King Meadow Farms Ltd. And Gloriation Investments Limited v. Minister of National Revenue, [1993] 1 CTC 2087, 93 DTC 125

Brulé, T.C.CJ.:—These are appeals heard on common evidence. In the case of King Meadow Farms Ltd. (” King”) 1982 and 1983 years were involved. In the Gloriation Investments Ltd. ("donation") case the years under appeal were 1982 and 1984. In the former case the 1983 year was a nil assessment and so it is not involved in these appeals and is accordingly dismissed.

Issue

The only issue in these appeals is whether or not the profits from the sale of real property may be claimed as a capital gain or must be declared as income.

Facts

The appellants along with others formed a company 353584 Ontario Ltd. and purchased a leased building in Toronto in March, 1977. After holding the property for four years it was sold and a large gain resulted, the purchase price being $1,000,000 and the sale price $2,600,000. The Minister of National Revenue ("respondent") taxed the participants allocating each a portion and charging this to income account. In the case of King this amounted to $406,187 in 1982 and for Gloriation the amount involved was $128,372 in 1982 and in 1984 the deletion of a mortgage reserve in the amount of $5,737.

Appellant's position

Counsel for the appellants provided the only witness at the trial. He was Anthony D. Leibel ("Leibel") a lawyer and involved from the outset in the property, especially with his brother James Leibel, also a lawyer, and since deceased. The Leibel interest was in JSL Properties Ltd. which owned a 25 per cent share of the operation.

Mr. Leibel, in evidence, traced the operation from the forming of the joint- venture company to the time of sale. The Court was told of the financing for the project, the projections made that indicated a profit could result, and the hope of a long-term investment.

At the time of purchase the building was fully leased. After taking possession one tenant cancelled a lease, while another who was a participant in the joint-venture had trouble meeting financial obligations. City zoning restricted the type of tenant who could occupy vacant space. Real estate companies were engaged to find tenants. The conformation of the building, a converted church, made leasing difficult. The property however was a designated historical site and the space provided was unique in the city.

While the financing of the operation involved little, if any, capital by the participants at the outset some was contributed later. A large floating mortgage was put in place believing interest costs would drop which they did at first but then rose rather dramatically. With vacant space in the building making a profit became unreasonable. By the end of 1979 evidence showed only a small overdraft in the operation. Tax arrears resulted and a decision was made to try and sell the property. Again different real estate agents were involved and finally in 1981 the sale was made.

Mr. Leibel indicated that the participants in the joint-venture were not traders in real estate, and the intention from the inception was to hold the building as an investment.

Respondent's position

The first matter mentioned was that the appellants had not discharged an obligation to show there was no secondary intent at the time of the purchase. Of major significance was the fact that the purchase had been fully financed by borrowings which indicated a trading intention. To this end the Court was directed to the case of M.N.R. v. Taylor, [1956-60] Ex. C.R. 3, [1956] C.T.C. 189, 56 D.T.C. 1125. Among others this case is considered a leading one for the determination of the term "adventure in the nature of trade”.

Other cases relied upon by the respondent were:

McDonald v. The Queen, [1974] C.T.C. 836, 74 D.T.C. 6644;

Norton Investments Ltd. v. The Queen, [1978] C.T.C. 154, 78 D.T.C. 6078;

Zen v. The Queen, [1985] 2 C.T.C. 313, 85 D.T.C. 5531;

Rickron Realty Inc. v. M.N.R., [1973] C.T.C. 355, 73 D.T.C. 5287;

Morev Investments Ltd. and Burnstein v. M.N.R., [1972] C.T.C. 513, 72 D.T.C.

6421; aff'd [1973] C.T.C. 429, 73 D.T.C. 5353;

The Queen v. Dobroskay, [1974] C.T.C. 260, 74 D.T.C. 6158.

Emphasis was placed on the contents of two letters from the bank financing the purchase, both of which mentioned and focused on a sale of the building. Also the question was raised why a group who had a long-term investment in mind would let tax arrears accumulate.

In summation the respondent's counsel stated that all the factors for a possible resale at a profit were present and accordingly the profit that was made should be taxed as income.

Analysis

The determination of whether the profit on the sale of real property should be treated as a capital gain or income has been considered by the courts over many years. The decision in Taylor, supra, mentioned by both counsel provides an analysis of the factors or tests to be applied. Some of these tests are involved in the present case and are mentioned below.

First of all in this case there are two important factors. Evidence showed that projections were made before the purchase by the joint-venture company and these showed the project to be viable. Very little significant cross-examination took place on this point. Also evidence suggested that the participants did not have a history of trading in real property.

It is important to note that when tenants left help was sought from real estate agents to fill the space. Only some four years later when difficulties arose with the financing bank and tax arrears were attempts made to sell. Again real estate companies were asked to assist. When a buyer was found such was not a complete sale as the vendors had to take back a mortgage and a lease arrangement.

There is a great deal of difference between purchasing vacant land and a fully rented commercial building. In the former an adventure in the nature of trade is more significant. The cases cited by the respondent dealt largely with vacant land and in each case the Court held that the profit was on income account.

Another point made by the respondent was that the purchase was financed by borrowing funds, a part of which came from one of the participants. I do not find this, in itself, a factor which would determine the lack of investment interest. In the case of Irrigation Industries Ltd. v. M.N.R., [1962] S.C.R. 346, [1962] C.T.C. 215, 62 D.T.C. 1131, while dealing with the problem of securities investment as opposed to real property, Mart and, J. in the Supreme Court of Canada said at page 350 (C.T.C. 218, D.T.C. 1132):

With respect, I would not think that the question of whether securities are purchased with the purchaser's own funds, or with money borrowed by him, is a significant factor in determining whether their purchase and subsequent sale is or is not an investment.

While securities and real property are different the principle of investment is the same.

With reference to a secondary intention the evidence did not disclose this but rather denied such, maintaining that the intention was investment and all attempts at this were carried out before a sale was contemplated.

The matter of secondary intention was dealt with in the recent case of Les Placements Richard Martineau Ltée v. M.N.R., [1992] 2 C.T.C. 2170, 92 D.T.C. 1051 wherein Garon, J. in considering a similar problem referred to the Exchequer Court judgment in Racine, Demers and Nolin v. M.N.R., [1965] 2 Ex. C.R. 338, [1965] C.T.C. 150, 65 D.T.C. 5098. Two of the points made were the possible intention of the purchaser to sell at the time of purchase and the length of time the property was held.

Here I do not believe the possibility of resale was considered by the company at the time of purchase and also the property was held for some four years before a sale and that was only upon encountering many difficulties.

Based on the above I have reached the decision that the profit made on the sale was a Capital gain and must be treated as such.

Other than the nil assessment of 1983 for King Meadow Farms Ltd. which is dismissed, the appeals are allowed with costs and the matter is referred back to the respondent for reconsideration and reassessment on the basis that the gain on the sale of the building is a capital gain.

Appeal allowed.