Cook v. The Queen, 87 DTC 5231, [1987] 1 CTC 377 (FCTD)

The Associate Chief Justice:—This appeal of the plaintiffs income tax reassessments for the years 1980 and 1981 came on for hearing at Vancouver, British Columbia, on January 13 and 14, 1987. In the years in question the plaintiff granted options to purchase certain real property which she owns. She reported the amounts received in return as capital gains. The defendant reassessed these amounts as business income. At issue is whether the gain from these transactions constitute capital gain under section 39 of the Income Tax Act or income from a business under section 3.

The plaintiff is a school teacher in the Port Coquitlam district. She is married for the second time to a retired Air Force pilot and they have four grown children: his two daughters from a previous marriage, her daughter from her first marriage, and their son. They moved to British Columbia in 1965 after her husband retired and she began to teach right away. The following year her husband received his real estate license. He worked for a large real estate office for four or five years and then moved to a trust company where he could work for a friend. After leaving the real estate office, he did very little in the way of real estate dealing but did buy and sell a few lots for himself. He never developed real estate.

Between 1965 and 1980 the Cooks bought and sold three homes in the Port Moody area, spending at least three years in each. They moved each time for reasons of size and aesthetics. The husband and wife now live in an apartment due to Mr. Cook's ill health.

In 1968 the husband’s first wife died, leaving a legacy to Mr. Cook and each of his two daughters. By 1971 this inheritance had begun to come in to the Cook family in the amount of $67,000 to each of the three recipients. Mrs. Cook's evidence is that good investments were sought for this money, particularly on behalf of the two daughters, and that the family finally went ahead with three projects. First, on the advice of their lawyer and accountant, in February of 1971 the Cooks incorporated a family company by the name of “Primavera Holdings". The directors were Mr. and Mrs. Cook and Mr. Cook's two daughters. The company’s objects included, among other general powers, the capacity to acquire, hold and sell real or personal property. Mrs. Cook was the secretary of the company and as such had to sign documents connected with it, many of which were presented to her during cross-examination. Her testimony on this point was that she signed only on the advice of her husband, lawyer and accountant, all of whom she trusted completely. Consequently, she never read the documents to discover their content and does not consider herself to have been “involved” in the business of the company in any active way.

Second, in 1969 the daughters gave a mortgage to three businessmen, all by the name of “Dolmat’’, on a block of three lots in New Westminster. In February of 1971, this land was sold to the plaintiff for $50,000. She claims that she never intended to own this property in her own right, that this was a family business transaction and that her name went on the deed only because she was "handy", both daughters by now living away from home. The plaintiff sold this land to Primavera in March of 1971, whereupon the mortgage from the daughters was increased to $50,000. In 1975, the company sold an option to purchase this land to the Coquitlam School Board for $10,000.

The third use of the inheritance funds led to the transactions at issue here. Mr. Cook had a real estate agent friend by the name of Art Lyons whose brother, Tom Lyons, was an artist living in Spain. At Easter of 1971, Tom Lyons came to visit his brother and met with the Cooks several times. The Cooks commissioned him to paint their family portraits. During the sittings for her portrait, Mr. Lyons mentioned to Mrs. Cook that he had two pieces of land in B.C. which he wished to sell. For one he was asking $100,000, which she felt was well beyond her means, for the other $62,000. The second piece interested her so she and her husband went to look at it. It was 17 /2 acres of uncleared rural land with a road access which had been dedicated but not yet built. Mrs. Cook was very attracted by the land. She thought it "pretty" and affordable. She says she could see herself living there in the future and hoped that one day she could build a house there. In addition, just the idea of having a piece of property she could say was "hers" appealed to her. The other adult members of the family had recently acquired fairly substantial assets and she felt that she too would like to own something of value. She looked on the property as a means of achieving "security", land being a form of investment she could understand and appreciate.

After talking it over with her family, Mrs. Cook signed an agreement of purchase and sale with Tom Lyons in July of 1971. The purchase price was $62,000, payable on terms of $14,000 down, $10,000 in 1972 and 1973, and the balance in 1974. No interest was charged on the outstanding balance. At the same time, Mrs. Cook borrowed $20,000 from her two stepdaughters. The loan was secured by a mortgage on the property and subject to an interest rate of ten per cent per year. The mortagage provided that the principal and interest were due on August 1, 1974, however it was verbally agreed that the interest would be paid monthly for ten months of each year, the period in which Mrs. Cook received her teacher’s salary. The due date for the principal sum was extended verbally from year to year until 1980 and interest continued to be paid.

The sale was a private one — the land was never listed with a real estate agent. Mr. Lyons' brother Art prepared the sale documents. Art then de- manded that he receive a commission of $6,000. Mrs. Cook agreed. She thought it was "fair" that Art receive something from the sale as his brother stayed with him for long periods without paying room and board and she felt that Tom should have listed the property with Art to begin with. She mentioned in her testimony that another reason she didn't mind paying the commission was that if the property was sold, it could be deducted for income tax purposes. Her husband also agreed that a commission would be paid, but since he too was a real estate agent, he insisted that he receive half. So both Art Lyons and Mr. Cook received $3,000 and the total price of the property went to $68,000.

Two weeks later on August 2, 1971, the agreement of purchase and sale was assigned by Mrs. Cook to Primavera Holdings. The following day, August 3, by an identical agreement, it was assigned back to Mrs. Cook. The plaintiff could provide no coherent reason for these actions except that she had been advised to do so by her lawyer and accountant. As far as she was concerned, however, the property remained "hers" the whole time.

In 1972 the plaintiff's husband gave her a mortgage of $12,000 on the property, with which she paid the first $10,000 payment. In 1973 he bought half of his daughters' mortgage because one of them needed some ready cash. The $10,000 payment in 1973 was made out of the plaintiff’s own salary. In 1974 and again in 1977, the payment provisions for the balance of the purchase price ($28,000) were extended for three years by agreement with the vendor's heirs, the second time at an interest rate of ten per cent.

Between 1971 and 1980, the plaintiff and her family did very little with the land. It was included in a land development freeze in 1972. About that time a sewer was put through. No formal plans were developed to build on the property, though the plaintiff and her family went for occasional walks there and dreamed where they might put a house. The land is still zoned for rural use only.

In 1975 the plaintiff began to get requests to sell the property which she ignored. In 1980 her husband became ill. They sold their house and she took a year's leave of absence from teaching. About this time the Vancouver area began to experience a fantastic boom in the price of real estate. Speculation was rife and the pressure to buy and sell property became quite intense.

In the year 1980 the plaintiff’s husband brought her another offer to sell the property which she refused. The offer was changed to one for an option to purchase later. She still refused. Then the option was to be on only half the property at a price of $62,000 for the option and $405,500 as a purchase price, to be exercised in ten years. Mrs. Cook realized that the price of the option would allow her to pay off her debts and that even if it was exercised, she would have enough land and enough money to build on the other half. She accepted. A $6,000 commission was taken off the price of the option so Mrs. Cook actually received $56,000. Counsel for the Crown brought out the fact that there was some delay between her signing the option and receiving the money with which to pay her creditors, also that $56,000 left a $4,000 shortfall in paying off her husband. I do not see either of these facts as significant. Crown counsel also pointed out that Mrs. Cook made a loan to Primavera Holdings of $54,000 in 1980 with which the company purchased some property in Washington State. Mrs. Cook knew nothing about that loan but insisted that the option money went to pay off the vendor's heirs and her mortgagees.

In 1981, the same real estate broker brought the Cooks another unsolicited offer for an option to purchase the other half of the property. This time the option price was $100,000 and the purchase price another $410,000. Again the option was to be exercised in ten years. At this point the offer became too good to refuse. When asked why she would run the risk of losing her beloved property, Mrs. Cook replied that her husband was not well and this money would ensure she would be able to look after him. The offer was accepted and the plaintiff received $90,000, the option price less a $10,000 commission. The company which purchased the second option has since declared bankruptcy. The first option has not yet been exercised. Mrs. Cook is consequently still in possession of the clear title to the full 171/2 acres. If the options are not exercised and provided her husband is well enough, she still plans to move there to live when she retires. She hopes to retire early and will not have been working in B.C. long enough to receive a full pension.

Mrs. Cook reported the sums received from the options as capital gains on her 1980 and 1981 income tax returns. In 1983, she was reassessed by Revenue Canada and the amounts received included in her income for those years. She appeals that assessment.

The statutory provisions relevant to this appeal are sections 3, 9, 39(1) of the Income Tax Act:

3. Income for taxation year.—The income of a taxpayer for a taxation year for the purposes of this Part is his income for the year determined by the following rules:

(a) determine the aggregate of amounts each of which is the taxpayer’s income for the year (other than a taxable capital gain from the disposition of a property) from a source inside or outside Canada, including, without restricting the generality of the foregoing, his income for the year from each office, employment, business and property;

(b) determine the amount, if any, by which

(i) the aggregate of

(A) the aggregate of his taxable capital gains for the year from dispositions

of property other than listed personal property, and

(B) his taxable net gain for the year from dispositions of listed personal property

exceeds

(ii) the amount, if any, by which his allowable capital losses for the year from dispositions of property other than listed personal property exceed his allowable business investment losses for the year;

(c) determine the amount, if any, by which the aggregate determined under paragraph (a) plus the amount determined under paragraph (b) exceeds the aggregate of the deductions permitted by subdivision e in computing the taxpayer's income for the year (except such of or such part of those deductions, if any, as have been taken into account in determining the aggregate referred to in paragraph (a); and (d) determine the amount, if any, by which the amount determined under paragraph (c) exceeds the aggregate of all amounts each of which is his loss for the year from an office, employment, business or property or his allowable business investment loss for the year;

and the amount, if any, determined under paragraph (d) is the taxpayer's income for the year for the purposes of this Part.

9.(1) Income from business or property.—Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.

(2) Loss from business or property.—Subject to section 31, a taxpayer's loss for a taxation year from a business or property is the amount of his loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source mutatis mutandis.

(3) Gains and losses not included.—In this Act, “income from a property” does not include any capital gain from the disposition of that property and “loss from a property” does not include any capital loss from the disposition of that property.

39.(1) Meaning of capital gain and capital loss.—For the purposes of this Act,

(a) a taxpayer’s capital gain for a taxation year from the disposition of any property is his gain for the year determined under this subdivision (to the extent of the amount thereof that would not, if section 3 were read without reference to the expression “other than taxable capital gain from the disposition of a property” in paragraph (a) thereof and without reference to paragraph (b) thereof, be included in computing his income for the year or any other taxation year) from the disposition of any property of the taxpayer. . .

248.(1) Definitions.—In this Act,

“business”.—“business” includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), an adventure or concern in the nature of trade but does not include an office or employment;

The question is whether the amounts paid for the options on Mrs. Cook's property are income from a business or capital gains from the disposition of property, the two being mutually exclusive by the operation of section 9. If they are the former, the whole of the amounts received must be included in Mrs. Cook's income for the year; if the latter, only one half of each amount is taxable.

The theory of the Crown is that in buying this property and selling options on it Mrs. Cook was engaged in a business, specifically “an adventure or concern in the nature of trade" pursuant to subsection 248(1) of the Act. To support such a conclusion I must find that at least one of the motives with which Mrs. Cook acquired the property was to make a profit from trading in real estate (see Racine et al. v. M.N.R., [1965] C.T.C. 150; 65 D.T.C. 5098, and Happy Valley Farms Ltd. v. The Queen, [1986] 2 C.T.C. 259; 86 D.T.C. 6421). Counsel asks me to so find for two reasons. First, she maintains that this transaction, like the ones involving the family company, were completely controlled by the plaintiff’s husband and her name went on the deed only for reasons of convenience and to minimize taxes. If that was so, it is argued, Mr. Cook's experience and intentions as a real estate trader may be attributed to Mrs. Cook and she may be found to have been engaging in speculation. Second, on the basis of her own statements, Mrs. Cook's intention when buying the property was to use it as “security". The only way to realize on that security it is argued, was to sell it whenever it became profitable to do so. Thus the purchase and disposition of this property form an adventure in the nature of trade on the part of Mrs. Cook herself. This position is supported by her apparent involvement in the trading activities of Primavera Holdings.

I indicated at trial that in my opinion the stronger of these arguments is the first one, that this transaction was part of the business of the husband and family company and that it was consequently an exercise in speculation from the beginning. Two cases have come to my attention which support this line of reasoning. Indeed, if I find that the transaction was directed entirely by the husband’s mind, such a conclusion would be appropriate (see Boychuk v. M.N.R., [1981] C.T.C. 2098; 81 D.T.C. 107). Counsel asked me to follow the line of reasoning in Arnot v. M.N.R., [1986] 1 C.T.C. 2131; 86 D.T.C. 1085. In that case, the taxpayer was an economics graduate who worked in her father's real estate office. On the advice of her father and funded entirely by him she purchased a farm which had been listed with her father’s company. The property was rented out and operated as a farm but brought in very little income. While the appellant held it, the property was listed for sale a few times with her father’s company to attract prospective purchasers to the area. The farm was leased with an option to purchase four years after its acquisition. The option was subsequently exercised. The Court found that the appellant’s father was the person primarily involved in the purchase, leasing and sale of the property. However, given the appellant's training and occupation, she must have known the significance of these transactions. There was consequently found to be a substantial element of speculation on the part of the appellant herself. The gains from the transactions were correctly taxed as business income.

The facts in this case do not support the conclusion reached in either the Boychuk or Arnot cases. Here, the person primarily involved in the purchase and disposition of this property was the taxpayer herself. While she may have received advice and even some financing from her husband, his was not the controlling mind in the transactions. Consequently, his intentions with regard to the property do not determine the character of the gains received. It cannot be said either that Mrs. Cook was speculating on her own account. Unlike Mrs. Arnot, she did not have the training or experience for such a motive to be imputed to her in the absence of concrete proof of speculation. I accept her evidence that her previous experience with real estate trading was on behalf of the family company and did not involve her active participation. And unlike either Mrs. Boychuk or Mrs. Arnot, Mrs. Cook had in mind a personal use for this property.

The plaintiff argues that two decisions by which this Court is bound are directly on point. The first of these is M.N.R. v. Lawee, [1972] C.T.C. 359. In that case, the two taxpayers had immigrated with their husbands to Canada to escape religious persecution in the Middle East. All four were independently wealthy and had a variety of investments. The husbands were engaged in land speculation and development. The wives bought land which bordered property their husbands owned and were subdividing. They paid for it in cash over three years using their own funds exclusively. Nine years later they sold it at a tremendous profit to a company owned by their sons. In the meantime, they had sold an option to the developer of the adjacent land which was not exercised. The taxpayers were found to have acquired the land for the purpose of investment to the exclusion of any purpose of trading therein. They were not considered to have participated in their husbands' development activities, even though their names were on some other parcels of land which had been traded. Indeed, with regard to this particular purchase, the wives acted on their husbands' advice and the husbands conducted the transactions for them, partly because of the latters’ greater facility with the language. The Court held that that did not mean that the wives’ transactions were not their own, nor that the minds of the husbands in this matter became the minds of their wives. It found that the purchase was made by the wives independently of their husbands' motives. The profits were to be taxed as gains from capital investments.

The second case is that of Palmer v. The Queen, [1973] C.T.C. 323; 73 D.T.C. 5248. The plaintiff purchased land on Redstone Lake in the Halibur- ton Highlands to which there was no access except by water. She paid $4,500 for it in 1963 and sold it for $50,000 in 1968. Her purpose for buying the land was to use it as a retreat but because of the difficult access and her busy family life, little use of it was in fact made. She came to know of and buy the property through her husband, a lawyer active in real estate. The couple had occasionally bought and sold properties in their joint names and for the benefit of his clients. They were both shareholders of a company called Leisure Land Limited which they had formed with another couple for the purpose of dealing in real estate. The plaintiff was secretary of the company. She gave convincing evidence that despite this fact, she had little or no knowledge of her husband’s real estate dealings or his legal practice. Her exclusive intention at the time of the acquisition of the property was to use it as a private retreat for herself and her family. She was found to have sold it only because that purpose became frustrated by the influx into the area of undesirable neighbours. The profit was held to be a Capital gain.

I agree with the plaintiff that the Lawee and Palmer cases are applicable. Here, it was the plaintiff who came to know that the property was for sale, it was she who saw it and liked it, she who thought it affordable on her salary, and she who had a desire to own a valuable asset in her own right. The title went into her name and has stayed there, except for the day-long assignment to the family company. She made the decision as to when it would be sold and on what terms and gave personal reasons for doing so. She put a considerable portion of her own income into the property. While she did not pay for it entirely by herself, the additional financing was contributed by three members of her family, not just her husband. She derived enjoyment from the property by visiting there and dreaming about building a residence on it one day. Her plans were to hold it as security and possibly to retire there. Nothing has happened to date to frustrate those plans and she still owns the land — now with a completely clear title. The land is therefore the plaintiff’s, not her husband's. The determination of whether these are business income or capital gains will rest upon her intentions.

On the subject of Mrs. Cook's intentions, the Crown would have me believe that her motivating purpose when she purchased the property was to resell it at a profit. The plaintiff’s position is that it was acquired solely for the purpose of long-term security, perhaps a retirement residence. As usual, the truth probably lies somewhere in between. Almost everyone who acquires real estate does so with the expectation of a steady, if unspectacular, rise in value. Such an expectation is quite normal and certainly does not mean that the purchase is an adventure in the nature of trade.

Only if the hope of an increase in value amounts to a "secondary intention" in the mind of the purchaser will it transform a purchase into a business acquisition. In Racine et al. v. M.N.R., supra, Mr. Justice Noël set out the test for a "secondary intention". He held at 159(D.T.C. 5101):

To give to a transaction which involves 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.

The circumstances surrounding this transaction do not indicate that the possibility of reselling was an operating motivation for Mrs. Cook. The land had no road access. The Crown established that the sewer did not go through the area until some years later. The zoning was rural and nothing was done in the time she held it to have that changed. The land was not listed for sale, nor was there any attempt to subdivide it until the first option in 1980. The early offers to purchase, beginning in 1978, were all refused. Except for one 24-hour period the land has been kept completely separate from the family company, through which the family carried on its real estate dealings. It is true that a commission was paid on the purchase when it needn't have been, but Mrs. Cook has adequately explained her reasons for allowing that. The transaction was heavily financed, but the plaintiff put a large portion of her own income into the property and the rest of the financing was from members of her own family.

I do not believe Mrs. Cook would have bought the 17 /2 acres if she believed it was going to decrease in value. In that case, it would not have provided her with the “security" she desired. Neither do I believe that the possibility of reselling was “an operating motivation” for the transaction. She did not want to resell the land. She wanted to hold it as security and possibly build a home there. Had it not been for the explosive real estate market in the early 1980s, she might not even have sold options on it. However, that unusual economic climate produced two offers which were simply too good to refuse. Mrs. Cook had other priorities which would not allow her to hang onto the property at any price. The reasoning in Palmer has direct application. I do not find that she received business income when she accepted the offers. The amounts received should have been taxed as a capital gain.

The appeal is allowed with costs, and the matter is referred back to the Minister for the appropriate reassessment.

Appeal allowed.