Anstel Holdings Ltd. v. Minister of National Revenue, [1991] 2 CTC 2515, 91 DTC 1050

Goetz, T.CJ.: —In 1964 Stellio Bulietta incorporated Stan’s Transmission Centre Ltd., hereinafter referred to as ("Stan's") of Vancouver, British Columbia. Mr. Bulietta held 51 per cent of the corporation, his wife Anne held the remaining 49 per cent or the shares. Stan’s is an automobile repair business concentrating on transmission work. In 1984, Anstel Holdings Ltd., hereinafter referred to as ("Anstel") acquired all of the shares of Stan's. Anstel is owned 55 per cent by Stellio Bulietta and 45 per cent by Anne Bulietta. Stan's is still active in the automobile repair business. For the taxation years in issue, 1980 and 1981, the appellant, Anstel Holdings Ltd. was known as Stan's Transmission Centre Ltd.

In 1974, Chatelaine Homes Ltd., hereinafter referred to as ("Chatelaine") was incorporated with Stellio Bulietta as sole shareholder. Chatelaine carried on a successful mobile home sales operation out of Kelowna, British Columbia. For various reasons Chatelaine ceased its mobile home sales operation in 1977.

In 1978, Chatelaine purchased 12 lots at a marina located at Point Robert, in the State of Washington, U.S.A. A feasibility study obtained by Mr. Bulietta indicated that the property being purchased at $40,000 per lot could sell for $60,000 per lot. Chatelaine obtained the money to invest in the Point Robert Marina, namely $400,000 from what was then Stan's Transmission Centre Ltd. Stan's (Anstel) in turn had borrowed this money ($400,000) from the Bank of Montreal. Stan's was to receive 40 per cent of any profits Chatelaine made from the Point Robert Marina with Chatelaine retaining the other 60 per cent. A subsequent written agreement was entered into by Stan's (Anstel) and Chatelaine, as a result of queries by Revenue Canada, whereby the appellant would receive 40 per cent of the profits realized from the sale of the Point Robert properties and that all excess funds would be first applied to repay the appellant's advances. Chatelaine, through its lawyers, drew up a prospectus which included among its objects "the business of land development". The property was immediately listed with a real estate agent in June 1978. Offers were received after the listing but were not acceptable. The Point Robert Marina "Complex" fell into bankruptcy at about this time. It had been expected by Chatelaine that the development of the Marina Complex would assist in the development of their own marina property. In 1978 and 1979, the Canadian dollar fell in value and interest rates climbed very high, adversely affecting the real estate market.

From 1978 through to 1988 no sales of Point Robert lots were made by Chatelaine. Chatelaine therefore had no income during these years. In 1989, things began to turn around and three lots were sold. In 1990, four lots were sold. The profits were treated in the following manner: 40 per cent to Anstel, 60 per cent to Chatelaine. Anstel treated the profits as interest income, Chatelaine treated the profits as business income.

Issue

In determining its income for the 1980 and 1981 taxation years, the appellant deducted the interest incurred on the money ($400,000) that was borrowed by it and loaned to Chatelaine. The Minister has disallowed to the appellant the following interest payments:

The denied interest deduction of $43,713.46 for the appellant's 1981 taxation year included a foreign exchange loss of $15,505.47.

The appellant maintains that the interest expense was incurred for the purpose of gaining and producing income and therefore the amounts of $61,112.99 and $28,207.99 are properly deductible pursuant to paragraph 20(1)(c) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). The appellant further maintains that the foreign exchange loss of $15,505.47 is properly deductible pursuant to subsection 9(1) of the Act. The Minister submits that he properly reassessed the appellant's 1980 and 1981 taxation years and correctly disallowed the $61,117.99 and $28,207.99 amounts of interest expense claimed by the appellant in those respective years, pursuant to subsections 18(2), 248(1) and paragraph 18(3)(b) of the Act.

The Minister's position is that the said interest costs were in respect of borrowed money loaned by the appellant interest-free to Chatelaine who did not deal with the appellant at arm's length and who used the funds to acquire land which cannot reasonably be considered to have been used or held in the course of a business carried on in the 1980 or 1981 taxation years or to have been held primarily for the purpose of gaining or producing income from the land for those years.

The Minister submits further that the appellant is not entitled to a deduction from income in the 1981 taxation year for the amount of $15,505.47 foreign exchange loss, as the said loss was not incurred for the purpose of earning income from a business or property of the appellant, as is required by paragraph 18(1)(a) of the Act.

Analysis

In general, interest expenses incurred by a taxpayer in the course of his business operation are deductible under paragraph 20(1)(c) of the Act. Subsec- tion 18(2) provides that interest is not deductible in certain circumstances even though it would be allowed under paragraph 20(1)(c). Subsection 18(2) limits the deduction of interest expenses and property taxes incurred in connection with undeveloped land. Generally, the deduction is limited to the net revenue produced from the land. However, the limitation does not apply where the land is used in, or held in the course of, a business carried on in the year by the taxpayer. Furthermore, there is no limitation where the land is held primarily for the purpose of gaining or producing income of the taxpayer from the land for that year. In 1981, subsection 18(2) read as follows:

18.(2) Notwithstanding paragraph 20(1)(c), in computing the taxpayer's income for a taxation year from a business or property, no deduction shall be made in. respect of any amount paid or payable by the taxpayer in the year and after 1971 as, on account or in lieu of payment of, or in satisfaction of,

(a) interest on borrowed money used to acquire land, or on an amount payable by him for land, or

(b) property taxes (not including income or profits taxes or taxes computed by reference to the transfer of property) paid or payable by him in respect of land to a province or a Canadian municipality,

if, having regard to all the circumstances, including the cost to the taxpayer of the land in relation to his gross revenue, if any, therefrom for that or any previous year, the land cannot reasonably be considered to have been, in that year,

(c) used in, or held in the course of, a business carried on in the year by the taxpayer, or

(d) (Repealed, 1974-75-76, c. 26, s. 7(2)),

(e) held primarily for the purpose of gaining or producing income of the taxpayer from the land for that year.

Under paragraph 18(3)(b), the expression “interest on borrowed money used to acquire land” is given an expanded meaning for the purpose of subsection 18(2). In 1981, paragraph 18(3)(b) read as follows:

“interest on borrowed money used to acquire land” includes

(i) interest paid or payable in a year in respect of borrowed money that cannot be identified with particular land but that may nonetheless reasonably be considered (having regard to all the circumstances) as interest on borrowed money used in respect of or for the acquisition of land, and

(ii) interest paid or payable in the year by a taxpayer in respect of borrowed money that may reasonably be considered (having regard to all the circumstances) to have been used to assist, directly or indirectly,

(A) another person with whom the taxpayer does not deal at arm's length,

to acquire land to be used or held by that person, corporation or partnership otherwise than as described in paragraph 18(2)(c) or (d), except where the assistance is in the form of a loan to that person, corporation or partnership and a reasonable rate of interest thereon is charged by the taxpayer.

In the case at bar we are concerned specifically with subparagraph 18(3)(b)(ii): where one taxpayer borrows money and it is reasonable to conclude that this money is used to assist a second taxpayer with whom the first does not deal at arm's length to acquire land, the first taxpayer will be considered to have borrowed the money to acquire land.

It should be noted that the definition of "business" in subsection 248(1) specifically provides that for the purpose of paragraph 18(2)(c), an "adventure or concern in the nature of trade" does not constitute a "business". In 1981, the definition of "business" in subsection 248(1) read as follows:

"Business".—"business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, (except for the purposes of paragraph 18(2)(c)), includes an adventure or concern in the nature of trade but does not include an office or employment;

The term "adventure or concern in the nature of trade" has been relevant in determining whether the profit made on a sale of property should be taxed as income or a capital gain. It contemplates that the profits from an isolated transaction may be taxable as income if the transaction is in the nature of trade. Since the reported decisions invariably involve a sale of property, it is difficult to apply the existing principles to determine whether the limitations in subsection 18(2) apply. Where land is not capital property of a taxpayer, the taxpayer must show that the land is being used or held in the course of a business carried on in the year and not merely as an adventure in the nature of trade. Since the distinction between these terms may well depend on the taxpayer's course of conduct over a number of years it may be difficult to determine the question during the first years during which the land is held. The taxpayer who is embarking upon his first venture in real estate trading or development will have to show that sufficient time, attention and labour were expended in each year such that his activities constituted a business in that year and that he was not merely holding the land as part of an adventure or concern in the nature of trade. Quoted verbatim from "CCH: Canadian Tax Reporter", Volume 1, pages 4413-14.

After oral argument, counsel for the appellant kindly reduced the appellant's position to writing. Counsel was keenly aware that subsection 18(2) and paragraph 18(3)(b) could adversely affect his client's case.

Said counsel at page three of his "reduced-to-writing" argument:

In order to determine whether a taxpayer is caught by the prohibition contained in 5.18(2) it is necessary to carefully examine the words of S. 18(3)(b). Section 18(3)(b) provides for the meaning of certain expressions in Section 18(2). Section 18(3)(b)(ii) provides that “interest on borrowed money used to acquire land” includes (ii) interest paid or payable in the year by a taxpayer (i.e. Anstel) in respect of borrowed money that may reasonably be considered (having regard to all the circumstances) to have been used to assist, directly or indirectly, another person (i.e. Chatelaine) with whom Anstel does not deal at arm's length to acquire land to be used or held by that person i.e. Chatelaine, otherwise than as described in paragraph 2(c). If we examine Section 18(2)(c) it will be noted that that Subsection refers to a taxpayer who owns land that is used in or held in the course of a business carried on in the year by the Taxpayer.

Of course counsel is only partly correct in his attempt to "walk" Anstel and Chatelaine through subparagraph 18(3)(b)(ii). This provision also refers to paragraph 18(2)(e). Paragraph 18(2)(e) refers to land “held primarily for the purpose of gaining or producing income of the taxpayer from the land for that year".

Counsel for the appellant seeks to show that his client does not come within paragraph 18(3)(b). If the appellant's “situation” does not fall within the paragraph 18(3)(b) expanded meaning of “interest on borrowed money used to acquire land", then the chances of the appellant coming within the ambit of subsection 18(2) are lessened. The appellant is seeking to avoid the "limiting" effects of subsection 18(2), so that it may receive the full interest expense deduction provided by paragraph 20(1)(c).

To exclude itself from subparagraph 18(3)(c)(ii) the appellant must show the Court that Chatelaine acquired the Point Robert land (1) to be used or held by Chatelaine in the course of a business carried on in the year or (2) to be held by Chatelaine primarily for the purpose of gaining or producing income.

Counsel for the appellant raised the case Guest v. M.N.R., [1985] 1 C.T.C. 2241; 85 D.T.C. 236 (T.C.C.). In issue was whether or not a parcel of land (the "Lynwood" property) owned by the appellant could reasonably be considered to have been used in, or held in the course of, a business carried on in the year by the appellant, vide subparagraph 18(2)(c) of the Act. The taxation years in question were 1979 to 1980. Judge Kempo found that the "acquisition and holding of the subject Lynwood Property formed an integral part of the carrying on of a business or scheme of profit-making by him during his 1979 and 1980 taxation years beyond that of an adventure in the nature of trade”. (page 2251 (D.T.C. 243))

Judge Kempo further says at pages 2251-52 (D.T.C. 243):

More particularly, during the three-year period 1977-1979 inclusive the appellant, on his own account, had acquired seven parcels of property—all of which, save the Lynwood land in question, had been subjected to some form of development activities and/or improvement by him followed by sale or holding for sale, as the case may be.

In viewing the totality of the appellant's course of conduct it is difficult to infer that his activities qua each of the seven parcels of property aforementioned were severable or isolated, or that each property or group of properties represented a project or projects as a series of isolated adventures in the nature of trade as opposed to their holding or use in the carrying on of a business of real estate development.

Judge Kempo suggests that activities involving the acquisition and sale of real estate found to be an isolated event and not part of a series of "adventures" have been held not to constitute the carrying on of a business and she refers to Jellaczyc v. M.N.R., [1985] 1 C.T.C. 2158; 85 D.T.C. 184 (T.C.C.). In Jellaczyc, supra, at page 2159 (D.T.C. 185) the facts revealed:

In 1974, Mr. Jellaczyc acquired a 40 per cent interest as a tenant in common with two other individuals in 26.923 acres of agricultural land on Trafalgar Road in the region of Halton. This property was purchased by them expressly for the purpose of profiting from its eventual resale since it was designated for future urban development. At all relevant times the property continued to be held by the appellant for such purpose and was not sold in whole or in part. According to Mr. Jellaczyc, this transaction was the only time in recent years that he acquired and held land in his personal capacity, all other transactions of a similar nature having been conducted by him as an employee of George Jellaczyc Real Estate Ltd. and strictly on its behalf.

In reaching his decision, Judge Sarchuk commented at page 2162 (D.T.C. 187):

In the case at bar there was no evidence that the appellant had embarked on a course of dealing contemplated or intended to continue. It was simply an isolated transaction with no continuity of time or operations involved. I find that the appellant was not carrying on a business and the transaction in issue was simply an adventure in the nature of trade. Having regard to the foregoing I conclude that subsection 18(2) of the Act operates to prohibit the appellant from deducting the amounts in issue.

Upon considering both the Jellaczyc, supra and Direnfeld v. M.N.R., [1985] 1 C.T.C. 2200; 85 D.T.C. 172 decisions I can only reiterate the conclusion I reached after reviewing the Guest, supra case: Chatelaine's involvement with the Point Robert Marina was a single activity, a one-time involvement, an isolated transaction, and therefore an adventure or concern in the nature of trade. Given this finding and the definition of "business" in subsection 248(1) of the Act, Chatelaine does not come within the ambit of paragraph 18(2)(c) of the Act, as referred to in subparagraph 18(3)(b)(ii).

Is Chatelaine within the ambit of paragraph 18(2)(e) of the Act? Paragraph 18(2)(e) contemplates land "held primarily for the purpose of gaining or producing income of the taxpayer from the land for that year".

Having regard to the cost of the Point Robert Marina lots and the income produced during the years 1980 and 1981 (zero dollars), it cannot be reasonably said that this land was “held primarily for the purpose of gaining or producing income of the taxpayer from that land” for those years.

With subparagraph 18(3)(b)(ii) in mind, I find that Chatelaine did not "use" or “hold” the Point Robert Marina lots, "otherwise than as described in paragraph 2(c) or (e), . . .”. This means that the appellants (Anstel) "situation" is still within the subparagraph 18(3)(b)(ii) expanded meaning of "interest on borrowed money used to acquire land”. Therefore, subsection 18(2) may still bind the appellant.

However, subparagraph 18(3)(b)(ii) will not encompass the appellant "where the assistance is in the form of a loan to that person and a reasonable rate of interest thereon is charged by the taxpayer". The appellant will "escape" subparagraph 18(3)(b)(ii) if it charged Chatelaine a reasonable rate of interest on the $400,000 loan. Before I can decide whether a "reasonable rate of interest" was charged, I must decide whether any interest at all was charged by Anstel on its loan to Chatelaine.

In his "reduced-to-writing" argument, counsel for the appellant says:

In the alternative, I suggest that Anstel would come within the second exception contained in Section 18(3)(b)(ii) since the business arrangement whereby Anstel was to obtain 40% of the profit realized on the business arrangement would come within the words of that exemption.

It should be noted that the word “interest” is not defined in the Income Tax Act.

I suggest that within the context of the Income Tax Act "interest" includes income participation payments.

I suggest that it is open to a Canadian Court to find a “participation payment" to be interest.

Counsel sums up:

In conclusion, I suggest as an alternative argument that Anstel comes within the second exception in Section 18(3)(b)(ii) since the assistance from Anstel to Chatelaine was in the form of a loan and a reasonable rate of interest was charged by Anstel.

Halsbury states that two requirements must generally be satisfied for a payment to be an amount of interest: (1) there must be a sum of money by reference to which the payment is to be ascertained and (2) that sum of money must be a sum which is due to the person entitled. [1]

The first requirement is not present in the case at bar. There is not a sum of money by reference to which "interest" is to be ascertained. The $400,000 loan was the only “sum of money" present in this whole case. The $400,000 loan from Anstel to Chatelaine was not used as reference for the ascertainment of interest. For interest to have been found in this case, an amount referable to the $400,000 loan would have to have been present. Any potential payment by Chatelaine to Anstel was not going to be a percentage of or in any way related to, the principal sum of $400,000. Any potential payment by Chatelaine to Anstel would be business income to Anstel, not interest income.

I find as a fact that not only was a reasonable rate of interest not charged by Anstel to Chatelaine, no interest whatsoever was charged by Anstel to Chatelaine. The loan in question was interest-free. The appellant is squarely within the wording of subparagraph 18(3)(b)(ii). This simply means that the interest payments the appellant is seeking to deduct are “Interest on borrowed money used to acquire land” so as to bring this case within the ambit of subsection 18(2).

Using the facts in this case, subsection 18(2) reads as follows:

Notwithstanding paragraph 20(1)(c), in computing Anstel’s income from business or property in taxation years 1980 and 1981, no deduction shall be made in respect of any amount paid by Anstel in those years on account of

(a) interest on borrowed money used to acquire land,

if the land cannot reasonably be considered to have been, in the years 1980 and 1981,

(c) used in, or held . . . by Anstel, or

(e) held primarily . . . of Anstel,. . .

I stop at this point to say that since Chatelaine "used and held" the Point Robert lots, and not Anstel, then obviously Anstel cannot avail itself of the exculpatory effects of subparagraphs (c) and (e) above.

Therefore, to give effect to subsection 18(2), since Anstel's gross revenue from the “land” in 1980 and 1981 was nil, no deduction for the interest on the borrowed money may be had by Anstel. The appeal in this respect concerning the amounts of $61,117.93 for 1980, and $28,207.99 fro 1981, fails.

Dealing with the foreign exchange loss of $15,505.47 Vern Krishna, The Fundamentals of Canadian Income Tax: An Introduction Third Edition, (Carswell, Toronto, 1989) at page 363 states most succinctly:

792 Assets that are purchased and sold in foreign currencies may trigger a gain or loss in Canadian dollars. It is important to distinguish between that portion of the gain or loss that is attributable to the intrinsic market value of the asset itself and the portion that is attributable to foreign exchange fluctuations between the time of purchase of the asset and the time of its disposition. The foreign exchange gain or loss is to be accounted for separately from the purchase and sale of the asset. The foreign exchange gain or loss is not an adjustment to the cost of the property acquired or sold.

793 Gains and losses on account of foreign exchange transactions are characterized as capital gains (losses) or revenue gains (losses) and treated according to the rules applicable to each category. Generally speaking, the characterization of foreign exchange gains and losses depends upon the nature of the property that gives rise to the gain or loss. Hence, gains and losses on account of inventory transactions give rise to business income (losses); gains and losses on account of capital transactions give rise to capital gains (losses).

794 Foreign exchange gains and losses on account of income transactions are included in the taxpayer's income according to the general rules contained in s. 9. In contrast, foreign exchange gains and losses on account of capital transactions are governed by the rules in subs. 39(2).

In Ethicon Sutures Ltd. v. The Queen, [1985] 2 C.T.C. 6; 85 D.T.C. 5290 (F.C.T.D.), Cullen, J. commented at page 10 (D.T.C. 5293-94):

To determine whether a foreign exchange pain is to be treated as income or capital, it is necessary to look at the nature of the underlying transaction which gives rise to the gain.

Where the foreign currency was acquired as a result of the taxpayer's trading operations, or for the purpose of carrying on trading operations, any gains will be treated as occurring in the course of the taxpayer's trade and will be treated as income.

In the case at bar, at all material times the appellant's “trading operation" was automobile repairs. The foreign currency loss was not acquired as a result of Anstel's trading operations, or for the purpose of carrying on its trading operations. The loss therefore cannot be treated as occurring in the course of Anstel’s trading operations.

Nor did the loss arise out of the investment of idle funds (Anstel had to borrow the $400,000) or the depreciation of a temporary investment. Therefore the loss cannot be treated as a capital loss.

However, although Anstel's trading operation ("business") did not include the lending of money, the advance to Chatelaine was a speculation made in the hope of profit. Therefore, the transaction should be treated as an adventure in the nature of trade, and the foreign exchange loss sustained in connection with it should be treated as an income loss.

The appeal relating to the foreign exchange loss is allowed and the taxpayer is entitled to a $15,505.47 deduction from income. The appeal with respect to interest deductions is dismissed.

Appeal allowed in part.