Cantor v. MNR, 85 DTC 79, [1985] 1 CTC 2059 (TCC)

Cardin, TCJ:—The appeals of Allan Cantor, Norman S Goltsman and Abraham L Simkin, heard on common evidence with respect to the 1975, 1976, 1977 and 1978 taxation years, present a number of ancillary issues, the eventual litigation of which depends on the determination of one major issue. That issue, simply put, is whether there occurred a change in the nature or character of a capital property prior to or at the time of its disposition which had the result of converting to inventory a capital property.

The subsidiary issues relate to the purchase by the appellants, subsequent to the disposition of the property, of income averaging annuity contracts in the 1976 and 1977 taxation years. (The sole issue in Allan Cantor’s 1978 appeal is whether the appellant’s income qualified him to purchase an Income Averaging Annuity Contract in the amount of $11,257.68.) The remaining secondary issues are whether the appellants could rightly claim capital cost allowance on the subject property in 1975, the determination of the V-Day value of the property and the alleged conversion value of the property as of December 31, 1975.

The Tax Review Board (now the Tax Court of Canada) was advised that a settlement had been reached with respect to the Southwood Green property which appears as an issue in Abraham L Simkin’s appeal for the 1975 and 1976 taxation years. That item in Mr Simkin’s appeals is therefore no longer in litigation.

Counsel for the appellants and counsel for the Minister asked the Board to hear and determine but the principal issue in these appeals, leaving the hearing of the related issues, should it become necessary, to a later sitting. Counsel in effect were asking that the cases be split, and the Board agreed to do so. The only question presently before the Board, therefore, is whether prior to its disposition in 1976 and 1977, the appellants’ capital property was converted to inventory.

In the pertinent taxation years, Allan Cantor, Norman S Goltsman and Abraham L Simkin were partners in an active law firm. In the fall of 1969, the firm had accumulated funds which were surplus to its operational needs. The partners having decided to invest in rental income property, purchased 28 townhouses situated on Ness Avenue in Winnipeg, Manitoba, on December 15, 1969 at a cost of $495,369. Abraham L Simkin held a one-half interest and Allan Cantor and Norman Goltsman each held a 25 per cent interest in the property.

There is no dispute that the property was acquired as a rental-producing investment. At the time of purchase, the townhouses were approximately one year old and were fully occupied. The 28 townhouses each being an independent unit with accesses in the front and back consisted of twenty two-storey, three-bedroom units and eight single storey, two-bedroom units located in six separate buildings (Exhibit A-1).

The appellants had found the property and its location attractive and expected a return of 10-12 per cent on capital, sufficient to service the mortgages and expenses, and even to provide a small return. The original developers of the complex were to continue on as managers on behalf of the appellants.

The balance sheets and operating statements covering the period of 1969 to 1977 inclusive (which were accepted by the respondent as Exhibit A-2) show that the appellants’ rental incomes decreased from $53,696.27 in 1970 to $45,550 in 1973, and then rose to $50,000 in 1974. Mr Cantor testified that the quantity of available rental housing had subsequently increased, principally because of the Government of Manitoba’s low rental housing projects.

As a result, there was a surplus of housing in Winnipeg; rents could not be increased to meet increasing expenses, particularly municipal taxes which rose from $8,400 in 1969 to $18,400 in 1975, without further increasing the number of vacancies. The investment was considerably less interesting than it had appeared in 1969.

Although the original developers were to provide professional management of the property, the manager left in November of 1970. The limited return on the property made the hiring of professional management uneconomical and part- time management had to be resorted to, leaving a considerable amount of the management to be carried out by the appellants themselves. In 1976, the property was then five years old, and very little maintenance and repairs to the property had been made because of the decreasing amount of income generated over the years.

It was estimated that substantial maintenance costs of over $100,000 were necessary for exterior and interior decorating, landscaping, recarpeting, and for new drapes furnished with each unit. The renovations, according to Mr Cantor, had become necessary whether the appellants continued to rent the property or whether they decided to sell it outright — a consideration which was seriously entertained because of diminishing returns and increasing costs. However, in either case it was felt that the costs of renovating the property would not be recovered. On the one hand the cost of the renovations would require a corresponding increase in rental income beyond what the tenants would be willing to pay at a time of surplus housing. On the other hand, the appellants would have to accept a considerable loss of capital if they were to sell it as a revenueproducing property.

By the end of 1974 and the beginning of 1975, the appellants felt that the property had become an investment they could no longer afford and sought a way to dispose of the property and recoup their investment. Serious consideration was given to the possibility of disposing of the complex by splitting title and selling each townhouse separately.

The appellants, having acted on a condominium project in a legal capacity in Winnipeg, were aware of the existence of the condominium legislation of the province of Manitoba which, at the time, had been very recently adopted. In essence, the legislation authorized the Land Titles Office to issue a separate title for-unit complex originally held under one title. The conditions under which this could be done were relatively simple. A survey of each unit of the complex had to be made and a complete plan of each unit filed in the Land Titles Office. A declaration indicating the dimensions and the details of each unit and its relationship to the common areas were also required.

The appellants who looked after the legal aspect of the transactions complied with all the regulations, the survey plan was registered, a declaration made and a Certificate of Title was issued for each individual unit in January of 1976. This certificate of split titles with respect to the appellants’ complex was the sixth issued by the Manitoba Land Titles Office.

In March of 1975, with the splitting of title in mind as a possibility of disposing of the property profitably by selling the townhouses individually, the appellants had consulted a Mr Gary Adams who was active in real estate and who already had had experience in marketing condominium complexes whose titles had subsequently been split. It was only after discussions with Mr Adams that the appellants finally decided to dispose of the complex by selling the townhouses separately. Although the complex as a rental-income producing investment could no longer be profitably operated by the appellants or sold as such at cost price, each townhouse could be offered to a potential purchaser as a self- contained residence, at an attractive price, even after the costs of renovations had been incurred — the appellants could then reasonably expect to recoup their capital outlay and, indeed, did make a handsome profit from the transactions.

The services of Mr Adams were retained in April of 1975 and he managed the property for the rest of the period of the appellants’ ownership. He also organized and supervised the renovations and repairs to the townhouses, prepared all the advertisement, directed the real estate agents who were to sell the units, and did all that was necessary for the successful marketing of the townhouses. Mr Adams was paid $25,000 for his services.

The costs of the renovations and repairs to the townhouses for 1975 and 1976 were $74,476 and $81,353 respectively, as shown with a breakdown of the figures in Exhibits A-3 and A-4. These amounts are not disputed by the respondent. Mr Adams had used two townhouses as models of what could be done with the interior of the units and furniture had been rented for that purpose. New landscaping in the amount of $5,699, spent in 1975, was also included in the costs of renovations and repairs. These two items of expenses appeared to give counsel for the respondent some difficulty. Without determining the issue at this point, I am satisfied that lawns, trees, shrubs and hedges that had been neglected for a period of five years might well have required replacement and the landscape renewed if the property was to appear at its best advantage for sale purposes. Decorating two units as models with rented furniture also appears to me an acceptable method of promoting the sale of the townhouses in the circumstances.

In the pleadings there is a discrepancy in the parties’ respective figures as to the exact amount of the gross proceeds of disposition of the 28 townhouses. Having no evidence before me, I shall use for purposes of determining the major issue an approximate figure, leaving the parties to agree on what the exact sale price was should counsel find it necessary to do so. In 1976, 26 townhouses were sold at an approximate price of $830,000. In 1977, the remaining two townhouses were sold for approximately $65,000.

The appellants computed the income for the 1976 and 1977 taxation years on the basis that the disposition of the townhouses was on capital account which gave rise to a capital gain. Full recapture of the capital cost allowance previously taken on the rental complex was included in the appellants’ 1976 tax returns.

The Minister assessed the appellants for the 1976 and 1977 taxation years on the basis that, from the end of 1969 to December 31, 1974, the rental complex was capital property whose V-Day value was $490,000 and whose fair market value on December 31, 1974 was no more than $550,000. However, the Minister assumed in his assessment that there was a notional disposition of the rental complex in December 1974 and that the property was converted at that time from a capital asset to inventory. The Minister’s submission is that the profits derived from the disposition of the townhouses in 1976 and 1977 were income from a business.

At the hearing, counsel for the respondent explained that the term “notional disposition’’ meant a change of use or a conversion of the rental incomeproducing complex to an inventory of townhouses as of December 31, 1974. Again without deciding the major issue, it is difficult indeed to understand, and the respondent did not satisfactorily explain the basis on which he alleges that a notional disposition, a change of use or conversion of the complex, if indeed there was one, occurred on December 31, 1974, the date used in the computation of the Minister’s assessment for the appellants’ 1976 and 1977 taxation years. Why would the Minister, on the basis of that assumption, not have included the capital gain and the recapture of the capital cost allowance in the appellants’ income for the 1974 taxation year? I do not see how those 1974 amounts can properly have been assessed in the appellants’ 1976 and 1977 taxation years even if the Minister’s assumption that a conversion from a capital asset to inventory took place on December 31, 1974 was correct.

The evidence clearly established that the decision to sell the townhouses separately was made in March or April of 1975, and the tenants subsequently continued to occupy the premises — the renovations being made to each unit as the tenants moved out. The Certificate of Title permitting the appellants to proceed with the sale of the townhouses was only issued in January of 1976. Even if I were to find that a conversion or a change of use of the rental complex did occur, I do not accept that it occurred on December 31, 1974 and the Minister’s assumption in that respect is, in my opinion, unfounded.

Whether or not there was a conversion or change of use of the rental complex is a question of fact rather than law. Mr Cantor’s testimony, which was corroborated by the evidence given by Mr Goltsman, was clear, complete, logical and plausible and was in no way shaken or weakened by the able cross-examination of counsel for the respondent.

Had the appellants sold the rental complex as such, the transaction would unquestionably have been capital in nature. The question to be decided, as I see it, is whether a capital property clearly acquired by a taxpayer as a long-term income-producing investment can lose its nature or character of a capital asset by the choice made by the taxpayer as to the most profitable means of disposing of that capital asset once it has subsequently proven to be an uneconomical investment.

In argument, counsel for the respondent admitted that the mere realization of a capital asset as a result of minimal effort does not, of itself, constitute trading. He contends, however, that the determining factor in deciding that a capital asset has been converted to a trading inventory is the degree of activity exercised by the taxpayer in disposing of the property.

For that proposition, the respondent relies on a decision of the Exchequer Court of Canada in Harry Moluch v MNR, [1966] CTC 712; 66 DTC 5463. In that case, Moluch acquired 55 acres of bushland, part of which he cleared and farmed. Because of his wife’s ill health, he was forced to abandon the property in 1956. For that purpose Moluch had the land subdivided, roads built, sewers and necessary utilities installed. He then advertised and disposed of his farm by selling fully serviced lots. From 1956 to 1962, Moluch realized a substantial profit from the sale of his lots. In reassessing Moluch the Minister of National Revenue assessed the gains from the sale of the lots as income from a business and Moluch appealed. The Minister’s assessment was first maintained by the then Tax Appeal Board and subsequently confirmed by the Exchequer Court.

In dismissing Moluch’s appeal [1966] CTC 712 at 718; 66 DTC 5463 at 5467, Cattanach, J cited a decision of Thorson, then President of the Exchequer Court in Cragg v MNR, [1952] Ex CR 40; [1951] CTC 322; 52 DTC 1004, in which the learned President stated:

. . . the Court must be careful before it decides that a series of profits, each one of which would by itself have been a capital gain, has become profit or gain from a business. Such a decision cannot depend solely on the number of transactions in the series, or the period of time in which they occurred, or the amount of profit made, or the kind of property involved. Nor can it rest on statements of intention on the part of the taxpayer. 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. The conclusion in each case must be one of fact.

Counsel for the respondent placed on record certain passages of Cattanach, J’s reasons found at 720 and 5467 of Muloch (supra):

Merely putting the article into a more suitable condition for favourable sale would not necessarily have this effect, as, for example, having a house repainted or jewels cleaned and the like. I am disposed to think that the matter is one of degree depending upon the business-like enterprise and activity displayed. I should also think that the element of carrying on a trade would be introduced if a purchaser were by himself, or his own employees or by a contractor through an expenditure of effort and monies to change the character of the property (vide CIR v Livingston, 11 TC 538).

However, the learned Judge continued saying:

This is what I think the appellant did. He took the raw land which he owned and by the expenditure of money and effort he ended up possessing a number of fully serviced residential lots for sale.

Neither do I think that he was forced by circumstances to adopt the course that he did because no alternative course was available to him. He voluntarily made the decision to subdivide his land with the full knowledge that he would be obliged by his agreement with the City to provide the services required.

At 721 and 5468 respectively of Muloch (supra) Cattanach, J also stated:

The facts in the McGuire case are distinguishable from those in the present appeal in that there the effect of filing a plan of subdivision was merely to divide the land into a number of smaller parcels which were sold piecemeal without effecting any physical change in the land, whereas in the present appeal, the character of the raw land was changed to that of serviced lots by the expenditure of considerable effort and money, in addition to the land being divided into a number of smaller parcels.

The learned Justice concluded at 721 and 5468:

Like the Chairman of the Tax Appeal Board I cannot refrain from commending the appellant and his family for their industry and perspicacity by which they improved their material circumstances. Nevertheless, I am of the opinion that the appellant’s whole course of conduct constituted the embarkation upon a business and the gains realized are accordingly profit from a business within section 3 of the Income Tax Act.

No one can now seriously doubt that the degree of activity of a taxpayer, his efforts, and the amount of money expended are among the basic factors generally considered in determining whether the exercise by the taxpayer of any specific activity constitutes a business operation. I do not believe, however, that the degree of Moluch’s activity was the only, or indeed the more important criterion applied by Cattanach, J in deciding the Moluch (supra) as suggested by the respondent.

In considering Moluch’s whole course of conduct, the learned Justice also found that the nature and the character of the bush farm had been changed and converted into fully serviced lots for sale. In my opinion, the fact that the taxpayer’s activities were aimed at changing the basic use of the farm land to that of marketable, serviced residential-lots was a preponderate consideration in his finding that Moluch was engaged in business. Had there been no conversion or change of use of the farm, I do not believe, according to the learned Justice’s own words (supra) that he would have concluded that Moluch was in business.

In MNR v Firestone Management Limited, [1966] CTC 771; 66 DTC 5502, also cited by the respondent, the issue in essence was whether profits realized as the result of converting a private company to a public corporation were income (for the company) from a business of trading in shares. In dismissing the Minister’s appeal, Mr Justice Jackett, then President of the Exchequer Court, agreed with Mr Justice Cattanach’s decision in Moluch (supra) and states at 774 and 5504 respectively:

I entirely agree with that decision and I also agree with Mr Justice Cattanach that, in any particular case, “the matter is one of degree depending upon the businesslike enterprise and activity displayed’’, I also agree that an “element of trade’’ would be introduced if a purchaser were, by himself or his own employees, or by a contractor, through an expenditure of effort and monies, to change the character of the property. [Emphasis mine]

In both the above decisions, the degree of activity of the taxpayers is referred to in relation to a change of character of the property. In Moluch (supra) there was a change of character of the property from farm land to serviced lots, and the taxpayer was found to have been engaged in the business of selling serviced lots. In Firestone (supra) Jackett, P found that the taxpayer’s activity did not produce any change in the nature or character of the company’s operations, and he concluded that Firestone was not engaged in the business of selling shares.

In the case at bar, there was no change in the character or indeed in the use made of the townhouses. Whether they were rented or owned by the occupier, their use was residential. The townhouses had been originally planned and built as self-contained residential units. The expenditures made on the property were clearly for renovations, repairs and landscaping — no structural changes were required or made. As of April 1975, the management of the property as well as the organization and supervision of the renovations to the townhouses were carried out by Gary Adams, a real estate man who was also entrusted with the sale of the 28 townhouses.

It appears evident to me from the evidence that the appellants’ whole course of conduct as of late 1974 was to dispose, at the best possible price, of rental income property which was no longer a profitable investment. In this respect, I find the words of Mr Justice Jackett in Firestone (supra) particularly applicable to the facts of the case at bar when, referring to Firestone, he states at 775 and 5505 respectively:

It merely did what its advisers advised it to do in order to realize most advantageously a portion of an investment which, as a matter of good judgment, called for some “diversification”.

With respect to the sole issue to be decided by the Court for the appellants’ 1976 and 1977 taxation years, I find that the proceeds of disposition of 26 townhouses in 1976 and of two townhouses in 1977 were on capital account. The appeals are therefore allowed on that specific issue and the matter is referred back to the Minister for reconsideration and reassessment on that basis. The Court, as requested by counsel, has made no other findings with respect to related issues raised by the appellants in their appeals for the 1975, 1976, 1977 and 1978 taxation years.

Appeals allowed.