The Sands Motor Hotel LTD v. Minister of National Revenue, [1985] 2 CTC 2390, 85 DTC 677

Goetz, TCJ:—This is an appeal by the appellant from an assessment of its 1980 income tax return by the Minister of National Revenue. The assessment involves the appreciation in value of certain hotel property owned by the appellant, the sale of which was consummated in May 1980. The Minister, in his assessment, treated the appreciation in value as profit in an adventure in the nature of trade as opposed to the appellant's contention that it was a Capital gain.

Facts

The majority shareholder and the moving force of the appellant was one Gerald Kristian (“Kristian”). Kristian acquired a “Dairy Queen” franchise in 1970, obtaining same on money that he borrowed. He had a large staff and says that he worked almost 18 hours a day with a 25-member staff. He decided to sell the franchise and the property that he had acquired in 1976, enjoying a profit of $250,000 on the sale.

Kristian acquired what is known as Parcel “A”, in the proceedings, on the 7th day of February, 1977, after having exercised an option to purchase dated October 20, 1976. It was his intention to construct an apartment block on the property as a lasting investment. When he presented the proposition to an engineer, it was suggested to him that he was underdeveloping the property and that it would be preferable to construct a hotel. Kristian acquiesced but was not keen on assuming managerial duties. As a result of this advice, Kristian obtained a feasibility study for the hotel on January 17, 1977. Armed with the results of the feasibility study, he decided to construct a hotel but this involved doubling the costs that he had originally contemplated and, as a result, he brought in Frank Scott who obtained a 30 per cent interest in the venture.

Kristian set up The Sands Motor Hotel Ltd and transferred his interest in Parcel “A” to the appellant. He studied many hotels in Saskatchewan for ideas as to the nature of the construction of the hotel and, taking the long range view to expansion, he acquired what is known as Parcel “B” composed of 3.3 acres, one acre of which he paved. Both parcels were adjacent to and east of Idylwyld Drive, the main north and south thoroughfare in the city of Saskatoon.

Since 1972 Kristian had been acquiring residential property in a block west of this thoroughfare from the profits of his Dairy Queen operation. As collateral for the mortgages on the properties in question, he gave a personal guarantee on the security of these rental properties, used the profits from the sale of the Dairy Queen operation and used up all of his term certificates that he had acquired from the Dairy Queen operation. In short he had committed himself financially and completely to the construction of the hotel.

The actual construction was composed of steel frame, concrete floors, insulated steel and studs, screens on exterior for stucco, exterior weatherproof drywall with screens. The stucco was composed of two layers of heavy cement, capable of carrying large stones as a decor. It was a six-storey hotel in the Spanish style.

Construction of the hotel commenced in the summer of 1977 and the hotel was opened on August 2, 1978.

Kristian entered into a long-term managerial contract with Wayne Cho- ponis whose employment was to be effective as of January 1978. At this point in time Choponis was the manager of the Bessborough Hotel in Saskatoon (a former Canadian National Railway hotel). However, in January 1978, Choponis advised Mr Kristian that he intended to remain an employee of the Bessborough Hotel. Kristian then proceeded to hire Irwin Bayda as manager, who apparently could not properly perform his functions as manager and was dismissed in March 1978. He advertised in the newspapers for a hotel manager and eventually hired one Johann Hermans.

After taking a management course, Kristian obtained a franchise from Best Western Inc after taking training therefor in the United States. He also took training in hotel management and housekeeping. These were two- week courses and quite intensive. He took these courses with a view to being knowledgeable as to what was going on in hotel management so that he could deal with the staff and any possible problem area in the operation of a hotel. He became a Governor in the province of Saskatchewan of Best Western Inc. He had an office in the hotel to keep abreast of the operation in all aspects. He encountered problems with Hermans who could not get along with the staff and who was firing key personnel.

Prior to Hermans' arrival as manager in October 1978, Mr Kristian had contemplated a development of a motor hotel complex in the city of Prince Albert, Saskatchewan. On November 1, 1978, he advised that city that due to health reasons he had to postpone and delay any steps to commencing such a development. Since November 28, 1977 through to 1980 Mr Kristian was under medical care for cardiac irregularity and associated anxiety symptomatology. The medical report is most relevant and reads as follows:

PLEASANT HILL MEDICAL CLINIC

1528-20th Street W — Saskatoon, Sask 57M 0Z6

6 April 81

To whom it may concern:

Re: Mr Gerald KRISTIAN

4102 Degeer Street

SASKATOON, Saskatchewan

This is to confirm that the above named has been under treatment at our Clinic since November 28th, 1977 for cardiac irregularity and associated anxiety symptomatology. Dates of treatment were November 28th, 1977, December 12th, 1977, February 15th, 1978 and March 13th, 1978.

On July 5th, and 10th, 1978 he was treated for a right renal colic.

On October 4th, 1978 he was seen for repeated episodes of tachycardia and was referred to the Cardiac Out-patient Clinic at the University of Saskatchewan, Dept of Medicine. Dr J Lopez’ summary states that Mr Kristian has supraventricular tachycardia or possibly even sinus tachycardia. "We feel that the tachycardias are related to his high stress style of life”.

He was also seen on August 2nd, 1979 with chest pain.

In May and June 1980 he was again seen with multiple symptoms of chest and abdominal pain with peptic ulcer symptoms and possibly a pancreatitis all related to stress and anxiety.

It was strongly recommended that he change his life style, get some more physical activity, alter his work habits and get away from the pressure of his business; otherwise, continuing in his business would be detrimental to his health.

Yours very truly,

(Signature)

M B Krochak, MD

Initially, Kristian was relieved when Mr Hermans started working but on return from a conference in Los Angeles in April 1979, he found that the operation was going very poorly and losing money. He fired Hermans and had to become personally much more heavily involved in the operation which wore him down. In May 1979 he placed advertisements in other cities for a new manager, without success. As a result, he says that stress was building up again and he was faced with worries of his personal guarantees and all of his personal finances being endangered. Kristian says the combination of managerial and health problems forced him to list the property for sale in September 1979. Kristian had given a listing to Lobsinger Real Estate Ltd, listing the property for sale at $8,500,000. On October 29, 1979, he says he received an unsolicited offer from Ashk Development Corporation Ltd ("Ashk”). The offer was for $7,650,000 and the closing date for the sale was May 1980. A Mr John Zatwarnisky, who had visited the hotel in September 1979, put the appellant in contact with the ultimate purchaser, Ashk. Kristian admitted that, in July 1979, because of the problems he was having, he had considered selling the hotel if he could not obtain a suitable manager.

The Crown called Gerald Clackson ("Clackson”), an experienced realtor, in the city of Saskatoon, involved in commercial and industrial real estate transactions. Clackson had visited the hotel in July 1979 when Kristian had called him to see the premises at which time he stated that Kristian told him that he was having management problems. Clackson had done business with Kristian over the years and it is not clear why he took a tour of the hotel, seeing the coffee shop and the boiler room. He stated in cross- examination that Kristian appeared to be very proud of his hotel and that he took no steps to get a listing nor was he provided with any information. He saw workmen working at the time, but did not know precisely what they were doing. He never asked for nor did he get a listing for the sale of the property.

Leonard Arling ("Arling”), manager of the city of Saskatoon building department and an architect, gave evidence to the effect that the hotel was designed per minimal capital construction and that he considered it a cheap building, saying that in his opinion ". . . it is not a quality building . ..” and that its life span would only be 20 years. He indicated that the Bessborough Hotel, in making a comparison, was a "medium” rated hotel. In light of this statement, the Court gives little weight to his evidence completely, in that the Bessborough Hotel in Saskatoon was constructed as a Canadian National Railway Hotel and was and is of the highest quality.

In rebuttal, the appellant called Farouk Shah (“Shah”), an architect and professional engineer with wide experience who had designed the hotel after persuading the appellant to build a hotel as opposed to an apartment building. Arling suggested that the exterior construction should have been composed of precast concrete panels or brick. Shah testified that the stucco used was composed of a larger amount of cement as opposed to house stucco which uses much more lime. He suggested that the longevity of the building would be at least 40 years without maintenance. He admitted precast concrete had a longer life but, at the time, precast was difficult to obtain and it was impossible to get a firm price on supplies because of demand and inflation. He further testified to the high quality of equipment, fixtures and furniture which were obtained from the United States and that the heat pump system under each window to heat and cool was quite expensive, but Kristian wanted a good hotel. He felt that the hotel was not designed for a short-term life span.

Contentions

Mr Kristian states that, at the time of purchase and construction, it was intended that the hotel would be a long-term investment wherein he would not have to be personally involved in its operation. In order to finance the purchase of the land and the construction of the hotel, the officers (Scott and Kristian) had to enter into a long-term mortgage involving personal guarantees and the hypothecation of all of their personal assets and that the heavy personal investment of the officers confirms an avowed intention, as of the time of acquisition, to acquire a lasting investment and not a short-term investment for a quick turnover.

The reason put forward for the sale of the land in question was the managerial problems encountered by the appellant and, secondly, and more important, the personal health of Mr Kristian.

The respondent, on the other hand, maintains that from the outset the appellant had the intention of constructing the hotel and turning it over quickly for a profit or, in the alternative, that it had a secondary intention of selling the property. The respondent contends that, before the hotel was finished, an offer to purchase was made by Headway Corporation in the belief that the appellant was in financial difficulty and that Headway Corporation was looking for a “fire sale” price. The appellant refused this offer. The respondent also asked that an inference be drawn from the fact that the acquisition by Mr Kristian of over 33 homes in the block immediately west of Idylwyld Drive was with the view to an eventual large development. Kristian states that indeed he owned 33 homes at the time of the appeal and that these were all rental properties. Any property that had been demolished (approximately three or four) was as a result of fires and that this was not a very high grade district for dwellings. The respondent further attempted to minimize the health condition of Mr Kristian and says that in spite of his medical condition, Mr Kristian was actively engaged in the operation of the hotel.

In determining the purpose and intention of the appellant when acquiring the property in question, there must be examined all events antecedent to, at the time of, and subsequent to the purchase of the property. Kristian, in obtaining the Dairy Queen franchise in 1970, built his business into a high profit operation which enabled him, commencing in 1972, to acquire residential dwellings for the purpose of rental income. In that the units were all located in one city block, the respondent maintains that their acquisition was for a development project some time in the future. Be that as it may, it is not relevant at this time in that the inference is purely speculative.

Kristian sold his Dairy Queen business and property in 1976 using the proceeds of the sale as partial payment on the purchase of the property in question in this appeal. It was his intention to construct an apartment building for investment revenue but opted for the building of a hotel. This was as the result of professional advice in order to get the highest and best use from the property which was on a busy thoroughfare leading to the airport.

Before building the Hotel, Kristian obtained a feasibility study and assistance from Concept 4 Inc, a Los Angeles company as to design, decor and furnishings. The type of construction was adequate to meet the long-range view of a hotel operation by the appellant. Quality fixtures and equipment were purchased with a view to the expansion of the hotel at a later date.

The decision to build a hotel required much more capital than had been anticipated for the construction of an apartment block and Kristian brought in a Mr Scott to assist in the raising of capital for the hotel project. The appellant entered into a long-term mortgage and personal guarantees and hypothecation of all the personal assets of Kristian and Scott were required to finance the hotel project. This personal financial commitment is not consistent with an adventure in the nature of trade but rather, is consistent with the concept of a long-term investment. See: Greenbranch Investments Ltd v The Queen, [1980] CTC 514; 80 DTC 6384; and Robbie Holdings Ltd v The Queen, [1980] CTC 422; 80 DTC 6336.

Kristian (the alter ego of the appellant) obtained a franchise from Best Western Inc and received diplomas for courses in management and housekeeping from Best Western Inc — another personal commitment. He became a Provincial Governor of that organization.

The reason for the sale of the Hotel in October 1979 was the direct result of the appellant encountering managerial problems which could not be resolved. This compounded the pressure on Kristian’s shoulders having regard to his medical condition. Further, without proper management, the appellant was losing money in its operations. The decision to sell the hotel was reasonable under the circumstances. Though the time between acquisition and sale of the property is seemingly short, the change of circumstances removes any colour of a trading transaction. See Racine, Demers and Nolin v MNR, [1965] CTC 150; 65 DTC 5098.

The respondent argued that if there was not a primary intention to turn over the property, there was at least a secondary intention to do so. In Racine et al (supra), Mr Justice Noël of the then Exchequer Court of Canada, said at 5102 (CTC 159):

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.

In face of all the facts, the contentions of the respondent with respect to a secondary intention on the part of the appellant have no validity. The appellant’s witnesses were fully credible and their evidence is fully acceptable. The respondent's evidence and contentions fail to establish the basis for the Court to accept, as plausible, a secondary intention to sell at a profit on the part of the appellant.

The appeal is allowed and the matter is referred back to the respondent for reconsideration and reassessment. The appellant is entitled to costs to be taxed.

Appeal allowed.