Les Immeubles Jos Pelletier Inc. v. Majesty the Queen, [1993] 2 CTC 2643, 93 DTC 1552

Lamarre Proulx, T.C.C.J.:—This is an appeal from an assessment by the Minister of National Revenue (the"Minister") for the 1987 taxation year.

The issue is whether the gains from the sale of three buildings are capital gains or income from a business.

The facts on which the Minister relied in assessing the appellant are described in paragraph 10 of the reply to the notice of appeal as follows:

(a) the appellant was founded by its principal shareholder, Mr. Joseph Pelletier, and was incorporated under part 1(a) of the Quebec Companies Act, R.S.Q. 1977, c. C-38;

(b) the principal shareholder, Mr. Joseph Pelletier, is a construction contractor who works in the field of excavation; he moreover founded the company Excavation Jos Pelletier Inc., in 1983;

(c) the first buildings which the appellant acquired, that is, the income properties located at 112 Albertine and 116 Albertine in St-Romuald, are buildings which Mr. Joseph Pelletier had himself constructed in 1977 and 1981 which he transferred to the appellant in 1984; the appellant then sold the two buildings in 1985 and 1986;

(d) since the appellant was incorporated it has constructed several buildings every year, which it kept to rent out or resold at a profit at the first opportunity;

(e) Mr. Jos Pelletier personally constructs the appellant's buildings, with the participation of members of his family;

(f) the building at 39 rue des Mélèzes is a duplex which the appellant constructed in 1984-1985 and resold in April 1987 for a profit of $29,220;

(g) the building at 20 rue Lavoisier is a twelve-unit building which was constructed in 1985 and resold in May 1987 for a net profit of $226,264;

(h) the building at 30 rue Lavoisier is a twelve-unit building which was constructed in 1986 and resold in August 1987 for a net profit of $231,081;

(i) the profit from the sale of these three buildings totalling $486,565 in 1987 is income from a business;

(j) in having these three buildings constructed, and other buildings thereafter, the appellant always had at least the secondary intention of reselling at a profit when the opportunity presented itself.

Moreover, the appellant also constructed and sold other properties in 1986, 1987 and 1988, the profits from which were reported as income from a business;

(k) in addition, in 1987, as for subsequent years, the buildings that were resold by the appellant showed a good profitability and the sales cannot be justified by a need for working capital, but rather by a desire for a business profit; moreover, the buildings sold in 1987 were 100 per cent rented and were disposed of after being owned for a short period;

[Translation.]

In the appellant's rejoinder, it denied paragraphs (d), (i), (j) and (k) and admitted the other paragraphs.

The documentary evidence established that the profits from the sales described in paragraph (c) were considered to be capital gains because of the length of ownership and because these were the first sales. A table of the acquisitions (constructions) and sales, prepared by the Minister and shown at page 109 of tab 11 of Exhibit 1-1, shows that the first two apartment buildings sold by the appellant had been owned for eight and five years respectively. According to Mr. Pelletier, these buildings were sold after receiving attractive offers.

The Court heard the testimony of the following persons for the appellant: Mr. and Mrs. Pelletier, two purchasers of the properties in issue in this case and an employee of the bank where the appellant and its principal shareholder did business.

According to these witnesses, Mr. Jos Pelletier is well known in the construction industry on the South Shore of Quebec. In addition to working as manager of an excavation company during the day, Mr. Pelletier constructed buildings in the evenings and on weekends.

From 1984 to 1987, the appellant constructed about 20 properties, including single-family homes and income producing properties. The appellant reported the income from the single-family homes as income from a business. Thereafter, this portion of the ‘business was carried on by another corporation of which Mr. Pelletier is also the principal shareholder.

The income properties owned by the appellant were all built by Mr. Pelletier in the following manner: a qualified worker did the construction during the day, and in the evenings and on weekends, Mr. Pelletier and his sons continued the construction. The sons were not paid for their labour.

As a result, it is obvious that construction costs were low and that the sale of each of the properties yielded substantial profits. Because all the profits were reinvested in the appellant's real estate assets, his holdings grew from two buildings comprising of 18 apartments, with a value of $194,000 in 1983, to 17 buildings comprising of 100 apartments with a value of $2,000,504 in 1992.

Mrs. Pelletier explained that the housing units in the buildings constructed by the appellant were rented from the blueprints. There does not seem to have been any problems with the tenants. On the contrary, the purchasers of the appellant's buildings sought them out because the excellent profitability rate and because they were well built.

20 Lavoisier

This building was constructed by the appellant in 1985. The appellant obtained a mortgage loan of $190,000, for a three-year term, with an amortization period of 15 years, at a rate of 11.75 per cent, on November 25, 1985. Pursuant to an amending deed dated January 17, 1986, January 1, 1986 was designated as the interest calculation date.

Mr. Boivin, the purchaser, testified to the effect that he had just sold two rental properties through a real estate agent, Mr. Labbé, and was looking to invest in an income producing property. In February 1987, he met Mrs. Pelletier, who told him that she had no intention of selling this property. However, on March 14,1987, an offer was made, through Mr. Labbé, for $415,000, and was accepted on March 17, 1987. According to Mr. Pelletier, Mr. Labbé is a friend and, in view of the significant amount of the offer, the appellant accepted it. The appellant paid Mr. Labbé a commission of $10,000. It should be noted that Mr. Labbé did not testify. The purchaser obtained a $310,000 mortgage and a $45,000 second mortgage, and paid $60,000 cash. He resold in June 1992 for a sum of $400,000.

30 Lavoisier

The appellant started building the 30 Lavoisier property in 1986. The loan, dated January 21, 1985, was for the amount of $190,000, with a term of three years, amortized over 180 months, at a rate of 9.5 per cent.

Messrs. Caron and Langlois purchased this 12-unit building. Mr. Caron testified. He and Mr. Langlois were the owners of an income producing property located at 352 Wilson Street in St-Romuald. He was looking for another income producing property close to the one he already owned. Behind their building, there was a building under construction, the 20 Lavoisier property. Mr. Caron met with Mrs. Pelletier, who told him that the 20 Lavoisier property was not for sale but that there would be another one built in the following year that would be. It was this other building that Messrs. Caron and Langlois purchased in August 1987. No sign was put on the property, nor was there any advertising done. The price paid was $405,000. At the time of sale, the building was fully rented.

39 rue des Mélèzes

This building was constructed during the years 1984 and 1985. It was sold on April 6,1987 for the sum of $57,000. Mr. and Mrs. Pelletier explained that this building was a house that was part of rented row townhouses. A tenant wanted her mother to come and live near her. The mother, who owned a condominium, did not want to move unless she could own her home. The appellant agreed to sell her a house to satisfy its good tenant.

Mr. and Mrs. Pelletier explained that they did not build to sell, but that if they received an attractive offer they accepted it. They consider the apartment buildings as long-term investments in order to establish a retirement fund. They have always used the money received to build other income properties.

According to the report of an official of the Minister which is found at tab 11 of Exhibit I-1, at page 106, the buildings showed a good profitability margin and the financial statements did not indicate any need for liquidity for working capital.

Analysis

Counsel for the appellant referred, inter alia, to the following decisions:

Irrigation Industries Ltd. v. M.N.R., [1962] S.C.R. 346, [1962] C.T.C. 215;

Crystal Glass Canada Ltd. v. Canada, [1989] 1 C.T.C. 330, 89 D.T.C. 5143 (F.C.A.);

Hiwako Investments Ltd. v. Canada, [1978] C.T.C. 378, 78 D.T.C. 6281 (F.C.A.).

In Irrigation Industries Ltd., supra, at page 352 (C.T.C. 220), Martland, J. cited the tests set out by Thorson, J. in M.N.R. v. Taylor, [1956] C.T.C. 189, 56 D.T.C. 1125 (Exch. Ct.) to assist in deciding a case of an adventure in the nature of trade:

The positive tests to which he refers as being derived from the decided cases as indicative of an adventure in the nature of trade are: (1) Whether the person dealt with the property purchased by him in the same way as a dealer would ordinarily do and (2) whether the nature and quantity of the subject-matter of the transaction may exclude the possibility that its sale was the realization of an investment, or otherwise of a capital nature, or that it could have been disposed of otherwise than as a trade transaction.

In Crystal Glass Canada, supra, at page 331 (D.T.C. 5143), Mahoney, J. of the Federal Court of Appeal explained the concept of secondary intention as follows:

Secondary intention requires not only the thought of sale at a profit but that the prospect of such a sale be an operating motivation in the acquisition of the capital property.

That misstatement of the test taken with his failure to find facts that brought the transaction within the test, that is his failure to find that the prospect of the resale of Crystal Manor at a profit had, in fact, been an operating motivation in its acquisition, leads us to conclude that the learned trial judge erred in law in finding that the disposition of Crystal Manor resulted in a trading profit.

Judson, J. of the Supreme Court of Canada made the following comments concerning secondary intention in Regal Heights Ltd. v. M.N.R., [1960] S.C.R. 902, [1960] C.T.C. 384, 60 D.T.C. 1270 at page 905-07 (C.T.C. 388-90; D.T.C. 1272):

There is no doubt that the primary aim of the partners in the acquisition of these properties, and the learned trial judge so found, was the establishment of a shopping centre but he also found that their intention was to sell at a profit if they were unable to carry out their primary aim. It is the second finding which the appellant attacks as a basis for the taxation of the profit as income. The Minister, on the other hand, submits that this finding is just as strong and valid as the first finding and that the promoters had this secondary intention from the beginning.

These efforts were all of a promotional character. The establishment of a regional shopping centre was always dependent upon the negotiation of a lease with a major department store. There is no evidence that any such store did anything more than listen to the promoters' ideas. There is, understandably, no evidence of any intention on the part of these promoters to build regardless of the outcome of these negotiations. There is no evidence that these promoters had any assurance when they entered upon this venture that they could interest any such department store. Their venture was entirely speculative. If it failed, the property was a valuable property, as is proved from the proceeds of the sales that they made. There is ample evidence to support the finding of the learned trial Judge that this was an undertaking or venture in the nature of trade, a speculation in vacant land. These promoters were hopeful of putting the land to one use but that hope was not realized. They then sold at a substantial profit and that profit, in my opinion, is income and subject to taxation.

In the case at bar, did the appellant deal with the buildings in question in the same way as a business selling real properties or in the construction business, or did it act like a business investing in income properties?

The tax legislation prescribes different tax treatment for income from a business than it does for a capital gain. Effect must be given to this distinction. The possibility of reselling at a profit is not sufficient to make a transaction an undertaking in the nature of trade. This possibility of reselling at a profit must have been one of the determining reasons for the acquisition of the property in question. The determination that the possibility of reselling at a profit was a reason which led to the decision to purchase must be made on the basis of the tests set out in the case law.

These tests, as they have been stated by the Supreme Court of Canada, are: whether a person dealt with the property in the same manner as a trader in similar matters, and whether the nature and quantity of properties acquired indicate a speculative transaction or a capital transaction, that latter being an investment made in order to earn income from property.

I have concluded that, except in the case of 30 Lavoisier, the appellant behaved like an investor in income property. It did not behave like a real estate trader or like a construction business, and the nature and quantity of the buildings do not indicate an intention to resell.

The appellant built 20 Lavoisier and 39 des Mélèzes as rental properties. Il did not put them up for sale and did not need to put them up for sale. The sale occurred, in the first instance, because a real estate agent came forward and made the appellant an attractive offer. In the second case, it was to please < tenant. When the buildings were constructed, they could have been retained because they were profitable and the appellant had the financial ability to continue to own them without too much effort. The nature and quantity of the properties did not indicate an intention to acquire properties for resale. The buildings sold previously had been owned for extended periods of time. These were not acquisitions where the principal borrowed was too great to allow for profitability and the latitude required in operating a successful rental business The people involved had experience in property rental and knew how to manage this sort of business. They were, of course, also people who had experience in construction. However what they built for resale was reported a income from a business.

In the case of the building located at 30 Lavoisier, the appellant had agreed from the outset to sell it to Mr. Caron. If Mr. Caron had not pursued the purchase negotiations, it is possible that the Pelletiers would simply have continued to rent out the building, which was fully rented at the time it was sold. However, in light of the circumstances surrounding the construction of that building, I am of the opinion that the profit from that sale must be considered to be income from a business on the same basis as that from the houses which were built for sale.

The gains realized on the sale of the buildings located at 20 rue Lavoisier and at 39 rue des Mélèzes are capital gains. Those realized on the sale of the building located at 30 rue Lavoisier are income from a business.

The appeal is allowed with costs.

Appeal allowed.