Universal Business Consultants Limited v. Minister of National Revenue, [1993] 1 CTC 2353, 93 DTC 342

Rowe, D.T.C.C.J.:—The appellant appeals from a reassessment of income tax for the 1984 and 1985 taxation years. The Minister of National Revenue included into income the gain from the sale of 848-50 Fort Street, Victoria, British Columbia in the appellant's 1984 taxation year and subsequently revised the reserve claimed as an income reserve for the 1985 taxation year. The appellant takes the position the gain from the disposition of the property was on account of capital.

The appellant, referred to in these reasons as Universal, is a body corporate under the laws of the Province of British Columbia. The property which is the subject matter of the appeal is referred to as 850 Fort Street.

William Giglio testified he is a chartered accountant on the Faculty of Business at Camosun College, Victoria, British Columbia. In 1983 and 1984, he was in private practice as an accountant and acted for the appellant, of which Gerald Tarantino was the President and principal shareholder. He prepared financial statements for the appellant for the period ending April 5, 1983, as well as the corporate tax return for the 1983 taxation year. In that return a capital loss was reported with respect to a property located at 1702 Belmont Street in Victoria, British Columbia. Mr. Giglio’s perception, based on information received from Mr. Tarantino, was that the property had been purchased as a rental property with the intent it be retained for such purpose. Mr. Giglio also prepared financial statements for the appellant for the period ending April 5, 1984, as well as the corporate tax return for the 1984 taxation year. The financial statement indicated funds flowing from a settlement of a lawsuit and this amount was included into income. Mr. Giglio stated he was aware the lawsuit settlement was the result of an incomplete property transaction but did not know until later that it was specifically in connection with 850 Fort Street. At the time he treated the settlement proceeds as income he did so on the basis on GAAP and his own credo that' if in doubt, put it into income”. However, he indicated that, on reflection, the categorization of the settlement proceeds should have been reported on account of capital in the same manner as the gain from the sale of 850 Fort Street.

James Clapp is a barrister and solicitor practising in Victoria, British Columbia. Gerald Tarantino had been a client and a friend for several years. In July of 1980, Mr. Clapp had left a law practice and relocated to space in a building at 850 Fort Street, which was owned by another lawyer, Mr. Hallatt, known to Mr. Clapp. Mr. Hallatt had once headed a large law firm which occupied space in the building and there were other tenants also occupying varying amounts of space. However, the Hallatt firm dissolved and a large amount of space became available. As a result of conversations with Mr. Hallatt, with whom Mr. Clapp was temporarily associating in the practice of law, Mr. Clapp learned the building was for sale. In his view, the building was a good buy and could be used by him as a base for his law practice over the long term. Knowing he could not handle the transaction himself, he sought out Mr. Tarantino who was not only an experienced businessman but had the assets to support the purchase and financing of the necessary mortgages required to complete. After discussions with Mr. Tarantino concerning the viability of the 850 Fort Street purchase, Mr. Tarantino, through Universal, on November 21, 1980, entered into an interim agreement with Cutty Sark Investments Ltd., the corporation controlled by Mr. Hallatt. The interim offer, Exhibit A-11, was for $1,150,000, payable by $150,000 cash and the remainder by assumption of a first mortgage in the sum of $750,000 and a second mortgage for $250,000. The transaction closed on December 31, 1980, in accordance with the statement of adjustments, Exhibit A-12, and the cash required to close, in the sum of $136,819.19, was paid by the appellant. However, Mr. Clapp had contributed $75,000 towards the total down payment of $150,000. Although Mr. Clapp's name did not appear on any of the purchase documents or as guarantor on the mortgages, he stated he trusted Mr. Tarantino and it was understood between them that the purchase of 850 Fort Street was a 50-50 partnership. After the purchase, Mr. Clapp took over four offices and a reception area previously occupied by Mr. Hallatt. Shortly before March 4, 1981, a realtor approached Mr. Clapp, who in turn contacted Mr. Tarantino, and they were presented with an offer to purchase on behalf of Munzel Properties Ltd., a development corporation controlled by Mr. Munzel, an architect. The offer was for $1,625,000 which Mr. Clapp stated both he and Mr. Tarantino regarded as "a ridiculous price but we could hardly turn it down". An interim agreement dated March 4, 1981, Exhibit A-15, was entered into between the appellant and Munzel Properties Ltd. and an initial deposit of $20,000 was received and the closing date was fixed at April 7, 1981. On March 14, 1981, certain "subject to" conditions were removed, inter alia the requirement an additional $30,000 deposit be paid, but the purchaser thereafter did not complete the transaction on the closing date. The appellant commenced a lawsuit for specific performance and/or damages in the alternative and the litigation carried on for several years. By the late fall of 1981, Mr. Clapp realized he could not continue to carry his investment in the property as he and his wife had borrowed the entire $75,000 for his share of the down payment from the bank and interest was running at over 19 per cent on a demand loan. On November 16, 1981, Mr. Clapp entered into an agreement, Exhibit A-17, with the appellant whereby he agreed to relinquish all claims on 850 Fort Street in return for three separate payments totalling $120,000. He received $100,000 but then became involved in a dispute with Mr. Tarantino over the balance of $20,000 and the matter proceeded to litigation but was finally resolved.

In cross-examination, Mr. Clapp indicated he is still a friend of Mr. Tarantino although he has not had any more business dealings with him. He agreed the rent of $3,500 per month to be paid by him for space occupied by his law firm was “a bit rich" but his professional income depended to a large extent on a real estate and conveyancing practice and he wanted to secure a permanent place to carry on an expanding law practice during times which were prosperous with no apparent end in sight. He indicated he and Mr. Tarantino had talked at length about rental revenue from the building and they were satisfied tenants could be attracted to occupy space for relatively long terms and that the entire building would be rented in the foreseeable future. Although the building was underdeveloped for the size of the lot there was not any discussion about additions to the building. Until full occupancy was achieved Mr. Clapp knew Universal was capable of carrying any shortfall in the interim. He stated there was never any conversation with Mr. Tarantino at the time of purchase about selling the building and in his own mind had no thought of resale but acknowledged "there is always that possibility”. The offer from Mr. Munzel“ came out of the blue”. He would not have sold out his interest to the appellant except for the high interest rates on the bank loan and the fact that his law practice had decreased significantly in the face of a downturn in the economy and in the real estate market.

In his testimony, Gerald Tarantino stated Universal was incorporated in 1972 and since that time he has been the President, and director and controlling (later sole) shareholder. The business activities of Universal were in dealing with mortgages, a natural by-product of which was selling and trading properties acquired as a result of foreclosures. In 1976, the mortgage activity began to decrease and then ceased totally after Mr. Tarantino and his family moved to North Saanich on Vancouver Island in 1979 and purchased a residence. Between 1972 and 1979, he estimated Universal had been involved in approximately one hundred real estate transactions, mainly resale of properties following foreclosure. After moving to North Saanich he intended to have Universal become involved in owning buildings which produced rental revenue. His wife purchased a 24 unit apartment in Brentwood Bay and he began to seek out an alternative lifestyle including different methods of generating income. In 1983, he began working as a commodity trading adviser and later purchased a stamp and coin business which he currently operates. In 1980, James Clapp, whom he knew as a lawyer, contacted him about a building at 850 Fort Street and Mr. Clapp was interested in having his law firm occupy space in the premises. Mr. Tarantino stated he knew the vendor, Mr. Hallatt, was a lawyer and that there were other tenants in the building. He examined the lease of an upper floor space leased to the British Columbia Government and statements of costs, rental projections, and other material in order to satisfy himself the purchase of the building was a good long-term investment. He was aware the building would not immediately be profitable but once the lower floor was fully occupied and certain modifications were made to suit the purposes of a major tenant he believed the outlook to be favourable. Mr. Clapp and his expanding law firm would occupy a good portion of the space at a fair market rent. He knew that Mr. Clapp's financial situation would not permit him to qualify for assumption of the mortgages in order to close the deal but was prepared to commit Universal to the purchase and recognized that Mr. Clapp had a 50 per cent interest, which understanding was never reduced to writing, although a memo may have been done up to that effect. Universal had to apply to assume the outstanding mortgages and Mr. Tarantino was aware the downstairs tenant had gone broke but remained confident a major substantial tenant could be found.

In March of 1981, two realtors advised he and Mr. Clapp they had a client who was willing to buy the building for $1,625,000. He and Mr. Clapp agreed to accept the offer but only on condition the initial deposit of $20,000 be increased by an additional $30,000 by March 15, 1981, prior to the closing date of April 7, 1981. The large deposit was demanded due to their joint belief the purchase price being offered was not only "very, very high”, but "unrealistic". The building had not been advertised or otherwise known as being available for purchase and Mr. Tarantino indicated he felt Mr. Munzel had been trying to pre-sell the building and something had gone wrong which led to his inability to complete the deal. An artist's conception of the building, Exhibit A-20, was apparently commissioned by Mr. Munzel or done by him as part of his attempt to broker the 850 Fort Street property. Universal commenced litigation against Munzel Properties Ltd. and while the process continued several persons approached him inquiring whether the building was for sale and all were advised that it was not. In November 1981, Universal bought out Mr. Clapp's interest as his law firm could no longer pay the rent and other financial pressures had intervened. Mr. Clapp was given a notice to vacate effective November 30, 1981.

On November 25, 1981, Universal obtained a $200,000 line of credit from The Toronto-Dominion Bank secured by a demand mortgage. Mr. Tarantino had been pursuing the Provincial Government for some time about leasing additional space in the building and on December 1, 1981, the British Columbia Buildings Corporation, a Crown corporation, entered into a five-year lease with Universal on excellent terms which provided for assumption of a percent- age share of certain operating costs, including taxes, and any increases during the term of the lease. Prior to obtaining the British Columbia Government as a tenant, Universal undertook mechanical work, including alterations and additions to the air-conditioning system, roof repair, replacement of carpet, repainting and, most important, bringing washrooms up to the standard required by the tenant mainly by making them accessible to disabled persons. The lease secured, the building could then be in a position to show a profit especially if the outstanding mortgages could be refinanced at a rate 2 per cent lower than the current debt. Details of the proposed refinancing can be found in a letter to Universal dated May 31, 1983, filed as Exhibit A-29. The building continued to maintain its tenants and was not advertised for sale nor had Universal undertaken any efforts whatsoever to sell it. In mid-summer 1983, Mr. Tarantino was approached by an individual who wanted to buy 850 Fort Street and Mr. Tarantino insisted on learning the identity of the buyer and was informed the purchaser would be City Trust. He doubted that to be the case but it turned out, through a merger of certain investments, City Trust had Guaranty Trust make an offer to purchase which was accepted by Universal and the deal closed on August 31, 1983. The vendor's statement of adjustments, Exhibit A-30, reveals the selling price was $1,751,250, resulting in a considerable profit in excess of $500,000. Mr. Tarantino stated he considered the sale price to be excellent and the profit, taken in the form of a mortgage by the new purchaser in favour of Universal at ten per cent interest, would return as much money per annum as the fully rented building. At the time of the sale to Guaranty Trust, the deposit from the aborted Mr. Munzel deal in 1981 had been accumulating interest and a settlement was reached whereby Mr. Clapp and Universal would take the $50,000 deposit and the interest would be retained by Mr. Munzel. Messrs. Clapp and Tarantino then settled their outstanding differences and the net amount, after legal expenses, of $14,714 was reported by Mr. Giglio, the accountant, as income in the 1984 corporate return.

In cross-examination, counsel for the respondent put to Mr. Tarantino tax returns of the appellant for the 1978-81 years and he agreed the business of Universal was described as "Mortgage Broker and Real Estate” or “ Broker, Sales, Real Estate" or "Management Consultant and Real Estate Broker”. None of the corporate tax returns for the period 1978-81, inclusive, showed any capital losses or gains. Mr. Tarantino agreed that for the 1981 taxation year the appellant had real estate sales of $649,000 and a cost of sales of $397,750 while rental income was only $31,336. Mr. Tarantino stated that after the sale of 850 Fort Street, Universal had not acquired any additional rental properties. Although the 850 Fort Street property lost $38,000 between December 30, 1980 and August 31, 1981, Mr. Tarantino stated he was prepared to lose even more money until the building could be properly rented to substantial tenants and that when the British Columbia Government became a tenant the previously vacant space would now produce $117,000 in revenue. Mr. Tarantino indicated he did not know why Mr. Clapp sold out when the building was about to be fully rented but he was willing to have Universal out Mr. Clapp's interest so the building could be retained as a long-term investment. He indicated that shortly after buying 850 Fort Street the real estate market declined but it did not particularly concern him. Mr. Clapp would be occupying space along with existing tenants and with the potential for new tenants, following necessary improvements to the building, he was confident the investment was a good one. As for Mr. Clapp's failure to give any indemnification to Mr. Tarantino or Universal to secure any mortgages or operating shortfall, that was never of any concern.

Both counsel submitted several authorities on the subject of capital versus income arising from disposition of a property. There is a vast case literature on the meaning of reasonable expectation of profit and the several hundred reported decisions on the matter of "capital gain” or "ordinary income” must rank a close second in sheer volume. Both topics offer up an extreme difficulty in reconciling the decisions, often inconsistent on their face, but closer examination reveals that, apart from some well-enunciated general principles, the outcome is dependent on a particular set of facts.

A good starting point is the analysis of Noël, J. of the Exchequer Court of Canada (as it then was) in Racine, Demers and Nolin v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098. In that case, three experienced businessmen, known to each other as a result of past dealings, purchased the assets of a bankrupt company. After undertaking certain business procedures designed to improve the enterprise, they operated it for a few months and then sold the real estate and the shares in the newly formed corporation at a profit. In holding the profit was not subject to tax on income, Noël, J. at page 159 (D.T.C. 5103) stated:

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.

In Reeves v. M.N.R., [1985] 2 C.T.C. 2054, 85 D.T.C. 419, Christie, A.C.J. of this Court set forth seven factors to be considered in determining intention at the time of acquisition of the property in question, and, from pages 2058-59 (D.T.C. 421) of the judgment, they are:

1. If the appellant is a corporation, the relevant intentions to be attributed to it are those which the natural person by whom it was managed and controlled had for it: Metropolitan Motels Corp. v. M.N.R., [1966] C.T.C. 246, 66 D.T.C. 5208 per Jackett,

P. (as he then was) at page 247 (D.T.C. 5209).

2. If the appellant entered into a partnership or a syndicate or some other arrangement with others for the purpose of dealing in land and played a passive role leaving it to another to be the active or dominant member, that member's intentions are attributable to the appellant: M.N.R. v. Lane, [1964] C.T.C. 81, 64 D.T.C. 5049 per Noël, J. at page 91 (D.T.C. 5051) and Wiss v. M.N.R., [1972] C.T.C. 264, 72 D.T.C. 6231 per Heald, J. at page 264 (D.T.C. 6231-32). If the appellant is a corporation and the person by whom it is managed and controlled places it in the passive or subservient role described, the intentions to be attributed to the appellant are those of the active or dominant member.

3. The direct evidence of a person who has an interest in the outcome of an appeal regarding the intention behind a transaction or series of transactions is not determinative of the existence of the stated intention. Generally speaking the intention is to be ascertained from the entire course of conduct and relevant circumstances and the inferences flowing therefrom: Gairdner Securities Ltd. v. M.N.R., [1952] C.T.C. 371, 52 D.T.C. 1171 per Cameron, J. at page 381 (D.T.C. 1175) and Racine et al. v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098 per Noël, J. at page 159 (D.T.C. 5103).

4. À consideration of statements in Articles of Incorporation regarding the objects of the corporation or restrictions on the businesses it may carry on is not helpful. What the company did in fact is paramount: Regal Heights Ltd. v. M.N.R., [1960] C.T.C. 384, 60 D.T.C. 1270 per Judson, J. at page 390 (D.T.C. 1272-73); Glacier Realties Ltd. v. The Queen, [1980] C.T.C. 308, 80 D.T.C. 6243 per Addy, J. at page 310 (D.T.C. 6245). The same is true with respect to what may be said in a partnership agreement regarding the nature of the partnership’s business.

5. Evidence of transactions of the sale and purchase of real estate by an appellant after the years under review in an appeal is admissible: Osler Hammond & Nanton Ltd. v. M.N.R., [1963] C.T.C. 164, 63 D.T.C. 1119 per Judson, J. at page 166 (D.T.C. 1120): G.W. Golden Construction Ltd. v. M.N.R., [1967] C.T.C. 111, 67 D.T.C. 5080 per Ritchie, J. at page 114 (D.T.C. 5082) and Fyke v. M.N.R., [1964] C.T.C. 54, 64

D. T.C. 5032 per Cameron, J. at page 56 (D.T.C. 5033). The weight to be assigned to evidence of this kind will depend on the circumstances of particular cases. Evidence of an intended sale and purchase that for some reason was not consummated is also admissible. The comment respecting assignability of weight also applies to evidence of this type.

6. The fact that real estate is not advertised for sale and that an offer which results in a sale and purchase is unsolicited is not preclusive of there having been a primary intention on the part of the appellant at the time of purchasing the property to sell it at any time he regarded it as financially favourable to do so. Lack of advertising and the fact of an unsolicited offer are simply matters to be weighed together with the other relevant evidence: Slater et al. v. M.N.R., [1966] C.T.C. 53, 66 D.T.C. 5047 at page 59 (D.T.C. 5050).

7. If an individual who is an appellant has a history of trading in real estate or if the appellant is a corporation that is controlled by such a person, this is a relevant consideration which points away from the purchase in issue being made with the primary intention of securing an income-producing asset: Vaughan Construction Co. v. M.N.R., [1970] C.T.C. 350, 70 D.T.C. 6268 per Laskin, J. (as he then was) at 353 (D.T.C. 6270) and Slater at page 60 (D.T.C. 5051).

In Grouchy v. Canada, [1990] 1 C.T.C. 375, 90 D.T.C. 6267 Martin, J. of the Federal Court of Canada-Trial Division issued what I interpret as an admonition to the trier of fact not to become so jaded in constantly hearing declarations of intention at time of acquisition that such are to be regarded as merely de rigueur for purposes of litigation. At pages 379-80 (D.T.C. 6271), Martin, J. expressed his views as follows:

Although the taxpayer's expressed intention at the time of the acquisition of the property is not conclusive of that intention it does not have to be completely ignored. Granted that there would be no trial if his intention was not that which he has said it was, but some weight, beyond its mere expression, should be given to it when one finds, as in this case I have found, the taxpayer to be an open, frank and credible witness. Counsel for the defendant did, quite properly, point to inconsistencies in his discovery evidence and his evidence at trial but those inconsistencies were, in my view, Of a relatively insignificant nature and no more than one would expect from an honest witness giving evidence of events and recollections of intentions which occurred years earlier. The plaintiff said, and I believe him, that it was his intention to acquire the townhouses as part of a real estate rental investment portfolio. He said, and once again I believe him, that he had no intention of selling the townhouses at the time they were acquired.

There is no doubt that the intention to be attributed to the appellant is that of Mr. Tarantino and that it is his intention which would dominate with regard to the relationship between the appellant and James Clapp. There is also no doubt the appellant was, from its inception, a company that traded in real estate. However, upon Mr.Tarantino moving to North Saanich at the end of 1979, he began to embark on a change in lifestyle and the direction of Universal began to change as the mortgage business was no longer viable and the inventory of repossessed properties was reduced on an ongoing basis whenever possible. There had been a purchase of a rental property at 1702 Belmont and Mrs. Tarantino had acquired a significant rental property. It was fortuitous that Mr. Clapp, positioned as he was when Mr. Hallatts large law firm disintegrated, was able to bring the purchase of 850 Fort Street to Mr. Tarantino for his consideration. The deal when consummated was clearly based on future potential as a property capable of producing rental revenue and Mr. Tarantino was proved right in his projections when the building was later fully rented to financially secure tenants. In the interim, the offer from Mr. Munzel came out of the blue and was considered by both Messrs. Tarantino and Clapp to be only loosely connected to reality. Again, they were correct as the deal did not close and the purchaser's deposit was forfeited. Later, when queried by others as to whether the building was up for sale, Mr. Tarantino advised that it was not. Universal in buying out Mr. Clapp's 50 per cent interest still hung in for the long term and the rental revenue was secure with re-financing a distinct probability to enable debt servicing costs to be reduced. The sale to Guaranty Trust by the appellant came as a result of an unsolicited offer and Mr. Tarantino, stung once by the hassle involved in the aborted sale to Mr. Munzel, insisted on being informed as to the identity of the interested purchaser so as to gauge the bona fides of the proposal. While the history of trading in real estate by an appellant is relevant, so is a marked departure from the normal practice when the explanation is reasonable and founded on sound business principles in the face of circumstances surrounding the transaction. The appellant, through Mr. Tarantino, did not act like a seller at any time it owned 850 Fort Street. The building was renovated only to make available additional rental space and was repaired, maintained and adapted solely for the purpose of attracting qualified tenants for a long-term lease. The sale of the building to Guaranty Trust for more than $1.75 million was obviously too good to refuse and the resulting take-back of mortgage produced ongoing revenues to the appellant equal to that gained by functioning as an operating landlord.

On all of the evidence, the appellant has demonstrated that the intention at time of acquisition and throughout, until the final acceptance of an unsolicited offer from a major player in Victoria financial circles, was to secure an incomeproducing asset. The actions of the appellant, through Mr. Tarantino, were consistent with that intention.

The appeal is allowed, with costs, and the assessment is referred back to the Minister for reconsideration and reassessment on the basis the gain arising from the disposition of 850 Fort Street, Victoria, British Columbia is to be on account of capital.

Appeal allowed.