Group 35 Engineering Limited v. Her Majesty the Queen (Informal Procedure), [1993] 2 CTC 3181

Teskey, T.C.C.J.:—The appellant elected to have this appeal from an assessment of tax for its fiscal year ending March 31, 1988 heard pursuant to the informal procedure.

Issue

The issue is whether the appellant’s profits from the disposition of its interests in a 38-suite apartment building municipally known as 1315 Bayview Avenue ("Bayview") in the Borough of East York and in a 50-suite apartment building municipally known as 37 Oriole Road ("Oriole") in the City of Toronto are to be considered as a capital gain or as being on income account. (Both properties are within the Regional Municipality of Metropolitan Toronto.)

Facts

The appellant was incorporated under the Ontario Business Corporations Act, 1982, S.O. 1982, c. 4, on August 19, 1977. The applicant for the incorporation was James Ward Hoffman ("Hoffman") who was, and still is, the only director, officer and shareholder of the appellant. The original name being Group 35 (Project Management) Ltd., Hoffman said that this company has gone through name changes and amalgamations and is now known as Group 35 Engineering Ltd. (the "appellant"). Without evidence as to what amalgamations took place, I cannot draw any conclusions from the objects set forth in the original incorporation. A corporation on amending its articles of incorporation, may, amongst other matters, change its name and extend, limit or otherwise vary its objects. A corporation on amalgamation with another corporation combines its objects with the amalgamating corporations and collectively they become the objects of the amalgamated corporation unless otherwise extended, limited or varied.

Hoffman is an engineer with a master's degree in engineering. He, in his own name and not as trustee, made an unconditional offer to purchase Bayview, which was irrevocable until March 8, 1986. The offer was accepted and the transaction was scheduled to close on May 5, 1986. The total purchase price was $993,000. Hoffman assigned the purchase and sale agreement to 1315 Bayview Avenue Investments Ltd. ("1315 Investments") for a consideration of $1,085,000. The purchase was completed on May 5, 1986 with title being taken by 1315 Investments. Eighty-five per cent of the $1,085,000 was financed. In a joint venture agreement (Ex. A-1), this amount was allocated as follows:

1. 1315 Bayview Avenue Investments Ltd. would be a bare trustee for the joint venture.

2. Hoffman shall pay his interest in the joint venture by setting off this interest against his fees of $67,845 and repayment to him of his original deposit of $20,000.

3. The ownership was:

The Minister of National Revenue (the" Minister”) in assessing the appellant made many assumptions of fact which were reproduced in paragraph 9 of the reply to the notice of appeal (the" reply") filed herein. Although I suggested to Hoffman at the beginning of his evidence that he deal with these assumptions of fact one by one as to those he agreed with and then those he disagreed with, he elected not to refer to the reply in any manner and proceeded to present his evidence without reference to these assumptions of fact.

Subparagraph (f) of paragraph 9 of the reply reads:

(f) as at July 31, 1986, the Partners’ equity in the Bayview property was as follows:

Partner	Equity Interest
Group 35 Engineering Ltd.	$29,562
586054 Ontario Ltd.	30,811
Joan F. Zarry	30,207
Theresa Reidelmeier	15,406
Walter Reidelmeier	15,406
TOTAL EQUITY	$121,392

Although the word partner was challenged by Hoffman and by the wording of Exhibit A-1, he never challenged the equity interest in anyway.

Thus, the appellant earned fees on the assignment of the agreement of purchase and sale of $67,845. Since his 24 per cent interest in the joint venture was only $29,562, it made a gain on the assignment before tax of $38,283. Thus, the appellant's only investment in 1315 Investments was Hoffman's time and its guarantees.

On May 20, 1315 Investments received an offer to purchase Bayview from a B. Greene for $1,250,000. This offer was made through R. Cholkan & Co. Ltd. ("Cholkan") a real estate broker. This offer was not accepted by 1315 Investments. An acceptance by 1315 Investments would have named Cholkan as its agent and would have obligated it to pay a commission of five per cent of the sale price. Hoffman says that this was an unsolicited offer. I do not accept this statement as fact. Cholkan must have received some encouragement from Hoffman or the offer never could have been put in writing in the form received. There are simply too many details in the written offer for it to have been prepared in the form it was in without encouragement and the divulging of pertinent information, which could only have come from Hoffman. On June 20, 1986, Hoffman personally signed a multiple listing agreement on behalf of 1315 Investments with R. Villani Real Estate Ltd. to sell Bayview for $1,275,000.

A written offer to purchase Bayview dated July 2, 1986 was received and after negotiation was finalized on July 3, 1986 for a sale price of $1,240,000, the transaction was scheduled to close on August 8, 1986.

The assumptions of fact in subparagraphs (i) to (p) inclusive of the reply were either confirmed by testimony or were unchallenged and are:

(i) during the period in which the partnership held the Bayview property, the expenses exceeded the rental income earned;

(j) the profit from the sale of the Bayview property was $182,717, and the appellant's share thereof was $36,213;

(k) Hoffman had an active role in both the purchase and sale of the Bayview property;

(l) On August 19, 1986, the appellant entered into a joint venture agreement with seven other investors with the following percentage interests:

Investor	Interest
Julia Marton	10%
Robwildon Ltd.	25%
Group 35 Engineering Ltd.	20%
Alan Butler	10%
Joan F. Zarry	10%
Dr. Glenn Renecker	10%
Robert Neally	5%
586054 Ontario Ltd.	10%

(m) at all relevant times, Walter Reidelmeier was a principal shareholder of Rob- wildon Ltd.;

(n) the joint venture was carried on under the name of 37 Oriole Road Investments Ltd. (the"Corporation");

(o) Hoffman was the signing officer for the Corporation;

(p) On August 20, 1986, Hoffman purchased the Oriole property, being an apartment building located at 37 Oriole Road, Toronto, for a purchase price of $2,000,000 and assigned it to the Corporation for $2,100,000;

On July 2, Hoffman made an offer to purchase Oriole. The purchaser is described as James Ward Hoffman In-Trust and under his signature appear the words "James Ward Hoffman in Trust". The offer was negotiated back and forth and concluded on July 10, 1986 at a purchase price of $2,0000. The transaction was scheduled to close on August 20, 1986.

Hoffman assigned the Oriole purchase and sale agreement to 37 Oriole Road Investments Ltd. ("37 Investments") for $2,100,000 that was allocated as per Schedule B to a joint venture agreement dated August 19, 1986 (Exhibit A-2). The increase of $100,000 from the original purchase price allocated $71,775 as fees to be paid to Hoffman for raising equity investments, guaranteeing the mortgages and the bank's line of credit and for syndication of the transaction. The purchase was completed on August 25, 1986.

37 Investments executed both a trust declaration and the joint venture agreement (Ex. A-2) which is referred to in subparagraph (I) above. Both documents make 37 Investments a bare trustee for the joint venture.

In regards to the assumptions (q) and (r), neither were disputed and they read:

(q) the above-mentioned acquisition of the Oriole property by the Corporation largely was financed with borrowed funds;

(r) Hoffman was responsible for the day-to-day operations of the Oriole property;

It should be noted that 85 per cent of the purchase of Oriole was financed and Hoffman received a fee of four per cent of the gross annual rental income for managing the day-to-day operations of Oriole.

The assumptions of fact found in subparagraphs (s), (t), (v) and (w) were not challenged in any way and these read as follows:

(s) pursuant to the terms of the joint venture agreement, the appellant was represented by Hoffman, on the Management Committee, and such committee was responsible for approving the sale or other transfer of any property of the joint venture;

(t) in or around the month of January 1987, the Oriole property was listed for sale pursuant to a multiple listing agreement, and on April 7, 1987, the property was sold;

(v) the Oriole property was sold at a profit of $338,903.51, and the appellant’s share thereof was $67,782;

(w) during the period in which the Corporation held the Oriole property, the expenses exceeded the rental income earned;

Analysis

The appellant reported the profit as a capital gain in the year ending March 31, 1988. This was accepted by the Minister as profit earned in the year ending March 31, 1988 but the profit was treated as income and not as a capital gain. The taxpayer objected to the assessment on this basis. As a result of the objection, the Minister reassessed, adjusting the amounts of profit but assessing the profit as income. The appellant appealed to this Court on the basis that the profit in the year ending March 31,1988 was capital and not income.

Hoffman said (see page 27 of the transcript):

I targeted 1315 Bayview for specifically that reason. Buildings were selected where rents were substantially below the market potential for the location, and both buildings were excellent locations. Up until December, 1986 the rent increase legislation allowed substantial annual rent increases as a result of refinancing on a sale or selective capital expenditures. If you can imagine making an investment where you are guaranteed absolutely no risk, these buildings had not had prior vacancies, people did not move out of these buildings because the rents were so low and they were prime locations in Toronto and, more importantly, recognizing that the cost pass-through on the sale of these buildings by selected capital expenditures, you are guaranteed, as in a government bond, increasing net income.

The practice of selective spending on these buildings that yielded the greatest payback in the form of annual rent increase was a well known. . . .

and (see at page 30):

These buildings were purchased solely because the rents were low relative to location and the existing rent review legislation allowed creative and aggressive landowners to annually impact rent increases and therefore net income and profitability.

I find that it was obvious to the appellant that as the income for each building was increased the value of the buildings would be increased. The increased value of these buildings was a direct result of the actions of the syndication. I have no doubt that Hoffman knew that his actions were going to increase the value of these apartment buildings. The appellant, in essence, had no money at risk, only Hoffman's time spent in these projects.

The respondent submits that the appellant had a secondary intention to resell both properties at the time both were acquired.

Noël, J. of the Exchequer Court of Canada said in Racine v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098 at page 158 (D.T.C. 5103):

It seems to me that one must ask oneself the question, was the only objective of the appellants, at the time they made their purchase, to add this business to all their other enterprises, or did they acquire the business for the purpose of running it and for the purpose of reselling it at a profit following circumstances which might arise and offers which might be made to them?

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.

Pinard, J. in Lee v. Canada, [1992] 1 C.T.C. 64, 92 D.T.C. 6067 (F.C.T.D.) says that it has been consistently held in cases of this kind that secondary intention is a question of fact: the onus is on the taxpayer of disproving the Minister’s assumption, in assessing the plaintiff as he did.

An indicator of trade is if the purchase is made with all or almost all borrowed funds.

The Federal Court of Appeal reiterated in Crystal Glass Canada Ltd. v. Canada, [1989] 1 C.T.C. 330, 89 D.T.C. 5143, that to find secondary intention that the prospect of resale at a profit had in fact been an operating motivation in its acquisition.

Walsh, J. of the Federal Court-Trial Division in Pierce Investment Corp. v. M.N.R., [1974] C.T.C. 825 , 74 D.T.C. 6608, said at page 831 (D.T.C. 6612):

. . . 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.

Thorson, J. in the Exchequer Court decision of M.N.R. v. Taylor, [1956] C.T.C. 189, 56 D.T.C. 1125 said at page 199 (D.T.C. 1131):

It is, I think, plain from the wording of the Canadian Income Tax Act [R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act")], quite apart from any judicial decisions, that the terms "trade" and "adventure or concern in the nature of trade", are not synonymous expressions and it follows that the profit from a transaction may be income from a business within the meaning of section 3 of the Act, by reasons of the definition of business in paragraph 127(1)(e), even although the transaction did not constitute a trade, provided that it was an adventure or concern in the nature of trade.

And again at page 210 (D.T.C. 1137):

But” trade” is not the same thing as"an adventure in the nature of trade" and a transaction might well be the latter without being the former or constituting its maker a "trader". . . . The very word "adventure" implies a single or isolated transaction and it is erroneous to set up its singleness or isolation as an indication that it was not an adventure in the nature of trade.

Jackett, J. in the Exchequer Court decision of Tara Exploration & Development Co. v. M.N.R., [1970] C.T.C. 557, 70 D.T.C. 6370 [aff'd [1972] C.T.C. 328, 72 D.T.C. 6288 (S.C.C.)], said at page 567 (D.T.C. 6376):

. . . the words “carried on" are not words that can aptly be used with the word "adventure". To carry on something involves continuity of time or operations such as is involved in the ordinary sense of a “business”. An adventure is an isolated happening. One has an adventure as opposed to carrying on abusiness.

Mahoney, J.A. of the Federal Court of Appeal in First Investors Corp. v. The Queen, [1987] 1 C.T.C. 285, 87 D.T.C., 5176 (F.C.A.), at pages 290-92 (D.T.C. 5179-81) said, under the heading:

THE RELEVANT JURISPRUDENCE AS APPLIED TO THE FACTS OF THIS CASE

The issue in this case is the issue decided by the Lord Justice Clerk (McDonald) in Californian Copper Syndicate Ltd. v. Harris (Surveyor of Taxes) (1904), 5 T.C. 159 (Ex. Ct., 2nd Div.) at page 166:

Is the sum of gain that has been made a mere enhancement of value by realizing a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?

Scace and Ewens in their work on The Income Tax Law of Canada, Fifth Edition, 1983 (pages 22-26 incl.), set out several tests developed by the Courts, over the years, to be employed when deciding whether a gain is capital or income. I think it useful to consider those tests in the context of the facts in the present case:

1. The subject-matter of the realization — In this connection the authors comment: “... property which does not yield to its owner an income or personal enjoyment merely by virtue of its ownership is more likely to have been acquired with the object of a deal than property that does. . . ."

2. The length of the period of ownership — In this regard the authors observe: “Generally speaking, property meant to be dealt in is realized within a short time after acquisition. .. ."

3. The frequency or number of similar transactions by the same person — Under this heading the authors comment as follows:

If realization of the same sort of property occurs in succession over a period of years or there are several such realizations at about the same date, a presumption arises that there has been dealing in respect of each. . . .

4. Supplementary work on or in connection with the property realized — The authors' comments under this heading read:

If the property is worked up in any way during the ownership so as to bring it into a more marketable condition; or if any special exertions are made to find or attract purchases, such as the opening of an office or large scale advertising, there is some evidence of dealing. For when there is an organized effort to obtain profit there is a source of taxable income. But if nothing at all is done, the suggestion tends the other way. . . .

5. The circumstances that were responsible for the realization — Under this heading Scace and Ewens observe:

There may be some explanation, such as a sudden emergency or opportunity calling for ready money, that negatives the idea that any plan of dealing prompted the original purchase. . . .

6. Motive — The authors observe (page 24) that in Canada over the years factors one to five supra have been considered by the courts but that the question of motive or intention at the time of acquisition of an asset has received the most attention. It is stated further that the intention at the time of acquisition together with a consideration of the taxpayer’s whole course of conduct while the asset was held is what finally influences the determination by the courts. They add that this test has been carried further in Canada by the acceptance of the "secondary intention test". A concise summary of the secondary intention test is to be found in the decision of Noël, J. in Racine, supra, at page 159 where he said . . .

At page 293 (D.T.C. 5182), Mahoney J.A. referred to Hiwako Investments Ltd. v. The Queen, [1978] C.T.C. 378, 78 D.T.C. 6281, where Jackett, J. said at page 382 (D.T.C. 6284):

An intention, at the time of purchase, to resell at a profit does not, in my view, necessarily give the purchase and a subsequent sale the character of "an adventure or concern in the nature of trade".

And again at page 383 (D.T.C. 6285):

In my view, an intention at the time of acquisition of an investment to sell it in the event that it does not prove profitable does not make the subsequent sale of the investment the completion of an "adventure or concern in the nature of trade”.

Mahoney, J.A. went on to say at page 294 (D.T.C. 5182):

In my view, the relevant jurisprudence does not carry us to the point where someone with a trading history must be irrevocably so characterized in all future transactions. All of the circumstances, including that circumstance, must be considered.

In this case, the direct evidence as well as the proper inferences to be drawn from the surrounding circumstances point unmistakably to the conclusion that at the time of purchase, the appellants did not possess either a primary or secondary trading intention. . . .

Considering the evidence before me and the conclusion to be drawn from the facts before me, I am satisfied that Hoffman (the controlling mind and owner of the appellant) had the secondary intention at the time of each purchase to sell both properties at a profit when the rents were escalated.

The appeal is dismissed.

Appeal dismissed.