Magilb Development Corp. Ltd. v. The Queen, 87 DTC 5012, [1987] 1 CTC 66 (FCTD)

McNair, J.:—This is an appeal by the plaintiff from a decision of the Tax Review Board dated December 22, 1981 whereby the plaintiffs appeals from assessments of income tax for the 1975 and 1976 taxation years were dismissed. The notices of reassessment treated the sale proceeds of land as business income rather than capital gain.

The issue is whether the plaintiffs property sustained a change in use on December 31, 1971 from farm land to business inventory. The plaintiff’s position is that such change did not occur until January 1, 1976 at the very earliest.

The plaintiff was incorporated as a private company under the laws of the Province of Alberta on August 9, 1963. The corporate objects were broadly stated in the memorandum of association to authorize the carrying on of a general construction and contracting business for the construction and development of public and private works of all kinds. Subclause 3(a)(iv) stated the following specific object, namely:

(iv) the holding or exchange of real property, chattel goods, securities, debentures, notes or any other business generally.

Some family history and background are essential to a proper understanding of what becomes the key issue. In 1940 Gilbert Hermary purchased at a tax sale a 72-acre parcel of farm land in Red Deer, Alberta, as a homestead for himself and his wife and their 13 children. The property lay westerly and adjacent to his father’s dairy farm of some 2,000 acres on which Gilbert had worked from boyhood, along with other family members. The mode of operation was akin to that of a farming commune.

The Gilbert Hermary homestead was traditionally operated as a family farm with the main effort devoted to market gardening, especially the growing of potatoes. The Hermarys raised sufficient livestock and poultry to meet the everyday needs of a large family. While the operation was always marginal, the communal effort engendered by close family ties coupled with frugality and hard work were sufficient to compensate for the rela- tively meagre cash return. By the mid-40s a large two-storey frame house had been constructed on the homestead property. The house was commodious enough to house Gilbert Hermary's immediate family and his crippled brother and, in later years, such of the adult Hermary children as chose to reside there from time to time with their mother and father. The Hermary family always regarded the homestead as the family farm. Mrs. Gilbert Hermary passed away in 1967. Gilbert Hermary died on May 22, 1976. At the time of the actual subdivision in 1976, one part of the dwelling house was occupied by a son, Robert Hermary, and his family with the other part being occupied by a married daughter, Gilberta, and her family.

Gilbert Hermary was something of a visionary. Over the years, he explored the possibility of some five or more business ventures involving one or other of his children or another family member but these projects never came to anything. He suffered delicate health and from 1960 or thereabouts he was subject to recurrent bouts of severe depression. In fact, there was some concern on the part of the family as to his mental competency. All in all, Gilbert Hermary's flights of fancy made him readily susceptible to promotional schemes. The family experienced a real scare over this in or about the year 1957. Gilbert Hermary had been approached by several promoters of service station ventures. One scheme would have involved pledging the title of the homestead to the promoters. Maurice Hermary, who was then working in Regina, received a telephone call from his mother about having to go to the bank to sign papers. She voiced concern that they might lose the property. Maurice went immediately to Red Deer and, after discussions with his parents and the family banker and acting on the advice of friends in the Department of the Attorney General, was able to forestall the promotional scheme. This episode paved the way for the incorporation of the company, Magilb Development Corp. Ltd.

The decision was made in 1963 to set up a family corporation with a view to safeguarding the homestead property and providing ultimately for its rateable division among the family members. The share capital at the time of incorporation provided for the issuance and allotment of 518 common shares without nominal or par value to Gilbert Hermary and one of such common shares to each of his wife and 13 children, for a total of 532 issued shares. Initially, there were three directors, one of whom was Gilbert Hermary. Annual meetings of shareholders were usually held each year on an informal, family get-together basis. Despite the fact that Gilbert Hermary held the majority of the issued shares, any voting on resolutions was done by a show of hands, without a poll. The company functioned as a family corporation with each member having equal input.

At a meeting of directors of the company on August 22, 1974, following the annual meeting of shareholders, there was a restructuring of shares. Gilbert Hermary transferred all but six of his common shares to his 12 surviving children. Those eight children who had contributed $30 or so a month over the past few years toward their father’s maintenance and general wellbeing received 51 shares. The four remaining children who had not made this contribution received only 29 shares. Gilbert Hermary resigned as a director of the company, leaving as continuing directors his sons Andrew and Paul. The financial statement of the company as at August 31, 1975 shows 524 issued shares.

The homestead property was conveyed to the company at the time of incorporation. From then until 1976 the homestead property remained in its farm land state.

In 1971 Gilbert Hermary became interested in the possibility of developing a small corner of the homestead property as a trailer park. He also entertained the notion of building a low cost housing development on the property. The City of Red Deer was receptive to land development schemes at the time. Promoters may have been instrumental to some extent in animating this sudden interest for land development on the part of Gilbert Hermary. Tentative overtures were made to the City but no final subdivision plans were prepared or filed. In fact, Gilbert Hermary became somewhat resentful that the city was discriminating against him with the result that Maurice Hermary came to Red Deer in 1973 to ascertain what was going on. He talked with his father and they met with the engineering and planning officials of the city. The upshot was that they were informed in no uncertain terms that the homestead property was beyond the reach of existing water and sewage facilities and that it would be some years before these utilities would be in place to service any subdivision development. The notional scheme, such as it may have been, died on the vine.

It later transpired that water and sewage utilities became available to service the homestead property in the fall of 1975. This aroused much interest on the part promoters and developers and a number of substantial offers for the homestead were made. Following Gilbert Hermary's death in the spring of 1976, the family held the first official meeting of shareholders to discuss what should be done with the homestead property. The subdivision development fell quickly into place. On October 29, 1976, slightly over five months to the day from the date of Gilbert Hermary's death, the Mayor of Edmonton turned the sod for the official sponsoring of the company's residential subdivision, named Highland Green, located in the North Hill district of the city and scheduled for completion in early 1978. The president, Andrew Hermary, was present on behalf of the family corporation. The subdivision had finally become a reality.

The question to be resolved is whether the tentative overtures made by Andrew Hermary or interested promoters on his behalf to the City of Red Deer in 1971 were sufficient to constitute a change in use of the homestead property from farm land to business inventory.

The relevant statutory provisions are contained in sections 3, 9(1) and 20(1)(n)(ii) of the Income Tax Act. The assumptions on which the Minister relied in determining that there was a change of use to business inventory are taken verbatim from the defence, and read as follows:

3. In reassessing the Plaintiff for the fiscal period ending December 31, 1976, the Minister of National Revenue assumed, inter alia:

(a) that Gilbert Hermary was a director and “controlling shareholder” until August 22, 1974 and that of the 535 shares issued, 379 shares were registered in the name of Gilbert Hermary and the remaining 156 shares were registered in the names of his 13 children on the basis of 12 per child;

(b) that on August 2, 1974 all shares of Gilbert Hermary were transferred to the

other various individuals leaving no one individual in control of the Plaintiff;

(c) that by December 31, 1971 the Plaintiff had formed the intention of developing, subdividing and selling the farm land and had taken steps to carry out this intention;

(d) that during the 1970 and 1971 years, considerable activity was undertaken in anticipation of developing a portion of the land as a mobile home park and preliminary plans were drawn up and approval in principal was given by the Red Deer City Council for the development of the said mobile home park;

(e) that the land in question was converted to inventory on or about December 31, 1971.

The plaintiff’s case in a nutshell is that there is no evidence of any clear and unequivocal positive act in 1971 that changed the character of the homestead from a capital asset in its then farm land state to business inventory or trading asset. The plaintiff concedes that it must more or less prove the negative in the sense of meeting the onus of successfully challenging the correctness of the Minister's assessment. Counsel for the plaintiff contends, however, that once having established a prima facie case sufficient to discharge the original onus then the onus shifts to the Crown of adducing evidence to establish that there was a change of use of the subject property to business inventory in 1971. It is urged that the court must of necessity look behind the corporate veil to determine the real shareholder intent, which essentially comes down to the question of what the Hermary family did or sought to do at the material time. Counsel contends that the evidence amply establishes the fact that the decision to subdivide and sell the land in 1976 was the result of the family consensus achieved at that time and not before and that this marks the actual change of the subject land from capital asset to business inventory. The bottom line is that there is no evidence of any change of use of the land in 1971.

The Crown's case, briefly stated, is that there was no evidence adduced by the plaintiff to negative the assumptions of fact made by the Minister. Counsel for the defendant contends that the objects stated in the memorandum of association support the prima facie presumption that the overtures made to the City of Red Deer during the period 1970 to 1971 regarding the mobile home park and the low cost housing development were sufficient in themselves to constitute a change to business inventory. The plaintiff became involved in the business of land development at that point in time.

Counsel for the Minister relied heavily on the authority of Moluch v. M.N.R., [1966] C.T.C. 712; 66 D.T.C. 5463 (Ex. Ct). The taxpayer acquired 55 acres of bushland in 1937 which he afterwards cleared and farmed with the assistance of his wife. Because of his wife's poor health, the taxpayer began to subdivide the land in 1956. Lots were sold off between then and 1962 resulting in substantial profit to the taxpayer. The Minister assessed these profits as income to the taxpayer for the years 1959 through 1962. The taxpayer contended that the profits were nothing more than a realization of Capital in a series of advantageous sales. The court held that the profits were taxable as income from a business and not capital gain on the ground that the taxpayer's whole course of conduct constituted the embarkation upon a business whereby the gains realized therefrom were taxable as income.

Mr. Justice Cattanach stated the rationale at 718 (D.T.C. 5466):

. .. even if, at the time of acquisition, the intention of turning the lands to account by resale was not present, it does not necessarily follow that profits resulting from sales are not assessable to income tax. If, at some subsequent point in time, the appellant embarked upon a business using the lands as inventory in the business of land subdividing for profit, then clearly the resultant profits would not be merely the realization of an enhancement in value, but rather profits from a business and so assessable to income tax in accordance with sections 3 and 4 of the Income Tax Act, R.S.C. 1952, chapter 148.

It must be noted that the appellant in Moluch began to register subdivision plans with the planning authorities of Sault Ste. Marie in 1956 and that he entered into several agreements with the city to provide services to his subdivided lots. None the less, the learned judge felt impelled to make this cautionary statement at 719 (D.T.C. 5467):

. . . The filing of a plan of subdivision and selling lots thereunder does not of itself constitute a business in the absence of other circumstances.

Glacier Realties Limited v. The Queen, [1980] C.T.C. 308; 80 D.T.C. 6243, (F.C.T.D.) held that the profitable sale of land purchased initially by a holding company for investment purposes represented an income transaction and not capital gain on the ground that the evidence clearly established that the main purpose of the purchase was the prospect of being able to resell the land at a profit in the future with the result that the investment was not one of a capital nature but rather an adventure in the nature of a trade.

Addy, J., said at 310 (D.T.C. 6245):

The fact that the company was incorporated for the sole purpose of holding a single parcel of land and did not engage in any other type of business, is a factor to be considered but is by no means conclusive as to what the object of the taxpayer was in purchasing the land. (See Birmount Holdings Limited v. Her Majesty The Queen [1977] C.T.C. 34; 77 D.T.C. 503; [1978] C.T.C. 358; 78 D.T.C. 6254); Hummel Corporation of Quebec Limited and Hummel Estate Corporation of Canada Limited v. Her Majesty The Queen, [1979] C.T.C. 483; 79 D.T.C. 5426; and Program Properties Limited v. Her Majesty The Queen, [1978] C.T.C. 320; 78 D.T.C. 6215; The objects clauses of a corporation are also relatively unimportant in determining its intentions as compared with what it actually did. (See Regal Heights Limited v. M.N.R., [1960] S.C.R. 902; [1960] C.T.C. 384; 60 D.T.C. 1270 and Clemow Realty Limited v. Her Majesty The Queen, [1976] C.T.C. 129; 76 D.T.C. 6094). It is important where private company such as the present one is concerned to go behind the corporate veil and examine the background of the shareholders in order to determine more precisely if possible the purpose or purposes of the purchase.

[Emphasis added.]

In Be-Vi Corporation v. The Queen, [1975] C.T.C. 636; 75 D.T.C. 5444 (F.C.T.D.), a company incorporated for the purpose of carrying on a real estate business sold its apartment building at a considerable profit pursuant to an unsolicited offer and the court held that the proceeds thereof were income and not capital gain by reason that there was clear evidence of a secondary intention at the time of acquisition to resell the property at a profit.

Mr. Justice Heald dealt with the matter of prima facie presumption arising from the stated objects of a corporation, at 643 (D.T.C. 5449):

I attach some significance to the specific objects of the plaintiff company. While this circumstance, if taken by itself, would not likely be conclusive, it is, in my opinion, a factor to be considered.

In the case of Western Leaseholds v. M.N.R., [1959] C.T.C. 531; 59 D.T.C. 1316, Mr. Justice Locke said at 542 [1322]:

In Anderson Logging Company v. The King, [1925] S.C.R. 56; [1917-27] C.T.C. 207, Duff J., as he then was, said that if the transaction in question belongs to a class of profit-making operations contemplated by the Memorandum of Association, prima facie at all events the profit derived from it is a profit derived from the business of the company. That presumption may, of course, be negatived by the evidence as was done in the case of Sutton Lumber & Trading Company v. M.N.R., [1953] S.C.R. 77; [1953] C.T.C. 237. In the present case, however, the evidence, far from negativing the presumption, appears to me to support It.

In the case at bar, as in the Western Leaseholds case, the evidence, in my view, clearly supports the prima facie presumption referred to supra. The plaintiff only engaged, for all practical purposes in two major land transactions — the first was the farm purchase in 1958, followed by subdivision and sale. This transaction was clearly in furtherance of the first object of the company as stated in the Letters Patent — ie. — to carry on the business of a real estate development company. The other transaction, the Sussex House transaction under review in this action, was, in my opinion, in furtherance of the second expressed object of the company — ie. — to acquire land for the purpose of erecting buildings thereon for sale.

Edmund Peachey Ltd. v. The Queen, [1979] C.T.C. 51; 79 D.T.C. 5064 (F.C.A.) was an interesting case before the Federal Court of Appeal in which the taxpayer contended that an area rezoning to industrial use frustrated any further plans for residential development so that there was a change of intent to take the subject property out of inventory and treat it as capital. A substantial profit from the subsequent sale of 40 acres of the property following an unsolicited offer was therefore said to be capital and not income. The court held otherwise on the ground that the land remained a part of business inventory in the absence of any clear and unequivocal positive act manifesting a change of intention in that regard and because the evidence clearly established that the land was acquired as inventory for resale as soon as a desirable opportunity presented itself.

Heald, J., said at 55 (D.T.C. 5067):

. a Clear and unequivocal positive act implementing a change of intention would be necessary to change the character of the land in question from a trading asset to a capital asset — and that on the facts here present, there was no evidence of such a positive or overt act. There was no documentary evidence to indicate that the new intention had been carried into reality, there was no dedicating of the land for another purpose. All that we have here is the expressed intention of the appellant to thenceforth hold the land as a capital asset. That is not, in my view, sufficient of itself to convert the proceeds of sale from trading proceeds to proceeds from the sale of a capital asset.

[Emphasis added.]

The case of Peachey represents the reverse of the situation that obtains here so that the determinative issue, and indeed the whole point on which the case turns, is whether there is any evidence of a clear and unequivocal positive act implementing such change of intention as to clearly indicate a change in the character of the homestead property from a capital asset to a trading asset.

The assumptions on which the Minister primarily relied in making his reassessment have already been referred to. They are contained in paragraphs 3(c) and (d) of the defence and the one largely depends on the other. Maurice Hermary was the plaintiff’s only witness. The Crown elected to call no evidence.

The Crown's case is seen to rest on the assumption that the flurry of activity with respect to the mobile-home prospect in the years 1970 and 1971 culminated in the Council of Red Deer approving in principle preliminary plans for the development of such mobile home park.

It seems to me that it would have been a relatively simple matter to properly prove this resolution as well as excerpts of any relevant minutes of meetings of the City Council pertaining thereto. Whether this would have been enough to establish any intent on the part of the corporation to subdivide and sell at that time in the absence of specific, separate and corroborative corporate evidence to that effect is something of a moot point. However, it is unnecessary to decide the point because there was no evidence of either.

Crown counsel's cross-examination of Maurice Hermary on this point may have represented something of an attempt to close the gap. He put to the witness the express wording of a purported resolution by the City Council of Red Deer. The witness replied that he was unaware of it. Counsel then asked the witness whether he had been told of the existence of this resolution when he and his father had the discussions with the city officials about the extension of utilities to the homestead property in 1973. The witness stated unequivocally that there had been no mention of it.

It should be noted that this was not a case of cross-examining a witness as to previous statements made by that witness in writing or reduced by him to writing within the purview of subsection 10(1) of the Canada Evidence Act. Rather, it would appear to represent a surreptitious attempt to adduce evidence of the contents of a written document without putting in the document itself. The rule in Queen Caroline’s Case (1820), 2 Brod. & B. 284; 129 E.R. 976 prohibits this. Generally, a document which is inadmissible cannot be made admissible simply because it is put to a witness in cross-examination unless the witness accepts that what the document purports to say or record is true: see Sopinka and Lederman, The Law of Evidence in Civil Cases, at 503; and Phipson, On Evidence, 13th ed., 33-74. In my opinion, this cross-examination evidence is inadmissible to prove the resolution in question.

The Minister also relies on the assumptive fact that Gilbert Hermary was a director and controlling shareholder of the plaintiff corporation until the restructuring of shares in August of 1974. This is true so far as it goes, although the actual breakdown of shares given by the Minister is incorrect. While Gilbert Hermary may have had apparent control of the company in the years 1970 and 1971, the question is whether he exercised real and actual control to such extent as to change the character of the homestead property from farm land into business inventory, and this would seem to turn on whether a corporate decision was made at that time to subdivide and sell the property.

The management of the business and affairs of a company is generally entrusted to the board of directors, unless this power and authority is expressly curtailed or specifically required to be exercised in some other manner by statute. Welling, Corporate Law in Canada The Governing Principles, points to the collective nature of the power of the board of directors and goes on to state at 317-18:

The board, like any collective body, can only operate through meetings, resolutions, and motions. Some degree of formalism is required. We can begin with the general proposition at common law that corporate business can be transacted only at properly constituted meetings and that any decisions made outside such meetings do not bind the corporation. This rule is substantially altered by Canadian corporate statutes, but like all common law rules must be interpreted as having been varied only to the extent that it is specifically changed by statute. Thus, where an alternative to a properly constituted meeting is permitted by the statute, the alternative procedure set out must be strictly adhered to or else the meeting's decision will be a nullity.

Moreover, the principle that a corporation is a distinct legal entity with a separate personality of its own does not mean that one can safely ignore the identity, character and behaviour pattern of the individual shareholders. It may be necessary, and indeed often is, to look at the shareholder background and behaviour pattern to determine the true nature of the circumstances surrounding a particular corporate transaction and, if need be, the corporate intent that motivated it: see Welling, ibid., at 125 et seq.; In re Westbourne Galleries, [1973] A.C. 360 (H.L.) per Lord Wilberforce at 379; and De Salaberry Realties Ltd. v. The Queen, [1976] C.T.C. 656; 70 D.L.R.

(3d) 706 (F.C.A.).

Maurice Hermary testified on direct examination as follows:

Q. Now, how are corporate decisions made with Magilb?

A. Magilb was very much a family company. Decisions were made by a show of hands, usually very informal, and we didn't make that many decisions in actual fact.

Q. Did the company actually meet once a year:

A. Most years they met once a year. It was pretty well — there are a few years when we didn't meet, but usually there was nothing going on at the time, but the family would still meet regardless.

Q. The family —

A. The social aspect of it was, I think, every year we did meet.

Q Every year you did meet, and that was partially social, and?

A. And if there was anything to discuss in business, then the business was discussed.

Q. Were any corporate decisions taken without the concurrence of the family?

A. Not to my knowledge, no.

Q. How did the family come to decisions? Was it by majority, unanimaty? [sic]

A. It was by majority of one vote per person including dad. He never — he just voted like the rest of us.

Q. You didn't have a formal arrangement, though, as to whether it took a majority, or unanimity, or?

A. Not really, no. It was just a show of hands, and a majority type of —

Q. And did you talk out the corporate problems before a vote?

A. I’m sorry, I —

Q. Was there a large discussion of the problems before a vote would be held?

A. Oh, yes, usually there was. Not in a corporate sense, more of a family communication sense.

The same witness stated under cross-examination that the actual subdivision development commenced five months after the death of his father in May 1976.

I find that there is no evidence of any corporate intent to subdivide and sell the homestead property during the years 1970 and 1971. Any corporate resolutions or actions that might indicate the contrary are conspicuous by their absence. Furthermore, the shareholder behaviour pattern discloses that any decision to subdivide and sell the subject property would more likely be taken by the shareholders acting in concert rather than by the exercise of the directors’ collective power and authority.

The Minister's underlying assumption for assessing as he did is based on the syllogism that Gilbert Hermary was a director and controlling shareholder of the plaintiff until August 22, 1974, that he had discussions with city officials regarding the possibility of subdivision development in 1970 and 1971, and that it therefore follows that these discussions had the effect of changing the character of the homestead property from a capital to a trading asset. I find that the evidence adduced by the plaintiff demonstrates just the contrary.

As to the memorandum of association argument, it is my opinion that the objects stated in the memorandum are broad and general in their scope and typical of those that could be expected for any commercial company. There are no enumerated objects specifically authorizing the company to carry on the business of a real estate development. Even if there were, this in itself would not be conclusively decisive, as Mr. Justice Locke took care to point out in Sutton Lumber and Trading Co. Ltd. v. M.N.R., [1953] C.T.C. 237; 53 D.T.C. 1158 (S.C.C.) by propounding the following question at 244 (D.T.C. 1161):

The question to be decided is not as to what business or trade the company might have carried on under its memorandum, but rather what was in truth the business it did engage in.

In my opinion, the weight of evidence in this case amply demonstrates that the plaintiff company did not carry on or intend to carry on the business of subdivision development in 1971.

Furthermore, the St. Albert building lot venture does not in any way assist the defendant. The evidence is that the company, on the advice of its banker, acquired 16 building lots in this locality at the time of incorporation in order to have the same available as security for loans so that it would not have to charge or encumber the homestead property. This dabbling in real estate never amounted to anything and, in any event, there is nothing to link this prior isolated occurrence to any business activity involving the homestead property in the years 1970 and 1971.

I am satisfied that the plaintiff has raised a sufficient prima facie case to successfully challenge the Minister's factual assumptions on the issue of Capital asset or business inventory. The plaintiff has met its burden of proof and the onus thus shifts to the Minister to rebut the prima facie case made out by the plaintiff. In my opinion, the Minister has adduced no evidence whatever that could have that effect.

For the foregoing reasons, the plaintiff's appeal is allowed and the matter is referred back to the Minister for reconsideration and reassessment on the basis that the subject property of the plaintiff corporation did not change to business inventory until January 1, 1976. On my understanding, the claims for interest, as pleaded in the statement of claim, are no longer in issue. The plaintiff shall have its costs of the action.

Appeal allowed.