George Jellaczyc v. Minister of National Revenue, [1985] 1 CTC 2158, 85 DTC 184

Sarchuk, TCJ:—These appeals are from income tax reassessments for the appellant’s 1977, 1978 and 1979 taxation years. At issue is the deduction of certain “carrying charges” (mortgage interest and realty taxes) which “carrying charges” pertained to a piece of real property at 5189 Trafalgar Road, Milton, Ontario, held by the appellant for the express purpose of resale at a profit. The Minister, pursuant to subsection 18(2), disallowed the deduction of mortgage interest and realty taxes (in excess of net income from the land) which the appellant had capitalized, added to cost, and claimed as business losses for the years in question. These amounts were $14,390.40, $3,728.40 and $3,488.80 respectively.

The material facts in these appeals are not in dispute. Mr Jellaczyc has been a real estate broker since 1963. For most of this period he was employed by George Jellaczyc Real Estate Ltd, a company in which the appellant owned, directly or indirectly, all of the issued shares. Throughout the years the company was involved in many real estate transactions and it is common ground that the appellant acquired a wide range of experience and was an astute and knowledgeable businessman.

In 1974, Mr Jellaczyc acquired a 40 per cent interest as a tenant in common with two other individuals in 26.923 acres of agricultural land on Trafalgar Road in the region of Halton. This property was purchased by them expressly for the purpose of profiting from its eventual resale since it was designated for future urban development. At all relevant times the property continued to be held by the appellant for such purpose and was not sold in whole or in part. According to Mr Jellaczyc, this transaction was the only time in recent years that he acquired and held land in his personal capacity, all other transactions of a similar nature having been conducted by him as an employee of George Jellaczyc Real Estate Ltd and strictly on its behalf.

In 1977, 1978 and 1979 the appellant deducted from his income business losses derived in the following manner. The Trafalgar Road property was treated as inventory. In each taxation year the carrying charges ie mortgage interest and realty taxes were capitalized and added to cost following which the appellant calculated a purported loss based on a “proceeds of sales less cost of sales” formula. The appellant’s share of these capitalized carrying charges in excess of income amounted to $14,390.40, $3,728.40 and $3,488.80 in 1977, 1978 and 1979 respectively and constituted the business losses deducted from income by the appellant.

The appellant’s case is founded on two major premises. The first is that the purchase of the Trafalgar property was not, as the respondent had assumed, an adventure or concern in the nature of trade. Although admittedly an isolated transaction it was purchased and held by Mr Jellaczyc in the course of the business of buying and selling land carried on by him in the relevant years. Counsel for the appellant argued that proof that Mr Jellaczyc was in fact carrying on a business could properly be obtained by reference to the real estate activities of George Jellaczyc Real Estate Ltd whose directing mind for all practical purposes was the appellant. In view of this, “it was the appellant’s alter ego and accordingly both persons should be entitled to and accorded the same treatment”. The appellant contended that the activities of the company should not be distinguished or severed from those of the appellant, and since the company is in the business of buying and selling land that fact determines the true nature of the appellant’s acquisition and ownership of the Trafalgar property.

Secondly, the appellant submitted that since Mr Jellaczyc was carrying on the business of buying and selling land the principle of writing down inventory to fair market value was properly applicable to the property in question for the purposes of reporting taxable income for the taxation years at issue and was in accordance with the provisions of subsections 10(1) and 10(1.1) of the Income Tax Act. Although paragraphs 18(2)(a) and (b) prohibit the deduction of mortgage interest and realty taxes, subsection 10(1) allows the appellant to add those amounts to the cost of inventory. Counsel contended that it was therefore correct, both from the standpoint of sound accounting practice and for income tax purposes to capitalize these charges (by adding them to the cost of the property) and then to apply the “sales less cost of sales formula” applicable to inventory accounting. If the result was a business loss in each year from the joint venture by which the property was held, this business loss could properly be deducted from the appellant’s income for income tax purposes as had been done.

The respondent’s position was that as an adventure in the nature of trade the property was not held by the appellant in the course of a business carried on by him within the meaning of subsections 18(2) and 248(1) of the Act and that the profit therefrom, if any, in any taxation year was computable without regard to the profit or loss from any other business or adventure in the nature of trade as required by section 4 of the Act.

With respect to the manner in which the appellant calculated the purported business losses it was the respondent’s position that the deduction of mortgage interest and realty taxes in excess of net income from the Trafalgar Road property was prohibited by subsection 18(2) of the Act. Furthermore, such costs were not deductible by the use of the “sales less cost of sales” formula applicable to inventory accounting and by reliance on subsections 10(1) and 10(1.1) of the Act. Such a formula was not applicable in this case, because as counsel submitted:

The land had not been sold, no profit (or loss) within the meaning of subsections 9(1) and 9(2) of the Act from this adventure in the nature of trade had arisen and was applicable in any of the taxation years in question and accordingly, there was no income (or loss) from a business;

As there was no sale and no profit and thus no income from a business with respect to the said property, it was not inventory within the meaning of section 248(1) for the taxation years in question, and subsection 10(1) and 10(1.1) were not applicable. The respondent therefore submits that not only were the capitalized carrying charges thus not deductible as business losses, but in 1977, no amount on account of a write-down of inventory should have been allowed.

It was conceded by the appellant that if the acquisition of the Trafalgar property by him is a transaction being an adventure in the nature of trade, subsection 18(2) of the Act operates to prevent the deduction of these carrying charges in all years under appeal. Prior to November 16, 1978, subsection 18(2) prohibited the deduction of excess carrying charges with respect to any business “in the ordinary course of which land is held primarily for the purpose of resale or development”. In 1979, subsection 18(2) was amended to delete this limitation for expenses incurred after November 16, 1978, in respect of land “used in, or held in the course of, a business carried on in the year by the taxpayer”. Concurrently, the definition of “business” in subsection 248(1) was amended to exclude an “adventure or concern in the nature of trade” from the definition of business for purposes of paragraph 18(2)(c). It is clear that subsection 18(2) continued to operate at all relevant times so as to prohibit in the taxation years in question the deduction of such charges incurred in respect of land held as, or in the course of, an adventure in the nature of trade.

The question as to whether a business was being carried on by the appellant as contended must be solved as a question of fact having regard to the circumstances of a particular case. The fact that George Jellaczyc Real Estate Ltd carries on business as a trader in land is of no assistance to the appellant. They are separate and distinct legal entities. Each acts on his or its own behalf and is independent of the other. In my view the appellant’s “alter ego” argument has little merit.

In these appeals the intention of the appellant was clear and unambiguous. The property, designated for urban development, was purchased solely for the purpose of eventual resale at a profit. Nothing was done with the land. There was no intention to subdivide or in any fashion to make the property more marketable. The profit-making scheme involved only one trading asset which upon its eventual disposition would bring the joint venture to an end. Unquestionably, the stucture underlying the venture was, and was contemplated to be, a temporary alliance of interested investors with a common objective. It was not intended to be nor was it a more or less permanent business structure with an objective of ongoing revenue-producing activities. In his personal capacity Jellaczyc did not trade in real estate and the acquisition of this property was an isolated transaction. The evidence is clear that he had never acquired any other land (with the exception of his personal residence) in recent years.

If the phrase “adventure in the nature of trade” is to have any meaning at all a distinction must be drawn between it and the words “business” or “trade”. The phrase was considered by the Exchequer Court of Canada in MNR v James A Taylor, [1956] CTC 189; 56 DTC 1125, and Thorson, P commented at 199 [1131]:

It is, I think, plain from the wording of the Canadian Act, quite apart from any judicial decisions, that the terms “trade” and “adventure or concern in the nature of trade”, are not synonymous expressions and it follows that the profit from a transaction may be income from a business within the meaning of section 3 of the Act, by reason of the definition of business in section 127(l)(e), even although the transaction did not constitute a trade, provided that it was an adventure or concern in the nature of trade.

In considering the circumstances in which a transaction might be an “adventure in the nature of trade” Thorson, P stated at 210, 211 [1137]:

But “trade” is not the same thing as “an adventure in the nature of trade” and a transaction might well be the latter without being the former or constituting its maker a “trader”. “. . . The very word “adventure” implies a single or isolated transaction and it is erroneous to set up its singleness or isolation as an indication that it was not an adventure in the nature of trade.

Another case, Tara Exploration and Development Company Limited v MNR, [1970] CTC 557; 70 DTC 6370, although not directly on point contains a useful discussion of the distinction between ‘‘an adventure in the nature of trade” and “carrying on business”. In Tara, Jackett, P (as he then was) said at 567 [6376] :

With great doubt as to the correctness of my conclusion, I am of opinion that Section 139(l)(e) does not operate to make a non-resident person subject to Canadian income tax in respect of a profit from an adventure that otherwise does not amount to, and is not part of, a “business”. With considerable hesitation, I have concluded that the better view is that the words “carried on” are not words that can aptly be used with the word “adventure”. To carry on something involves continuity of time or operations such as is involved in the ordinary sense of a “business”. An adventure is an isolated happening. One has an adventure as opposed to carrying on a business, [emphasis added]

In the case at bar there was no evidence that the appellant had embarked on a course of dealing contemplated or intended to continue. It was simply an isolated transaction with no continuity of time or operations involved. I find that the appellant was not carrying on a business and the transaction in issue was simply an adventure in the nature of trade. Having regard to the foregoing I conclude that subsection 18(2) of the Act operates to prohibit the appellant from deducting the amounts in issue.

I am constrained to note that extensive arguments were submitted with respect to the appellant’s use of a “sales less cost of sales” formula applicable to inventory accounting to claim as expenses against other income that would otherwise be non-deductible carrying charges. On this issue the appellant failed to present any evidence whatsoever to support his position. The onus is on the appellant to disprove the Minister’s assumptions. Counsel’s opinion as to what constitutes a proper and acceptable accounting practice does not satisfy that requirement.

Counsel for the respondent contended that it is seriously questionable whether the inventory accounting method has any application to the circumstances of these appeals and submitted that a doubt in similar circumstances was expressed by the Supreme Court of Canada in MNR v Joseph Irwin, [1964] CTC 362; 64 DTC 5227 and in Oryx Realty Corporation v MNR, [1974] CTC 430; 74 DTC 6352, a decision of the Federal Court of Appeal. In the latter case the Court referred to the formula of “proceeds of sale less cost of sales” as a formula to be used for a “trader whose transactions are so numerous or of such a character as to dictate” its use. These decisions, although distinguishable, do cast doubt on the account method utilized by the appellant.

There is as I have indicated no evidence upon which I can conclude that the inventory accounting method utilized by the appellant was applicable or appropriate. In view of this and having regard to my conclusion that the appellant was not carrying on a business I find that he has failed to make out a case for deducting the amounts in question in computing his income for the taxation years in issue.

The appeals will, accordingly, be dismissed.

Appeals dismissed.