Hypark Investments Ltd. v. Minister of National Revenue, [1990] 2 CTC 2254, 90 DTC 1752

Teskey, T.C.J.:— The appellant appeals from the reassessments dated August 24,1987 for the years 1984 and 1985.

Issue

The broad issue is whether the appellant was trading in real estate. If the appellant was not trading in real estate, then the narrow issue is whether the appellant is deemed to be trading since it held a small minority interest in an investment when the majority interests were trading.

Facts

The appellant acquired an undivided 5.56 per cent interest of a shopping centre called Chaparral Plaza in Scottsdale, Arizona.

There were eight participants in this adventure as listed together with their percentage of participation:

Mr. Linhart, a principal of Lakeview Properties Ltd. (Lakeview), introduced the project to the appellant. Lakeview was the manager and developer of the project. Linhart, through Lakeview, over a number of years, introduced the appellant to several long-term investments that it entered into, some of which it still owns. The appellant, besides discussing the project with Linhart, a neighbour, received a letter from Lakeview dated May 27, 1980. The important portions are:

Re: Chaparral Plaza

Scottsdale, Arizona

The project is a 71,000 square foot shopping plaza located in a prime area in Scottsdale.

The plans call for the sale of three Pads to individual users and I am enclosing a Pad sale activity report to provide an indication of the type of purchaser-user we are considering.

As mentioned, we feel that this project is an ideal investment for long term appreciation and for that reason we are retaining 33 /3%.

The main attractions of the investment are:

(a) Excellent location.

(b) A long term mortgage of $3,100,000 at 10 /4% with a 15 year term and a 30 year amortization. This mortgage is extremely attractive, not only because the rate is well below the current market, but more so because the indications are that when the institutional lenders re-enter the mortgage market when interest rates settle down, the rates will settle at a level higher than 10 /4% and terms will likely be limited to 5 years rather than 15 years.

(c) Strong anchor tenants.

(d) Opportunity for rapid increase in return on investment by virtue of inflation and participation clauses. Percentage rent participation clauses have already been incorporated in the leases that were signed with the anchor tenants. Bayless Supermarkets pays 3/4 of 1% of gross sales in excess of $13,090,000 and Revco pays the amount by which 212% of annual gross receipts exceeds the fixed rent of $2,746 per month. The standard form lease for the satellite shops contains percentage rent provisions and where percentage rents are not applicable a cost of living escalator is included.

Lakeview Properties Ltd. is acting as developer of the property and all development activity is under the direct supervision of our Phoenix associate, Mr. Jim Kiely. Our subsidiary, Lakeview Properties of Arizona Inc., is the manager of the property and our fee for acting as developer and supervising the initial lease-up, has been included in the budget and as indicated previously, a portion of your purchase price would be allocated to the latter services.

If you decide that you are interested in proceeding with this investment we will provide you with a Co-Tenancy Agreement and related documentation in form similar to the documentation you executed in connection with Gateway Court in Phoenix. You indicated that you felt the $500,000 investment for a 1/3 interest was larger than you would normally entertain and we will consider making available an interest of approximately 11.11% in the project for $166,667.

[Emphasis added.]

The parties entered into a co-tenancy agreement dated June 2, 1980. The pertinent parts are:

And Whereas construction on the Lands of a shopping centre, comprising approximately 70,950 square feet of leasable area, has commenced and the parties have agreed to complete such construction and to hold the lands and shopping centre (hereinafter collectively called the "Property" for investment purposes);

The Co-Tenants intend to develop the Project for investment purposes, and have entered into this Agreement to confirm that undertaking.

(a) Meetings of the Co-Tenants may be held in Winnipeg, Manitoba, and shall be held:

(i) if Co-Tenants owning at least sixty-six and two-thirds (66 A%) per cent of the Property are present in person or represented by proxy

(c) Co-Tenants owning and/or representing by proxy at least sixty-six and two- thirds (66 A%) per cent of the undivided interests in the Property shall constitute a quorum.

Each Co-Tenant shall be entitled to one vote for each one-half of one-ninetieth (1/90th) interest owned by such Co-Tenant, and except as otherwise herein provided all decisions at meetings of Co-Tenants at which a quorum is present shall be decided by three-quarters (3/4) of the undivided interests in the Property present or represented at the meeting. Procedures at meetings need not be formal.

3:07 The purpose of this Co-Tenancy is to be limited strictly to developing, owning, operating and maintaining the Property as an investment for the production of income.

Equity Contributions

4:02 (a) Each of the Co-Tenants agree to provide in cash its Proportionate Share of the required initial contributed equity based on an estimated total cost for the development of the Property as submitted by LPL and approved by the Co-Tenants in accordance with the terms of this Agreement.

(b) It is acknowledged by each of the Co-Tenants that from time to time following the date of execution hereof that the initial contributed equity may be insufficient to meet the cash requirements of the Property. In such case, the Co-Tenants shall advance in proportion to their respective undivided interests, such additional amounts as may be required to retire in an orderly fashion the obligations of the Property.

Sale of the Whole Property

6:07 (a) In the event that during the currency of this Agreement, a Bona Fide Offer to purchase the whole of the Property is received, then the recipient of such offer shall forthwith give notice thereof to the other Co-Tenants and a special meeting of the Co-Tenants shall be called upon the request of any Co-Tenant if made within three (3) days from the date of notice of the receipt of such offer.

. . . those Co-Tenants owning at least sixty-six and two-thirds (66 /3%) per cent of the Property as represented by the aggregate of their undivided interests therein, must vote in favour of the sale at such meeting. If such favourable vote is obtained, all of those Co-Tenants opposed to the sale shall have the opportunity together of purchasing the interest of those Co-Tenants who voted in favour of such sale on terms and conditions similar to those contained in the offer amended only to reflect the difference in the undivided interests sold, free of all other provisions of this Agreement, provided. . .

[Emphasis added.]

By year end 1980, the plaza was being prepared for opening and by year end 1981, 92.5 per cent of the plaza was leased.

The last two paragraphs in an updating memorandum from Lakeview to the investors dated December 16, 1981 stated:

Possible Sale of Project

We have received some indication of interest from prospective buyers and have prepared a brochure outlining the project features for sale purposes. We would not entertain a sale proposal at this time unless it produced for investors, a return on average net invested equity in excess of current borrowing costs. A sale proposal would provide for the pads to be retained for future sale.

Summary

This is a very attractive project situated in an excellent retail location. The fact that the project is in a positive cash flow situation when the retail markets in general are suffering, is a very good sign. We are also fortunate to have the 10 /4% mortgage which adds considerably to the value of the project.

The appellant says this was the first indication or mention of a possible sale of Chaparral Plaza and that Ms. Berkowitz was indignant and told Linhart that she was not interested in a sale.

The next time a sale came up was in a further memo to the investors dated May 4, 1982 which says:

Re: Possible Sale of the Project

Attached is an offer to purchase a 60% interest in the project from Paine Webber Properties. You will note from the letter that I have indicated to Paine Webber that we would not be able to accept this offer, because the price is too low. I did want to send the letter to you to indicate the type of deal that is available in today's market. Also, I think we would recommend to you that the offer be accepted if the price were higher, say $1,300,000 net. This level of pricing would return a substan- tial amount of the equity to the investors and would also give them the opportunity to participate in future growth of the project. There are some other items in the letter that we would want to negotiate, but generally the concept appears favourable to us. If you have comments please call me.

Ms. Berkowitz was surprised that a sale was still being pursued and she advised Linhart of her dissatisfaction.

A further memorandum to investors dated February 22, 1983 which besides updating the investors on leasing and accounting had as the final two paragraphs the following:

Equity Requirements

I would refer you to Exhibit B which notes capital expenditures . . . Also, unless a sale is arranged for the final pad, we will be obligated to repay the Mercantile Bank loan in June of this year. This will require an equity call. If a . . . further extension can be negotiated, but at the time of the last extension the Bank was very clear that they would not look favourably on any further extensions. We will keep you advised of our progress in negotiating any sale.

Sale and/or Refinancing

We are currently discussing the possibility of secondary financing on the project with a Canadian Bank. Negotiations are in the preliminary stages, but we are discussing a "bowtie" loan, which is a loan structured with a fixed rate of interest payable currently, with the difference between this rate and the Bank’s floating rate being capitalized and paid at maturity of the loan. The loan amount being discussed is in the range of $700,000 to $1,000,000.

We also continue to provide information to other various interested parties with respect to an outright sale of the project, or the sale of a partial interest, but there are no serious negotiations underway at the present time. We will keep you advised of any sale and/or refinancing developments.

[Emphasis added.]

A further memorandum to investors dated August 3, 1983 contained the following:

Memorandum to Investors—Chaparral Plaza

Re: Project Update

Second Mortgage Financing

We continue to pursue various sales and/or refinancing opportunities but have nothing specific under negotiation at this point in time. We are receiving numerous purchase enquiries and are discussing a price in the $6,000,000 range with any interested parties.

By a memorandum to investors dated October 13, 1983, Lakeview advised that a sale had been negotiated. The relevant portions of this memo are:

October 13, 1983

Memorandum to Investors—Chaparral Plaza

Re: Sale to Evans or Nominee

Enclosed please find the following:

1. Notice of meeting pursuant to paragraph 6.07 of the Co-Tenancy Agreement.

2. Copy of Escrow Instructions re sale to Evans.

The commercial terms of this sale are as follows:

Price: $6,000,000

In order to protect the co-tenants’ interest in the property, we feel that a 1% fee would not be sufficient and are requesting that the co-tenants provide us with an additional 1% management fee to compensate us for our work in co-managing the property. Also, there is no fee payable to Lakeview for negotiating this sale and this would normally be a part of any transaction.

2. The sale price is attractive and we believe it represents a price above the current market. Part of the reason for this higher price is based on the fact that the purchaser is very anxious to trade into a property and defer tax.

3. The investors are realizing a substantial capital gain and the overall return including tax benefits will have been most attractive for the time the monies were invested.

You should note that a portion of the payment of this tax can be deferred and in fact there may be no tax payable depending on the investor's individual circumstances and other real estate shelter available.

[Emphasis added.]

Ms. Berkowitz was disappointed in this sale, briefly considered buying the other interests in the project herself then discarded the idea. She made no attempt to block the sale or to put together a group to take over the project.

The sale was duly completed. Lakeview reported as income its portion of the gain.

The Minister in his reply assumed that the appellant purchased a 6 per cent interest in a limited partnership in 1983 in the Norcal Building in Denver, Colorado which was sold in 1984. Although the appellant reported the gain as a capital gain and filed an objection to its reassessment, Ms. Berkowitz acknowledged that the Norcal Building was originally purchased for the purpose of quick resale at a profit and that money made on the sale represented income, the appellant has withdrawn its objection to the reassessment.

The Minister also in his reply assumed:

(1) the developers of both the Norcal Building and Chaparral Plaza projects were involved in the real estate business and had reason to believe that the properties could be resold at a profit;

(o) an operating motivation at the time of the acquisition of the said Chaparral Plaza project was the intention of the other participants in the Chaparral Plaza project to turn in property to account and to resell it at a profit.

Analysis

The test whether a taxpayer is trading as opposed to making a capital investment is objective. Intention alone does not determine what a taxpayer's acts amount to and in some cases the taxpayer's intention can be negated by the facts, M.N.R. v. Lane, [1964] Ex. C.R. 866; [1964] C.T.C. 81; 64 D.T.C. 5049. Since counsel for the respondent advised the Court that he took no issue with the credibility of Sharon M. Berkowitz, the president and sole shareholder of the appellant, I am satisfied that neither she nor the appellant did anything that could negate the stated intention.

The latest reported decision dealing with income v. capital gain is the Federal Court-Trial Division decision of Grouchy (F.) v. Canada, [1990] 1 C.T.C. 375; 90 D.T.C. 6267 released March 28, 1990. Although this decision is easily distinguished on its facts, there are some significant similarities. Like Martin, J., I have come to the conclusion (based on Ms. Berkowitz's investments both before and after the Chaparral Plaza investment and because of the admission of counsel for the respondent) that her intention has always been to acquire an interest in real estate as an investment. In this instance, the appellant's operating motivation for entering into the Chaparral Plaza investment was to make a long-term investment in a commercial rent producing enterprise. The Court therefore finds as a fact that when Ms. Berkowitz caused the appellant to invest into the Chapparal Plaza project, it did so for the sole purpose of making a long-term investment.

With the respondent accepting the evidence of the appellant, the narrow point to be determined is whether the appellant on entering into a joint venture with only a small percentage (in this case 5.5556 per cent) that its intention (which was to enter into a long-term investment) was suppressed in favour of the intention of the majority (which was to sell at a profit).

Because of the appellant's previous experience with Linhart, namely several minority holdings in real estate which had been held for periods of 5 to 15 years, Ms. Berkowitz had no reason to believe that this project would be any different from those past projects put forth by Linhart. She is not guilty of wilful blindness or lack of knowledge. She, from her previous experience, knew that Lakeview could deliver a long-term investment in line with her investment philosophy as known by Linhart. Besides having long conversations with Mr. Linhart, the introduction letter and co-tenancy agreement all speak only of a long-term investment intention.

Notwithstanding that the operating motivation at the time of acquisition of the Chaparral Plaza project of the other participants was to resell at a profit, the appellant did not know about this intention and there was no reason for Ms. Berkowitz to be suspicious about Lakeview's true intentions. Ms. Berkowitz was not wilfully blind and the Court finds (partially on the basis of the admission of counsel for the respondent) that under all the circumstances of this case she made all necessary enquiries as to the intention of the majority because of her past association with Mr. Linhart.

Counsel for the appellant has suggested that this case is distinguishable from three decisions, namely:

Wright (J.E.) v. M.N.R., [1990] 1 C.T.C. 2477; 90 D.T.C. 1265,

Stroz (J.F.) v. M.N.R., [1990] 1 C.T.C. 2417; 90 D.T.C. 1271, and

Mohawk Horning Ltd. et al. v. The Queen, [1986] 2 C.T.C. 89; 86 D.T.C.

6297.

This Court must determine if Mohawk is authority for the proposition that it is the intention of a consortium as a whole that must subsume that of the individuals in all circumstances.

In Mohawk all the members of the consortium had the original intention to purchase the land on income account. After purchase and during the planning stage, the appellant had a change of intention and dealt with the asset as a capital asset. The Court found that there was no evidence available to show that there was a changed intention of the remainder of the group and therefore it could not find a changed intention by the group as a whole. The Court also found that a Mr. Schneider, the controlling member behind the appellant Mohawk, was not the directing mind behind the consortium.

The Court then said at page 98 (D.T.C. 6304) after accepting these facts:

. . . the question then becomes whether a change of intention by one member of a consortium [Schneider] can be given effect to in the determination of the taxability of his profits or is it the intention of the consortium as a whole which must prevail in such a determination. I am of the opinion that it is the intention of the consortium as a whole that must subsume that of the individuals.

When a group of persons participate in the acquisition and disposition of property, the character of the gain realized by one person may be different from the character of the gain realized by the other persons in the group. My authority for this is The Queen v. Elmer D. Bassani, [1985] 1 C.T.C. 314; 85 D.T.C. 5232.

The Court herein is not dealing with a situation where there are active participants and passive ones. Lakeview at 30 per cent was the only active participant. All others were only passive investors in the Chapparal Plaza. Winnipeg Photo Ltd. one of the participant investors held a greater percentage than Lakeview. At all times, the passive investors could outvote Lakeview. Under the facts herein, Lakeview did not have carte blanche authority to handle the business of the syndicate. This separates the facts of this case from the dicta of:

Rothenberg v. M.N.R. (1961), 28 Tax A.B.C. 53; 61 D.T.C. 637; affd [1965] 1 Ex.

C.R. 849; [1965] C.T.C. 1; 65 D.T.C. 5001

Ettie Wiss v. M.N.R., [1972] C.T.C. 264; 72 D.T.C. 6231.

Stanley W. Carr v. M.N.R., [1965] C.T.C. 334; 65 D.T.C. 5201.

I believe that the facts of this case are so dissimilar from Mohawk, Stroz and Wright that what appears to be a general principle of law does not apply to this case. This is particularly so when the Court considers that the appellant had made several prior long-term investments with Lakeview or Linhart as the developer. A review of her personal and corporate portfolio shows that Ms. Berkowitz has invested in some 24 real estate projects of which only one was purchased for resale, all the remaining 23 were purchased as long-term investments and were held for many years, some for periods exceeding 15 years. From the evidence submitted, her basic investment philosophy appeared to be and still is, to invest in long-term income producing projects. Ms. Berkowitz believed that she was causing her company (the appellant) to make a long-term investment and that the intention of the syndicate was to make a long-term investment. She was not guilty of intentional blindness nor of not making proper enquiries. She did not want the plaza sold nor did she consent to the sale. The terms of the co-tenancy agreement allowed the others to override her desires. Her original intention never changed. The sale clause in the cotenancy agreement is a standard clause in this type of agreement and in this case does not weaken or take away from the appellant's case. The written documentation points to a long-term investment. Therefore, even though the appellant did not attempt to rebut the respondent's assumptions (I) and (o) as set out above her intentions are not suppressed by the majority.

Decision

For the reasons set out above, the appeal is allowed and the reassessments are referred back to the Minister for reconsideration and reassessment on the basis that: Firstly the appellant's gain on the sale of its interest in the Chaparral Plaza is to be treated as a capital gain and, secondly on consent to the extent of $8,373 in 1984 and $24,859.25 in 1985 amounts previously characterized by the Minister as foreign business income ought properly be characterized as foreign investment income.

The appellant is to have its costs on a party-to-party basis.

Appeal allowed.