Mario Gagnon v. Minister of National Revenue, [1991] 1 CTC 2203, 91 DTC 473

Tremblay, T.C.J. [Translation]:—This appeal was heard on July 27, 1990, in Québec, Québec.

7. Issue

The issue is whether the appellant, in calculating his income for the 1985 and 1986 taxation years, was justified in regarding the profits of $7,833 and $25,900 from the sale of two buildings in Rimouski as a capital gain.

The appellant submits that his intention in purchasing the two buildings was to earn rental income, but that the possibility of liquidity problems for his company, Construction Mario Gagnon Inc., plus a loss of credibility with surety companies led him to resell them.

The respondent submits that the profits from the sale of the buildings constituted business income: taking the short period of possession into account, the appellant's intention in purchasing the buildings could only have been to resell them at a profit.

2. Burden of Proof

2.01 The burden is on the appellant to show that the respondent's assessment is incorrect. This burden of proof derives from several judicial decisions, including a judgment delivered by the Supreme Court of Canada in Johnston v. M.N.R., [1948] S.C.R. 486; [1948] C.T.C. 195; 3 D.T.C. 1182.

3. Facts

3.01 In June 1985, the appellant purchased a building located at 184 St-Jacques Street in Rimouski for $75,000. According to Mr. Gagnon's testimony, the intended use of the building was as a rooming house for students from the local CEGEP and university. In July 1985, a building located at 45-47 De l'Evêché Street in Rimouski was purchased for $125,000. Again according to the appellant's testimony, this building was also earmarked for renting rooms to students.

3.02 Mr. Gagnon is the majority shareholder of a Company specializing in industrial and commercial construction. The company, Construction Mario Gagnon Inc., also does civil engineering work (Exhibit A-5).

3.03 The appellant submitted that the buildings were bought, among other reasons, because of the appreciable drop in interest rates and because investing in real estate was seen in a good light at the time.

3.04 Mr. Gagnon's testimony also shows that his company's financial performance during the fiscal year between February 1, 1985 and January 31, 1986, encouraged him to invest this momentary surplus of liquid assets.

3.05 The appellant also adduced in evidence the purchase of a house in St- Anaclet in 1976. That building was rented until 1985 and provided Mr. Gagnon with substantial rental income.

3.06 In his testimony, the appellant raised the proximity of the purchased buildings to the Rimouski CEGEP and to the Rimouski campus of the Université du Québec (U.Q.A.R.).

3.07 The appellant also testified as to the instability of the construction market in Rimouski.

3.08 The two purchased buildings were practically hypothecated to their full value in order to cover the prior bank loans.

3.09 The appellant sold the building on St-Jacques Street in December 1985 for $82,833. As for the building on De l'Evêché Street, it was sold in March 1986 for $150,900.

3.10 The appellant's testimony also revealed that a federal subsidy policy to grant $1,500,000 for the construction of residences for local students suddenly went, during the fall of 1985 and during 1986, from being an election promise to being a project on the point of implementation. According to the appellant once again, his contacts in the construction industry and in college and university circles only confirmed the increasingly regular media coverage of this election promise, the first rumours of which had been heard some ten years earlier.

3.11 The appellant also submitted that fear of possible liquidity problems for his company in the fiscal year between February 1, 1986, and January 31, 1987, played a preponderant role in his disposition of the buildings.

3.12 According to the appellant, the responsibility for administering and maintaining 40 rooms with an 80 per cent occupancy rate was too demanding to be reconciled with the activities of his primary source of income: Construction Mario Gagnon Inc.

3.13 The period of possession of the buildings was six months for the house at 84 St-Jacques Street and eight months for the house on De l'Evêché Street.

3.14 Some $17,151 was spent on renovating the buildings during their short period of possession. These renovations were carried out by Construction Mario Gagnon Inc.

3.15 That company purchased a building during the fiscal year between February 1, 1985, and January 31,1986, with a view both to turning it into the business office for its own activities and to renting the other available offices in the same building. The company made this purchase on the basis of advice from its accountants so as to provide better collateral for the surety companies.

4. Act—Case Law—Analysis

4.01 Act

The provisions of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") raised in this case are sections 3, 9 and as well as subsections 38, 39(1) and 248(1). They will be quoted in the analysis if necessary.

4.02 Case Law

The respondent has referred to the following cases:

1. M.N.R. v. Taylor, [1956-60] Ex. C.R. 3; [1956] C.T.C. 189; 56 D.T.C. 1125; 2. Friedman v. M.N.R., [1977] C.T.C. 2611; 78 D.T.C. 1020 (T.R.B.);

3. Loyens v. M.N.R., [1983] C.T.C. 2601; 83 D.T.C. 535 (T.C.C.);

4. C.I.R. v. Livingston (1926), 11 T.C. 538;

5. Morrisson v. M.N.R., [1928] Ex. C.R. 75; [1917-27] C.T.C. 343; 1 D.T.C. 113;

6. C.I.R. v. Fraser (1942), 24 T.C. 498;

7. McDonough v. M.N.R., [1949] Ex. C.R. 300; [1949] C.T.C. 213; 4 D.T.C. 621;

8. No. 23 v. M.N.R. (1951), 4 Tax A.B.C. 358; 51 D.T.C. 294;

9. Gordon v. M.N.R. (1951), 4 Tax A.B.C. 231; 51 D.T.C. 230;

10. Cragg v. M.N.R., [1952] Ex. C.R. 40; [1951] C.T.C. 322; 52 D.T.C. 1004;

11. Grenier v. M.N.R. (1957), 16 Tax A.B.C. 228; 57 D.T.C. 11;

12. Mayo v. M.N.R., [1967] Tax A.B.C. 146; 67 D.T.C. 137;

13. Power v. The Queen, [1975] C.T.C. 580; 75 D.T.C. 5388 (F.C.T.D.);

14. Marois v. The Queen, [1983] C.T.C. 304; 83 D.T.C. 5344.

5. Analysis

The Court feels that the position of the Minister of National Revenue can be presented in two parts. On the one hand, counsel for the respondent established on the basis of the Taylor decision, supra, that the sale of the buildings by Mr. Gagnon, although it was an activity remote from the usual course of his business, was an adventure in the nature of trade under the definition of" business" in subsection 248(1) of the Act, which reads as follows:

248. (1) In this Act,

” business” includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), an adventure or concern in the nature of trade but does not include an office or employment;

On the other hand, the respondent's claim is also based on the fact that the circumstances of this case are insufficient to corroborate the appellant's position convincingly enough to dismiss the presumption that the assessment of the Minister of National Revenue is correct.

With respect for the contrary position, the Court is of the opinion that the activity at issue cannot be called an adventure in the nature of trade.

5.01 The basic judgment concerning adventures in the nature of trade is without question that in the Taylor case, supra, which laid down the following general rule: only an analysis of all the circumstances surrounding the transaction at issue can make it possible to call it an adventure in the nature of trade. The taxpayer's true intention in purchasing the immovable property on St- Jacques Street and that on De l'Evêché Street can ultimately be determined by taking all of these factors into consideration.

The case law appears to have been constant in confirming the validity of applying this rule in determining the taxpayer's intention. In his decision in Grenier v. M.N.R., supra, Board member Monet quoted (at page 233 (D.T.C. 18)) a passage from Cragg v. M.N.R., supra, in which Mr. Justice Thorson said:

Such a decision [the determination of the taxpayer's intention] 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.

The words used by Addy, J. in Power v. The Queen, supra, were almost identical, as he reiterated the need to consider the evidence as a whole in determining the taxpayer's intention in purchasing the property (page 585 (D.T.C. 5392)):

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.

5.02 It has generally been recognized both in the case law and among legal theorists that certain tests are especially revealing in evaluating whether the profits from the sale of property are the result only of the realization of an investment or of an activity manifestly stamped with speculation.

5.03 In the first place, the case law has generally stopped to analyze the taxpayer's conduct during the period of possession of the property later involved in the transaction. Thus, it is fundamental to assess whether the taxpayer has behaved as a seller of such items would have behaved during the period of possession. This test from the case law was stated clearly by Lord Clyde in C./.R. v. Livingston, supra. The following excerpt from the judgment is especially eloquent:

I think the test, which must be used to determine whether a venture such as we are now considering is, or is not, “in the nature of trade", is whether the operations involved in it are of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made.

Moreover, such a test was decisive in a recent judgment in Marois v. The Queen, supra, (page 306 (D.T.C. 5346)): [Translation] “In my opinion, the plaintiff's conduct, which must be taken into consideration in deciding the present case, indicates behaviour based on speculation rather than on investment."

5.04 The nature of the property involved in the disposition is another test the Court might take into consideration. The fact that the property in question is capable of bringing pleasure to its possessor or of making him proud to possess such an article is a clue that makes it possible to classify the profits from its disposition. The fact that mere possession of the property generates income is also decisive. The importance of the nature of the property [in] determining the taxpayer's intention was established in the classic decision of C.I.R. v. Fraser, supra:

The individual who enters into a purchase of an article or commodity may have n view the resale of it at a profit, and yet it may be that that is not the only purpose for which he purchased the article or the commodity, nor the only purpose to which he might turn it if favourable opportunity of sale does not occur. In some of the cases the purchase of a picture has been given as an illustration. An amateur may purchase a picture with a view to its resale at a profit, and yet he may recognise at the time or afterwards that the possession of the picture will give him aesthetic enjoyment if he is unable ultimately, or at this chosen time, to realise it at a profit. A man may purchase land with a view to realising it at a profit but it also may yield him an income while he continues to hold it. If he continues to hold it, there may be also a certain pride of possession. But the purchaser of a large quantity of a commodity like whisky, greatly in excess of what could be used by himself, his family and friends, a commodity which yields no pride of possession, which cannot be turned to account except by a process of realisation, I can scarcely consider to be other than an adventurer in a transaction in the nature of a trade; . . .

5.05 The reasons for the sale have also been taken into consideration in classifying the profit made by the taxpayer. The main tests adopted in the case law are health problems and an urgent need for liquid assets that got in the way of the taxpayer's original intention. Mayo v. M.N.R., supra, is only one case among the many decisions to this effect (page 157 (D.T.C. 144)):

The proper deduction to be drawn from the appellant's whole course of conduct is that he purchased the Queen Street property as an investment and only sold it when he was hard pressed for funds. See Morasutti v. M.N.R., 13 Tax A.B.C. 40, and also No. 13 v. M.N.R., 3 Tax A.B.C. 397.

5.06 The connection between the transaction at issue and the usual course of the taxpayer's business is another test that has been adopted in the case law. A large number of decisions have been rendered to this effect, including Mor- risson v. M.N.R., supra, McDonough v. M.N.R., supra, No. 23 v. M.N.R., supra, and Cordon v. M.N.R., supra. The following passage from CCH Canadian Ltd., page 5182, #6084, rounds off the presentation of this test very well:

The basis of these decisions is that if the taxpayer already is in a business of a similar nature to the transaction in question, it is more likely that the transaction will be considered part of his business, whereas if the transaction is completely removed from his normal field of activity, it is more unlikely that a business will be held to be carried on.

5.0 7 Finally, the period of possession is another test that might be taken into consideration, as Lord and Sasseville have pointed out in Les principes d'imposition au Canada:

[Translation]

A long period of possession can be indicative of a good's capital nature, and the subsequent disposition of it will probably be treated as giving rise to a capital gain. On the other hand, the possession of property for a short period might lead to the belief that it was bought to be resold and that the profits constitute income.

5.0 8 It should be noted that Interpretation Bulletin IT-459 contains a detailed enumeration of the tests the courts have adopted when they have had to decide whether an adventure in the nature of trade existed or did not exist.

5.0 9 Taking the circumstances of the present case into consideration as stipulated by the case law referred to above, the Court leans toward the conclusion that Mario Gagnon's purchase of the two buildings must be regarded as an investment. The appellant's evidence constitutes a sufficiently coherent whole to permit him to shift the burden he was under (2.01). The profits from this sale must therefore be treated for tax purposes as a capital gain.

5.10 Thus, the evidence adduced by the appellant shows on the one hand that the purchased buildings were intended to be rooming houses. The proximity of these two buildings to the local post-secondary institutions seems to confirm the appellant's claim on this point. The fact that the property involved in the disposition had generated income favours the possibility of an investment (3.01, 3.05, 3.06).

5.11 Furthermore, the Court considers the appellant's fear of liquidity problems for his company to be a fully plausible reason for him to have sold his buildings. It is in fact, given the type of undertaking operated by the appellant, not surprising that its directors might, considering the short-term lack of lucrative contracts, anticipate the coming of less-favourable periods from a financial point of view. A brief analysis of the financial statements for the period between February 1, 1986 and January 31, 1987, unequivocally corroborates the feared financial difficulties:

Income from contracts during the fiscal year ending in January 1987 fell by more than half from the performance recorded during the preceding fiscal year. As for the gross margin, it was three times smaller. Finally, the net profit fell by half from that recorded during the fiscal year ending in January 1986. It was therefore reasonable for Mr. Gagnon to realize his investment so as to ensure the existence of sufficient liquid assets to permit him, if necessary, to grant his company the credit it might need. Moreover, the imminent completion of the residence construction project can only confirm the appropriateness of the reasons given by the appellant for having disposed of the buildings. Is it necessary to go on at length to demonstrate the unfortunate consequences the concrete completion of the residence project could have had on the occupancy rate of the appellant's rooming houses? In short, the Court is satisfied with the evidence submitted to it to the effect that circumstances out of the appellant's control led him to dispose of the buildings he had previously purchased.

5.12 It is also revealing that Mr. Gagnon had earned rental income from a house located in St-Anaclet for nearly ten years. The evidence does not show that the appellant's conduct with respect to that building resembled that of a seller of real estate. Why would Mr. Gagnon suddenly have made a radical change in his investment perspective with respect to the buildings purchased in June and July 1985? This factor once again favours the existence of an investment.

5.13 Counsel for the respondent tried to show that the fact of having made improvements, which, moreover, were carried out by Construction Mario Gagnon Inc., can only indicate a desire to resell at a profit the buildings previously purchased. However, the Court feels that a person involved in uying and selling real estate would try to minimize expenditures on the purchased building in order to maximize his profit at the time of sale. It is also an acknowledged fact that part of the improvements in question consisted of pieces of furniture commonly found in a student's room. Furthermore, is it surprising that the basic improvements to the very structure of the buildings were carried out by Construction Mario Gagnon Inc.? The Court feels that a contrary solution would have been surprising. Although the appellant's company, of which he is the majority shareholder, is mainly involved in industrial and commercial construction, it is obviously in a position to take on general renovation work. The appellant's use of his company's general expertise enabled him to avoid unnecessary costs for the improvements that were to be carried out. Thus, considering the evidence as a whole, renovations fit in very well with the investment context.

5.14 It is necessary at this point in our analysis to explain that industrial and commercial construction is not closely linked to the normal activities of a seller of real estate. Can we accept the respondent's claim that the appellant's occupations provided him with a level of knowledge of the residential real estate market making it possible to compare his activities with those of a seller of such property? Although the construction of buildings is obviously not carried out in isolation, and although there are regular contacts between promoters and builders, it is hard to believe that such contacts make it possible to classify any involvement by the appellant in residential real estate as an activity in the nature of trade. It is questionable that the level of knowledge likely to feed an intention to sell at a profit was attained in the present case.

5.15 Counsel for the respondent also tried to show that the fact that the two buildings were practically hypothecated to their full value implied an intention to resell quickly, which is contrary to the existence of an investment whose realization would give rise to a capital gain. Here, the Court feels that the inference the respondent is trying to make is not convincing enough. A hypothecary level like this is in fact fully understandable when the purchased buildings are not the taxpayer's main source of income. Would it be sensible for the appellant to jeopardize his undertaking for the sole reason of reducing the hypothec on the purchased buildings? An investment originally intended to be for a long term is not inconsistent with gradual payments on a loan practically equal to the purchase price of the purchased property. Once again, the Court feels that this factor in no way rules out the probability of an investment.

5.16 Finally, it was adduced in evidence that the periods of possession of the two buildings were not more than eight months. It is fully appropriate to consider such a test in classifying the profits from the disposition of property. A short period of possession can in fact lead to the belief that there was business income. In the present case, however, the announcement in the fall of 1985 that the election promises to build student residences would be realized, which was confirmed by university contacts, showed inter alia that the two buildings at issue would be unprofitable in the short term (3.10).

5.17 There is an established case law to the effect that a single test cannot be relied upon in determining whether an amount is business income or a capital ain. In this case, the balance of the evidence is unquestionably to the effect that Mr. Gagnon purchased the buildings from an investment perspective. The appellant's conduct, both during the period preceding the transaction at issue and during the period following it, never resembled that of a seller of real estate. The Court's analysis of the evidence supports this position convincingly enough.

For all these reasons, the Court must allow the appeal.

6. Conclusion

The appeal is allowed with costs and the matter is referred back to the respondent for reconsideration and reassessment in accordance with the above reasons for judgment.

Appeal allowed.