Date: 20011122
Docket: 2000-1410-IT-G
BETWEEN:
318806 B.C. LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor
Judgment
Rip, J.
[1]
The appellant 318806 B.C. Ltd. appeals an income tax assessment
for its taxation year ending December 14, 1995, in which it
claimed an "inventory write-down" pursuant to
subsection 10(1) of the Income Tax Act
("Act") in respect of certain property the
appellant reacquired in that year on default of a debt due to it.
The issue before me is whether the property in question was
capital, as claimed by the respondent, or inventory, as claimed
by the appellant.
[2]
Mr. Michael Smith is the sole director and officer of the
appellant. Mr. Smith is also the sole shareholder, director
and officer of M.R. Smith Ltd. ("Smithco"), the only
shareholder of the appellant.
[3]
At all relevant times Smithco carried on the business of a
wholesale sales agent of Imperial Oil Canada Limited
("Imperial") selling oil and gas north of the Fraser
River in British Columbia. Sometime in about 1989 Mr. Smith
decided that he would like to increase his business activity by
owning an Esso service station and incorporated the appellant for
this purpose. ("Esso" is a trade name under which
Imperial sells gasoline.) The appellant purchased a gasoline
station consisting of gas pumps and a convenience store
("Property") east of the Pitt River and along the
Lougheed highway. The facility purchased was rundown and had to
be converted to an Esso station. The purchase price was
$345,000.
[4]
The Property's location was ideal for a retail gas outlet. A
sales tax of four cents per litre of gasoline was exigible on gas
sold within the Greater Vancouver Regional District
("District"). In 1990 Pitt Meadows was outside the
District and gasoline retailers could sell gasoline for four
cents less per litre than the dealers within the District. The
Property was located only metres east of the District and the
gasoline station on the site could sell gas at the lower price.
Potential customers could cross the Pitt River and then return to
the District at minimum convenience. Mr. Smith also believed he
had an opportunity to develop a "card lock" operation
on the Property. Commercial users, that is large trucks, would be
granted access to the gasoline station 24 hours a day using
special access cards to purchase their gasoline.
[5]
After the appellant purchased the Property, it incurred expenses
of approximately $350,000 to refurbish the Property, installing
new gasoline storage tanks and improving the convenience store.
During the renovations Mr. Smith discovered contaminated soil on
the Property, which had to be cleaned and replaced with clean
soil.
[6]
The appellant operated the Property as a gasoline station and
convenience store for a period of approximately 46 months. The
appellant was very successful. The volume of business increased
from 400 litres a day at the time of purchase to 20,000 litres
per day when the station was reopened after renovations, an
increase of 500 per cent.
[7]
On several occasions Mr. Smith was approached by principals of
Soni & Sai Holdings Ltd. ("Soni") to purchase the
Property. Offers to purchase ranged from $1.2 million to $1.6
million and each time Mr. Smith rejected the offer. However, in
the spring of 1990 Soni offered the appellant $1,950,000. The
offer was accepted since, amongst other things, it was three
times the cost of the Property to the appellant. Another reason
for accepting the offer, Mr. Smith said, was because
Smithco's wholesale business was increasing and he did not
have enough time to devote to the retail outlet. Mr. Smith
recalled that the appellant could not build a card lock operation
because there were too many cars on the lot buying gas and it
would have been difficult for large trucks to enter and exit the
Property. Once the appellant sold the Property, Mr. Smith devoted
all his time and effort to the business of Smithco.
[8]
The purchase price of $1,950,000 was payable as follows: cash of
$700,000 on closing (April 30, 1990) plus an additional
$100,000 plus interest to be paid on December 31, 1990. The
balance, $1,150,000, plus interest, was payable over five years
with a final balloon payment on May 31, 1995. The blended monthly
payment of interest and principal was $11,866.85. The balance of
purchase price was secured by an Agreement for Sale to the
vendor.
[9]
After the transaction neither Mr. Smith nor the appellant had
anything to do with the Property. Smithco delivered gas to the
site for the first couple of years. Soni met all monthly
payments.
[10] Upon
completing the transaction in 1990 the appellant recorded the
debt as a receivable from Soni in its books of account. The
Property was no longer reported as an asset of the appellant. The
appellant reported the transaction as a capital gain in its 1990
tax return, claimed a reserve under
subparagraph 40(1)(a)(iii) and continued to claim a
reserve in its 1991 to 1994 tax returns accordingly.
[11] Soni did
not make the final payment on May 31, 1995. Soni advised
Mr. Smith that it had arranged to sell the Property to a
third party ("third party") and undertook to make the
final payment once the Property was sold. Mr. Smith agreed to
defer the making of the final payment so long as Soni continued
to make monthly payments in the amount of $11,866.85 until the
sale was completed.
[12] In the
course of carrying out its due diligence, the third party
discovered soil contamination on the Property and, as a result,
the transaction did not take place.
[13] The
contamination was "news" to Mr. Smith. He thought the
contamination had been cleaned up when he acquired the site but
he was not surprised. In 1995 contamination on oil sites was a
"big issue". However, the extent of the contamination
was a surprise to him and he had to notify the Provincial
government of the dangerous waste. Because the transaction with
the third party did not take place, Soni could not get financing
and did not make the balloon payment. Soni was told that it would
cost "six digits" to clean up the site. According to
the assumptions made by the Minister of National Revenue
("Minister") in assessing the appellant, the third
party indicated the clean up cost would be approximately
$500,000. Soni also advised the appellant that it was in arrears
of approximately $115,000 for Goods and Service Tax
("GST") it failed to remit to the Receiver General for
Canada and that Revenue Canada, as it was then called, was
prepared to garnish its bank account. Soni told the appellant
that it was in no position to continue making the monthly
payments.
[14] Mr. Smith
sought legal advice. He was told that regardless of when the
contamination occurred the appellant and he could be personally
liable for the cost of the remediation of the property as well as
fines and penalties under the Waste Management Act of
British Columbia. The appellant could be liable to Soni and even
the third party in both contract and tort.
[15] Mr. Smith
decided to buy back the Property with the intent of cleaning it
up and then selling it. He wanted to "go back to square
one", the state of affairs in 1990. He feared any potential
liability he or the appellant may have incurred with Soni. As far
as Mr. Smith was concerned he wanted to "clean up the
property and flip it" to a purchaser for a profit.
[16] Mr. Smith
got in touch with Mr. Bob King of Imperial's Environmental
Department. Mr. King informed him that there was a firm in the
Vancouver area that could clean up the contaminated soil using a
new process for less cost than Soni indicated. Mr. Smith got in
touch with this firm and was informed that the site could be
cleaned up for between $65,000 and $75,000. Also, the business
could continue to operate during the cleaning or remediation of
the soil.
[17] That the
gasoline station could continue to operate during the clean up
was very important to Mr. Smith. If the station were closed, he
stated, any good will related to the Property would be lost. In
Mr. Smith's view, the Property had problems and the last
thing he wanted to do was to close the station for any period of
time. He wanted to maintain the value of the station so that he
would be able to obtain a price of over $1 million for the
Property.
[18]
Apparently the Property became part of the District in 1992 or
1993 and the advantage of selling cheaper gasoline was lost.
Also, by 1995 the intersection allowing entry and egress from the
Property was relocated. In 1995 the business of Smithco was
expanding and demanding all of Mr. Smith's working hours, as
in 1990, he had no time available to operate another business.
This also influenced Mr. Smith's decision to sell the
Property as soon as possible.
[19] On or
about December 12, 1995, the appellant reacquired the property
from Soni for $150,000 plus the cost of some equipment Soni had
purchased which the appellant wished to acquire. The Property was
not conveyed to the appellant pursuant to its rights under the
Agreement for Sale but under an agreement dated October 20,
1995. The purchase price was satisfied by the appellant paying
directly to the Receiver General for Canada the amount of GST
owing by Soni and the balance was paid to Soni. The appellant
also released Soni of its obligation to pay $1,097,000 then owing
under the original sale to Soni. Soni and the appellant entered
into a mutual release of all claims one may have had against the
other.
[20] Once the
Property was reacquired by the appellant, the appellant engaged
the firm recommended by Imperial to remediate the soil. The work
was completed within budget and the business continued to
operate.
[21] While
negotiating for the repurchase of the Property Mr. Smith arranged
to cause the appellant to enter into a lease with
Mr. Barj Dhahan, an experienced and successful gas
station operator in the Lower Mainland to operate the gas station
for one dollar a month. Mr. Smith arranged with Imperial for
the appellant to receive 1.5 cents per litre on all gasoline
Smithco sold to Mr. Dhahan. The lease included an option to
Mr. Dhahan to purchase the Property for $1.25 million; the
option was to be exercised on or before July 1, 1997.
[22] Mr. Smith
testified that he charged only a nominal rent to Mr. Dhahan
because he did not want to take the Property back. As an
experienced operator Mr. Dhahan could continue the
station's operation without Mr. Smith's involvement.
Once the Property was remediated, Mr. Smith hoped,
Mr. Dhahan would purchase the station.
[23]
Unfortunately Mr. Dhahan did not exercise the option. In 1997 Mr.
Dhahan and Mr. Smith reviewed the operation of the gasoline
station and both realized the Property was no longer worth $1.25
million. The business changed from earlier: margins were lower
and there were greater environmental problems and concerns. Mr.
Dhahan continued to operate the Property for $1 a month until he
found someone to purchase the Property from the appellant in 1999
for $725,000.
[24] The
appellant's accountant prepared the appellant's financial
statements and income tax return for 1995. He treated the
reacquisition of the Property as an adventure in the nature of
trade. The appellant considered the Property to be inventory. It
computed the cost of the Property on reacquisition to be
$1,244,296, relying on subsection 79.1(6) of the Act and
claimed an "inventory write-down" of $885,296 to
$359,000 in respect of the Property pursuant to subsection 10(1)
of the Act.
[25] By notice
of reassessment the Minister disallowed the deduction on the
basis that the Property was a capital property when reacquired by
the appellant in 1995.
[26] The
parties concede that if the Property was inventory or if the
reacquisition and eventual sale in 1999 was a venture in the
nature of trade, the appeal should succeed but if the property
continued to have the character of capital when so acquired, the
appeal should fail.
[27] The
appellant's argument proceeded on the basis that there is no
rule of law that requires a taxpayer's former capital
property to continue to be treated as capital property when
subsequently reacquired by the taxpayer in consequence of a
default under a loan.
[28] Section
79.1 of the Act, sets out the rules applicable to a
creditor who reacquires property in consequence of non-payment of
a debt, whether the creditor had held the property as capital or
inventory. Subsection 79.1(6) contains a formula that is deemed
to be the creditor's cost of the reacquired property,
depending on whether the debt itself is capital or non-capital
property to the creditor. Subsection 79.1(7) provides for the
treatment of the debt. There is no rule in section 79.1
respecting the character of the reacquired property.
[29] Counsel
for the appellant argued that if Parliament had intended to
provide a specific deeming rule that the taxpayer's former
capital property continues to be capital property when reacquired
by the taxpayer in circumstances to which section 79.1 applies,
it could easily have done so. In the absence of such express
statutory language I should be cautious before finding in the
clear provisions of section 79.1 an unexpressed legislative
intention.[1] The
normal tests for distinguishing capital from investing should be
applied, counsel submitted. These tests include whether the
taxpayer dealt with the asset as a trader would, the
length of time between acquisition and sale, whether the taxpayer
took steps to improve the marketability of the asset, the nature
of the asset and, among other factors, the intention to resell
the asset at a profit.[2]
[30] In
appellant counsel's view, this approach is consistent with
the scheme of the Act. The Act treats the original
disposition of capital property (from the appellant to Soni)
subject to "vendor back" debt as a "complete,
discrete disposition" and taxes it accordingly. Then, the
disposition of the vendor back debt on reacquisition of the
property is treated as another complete, discrete transaction,
taxable in accordance with subsection 79.1(7) of the Act.
On reacquisition of the asset, at a cost determined in accordance
with subsection 79.1(6), the Act does not determine
the tax character of the asset.
[31]
Appellant's counsel considered it important to the facts at
bar that once the appellant disposed of the Property in 1990 and
acquired a secured debt evidenced by the Agreement for Sale, that
from April 30, 1990 to December 12, 1995, the appellant had no
beneficial interest to the Property, except as security for
Soni's debt and, on December 12, 1995, the appellant disposed
of the debt for the consideration of reacquiring the Property.[3] A taxpayer who
acquires or reacquires property on the default of a loan, counsel
declared, may do so with the intention of holding the asset as an
investment on capital account or as a speculative venture in the
nature of trade and, in any event, with the intention completely
different from the taxpayer's interest when the property was
originally acquired.
[32] Counsel
argued that if the appellant was not a trader, it dealt with the
Property in the same way a trader would and, therefore,
reacquired the Property and disposed of the Property as part of a
venture in the nature of trade. Appellant's counsel described
Mr. Smith's actions as those of "a classic
'flipper' of real estate". He simultaneously
arranged to reacquire the Property from Soni and to resell it to
Mr. Dhahan after repairing the soil contamination. There was no
time interval between the appellant's reacquisition of the
Property and granting an option to purchase the property to Mr.
Dhahan or to a corporation he owned. When the appellant
reacquired the Property, its sole intention was to sell it at a
profit.
[33] Further,
appellant's counsel argued, the appellant took steps to
maintain the Property's value and improve its marketability:
it paid off Soni's GST liability, it repaired the soil
contamination and it arranged for the gasoline station to
continue operating during the soil remediation process.
[34] Lastly,
the nature of the Property was that it could be held as capital
or as a trading asset in an adventure in the nature of trade.
[35] Thus,
counsel asked me to conclude, the appellant reacquired the
Property in December 12, 1995 as adventure in the nature of trade
and is entitled to claim an "inventory write-down" for
its 1995 taxation year in accordance with the decision of the
Supreme Court of Canada in Friesen.[4]
[36] I cannot
agree with appellant's counsel. One cannot, on the facts at
bar, sever the original sale to Soni from the appellant's
reacquisition of the Property from Soni. The appellant reacquired
the Property to protect its investment. When Soni was not able to
consumate a sale to a third party due to the soil contamination,
it failed to make the final "balloon" payment to the
appellant. Because of the soil condition, the appellant and Mr.
Smith feared legal action and a distinct possibility of a
decrease in the value of the Property. The appellant decided to
reacquire the Property, repair the soil and sell the Property.
The appellant's motives for reacquiring the Property were to
mitigate against any potential legal action against it and to
protect its investment in the Property by disposing of it as
quickly as possible for the best possible price. Its actions
confirm this: remediating the soil, ensuring that the business
continued during the remediation process, having a competent
person operating the business until the Property could be sold.
It is true, as appellant's counsel stated, that these actions
improved the marketability of the Property, but it does not
necessarily follow that these actions are always those of a
trader or that the appellant reacquired and held the Property as
inventory.
[37] Counsel
stated that the facts on page 1327 of Bailey v. M.N.R.,[5] leading to my
conclusion that in the property in that appeal did not change its
character, are distinguishable from the appeal at bar. The facts
in Bailey are different, but it does not follow that the
difference in facts requires a different conclusion. In
Bailey, I referred to President Thorson's comments in
Taylor:[6]
. . . The intention to sell the purchased property at a profit
is not of itself a test of whether the profit is subject to tax
for the intention to make a profit may be just as much the
purpose of an investment transaction as of a trading one. . .
.
[38] In 1995
the appellant reacquired the Property with the intention of doing
with it what it intended to do in 1990, to complete the sale of
the Property. The appellant's actions to sell the Property
were not part of a venture in the nature of trade and the
Property was not inventory of the appellant.
[39] The
appeal is dismissed, with costs.
Signed at Ottawa, Canada, this 22nd day of November 2001.
"Gerald J. Rip"
J.T.C.C.
COURT FILE
NO.:
2000-1410(IT)G
STYLE OF
CAUSE:
318806 B.C. Ltd. v. The Queen
PLACE OF
HEARING:
Vancouver, B.C.
DATE OF
HEARING:
November 5, 2001
REASONS FOR JUDGMENT
BY:
The Honourable Judge Gerald J. Rip
DATE OF
JUDGMENT:
November 22, 2001
APPEARANCES:
Counsel for the
Appellant:
Richard J. Bennett
Counsel for the
Respondent:
Patricia A. Babcock
COUNSEL OF RECORD:
For the
Appellant:
Name:
Richard J. Bennett
Firm:
Lang Michener
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-1410(IT)G
BETWEEN:
318806 B.C. LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on November 5, 2001, at Vancouver,
British Columbia, by
the Honourable Judge Gerald J. Rip
Appearances
Counsel for the
Appellant:
Richard J. Bennett
Counsel for the Respondent: Patricia
A. Babcock
JUDGMENT
The
appeal from the assessment made under the Income Tax Act
for the 1995 taxation year is dismissed, with costs.
Signed at Ottawa, Canada, this 22nd day of November 2001.
J.T.C.C.
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