William Bell, Fred McCullough, Renee Makino v. Minister of National Revenue, [1989] 1 CTC 2272, 89 DTC 165

Mogan, T.C.J.:— The appeals of William Bell, Fred McCullough and Renee Makino were heard together on common evidence. These three appellants participated with four other persons in the ownership of certain property (land and building) which was purchased and sold within a short period of time. The only issue in each appeal is whether the gain realized upon the sale of the property was a capital gain or business income arising from an adventure in the nature of trade.

Messrs. Bell and McCullough testified on their own behalf. Renee Makino did not testify but her husband, Kenji Makino, appeared as a witness on the basis that his wife’s intentions with respect to the property were identical with his own. He was the agent of his wife in deciding whether to participate in the purchase of the property and whether to sell it. Renee Makino was, however, the beneficial owner of the portion of the gain allocated to her; and there was no question of attribution of her portion of the gain as between husband and wife.

The property in question was located at 290 Carlingview Drive in the Borough of Etobicoke, approximately two miles from the Toronto International Airport, within an area which was zoned and developed for industrial use. The land comprised 2.3 acres with 250 feet of frontage on Carlingview Drive and 400 feet of depth. The building was of brick, block and steel frame construction containing 50,600 square feet for industrial use and 3,600 square feet for office use.

The property which was owned and occupied in 1980 by Acmetrack Limited ('Acmetrack") was offered for sale in the summer of 1980 because Acmetrack had purchased another site on which it was constructing a building which was expected to be completed in March 1981. On September 12, 1980 an agreement of purchase and sale was signed by Acmetrack as vendor and Messrs. William Bell (one of the appellants) and Dean Morrison as purchasers. That agreement included the following provisions:

(a) the purchase price was $1,155,000;

(b) the transaction was to close on April 15, 1981;

(c) the title on closing was to be free from all encumbrances; and

(d) upon acceptance of the offer, the Purchaser had the right to erect a sign offering the property for lease.

When the transaction closed on April 15, 1981, the three appellants and four other parties were registered on title as the seven co-owners with the following respective participating interests:

A $50,000 deposit was paid on behalf of the purchasers in September 1980 when the agreement of purchase and sale was signed. There was no mortgage on the property at the time of closing and so it was a cash transaction. Upon closing each purchaser was required to pay $118,410 for each 10 per cent interest, less any amount previously paid as a deposit.

William Bell, Fred McCullough and Kenji Makino (husband of the appellant, Renee Makino) were experienced real estate agents with the firm of A.E. LePage as it was known in 1980. Bell had joined LePage in 1976; McCullough had joined in 1968 and Makino had joined in 1973. Dean Morrison, the other person who had signed the purchase agreement in September 1980 was also a real estate agent with LePage. These four men were engaged in the sale and leasing of industrial and commercial real estate as opposed to residential real estate; and so the subject property fell within their area of special knowledge.

The other co-owners who were not appellants became participants through their personal connections with either William Bell or Fred McCullough. Kenneth Brown was a friend of Mr. Bell; John Burke was a friend of Mr. McCullough; A.S. Kingsmill was the lawyer for the group; and Melmart Holdings was a holding company for the Martin family who were friends of Mr. McCullough.

A seven-page agreement was signed on July 6, 1981 under which the appellants and the other four co-owners sold the subject property for $1,500,000, with the closing date set for August 5, 1981. Upon the sale of the property, the co-owners realized a net gain (after all expenses related to the purchase and sale) of $234,230 allocated as follows:

It is the portion of the above gain earned by the three appellants that is the subject of these appeals. The appellants claim that, when purchasing the property, their only intention was to hold it as a long-term investment. The respondent claims that the appellants, at the moment of purchase, were motivated to acquire the property at least in part by the possibility of resale for profit.

Counsel for the respondent referred to the occupation of the appellants Bell and McCullough (and the occupation of Renee Makino's husband) as experienced real estate agents; and he argued forcefully that it is more difficult for such persons to achieve a capital gain upon the purchase and sale of real property than it is for other persons whose occupation is not linked to the real estate market. In support of that proposition, he cited the decisions in Kostiner v. M.N.R., [1978] C.T.C. 3063; 78 D.T.C. 1746, and Methner v. M.N.R., [1979] C.T.C. 2085; 79 D.T.C. 131. In my view, the proposition is well-founded.

A person who is engaged in the business of buying and selling or otherwise dealing in a particular kind of property, real or personal, has special and perhaps expert knowledge of the market with respect to that property. When such a person makes a purchase within the market where he has special knowledge derived from his occupation and then sells the purchased property shortly thereafter, there is a strong probability, if not a presumption, that his decision to buy was motivated at least in part by his ability and hope to resell at a profit. If the thing that is purchased is the kind of property not normally held for investment purposes as in M.N.R. v. Taylor, [1956-60] Ex. C.R. 3; [1956] C.T.C. 189; 56 D.T.C. 1125, and The Queen v. Anderson et al., [1973] C.T.C. 606; 73 D.T.C. 5444; [1974] C.T.C. 838; 74 D.T.C. 6645, it is very difficult to conclude that the purchase was on capital account and that a profit resulting from a quick resale was a capital gain. But if the thing that is purchased is the kind of property normally regarded as an investment to a long-term owner (i.e. rental real estate or listed securities), it is less difficult to conclude that the purchaser with special knowledge of the particular market was motivated in his purchase only by investment criteria. In such cases, the sworn statements of the purchaser as to his intention would have to be weighed carefully with all of the admissible evidence which is in any way relevant to the issue of intent. See Power v. The Queen, [1975] C.T.C. 580; 75 D.T.C. 5388 at pages 583-4 (D.T.C. 5391-2).

Therefore, apart from the ordinary onus of proof, the appellants here begin with an additional hurdle because of their business connection to industrial and commercial real estate. It is a hurdle, however, which can be overcome in appropriate circumstances; or if their background occupation creates a presumption, then the presumption is rebuttable.

Counsel for the respondent also argued that, even if the appellants did at the time of purchase have an intention to hold and rent the property, the possibility of resale for profit was an alternative operating motive for their purchase. This concept of secondary intent was well stated by Noël, J. (as he then was) in Racine et al. v. M.N.R., [1965] 2 Ex. C.R. 338; [1965] C.T.C. 150; 65 D.T.C. 5098 at page 159 (D.T.C. 5103):

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. Generally speaking, a decision that such a motivation exists will have to be based on inferences flowing from circumstances surrounding the transaction rather than on direct evidence of what the purchaser had in mind.

The above passage from the Racine case was adopted by the Federal Court of Appeal in De Salaberry Realties Ltd. v. The Queen, [1976] C.T.C. 656; 76 D.T.C. 6408 at 660 (D.T.C. 6411). The concept of secondary intent invariably arises when the primary intention is frustrated and a resale of the property results from that frustration. If the primary intention is speculative, and if the property is sold because such intention is not achieved, a Court can easily conclude that no sensible business person as a practical matter would have completed the purchase without having in mind a "Plan B"—the possibility and hope of resale for profit. See Regal Heights Ltd. v. M.N.R., [1960] S.C.R. 902; [1960] C.T.C. 384; 60 D.T.C. 1270. It is therefore necessary to determine the primary intention of the appellants at the time of purchase and, if that intention has an investment character, whether such intention was speculative.

Among the seven co-owners, I regard the appellants Bell and McCullough as the leaders because they recruited the other five participants and they were most involved in the attempts to find a tenant. When Mr. Bell signed the offer to pruchase on September 11, 1980, providing for a closing on April 15, 1981, he knew that the vendor (Acmetrack) was selling in order to move to its new building. Indeed, the offer provided for the purchaser to be given vacant possession on closing. Mr. Bell stated that normally there would be a period of only 60 to 90 days between the signing of the purchase agreement and the closing. He regarded the seven-month closing period in the Acmetrack agreement as an advantage to the purchasers because it gave them additional time to find a tenant.

The land in question was improved with a multiple purpose building containing 50,600 square feet dedicated to industrial use and 3,600 square feet dedicated to office use. The property was located on a paved street in an industrial area of Etobicoke close to the Toronto International Airport and major four-lane highways. Mr. Bell was confident that he and his colleagues would find an appropriate tenant to permit their continued ownerships because of the quality of the building, its good location, and the seven- month period between the Purchase Agreement (September 12, 1980) and the closing date (April 15, 1980).

Messrs. Bell and McCullough performed certain computations in September 1980 to determine the "internal rate of return" with respect to the subject property making a number of assumptions as to a lease period of 5 to 10 years, rent in the range of $2.35 to $2.75 per square foot, annual inflation from 3 per cent to 5 per cent and different values for the property at the end of the assumed lease periods. These computations demonstrated an annual yield of 11.34 per cent to 15.74 per cent depending upon the different assumptions as to rent and the value of the property at the end of the lease. The computations were presented to other persons to induce them to join Bell and McCullough as co-owners of the property. In three of the eight examples, Messrs. Bell and McCullough assumed that there would be a $800,000 mortgage on the property at 13 /2 per cent to 14 per cent.

After the agreement of purchase and sale was signed, the purchasers had the right to erect a sign offering the property for lease and to conduct inspections of the property with prospective tenants. On September 15, 1980, A.E. LePage was granted an exclusive listing of the property for lease at $2.75 per square foot; and a standard LePage sign “FOR LEASE" was erected immediately. A LePage flyer containing a picture of the property and a list of pertinent facts was circulated to about 5,000 persons early in October. When no tenant was found by December 1980, the property was given multiple listing (MLS) for lease at the same rent with all real estate brokers in Metropolitan Toronto. In March 1981 the MLS listing was renewed and the appellants arranged an "Open House" for agents and brokers and gave away a gas Bar B-Q as a door prize to induce attendance. It was Mr. Bell’s recollection that in the period September 1980 to June 1981 only four or five prospective tenants were shown the property.

There was no evidence that $2.75 per square foot was not a realistic rent for the property. When computing the internal rate of return in September 1980, Messrs. Bell and McCullough assumed different rents in the range of $2.35 to $2.75 per square foot. It was reasonable to list the property for lease at the upper limit of the range expecting that a prospective tenant might offer to pay rent at a lower rate but still within the range. The fact that four or five tenants were shown the property is an indication that the listed rent was reasonable.

When the appellants closed the purchase on April 15, 1981 as a cash transaction, still without a tenant, they commenced discussions with Canada Life with a view to placing a first mortgage on the property. A letter from Canada Life dated May 6, 1981, offered the appellants a fixed rate commitment at 15.75 per cent when the ''going rate" appeared to be 16.50 per cent. The appellants paid a $16,000 standby fee to Canada Life but, as events transpired, they did not draw down any of the mortgage funds.

The dearth of tenants was explained in relation to the serious economic recession which began in late 1980 and continued through 1981. Interest rates on first mortgages which were in the range of 13 /2 per cent to 14 per cent in September 1980 were in excess of 20 per cent by September 1981. Canada Savings Bonds were issued in the fall of 1981 with a 19 per cent coupon for the period November 1, 1981 to October 31, 1982. People were reluctant to commence a new business or expand an existing business during this period of high and rising interest rates; and there was very little activity in the leasing of industrial property.

There was no evidence that any one of the appellants or Mr. Makino could have or should have or did in fact anticipate the dramatic rise in interest rates and the ensuing economic recession which was just over the horizon in September 1980. A letter dated May 6, 1981 from Canada Life to Mr. Bell discussing interest rates on a proposed mortgage contained the words: "Despite the unexpectedly high rates we are experiencing now . . .”. If such events could have been foreseen, many people with mortgages falling due in mid-1981 would have refinanced in the fall of 1980 at rates of interest which would prove to be more advantageous to the borrower.

In the winter of 1980-1981, Mr. McCullough was an agent for Handy & Harman of Canada Ltd. ("Handy & Harman") in their search for a new plant. They were shown the subject property on a “lease” basis but turned it down because they wanted to own their plant. When no tenant was found by June 1981, there were further discussions with Handy & Harman concerning a possible sale of the property and, under the seven-page agreement referred to above which was signed on July 6, 1981, Handy & Harman purchased the property.

Dean Morrison (the second person who signed the purchase agreement along with the appellant Bell) also testified at the hearing. He had intended to participate as a ten per cent owner but transferred his ten per cent equity to William Bell in March 1980 because he (Morrison) was required to move from Kitchener to Toronto that spring and, in his own words, wanted to put his money into his own home as opposed to a factory. Mr. Morrison saw the subject property as perhaps requiring continued financial input from the owners. I regard Mr. Morrison's evidence as important because in March 1980, six months after signing the purchase agreement and without any success in finding a tenant, there did not appear to be any intention among the appellants and Mr. Morrison to offer the property for sale. Otherwise, Mr. Morrison would have continued as a participant in the expectation that he would get his money out upon a sale in the near future. Mr. Morrison’s reasons for withdrawing from the transaction in the circumstances of March 1980 indicate that resale for profit was not a motivating factor when the appellants decided to purchase the property in September 1980.

The financial projections which were prepared by Messrs. Bell and McCullough in September 1980 provided for a vacancy period of three months possibly to permit modifications to the building after Acmetrack moved out. When the purchase was completed on April 15, 1981, each of the appellants and the other four co-owners advanced his/her own funds to close on a cash basis. Mr. Bell was required to advance $236,000 for his 20 per cent interest. He provided approximately 50 per cent of his contribution from his own resources and he borrowed the remaining 50 per cent from the bank. Mr. McCullough for his 10 per cent interest was required to advance $118,000 of which he borrowed part from the bank.

Because there was no mortgage, Mr. McCullough stated that the carrying costs of the property alone (utilities and municipal taxes) would be only about $1 per square foot. He could have continued to carry his share of the property indefinitely without a tenant but he felt responsible for the more passive co-owners who were not close to the real estate market and who had become investors on the advice of Mr. Bell or himself.

Mr. Bell stated that he was still thinking in terms of leasing the property when he took over Morrison's ten per cent interest in March 1981. Under cross-examination, he said he could have generated offers to buy in the winter of 1980-1981 if resale had been his motive for the acquisition. To him, the Handy & Harman offer changed the ground rules of their investment position because it was the first offer of any kind which they received; it was an attractive offer in the economic climate of July 1981; it came just a few weeks after they had arranged long-term financing with Canada Life; it provided for reimbursement of the costs to put the long-term financing in place; and it came at a time when they still did not have a tenant. Mr. Bell further stated that conceptually, even in July 1981, all of the co-owners wanted to stick with the original plan to lease the property but there was a consensus to accept the Handy & Harman offer because it was the best offer that could be expected at that time.

The incidental details of the purchase seem to support the appellant's position. Title to the property was taken in the names of all seven coowners. This makes the execution of title documents (a deed, mortgage or lease) inconvenient but protects all co-owners over the long term because they are all required to sign and they all must know what is happening to their property. If resale had been a probability or realistic possibility on April 15, 1981, it would have been more convenient to take title in the names of Bell and McCullough who would be expected to negotiate any resale.

Individual financing left each co-owner free to arrange his/her level of borrowing without burdening all co-owners with a common mortgage debt. The long-term financing of $800,000 which was arranged in May 1981 provided for an immediate advance of $400,000 but the second $400,000 was conditional upon annual rental income of $148,000 for the whole property. As stated above, the sale agreement required Hardy & Harman to reimburse the co-owners an aggregate amount of $27,473 for the standby fee and other costs connected with the Canada Life long-term financing.

I have considered the expertise of Messrs. Bell, McCullough and Makino as licensed real estate agents engaged in the sale and leasing of industrial and commercial property. In my view, the appellants have overcome this additional hurdle with the following facts: (i) the subject property would normally be regarded as an investment to a long-term owner; (ii) there was independent evidence concerning exclusive listing with A.E. LePage, multiple listing with Metro Toronto real estate brokers and other bona fide efforts to find a tenant; (iii) the evidence of Mr. Morrison is a strong indication that there was no thought of resale in March 1981; (iv) there was no evidence that the appellants attempted to find a buyer in the winter and spring of 1980-1981 and the ultimate buyer (Handy & Harman) was shown the property by Mr. McCullough on a “lease” basis during that period; and (v) the frustrating event being the economic recession which began in late 1980 and continued through 1981 could not be foreseen or anticipated when the appellants agreed to purchase the property on September 12, 1980. This last fact is probably the most important one of all.

Evidence was adduced concerning other properties which were acquired by certain of the appellants or their spouses. Messrs. Bell and McCullough had acquired industrial properties on Evans Avenue, Oxford Street and Birdhill Street in the Metro Toronto area and a gas station on Erin Mills Parkway in Mississauga. They still owned all four properties when these appeals were heard. The four properties owned jointly by Messrs. Bell and McCullough indicate, in general, an investment attitude on their part with respect to industrial/commercial real estate.

Mr. Makino (the husband of the appellant Renee Makino) and the wives of Messrs. Bell and McCullough joined with one David Garret to purchase an industrial building on Aimco Boulevard in Mississauga. The Aimco property was purchased in 1980; sold in 1981; and the gain on sale was the subject of an appeal to this Court reported as McCullough et al. v. M.N.R., [1988] 1 C.T.C. 2130; 88 D.T.C. 1096. The details of that transaction are set out fully in the reported case.

The quick purchase and resale of the Aimco property around the same time as the subject property is, of course, relevant. Referring to the facts set out in the reported case, it is sufficient here to note that Mr. Makino and the wives of Messrs. Bell and McCullough were still contented owners of the Aimco property in September 1980 when the appellants herein agreed to purchase the Carlingview Drive property. The unforeseen economic recession which was the underlying frustrating event in these appeals may also have been the cause of the Aimco tenant's financial difficulties which, as I read the reported case, triggered the sale of the Aimco property. In any event, the character of the Aimco property as rental real estate is consistent with the character of the subject property in these appeals and the four properties owned jointly by Messrs. Bell and McCullough.

I have concluded that the only intention of the appellants at the time of purchase (September 1980) was to hold and rent the Carlingview Drive property. Objectively, there was a strong probability that an appropriate tenant would be found and there were reasonable grounds for the appellants' confidence that they (in their business as agents for the leasing of industrial property) could and would find such a tenant. The event which frustrated their intention, a serious economic recession which began in late 1980 and continued through 1981, could not reasonably be foreseen or anticipated at the time of purchase in September 1980. In my view, the appellants have discharged their onus of proof and have established that their intention was not speculative.

When the issue is capital gain or income as in these appeals, the appellants are required to testify and make a number of self-serving statements as to their intention at a particular time. In order for the appellants to succeed, such statements must be supported by objective evidence. Although there was more than adequate objective evidence in support of these appeals, I should state that I was favourably impressed by the credibility of all four witnesses: Messrs. Bell, McCullough, Makino and Morrison.

The appeals are allowed with costs.

Appeals allowed.