Frederick Cromwell and Rose Cromwell v. Minister of National Revenue, [1990] 1 CTC 2438, 90 DTC 1335

Sarchuk, T.C.J.: —The appeals of Frederick Cromwell and Rose Cromwell arise from reassessments made by the respondent with respect to their 1981 and 1982 taxation years. By consent of all parties the appeals were heard together on common evidence.

For several years prior to the years in issue the appellants carried on a farm operation. In 1981 and 1982 they sold standing timber on their farm property, and in their respective income tax returns for those years treated the proceeds from this disposition as being on account of capital. The respondent reassessed, and in so doing included profits from the sale amounting to $21,622.47 and $7,693.34 in each appellant's income on the basis that they were amounts received by them that were dependent upon the use of or production from property, being the sale of certain standing timber from their land and alternatively, on the basis that the sale of the timber was an adventure in the nature of trade.

Mr. Frederick Cromwell (Cromwell) was the sole witness called on behalf of the appellants. He testified that in 1978 he and his wife Rose purchased 196 acres situated on the Kettle River approximately 36 kilometres north of Westbridge, British Columbia. The river divided the property into two parcels, one approximately 54 acres in size, and the other approximately 142 acres. The purchase price was $70,000 or slightly in excess of $350 per acre. Although Cromwell initially spoke of the existence of a mortgage, ultimately it became apparent that the farm had been purchased by way of an agreement for sale. The agreement itself was not produced. Cromwell was not able to recall any of the terms of the agreement although he did respond affirmatively to counsel's leading question suggesting that no portion of the purchase price was designated as being the value of the standing timber. No other evidence on this point was adduced.

The land was described as river bottom and was for the most part covered by standing timber. It had never been farmed. At the time of acquisition approximately 25 acres of the smaller parcel were "rough cleared”. Cromwell said the property was purchased for the purpose of organic farming, principally root crops, with mixed farming to be added in due course to create a balanced farm. Their plans were to utilize the smaller parcel for a residence, stables for the livestock and for root crop production. During the first two years the appellants constructed a modest house, a small barn (using logs from their property) and began preparing the balance of the 25 acres for seeding, a difficult task because the rough clearing had been poorly done. In 1979 they first seeded a small portion and in 1980 began raising some sheep and pigs. By that year as well they had most of the 25 acres fenced to protect it from range cattle which foraged on adjoining open Crown land.

The larger parcel was utilized for cattle although for a number of reasons the appellants never ran more than 14 or 15 head. According to Cromwell approximately 80 acres of the larger parcel consisted of good flat ground which he intended to put into production for pasture and hay land. To do so it was necessary to remove the standing timber. Shortly after purchasing the land Cromwell had been approached by Bill Bosovich, a neighbour's son, who owned equipment suitable for land clearing and was available for such work. In 1981, having determined to proceed, Cromwell called Bosovich to make the necessary arrangements. Although his evidence is unclear and imprecise as to the sequence of events at some point of time he and Bosovich examined the 80 acres to be cleared. Then on September 17, 1981 Cromwell entered into a contract with Crown Zellerbach Canada Limited for the removal of the timber (Ex. A-1). It is difficult to ascertain from Cromwell's evidence how this arrangement came about and what relationship existed between Bosovich and Cromwell. There is no question that Bosovich’s involvement was substantial and it is fair to say that with respect to the Crown Zellerbach agreement it is likely that the arrangements had been made by Bosovich on behalf of Cromwell.

By this agreement Crown Zellerbach agreed to purchase an estimated volume described as “500 cun its" of saw logs at $82 per "cun it". The agreement contained a direction to Crown Zellerbach to deduct from the payments due to Cromwell the amount of $52 per "cunit" and to pay it to Bosovich for logging and hauling. The term of this contract was September 17, 1981 to December 31, 1981.

At some point of time Crown Zellerbach decided that it did not wish to take any more timber. According to Cromwell, Bosovich ”. . . lined up another contract with another mill to take the remaining amount of trees from that land". Cromwell maintains that once the clearing started his involvement was supervisory to ensure that Bosovich stayed within the limits chosen by him.

The appellants’ arrangement with Bosovich did not end with the removal of the standing timber from the 80 acres since he had agreed to return with his equipment to push up the stumps and to burn the brush. This was to have been completed after Cromwell received the sale proceeds and was in a position to pay Bosovich for the work still to be performed. The logging was completed in 1981, and Cromwell and his wife received most of the proceeds in that year. However, bad weather and flooding delayed the clearing until 1982. According to Cromwell before Bosovich was able to commence clearing the vendor of the farm property, apparently acting pursuant to the terms of the agreement for sale, claimed some or all of the proceeds of the disposition of the standing timber. Cromwell described this event as follows:

And then, apparently, the man that owned, held the mortgage on the farm, since we'd taken off an asset he wanted his mortgage paid for. So, we took the money that was supposed to go for the rest of the cleaning [sic] and paid it on the mortgage.

Cromwell and his wife paid him an unspecified amount without consulting counsel or obtaining any other advice. He was not able to explain this transaction any further other than to say that he believed that the "mortgagee", as he described him, had the right to the proceeds from the sale of the timber.

The issue in this case turns on the applicability to the transaction of the provisions of paragraph 12(1)(g) of the Income Tax Act (the Act) which read:

12(1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:

(g) any amount received by the taxpayer in the year that was dependent upon the use of or production from property whether or not that amount was an instalment of the sale price of the property (except that an instalment of the sale price of agricultural land is not included by virtue of this paragraph);

Counsel submitted that the appellants acquired the property solely for the purpose of conducting an organic and mixed livestock farm. They had no other interest in the property, did not at any time discuss or otherwise consider the value of the standing timber, nor was any portion of the sale price attributed to it. Furthermore, their activities on the property from the time of its acquisition demonstrated continuing efforts to develop a farm along the specialized line intended at a pace in keeping with their restricted financial means. Counsel submitted that the appellants had not purchased the property with an intention of logging the standing timber and it was only their desire to clear an additional 80 acres to provide for pasture land and the cultivation of hay which led to the discussions with Bosovich and the fortuitous financial arrangements with Crown Zellerbach.

Counsel contended that the appellants became involved in an isolated transaction whereby they sold standing timber in order to clear land for farming. Since the removal of the timber and its sale was incidental to their farming operation the appellants were entitled to classify the proceeds for income tax purposes as proceeds of disposition of a capital asset. It could not be said that the amounts received by them were dependent upon the use or production from property so as to bring into operation the provisions of paragraph 12(1)(g) of the Act. Counsel relied on Israel Hoffman v. M.N.R., 39 Tax A.B.C. 220; 65 D.T.C. 617; T. W. Mouat v. M.N.R., 20 Tax A.B.C. 424; 58 D.T.C. 694; 32 Tax A.B.C. 269; 63 D.T.C. 548 and W.F. Farrell et al. v. M.N.R., [1985] 1 C.T.C. 2429; 85 D.T.C. 706.

Counsel for the respondent submits that the issue before this Court is not whether the proceeds are to be categorized as a capital receipt or an income receipt, and that the intentions of the taxpayer were of marginal significance in the determination to be made. He urged the Court to find that the respondent's assessment was consistent with the principles outlined in Lackie v. The Queen, [1978] C.T.C. 157; 78 D.T.C. 6128 (F.C.T.D.); [1979] C.T.C. 389; 79 D.T.C. 5309 (F.C.A.) and M.N.R. v. Lamon, [1963] C.T.C. 68; 63 D.T.C. 1039. With respect to a more recent decision, The Queen v. Mel-Bar Ranches Ltd., [1989] 1 C.T.C. 360; 89 D.T.C. 5189 counsel suggested that it was distinguishable on its facts and that a statement made by the Court in Mel-Bar which distinguished, within the framework of paragraph 12(1)(g), situations which dealt with removal of material other than timber, in particular sand and gravel, was both obiter and not necessary to the judgment.

At the outset I am constrained to note that some of the submissions made on behalf of the respondent with respect to Mel-Bar might more properly have been made in an appellate forum.

The facts in Mel-Bar are summarized in the headnote [at D.T.C. 5189] as follows:

The corporate taxpayer owned a 2,200-acre piece of land on which it carried on a cattle ranch operation. Pursuant to the terms of a log purchase agreement between the taxpayer and H. Ltd., entered into on April 12, 1979, the latter agreed to pay the taxpayer for 25,500 tonnes of fir at a price of $11.85 per tonne on the stump.

H. Ltd. was to cut and remove the entire 25,500 tonnes from the taxpayer's land, at its expense, prior to December 31, 1979, which it was unable to do. An extension agreement entered into early in 1980 permitted H. Ltd. to continue cutting up to the 25,500 tonne limit, albeit at an increased price of $1 per tonne, until June 30, 1980. In June of 1980, the taxpayer terminated the agreement because the logging operations were interfering with its cattle ranch operation. At this point, H. Ltd. had cut and removed the entire 25,500 tonnes, but it paid the taxpayer during 1979 and 1980 a total of $294,134 for the logs which actually were cut and removed. The taxpayer initially included the amounts comprising the $294,134 in its business income for its 1979 and 1980 taxation years, but was advised by its accountant to treat those amounts as capital receipts, which was done. The Minister reassessed the taxpayer, adding the amounts back into income either as business income, or, as amounts "dependent upon the production or use of property" which, under s.12(1)(g), are required to be categorized as income.

In the course of his judgment, Strayer, J. stated at page 361 (D.T.C. 5191):

There is, at the outset, a certain probability that an isolated sale of all marketable timber on property to improve land or maximize its value will not be regarded as yielding an "amount . . . dependent upon the use of or production from property".

and in a footnote referred to the cases of Mouat and Hoffman. Strayer, J. then went on to say:

. . . there is at least some authority that paragraph 12(1)(g) only applies to revenues from use or production of a continuing nature.,

and in this context referred to Lackie, a decision of Dubé, J. It is these quotations which counsel for the respondent suggested were both obiter and inconsistent with the ratio in Lackie.

With respect to his contention that paragraph 12(1)(g) of the Act was misconstrued in Mel-Bar counsel argued that the amounts received by the appellants in the taxation years in issue were dependent upon the use of or production from their property and by virtue of the provisions of subsection 12(1) were required to be included by the appellants in computing their income. If I understood counsel correctly this "requirement" is referable to production or use in the broadest, most untrammelled sense. He said

Its not dependent on production or use over recurring intervals or recurring periods, or carrying on business, or having any sort of rental or royalty agreement. Those are caught by other sections of the Act. There is a specific section dealing with royalties. There is a specific section dealing with business and property income.

Counsel further submitted that the respondent's position was consistent, not only with Lackie, but also with the decision of Mr. Justice Cameron in Lamon, in which it was held that the amounts received by the taxpayer for the sale of gravel were taxable under the provisions of paragraph 6(1)(j) (the predecessor of 12(1)(g) ) and that the taxpayer had embarked on a scheme of profit making and engaged in an adventure in the nature of trade. The rationale of this judgment, according to counsel is that where an amount was dependent upon the number of cubic yards of gravel removed from the premises, that, by virtue of itself, constitutes use of or production from the property and brings it within the definition of paragraph 12(1)(g) of the Act. Counsel argued that there is no distinction between the facts found in Lamon and the facts at Bar and that any distinction based on removal of gravel as opposed to removal of timber is inconsistent with the provisions of the Act (12(1)(g) ).

While the language of paragraph 12(1)(g) is not, in my view, strained by the interpretation placed upon it by the respondent, the position advanced thereby is not consistent with the decisions cited by counsel, in particular Lackie and Mel-Bar, both of which are binding upon this Court. I have considered and reviewed, in the context of these submissions, Lamon, Lackie and Mel-Bar. The facts in Lackie are distinguishable from the Cromwell appeals, while those in Mel-Bar bear a marked similarity. In so far as Lamon is concerned I note that this decision as well as the decision in Smethurst (H.M. Inspector of Taxes) v. Davey (1957), 37 T.C. 593 (a case referred to by Cameron, J. in Lamon) were considered by Dubé, J. I am satisfied, even though Lackie deals with sand and gravel rather than timber, that the guidelines enumerated by Dubé, J. clearly assist in the interpretation of paragraph 12(1)(g) of the Act and are in my view applicable in this appeal. From page 163 (D.T.C. 6132) of Lackie I quote:

Several useful guidelines emerge from the decisions above referred to. Where property is sold for a set sum to be paid in fixed instalments, those payments are not income. If it is sold for a share of the profits, the payments then bear the character of income, and so would annuities and royalties. If property is sold for a sum certain, plus annual sums dependent on the volume of business, those annual sums would be income. But, if what is sold relates to the use of land, including excavation for gravel, that is a profit a prendre, thus taxable income, whether or not the sale is considered to be a “business” (under the provisions of the old paragraph 139(1)(e) or the new subsection 248(1). Profit à prendre implies a continuing license, or continuous right to use land: a single final transaction transferring all the property (i.e. gravel) would not be a profit à prendre.

I should think that if plaintiffs spouse had sold all the gravel, whether the amount agreed upon had been paid in one lump sum, or by instalments, that would be described as a transaction in the nature of capital (It is common ground that she was not in the business of selling gravel). But we are faced here with the sale of some gravel over a continuous period, the use of land and a profit à prendre over more than five years. The agreement does provide a minimum of $50,000, but no maximum. Neither can it really be said that the agreement and the benefits derived therefrom are not dependent upon the volume of business: to recall the words of Rowlatt, J. in Jones v. Commissioners of Inland Revenue (supra), the vendor "took something which rose or fell with the chances of the business”. True, the amounts could not fall below a certain floor, but above that, they could rise and fall, and in fact did rise and fall during the first part of the schedule.

[Emphasis added.]

I am not convinced that counsel's submission regarding the "inconsistency" between Lackie and Mel-Bar is correct. Dubé, J. reviewed a number of earlier decisions in which paragraph 6(1)(j) of the Act (the predecessor of 12(1)(g) ) was considered, including Mouat and Hoffman. Indeed Dubé, J. quoted the definition of “profit à prendre" provided by J.O. Weldon, Q.C. in Hoffman and subsequently incorporated that definition into his guidelines. Given Strayer, J.'s comments earlier quoted, and his ultimate conclusion that the sale was a one time sale of a finite amount of timber and that took it out of the purview of paragraph 12(1)(g), there appears to be no distinction in principle between these judgments.

Since they are binding authorities it only remains to me to determine whether the facts support a conclusion that the sale of timber by the appellants in the years in issue was a single final transaction transferring all the property rather than the sale of an indefinite amount of timber over a continuous period.

Counsel for the respondent submitted that the transaction in this appeal can be distinguished from the facts found by Strayer, J. in Mel-Bar. The position is succinctly stated by counsel as: "Once the taxpayer enters into an agreement to have timber removed at a per unit price, at a unit of measurement, that puts it within the definition of paragraph 12(1)(g)". He contended that the contract between Crown Zellerbach and Cromwell was not a fixed price agreement because "We have an amount that is paid depending on the use or production of the property. How much timber they cut down resulted in how much money the taxpayer will get." The result of this was "a periodic payment rather than a lump sum". Counsel contrasted Mel-Bar where, according to him, a lump sum price for a finite quantity of product existed, more specifically 25,500 tonnes of fir at a price of $11.85 per tonne.

I do not agree. Although much of the testimony given by Cromwell was unclear and imprecise and no more than marginally relevant to the issue before me I am reasonably satisfied of the following. To expand his farm operation Cromwell determined to take off the standing timber from an 80- acre portion of his farm and to that end, with Bosovich's assistance, clearly delineated the area. He then contracted with Crown Zellerbach for the sale of a number of logs estimated at 500 "cunits", all bearing the timber mark H.H. 100. I inferentially conclude from Cromwell's evidence that “walking the area" with Bosovich was the basis for this estimate. The price was fixed on a per "cunit" basis. The term of the contract was from September 17, 1981 to December 31, 1981. It is also a fact that Crown Zellerbach terminated the agreement prior to taking the 500 "cunits" contracted for, as it was entitled to do pursuant to the contract, and that Cromwell sold the remaining timber on the 80-acre parcel to another purchaser. I find nothing inconsistent in Cromwell’s conduct in this regard.

On the evidence I am satisfied that the appellants must succeed. I am not able to distinguish the Cromwell situation from that found in Mel-Bar in respect of which Strayer, J. stated at pages 362 and 363 (D.T.C. 5191 and 5192):

This was a one-time contract for the removal of timber in a specified area within a specified time. It was eminently reasonable that the purchaser should pay, and the defendant should receive, a price related to the amount of usable timber actually cut and removed in the fulfilment of the objective of removing timber. . . . Recognizing the difficulties of estimating quantities available this precisely, the price was fixed at a rate per tonne actually cut. But the main focus throughout was the objective of getting all usable timber removed from the area designated within the time specified. That the defendant realized some undoubtedly welcome proceeds from the clearing of its land for grazing does not make those proceeds revenues "dependent upon the use of or production from property" in my understanding of the jurisprudence.

These comments apply to the facts before me. I am satisfied that the Cromwell-Crown Zellerbach agreement provided a fixed price for a fixed quantity of timber to be taken within a fixed period of time. Accordingly the appeals are allowed and the matter is referred back to the respondent for reconsideration and reassessment in accordance with these reasons.

Appeals allowed.