David G. Miller v. Her Majesty the Queen, [1995] 1 CTC 2683

Sarchuk J.T.C.C.:—David G. Miller (Miller) appeals from an assessment of tax with respect to his 1987 taxation year. In that year he acquired a property located in British Columbia known as Sicamous Marina (the Marina) which he then transferred to Go Vacations Canada Inc. (Go Vacations). In filing his income tax return he failed to report the disposition of the property. The Minister assessed on the basis that Miller had acquired the marina with the operating motive of selling it at a profit and added to his income the amount of $55,362 as an income gain. The Minister further imposed penalties pursuant to subsection 163(2) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the "Act"), and, relying on subsection 110.6(6) of the Act, denied Miller’s request for a capital gains deduction.

At the commencement of the trial counsel filed with the Court an agreed statement of partial facts (sic), as follows: [1]

1. At all times material hereto, the appellant was a resident of Canada for the purposes of the Income Tax Act (Canada) (herein called the "Act").

2. In 1986 the appellant commenced discussions with the shareholders of Dyad Data Services Ltd. (herein called the "company"), Mr. Norman Pascal and Mr. Clifford Henry concerning the purchase by the appellant of a percentage of their shares in the company.

3. Prior to April 1987, the appellant and Messrs. Henry and Pascal agreed that the appellant should attempt to sell a marina owned by a subsidiary of the company ("Sicamous Marina") and located at Sicamous, British Columbia (herein called the "marina"). By April 1987, Mr. Miller had not sold the marina on the company’s behalf.

4. The marina was leased to an affiliate of Go Vacations Canada Inc. ("Go Vacations") for a three-year term commencing May 7, 1985 with an option to extend the term for a further three-year period. The lease also contained an option to the lessee to purchase the marina at any time during the term of the lease, including the option period, for the amount of $225,000, provided that such option would become null and void upon receipt by the lessee of a notice from the lessor of a bona fide offer to purchase the marina. In the event of such a bona fide offer the lessor was required to give written notice to the lessee by sending to it a true copy thereof. Upon receipt of such written notice the lessee had ten days to elect to purchase the marina on the same terms as those contained in the offer which gave rise to the right of first refusal.

5. In early 1987 the appellant inquired of legal counsel regarding the effect on the lease of a sale of the marina to a third party and received a legal opinion dated April 6, 1987 which provided, inter alia, that the lease of the marina then in place to Go Vacations could, in certain circumstances, be effectively terminated without cost or penalty.

6. On June 12, 1987 the appellant entered into a written agreement with Go Vacations, to purchase an interest in Go Vacations BVI Ltd. Partnership being a special investor unit (the "unit") in sufficient quantity to acquire his chosen property being a 45-foot boat in exchange for title to the marina.

7. The appellant and Sicamous Marina completed a real estate purchase contract in writing dated September 23, 1987. Immediately after completion of the said real estate purchase contract the appellant transferred title to the marina to Go Vacations. As part of this transaction the appellant received a cheque from Go Vacations in the amount of U.S. $194,000 (approximately Cdn. $256,000).

(b) Although the September 23, 1987 real estate purchase contract states that in addition to the $200,000 consideration to be paid for the purchase of the marina by David Miller he would also assume the encumbrances then registered against the property, in fact the intention of the vendor and the purchaser was that the purchaser was not to assume the mortgage encumbrances and those encumbrances would be discharged from the cash consideration paid by David Miller to the vendors. The transaction was in fact completed on this basis.

8. The unit had a stated price of $194,000 (in U.S. funds) in the offering memorandum pursuant to which it was subscribed for by the appellant.

9. On or about February 29, 1988, the appellant received advice from Go Vacations that he had incurred a loss of $90,307 in respect of the taxation year of the Go Vacations BVI-II Ltd. Partnership (of which the appellant had become a partner by virtue of his acquisition of the unit) ended December 31, 1987. In completing his income tax return for 1987 the appellant deducted an amount equal to the loss set forth in the statement of advice referred to.

10. The appellant did not report the disposition of the marina in his 1987 income tax return.

Additional evidence was adduced on behalf of Miller from Mr. Clifford A. Henry (Henry) and from Miller himself, the relevant portions of which follow.

Mr. Henry and Mr. Norman Pascal (Pascal) founded Dyad Data Services Ltd. (Dyad). Miller first came into contact with Henry and Pascal when he solicited them to purchase business life insurance. Over a period of time he became involved in Dyad’s business affairs. He recognized that Dyad was suffering from working capital problems, took on the task of dealing with its lending institutions and at some point of time in 1986 began providing financial assistance to it with the understanding that he would be able to acquire some of its shares.

Through a subsidiary, Sicamous Marina Ltd., Dyad had become involved in the houseboat business in Shuswap, British Columbia and _ in that connection acquired the marina. That endeavour, operated by a residential manager, failed to do as well financially as expected. At some point of time prior to Miller’s arrival on the scene the houseboat division of the business was sold but the marina itself had been retained. In 1986 it became apparent that the marina would also have to be sold. According to Henry, towards the end of that year an initial arrangement was made by virtue of which he and Pascal "more or less turned over to David Miller to take care of disposal of that marina”.

Miller said that when given the authority to dispose of the marina he contacted real estate agents in Sicamous to determine both its value and current market conditions. The responses were not encouraging and he decided to personally approach a number of houseboat operators including the lessee of the marina, an affiliate of Go Vacations. He said that several months of actively soliciting offers produced nothing but negative responses. In January Miller received an opinion to the effect that a bona fide purchaser would not necessarily be required to recognize the existing lease (Exhibit A-1, tabs 5 and 6). [2] In or about March 1987 he concluded that the only solution was to make an offer himself. The plan was to buy the Marina, break the lease, move to renegotiate a higher rent and thereby increase the value of the Marina. He alleges that in April Henry and Pascal were advised of his intentions and agreed to. sell the Marina to him for $200,000. Miller added that according to this arrangement he "had one year to effect the transaction". He said he was motivated both by a desire to assist in rearranging Dyad’s financial affairs and because the marina could be a good investment.

Very shortly thereafter an additional legal opinion was received by Miller suggesting that the lease could not be broken as readily as previously believed. [3] Nonetheless he says he still intended to complete the purchase. However, before any steps were taken to do so, he had a serendipitous visit from a Go Vacations "tax shelter salesman". During the course of their discussions Miller mentioned his concerns regarding the marina and this ultimately led to an arrangement the terms of which were outlined to Miller by way of letter from Go Vacations dated June 11, 1987. These were acceptable and on June 12, 1987 Miller executed an agreement with Go Vacations by virtue of which he was to acquire a special investment unit in Go Vacations BVI Ltd. Partnership [4] and Go Vacations for its part would acquire the marina (Exhibit A-l, tabs 1 and 2). Miller says he immediately instructed his solicitor to commence "preparing legal documentations to effect my acquisition of the marina from Dyad". Apparently Miller had some difficulty in arranging financing and the purchase agreement was not concluded until September 23, 1987. On that date, Miller received a transfer of the marina from Sicamous in consideration of payment by him of the sum of $200,000. He then transferred the marina to Go Vacations for consideration received in the sum of U.S. $194,000 (Cdn. $255,362.20).

Miller said that in completing an income tax return for the taxation year in issue he did not appreciate that he was required to report the disposition of the marina since he believed that it was a neutral transaction and no gain or loss had been realized.

Appellant’s position

The facts, counsel for the appellant submitted, established that no gain had been realized by Miller on the exchange of the marina for the partnership units since it was a simple barter transaction. The contract entered into on June 12, 1987 between Miller and Go Vacations made no reference to price because the consideration between the parties was clearly understood to be properties in kind. Counsel argued that in a barter transaction the proceeds of disposition to the vendor is equal to what is considered to be the cost of the property acquired by him in the exchange. The value of. the marina had been established as $200,000 by way of an arm’s length transaction in April 1987 in a non-barter agreement, that is, the option to purchase between Miller and Sicamous Marina Ltd. In support counsel relies on paragraph 7 of Interpretation Bulletin IT-490 "Barter Transactions". [5]

In the alternative, if a gain has been realized, the April 1987 arrangement to buy the marina was not made with the intention of reselling it at a profit. Any gain realized by Miller was a capital gain in that he considered the marina to be capable of providing him with a reasonable rate of return as a long-term investment upon renegotiation of its lease. Counsel argued that when Miller’s initial intention was frustrated, preventing him from realizing the reasonable return he had counted on, he was presented with an unsolicited opportunity to exchange the marina for another property, 1.e., the special investment unit that he considered would also give him a reasonable return. This subsequent purchase and sale ought to have no bearing on Miller’s original intention in acquiring the property. In support counsel for Miller relied on the following comment in Armstrong v. The Queen, [1985] 2 C.T.C. 179, 85 D.T.C. 5396 (F.C.T.D.) at page 184 (D.T.C. 5399):

A common thread running through these cases is that circumstances which force the sale of a property or make such a sale attractive...do not have the effect of retroactively converting a property held to produce income and as a capital property into something of a trading nature.

Counsel contended this is not merely a case where an appellant states that his intention was to hold the property as an investment but a case where evidence has been presented that supports that stated intention.

Counsel further argued that even if the April 1987 agreement between Miller and Sicamous Marina Ltd. was only an option to purchase, his intention with respect to the property at the time he acquired the option is relevant to the subsequent acquisition of the property (Snell Farms Ltd. v. Canada, [1991] 1 C.T.C. 5, 90 D.T.C. 6693, at page 10 (D.T.C. 6696) (F.C.T.D.)).

Respondent's position

This was not a true barter transaction. The manner in which the transactions were ultimately structured and carried out reflects their true nature, that is the purchase and resale of the marina by Miller, and the concurrent purchase by him of an investment unit in Go Vacations BVI Ltd. Partnership.

Counsel also submitted that the evidence confirms the appropriateness of the Minister’s characterization of the gain on the sale of the marina as being on income account, since one of the operating motives of Miller in acquiring the property was to resell it at a profit. He argued that the Minister was also correct in assuming that Miller realized a gain on this disposition represented by the difference between his cost, $200,000, and the consideration he received from Go Vacations which was U.S. $194,000 (Cdn. $255,362.20). Counsel argued, relying on Les Immeubles M.H.T. Ltd. v. M.N.R., [1992] 2 C.T.C. 2703, 93 D.T.C. 79 (T.C.C.); Warnford Court (Canada) Ltd. v. M.N.R., [1964] C.T.C. 175, 64 D.T.C. 5103 (Ex. Ct.), that if an option existed, it merely conferred an irrevocable right to acquire property in the future, and that it is the exercise of that option which constitutes the acquisition, since it is only at that moment that there is a legally binding obligation on him. It is the intention of Miller at the moment the option was exercised which is relevant, and since that was done at a point of time when a resale of the marina had been effected it could not be said to have been acquired as an investment.

Conclusions

Let me deal first with Miller’s contention that his disposition of the marina to Go Vacations was "a form of barter transaction". While the agreement of June 12 (Exhibit A-l, tab 1) might suggest such an arrangement, that is not what in fact occurred. The relevant documents indicate that Miller sold the marina to Go Vacations as one transaction and then by way of a separate transaction purchased the Investment Unit. [6] Miller suggested this was done at the behest of Go Vacations or its solicitors. Indeed, the contrary appears to be the case. While Miller disavowed any responsibility for structuring the transactions in the manner that they were he did concede under cross-examination that he instructed his lawyers to ensure that a clear audit trail for the tax deductions existed. That Go Vacations accepted these instructions is clear from their solicitor’s letter dated August 19, 1987 setting out the form in which the transactions were to be completed and noting that:

Mr. Miller has stated that he would like somewhat of an "audit" so that Revenue Canada can trace his payment in regard to the memorandum and therefore allow Mr. Miller credit for the tax deductions which are available as a result of Mr. Miller subscribing in this investment. [7]

In my view the transactions in issue do not constitute a barter.

Had I concluded otherwise I would nonetheless have found that the proceeds of the disposition to Miller were $255,362.20 and not $200,000 as urged by his counsel. Barter is the acquisition of an asset other than by paying cash or assuming a liability. As was noted by Viscount Buckmaster in Westminster Bank Ltd. v. Osler (1932), 17 T.C. 381 (H.L.), in such a case there exists a ’’probability that articles exchanged in the way of trade would prima facie be of equal commercial value". On the evidence one can only conclude that Miller and Go Vacations considered the true commercial value of the "exchange" to be U.S. $194,000. The offering memorandum dated June 29, 1987 states the cost of the property acquired by Miller from Go Vacations to be U.S. $194,000. The agreement between Miller and Go Vacations refers to the value of the marina as "currently appraised at approximately Cdn. $240,000". [8] Finally, the transfer of the marina to Go Vacations executed by Miller stipulates that "$194,000 (in U.S. funds), Canadian equivalent $255,362.20" was the consideration he was to receive.

Since I have concluded that the transaction in issue was a purchase and resale of property it becomes necessary to determine Miller’s intention at the time of his acquisition of the marina which I find to be September 23, 1987.

Counsel argued that Miller’s operating motivation was formulated in the spring of 1987 and was to buy the marina as a long-term investment. Miller’s testimony does not convince me that that was the case. While its purchase may have been considered, no substantive steps were taken to bring it about. Although Miller professed to have the means to buy the marina at that time, I am satisfied that was extremely unlikely. Indeed, he later conceded bank financing would not have been available unless the lease could be broken and that, on the evidence, was never given much serious consideration. I do not accept counsel’s submission that the relevant time for determining Miller’s intention was the time at which the so-called "option to purchase" was arranged with Pascal and Henry. In fact on the evidence it is difficult to conclude that Miller ever had an enforceable option. While Henry said that Miller could "dispose of it in whatever fashion he saw fit" and that Miller "had the right to buy it", he was also quite emphatic that if another purchaser made an offer, they were not obligated to sell the marina to Miller. Furthermore, there was no mention by Henry of a price, nor did he refer to the existence of any time limit within which Miller was to act. According to Miller the "understanding" was quite different. He said Henry and Pascal specifically agreed to accept his offer to purchase the marina for $200,000, said offer to be open for the term of one year. Miller’s testimony in this context was self-serving and stands unsupported by any other evidence. [9] On the evidence I would describe this arrangement as a non-binding understanding between Henry, Pascal and Miller.

A new and quite different reason motivated Miller’s subsequent acquisition of the marina, that being the probability of earning a substantial profit on its resale to Go Vacations. I have concluded that the Minister was correct in assessing tax on the basis that the gain on the sale of the marina was on income account since Miller had acquired it with the operating motive of selling it at a profit.

Penalties

As to the penalty and the denial of the capital gain deduction to Miller counsel for the respondent contends that the failure to report the income from the disposition of the marina constituted gross negligence within the meaning of subsections 163(2) and 110.6(6) of the Act. Accordingly, Miller is not entitled to have the penalties vacated, nor is he, because of the application of subsection 110.6(6), entitled to claim the capital gains deduction permitted by subsection 110.6(3). [10]

Subsection 110.6(6) is only relevant to capital gains. Since I have concluded that the gain on the sale of the marina was on income account that section has no application.

With respect to the penalty the burden of establishing that Miller knowingly or under circumstances amounting to gross negligence failed to report the gain in his return of income is on the Minister. On the evidence before me, I am not satisfied the onus has been met. Miller said the failure to do so was the result of his belief that the value of the marina was the amount that he paid Sicamous. It was his view that a gain had not been realized in respect of the subsequent "exchange of properties" with Go Vacations, otherwise he would have reported it and taken advantage of the recently introduced capital gain exemption provision. While his rationale for concluding that the transaction produced no gain is not particularly sound, I cannot say he did not believe that to be the case. Miller is a very shrewd businessman, quick to spot opportunities and quick to change course when circumstances so dictate. However I am not prepared to find that in this instance he knowingly or intentionally under circumstances amounting to gross negligence failed to report the proceeds of disposition. For these reasons the penalty assessed pursuant to subsection 163(2) is vacated.

The appellant is entitled to no further relief.

Appeal allowed in part.