Les Placements Richard Martineau Ltée v. Minister of National Revenue, [1992] 1 CTC 2170

Garon, T.C.C.J. [Translation] [Orally]:—In this case the appellant has appealed to this Court from income tax assessments dated November 18, 1988 for its 1986 and 1987 taxation years.

The point at issue in these appeals is whether the gains made by the appellant when it sold two pieces of real estate are capital gains.

The appellant was incorporated on June 30, 1981. During the period at issue, the appellant's fiscal year ended on June 29 of each year. From its formation to the present time the company has had only one shareholder, the president and director, Mr. Richard Martineau.

Mr. Martineau has a diploma from the Montreal Institution les Hautes Études Commerciales, where he obtained a B.A. in administration and marketing. In 1972, he purchased in partnership with his brother a firm known as Sirbain which operated a synthetic fur business. In managing this business, Mr. Martineau was responsible for production and administrative functions while his brother concentrated on the question of advertising and public relations. Mr. Richard Martineau devoted all his energies to his work for Sirbain for a ten-year period, working up to 16 hours a day. During this period, the turnover increased from $100,000 to $3,000,000 in 1982, and at the close of this period 55 employees were working in the business, which consisted of a principal shop and eight sales outlets operated as franchises.

As the result of a major dispute with his brother, who had plans to expand into the American market, the appellant, which in 1981 had purchased Mr. Martineau's shares in the capital stock of Sirbain, was obliged to sell them to Mr. Richard Martineau's brother during 1982. Mr. Richard Martineau then ceased working for this business.

For Mr. Martineau, this period of intense activity was followed by one of a respite in which he undertook other studies, and on the recommendation of his accountants he decided to invest through the appellant in "blue-chip" securities, to use his phrase. At one point, the appellant had shares worth $125,000 in a banking company which suddenly ran into very serious financial difficulty. From 1985 and for a period of 12 to 18 months, the appellant began disposing of the shares in its portfolio. The appellant's activities were soon to take a new direction.

In 1985 and 1986 Mr. Martineau again went to work for the Sirbain business at his brother's request. The company was then experiencing serious financial problems. On this latter occasion, his status at Sirbain was that of a paid employee. At this time, Mr. Richard Martineau himself purchased shares in Sirbain which he resold in April 1986.

In late 1985 the appellant went into the real estate field. As a matter of fact, when he was working with Sirbain, Mr. Martineau was told that a building located at 417 Boulevard St. Joseph in Outremont was for sale. The building was about 60 years old. The appellant decided to purchase this building on November 25, 1985 for $460,000, $191,994 of which was paid in cash and a mortgage for $268,006 was assumed for the remainder. The appellant did not have to borrow any money to make this initial payment of nearly $200,000.

Prior to the purchase of this building by the appellant, Mr. Martineau had visited three or four apartments in the building, which contained a total of 19. He found that the floors were not level and might require the application of a special product known as Gypcreet, a sort of light concrete. At the time of purchase of this piece of real estate, the appellant was prepared to do minor work on the apartments as soon as they became vacant. In other words, as tenants departed the appellant would do what was necessary to renovate or improve the apartments in question.

Before undertaking any work, Mr. Martineau consulted Mr. Denis Robert, a man with experience in the area, who after visiting in particular the basement of the building, told Mr. Martineau that the footing of the building was sinking into the ground and the ideal and permanent solution to the problem would be to redo the foundations and raise the building. This was clearly a major structural defect. The work would require the evacuation of the building. The appellant was not prepared to adopt this solution, which entailed considerable expense and substantial risk. It must be recalled that at the time Mr. Martineau was still working for Sirbain.

Mr. Martineau's testimony regarding the discovery of this important structural defect and the method of correcting it was confirmed by Mr. Denis Robert in all respects. For example, Mr. Robert pointed out that in addition to redoing the footing, repair work also had to be done on the walls and panelling in each of the apartments.

A few months later, in March 1986, the appellant accepted a purchase offer of $515,000 for this piece of real estate. The appellant thus made a gain of $30,290. A commission of $20,000 was paid by the appellant when this building was sold.

It should be noted that while the building was held, the appellant made a quite modest net income from the rental of the various apartments.

On May 9, 1986 the appellant purchased the undivided half of a building located at 4940 Côte St. Luc, in Montreal, while the other undivided half was purchased by George Gantcheff and his mother, Hélène Gantcheff. The purchase price was $2,600,000. The sum of $730,807 was paid in cash and an existing mortgage for $1,869,193 was assumed.

No real estate broker was used in making this purchase. Mr. Gantcheff learned that the building in question was for sale. The appellant loaned Mr. Gantcheff the money necessary for him to make his share of the initial payment in purchasing the building.

The distribution of work adopted by the appellant and Mr. Gantcheff was that the appellant would be responsible, through the services of Mr. Richard Martineau, for the accounting and administrative work and minor repairs to the building and that Mr. Gantcheff would deal with tenants in general and handle rental problems. Mr. Gantcheff, who was in his twenties, already had six years' experience in real estate, and especially in the rental of apartments.

The building in question was made of concrete with an underground garage and had about 60 apartments. The structure was solidly built. The building had an ideal site; there was a magnificent view of Montreal and the surrounding area from the various apartments. Mr. Martineau said that this building was just the kind of piece of real estate that would be purchased as a long-term investment. It required only minor repairs and some renovation work.

Soon after purchasing the building at Côte St. Luc, serious management problems arose. Specifically, relations between Mr. Gantcheff and some tenants became very unpleasant and disputes with racist overtones reached a critical stage. Police assistance was requested on certain occasions and Mr. Gantcheffs car in particular was deliberately damaged by one female tenant. The tenants in the building, who all belonged to the same ethnic group, became more and more demanding and their requests for repair work and demands seemed to know no limit. It was in these circumstances that the appellant and Gantcheff accepted a very attractive purchase offer. The building was sold on August 21, 1986 for $3,200,000 and the appellant made a gain of $275,338 for its undivided half.

During the period it had been held the building produced a net rental income of some $9,000. A rental increase of some four to five per cent would ordinarily have come into effect in July of that year.

Mr. Gantcheff corroborated Mr. Martineau's version on the major aspects of this transaction involving the building in Côte St. Luc. In particular, he said that this was a quality building, which was a good long-term investment.

As to relations with the tenants, Mr. Gantcheff said that neither then nor since had he ever had to deal with such difficult or demanding tenants. He said that there were constant problems and he had to devote much more time than he expected to matters involving the tenants.

It also appeared from the evidence that at the time of the purchase of the Côte St. Luc building Mr. Gantcheff and his mother had already purchased six pieces of real estate. Two of these pieces of real estate were sold some time after their purchase and two others would be sold in the course of 1990. It was further established that Mr. Gantcheff and his mother have since 1987 been parties to a series of purchases and sales of pieces of real estate.

The evidence further disclosed that during 1987 the appellant purchased a third 19-apartment building at 17 and 19 Côte Ste-Catherine, in Montreal, for $800,000. The building was resold some months later, on July 2, 1987, during the appellants 1988 taxation year, for $975,000. Mr. Martineau gave as his reason for selling this third building his need for liquidity to purchase a lot in Laval and the creation of a large residential project at this latter location. It should be added that another joint stock company was formed by Mr. Martineau and the appellant. The latter company undertook the creation of a sizeable residential project in Laval. In connection with this operation, the company sold a large number of apartments. A large sum from the sale of the Côte Ste-Catherine building was used to create this new company.

Finally, as to Mr. Martineau himself, he had on one occasion in 1986 disposed of a building as he said he wished to take advantage of the taxable capital gains exemption.

The appellant, for its part, purchased no buildings apart from those mentioned above.

Throughout his testimony Mr. Martineau insisted that the purchases of the buildings at Boulevard St. Joseph and Côte St. Luc were made as long-term investments.

In light of these facts, I must determine whether the gains made by the appellant on the sale of the Boulevard St. Joseph and Côte St. Luc buildings were in the nature of business income or were capital gains. In other words, were these two sales the realization of an investment or were they rather a "concern in the nature of trade", to use the terminology found in the definition of "business" in section 248 of the Income Tax Act .

This point has been considered many times by the courts. The decision in Taylor v. M.N.R., [1956] C.T.C. 189, 56 D.T.C. 1125, perhaps contains the most complete analysis of the factors or tests for determining whether in a particular case the Court is dealing with a capital gain or with business income.

It is quite clear that there is evidence in the instant case to indicate that the transactions in question could be concerns in the nature of trade. To begin with, the two buildings in question were held for a very short time. The appellant sold the two buildings a few months after buying them. There is also the fact that shortly afterwards the appellant also disposed of another building, that located on Côte Ste-Catherine. The fact that the appellant went into partnership with the Gantcheffs to purchase the Côte St. Luc building may also be mentioned, although according to the evidence it was not until some time later that the Gantcheffs were parties to a series of purchases and sales of pieces of real estate, apart from the two buildings they disposed of before 1986.

There are also facts pointing in the opposite direction, that is suggesting that in the case of the Boulevard St. Joseph and Côte St. Luc buildings this was the realization of an investment by a company which was operating in the real estate field for the first time.

For example; the two buildings produced net rental income and could have the characteristics of a long-term investment. The way in which the purchase of these two pieces of real estate was financed was more compatible with the approach of an investor than of a speculator. The cash payments made by the appellant to purchase these two buildings were in both cases a substantial percentage of the purchase price. The sale of the two pieces of real estate was also made without organizing any publicity. There is also the fact that, immediately before going into the real estate field, the appellant had for a period of three years, beginning shortly after its creation, focused its activities on blue- chip investments in the form of shares or bonds issued by public corporations. The appellant was also financially able to hold onto the two buildings in question as a long-term investment.

In looking at all the facts surrounding the purchase and sale of the Boulevard St. Joseph and Côte St. Luc pieces of real estate, I must also keep in mind the comments of Noël, J. of the Exchequer Court in Racine, Demers and Nolin v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098. The following passage at page 159 (D.T.C. 5103), where he deals with the theory of secondary intention, is especially worth noting:

[Translation]

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 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.

Later in the same judgment, the learned judge added the following at page 162 (D.T.C. 5105):

[Translation]

The inference of an intention to make a profit by a rapid resale can also flow from the fact that the purchaser did, in fact, resell almost immediately at a profit, but only if there exists no satisfactory explanation for this rapid resale. The appellants in this case give an explanation for the rapid resale which I find believable and which I accept.

Based on the evidence as a whole, I consider that at the time it purchased these two pieces of real estate the appellants primary intention was not to resell them. As Noël, J. observed in the aforementioned case, I consider that reasonable and satisfactory explanations were given to justify these two quick sales. Mr. Richard Martineau seemed to me to be a credible witness and I I feel he has demonstrated that the appellants intention was actually one of investment, and that it was both unforeseen and sufficiently serious circumstances which led the appellant to sell the buildings in question.

I therefore conclude that the gains made by the appellant on these two transactions were capital gains, not business income.

For these reasons, the appeals are allowed with costs and the assessments referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the gains in question made on the sale of the two buildings constituted capital gains.

Appeals allowed.