Hamlyn, T.C.C.J.:—The appellant purchased a residential unit (the''unit") and in January of 1988 sold the unit and made a profit of $47,292 (the ” profit"). The appellant's 1988 tax return (the "return") did not reflect the profit. In reassessing the appellant's return, the Minister of National Revenue (the"Minister") included the profit in the appellant's income. In addition, the Minister levied penalties (the " penalties”) under subsection 163(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act")..
The appellant filed a notice of objection with respect to the Minister's reassessment. The Minister confirmed his reassessment and the appellant has appealed to this Court. In the notice of appeal, the appellant raises an issue not addressed in the notice of objection. The appellant seeks to have losses incurred in 1988 from the disposition of certain shares (the"shares") classified as trading losses and not a capital loss, even though the losses were claimed as a Capital loss in the return.
Issues
1. Whether the profit was “income from a business", "an adventure in the nature of trade" or a“ apital gain"?
2. Whether penalties levied pursuant to subsection 163(2) of the Act are exigible in these circumstances?
3. Whether the loss realized by the appellant on the disposition of the shares was a“ "capital" loss or a "business" loss?
The Minister's position
In reassessing the appellant, the Minister relied on the following assumptions of fact:
(a) the appellant entered into a joint venture agreement in 1981 for the development of certain property;
(b) the joint venture agreement provided the following, as reproduced in paragraph 10(m) of the reply to notice of appeal:
... it shall be the primary intention of the parties hereto to develop the subject property as a luxurious residential condominium project which will promote owner occupation of the units purchased as opposed to a project which would facilitate the purchase of condominium units as an income property
(c) the joint venture also gave the appellant an option to purchase one residential unit at cost;
(d) the appellant exercised this option and purchased one residential unit on December 31, 1986;
(e) the appellant also purchased a second unit, the unit which forms the subject matter of this appeal on March 10, 1987;
(f) the appellant listed the unit for sale on July 8, 1987 and again on October 1, 1987;
(g) on October 8, 1987, the appellant accepted an offer to purchase the unit; and,
(h) the appellant transferred the unit to the purchaser on January 22, 1988.
It is the Minister's position that the appellant acquired the unit with the intention of reselling it and the profit was "income from a business" or "an adventure in the nature of trade". The Minister also asserts that the appellant knowingly, or in circumstances amounting to gross negligence in the carrying out of a duty or obligation imposed by the Act, made, participated in, assented to or acquiesced to false statements in his return by failing to report the disposition of the unit. With respect to the loss on the shares, the Minister states that the loss amounted to a capital loss as reported in the appellants return.
The appellant's position
It is the appellants position that the joint venture was entered into by Kilmovee Holdings Ltd. ("Kilmovee") of which the appellant owns all the issued and outstanding common shares. The appellant concedes that he acquired two units but that these two units were not acquired as a consequence or an extension of the business activities related to Kilmovee's participation in the joint venture. The appellant alleges that he acquired both units at pre-construction prices which were also available to the general public.
It is the appellant's position that, prior to taking title to the property, he had made arrangements with a management company for the rental of these units. Although one unit was successfully rented, the unit which forms the subject matter of this appeal was empty for almost eight months before it was sold. The appellant contends that the units were acquired as long-term investments for the purpose of generating income.
With respect to the purchase of the shares, it is the appellant's position that he anticipated an increase in the price of the shares within six months of their purchase and that it was his intention to sell them when the price increased. The taxpayer therefore contends that he purchased the shares on the basis of a speculative venture as he had done on three prior occasions in 1979, 1982 and 1984.
With respect to the penalties, the taxpayer contends that he did not knowingly, or in circumstances amounting to gross negligence, fail to report the profit. He claims that he has limited understanding of matters related to income tax and, therefore, he relied on his accountant to prepare his return. It is the appellant's position that the penalties are not warranted in such circumstances.
Jurisprudence
Capital account or income account
The determination of whether an amount is "business income”, "income from an adventure in the nature of trade”, or a “capital gain" is a factual question to be determined in the context of each case. The primary test used in making this determination is set out in California Copper Syndicate Ltd, v. Harris (1904), 5 T.C. 159 (Ex. Ct., Scot.) at page 166:
Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?
M.N.R. v. Taylor, [1956] C.T.C. 189, 56 D.T.C. 1125 at pages 210-12 (D.T.C. 1137-38), discusses the meaning of “adventure in the nature of trade" and states:
. . .. the singleness or isolation of a transaction cannot be a test of whether it was an adventure in the nature of trade.
Nor is it essential to a transaction being an adventure in the nature of trade that an organization be set up to carry it into effect. ... .
And. ... a transaction may be an adventure in the nature of trade even although nothing was done to the subject matter of the transaction to make it saleable. .. . .
And a transaction may be an adventure in the nature of trade although the person entering upon it did so without any intention to sell its subject matter at a profit. The intention to sell the purchased property at a profit is not of itself a test of whether the profit is subject to tax for the intention to make a profit may be just as much the purpose of an investment transaction as of a trading one. Such intention may well be an important factor in determining that a transaction was an adventure in the nature of trade but its presence is not an essential prerequisite to such a determination and its absence does not negative the idea of an adventure in the nature of trade.
And at page 214 (D.T.C. 1139):
... the general rule that the question whether a particular transaction is an adventure in the nature of trade depends on its character and surrounding circumstances and no single criterion can be formulated.
Penalties
Pursuant to subsection 163(2) a penalty assessment is justified if the Minister can establish that the taxpayer" knowingly, or under circumstances amounting to gross negligence . . . has made . . . or acquiesced in the making of, a false statement or omission in a return. . . ." Subsection 163(3) places a strict burden on the Minister to establish the facts justifying the assessment of a penalty assessed either under subsection 163(1) or 163(2). A penalty assessed under 163(2) requires "a mens rea of intent or of recklessness" (Maltais v. Canada, [1991] 2 C.T.C. 2651, 91 D.T.C. 1385 (T.C.C.) at page 2653 (D.T.C. 1387) which has been described in Patricio v. The Queen, [1984] C.T.C. 360, 84 D.T.C. 6413 (F.C.T.D.) at page 365 (D.T.C. 6418), as follows:
Wilful blindness by someone capable of acting in a responsible manner is in my view, in the circumstances of this case, gross negligence. . . .
When the discrepancies are large it becomes difficult to believe that a taxpayer could have inadvertently failed to notice the discrepancy (even when relying more or less completely on an accountant to make out the return). Thus, large discrepancies may often be a compelling feature leading to a finding of gross negligence. However, the discrepancies assessed do not have to be large to constitute gross negligence. A determination of gross negligence is one that is to be made in the light of all the circumstances of the case.
In Udell v. M.N.R., [1969] C.T.C. 704, 70 D.T.C. 6019 (Ex. Ct.), the issue before the Exchequer Court was whether the gross negligence of the appellant's accountant could be attributed to the appellant. It was the Court's opinion that the relevant provision did not contemplate that gross negligence on the part of the appellant's agent, the professional accountant, could be attributable to the appellant. In so holding, the Court stated at pages 713-14 (D.T.C. 6025-26):
Accordingly there remains the question of whether or not subsection 56(2) contemplates that the gross negligence of the appellant's agent, the professional accountant, can be attributed to the appellant. Each of the verbs in the language “ participated in, assented to or acquiesced in” connotes an element of knowledge on the part of the principal and that there must be concurrence of the principal's will to the act or omission of his agent, or a tacit and silent concurrence therein. The other verb used in section 56(2) is “has made". The question, therefore, is whether the ordinary principles of agency would apply, that is, that what one does by an agent, one does by himself, and the principal is liable for the actions of his agent purporting to act in the scope of his authority even though no express command or privity of the principal be proved.
In my view the use of the verb "made" in the context in which it is used also involves a deliberate and intentional consciousness on the part of the principal to the act done which on the facts of this case was lacking in the appellant. He was not privy to the gross negligence of his accountant. This is most certainly a reasonable interpretation.
I take it to be a clear rule of construction that in the imposition of a tax or a duty, and still more of a penalty if there be any fair and reasonable doubt the Statute is to be construed so as to give the party sought to be charged the benefit of the doubt.
Share acquisition and disposition
The issue of whether a loss on the disposition of shares is a "capital loss" or “business loss" is based in large measure on the conduct of the taxpayer. In Admiral Investments Ltd, v. M.N.R., [1967] C.T.C. 165, 67 D.T.C. 5114 (Ex. Ct.), the Court stated at page 175 (D.T.C. 5120-21):
While shares may be the subject matter of investment, they are equally susceptible of being the subject matter of trade. Whether they fall into one category or the other, is dependent upon the particular facts of the case. . . .
What must be looked at is what was done by the appellant with a view to asking the question in Lord President Clyde's words in C.I.R. v. Livingston, 11 T.C. 538 at page 542:
. . .. whether the operations involved (in the transactions of the company) are of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made.
In Irrigation Industries Ltd. v. M.N.R., [1962] S.C.R. 346, [1962] C.T.C. 215, 62 D.T.C. 1131, a leading decision, where the appellant, a more or less inactive company, purchased shares in a new mining company using borrowed money. The shares were sold within a short period of their acquisition at a substantial gain. The Exchequer Court ([1960] C.T.C. 329, 60 D.T.C. 1232) held that the amount was not in the "nature of a profit from investment”.
In Wellington Hotel Holdings Ltd. v. M.N.R., [1973] C.T.C. 473, 73 D.T.C. 5391 (F.C.T.D.) at page 482 (D.T.C. 5397), Mr. Justice Urie discussed Mr. Justice Martland's decision in Irrigation Industries, supra:
In the Irrigation Industries case, supra, the appellant had been largely inactive whereas in this instance the appellant was actively engaged in the hotel and restaurant business and also in the purchase and sale of securities. While the two businesses are not related I do not think that that fact in itself precludes the possibility of the appellant engaging in a business other than its main business. On this basis, therefore, I do not understand Martland, J. to have rejected the possibility that a company can engage in the business of trading in securities notwithstanding that it is not its main business and it is not a securities broker in the accepted sense.
In fact, Martland, J. in writing the judgment for the Supreme Court of Canada in a later case, N.R. Whittal v. M.N.R., [1967] C.T.C. 377, 67 D.T.C. 5264, concluded that the appellant in that case in the acquisition of the securities in question was endeavouring to make a profit from a trade or business, at all material times and, therefore, profits derived from sales were taxable. He found that the exchanges of securities were not a substitution of one form of investment for another. While he did not distinguish his judgment in the Irrigation Industries case, supra, he referred to it in the Whittal case, supra, and by implication I think it must be taken that he agrees that in a given set of circumstances persons or corporations not solely in the securities business who deal in corporate shares can be engaged in an adventure in the nature of a trade within the meaning of paragraph 139(1)(e) of the Income Tax Act. Such being the case, therefore, profits acquired from such trading would be taxable in the hands of the persons or corporations dealing in such shares and, of course, losses incurred would be deductible in computing their taxable income.
Mr. ustice Urie held that the taxpayer's conduct suggested that he was in the business of buying and selling securities to make a profit. In coming to the conclusion that the taxpayer could write off losses resulting from the security acquisition, Mr. Justice Urie, at page 482 (D.T.C. 5398), considered the following factors to be of significance: "the securities bought and sold were speculative in nature, were non-income-producing, were held for relatively short periods of time and formed a substantial portion of the total business of the appellant”.
Significant facts
Real estate transaction
The appellant, a practising medical doctor, placed his investment funds in various types of financial transactions including real estate and securities.
In May 1981, Kilmovee held a 10 per cent interest in a proposed condominium development to be located at 600 Talbot Street, London, Ontario.
All the issued shares of Kilmovee were held by the appellant. In 1985, after some delay the condominium units were marketed by way of reservation agreement at preconstruction prices. Initially, to encourage sales, the appellant acquired two units. One unit was transferred to the appellant in January 1987 (unit 808) and the other unit was transferred in March 1987 (unit 505).
The appellant retained Advance Property Management Consultants Inc. to lease out units 808 and 505. Unit 808 was leased and continues to be leased by the appellant to tenants.
As for unit 505, Advance Management Consultants Inc. were unable to lease this property. Advance Management Consultants Inc. presented several difficulties to the appellant in terms of their management performance. Other owners of the project had similar problems with Advance Management Consultants Inc. in securing tenants. The appellant's problem was attributed to poor communication between Advance Management Consultants Inc. and a weak rental market. As a consequence, unit 505 was listed for sale in September 1987 and was sold shortly thereafter.
The taxpayer maintained the original acquisition of unit 505 was to be a long term investment and only the events that occurred frustrated this intent.
Specifically, the appellant stated he was committed to buy unit 505 at least one year before completing the transaction. He had hoped that Advanced Property Management Consultants Inc. would look after all aspects of the property management. However, through the course of time the management company did not respond to the appellant's requirements and withheld moneys from the appellant. As stated, these difficulties and the soft rental market led him to the conclusion to sell the property.
At this time he also changed accountants who prepared his annual tax return.
The new accountant was represented to him by associates as being able to more than adequately meet the appellant's tax return needs.
Taxpayer's reporting practices
The appellant's method of keeping records was explored at length. Through each financial year the appellant had a box that was maintained by his secretary who filed various financial matters in the box. At tax return preparation time the secretary sent the box to the accountant. The accountant prepared the return, the appellant examined the return briefly, signed it and filed same with Revenue Canada. The appellant stated he knew approximately what he should submit by way of tax remittance and if it was within his parameters that was the end of his tax return inquiry.
When the accountant completed the 1987 tax return he attended at the appellants office, saw him in between patients. The date was May 1, 1988, the appellant saw the accountant for ten minutes; quickly looked at the form; inquired as to the amount of tax to be paid, signed it and then went on with his medical practice.
The accountant did not include the transaction in relation to unit 505 in the return. The appellant did not inquire as to its inclusion as he believed he had a “capital exemption" in relation to the disposition. However, he believed the transaction was included in the return. He said in relation to the particular taxation year he had some early discussion with the accountant about the property sale. Communications thereafter from Revenue Canada about the transaction went unheeded by the appellant in that he simply did not read them carefully and sent them on to his accountant who also apparently did not address the issue. Eventually, he changed accountants who inquired and found the reassessment was a“ fait accompli" and nothing further could be done at that time.
The appellant's knowledge about income tax matters was not without some sophistication; he was aware of certain tax shelters, he was also aware of medical practitioners’ filing requirements and he demonstrated some knowledge about the intricacies of capital income as opposed to business income.
His reliance on his retained accountant within his reporting system appeared to be total without any concern save the bottom line of what he had to pay.
Securities transactions
The taxpayer engaged in speculative trading of securities in the past. In 1979, 1982 and 1984 he realized losses in speculative trading and reported same in the respective tax returns. In 1988, he realized a loss on the sale of securities but did not report the loss as a trading loss but rather as a capital loss.
The appellant stated his brother, who is a dentist in Ireland, called him with a stock tip that was allegedly based on insider information. The brother asked the appellant to make a purchase on his behalf. The security was listed on the Vancouver Stock Exchange. The appellant did purchase securities on his brother’s behalf and as well on his own behalf.
The securities were stated to be common shares of Nor-Quest Resources that ended in a disposition loss of $38,941.58 from the respective purchases and sale on behalf of the appellant.
Analysis
Real estate transaction
The appellant's property acquisition intention was distinct and separate from Kilmovee. The taxpayer's stated intention in the acquisition of unit 505 was to hold the unit and to rent it out. However, frustration and lack of communication with the rental management firm as well as the failure after some period of time to find a tenant caused him to change his intention to hold.
It would appear at the inception of the project that the rental market was firm giving the aura of feasibility to the project.
The appellant is a medical doctor and as such the acquisition of the unit was not related to his ordinary course of business although closely linked with his corporation that was part of the development of the condominium project.
The overall assessment of the facts does not provide a pattern of conduct that would lead to the conclusion the appellant was dealing in real estate acquired by him in the same way a dealer of real estate would have done in the Ordinary course of business. Moreover, with the stated intention that the property was acquired for investment purposes and the unit was to be held for the yield that the rentals should produce is supported by the evidence. The change in intention was as a result of changed circumstances not foreseen by the appellant at the time of acquisition. As such, this Court concludes the appellant's profit with respect to unit 505 was not income from a business nor was the transaction an adventure in the nature of trade.
Penalties
In terms of penalties the Minister relied on the evidence as presented by the appellant. In this case the appellant has relied on his accountant. The accountant had been recommended to him by others. The appellant thought the unit proceeds were reported as he had some discussions with his accountant about the matter well prior to the tax return preparation. The appellant's system was to rely on his secretary to convey to the accountant all the business material that he (the appellant) had filed with the secretary. The appellant reviewed the tax return quickly and in view of his previous conclusion that no tax would be payable for the transaction in question he was satisfied, signed the return and went back to his patients. His failure to review the communications from Revenue Canada and simply forward them to the accountant was less than being careful. However, in view of the appellant's belief that the matter was included in the return and that if it had been reported in the return it would unlikely attract tax, his lack of care and lack of review was not gross negligence.
Securities transactions
For three prior tax years the appellant reported his securities transactions and claimed the incurred losses as trading losses. It would appear this transaction was similar to his other transactions, that is, speculative, held for a short period of time and held without any apparent hope of a yield from the securities in terms of dividends. The intention was to acquire and hold for a brief period and then sell. The taxpayer indicated originally in the early year returns, he had some qualms about claiming such losses as trading losses, however, he continued to do so and such filing was accepted by Revenue Canada. In view of the nature of the securities and the taxpayer's transaction conduct, this Court concludes the loss on the disposition of shares was a trading loss, that is, a business loss.
Decision
The appeal is allowed and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the net profit from the sale of unit 505, 600 Talbot Street, London, Ontario, was a capital gain and that the appellant's failure to report the capital gain from the disposition of the capital property was not gross negligence. Therefore penalties are not exigible. And further, the loss realized by the appellant on the disposition of the common shares of Nor-Quest Resources was a business loss. The appellant is entitled to his taxed costs.
Appeal allowed.
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