considerable importance in such cases is the nature of the ordinary business of the taxpayer. . . . The fundamental operation of acquiring land, obtaining development permission, developing, leasing and selling is indistinguishable from other business operations of the Appellant company.

At first sight, this case might seem more favourable to defendant's argument, that Mr. Hébert was engaged in a business. However, on looking more closely at the facts of Diamond Developments it can readily be seen that the conclusive factor was that the company was created specifically for speculation purposes. I cite in this regard a further passage from the decision, where Bonner, T.C.J. said on the same page that:

Where, as here, profit is earned from the carrying on of the ordinary business operations which the taxpayer was incorporated to carry on and did in fact carry on, that profit is income from a business.

In that case, the sale of the building which was the subject of the dispute could not be dissociated from the company’s usual activities. In the case at bar, Mr. Hébert's activities were concerned solely with construction and rental of buildings, and the sale of the seven buildings, prompted by circumstances beyond his control, were simply the means used to reach his objective of financial self-sufficiency.

I accordingly conclude from all of this that Mr. Hébert intended to create a bank of rentable apartments to support himself and his family, and that the transactions he engaged in were all consistent with this stated intent.

In view of the foregoing, I would allow the plaintiff's appeal and vacate the assessments made by the Minister for 1976, 1977 and 1978. The plaintiff will also be entitled to his costs.

Appeal allowed.