Robbie Holdings Ltd. v. The Queen, 80 DTC 6336, [1980] CTC 422 (FCTD)

Smith, DJ:—The issue in this case is whether a profit of $102,294.96 realized by the plaintiff on the sale of certain farm land in Manitoba should be classified as capital gain, as contended by the plaintiff, or income for the taxation year in which the sale was made (and the price received), 1974, as submitted by the defendant.

The plaintiff was incorporated under the laws of Manitoba by Morton Nemy, a Winnipeg lawyer as a holding company for his personal assets, including farmland and mortgages. Mr Nemy is the sole beneficial shareholder of the company and is its sole directing mind.

Mr Nemy’s law practice is substantially devoted to handling real estate transactions, in particular for European clients acquiring Manitoba farmland.

For a number of years prior to 1973 Mr Nemy had acted for lenders to farmers and by 1974 the appellant company had acquired two farms. It has since acquired another farm. All three farms have been and still are rented to tenants on a cash rental basis.

Over the years Mr Nemy had become familiar with the business of farming. In 1973, he met a German real estate agent named Roland Richter and through him began to act for a number of European investors who were interested in purchasing Manitoba farm land for long term investment. Mr Richter brought more and more of these investors to Mr Nemy, whose real estate legal practice increased rapidly in 1973 and 1974.

Early in 1974, Mr Richter decided to go into farming on his own account. On February 27, 1974, he agreed to purchase from George Boaler a farm of 1,120 acres for $162,400. He paid $1,000 as a deposit and agreed to pay a further cash payment of $80,200 on April 20, 1974. The balance, $81,200 was to be secured by mortgage payable in three equal annual instalments of $27,066.67 with interest at 8%.

Richter expected to borrow from the bank the money required to close the purchases on April 20 and May 1, 1974. Shortly before the first of these dates the bank refused to make the loans and Richter was unable to close the transactions. He discussed the situation with Mr Nemy, who feared that default by Richter would have a serious detrimental effect of Nemy’s relations with his European purchasers and on his own highly profitable legal business with those purchasers. It was agreed between them that Nemy, or rather the plaintiff company, would take over and complete the two contracts and that Richter would rent the farms from the plaintiff for one year at a rental of approximately $27,000, payable one-half on June 1, 1974, and the balance on December 1, 1974. A lease to this effect was executed on May 14, 1974.

At the trial Nemy stated that he could have borrowed from his bank the two sums of $80,200 and $63,000 required to complete the cash payments on April 20 and May 1, 1974. Instead he and his family cashed in $60,000 in Savings bonds and $10,000 in coupons, and Mrs Nemy advanced a further $10,000. The balance, of about $63,500 was borrowed from his bank. Nemy stated that the deal was handled in this way because it was to be a long term investment, and that if he had had any intention of reselling the land he would not have sold bonds but would have borrowed all the money from the bank.

Richter was unable or at least failed to pay the rent that fell due on June 1, 1974. How much of a surprise this was to Nemy is unknown. Certainly he could not have expected the money would be available out of the proceeds of any portion of the 1974 crop, of which, as a matter of fact, on account of the wet spring that year, the seeding had only been completed a short time before June 1. What other cash assets or sources of cash Richter had are not disclosed in the evidence.

Undoubtedly, Richter’s failure to pay the first half of the year’s rent caused Nemy a good deal of concern. He did not put any pressure on Richter, because to do so would mean the end of their business relationship and the loss of the highly profitable and growing volume of legal business Richter was bringing to his office. But Richter’s default rendered Nemy’s financial picture less secure. He had estimated that if Nemy paid the yearly rent of $27,000 and after allowing for real property taxes on the property of about $4,000 there would be a shortfall of about $14,000 in the revenue required to meet the payments on the bank loan and on the mortgages. He did not indicate the basis of his estimate of the shortfall, but if he had to meet the instalments of principal called for by the mortgages, amounting to $37,066.67 per year, and part of the principal of his bank loan, the shortfall would be considerably more than $14,000. Assuming that he could borrow or otherwise raise the amount of the shortfall, Nemy still had good reason for concern about the state of this investment.

Richter had been introduced to Nemy by a German post war immigrant, named Herman Poll, who also was interested in finding land for European investors. Nemy acted for both Richter and Poll.

Mr Poll frequently came to Nemy’s office on business. In early June he learned of Richter’s failure to pay the rent that was payable on June 1, 1974. At that time Poll was trying to find a large farm property for a German client of his, named Dr Schuler. He telephoned Nemy, who was then in Atlanta. Nemy did not offer the land to him for sale. He said the land was not for sale, but after some discussion, he agreed that he would sell if it was for Dr Schuler. Poll telephoned Dr Schuler on June 17, giving him particulars of acreage and price and on June 18, Dr Schuler wrote Nemy expressing his thanks for his help in making the land available and giving the names and addresses of three purchasers, one of whom would pay one-quarter of the price, the others each paying three-eighths of the price. On June 28, Nemy wrote Dr Schuler, enclosing a draft offer to purchase and information about the mortgages. This document had been executed by Robbie Holdings Ltd on June 28, 1974. It was signed by Dr Schuler on July 12,1974, and returned to Nemy. The price stated was $210 per acre for 1,824.56 acres or $383,157.60.

On July 19, Mr Richter was killed in an accident on the farm.

After allowing for adjustments the net gain on the sale was $102,294.96. In its income tax return for 1974, the appellant showed this amount as a capital gain and paid income tax on it as such. On February 1, 1977, the Minister of National Revenue reassessed the plaintiff, in respect of the 1974 taxation year, including the whole $102,294.96 as income. The plaintiff appealed to the Tax Review Board, which by its decision dated October 31, 1978, unanimously dismissed the appeal. From that decision the plaintiff has brought the present action, claiming, as set out in paragraphs 17 and 18 of the statement of claims:

17. The plaintiff says that the two farms were not acquired with a primary or secondary motivation of trading or otherwise, denies that it engaged or intended to engage in an adventure in the nature of trade and further says that the two farms were acquired for investment only and not with a view to resale.

18. The plaintiff further says that the two farms were purchased by the plaintiff in order to prevent a defaulting purchase from having a detrimental effect on Nemy’s law practice. Accordingly, the plaintiff says that if such profit is income as the Minister so assumes which the plaintiff expressly denies, then in the alternative such income constitutes income from an active business and the plaintiff is therefore entitled to the benefit of the small business deduction pursuant to section 125 of the Income Tax Act.

Nemy’s evidence at the hearing before me, June 24, 1980, agreed completely with what is contained in the foregoing quoted paragraphs, and was not shaken on cross-examination. He stated emphatically that at the time of purchasing his purpose and intention were to hold it as a permanent investment. He further stated that if he had bought it with the intention of selling he would not have bought it in his own name, or sold his bonds, but would have bought it in his wife’s name or in his children’s names, and would have borrowed all the necessary money from the bank. (In actual fact he did not buy the land in his own name but in that of the plaintiff company. This is only a technical distinction, because he was beneficial owner of all the plaintiff’s shares, as well as its president and sole director, so that he no doubt regarded the company as his alter ego.)

On cross-examination he said that he never considered, at the time of purchase, what effect a sale would have on his income tax situation, because he did not intent to sell. Nor did he consider this question when he sold the land to Schuler a few weeks later.

The motivation or motivations which lead a person to make a purchase of land are always questions of fact. What the purchaser says on this point must always be considered, but it may not be decisive. Particularly is this the case when the motives or intention he ascribes for the purchase would result in a substantial financial benefit to himself. The purchaser’s actions and other circumstances may be a far better guide to his true motives than are his statements about them. The Court must therefore look at all the facts and circumstances of the particular case, in order to reach the right conclusion.

As usual in cases of this kind some of the facts appear to be favourable to the plaintiff’s contentions and some appear to point in the opposite direction.

Perhaps the fact that is most favourable to the plaintiff’s case is that when the farms were taken over from Richter, Nemy and his wife and children sold their savings bonds to provide a substantial portion of the needed capital, instead of borrowing all of it from the bank. It was submitted that if the plaintiff’s purchase had been made with the intention of making a quick sale at a profit all the needed funds would have been borrowed from the bank, and the savings bonds would have been retained. This argument has merit, though not completely conclusive. No one from the bank was Called to give evidence as to the bank’s willingness to lend Nemy all the needed capital. Mr Nemy’s statement that he could have borrowed all the money from the bank is therefore not confirmed directly but there is some indirect support for it, or at least for concluding that his credit was very good, in the evidence of R J Statham, General Manager of Astra Credit Corporation, a company whose business is credit financing. Mr Statham stated that the company had some three thousand accounts and that Nemy was one of its key accounts—one out of perhaps eight such accounts. He and Nemy had had hundreds of business discussions about investments over the past ten years. He stated that Nemy was a conservative investor. He had told Nemy that if ever he needed to borrow money it would be available. In talking with Nemy about the loan needed at the time of purchase he got the impression that the purchase was intended to be a long term investment.

I was favourably impressed by Mr Nemy in the witness box and the way in which he answered questions. I see no reason for doubting that he could have borrowed from the bank all the capital required at the time he took over the farms from Richter.

A somewhat similar argument was Nemy’s statement that if he had been intending, at the time of acquiring the farms, to sell them at a profit, he would have bought them in the name of his wife or his children. Mr Poll Stated that if Nemy was engaged in buying and selling land he would not deal with him. This supplies a reason for Nemy’s statement, though it is not too convincing. One wonders how long it would take a business man with whom Nemy was constantly working to become aware of the real facts.

Another point in Nemy’s favour is that this was the only occasion in which he bought land and sold it shortly afterwards. On the two or three previous occasions when he had bought land he had retained it, renting it to tenants on a cash rental basis. No doubt he was confident that over the years the land he bought would increase in value and that if, sometime in the future he were to sell it he would make a profit on the sale. This does not mean that he had any intention, at the time of purchase, to sell it, as a motivating factor in acquiring it.

Nemy’s argument is that when he bought the farms from Richter his intention was the same as it had been when he bought the other farms, namely, a long term investment. If this is true, the purchase from Richter was not a trading transaction. A subsequent change of mind and sale, would not effect his intention at the time of purchase, which is the critical time.

Another point in the plaintiff’s favour is that there is no evidence that he was attempting to sell these farms. Poll brought the offer to purchase to Nemy by telephone, with no solicitation from Nemy. When he did so Nemy’s first response was that the land was not for sale. It was only after some discussion and learning that the intending purchaser was Dr Schuler, that he said he was willing to sell, but would have to consult his family and Richter. Mrs Nemy, who had provided some of the money to purchase the farms did not want to sell. She said they had put all their savings into the purchase and that it was to be a long term investment. She finally agreed with her husband’s view that it might be best to sell.

Michael Cudjoe, from the Valuation Division of the Winnipeg tax office gave evidence. He said that he had two lengthy discussion meetings with Nemy in June and July 1976, at which he asked Nemy many questions. He said Nemy was responsive to his questions and that all his files were made accessible. This suggests that his mind was clear as to his position and that he had nothing to fear from anything that might be found in his files.

Against these contentions counsel for the respondent argued that the quickness with which the farms were resold shows that an intention at the time of purchase, to resell, was a motivating factor in the purchase. Nemy signed the offer to purchase less than two months after he bought the land and Dr Schuler signed it a couple of weeks later. Such a quick resale always rouses suspicions but is not conclusive of an intention to sell having existed at the time of purchase.

Counsel asked what changed Nemy’s intention around, if in fact his intention had been as stated by him. He did not see that any convincing reason had been given. He cited several reasons that had been mentioned by Nemy from time to time, eg: that the property was not suitable for his purposes, and that he had financial difficulties. Richter’s failure to meet the first payment of interest certainly caused him some financial concern and in the end probably did have some influence on his decision to sell. If so it does not follow that at the time of purchase he had any intention to sell. Richter’s failure to pay the first half year’s rent was more disturbing and, as I view the facts, had a good deal of influence to cause him to change his mind about selling.

Counsel questioned Nemy’s credibility, particularly because of something in Cudjoe’s evidence. Cudjoe stated that at his first meeting with Nemy in 1976, Nemy gave as a reason for selling the farms that Richter’s death had left him ‘‘stuck with the farms.’’ At that time Cudjoe did not know the date of Richter’s death, but learned of it before his second meeting with Nemy, in July 1976. He said that at that meeting, he pointed out that Richter had died after the sale. He said Nemy was surprised, but was pretty sure Richter’s death had something to do with the sale. In response to a question put to him on cross-examination at the trial Nemy stated emphatically that he did not tell anyone that he sold the property because of Richter’s death. Here we have a direct contradition of evidence. It seems probable that Cudjoe’s statement is correct, because he made scribbled notes of what was said at the meeting and expanded them into formal minutes within an hour or so after the meeting. Even so, I do not think that this incorrect statement has any substantial effect on his general credibility. The meeting in question was held some two years after the sale was made, Richter’s death occurred only a week later, and Nemy’s denial in the witness box was six years after the sale. Bearing in mind the shock which Richter’s death must have been to Nemy and the close proximity of the dates it is likely that Nemy became confused about the chronological sequence of those events. Bearing in mind also that Richter’s failure to make the first rental payment under his lease had caused Nemy to be concerned, it is to my mind a certainty that if Richter’s death had occurred before Nemy had agreed to sell the farms his death would have had a good deal of influence to cause him to change his mind about selling. It is quite possible that by the time of his meetings with Cudjoe two years later he had confused what would have occurred if Richter’s death had occurred at an earlier date with what actually did happen.

In preparation for the trial of this action four years later Nemy no doubt refreshed his memory of the facts pretty thoroughly. His denial at the trial of the statement made to Cudjoe is only explicable on the ground that he had forgotten the incident, for he must have expected that Cudjoe would be called as a witness and he must surely have observed Cudjoe making notes during his meetings with him.

This incident has caused me some difficulty. However, apart from it my observation of Nemy in the witness box, and the manner in which he answered questions led me to conclude that he was a straightforward witness and that his evidence was credible.

My conclusion, after a full review of the facts and the jurisprudence applicable to this case is that the plaintiff had discharged the burden of proving that at the time when he purchased the lands in question, Nemy’s intention was to keep them as a long term investment and that at that time there was no intention in his mind of reselling them, that could be called a motivating factor in making the purchase. In my opinion it was not till after Richter failed to make his first half yearly payment of rent that any thought of selling entered his mind. He still made no efforts to effect a sale, but the difficulties occasioned by that failure were on his mind. Other considerations no doubt began to have some influence. Yet when Poll approached him with Dr Schuler’s proposal to purchase the land his answer was that the land was not for sale.

Schuler’s offer would produce a handsome gain. Poll persisted and after much discussion he came to the conclusion that a sale might be the best thing for him and his family. Only then did he have any real intention to sell and he accepted the offer, after persuading his wife that it might be best for them to sell.

There will be judgment for the plaintiff. The judgment of the Tax Review Board is set aside and the matter is referred back to the Minister for re- assessent of the plaintiff’s income tax for the year 1974 on the basis that the gain made on the sale of the farm lands in question was a capital gain.

The plaintiff is entitled to its costs of the action.

I have read all the judgments cited to me by counsel, many of which are distinguished from the present case. I have found nothing in any of the judgments that indicates that on the particular facts of this case my decision should be other than is stated above.