Laurent J. Deshaies Inc. v. Minister of National Revenue, [1993] 1 CTC 2687, 93 DTC 867

Tremblay, T.C.C.J.:—This appeal was heard on September 16, 17 and 25, 1992, in Quebec City, Quebec.

7. Point at issue

According to the notice of appeal and the reply to the notice of appeal, the point for determination is whether the appellant was entitled, in computing his income for 1985 and 1986, to consider as capital gains the profits of $276,592 and $768,880 respectively, resulting from the sale of three apartment buildings which it owned in the Trois-Rivières area.

According to the appellant, these buildings owned by it since 1970 were built in order to be held as investments. The capital cost allowance was apparently always taken, and more than some 20 offers to purchase had apparently been rejected.

The difficult real estate market in 1985 and 1986 and increasing repairs to these buildings led the appellant to sell them.

According to the respondent, from 1968 to 1970, the appellant proceeded with the construction of 20 apartment buildings which were subsequently sold. It also built and sold numerous single-family houses and duplexes.

In 1981 and 1982, the appellant also allegedly built two buildings of 32 apartments each which it allegedly sold in the year of construction. According to the respondent, profits from the sale of the buildings in issue constituted business income.

2. Burden of proof

2.01 The burden is on the appellant to show that the respondent's assessments are incorrect. This burden of proof arises from a number of judicial decisions including the judgment of the Supreme Court of Canada in Johnston v. M.N.R., [1948] S.C.R. 486, [1948] C.T.C. 195, 3 D.T.C. 1182.

2.02 The facts assumed by the respondent in the instant case are described in subparagraphs (a) to (p) of paragraph 18 of the reply to the notice of appeal. They read as follows:

18. In assessing the appellant as he did for the 1985 and 1986 taxation years, the Minister of National Revenue relied, inter alia, on the following facts:

(a) during the 1985 and 1986 taxation years, the appellant operated a business in the areas of residential building construction and sales;

(b) between 1968 and 1970, the appellant purchased a number of lots in order to construct apartment buildings, which were subsequently sold;

(c) between 1968 and 1971, the appellant proceeded with the construction of 20 apartment buildings, which were sold over the years;

(d) as regards the taxation years prior to those in issue, that is for the years 1969 to 1984, the appellant always considered the apartment buildings that it owned as being in inventory and even declared the profits realized on apartment building sales during 1973 and 1974 as business income;

(e) prior to 1978, the appellant also participated in the construction and sale of numerous single-family houses and duplexes;

(f) from 1968 to 1979, the appellant sold 16 apartment buildings which it had built, the whole as indicated in Table A appended to and forming an integral part of this reply;

(g) during the 1978 taxation year, the appellant disposed of two buildings, that is those identified at the following addresses:

110, 120, 130 rue Sirois, Trois-Rivières (24 apartments) 140, 150 rue Sirois, Trois-Rivières (16 apartments)

(h) during the 1979 taxation year, the appellant disposed of a 24-apartment building known and designated as being located at 4405 to 4425 chemin Ste- Marguerite, in Trois-Rivières;

(i) the transactions conducted during the 1978 and 1979 taxation years do not constitute isolated transactions;

(j) this Honourable Court has even determined that the profits realized in 1978 and 1979 constituted business income for the appellant;

(k) the appellant also built two other apartment buildings, that is those located at 5720 to 5750 rue Marion in Trois-Rivières Ouest and at 1055 to 1085 côte Richelieu, also in Trois-Rivières Ouest, which it sold during the year of their construction, that is in 1981 for the building on rue Marion and 1982 for that located on côte Richelieu;

(l) during the 1985 taxation year, the appellant disposed of a 24-apartment building, that is the building located at 195-215 rue Garceau, and realized the following profit from that disposition:

	195-215 Garceau
Selling price	$450,000
Less cost	$191,936
Profit on sale	$258,064

(m) during the 1986 taxation year, the appellant disposed of two buildings, that is one 24-apartment building located at 170-190 rue Sirois and one 32-apartment building located at 200-230 rue Sirois, and realized the following profits from those dispositions:

	170-190 Sirois	200-230 Sirois	TOTAL
Selling price	$500,000	$675,000	$1,175,000
Less: Cost	$175,798	$230,322	$ 406,120
Profit
on sale	$324,202	$444,678	$768 ,880

(n) when the appellant began construction of the apartment buildings sold during 1985 and 1986, it was with the primary, or at least secondary, intention of selling at a profit the said buildings when completed;

(o) during the construction of its apartment buildings, that is during the 1968 and 1971 taxation years, the appellant's primary objective was to act as a contractor in the construction of apartment buildings and to sell the buildings thus built;

(p) all the profits realized by the appellant on the sale of the buildings in question during the 1985 and 1986 taxation years constituted business income for the appellant and should have been reported as such in its income for each of those years.

TABLE A [Exhibit 1-2] Schedule 2 [not reproduced]

[Translation.]

3. Facts

3.01 On May 1, 1989, the undersigned delivered a judgment [85-68(IT)] between the same parties, but concerning the buildings sold in 1978 and 1979 and also built in the Trois-Rivières area in 1970-1971.

The facts then assumed by the respondent were mutatis mutandis the same as those alleged in the instant appeal. A large portion of the facts adduced in evidence in the instant case are similar to those presented in 85-68(IT).

Furthermore, I will use the description of the facts in that judgment for the instant case.

3.02 The appellant’s main witness, Mr. Laurent Deshaies, testified as follows.

3.02.1 Born in 1934 and having a father who was in the general construction business in Trois-Rivières, Quebec, the witness began to work with him at an early age. He left school at 14 years of age. After his father's death in 1956, the witness continued his business, specializing in masonry, then went into the construction of small ten-apartment buildings for the purpose of reselling them.

3.02.2 The appellant company was formed in 1966. The witness owned 98 per cent of the shares. The letters patent (Exhibit 1-7) provided, inter alia, the power “to carry on the business of general builders and contractors and also. . .in general, to deal in. . .all types of building materials” [translation]. There were also plans to operate quarries. According to Mr. Deshaies, those plans were abandoned.

At the first page of its T-2 returns for the 1970 to 1977 taxation years, the appellant declared at the item "Type of Business" that it was a "general contractor" [translation] or "building contractor" [translation].

From 1978, 1979, 1980 and 1981, one may read the following:

“Building construction and leasing of buildings.”

[Translation.]

3.02.3 The appellant continued building small ten-apartment buildings. It then cut down to eight apartments. Subsequently, around 1969, it also built 16- and 24-apartment buildings, as well as another building with 32 apartments. Until 1971, in fact, it built 12 eight-apartment buildings, two 16-apartment buildings, five 24-apartment buildings and one 32-apartment building. In 1970-1971, it built street numbers 165-175 (no. 14 in the respondent's Table A cited in paragraph 2.02) on rue Garceau in Trois-Rivières (T.-R.). This was the first that was sold, that is in 1974. After 1971, the appellant stopped constructing this type of building, since demand for it had considerably declined.

3.02.4 In 1972, the appellant decided to turn to the construction of singlefamily houses in order to resell them. To this end, it purchased a large tract of land. In 1987, the appellant was still building single-family houses. From 1978 to 1982, because of difficulties in selling, it had to lease roughly ten single-family houses and seven or eight duplexes while waiting for the right time to sell them.

3.02.5 In 1981 and 1982, after purchasing a lot from the appellant, the witness had the latter build two 32-apartment buildings at the cost price plus ten per cent. By also invoking the benefits of class 31 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act"), he wanted to provide himself with some security, a pension fund. These two buildings [the first on rue Marion (T.-R.), the other on côte Richelieu (T.-R.)] appear at numbers 20 and 21 of the respondent's Table A cited at the end of paragraph 2.02. Two loan certificates were issued by the Central Mortgage and Housing Corporation in the witness's personal name with respect to those lots. They were dated March 13, 1981 and October 16, 1981. The agreements were reached between the appellant and Mr. Deshaies. The minutes of the directors' meeting on this matter were issued. According to Mr. Deshaies, these two buildings which he had the appellant built were intended to provide him with some personal security.

3.02.6 The witness showed that 16-apartment buildings are more profitable than two eight-apartment buildings. The construction cost of 4 /2 rooms is lower because it is enough to build one concrete wall between two eightapartment buildings instead of two walls with insulation. In addition, a single furnace room suffices. The same is true for a 24-apartment building. This is in fact three eight-apartment buildings built together: “You save four insulated walls with two block walls. . .” etc. [translation] He also built one 32-apartment building.

3.02.7 When the appellant began constructing the 16-, 24- and 32-apartment buildings, the idea was “to keep them for security later” [translation]. The equity accumulating over the years constituted a basic asset for the purpose of obtaining credit from financial institutions. Furthermore, "you also have the benefit of taking advantage of inflation . . ." [translation]. The value of the property increased by two per cent, then three per cent and now four per cent per year.

3.02.8 During the period when it constructed its buildings, the appellant had no trouble renting the apartments. People even reserved apartments before construction was complete. The business was administered by the witness himself and by his relatives (his wife, his brothers, etc.).

3.02.9 The buildings here in issue were never listed for sale. The appellant never needed real estate agents. The latter telephoned him or visited him, as did investors, in order to determine whether the buildings were for sale. Five witnesses confirmed the appellant's remarks:

1. Mr. Pierre Bellemare, real estate broker since 1983 and real estate agent since 1973;

2. Mr. André Caron, real estate broker since 1990 and real estate agent since 1983;

3. Mr. Jules Lambert, real estate agent since 1983;

4. Mr. Yvan St-Pierre, real estate agent since 1982;

5. Mr. Jacques Roy, real estate agent since 1980.

It appeared from the testimony of the first four witnesses that the appellant was approached concerning the buildings in issue between 20 and 25 times. Some had already done so in 1973. According to Mr. Deshaies, other agents also came: Rénald Laquerre, Georges Vourvoulakis, Georges Ferland and others.

The answer in the witnesses' interviews with Mr. Deshaies was always the same, polite, but brief: "They are not for sale” [translation]. Some had mandates from clients, others did not. All the witnesses also explained that, since the said buildings were located opposite the Trois-Rivières Ouest shopping centre, they were in a location which ensured a higher apartment occupancy rate and which commanded higher rents. Mr. Deshaies was also known as a competent and conscientious builder. His buildings were therefore sought after.

Regarding the climate that existed at one time during this period of 1984, 1985 and 1986, Mr. Bellemare said “It was mainly the offers to purchase that were selling, not the buildings; it was a flip-flop market" [translation]. According to the same witness, the price of $20,000 to $22,000 paid per apartment in the buildings in issue was not high. According to him, the price at the time was $30,000 to $32,000 per apartment.

3.03 In 1984, the offer of the real estate agent Jacques Roy, who worked* exclusively for Mr. Yvon Forcier, then a Trois-Rivières businessman owning 600 to 700 apartments, nevertheless received Mr. Deshaies' consent for the sale of the rue Garceau building. Following a first refusal in the summer of 1984, he returned two or three times in the fall of 1984. He based his offer on the terms and conditions of purchase; he especially wanted to secure the increase in value of the building because of its geographical location and expected that interest rates would decline.

One of the factors that led Mr. Deshaies to sell and to accept Mr. Roy's proposal was the administration of 200 apartments, which he had had to do virtually alone since his caretaker had left in 1983: telephone calls at all hours, weekends, Régie des loyers, only free time with his family on Sunday evenings.

Another factor was the increase in maintenance expenses from $5,403 in 1981 to $24,450 in 1982, $40,251 in 1983, $26,962 in 1984 and $31,000 in 1985.

In addition, in 1984 and 1985, the vacancy rate in Trois-Rivières area apartment buildings stood at more than 20 per cent. Lastly, the net income from the buildings fell from $20,000 in 1983 to $7,000 in 1984 and to nil in 1985. It was preferable to sell and to invest the money at rates of 13 /4 per cent to 16 per cent.

3.04 Mr. Gilles Hamel, bookkeeper for the appellant and seven or eight other corporations of Mr. Deshaies, testified that he had worked for Mr. Gravel, a chartered accountant, from 1970 to 1975. In that capacity, he had been responsible for keeping the appellant's books. He began working for the appellant around 1976. He is still its employee.

3.05 Referring to the capital assets table in the balance sheet of the appellant's 1978 financial statements (pp. 2,11 and 12, Exhibit A-7), Mr. Hamel emphasized that the total cost of the multiple-unit buildings was $784,481. This figure concerned four buildings, including the three in issue, plus one of 24 apartments on rue Ste-Marguerite (no. 10 in Table A cited above, 2.02). The cost of the buildings was $751,737, that of the buildings in issue alone $573,313. Accumulated depreciation for the four buildings was $16,577 at December 31, 1977, and depreciation for 1978 was $18,794.

Exhibit A-4 which is "account 12 having become 113 of the ledger for the balance sheet" [translation] is entitled “Inventory of Houses for Sale — Apartments" [translation]. The balance at December 31, 1978 was $784,480.90 (that is $1,100,445.56 x $315,964.66), which is equivalent to the figure of $784,481 of Exhibit A-7 cited above in this paragraph.

3.06 According to Mr. Hamel, this title "Inventory of Houses for Sale — Apartments" [translation] was not at all representative of the economic reality. It was simply for bookkeeping purposes. It was an internal account. "Each accountant has his method" [translation], he said. Never had Mr. Deshaies or any other person told him that these were houses for sale. Mr. Deshaies himself testified that he had seen this "account 12 having become 113” [translation] for the first time approximately two months before the hearing of the instant appeal. From 1976 to 1986, this account contained only six entries, one of which was for $0.63.

It appears from the financial statements from 1971 to 1978 (Exhibit I-3) that depreciation was always taken on all the buildings, even if they were all recorded in the inventory. It was in 1978, following a meeting between Mr. Gravel, chartered accountant, and Mr. Deshaies, that a distinction was drawn between the buildings in inventory and the buildings included as capital property.

The witness Hamel said that he had been present at the time when Mr. Gravel questioned Mr. Deshaies concerning the buildings in issue. The latter said that he wanted to keep them.

Following this meeting and the determination of the buildings in issue as capital property in the 1978 financial statements, these two received the shareholders' approval at the meeting held on April 13, 1979 (Exhibit A-19). Mr. Hamel was also present when the real estate agent Rénald Laquerre came to ask Mr. Deshaies for a mandate concerning the buildings in issue. The answer was negative.

3.07 Mr. Hamel also showed on the basis of the financial statements from 1982 to 1985 that the item "Maintenance and Repairs" [translation] in the financial statements had constantly increased:

Furthermore, this item had been $7,920 in 1977 and $2,132 in 1978.

3.08 As Exhibit A-13, Mr. Hamel filed a list of not-sufficient-funds cheques received from tenants during the following years:

Collections were difficult, and tenants often moved or disappeared during the night, leaving apartments to be cleaned and repainted. The competition was tough; tenants preferred new apartments. In addition, they were even given free months rent.

3.09 On the one hand, the appellant's gross revenues for the years 1983 to 1986 appeared as follows:

* disposal of investments

[Translation.]

On the other hand, net rental profits (losses) for the same years appear as follows in the same financial statements:

3.10 On the balance sheet at December 31, 1984, in addition to the multipleunit buildings, the building cost of which was $1,218,130, the appellants capital assets included "Lot — Boulevard Jean XXIII" [translation], cost $134,000 (Exhibits 1-3, no. 15, page 9 and A-9, page 9). As Exhibit l-6, the respondent filed an excerpt from the August 4, 1984 issue of the newspaper Les Affaires, containing the following advertisement:

COMMERCIAL AND INDUSTRIAL LOTS

In Trois-Rivières Ouest, Boul. Jean XXIII,

intersections of Highways 55, 755, 40,

near bridge, 625 feet of frontage (1,200,000 sq. ft.)

Laurent J. Deshaies

(819) 374-7914

(819) 374-1386

[Translation.]

This advertisement appeared for six months starting on August 4, 1984.

Exhibit 1-5 shows the contract dated September 21, 1984, under which the appellant purchased the land adjacent to Boulevard Jean XXIII from Mr. Gilles Gagnon for the price of $268,000 “ payable bY the purchaser to the vendor out of the transactions which the purchaser will conduct on the building subject hereto, its purpose — being to sever this land and sell it in lots” [translation].

According to the respondent, the profits on the sale of those lots were declared as capital gains. According to Mr. Hamel, the broker involved in the sale was the principal purchaser.

3.11 As Exhibit 1-1, the respondent filed a table of profits on sales for 1985 and 1986, also including that of Boulevard Jean XXIII:

3.12 The respondent also filed as Exhibit 1-9 an itemized account of the appellant's rental income from 1971 to 1986, except for the years 1982 and 1983. During the investigation, the rental income for the single-family houses was added, that is $32,224 for 1984 and $5,585 for 1985. For those years, the profits should therefore read $39,282 in 1984 instead of $7,058 and $5,585 in 1985 instead of nil.

[Chart not reproduced.]

3.13 The respondent also filed a table of mortgage loans with respect to the buildings in issue as Exhibit 1-10:

[Chart not reproduced.]

3.14 Mr. Deshaies explained that, in 1983, 1984 and 1985, there were not only rental vacancies of 20 to 25 per cent, but also increasing repairs. Plumbing, heating, porches, roof, everything was replaced in the buildings in issue before they were sold in 1985 and 1986.

3.15 To a letter addressed to the respondent by counsel for the appellant on September 13, 1989 concerning the basis of the assessment (Exhibit A-15), Mr. Jean-Francois Lupien of the Audit Directorate answered as follows on October 4,1989:

Dear Sir,

In response to your letter of September 13 last, we hereby inform you of our conclusions which have resulted from the analysis of your representations.

1.0 Property on rue Plouffe:

1.1 Upon examination of the additional information submitted, we accept your position that the building could have been held as an investment. The principal points which altered our conclusions are as follows:

(a) "forced" purchase following the bankruptcy of the creditor whose company was the endorser;

(b) this transaction was not consistent with the corporation's normal activities, that is construction and sales; it was an isolated transaction.

The profit derived from the sale of this building therefore remains a capital gain.

2.0 Other income properties sold in 1985 and 1986 on rues Sirois and Garceau:

2.1 According to your representations, there was a change of intention concerning the destiny of these buildings. Following an on-the-spot examination of various books and records kept by the corporation, the following two factors support our position that the buildings were still in inventory at the time of their sale:

(a) no resolution of the directors or additional letters patent were obtained by the corporation to authorize the latter to hold those assets as investments. The objects of the corporation therefore did not change and are still to sell assets at the proper time;

(b) the accounting for these buildings in the ledger is done in account no. 113, which bears the title "Inventory of Houses for Sale — Apartments". Since no change was made during the period of possession, the buildings were still in inventory at the time of their disposal.

2.2 The capital cost allowance claimed by the corporation was also analyzed. To answer your statement in paragraph 2.3 of your letter, we refer you to Canadian Kodak Sales Ltd. v. M.N.R., [1954] C.T.C. 375, 54 D.T.C. 1194, in which Judge Thorson stated that the fact the capital cost allowance is claimed in no way influences the fact the profit is considered as business income.

2.3 We were unable to verify factually the nature of the offers to purchase which the corporation received and rejected since, according to the principal shareholder, most of them were made orally. On the other hand, Judge Cardin concluded in Palnick and Rosenfeld v. M.N.R., [1985] 1 C.T.C. 2011, 85 D.T.C. 109 (T.C.C.) by stating that the fact that offers to purchase are rejected must not supplant the initial intention to resell eventually the asset.

2.4 The absence of positive steps, such as advertising and retaining the services of brokers, may be explained in our view by two reasons which are independent of the nature of the buildings sold:

(a) since the multiple-unit building market was at its lowest from 1970 to 1985, it was pointless to take steps to sell unless forced to do so, which was not the case of the corporation;

(b) the buildings are located near the area which the corporation is to develop. They therefore benefit indirectly from the advertising done for the surrounding houses, thus obviating the need for direct advertising.

2.5.0 During our meeting and in item 2.6 of our [sic] letter, you submitted to us various points which might have forced the corporation to sell the buildings at the time. We restate them here, one by one, in order to analyze them in greater detail. 2.5.1 The major repairs done starting in 1981 were all included in the corporation’s operating expenses. We found no major capital item that could lead us to believe that the asset would be held over a long term. The repairs made only returned the asset to its initial condition. The corporation therefore merely maintained the buildings while waiting to sell them at the time it thought right.

2.5.2 As regards the investment's loss of profitability which you alleged, we conducted an analysis of gross and net rental incomes from 1981 to 1988. It appears from this analysis that the" rental" section shows profits until 1985 (year of the first disposal). It shows losses thereafter until 1988. The analysis therefore reveals that the buildings nevertheless had good profitability and that the corporation has been losing money in this area of activity since they were sold. Another detail was also observed. The value of the assets increased 264 per cent during the holding period. This increase was never reflected in your profitability analysis.

2.5.3 The other factors raised, that is the loss of the caretaker, vacancy rate, high turnover, etc., were also examined. We do not believe they constituted the main reasons for a corporation to dispose of profitable assets at the start of an economic recovery. Furthermore, the corporation and its principal shareholder owned other buildings which were facing the same rental problems. Nevertheless, they were not sold.

2.6 On the subject of the long holding period, we have analyzed the case law to determine the position of the bench with regard to the tax treatment of profits on disposition. The judges were unanimous in all the cases examined (see Schedule I: 8 cases). When the disposition occurs in the normal course of a corporation's business, the profits must be declared as business income. The fact that the holding period is long is secondary when the normal business of a taxpayer is the purchase of land, development, construction, leasing and sales. In fact, all these operations are indissociable stages in the very nature of the business.

Still in the cases examined, buildings were held for periods of up to 21 years, and the judges nevertheless found that the profit from the dispositions constituted business income, given the normal activities of the corporations and/or of their shareholders and directors.

2.7 In conclusion, based on our analysis of the facts, we maintain our position as set out in the draft reassessment submitted on July 17 last, that is that the profit on the sale of the buildings located on rues Garceau and Sirois must be considered as business income for the corporation Laurent J. Deshaies Inc.

We regret that we cannot grant your application in whole, and we remain at your disposal for any further information you may require.

Schedule I

Case Law Examined (ref. paragraph 2.6)

1. The Queen v. Edmund Peachey Ltd., [1978] C.T.C. 606, 78 D.T.C. 6411

2. Diamond Developments Ltd. v. M.N.R., [1984] C.T.C. 2992, 84 D.T.C. 1811

3. F.J. Lamb Farming Ltd. v. M.N.R., [1985] 2 C.T.C. 2320, 85 D.T.C. 606

4. Harry C. Palnick and Dr. Hirsh Rosenfeld v. M.N.R., [1985] 1 C.T.C. 2011, 85 D.T.C. 109

5. Leaside Realty Co. v. M.N.R., [1986] 1 C.T.C. 2024, 86 D.T.C. 1020

6. Regina Shoppers Mall Ltd. v. M.N.R., [1984] C.T.C. 2091, 84 D.T.C. 1081

7. Harmony Investment Ltd. v. M.N.R., [1965] C.T.C. 14, 65 D.T.C. 5009

8. Canadian Kodak Sales Ltd. v. M.N.R., [1954] C.T.C. 375, 54 D.T.C. 1194

[Translation.]

3.16 The following resolution was passed unanimously at a meeting of the appellant's directors on March 15, 1968:

Whereas the company wishes to act as a general contractor in the construction of apartment buildings and to sell the buildings thus built;

Whereas, furthermore, the company’s solvency is not sufficient to negotiate the loans required for this purpose, and whereas the personal solvency of Mr. Laurent J. Deshaies is sufficient to obtain easily the necessary financing to realize the projects; on a duly seconded motion, it is unanimously resolved to authorize Mr. Laurent J. Deshaies to:

(a) purchase the lots necessary for the execution of the projects;

(b) negotiate the necessary loans in his name;

(c) perform the necessary work;

(d) conduct the sales transactions at the appropriate time.

As a consequence of the fact that all these transactions are ultimately for the company, the company shall reimburse Mr. L.J. Deshaies for all outlays which he makes, and Mr. L.J. Deshaies shall remit the total selling price to the company. In other words, it is agreed that all profit shall belong to the company, which shall furthermore absorb any possible losses.

[Translation.]

During his testimony, Mr. Deshaies affirmed that this resolution had been prepared by a notary. Its purpose was to preserve the appellant’s solvency, while using his own, by naming him intermediary in the purchases of lands or other assets. He contended, however, that that resolution was never put into application. The appellant always purchased the assets acquired directly without going through him.

On the matter of solvency, he admitted that he had already personally endorsed a loan of the appellant at the bank.

4. Law — case law — analysis

4.01 Law

The sections of the Income Tax Act (the "Act") involved in an appeal of this kind, in which the point at issue is whether the profit is of a capital or business nature, are the general sections 3, 9 and subsection 248(1).

4.02 Case Law

The case law referred to by the parties is substantially the same as that cited in the previous case bearing the number 85-68(IT). In addition, the following cases were cited:

1. Makoi Holdings Ltd. et al. v. M.N.R., [1985] 2 C.T.C. 2023, 85 D.T.C. 372 (T.C.C.);

2. Couillard Estate et al. v. M.N.R., [1981] C.T.C. 2716, 81 D.T.C. 669 (T.R.B.).

4.03 Analysis

In the case which the undersigned heard between the same parties, judgment which was delivered on May 1, 1989 [file no. 85-768], the Court found that the profit on the sale of three buildings in 1978 and 1979 was business income. Of those three buildings, one of 16 apartments and one of 24 apartments (nos. 16 and 17 of Exhibit A-1) were located on rue Sirois and one of 24 apartments (No. 10 of Exhibit A-1) on chemin Ste-Marguerite, in Trois-Rivières Ouest.

In the instant case, substantially the same arguments and the same well- known tests were raised:

1. the taxpayer's intention at the time of purchase; the objects of the corporation if the taxpayer is a corporation;

2. the relation between the transaction and the taxpayer's business;

3. the nature of the transaction and the assets which it concerns;

4. the number and repetition of the transactions;

5. the duration of the holding of the asset;

6. the circumstances surrounding the sale.

The Court will therefore refer in a general way to the analysis of the previous case.

However, the appellant put forward new arguments and suggested that the facts of the buildings in issue in the instant case included specific factors in its favour.

4.03.1 Length of holding of the asset

The asset holding periods of 14 and 15 years unquestionably play in the appellant's favour. However, this test alone cannot be conclusive. Consequently, the other tests must be considered.

4.03.2 Objects of the appellant and resolution of March 15, 1968

As regards the appellant's objects, the conclusion which I previously reached (4.03.2(1) of the said judgment) still prevails, that is that there is nothing in its objects providing for the sale of real estate.

Furthermore, it is the activity carried on by the appellant which is important. The Court cannot ignore the some 20 apartment buildings and 560 singlefamily houses built and sold since 1966.

The resolution of March 15, 1968 cited in paragraph 3.16 cannot be ignored either. The appellant argued that this resolution was drafted because of its insufficient solvency, as appears from the text. However, the Court cannot ignore the first "whereas" of that resolution:

Whereas the company wishes to act as a general contractor in the construction of apartment buildings and to sell the buildings thus built;

[Translation; emphasis added.]

This "whereas" is the appellant's official statement of a policy that could not be clearer. The rest of the resolution is simply a mandate of the appellant given to Mr. Deshaies to conduct transactions personally in his own name, for which he will subsequently be reimbursed, etc., the whole once again because of the great solvency of Mr. Deshaies.

The policy statement contained in the "whereas" cited above binds the appellant in a general way with respect to every building built and sold by it.

It is still possible, however, that the buildings in issue in the instant case may be an exception to the general rule. That was in effect the claim of the appellant, who alleged, inter alia, that the said buildings had been classified as capital property and, further, that the appellant could even be considered as an investment company.

4.03.3 Buildings as investments

Mr. Deshaies claimed that, since their construction in 1971, these buildings had always been considered as buildings to be held for reasons of security and not to be sold (3.02.7). It is true, furthermore, that they were classified under the item "inventory" in the accounting records. However, according to the bookkeeper Gilles Hamel, that was not at all representative of the economic reality. Depreciation was always taken on the buildings in issue. In 1979, they were even officially classified as capital property in the 1978 financial statements, with the approval of the shareholders on April 13, 1979 (3.06). They were sold in 1985 and 1986.

According to the appellant, this official classification only confirmed the Original intention.

Can this fact permanently reverse the effect of the policy issued by the resolution of May 15, 1968?

The appellant referred the Court to Makoi [4.02(1)], in which it was determined, first, that the transfer of assets from the inventory" account to the "investment property” or “capital property" account was not a disposal of assets. Furthermore, the Court found that all the profits from a subsequent sale had to be considered as capital gains, regardless of the fact that the asset had been classified as inventory during a certain period.

In that case, a company which specialized in the construction and sale of houses from 1964 to 1973 and which had built more than 500 houses ceased its activities, and still had 21 houses in inventory. Fifteen were transferred from an inventory account to a rental income account. Six were sold at cost to individuals. Two other companies were incorporated to continue the construction business. The 21 houses were leased, and all offers to sell were rejected. Following numerous problems with tenants (collections, damage to houses, etc.), the houses were sold in 1978 and 1979. The Court found that the intention to invest was clearly established and that the profit was a capital gain.

Can the same be said in the instant case? The argument that there had been a desire to hold the buildings in issue since 1971 is greatly weakened by the fact that not only the 32-apartment buildings were supposed to be retained, but also those with 16 and 24 apartments (3.02.7). However, the latter were all sold.

Furthermore, in Couillard Estate, [4.02(2)] cited by the appellant, it is true that that company built and sold apartment buildings and residential houses. However, the Court considered the profit from the sale of a certain number of buildings as a capital gain. The evidence in that case clearly showed, inter alia, that a dual system of accounting existed, one part concerning the buildings in inventory and the other the buildings constructed for investment. This dual system had always existed.

In my view, the transfer from the inventory account in the 1978 financial statements is not on its own a strong enough factor to reverse the burden of proof.

Consequently, the other factors must be considered.

4.03.4 Counsel for the appellant alleged that the appellant could have been considered an investment company during the years in issue.

The gross rental and interest income alone amounted to $433,626 ($260,952 rent + $172,674 int.) in 1985 and $320,529 ($129,128 rent + $191,401 int.) in 1986, whereas gross construction income was $200,083 (1985) and $422,085 (1986), and that is without considering the gains from capital disposition and disposal of investments of $377,759 in 1985 and $1,524,873 in 1986. In 1984, interest alone amounted to $137,512 (3.09). Rental income and interest expenses were also emphasized (3.12).

Since 1975, the appellant allegedly had a policy of varying its investments by forming new companies or by purchasing bonds. Thus, in 1986, it invested $1,819,886 in Asphalte Spémont (1985) Inc., Transformation Distech Inc. and Roynat (Exhibit A-11, pp. 9-10, note 7).

The Court is of the view that, even though the investment income was temporarily higher than the other income, that did not make it an investment corporation.

Furthermore, transferring the proceeds of the sale of real estate to investments does not automatically characterize the buildings sold as having themselves been investment property. However, that may be a favourable factor.

4.03.5 Circumstances of the sale

The reasons adduced in evidence which led Mr. Deshaies and thus the appellant to sell the buildings in issue were, first, the absence of a caretaker, together with a high vacancy rate, the low quality of tenants and the problems which that caused, for example the N.S.F. cheques (3.03, 3.08, 3.09).

The Court observes that these circumstances are the lot of all lessors of buildings during a recession. It is true that these reasons, together with other circumstances, have often been considered sufficient by the courts to find that there was a capital gain.

The appellant here is a corporation which has operated in the areas of the construction, leasing and sale of buildings for 17 years. With his experience as a businessman, Mr. Deshaies knew well that the recession could not last much longer. Furthermore, the appellant's financial situation was sufficiently good for it to afford a caretaker without the president, Mr. Deshaies, being personally obliged to do that work. Repairs to be done to the buildings in issue, repairs that increased with time, were also argued (3.07). Mr. Deshaies testified that the repairs to the plumbing and heating systems, porches and roofs had already been done when the buildings were sold (3.14). However, these are in fact the principal repairs to a building, and that also explains the increased cost of repairs in the financial statements during the preceding years.

Lastly, can it be said that the selling price was exceptional in the instant case? The buildings were sold at $22,000 for each apartment. However, according to the evidence of one witness of the appellant, that price was not high, since the price of a new apartment was $30,000 to $32,000 in 1985 and 1986 (3.02.9 in fine).

If I return to Couillard, supra, the circumstances of the sale were much more influential: conflict between the shareholders, illness of the principal shareholder and difficult financial situation to the point where the bank had warned that it would put the matter in the hands of a trustee in bankruptcy.

4.03.6 Mr. Deshaies also testified that he wanted to keep the buildings in issue as a "pension fund”. The appellant, being a corporation, does not need a pension fund. This expression of Mr. Deshaies' could probably be interpreted as suggesting that he wanted to keep these buildings within the appellant and that he himself at retirement age could withdraw dividends from the income provided by those buildings.

Furthermore, as regards the two apartment buildings constructed in 1981 and 1982 and sold to Mr. Deshaies, as alleged at paragraph 18(k) of the respondent's reply to the notice of appeal, it appears clearly from the evidence (3.02.5) that these buildings were built by the appellant, but as the agent of Mr. Deshaies, the latter having personally purchased the land in advance for this purpose. The price paid for the construction was cost plus ten per cent.

The fact assumed is, in my view, without any foundation. The Court believes that these buildings were Mr. Deshaies'"pension fund”.

4.03.7 Whereas the burden of proof was on the appellant, and considering the balance of probabilities with regard to all the various tests examined, the Court favours the respondent's thesis. The reassessments must therefore be maintained.

5. Conclusion

For the above reasons, the appeal is dismissed.

Appeal dismissed.