Sikler v. The Queen, 73 DTC 5553, [1973] CTC 736 (FCTD)

Mahoney, J:—Pursuant to the order of Noël, ACJ made September 27, 1973, the trial of these matters was heard on common evidence at Saskatoon, Saskatchewan on October 23, 1973.

The late James P Leier and his four children, the other plaintiffs, were at all relevant times the sole shareholders of James Enterprises Ltd, a company incorporated July 22, 1960 under the laws of Saskatchewan and amalgamated into Cavalier Enterprises Ltd December 29, 1971. During its entire separate existence James Enterprises Ltd was a personal corporation within the meaning of the Income Tax Act as it then stood.

The memorandum of association provided that among the objects for which the company was established were:

(d) to purchase or otherwise acquire and hold or otherwise deal in real and personal property and rights and in particular lands, buildings, hereditaments, business or industrial concerns and undertakings, mortgages, charges, contracts, and any interest in real or personal property, any claims against such property or against any person or company and privileges and choses in action of all kinds;

(g) Generally to purchase, take on lease, exchange, hire or otherwise to acquire and to hold, own, sell, convey and deal in any real or personal property . . .

James P Leier, who died May 26, 1972, was president and Donald R Leier, who entered the business after completing his education in 1963, was secretary of James Enterprises Ltd. None of the other plaintiffs appear to have taken an active part in the management of its affairs. The company’s business was carried on entirely in Saskatchewan and was primarily conducted in the hotel field through shareholdings in and loans to private operating companies. During the entire period in question, James Enterprises controlled the King George Hotel and Cavalier Motor Hotel in Saskatoon, the Selkirk Hotel in Unity, and the Marlboro Hotel in Prince Albert. It also owned a property known as the IBM Building, a two-storey office building with 25 feet of frontage on 22nd Street E in Saskatoon and the Del Haven Lodge, a senior citizens’ home on 4th Avenue N in Saskatoon, the latter being leased on a “care free” basis to a third party who operates it.

In addition to customary hotel operations, the company managed the IBM Building, which, when full, had three or four tenants, and leased commercial space to twelve or fifteen tenants on the ground floor and parkade at the King George and to three or four tenants at the Cavalier.

It is difficult to estimate the value of investments in private companies at any particular time. However, the company’s non-liquid assets, upon its amalgamation at the end of 1971, were apportioned some 20% to direct interests in real property and some 80% to equity in private companies and loans to those companies.

In April 1959 James P Leier had purchased a 5-acre parcel of some 500 feet frontage on 8th Street E in Saskatoon for about $60,000. Eighth Street was then the main highway into Saskatoon from Yorkton and Regina and it was intended to build a motel on the property. In 1960 a 10 foot wide strip was sold to the City for $2,900 and James P Leier sold the remaining property for $57,710 to the newly incorporated James Enterprises. The Minister of National Revenue valued the property at $292,000 and the consideration was written up accordingly. In 1963 the City took a 42 foot wide strip across the entire 500-foot frontage in a land exchange and the Regina-Yorkton highway was relocated to some considerable distance from the property. Because of the highway relocation, the plan to develop the motel was abandoned and, in 1966, the property was sold for $283,000 to the Federated Cooperative for a shopping centre. The $9,000 deficiency accruing to the company was treated as a capital loss.

At the end of 1966 the potash mines near Saskatoon were brought into production. General economic conditions were good. The real estate market was brisk and the demand for first-class office space could not be satisfied by the approximately 130,000 square feet then available. The existing Investors and Financial Buildings and the Canada Permanent Building then opening were all fully leased. Nothing new was under construction although excavation for the CN Tower had been carried out two or three years earlier. Work on the CN Tower had been suspended and no work had been done in the interval. Announcements of other projects had been made from time to time but no action had followed. Construction of additional first-class office space was not regarded as imminent.

On January 13, 1957 Marathon Realty Company Limited, the real estate development arm of the Canadian Pacific Railway, gave James P Leier an option to purchase the building known as the Royal Trust Building (Exhibit P1). This building, consisting of a ground floor and three floors of office space above, is located at 115-2nd Avenue N on Saskatoon’s main business street. The main branch of the Bank of Montreal abuts it on the corner of 22nd Street. The option was accepted with James Enterprises, rather than James P Leier, appearing as the purchaser when the sale was completed.

Donald R Leier stated that while the $135,000 purchase price had been apportioned $110,000 for the building and $25,000 for the land, he felt the building was, at the time of purchase, worth $100,000 and the land between $100,000 and $125,000. He acknowledged that it was a bargain. Lyle Albert Simmie, a leading local commercial real estate salesman and vice-president of McClocklin Real Estate Ltd, termed the price “a steal” for the purchaser.

The purchase price was payable $25,000 down with the balance over twelve years commencing two years after the date of sale. It was contemplated that the CPR would likely continue to occupy space in the building provided it was extensively renovated and the agreement provided that the 7% interest on the deferred balance would be waived for the initial two years provided, within that time, the purchaser spent $75,000 on renovation and rehabilitation. No major renovation had occurred since original construction in 1910.

On August 2, 1967 a contract was entered into with Poole Construction Limited for the renovations (Exhibit P9). The entire front was removed and replaced; a new elevator, air conditioning and aluminum frame window units were installed along with new flooring, dropped ceilings and lighting fixtures. The building was partially rewired. The top floor of offices was entirely gutted and new partitions installed throughout. The second floor of offices was partly gutted and repartitioned. The CPR retained the first floor of offices which it renovated at its own expense. Donald R Leier estimates that James Enterprises spent upwards of $265,000 on the renovations and that the CPR spent another $20,000 on leasehold improvements. The work was largely completed by April 1, 1968.

A $325,000 mortgage at 9% was negotiated with Credit Foncier Franco-Canadien on February 15, 1968. Marathon was paid out with a discount of 31/2% of the principal balance and James Enterprises took title to the property. Of the $325,000, $300,000 was assigned to the value of the property. The remaining $25,000 was contingent upon the achievement of a standard of income that was not, in fact, achieved and so was not drawn down. The net proceeds, after paying out Marathon, were applied along with other funds to the building’s renovation.

An active leasing program was undertaken and, by the time of its sale a year later, the building was about 70% leased. The net annual return to the owner at this level of occupancy was about $10,000.

CPR held a ten-year lease on its business offices and a five-year lease on the telecommunications offices. Other five-year leases were held by Equitable Life, Royal Trust and Wood Gundy, all national firms. A variety of local and national tenants had shorter term leases. Mr Leier states that five-year leases were the standard objective but that this was not always achieved either because the tenant refused to commit itself for that long or the rent did not support that length of term from the landlord’s point of view. The building itself had no space for tenant parking but arrangements were made to reserve space in the parkade of the King George Hotel, which is located at the far end of the same block.

Meanwhile other entrants into the office space market were in the process of considerably more than doubling available first-class space and James Enterprises concluded that the effect of this on the Royal Trust Building would be to relegate it to second-class status as an office building, mainly because of the lack of convenient tenant parking. The ground floor space would continue, because of main street traffic, to be a prime retail location. As it turned out, the new owner has not been able to increase occupancy significantly and presently has it listed for sale at its 1969 purchase price.

The Canadian Imperial Bank of Commerce moved into the ground floor premises of its namesake building in June 1969. Completion of upper floor offices followed but the building is not yet fully leased. No tenant parking is provided in the CIBC Building and it has enjoyed a particularly difficult history. Its mortgage was foreclosed and it remained half occupied until June 1973 when the Department of National Revenue took considerable space.

Tenders for construction of the Avord Towers were invited in April or May 1969. The CN Tower was completed in June 1970. Together the CIBC Building and the CN and Avord Towers added some 210,000 square feet to Saskatoon’s stock of first-class office accommodation. In the result there developed, and continues today, a substantial over- supply condition with consequent lower than normal rents, underoccupancy and fierce competition for prospective tenants.

Mr Simmie says that the commercial real estate market at the end of 1968 and early in 1969 was still very good. It fell off during 1969 and 1970 and by the fall of 1970 was “terrible”. The witnesses state that the general economic climate, although not as good as in 1967 and 1968, continued good through 1969. It fell off during 1970, got worse during 1971 and picked up again in 1972. Saskatoon’s population was about 118,000 in 1968; it grew relatively quickly until it reached about 132,000 in 1971, a level it has since maintained.

On December 19, 1968 James P Leier, as president of James Enterprises, wrote to Mr O K McClocklin, president of McClocklin Real Estate Ltd, with respect to the CPR Building (Exhibit P3). The letter stated in part:

In reply to your letter concerning the sale of this building, this letter will authorize you to sell the Royal Trust Building at a price of $650,000. The terms of this offer would be that James Enterprises pays McClocklin Real Estate Limited the commission and that this offer will expire June 30, 1969.

The total income of the Royal Trust Building, when fully occupied, is $96,000 and the total net after all expenses, including the management commission, is $60,000 a year . . .

in Mr Simmie’s view, the price set in this letter was so unrealistic as to indicate that Leier did not really want to sell.

The letter to which the foregoing constituted the reply could not be located in the files of McClocklin Real Estate, James Enterprises or the late James P Leier after diligent searches although, it should be noted, James Enterprises did not maintain a business office of its own and, physically, its records and those of Mr Leier seem to have been much the same thing. Mr McClocklin was not called to testify.

Mr McClocklin immediately offered the property to the Bank of Montreal (Exhibit D7) which, incidentally, was James Enterprises’ banker. Mr Simmie says that the Leiers were not informed of this offer and Donald R Leier says he knew nothing of it until preparing for this trial. There is no evidence as to the nature of the bank’s response, if any.

Meanwhile MEPC Canadian Properties Limited, a large public company engaged principally in the acquisition, development and ownership of real estate investment properties in Canada, was entering the Saskatoon market. Mr Simmie was their local agent and was actively looking at properties for MEPC. It bought the Tamblyn Building, located about midway between the Royal Trust Building and the King George Hotel on the same side of 2nd Avenue. MEPC also bought the OK Economy store located diagonally across the intersection of 2nd Avenue and 23rd Street from the King George Hotel. The existing buildings on both these sites were demolished and new buildings erected.

By letter dated April 18, 1969 MEPC offered to buy the Royal Trust Building for $525,000 cash to the existing first mortgage (Exhibit P4). By letter dated April 23, James Enterprises purported to accept the offer (Exhibit P5) with some qualifications as to liability for the real estate commission and legal and land titles fees (Exhibit PS). In any event, a formal offer dated April 29 was accepted (Exhibit P10) providing a total price of $525,000, apportioned $125,000 to the land and $400,000 to the building, payable by the assumption of the mortgage in the principal balance of approximately $295,000; acceptance by James Enterprises of a $60,000 second mortgage at 7 /2% due January 2, 1970 and the balance of approximately $170,000 in cash. Closing was on June 1, 1969.

According to Mr Simmie, the price paid by MEPC was a top price for the time and prices for such property in Saskatoon were then at the peak. Following the sale Simmie approached Donald R Leier with respect to reinvestment of the cash proceeds and was told that these were already committed.

Mr Leier states that he and his father, as directors of James Enterprises, felt that in the circumstances the return on the investment in the Royal Trust Building could not have approached the return realized on the proceeds of its sale and that good business principles dictated that the MEPC offer be accepted. Indeed they felt that they could have been negligent had they not accepted. Their equity in the Royal Trust Building, at the time of its sale, was about $86,000. The MEPC offer represented $225,000 for that equity. The business decision they faced was whether they could make a comparable return by retaining the Royal Trust Building to that they could make by investing $225,000 in their other projects: Their conclusion, of course, was that they could not except under exceptional conditions which, even if achieved, could not be sustained. The company’s general policy was to maintain its investments and the decision to sell any asset depended entirely on the price and “the company’s circumstances” which I take to mean the need for or Opportunity to use the proceeds.

James Enterprises had increased its equity in the Marlboro Hotel in Prince Albert from 56% to 70% in 1967. It was extensively renovated at a cost of some $1,800,000; 120 rooms were rebuilt resulting in what Mr Leier termed “a new hotel with an old wing” which was officially opened April 8, 1969. The furnishings were financed by a chattel mortgage in favour of their supplier, the T Eaton Co. in July 1969 James Enterprises began construction of additions to Del Haven Lodge which resulted in its conversion from a senior citizens’ residence to a nursing home.

The proceeds of the sale of the Royal Trust Building were used along with other funds to buy up the Eaton’s chattel mortgage on the Marlboro furnishings and to pay for the additions to Del Haven Lodge. By the end of 1971, James Enterprises had advanced about $160,000 to Marlboro at 12% annual interest. Some $50,000, on which a return of over 20% annually is realized, was spent at Del Haven Lodge. None of the proceeds were distributed to the shareholders.

On May 19, 1972 the Minister of National Revenue reassessed the plaintiffs’ 1967, 1968, 1969 and 1970 income tax returns. This appeal is limited to the 1969 and 1970 reassessments to the extent that they reflect the addition to the plaintiffs’ respective incomes for those years of a portion of the gain of $110,631.91 realized by James Enterprises on disposition of the Royal Trust Buiding as a dividend deemed to have been received by the plaintiffs. The amount of the gain and its apportionment among the plaintiffs is not in dispute.

Donald R Leier and Lyle Albert Simmie were knowledgeable, frank and credible witnesses. No other witnesses were heard although the defendant took issue with the plaintiffs’ failure to call Mr O K McClock- lin to testify concerning the missing letter. The reply to the missing letter does not leave an impression that calls for an explanation. The plaintiffs, in discharging the onus imposed on them, were under no obligation to call witnesses whom the defendant’s counsel might have liked to cross-examine nor were they required to rebut speculative propositions.

It is argued that, given their knowledge and experience in Saskatoon’s commercial real estate market place, James P Leier and Donald R Leier, and hence James Enterprises, must, when acquiring the Royal Trust Building, have had at least a secondary intention of selling it. It is, I think, difficult to conceive of a knowledgeable purchaser of commercial real estate acquiring such a property with no intention whatever of selling it in the event he is offered a price that ordinary good business sense dictates he should accept. However, this imputed intention, by itself, does not constitute an operating motivation for the acquisition.

The nature of the business actually carried on by James Enterprises does not disclose a pattern of trading in real estate. Except where, by reason of significant changes in circumstances entirely beyond the company’s control, it became prudent to abandon its intentions for use of a particular real estate investment, the company held and improved that investment and derived its income therefrom. The rerouting of the main highway from Yorkton and Regina was such a significant change vis-a-vis the company’s intentions for the motel development on the 8th Avenue property. Likewise, the substantial expansion of the inventory of first-class office accommodation in Saskatoon, taken in the light of general economic trends which the company, familiar with the local situation, was obviously better able to interpret correctly than some of the national firms with whom it dealt, was such a significant change vis-a-vis the company’s intentions to hold the Royal Trust Building.

I am satisfied that the Royal Trust Building was acquired as an investment and that the renovations were carried out with a view to preserving and enhancing its value as an investment rather than with a view to enhancing its resale value although the latter was, of course, a coincidental result. The very short period that James Enterprises held the building was a fact that demanded an explanation. The explanation given is entirely reasonable and is supported by the conditions pertaining at relevant times in the local market place. It may well be that in other urban areas, a history of sustained increase in the demand for and value of downtown commercial real estate would cast a doubt on the bona fides of a decision to sell based on an apprehended arrest or reversal of such trends. I have no such doubt in this instance.

The appeals are accordingly allowed. The plaintiffs shall have their disbursements under Tariff “A” and, under Tariff “B”, costs calculated on the basis of these appeals having been a single Class III matter throughout.