First Investors Corporation Ltd. v. Her Majesty the Queen, [1987] 1 CTC 285, 87 DTC 5176

Mahoney, J. (Pratte J. concurring):—! have had the advantage of reading in draft the reasons for judgment of my brother Heald herein and am in agreement with his definition of the sole issue and his summary of the essential facts. I also agree with his statement of the criteria to be considered in a case of this sort but I question that all of them are seriously in play here.

There is no doubt that the acquisition of the Speedway Park land was structured so that the portions acquired by the appellants would be "qualified assets” within the definition of that term in the Alberta Investment Contracts Act, R.S.A. 1970, c. 191. The learned trial judge found as a fact that the land had been temporarily accepted as such by the provincial regulatory authorities. In my opinion that is of little relevance to the taxation issue.

Profit and recovery of costs of sales and operations aside, the purposes of any investment contract company in acquiring a qualified asset, as dictated by statute, were twofold: to support the total value of the contracts it could lawfully have outstanding and to provide the cash flow necessary to permit it to meet its obligations under those contracts to pay interest and redeem. It cannot, in my opinion, be said that because the acquisition of a particular asset satisfied the first of these purposes there was no trading intention. How was that asset to serve the second?

The definition of "qualified asset” also includes "bonds, debentures, stocks and other securities” authorized for investment under the Canadian and British Insurance Companies Act. Clearly such securities, like land, can be and regularly are acquired as investments on some occasions and for trading purposes on others. The fact that, while held, such an asset may be a "qualified asset” under the Alberta legislation does not lead necessarily to the conclusion that it was not acquired with a trading intention. The question remains the taxpayer’s entire intention on acquisition.

Associated Investors of Canada Ltd. v. The Queen

The learned trial judge concluded ([1985] 2 C.T.C. 96 at 110):

In these actions the respective statements of defence plead that the Minister proceeded on the assumption that one of the major motivating factors for acquisition the Speedway property was the possibility of resale at a profit at some future time. Despite the tenor of Mr. Marlin’s testimony, the inference of the validity of that pleading is quite compelling. To exclude that possibility as a major motivating factor in these circumstances would be simply absurd. The plaintiffs, in their plight, would never have contrived and exploited this particular acquisition had there been no perceived possibility of resale at a profit within seven years. What other action they might have taken is matter of speculation only.

I do not take his reference to the assumption as an acceptance of it as evidence, an error urged by the appellants. Rather, on a fair reading of the entire passage, I think that he was merely observing that Marlin’s testimony did not, in his opinion, rebut the assumption. That was a conclusion he was entitled to reach on the evidence. Marlin’s testimony did establish that neither the appellants nor their associates would have acquired the Speedway Park land if the acquisition could not have been so structured as to bring the appellants' interests within the qualified assets definition. It did not, however, cast any real doubt on the validity of the Minister’s assumption. There was no evidence whatsoever as to an intention on the part of any of its purchasers to do anything with the land except to hold it.

The asset subject of the gain in Hiwako v. The Queen, [1978] C.T.C. 378; 78 D.T.C. 6281, was a real revenue producer: an apartment complex; the land here produced no significant revenue and none was expected. If I am correct in my view that the fact that it was acquired as a qualified asset is not conclusive of the proper income tax treatment of the gain on its disposition then, with respect, I must agree with the learned trial judge that the Speedway Park transactions are most evocative of those considered by this Court in McDonald v. The Queen, [1974] C.T.C. 836; 74 D.T.C. 6644. The learned trial judge cannot be said to have erred in regarding Marlin’s denial of an initial, operating intention to sell it at a profit when an acceptable opportunity arose as incredible or, as he put it, “absurd".

I would dismiss the appeals with a single set of costs.

Heald, J. (dissenting):—These two appeals are from judgments of the Trial Division in respect of matters that were heard together on common evidence with the consent of the parties.

The issue raised by the appeals is a familiar and recurring one in the field of tax litigation. Shortly stated, the issue is whether the proceeds realized by the appellants on the disposition of certain parcels of real property, were income from an adventure in the nature of trade or were capital gains.

The Facts

The appellants are Alberta companies. They are part of a corporate group having Collective Securities Ltd. (Collective) as the parent company and Principal Group Ltd. (Principal) as the management company for the appellants. Principal also acts as the management company for Athabasca Holding Company (Athabasca). Athabasca deals mainly in real estate. The two appellant companies were the only two regulated companies in the Collective group, being the only two investment contract companies therein.

The appellants sold contracts to investors in Western Canada who agreed to remit to the investment contract company a certain sum (usually paid annually) over a long term, customarily 15 to 20 years. The guaranteed an- nual rate of return to the investors was 3.5 per cent. However, during the period from December of 1962 to April of 1976, the average annual rate of return on investment was approximately 4 per cent. The directors of an investment contract company may, in their discretion, declare additional credits annually or quarterly, much in the fashion that dividends are declared on common shares in a company. These additional credits remain tied to the individual investors’ contracts until maturity. They are usually paid to provide a rate of return on the contract which is competitive with other types of contracts and current interest rates. Because of the nature of their business, the appellants were subject to the provisions of the Investment Contracts Act of Alberta as well as the comparable legislation in other provinces where the appellants did business. In Alberta, the Alberta Securities Commission, initially, and the Superintendent of Insurance, latterly, supervised the assets held by the appellant companies, to ensure full compliance with the requirements of the Investment Contracts Act. At the relevant times, that statute contained requirements:

1. that “qualified assets" be on deposit equal to 100 per cent of the Certificate liabilities as represented by the investors, contracts at all times; and

2. that proper reserves be maintained by the investment contract companies. The objective of these requirements was to ensure to investors protection to the extent of the principal and accrued interest in their respective contracts. If the company did not meet both of these tests at all times, the regulatory authority had the power, in its discretion, to suspend or cancel registration or to refuse to renew registration of a company. The consequence of such action would undoubtedly lead to the demise of the company since the issuance of investment contracts without current registration under the Act is prohibited. The “qualified assets" referred to, supra, are defined in paragraph 1(g) of the 1980 Act (R.S.A., 1980, c. I-10) and may be characterized generally as follows:

(i) cash;

(ii) first mortgages on improved real estate;

(iii) marketable securities;

(iv) “real property acquired by foreclosure or in satisfaction of a debt and held for a period of less than 7 years"; and

(v) any other investments or securities designated by the regulations.* [1]

It should be observed, at this juncture, that, pursuant to the scheme of the statute, there is no guarantee that once an asset is declared a "qualified asset", it will always be so classified. The Securities Commission, or the Superintendent of Insurance (after 1973) had the power to declare an asset which was, formerly, "qualified" as now being "unqualified" if conditions relative to that asset change significantly (sharp rises in interest rates or sharp decreases in real estate value, for example). With such a scenario developing, the investment company would be compelled to substitute for the disqualified assets, more secure assets which would satisfy the regulatory authority. The two appellant companies found themselves in this position between 1962 and 1971. During that period, numerous and complex exchanges were effected to satisfy the Securities Commission. The culmination of these asset exchanges occurred on September 15, 1972, when a parcel of property comprising some 370 acres was purchased by the Collective group (including the appellant companies). Much of this land was formerly Associated Investors of Canada Ltd. v. The Queen

operated as the Edmonton International Speedway and was situated a short distance north of the northern boundary of the City of Edmonton (the Speedway land).

In so far as the appellants were concerned, it was essential that the acquisition of their portion of the Speedway land be accomplished in compliance with the provisions of subparagraph 1 (g)(iv) (supra) of the Investment Contracts Act. In other words, it was necessary that the property be acquired by foreclosure or in satisfaction of a debt and held for a period of less than seven years. Accordingly, the transaction was structured in order to comply with those provisions of the statute. Furthermore, it was approved by the regulatory officials and an independent legal opinion was obtained to the effect that the property had been properly acquired. The actual mechanics of the transaction are complex. While the appellant companies desired to acquire the asset in question, they could not simply purchase it since it would not be classed as a “qualified asset" within the meaning of subparagraph 1 (g)(iv) of the Act (supra). Hence, the Marlin and Rice groups which owed First and Associated money (First and Associated held debentures of Marlin and Rice), "purchased" the land and then assigned it to the appellants in satisfaction of some or all of their debt. In reality, Collective, the parent of the appellants furnished the money with Marlin and Rice switching one kind of debt to the Collective Group (debentures) for another (debt to the parent company, Collective). In this fashion, the appellants, First and Associated, had title to the property which, at least in legal terms, had been acquired in satisfaction of a debt.

Although the Securities Commission temporarily approved this transaction in 1972, the Superintendent of Insurance, who assumed the supervisory role in 1973, took a different view. By letter to First dated July 23, 1973, he said that the property "did not appear to be qualified for an investment contract company". Prior to that, there had been a meeting between the directors of Associated and the Chairman of the Securities Commission and his officials on March 30, 1973. At that meeting, the Commission officials had expressed dissatisfaction with the company because, in their view, Associated was not operating within the requirements of the statute. In so far as the Speedway land was concerned, the Commission requested that it be replaced or "shored up" as a qualified asset. In response to this request, Associated, by letter to the Commission dated April 16, 1973, advised that the company intended to sell the Speedway land. In any event, it seems that a suitable buyer was not located until 1976 since the land was not sold until April 1976. Both of the appellants realized substantial gains on the disposition of the real estate. The sale in question resulted from an unsolicited offer for the land.

The Findings of the Learned Trial Judge

After noting that "Mr. Marlin testified, and the defendant's counsel acknowledged, that the reason for the plaintiff’s acquisition of the Speedway land was to obtain qualified assets within the meaning of the Investment Contracts Act of Alberta)", (A.B. p. 36; C.T.C. 108), the learned Trial Judge found, nevertheless, that when the appellants ".. . contrived to structure this particular and chosen transaction . . . they . . . must be held to have intended:

— to hold the land for only seven years or less;

— not to develop it or to operate the speedway business;

— not to earn revenue from it over and above the costs of carrying it;

— to sell it for profit at the most propitious moment within the seven- year period after acquisition?' (A.B. p. 38; C.T.C. 109).

He then proceeded to find (A.B. p. 39; C.T.C. 110) that subject land acquisition “.. . was a straightforward adventure in the nature of trade whose profit was part of the plaintiff's income". He went on to state (A.B. p. 39; C.T.C. 110) that, notwithstanding the evidence of Mr. Marlin who was the only witness giving viva voce testimony at the trial, it would be absurd to exclude the assumption that one of the major motivating factors for acquisition of the Speedway property was the possibility of resale at a profit at some future time. He added:

The plaintiffs, in their plight, would never have contrived and exploited this particular acquisition had there been no perceived possibility of resale at a profit within seven years. (A.B. p. 39; C.T.C. 110).

The Relevant Jurisprudence as Applied to the Facts of this Case

The issue in this case is the issue decided by the Lord Justice Clerk (Macdonald) in Californian Copper Syndicate Limited v. Harris (1904), 5 T.C. 159 at 165:

Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?

Scace and Ewens in their work on The Income Tax Law of Canada, Fifth Edition, 1983, (pp. 22-26 incl.) set out several tests developed by the Courts, over the years, to be employed when deciding whether a gain is capital or income. I think it useful to consider those tests in the context of the facts in the present case:

1. The subject-matter of the realization — In this connection the authors comment: “. . . property which does not yield to its owner an income or personal enjoyment merely by virtue of its ownership is more likely to have been acquired with the object of a deal than property that does.” I agree that land purchases are generally suspect and in many cases lead to gains classed as income, following the decision of the Supreme Court of Canada in Regal Heights Limited v. M.N.R. ({1960] C.T.C. 384; 60 D.T.C. 1270). This is especially true in cases where, as here, the land yields a low return. However, the extra dimension in this case, missing in most of the jurisprudence to which we were referred, is the undeniable fact that the appellants did benefit substantially by virtue of their ownership of the Speedway property

— namely — survival as an investment contract company with sufficient qualified assets to enable them to remain in business. When asked what was in the appellants’ mind at the time of the Speedway acquisition, Mr. Marlin said (Transcript, p. 57):

I think the intention to preserve the company has probably been emphasized quite strongly, that we were, let’s say, fighting for our survival, if you like, in order to stay in business. We had been knocked out of business in Saskatchewan and B.C.; Associated had been knocked out of business in B.C., and we were looking for qualified assets that were acceptable and had value that the Securities Commission would be happier with.

The evidence is uncontradicted, and, in my view, serves to clearly distinguish this land acquisition from the general run of cases referred to by Scace and Ewens, supra. I think this important circumstance points towards capital rather than income.

2. The length of the period of ownership — In this regard the authors observe: “Generally speaking, property meant to be dealt in is realized within a short time after acquisition?' As noted, supra, the learned trial judge held, inter alia, that the appellants’ intention to hold the land for only seven years or less was a circumstance supporting his view that a major motivating factor in subject acquisition was a “. . . perceived possibility of resale at a profit within seven years". With every deference, I fail to see how such an inference could flow reasonably from the circumstances in this case. Subject property was disposed of within three and one-half years. This is not, in my view, a short period of time. When it is remembered that the sale in 1976 was, in effect, a forced sale, and that it was the result of an unsolicited offer, I do not think that a trading intention should be attributed to the appellants on these facts.

3. The frequency or number of similar transactions by the same person — Under this heading the authors comment as follows:

If realization of the same sort of property occurs in succession over a period of years or there are several such realizations at about the same date, a presumption arises that there has been dealing in respect of each.

The only other transaction in the instant case that was similar to the Speedway acquisition was the Saint John property which was sold at a loss of over $4000,000 which was treated as a capital loss by the appellants. (Transcript p.78). Accordingly, on these facts, I cannot see how the “presumption" of “dealing" referred to by Scace and Ewens could possibly arise on these facts.

4. Supplementary work on or in connection with the property realized — The authors' comments under this heading read:

If the property is worked up in any way during the ownership so as to bring it into a more marketable condition; or if any special exertions are made to find or attract purchases, such as the opening of an office or large scale advertising, there is some evidence of dealing. For when there is an organized effort to obtain profit there is a source of taxable income. But if nothing at all is done, the suggestion tends the other way.

In the case at bar, the appellants made no improvements on the land. The evidence does not disclose any efforts to sell the land until the Securities Commission, on March 30, 1973, requested that it be replaced as a qualified asset. As noted, supra, the appellants’ response to this request was the appellants' letter to the Commission of April 16, 1973, advising that efforts would be made to sell the Speedway land. Mr. Marlin testified that letters were sent to developers to satisfy the regulatory authority that a sincere effort was being made to market the property. There was no large advertising campaign. There were likely some small ads, he said. In 1975, the appellants were approached by a real estate agent but nothing came of this approach. Finally, the property was sold in 1976 pursuant to an unsolicited offer.

On these facts, it is clear that there was no “organized effort to obtain profit." The evidence establishes that the decision to sell the land was forced upon the appellants by the regulatory authorities.

The evidence also makes it clear that there was not any special exertion to find or attract purchasers. In my view, the only reasonable inference to be drawn from these facts is that the proceeds were capital and not income.

5. The circumstances that were responsible for the realization — Under this heading Scace and Ewens observe:

There may be some explanation, such as a sudden emergency or opportunity calling for ready money, that negatives the idea that any plan of dealing prompted the original purchase.

From the facts discussed in paragraph 4, supra, it seems clear that the appellants were forced to rid themselves of the subject property and to replace it with assets acceptable to the Superintendent of Insurance as qualified assets in order to remain in business. In my view, these circumstances would negative any impression that a plan of dealing motivated the original purchase.

6. Motive — The authors observe (page 24) that in Canada over the years factors one to five, supra, have been considered by the courts but that the question of motive or intention at the time of acquisition of an asset has received the most attention. It is stated further that the intention at the time of acquisition together with a consideration of the taxpayer's whole course of conduct while the asset was held is what finally influences the determination by the courts. They add that this test has been carried further in Canada by the acceptance of the "secondary intention test". A concise summary of the secondary intention test is to be found in the decision of Noel, J. in Racine et al. v. M.N.R., [1965] C.T.C. 150 at 159; 65 D.T.C. 5098 at 5103, where he said:

... the fact alone that a person buying a property with the aim of using it as capital could be induced to resell it if a sufficiently high price were offered to him, is not sufficient to change an acquisition of capital into an adventure in the nature of trade. In fact, this is not what must be understood by a “secondary intention” if one wants to utilize this term.

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.

On the basis of the somewhat unusual facts in this case, I have concluded that the gain in question should be classified as a capital gain. Counsel for the appellants submitted that the evidence established a sole and paramount intention at the time of acquisition — namely, to acquire a qualified asset acceptable to the regulatory authority which would enable the companies to remain in the investment contract business. In his view there was no room for a secondary intention. I think the evidence supports this view of the matter. None of the badges of trade discussed, supra, are present in this case. The appellants, at date of acquisition, had a legitimate and pressing requirement for qualified assets. That term, as defined in the statute, and as used in the context of investment contract companies, suggests the notion of capital assets. The learned trial judge in finding a trading intention as a major motivating factor for the acquisition drew inferences from the evidence which, in my view, are not reasonable in all the circumstances of this case. He seems to have concluded that subject acquisition was made because of Mr. Marlin’s knowledge of the Speedway property and its potential for capital appreciation due to its favourable location. The evidence does not support this view. Mr. Marlin swore .. that the land was acquired . . . only because it met the requirements that we had for qualified assets.” (Transcript p. 102). He was trying to sell the land because of pressure from the regulatory authority. Prospective purchasers raised questions about the value of the land because of problems with zoning. The property was on the flight path of the Namao airport which would inhibit its development. There were problems with the new sewer line and until that was settled, no one was interested in buying. (Transcript, p. 102). Mr. Marlin said that because of those problems tha land was not an attractive investment — its sole attraction was its use as a qualified asset. The trial judge also mentioned the appellants’ intention not to operate the Speedway business. The evidence established that there was some income from the Speedway operation in 1973 and 1974 and there was a firm lease covering the operation for $30,000 in 1976. I acknowledge that the course of conduct of Mr. Marlin as the directing mind of the appellants, as distinguished from his direct evidence of what he had in mind, might be sufficient to negative that direct evidence if the course of conduct and the circumstances surrounding the transaction were in conflict with and contradictory of that direct evidence. In this case, I find no such conflict or inconsistency. At the time of acquisition, there was no intention of quick resale; there was no potential for a quick profit because of the numerous disadvantages attached to the property at that time; there was no carefully calculated and aggressive campaign for resale. Feelers were sent out to potential buyers but no campaign was launched. The feelers were sent out to relieve the pressure from the regulators to sell the property. Finally after three and one-half years, the property was sold as a result of an unsolicited offer. In my view, all of the surrounding circumstances during the relevant period support the sworn and uncontradicted evidence of Mr. Marlin.

Turning now to the relevant jurisprudence, I consider that this Court's decision in Hiwako Investments Ltd. v. The Queen, [1978] C.T.C. 378; 78 D.T.C. 6281 is persuasive. In that case, the taxpayer in 1966 had purchased a group of high-rise apartments. In the 11 months that the apartments were held by the taxpayer, the profits proved to be less than anticipated at the time of purchase. Responding to an unsolicited offer, the properties were resold at a substantial profit. The trial judge found a secondary intention at the time of acquisition since the directing mind of the taxpayer was . . an experienced, sophisticated and sagacious businessman who has operated boldly in a number of difficult business environments and with a remarkable measure of success." He went on to add “. . . I very much doubt that, for many years at least . . . K . . . has bought anything in the international marketplace, where he is so successful and knowledgeable, without, as an operating consideration, the thought that changing conditions, either at the sites of the acquired property or elsewhere, might dictate its disposition.” This Court unanimously allowed the taxpayer's appeal. Chief Justice Jackett, speaking for the Court, said (at C.T.C. 382; D.T.C. 6284): “An intention, at the time of purchase, to re-sell at a profit does not, in my view, necessarily give the purchase and a subsequent sale the character of ‘. . an adventure or concern in the nature of trade'." And again at 383; D.T.C. 6285: “In my view an intention at the time of acquisition of an investment to sell it in the event that it does not prove profitable does not make the subsequent sale of the investment the completion of an adventure or concern in the nature of trade.”

I have found this decision helpful because it has some similarities to the case at bar. In Hiwako the trial judge imputed a secondary intention to the directing mind of the taxpayer mainly because he was a sagacious businessman with an impressive “track record" in profit-making ventures. On this basis, the trial judge assumed that any venture he was involved in would have a “trading" component. I have the clear impression that the learned trial judge in the case at bar adopted a somewhat similar approach. At page 37 of the Appeal Book (C.T.C. 109) he said: “Mr. Marlin well knew of the land's favourable situation and condition. He knew of the statutory limitation upon holding such land for not longer than seven years. The plaintiffs counsel rightly argued that knowledge is not intention. Generally speaking that is quite so, but in the instant circumstances knowledge is the womb of intention, just because of the regulatory constraints to which the plaintiffs were subject.” The trial judge in Hiwako and the trial judge in this case appear to have been decisively influenced by the trading background of the purchaser. In my view, the relevant jurisprudence does not carry us to the point where someone with a trading history must be irrevocably so characterized in all future transactions. All of the circumstances, including that circumstance, must be considered.

In this case, the direct evidence as well as the proper inferences to be drawn from the surrounding circumstances point unmistakably to the conclusion that at the time of purchase, the appellants did not possess either a primary or secondary trading intention. The trial judge has made no adverse findings as to the credibility of Mr. Marlin's testimony as to the appellants' sole intention at the time of purchase.

It seems, however, that he has found a secondary trading intention based on inferences drawn from the circumstances surrounding the transaction. On the authority of the Racine case, supra, and subsequent decisions, this is a perfectly proper procedure provided that the inferences which he drew are sustainable on the record. Based on my review of those circumstances and for the reasons expressed, supra, I conclude that the only reasonable inference to be drawn is that no primary or secondary trading intention has been established. In my view, the only circumstance pointing to a trading intention is Mr. Marlin’s past history as a trader. All the other surrounding circumstances point in the opposite direction.

On this basis, I think an appellate court is justified in setting aside a decision of a trial judge on the basis that the inferences which he drew from the surrounding circumstances were not reasonably open to him. A similar approach was adopted by this Court in Hiwako, supra, where, as here, it was apparent that the trial judge attached undue significance to the circumstance that the purchaser had a successful trading history.

Counsel for the respondents relied, inter alia, on the McDonald case (David C. McDonald v. The Queen, [1974] C.T.C. 836; 74 D.T.C. 6644). I think the McDonald case is clearly distinguishable on its facts. In that case there was ample evidence to support the conclusions of the trial judge that the taxpayer's sole purpose in purchasing a share of the subject property was to realize an accretion by resale at an opportune moment. In the case at bar, there cannot be any suggestion, on this record, of a sole trading intention at date of acquisition. Similarly, I do not find the other authorities relied on by the respondent to be persuasive since they are clearly distinguishable on their facts, in my view.

Accordingly, and for all of the above reasons, I would allow the appeals with a single set of costs and refer the matters back to the Minister of National Revenue on the basis that the amounts as agreed upon by the parties are taxable as capital gains. Furthermore, the appellants should also be allowed to claim any reserves to which they may be otherwise entitled.* [2]

Appeals dismissed.