Radiant Properties Inc. v. Minister of National Revenue, [1991] 2 CTC 2135, 91 DTC 1005

Rip, T.CJ.: —Radiant Properties Inc. ("Radiant"), the appellant, appeals from an income tax assessment for its 1987 nation year in which the respondent included in income all of the profit from a disposition of real property. The appellant claims the profit was on account of capital.

Since 1966 Leslie L. Majthenyi ("Majthenyi") has been a client and then friend of Thomas D. Campbell (“Campbell”), a solicitor in Chatham, Ontario. Majthenyi is a civil engineer who had worked for the federal government and then for a local engineering firm until 1965 when he commenced a construction business in Lambton County through a corporation he incorporated, Maylez Construction Ltd. ("Maylez"). Majthenyi's experience was in bridge construction but in 1971 Maylez commenced to build houses for sale in Chatham as well. Maylez purchased lots, performed the concrete work and then contracted the balance of the construction.

In the early 1970s Maylez was building semi-detached family homes in a subdivision in Chatham. A real estate agent advised Majthenyi of property available near the subdivision on which a 94-unit apartment building could be built. On March 6, 1975 Maylez agreed to purchase the property which is described as Part 1 of Reference Plan 24R1750 in the Registry Office of the County of Kent (“Part 1").

Sometime prior to 1975 Majthenyi had discussed with Campbell the prospect of investing together and to this end the appellant was incorporated in 1974. Each of Majthenyi and Campbell, together with their respective wives, owned fifty per cent of the shares of the appellant. Several offers to purchase property were made in the early years but were not accepted.

In any event Majthenyi learned of the availability of a lot, being Part 2 of the same reference plan as the lot for the apartment building. This lot (“Part 2") was zoned for commercial purposes, permitting a shopping centre. The owners had prepared a preliminary plan for a shopping mall in January 1975. By agreement dated April 19, 1975 Maylez agreed to purchase Part 2 together with the preliminary plan. Maylez assigned its rights in the agreement to Radiant, which purchased the property for $80,000. A first mortgage for $50,000 was assumed by Maylez and the vendor took back a second mortgage for $15,000. Both mortgages were due in June 1976. By 1976 the Part 2 property was owned free and clear of all encumbrances.

The properties were located in the eastern part of Chatham. Majthenyi testified there was a variety store nearby but nothing else. In his view it was important for the prospective tenants of the apartment building to have a shopping area close to their homes.

Later on—the dates are not in evidence—Maylez acquired land one block west of the proposed 94-unit apartment site for construction of a 76-unit apartment building and 25 acres of vacant land across the street from the 94- unit building for a future residential subdivision.

Construction of the 94-unit apartment building began in 1977 and the building was completed in early 1979. Majthenyi described the building as high quality and maintenance free. The construction was financed by a $2,000,000 first mortgage from Fort Gary Trust, and assistance by the Central Mortgage and Housing Corporation to the extent of $455,000 under its Assisted Rental Program. The building also qualified as a multiple unit residential building for the purposes of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the "Act").

Originally, Majthenyi testified, he did not look for a partner for the shopping plaza but because of his need for money he approached Campbell to put Part 2 in Radiant and Campbell agreed. By July 23, 1975 new preliminary plans were prepared for a strip shopping centre rather than the enclosed mall provided for in the preliminary plans; after discussing the new plans with a potential tenant the plan was revised slightly.

As early as the summer of 1975 Campbell canvassed potential tenants; Majthenyi wrote similar letters in 1978. No favourable replies were received. This did not concern Majthenyi too much as he was devoting his efforts to the planning and subsequent construction of the 94-unit apartment building. Further, he wanted the shopping centre to be 60 per cent rented prior to the commencement of its construction.

In February 1977 Majthenyi was running short of money and to accommodate him Campbell purchased his shares in Radiant for $40,000. Campbell agreed Majthenyi could reacquire the shares within six months for $40,000 and on July 11, 1977 Campbell sold the shares back to Majthenyi. Majthenyi soon found himself in further financial difficulty; the bank was not willing to advance further funds and the trades working on the 76-unit apartment building were demanding money. Efforts to sell the latter building were futile. Majthenyi sold his shares of Radiant for a second time to Campbell for $40,000 on December 12, 1978; he had the same right to repurchase the shares within six months for $40,000 but did not do so. (Campbell said he would have sold Majthenyi the shares after the six months expired if he wanted to buy them.) As a result Campbell and his wife became the sole owners of Radiant.

Majthenyi stated that notwithstanding his financial problems he never discussed with Campbell the possibility of Radiant selling Part 2 to get him in funds; he thought he would have money available to repay Campbell and reacquire the shares. He saw the shopping plaza as a complement to the 94- unit apartment building and never talked to real estate agents or others for purposes of selling the land. He said he never intended to sell the land since it was acquired as an investment. Further, he said, it was obvious that Maylez would be the contractor on the construction of the shopping centre.

The 94-unit apartment building was sold in 1982 under a power of sale, the 76-unit apartment building was foreclosed by the mortgagee, also in 1982, and the 25-acre property was transferred to the mortgagee. Majthenyi caused Maylez to sell a severed lot on property where its office was located but he could not sell the balance of the land. Majthenyi blamed his financial woes on the recession of the early 1980s which, according to Campbell, affected Chatham more than other areas of Ontario.

Campbell has carried on the general practice of law since 1958; at present about 35 to 40 per cent of his practice is devoted to real estate, 25 to 30 per cent to estates and the balance to commercial and corporate matters. He also has participated, and continues to participate, with others in corporations which acquire vacant land to subdivide and sell.

Campbell corroborated much of Majthenyi's testimony. He described the 94-unit apartment building as a nice structure; "Majthenyi", he said, "put a lot into the property". Campbell desired an investment property for himself and his family and he was “in complete unison" with Majthenyi that the shopping centre would complement the apartment building. Campbell added that Majthenyi “wanted to retain the plaza as much as I, but things were getting difficult in 1979 in the market place and development of a plaza was chancy and that particular area . . . was not yet ripe. . .". He stated Majthenyi became bankrupt sometime in the early 19805. “It was a very bad experience," he recalled.

In 1983 Campbell started to write again to prospective tenants for the shopping plaza. The replies to his letters indicated it was premature to build. Campbell had thought that with new roads to the area, including additional access to and from Highway 401, he would be able to attract tenants.

About the time Majthenyi left Radiant, Campbell said, he also was having financial problems. He had a 20 per cent interest in a shopping centre in Chatham called Heritage Place. A restaurant in that centre went bankrupt. The Bank of Montreal had a mortgage on the restaurant's chattels and incurred a deficiency of $137,000. Campbell and the other two owners of Heritage Place jointly and severally guaranteed repayment of the loan by the Bank of Montreal to the restaurants owners. One of the owners of Heritage Place was declared bankrupt and the other "refused to pay", according to Campbell. Campbell declared he was having a hard time making ends meet on Heritage Place in the early 1980s and “was not prepared to do another investment" at that time. Campbell testified no development of any kind took place in Chatham until 1984 or 1985 “when the economy came around".

Chatham, he explained, is a city with a population of 40,000 people, situated approximately 70 miles from London and 50 miles from each of Windsor and Sarnia. Chatham's economy is based on automobile-related industries and agriculture and both "suffered very badly” in the early 1980s.

Campbell described his financial liabilities on Heritage Place: a $600,000 first mortgage to National Trust, a $500,000 loan from the Canadian Imperial Bank of Commerce secured by a small business development bond, a second mortgage to National Trust in the amount of $250,000 plus his liability to the Bank of Montreal. As well the City had not been paid municipal taxes aggregating $80,000. Heritage Place also had a negative cash flow of $5,500 to $6,000 per month. Before he assumed the liabilities of the other two owners of Heritage Place on December 31, 1981, the value of the property had been appraised at $400,000 to $500,000, although the building was incomplete and only half occupied. Heritage Place had been managed by a management company owned by one of Campbell's cohorts in the property and Campbell took over its management when he effectively became the sole owner.

In order to satisfy the creditors on the Heritage Place property, Campbell caused Radiant to mortgage Part 2 to the Bank of Montreal. Another property, which Campbell and his brother inherited from his father, was also given to the Bank of Montreal as security, much to his brother's protests. The Bank of Montreal and his own bank, the Canadian Imperial Bank of Commerce, were warning him of his exposure and were advising him to reduce his liability. When he sold Part 2, the proceeds from the sale were applied to reduce his debt to the banks.

In 1983 the City of Chatham was in the process of altering the designation of many properties. An advertisement in the local newspaper notified the public that the zoning of Part 2 was to be changed to “B3”, highway commercial. Mr. M.G. Howell, Planning Director for the City of Chatham in 1983 and at time of trial, advised the Court that ”83” permitted the same uses as the previous zoning, ”BS”, but excluded retail stores such as food stores, drug stores and similar retail outlets. What would be permitted were retail outlets such as service stations, car washes and repair shops.

Unfortunately Campbell had not seen the published notice and learned about the zoning change sometime later. When he found out about the change, he testified, he requested the zoning be changed again to revert to what it was when it was acquired by Radiant. He said he had the full support of the municipal authorities and the change was made in 1985.

With respect to the zone change application the Chatham Planning Department Staff Report contained the following comment: "The rationale for the rezoning application is to place it in the proper thing to reflect the Official Plan

and to make it more marketable to those people who would be interested in developing it for a shopping centre".

[Emphasis added.]

In examination-in-chief counsel for the respondent asked Howell whether the word “marketable” in the Chatham Planning Department's Staff Report meant the owner of the property intended to sell. Howell replied he had no discussions with Campbell at the time but "I know he was out to market tenant space. .. I can’t say if ‘marketable’ . . . (means) . . . for sale . . . no idea." Later, in cross-examination by appellant's counsel, Howell stated there was no active plan to develop the property at the time.

In 1985, Campbell was again making inquiries of potential tenants to determine their interest. This time he received some favourable response.

Sometime in 1986 a Mr. C.A. Chapple telephoned Campbell to determine whether he was prepared to sell Part 2. Chapple was at the time, and is, a real estate broker. Chapple testified a Mr. Kahn informed him he wanted to build a shopping plaza in Chatham and the Part 2 property appeared interesting. He wanted Chapple to find out if Part 2 was properly zoned for a shopping plaza and, if so, who the owner was. When Chapple first approached Campbell, the latter told him he was reluctant to sell due to the fact he owned the property for so long and that he was planning to build a plaza himself. Eventually Campbell told Chapple he would sell for a "good price".

Kahn offered $190,000 for the property; Campbell counter-offered at $200,000 and Kahn accepted the counter offer. A clause typed in the offer provided for the sale to be conditional upon the purchaser inspecting and approving any current offers to lease with respect to the property. This clause was struck out and replaced with one in which the vendor agreed to “advise the purchaser of two prospective tenants for the subject property and for the purchaser to negotiate terms” and this was accepted by the purchaser. Campbell had given Chapple the names of two prospective tenants. Chapple said he wanted this clause in the agreement since it would “assist” him in consummating the sale.

Sometime before the sale Campbell had requested Mr. Donald McGeorge, a civil engineer and land surveyor, to prepare a new site plan for Part 2. McGeorge negotiated changes with the City authorities and eventually was advised the new plans were acceptable. McGeorge testified he never made final plans since Kahn took over. However, he said, "we could've gotten prices and gone to tender without very much additional work".

The offer by Kahn was unsolicited. Campbell testified he did not seek to sell the property; he did not "spread the word" the property was available for sale. The property was never listed for sale.

Kahn built a shopping plaza substantially along the lines planned by Campbell. Where Campbell saw three or four larger stores in the plaza centred around a larger food store, Kahn's plaza has more stores each with a smaller area.

In assessing the appellant, the respondent assumed that when the appellant purchased the Part 2 property in 1975, the possibility of resale at a profit was an operating motivation for the acquisition. He assessed the appellant on the basis that in purchasing the property it was engaged in a venture in the nature of trade: subsection 248(1) [1] . Hence, the profits were an income from a business.

Counsel for respondent acknowledges the credibility of witnesses Majth- enyi and Campbell. He points out, however, each of Majthenyi and Campbell were experienced in real estate and were close friends. When Radiant was incorporated, counsel submits, it was formed to develop land and Part 2 was the only land it acquired. For the period of ten years from purchase to sale, the land was left vacant, other than letters to potential tenants and changes to preliminary plans no action was taken with respect to the land. Both Majthenyi and Campbell were sophisticated land developers, counsel declared. Majth- enyi had purchased land to subdivide for sale and so did Campbell. When Part 2 was acquired they knew that it could always be sold if the shopping centre plans did not work out.

There is no principle cast in stone that taxpayers who are land developers cannot acquire land for investment purposes. Indeed, a taxpayer may own land that is inventory and land that is capital. At the risk of being trite it ought not to be forgotten that each case is to be decided on its own facts.

The facts in the appeal at bar favour the appellant. As I indicated to respondent's counsel during argument two important assumptions of fact relied on by his client in assessing were contrary to the evidence at trial. These assumptions were firstly, that the appellant's request for a zoning change in 1985 was "for the primary purpose of making the property more valuable for resale purposes"; in fact the rezoning charge was made so that the zoning would revert to what it was on the acquisition of the property. Secondly, the respondent assumed that although there was demand for a strip mall in the property area in the years 1975 to 1985, the appellant was content to hold the property for possible resale. The evidence is clear that there was no interest in the property by potential tenants until 1985 and there was no demand for a strip mall in the area before that time.

The reason for contemplating the building of a shopping centre in 1975 is valid. Majthenyi was building homes in a nearby subdivision. Except for a variety store, there was no shopping facility in the area. Majthenyi had purchased a property for the construction of a 94-unit apartment building. Subsequently he acquired land to build a 76-unit apartment building and a subdivision. The people living in these buildings would require basic retail services close to their homes. A developer could see the attractiveness of a shopping centre at the time and there is no reason not to accept the evidence of Maithenyi and Campbell—evidence respondent's counsel agrees was credible—that it was their primary intention on acquisition of the property to cause the appellant to construct a shopping centre to hold as an investment. Once the property was acquired it was held by the appellant and its disposition was not contemplated even when Majthenyi was in dire financial straits. There is no evidence that the possibility of reselling the property at a profit was an operating motivation for its acquisition: Racine, Demers and Nolin v. M.N.R., [1965] C.T.C. 150; 65 D.T.C. 5098 at page 157 (D.T.C. 5103).

The property was sold in an unsolicited sale at a time when the principal of the appellant was in need of money, and even then he was reluctant to sell, he said. Prior to sale there was no effort to make the property more attractive to any potential purchaser.

The respondent erred in analyzing the facts leading to the disposition of the property. The appeal is allowed with costs.

Appeal allowed.