Tubetest Service & Supply (1978) Limited, v. Her Majesty the Queen, [1994] 2 CTC 2320

O'Connor J.T.C.C.:—This matter was heard in Calgary, Alberta, on May 27, 1994. It is an appeal pursuant to the informal procedure of this Court concerning the appellant's taxation years ending April 30, 1990 and April 30, 1991.

Issue

The sole issue in these appeals is whether amounts of $47,926 in 1990 and $21,258 in 1991 constitute active business income or Canadian investment income and consequently whether the appellant can or cannot benefit from the small business deduction provided for in section 125 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") with respect to these amounts.

Facts

The relevant facts may be summarized as follows:

1. The appellant’s business involved services to the oilfield industry (“the main business");

2. In addition to its regular income from operations the appellant earned interest income as follows:

3. Only 20 per cent of the term deposits was used as security on outstanding bank loans with regard to the main business;

4. As of April 30, 1990 the appellant had outstanding shareholder loans of $574,044 and in the fiscal year ending April 30, 1990 paid or accrued directors fees of $110,000. For the fiscal year ending April 30, 1991 those figures were $99,070 and $305,000 respectively.

Submissions

The appellant's position is essentially summarized in the written submission of Mr. Ken Heywood, the appellant’s agent and a chartered accountant:

THE QUESTION before this court in our view is:

Does the taxpayer have the right to allocate revenues and expenses to particular cost centres of a business, to determine profitability of the various cost centres, or is it the prerogative of the Minister of National Revenue to make these determinations, having the advantage of subsequent activities inmaking his decision?

THE FACTS

The taxpayer chose to leave significant amounts of shareholders' loans in the company through the fiscal period of 1991; thereby, having the company show a very strong financial position and in particular a strong working capital position (ability to pay current obligations). The oil service industry during the late 1980s was anticipating numerous offshore projects (and) management of Tubetest Service & Supply (1978) Ltd. were of the opinion that the company should remain in a strong financial position to have the ability to take advantage of opportunities that could Le presented, and in particular, offshore opportunities.

The company chose to reduce its taxable income to $200,000 by paying directors' and management fees and having the shareholders and management pay income taxes at high personal tax rates rather than have Tubetest Service & Supply (1978) Ltd. pay high corporate tax rates on taxable income over $200,000.

Mr. Heywood acknowledged that this submission was novel and he quoted certain passages from the CICA Handbook to support his theory.

Counsel for the respondent pointed out that the Minister had allowed as active business income all of the 1990 and 1991 interest on the accounts entitled "Chequing", “U.S. Chequing" and "Rec. General” referred to above in paragraph 2 of the "Facts" as well as 20 per cent of the interest on the "term deposits" referred to in said paragraph.

Law

Aside from provisions of the Act related to the small business deduction the most relevant provisions are 125(7)(a) (active business carried on by a corporation), 125(7)() (income from an active business), and 129(4.1) (income or loss from a source which is property), which, so far as material read as follows:

125(7) In this section,

(a) “active business carried on by a corporation” means any business carried on by the corporation other than a specified investment business or a personal services business and includes an adventure or concern in the nature of trade;

(c) “income of the corporation for the year from an active business” means the income of the corporation for the year from an active business carried on by it including any income for the year pertaining to or incident to that business, but does not include income for the year from a source in Canada that is a property (within the meaning assigned by subsection 129(4.1));

129(4.1) For the purposes of paragraph (4)(a) and subsection (6), "income" or “loss” of a corporation for a year from a source in Canada that is a property includes the income or loss from a specified investment business carried on by it in Canada other than income or loss from a source outside Canada but does not include income or loss

(a) from any other business,

(b) from any property that is incident to or pertains to an active business carried on by it, or

(c) from any property used or held principally for the purpose of gaining or producing income from an active business carried on by it.

Analysis

The appellant's agent points to subsection 9(1) of the Act which states that

Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.

The argument as the Court understands it, is that since one is dealing with the concept of profit one can therefore determine what that profit really is by allocating types of expenses on a reasonable basis to certain types of income. Therefore since the corporation would not have had the interest on the term deposits if the shareholders/directors had not loaned moneys to the corporation, then the corporation can allocate against that interest, the director's fees which it paid, thereby reducing said interest to nil.

The Court cannot accept this submission. The loans were made and the funds became the property of the corporation. The corporation invested the funds in term deposits. I cannot accept that simply because loans existed the corporation can allocate the director’s fees against the interest on the term deposits.

Moreover, the Court cannot accept that because the loans may have been made to shore up the financial strength of the corporation, thus making it more likely to be able to expand, is a reason to conclude that the term deposits were “incident to or pertains to an active business” of the corporation.

The leading cases on this issue were canvassed by counsel for the respondent. In Atlas Industries Ltd. v. M.N.R., [1986] 2 C.T.C. 2392, 86 D.T.C. 1756 (T.C.C.), Christie A.C.J.T.C. stated at page 2404 (D.T.C. 1764-65):

Giving the words “incident to or pertains to an active business” their grammatical and ordinary sense, and bearing in mind their context, there must I think be a financial relationship of dependence of some substance between the property and the active business before the exclusion in paragraph 129(4.1)(b) comes into play. The operations of the business ought to have some reliance on the property in the sense that recourse is had to it regularly or from time to time or that it exists as a back-up asset to be called on in support of those operations when the need arises. This I regard to be the basic approach to paragraph 129(4.1(b). Whether income-producing property has crossed the dividing line into the paragraph will depend on the facts of each case. I am satisfied that the facts under consideration do not place the relevant property within it. The relationship between the debts created by the term deposits and the appellant's businesses was tangential at best. The debts were never resorted to in aid of the appellant’s businesses nor was there any real expectation that they would be. The fundamental purpose of these term deposits was unrelated to sustaining the appellant's businesses, but it was to direct the profits therefrom into the hands of the shareholders, primarily by way of bonuses. In McCutcheon Farms Ltd. v. M.N.R., [1991] 1 C.T.C. 50, 91 D.T.C. 5047 (F.C.T.D.), Strayer J. of the Federal Court-Trial Division, after quoting the above with approval, continued at page 54 (D.T.C. 5049-50):

Counsel have not relied on recent jurisprudence with respect to the meaning of paragraph 129(4.1 )(c) also added in 1979. It appears to be common ground, however, that the approach to this paragraph should be similar to that employed in interpreting former paragraph 129(4)(a) where there was excluded, from “Canadian investment income”, income from a property “used or held by the corporation in the year in the course of carrying on a business”. In the decision of the Federal Court of Appeal in R. v. Marsh & McLennan Ltd., [1983] C.T.C. 231, 83 D.T.C. 5180 (F.C.A.), Le Dain J., in referring to a fund of an insurance broker into which there were paid premiums received from insured parties and out of which the broker paid the company, the broker earning interest in the meantime on surplus amounts in the fund not yet due to the insurer, applied the following as the proper test under subparagraph 129(4)(a)(ii):

. . .was the fund employed and risked in the business? (Emphasis added).

He held that it was because an amount equivalent to the fund 'was committed to the carrying on of the business in order to meet the company's obligations to the insurers’. This test wasapproved by Wilson J. writing for the majority of the Supreme Court of Canada in Ensite Ltd. v. The Queen, [1986] 2 S.C.R. 509, [1986] 2 C.T.C.459, 86 D.T.C. 6521. In elaborating on the test of "risk" and on this test generally, she said:

But "risked" means more than a remote risk. A business purpose for the use of the property is not enough. The threshold of the test is met when the withdrawal of the property would “have a decidedly destabilizing effect on the corporate operations themselves". . .

. . .The test is not whether the taxpayer was forced to use a particular property to do business; the test is whether the property was used to fulfil a requirement which had to pe met in order to do business. Such property is then truly employed and risked in the business.

It is interesting to note that in McCutcheon, supra, it appears that some of the term deposits in issue arose because of a shareholder loan and further that Strayer J. stated at page 56 (D.T.C. 5052):

Secondly, I do not accept that money accumulated to expand a business, if that was really in contemplation here, creates any “financial relationship of dependence" between that sum and the existing business or that it involves money "employed" or "risked" in the existing business.

For all of the above reasons the appeals are dismissed.

Appeals dismissed.

Canworld Holdings Inc. and Gilmar Holdings Inc. v. Her Majesty The [Indexed as: Canworld Holdings Inc. v. Canada]

Tax Court of Canada (Sobier J.T.C.C.), June 13, 1994 (Court File No. 92-1137).

Income tax—Federal—Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63)—Whether gain on sale of two commercial properties was income or capital gain.

The appellant companies were both controlled by G who was the sole shareholder of both companies. The appellant, C Inc., purchased Sprinco, consisting of seven or eight industrial buildings on April 19, 1985 for $250,000. When purchased, there were nine tenants occupying the buildings producing gross annual income of about $120,000. When sold, on March 31, 1988 for $1,850,000, there were 15 tenants who paid about $233,000 in net annual rent. The appellant, G Inc., purchased Suncoast, a shopping mall, on June 6, 1985 for $2,478,000. When purchased, Suncoast had 15 tenants occupying 86,710 square feet of space and producing about $290,000 annual rent revenue. When sold, in November 1986 for $4,350,000, there were 23 tenants occupying 112,366 square feet and producing total annual rental income of about $473,000. The evidence indicated that G spent considerable time at both properties negotiating leases, attending to contracts for maintenance, etc. G testified, however, that he sold the properties because of problems he was having with his house. In this regard, G stated that he began having serious leaking problems with the house in March 1986 and that these problems continued until September 1987 and even afterwards since he was involved in litigation concerning the serious leaking problems. The evidence also disclosed that G, either directly or through corporations owned or controlled by him, had a history of dealing in real property, usually after receiving "unsolicited offers”. The issue was whether the gain on the sale of Sprinco and Suncoast was income, as the Minister contended, or a capital gain, as the appellants contended.

HELD:

The history of selling with a resulting gain went a long way towards indicating what G's intentions were. Furthermore, if salary had been charged for the management of the properties, the result would have been a negative cash flow as well as an accounting loss in the profit and loss statement. This was another indication that G was looking to the gain on sales as his reward for purchasing the properties. Finally, the problem with G’s home was not so large that it accounted for his selling the two properties. In the result, the totality of the evidence pointed to the fact that the appellants were engaged in an adventure in the nature of trade and accordingly the gains were on income account. Appeals dismissed.

Terrance A. Sweeney for the appellant.

Shatru Ghan for the respondent.

Cases referred to:

Racine, Demers and Nolin v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098;

Pierce Investment Corp. v. M.N.R., [1974] C.T.C. 825, 74 D.T.C. 6608;

Regal Heights Ltd. v. M.N.R., [1960] S.C.R. 902, [1960] C.T.C. 384, 60 D.T.C.

1270;

Happy Valley Farms Ltd. v. The Queen, [1986] 2 C.T.C. 259, 86 D.T.C. 6421;

First Investors Corp, et al. v. The Queen, [1987] 1 C.T.C. 285, 87 D.T.C. 5176.

Sobier J.T.C.C.:—These appeals were heard on common evidence under the Tax Court of Canada Rules (General Procedure).

The appellants appeal from the assessments of the Minister of National Revenue (the “Minister) for their taxation years ended April 30, 1987 in the case of Gilmar Holdings Inc. ("Gilmar") and April 30, 1988 in the case of Canworld Holdings Inc. ("Canworld").

With respect to Canworld, the Minister included in income the full gain realized by Canworld on the disposition of a property known as Sprinco located in Cambridge, Ontario and with respect to Gilmar the full gain realized on the sale of a shopping mall in Goderich, Ontario known as Suncoast Mall ("Suncoast").

Both appellants are controlled by John Leonard Gillis ("Mr. Gillis") he being the sole shareholder of both corporations.

Canworld purchased Sprinco, consisting of seven or eight industrial buildings on or about April 19, 1985 for a purchase price of approximately $250,000. The evidence shows that when purchased, there were about nine tenants occupying the buildings producing gross annual income of about $120,000. When sold, on or about March 31, 1988, for $1,850,000, there were approximately 15 tenants paying about $233,000 net annual rental income. In 1985, there were 85,439 square feet of the buildings under lease (72,439 after some non-producing space is removed from the total). At the time of the sale, the rented space amounted to about 127,961 square feet.

Gilmar purchased Suncoast, on or about June 6, 1985, for a purchase price of $2,478,000. Suncoast was a 150,000 square foot shopping mall and when purchased was tenanted by approximately 15 tenants occupying 86,710 square feet of space and producing about $290,000 annual rent. When sold on or about August 1986, Gilmar received at closing on November 28, 1986, $4,350,000. At that time there were about 23 tenants occupying 112,366 square feet and produced a total annual rental income of about $473,000. Of the 112,366 square feet, 13,200 square feet were occupied by a gas bar which ! reckon was located outside of the main mall building which would leave about 96,166 square feet rented in the main building. However this assumption is not vital to the outcome of these appeals.

Mr. Gillis' evidence, and that of a former tenant, Mr. Heidinger, indicated that Mr. Gillis spent considerable time at Suncoast negotiating leases, attending to contracts for maintenance, etc. Mr. Gillis made some cosmetic changes to the mall and was involved in promotion and advertising. He also went about changing the mix of tenants by not renewing the lease of some less desirable tenants as well as acquiring new tenants. Mr. Gillis claimed that he was unsuccessful in hiring management for Suncoast although in July 1986, Gilmar signed a three-year management agreement with one of the origina builders of Suncoast, a Mr. Bert Alexander. Mr. Alexander commenced work approximately August 1, 1986 and according to Mr. Gillis, he was totally unsuitable for the job and was discharged approximately two to three weeks later. It was after Mr. Alexander was hired but before he was fired that Mr. Gillis says he received an offer for Suncoast, which he refused, and that after he discharged Mr. Alexander he made inquiries to see if the offer was still open. The offer was resubmitted later in August at which time it was accepted.

The history at Sprinco was somewhat similar. Mr. Gillis signed up new tenants to "net-net" leases and as the old leases came up for renewal these too were made on a "net-net" basis. From the evidence it appears that many new tenants were obtained through the efforts of a real estate agent or agents. As well, itdid not appear that Mr. Gillis spent as much time at Sprinco as he did at Suncoast.

Because of the problems with which I will deal later, Mr. Gillis appeared to have given up on Sprinco and intended to keep Suncoast although Suncoast was sold before Sprinco.

The evidence disclosed that Mr. Gillis, either directly or through corporations owned or controlled by him, had a history of dealing in real property. While Mr. Gillis claimed never to have bought a property for the purpose of selling but only for the purpose of holding for rental income, he or his companies did sell these properties, for the most part, as a result of unsolicited offers including the offers on Suncoast and Sprinco. Mr. Gillis readily admitted that he wished to sell Sprinco because of the problems in Cambridge.

In 1982, the Gillises purchased a home in Cambridge, Ontario designed by the architect Arthur Erikson. Among other features, the home had cedar ceilings and roof gardens. There were minor roof leaks which were known to Mr. Gillis at the time of purchase. In mid-1984, he made inquiries concerning repairs to the roof but was advised that repairs could not be guaranteed whereas if a complete reroofing was done, guarantees were available. Mr. Gillis hired a general contractor from the Cambridge area to oversee the reroofing which was to be completed by a roofing contractor also from Cambridge. Mr. Gillis needed a general contractor to oversee the work because he would be away a good deal of time on other business.

In April 1985 the roofing contract was signed. Although it was represented that the work would take approximately six weeks from July 15,1985 to September 1, 1985, further leaks appeared in late August 1985 and continued until November 1985 after which there was a freeze up. However, in March 1986 after the spring thaw, serious leaking began. This continued until the house was reroofed by another contractor in 1987. Needless to say, considerable damage was done to the house and its contents. Mr. Gillis stated that the leaking was so extensive that wading pools, not just buckets had to be used to catch the water. Other devices were jury-rigged to help alleviate the problem. However, the result was that Mr. Gillis was required to spend considerable time coping with the problems and the litigation which resulted.

A claim for lien was registered against the property in September 1986. The litigation was commenced with the filing of a statement of claim with the Gillises named as defendants and of course they counterclaimed, naming all those involved in the fiasco as third parties and naming the plaintiff as a fourth party.

Briefly, Mr. Gillis claims that because of the problems with the roof, the resulting damage to the house and contents and harassment and vandalism which he attributes to persons engaged in the original repair work, he was unable to properly attend to his businesses and when offers were received, he was willing to accept them in order to be out from under the management of his businesses so that he would be able initially to deal with the leaks and roof repairs and subsequently, to deal with the litigation as well as with other repairs to the house and the furniture and furnishings.

The period of time when Gilmar owned Suncoast and the Gillises experienced the roof and other problems overlapped from March 1986 to November 1986 when the sale of Suncoast was closed keeping in mind, however, that the offer was accepted in August 1986.

The overlapping time with respect to Sprinco again began in March 1986 and ended with respect to the roof leaks in September 1987 when the new contractor completed major work on the roof. However, Mr. Gillis again claims that he was preoccupied after September 1987 with repairs to the house and its contents as well as the litigation.

The original claim for lien was filed in September 1986. In late November 1986, a statement of claim was issued in the action. Discoveries were held in June and October 1988 and the trial took place in October 1990. The litigation was settled after approximately eight days of trial and the Gillises received $310,000 as damages plus $55,000 party-and-party costs.

The appellants maintain that the gains realized in each of the two sales were on account of capital and of course the respondent claims they were on account of income.

The question becomes one of the intention of the appellants at the time of the acquisition of the property. Was there either a primary or secondary intention to resell? If so, the gain would be on account of income. If not, and the intention was to hold for investment for the purpose of earning or producing income, the gain would be on capital account.

Although Mr. Gillis disavowed any primary intention to resell, we must examine the facts to see whether there was any secondary intention. What is secondary intention?

Noël J. in Racine, Demers and Nolin v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098 (Ex. Ct.) had this to say at page 159 (D.T.C. 5103):

In examining this question whether the appellants had, at the time of the purchase, what has sometimes been called a "secondary intention” of reselling the commercial enterprise if circumstances made that desirable, it is important to consider what this idea involves. It is not, in fact, sufficient to find merely that if a purchaser had stopped to think at the moment of the purchase, he would be obliged to admit that if at the conclusion of the purchase an attractive offer were made to him he would resell it, for every person buying a house for his family, a painting for his house, machinery for his business or a building for his factory would be obliged to admit, if this person were honest and if the transaction were not based exclusively on a sentimental attachment, that if he were offered a sufficiently high price a moment after the purchase, he would resell. Thus, it appears that the fact alone that a person buying a property with the aim of using it as capital could be induced to resell it if a sufficiently high price were offered to him, is not sufficient to change an acquisition of capital into an adventure in the nature of trade. In fact, this is not what must be understood by a “secondary intention” if one wants to utilize this term.

To give to a transaction which involves the acquisition of capital the double character of also being at the same time an adventure in the nature of trade, the purchaser must have in his mind, at the moment of the purchase, the possibility of reselling as an operating motivation for the acquisition; that is to say that he must have had in mind that upon a certain type of circumstances arising he had hopes of being able to resell it at a profit instead of using the thing purchased for purposes of capital. Generally speaking, a decision that such a motivation exists will have to be based on inferences flowing from circumstances surrounding the transaction rather than on direct evidence of what the purchaser had in mind.

[Emphasis added.]

Counsel for the respondent referred to Pierce Investment Corp. v. M.N.R., [1974] C.T.C. 825, 74 D.T.C. 6608 (F.C.T.D.). At page 831 (D.T.C. 6612) Walsh J. wrote concerning determining intentions:

I am also of the view, as has been expressed in other cases, that while the evidence of the witnesses is helpful in endeavouring to determine their intentions, their actual conduct and the steps they took to carry out these intentions gives a much better indication of what they actually were. Without intending to cast any aspersions on the credibility of the witnesses in the present case it is nevertheless evident that in any case where a distinction must be made between a transaction which constitutes an adventure in the nature of trade and one which leads to a capital gain, one must expect the witnesses to insist that their intentions were solely to make an investment and that the idea of reselling the property at a profit had never occurred to them even as a secondary intention at the time of making the original investment, but was merely forced on them subsequently by some event beyond their control. If they were not in a position to testify to this effect they would have little or no ground for appealing against the assessment.

He then went on to refer to Regal Heights Ltd. v. M.N.R., [1960] S.C.R. 902, [1960] C.T.C. 384, 60 D.T.C. 1270 and Racine et al., supra, regarding the doctrine of secondary intention.

The appellants’ counsel argues that the traumatic experience revolving around the problems at the Gillises’ home frustrated his intentions to hold. Mr. Gillis is undoubtedly a highly strung and nervous individual. He admitted that his behaviour bordered on paranoia and with some good cause; however, that in itself did not appear to paralyse him. His evidence and that of Mr. Heidinger established that Mr. Gillis continued to manage his business albeit on a protracted basis but manage he did. I am not convinced that the problems with the house were such that he was not able to devote sufficient time to his businesses. Put another way although these problems took time, Mr. Gillis was not required to devote all of his time to them.

Using some of the tests set out in the jurisprudence, the appellants maintain that if their actions are consistent with holding for investment they are equally consistent with holding for sale. For example, the fact that Mr. Gillis tried to improve the quality of tenants, increased rent, renovated and increased the number of tenants is just as consistent with preparing the property as a package for sale as improving income.

Mr. Gillis’ history is full of instances where properties were sold. Sometimes, it is alleged that they were sold to change the investment mix or to invest in another area such as a change from residential to commercial or industrial real estate as evidenced by the sales of apartment buildings in Mississauga, Burlington and North York, Ontario between 1963 and 1976. Although there is authority to say that the gains on this type of sale might be regarded on capital account, the fact still is that after the changes, Mr. Gillis continued to sell so-called investment properties at a profit and usually as a result of “unsolicited offers". The Lome Park Mail was purchased in 1977 and sold in 1984. The Simcoe Mall was purchased in 1979 and sold in 1985 as well as the two properties being the subject matter of these appeals. In addition the Port Credit Plaza was originally sold pursuant to an unsolicited offer in 1978 having been purchased in 1975. The same property was repurchased in 1979 to protect an outstanding mortgage and was sold the same year. This property had a history of trouble with mortgagees but in the end it too was sold.

This history of selling with a resulting gain goes a long way in indicating what Mr. Gillis’ intentions could be.

Counsel for the appellants pointed out that the Suncoast property brought a ten per cent cash return when purchased in June 1985, but this was based on a purchase price for an asset purchased from the Greymac Trust bankruptcy for about $2,500,000 yet within a year, it was sold for $4,350,000. The rental increase did not reflect the increase in sale price. Mr. Gillis's actions lead one to believe that the bargain price, when coupled with good management, would produce the result which it did—a sale at a profit over the short term.

The appellants' accountant's cash flow figures show a positive cash flow. This was based on adding back to the calculation of profit non cash items such as Mr. Gillis’ salary and depreciation. However, some amount should have been charged for management of the Sprinco property. Mr. Gillis charged only $26,000 for the year ended December 31, 1985, nothing for the year ended April 30, 1986 and $35,000 for the year ended April 30, 1987. These amounts were paid to reduce income to nil. They were never determined as the proper salary for a manager of such properties. If a salary were to have been paid to a third party dealing at arm's length, the result would have been a negative cash flow as well as an accounting loss in the profit and loss statement. The same applied to Suncoast. This therefore would be another indication that Mr. Gillis was looking to the gain on sales as his reward.

Property which does not yield an income is more likely to have been acquired for the purpose of sale (Happy Valley Farms Ltd. v. The Queen, [1986] 2 C.T.C. 259, 86 D.T.C. 6421 (F.C.T.D.) at page 263 (D.T.C.6423)). This coupled with the holding periods, the work expended to bring the property into a more marketable position also point to an adventure in the nature of trade (Happy Valley Farms, supra, at page 264 (D.T.C. 6424)). All of the surrounding circumstances lead to the conclusion of purchases for resale. I do not believe that the problem with the home as large as it may have been accounted for the reasons for sale over the profit motive.

In applying the various tests such as those enumerated in Happy Valley Farms, supra, and First Investors Corp. v. The Queen, [1987] 1 C.T.C. 285, 87 D.T.C. 5176 (F.C.A.) the conclusion I must draw is that the appellants were engaged in an adventure in the nature of trade and accordingly the gains were on income account.

For these reasons the appeals are dismissed, with costs.

Appeals dismissed.