Demeter Equity Ltd. v. The Queen, 79 DTC 5230, [1979] CTC 311 (FCTD)

Mahoney, J:—The plaintiff disputes inclusion in its 1973 income tax assessment of the entire $441,860.61 gain realized on the sale of a parcel of real estate owned by it. The plaintiff has reported a taxable capital gain on the disposition in the amount of $24,073.04 on the basis of a fair market value on Valuation Day of $552,029.70. None of these amounts are disputed.

The plaintiff was incorporated March 29, 1965. At all material times its shares have been owned equally by Thomas R Merritt and William H Kaufman. They are distantly related by marriage. Merritt was, throughout, the directing mind of the plaintiff and certain other companies hereafter referred to.

Merritt was a schoolmaster at Appleby College, Oakville, Ontario, from 1948 through June, 1963. In 1961 he and his wife purchased a farm property near Guelph. They took up residence there in August, 1963. They still live there. In leaving teaching, Merritt had in mind to pursue an entirely new, two-fold career. He intended to be a farmer and he wanted to explore the development potential for recreational purposes of certain land he knew in the Collingwood area. He had never farmed nor engaged in land development before. Indeed, he had never owned an interest in real estate before the 1961 purchase of the Guelph farm. While at Appleby, the family lived in a house provided by the college. He taught history.

It is convenient to deal separately with the steps Merritt took to realize his agricultural and development plans. In August, 1960, a company called Thombill Investments Ltd had been incorporated to preserve Merritt’s father’s assets. His father had become impaired in his ability to do so himself. The shares were owned equally by Merritt and his sister. Its assets consisted entirely of marketable securities. Until 1965, Merritt was not actively involved in managing the portfolio.

In 1962, Pleiades Estates Ltd was incorporated as a holding company in connection with the intended development of recreational land. Merritt owns between 70 and 75% of its shares. It owns, as subsidiaries, Northmount Club Ltd and Castle Glen Estates Ltd respectively incorporated in 1963 and 1965. Northmount, a company without share capital, is apparently envisaged as the owner and operator of the recreational facilities in Collingwood Township. Castle Glen acquired the Collingwood land with a view to developing it. In 1972, a company called Swengada Developments Corporation acquired the Collingwood land. It intends to pursue the Castle Glen concept. The degree of Merritt’s interest in Swengada is not clear from my notes. I assume he has some. Swengada has sold a small parcel to the county for road widening but, otherwise, the Collingwood land appears to have remained intact, whatever the reduction of Merritt’s share as a result of the Swengada deal.

Merritt became interested in land development aside from Collingwood. College Acres Land Development Co Ltd, a wholly-owned subsidiary of Thombill, was incorporated in 1965 and acquired land to the south of the City of Guelph. Sales of developed parcels began in 1969. The land has now been fully developed and has all been sold. High Claire Park Estates Ltd, a wholly-owned subsidiary of College Acres, incorporated in 1972, is now actively engaged in buying and selling serviced lots. Stoneglen Construction Ltd, incorporated in 1970, owns a commercial gravel property but has never sold land.

The plaintiff has no interest in any of the companies mentioned in the preceding two paragraphs. I turn to Merritt’s farming career. As stated, he owns 50% of plaintiff and Kaufman the balance. Kaufman is a manufacturer who moved from St Catharines to Guelph shortly before the plaintiff acquired the subject land. There is no suggestion that, aside from the subject transactions, he has been involved, directly or indirectly, in real estate trading. The plaintiff was incorporated March 29, 1965, and the agreement to purchase the land was concluded April 1. The objects set forth in the plaintiff’s Letters Patent do not refer specifically to farming; they are, rather, objects suitable to an investment company.

Prior to the purchase, Merritt considered three parcels in the Guelph area. He had an expert report on their development potential. The written report was received a few days after the commitment was made to buy the subject property which, along with one of the others, was considered unsuitable for development. The third, considered suitable for development, was ultimately bought by College Acres.

The property purchased, then consisting of about 150 acres, lies about a quarter of a mile from the limits of the City of Guelph near its northeast extremity. When it was purchased, the distance was about half a mile; however, it was then known that an annexation was pending and that the property was not to be annexed. The property was, and remains today, zoned for agricultural use. It had been in the vendor’s family as a dairy farm for over 50 years. It included about 65 acres of peat bog.

In considering its purchase for a farm, Merritt had no intention to operate a dairy. He did not buy the vendor’s milk quota or specialized equipment. Nevertheless the only persons with farming experience he consulted as to its agricultural viability were the vendor and the realtor, both of whose experience lay in the dairying area. Merritt and Kaufman each subscribed $25,000 for shares in the plaintiff. Merritt borrowed $20,000 from his wife. After meeting the downpayment and providing for other obligations, the balance was invested in marketable securities.

The purchase price of $140,000 was payable $40,000 down with the balance, secured by a first mortgage, due in 5 years at 5 /4% per annum. The farm was leased back to the vendor for the rest of the year, while he built a anew home, at a rent of about $2,100, some 75% of the interest obligation for the period. The vendor does appear to have been generous in lending the plaintiff the use of his farm equipment. While farming the property, the plaintiff found it necessary to buy only one item of equipment, a hay baler, at a cost of $525.50. It was decided to go into finishing cattle. Merritt felt that, if that was not viable, at worst a decent return could be derived from cash crops.

In 1966, the plaintiff bought 49 head of cattle and finished them for market. A man was hired full time to tend them. Fourteen of these were sold in 1966 and the remaining 35 in 1967. In 1967, an additional 53 head were bought of which 39 were sold late in the same year and the remaining 14 on February 28, 1968. The plaintiff’s fiscal year is the calendar year. As a farmer, it reported income and expenditures on a cash basis and, therefore, the financial statements are of little use in assessing its financial progress. Suffice it to say, sometime in 1967, it was decided that the cattle finishing business was a losing proposition, mainly because of the quantity of feed that had to be bought to supplement the farm’s own production and that, to cut losses, the business would be discontinued. At this point, Merritt clearly decided that if it could not produce sufficient crop to sustain the finishing operation, it could not produce enough for viable cash cropping. In 1967, the intention to farm the property was abandoned. Thereafter, for the material period, the plaintiff’s only significant income was from the rent of the land to Stonedale Farms Ltd which became the vehicle for Merritt’s active farming pursuits.

Stonedale, incorporated in September, 1966, is owned by Merritt and the members of his immediate family. It bought the home farm from him and his wife, as well as additional land. It has pursued the cattle finishing business in a big way on lands owned and rented; for example, its cattle inventory grew from less than $150,000 at the end of 1967 to over $900,000 at the end of 1972. It is clear that Merritt pursued his intention to farm, even though he did not continue to use the plaintiff as his vehicle. Unlike the plaintiff’s, its Letters Patent expressly contemplate farming as an object.

During 1967, it became public knowledge that, because of flooding of the Speed River, the Conservation Authority proposed to take action that would involve the expropriation of land northeast of the city. It was not, it seems, a question of whether land would be taken but simply what land would be taken. On June 13, 1967, the plaintiff granted one Percy A Gilligan an option to buy the entire property at $3000 per acre. The option was recorded in the Registry. Gilligan was an old friend of Merritt’s father and was known to the plaintiff’s auditor. The option price of $4500 was evidenced by a demand note. Merritt and Kaufman each signed a demand note for $2250 in favour of Gilligan. All three notes were held by the auditor, whose evidence, corroborating that of Merritt, is that the option was not intended to be exercised. It was a sham as between the parties who intended to scare off the Conservation Authority by reason of its price when the Registry was searched.

The sham seems to have succeeded; no action was taken by the Authority in so far as the subject property was concerned. However, the property on which the vendor had relocated was expropriated and he approached the plaintiff with a view to buying back part of the subject property on which to relocate. He also, it appears, introduced two other persons similarly required to move. The plaintiff’s cash flow had continued negative in spite of cessation of the cattle finishing. The principal of the mortgage had come due. The opportunity to sell off the property to meet its obligations was welcomed by the company. In the result, applications to sever three parcels were approved by the Committee of Adjustment and the sales of the initial vendor and one of the other purchasers were completed. The remaining purchaser, having made an offer, left Canada and College Acres Land Development Co Ltd, previously referred to as another company of which Merritt is the directing mind, completed the purchase on the previously agreed basis. As part of the deal with the original vendor, an extension of the due date of the balance of the mortgage ($70,000) was granted.

Proceedings before the Committee of Adjustment occurred toward the end of 1971. In the process, Merritt got the impression that a subdivision of the property might be viewed with some favour. A draft plan of subdivision was prepared on the plaintiff’s request and circulated to the local authorities; however, it became clear that it would not be favourably received. The proposed subdivision did not proceed further and the balance of the property remains unsubdivided.

In 1973, the plaintiff was approached by German interests, through a Quebec corporation, Nisdal Properties Ltd, desirous of buying a half interest in the remaining property. The offer, said to have been unsolicited, contemplated the plaintiff buying a 50% interest in a company to be incorporated to effect the purchase. Provision was made for Merritt and Kaufman personally, “as tenants-in-common”, to subscribe for the shares to be allotted to the plaintiff. In the event, they did. The price was $630,000, payable $250,000 by a first mortgage maturing December 1, 1977 and bearing interest at 4% per annum, a demand note for $190,000 bearing interest at 3% per annum but not subject to presentation until either discharge or default of the mortgage, and the remaining $190,000 in cash. The new company, Chancery Park Developments Ltd, was incorporated. Nisdal subscribed $10,000 for shares. Merritt and Kaufman together did likewise. Nisdal loaned Chancery Park $190,000 to meet the cash payment. It was evidenced by a 3% demand note similar in its terms to that given the plaintiff as part of the purchase price. Nisdal and the plaintiff agreed to provide additional funds equally as required including any amounts necessary to meet the mortgage payments. Merritt was appointed manager of Chancery Park.

Merritt was an entirely credible witness. He says that, when he left teaching, he intended to pursue two distinct businesses: farming and land development. He knew little or nothing about either when he started. It is apparent that he has learned a great deal about both since. He has, in fact, through various corporations, pursued both businesses. In the case of each corporation he has been the controlling mind. He has, by his choice of organization, kept separate the two businesses.

The critical question is the intention which Merritt, as the plaintiff’s controlling mind, entertained when the subject property was acquired. He says it was intended to farm it and that the possibility of resale at a profit was not an operating motivation for the acquisition.

I adopt, as particularly apt in the circumstances, the following lengthy passage from the decision of Addy, J in Powers The Queen, [1975] CTC 580 at 584; 75 DTC 5388 at 5391.

The only direct evidence of what a person has in mind at any given time must necessarily come from a statement by that person either at the trial or orally or in writing to another person and any such expression of intention is most relevant and important, especially when given under oath at the trial by the person whose intention is at issue and after the statement of such intention has been thoroughly tested by cross-examination in the light of his actions both before and after the event in question. Conversely, it would be most difficult for me to find in favour of a taxpayer, whatever the surrounding circumstances might be, who, without any justifiable excuse, failed to testify personally at the trial as to what his intention actually was. It is such important and vital evidence that its absence would, in my view, almost invariably destroy the taxpayer’s case unless there was some good explanation offered as to its absence. Furthermore, it is evidence which has the added characteristic of being solely within the knowledge and control of the taxpayer himself. If a judge were to charge the jury to the effect that the law requires that circumstantial evidence of intention be given preference over direct evidence then I have no doubt that any such direction would constitute a mistrial. A judge should therefore refrain from charging himself in that manner.

All issues must be determined by a careful consideration of all of the relevant evidence both direct and circumstantial. In any particular case, a specific piece of evidence might, by reason of the surrounding circumstances of that case, necessarily possess great probative value while, in another case, evidence to the same effect might carry little or no weight. The Court must also bear in mind that facts often speak louder than words and that free acts are very good indication of what a person really intends and overt acts and their results constitute an excellent means of deciding what the intention actually was. In the same manner, other circumstances, which are not the result of any particular action of the person at the time and place in question, might also be considerable help in deciding the issue of intention. I have in mind for instance the circumstance of a taxpayer, whose intention is being scrutinized, being by profession a land developer (see Bel-Conn Limited v MNR, [1973] CTC 2009; 73 DTC 17). This is undoubtedly a very important circumstance. Yet, one cannot say that, as a matter of law, every land developer is precluded from establishing that in a particular case there was no primary or secondary intention to speculate, anymore than in a case such as the one at Bar where a mature man has never previously resold a piece of real estate at a profit, is one precluded from finding that, on his very first venture in this sphere, he did in fact have the intention of reselling at a profit when he originally purchased the lands. The issue of intention must therefore be resolved by a careful weighing of all of the admissible evidence which is in any way relevant to that issue and the person or body charged with finding the facts must refrain from considering each piece of evidence independently but must examine it in the light of all the other evidence both direct and circumstantial. Unless there is a specific statutory provision to the contrary, this general rule of evidence must be applied in all cases including taxation cases. It follows that little help can be obtained from former decisions regarding what weight should be attributed to any particular circumstance in so far as it may prove or disprove an intention to engage in an adventure in the nature of trade, except in so far as any such decision might make one aware of a particular area or circumstance which should be considered or taken into account.

When, toward the end of 1967, it was decided to stop farming, the intention to dispose of the property as advantageously as possible was formed. Nothing that transpired thereafter, such as the severances or the fact that the plaintiff did not actively seek a purchaser, are relevant to a determination of its intention on acquisition. The absence of farming as an express object in the Letters Patent is neither here nor there. The granting of the option demanded explanation. Whatever one’s view of its propriety, the sham was explicable in terms entirely consistent with the intention to farm.

I do not accept the conclusion drawn from the evidence by the defendant’s counsel that Merritt’s failure to consult disinterested agricultural experts before buying the subject property as a farm was a noteworthy departure from his normal practice. There is no evidence that he consulted experts in the acquisition of Stonedale or the subsequent development of its farming business. Merritt says he learned as he proceeded and admits that, when he bought the subject property, he was too anxious to get started in farming. With the benefit of hindsight, the operations actually undertaken or considered, cattle finishing and cash cropping, may clearly appear to have been doomed to failure. When that became clear to Merritt, he cut his losses immediately by terminating the operation, a course of action I consider most consistent with a genuine desire to farm as a business. A person seeking to cloak a speculative land purchase with the legitimacy of a working farm would, I think, have been tempted to keep the farm running for a cosmetically acceptable period.

I am satisfied, on a balance of probabilities, that the possibility of selling the property at a profit was not an operating motivation in its acquisition. The plaintiff’s 1973 income tax return will be referred back to the Minister of National Revenue for reassessment on the basis that the gain realized on the sale of the subject property was a capital gain, not income.