James D Rae, William R Jarvis v. Minister of National Revenue, [1984] CTC 2144, 84 DTC 1065

Sarchuk, TCJ:—These are the appeals of William R Jarvis and James D Rae from reassessments for their respective 1978 taxation years and of James D Rae from the reassessment of his taxation years 1979 and 1980. The two appellants jointly entered into the transaction which gave rise to the 1978 reassessments. Because the evidence and facts with respect thereto are applicable to both and since the issue involved and the assumptions made by the respondent upon which the reassessments were made are identical in each case the appeals were heard together. The evidence adduced and the arguments presented cover the appeals of each appellant.

The appeals involve the issue of whether each appellant’s respective share of profit in the sum of $810,709.31, realized on the 1978 resale of a parcel of land purchased in 1974 is to be considered as a capital gain or as income in the hands of the respective appellants.

In the case of the appellant Rae in relation to his taxation years 1978 to 1980 there is the further issue as to whether the respondent was correct in disallowing a reserve claimed by Mr Rae pursuant to subparagraph 40(l)(a)(iii) of the Income Tax Act and in allowing in substitution therefor a reserve pursuant to paragraph 20(l)(n) of the Income Tax Act.

The appellants are both businessmen residing in the City of Edmonton, Alberta. In 1974 each acquired a 50 per cent interest in a farm property situated near St Albert, Alberta consisting of 160 acres of land zoned for agricultural use. Following the purchase the appellants did not personally farm but did derive some income from the property by way of a share-crop arrangement with the former owner, which they duly reported for tax purposes. In 1977 forty acres of the farm property were designated as a “green belt” area and as a result could not be developed for any other purpose. The appellants at no time advertised or listed the farm property for sale. However, in 1978 they received an unsolicited offer to purchase which was accepted. They realized a gain on the disposition which they considered to be capital in nature and included the taxable amount thereof in income for their respective 1978 taxation years.

The appellants submitted that their interest in the farm property constituted capital property, and that the gain realized by them upon the disposition of their interest in the farm property constituted a capital gain.

Mr Jarvis was the only witness called by the appellants. He testified that he and Mr Rae were partners in a chain of fast food restaurants operating in the City of Edmonton under the name of Burger King. The appellants were married to sisters and have been friends and business associates since 1947. In 1953, while employed at the Imperial Oil Refinery, they decided to venture into the business world to supplement their incomes. Consideration was given to a Dairy Queen type of outlet and during the winter and spring of 1953 they located a property on 118th Avenue in Edmonton which they leased from the owner. The appellants constructed a building, doing all of the work themselves. They raised the necessary capital of $7,000 by way of cashing in their Canada savings bonds, by borrowing on their Imperial Oil shares and from various relatives.

Mr Jarvis gave a very detailed history of the development of the business and of certain problems which, the appellants say, led them to become involved in this transaction.

Initially the first and second outlets sold soft ice cream only. However, in 1958 the business entered into an agreement with the Kentucky Fried Chicken organization, acquiring a franchise and installing specialized Kentucky Fried Chicken equipment at its second location. With that the operation became a drive- through business offering the customers a choice of chicken, hamburgers or ice cream products at one location.

The business from its inception was carried on by Dairy Drive Inn Ltd, a company formed by the two appellants in or about 1952. In 1962 Dairy Drive Inn Ltd became a leasing/land holding company, retaining ownership of all property and leases (including improvements, equipment and furnishings) in respect of all the Drive Inn outlets. At the same time both appellants incorporated operating companies, Burger King Northern and Burger King Southern. These operating companies did not own any of the fixtures, land or buildings, but in partnership operated all Burger King Drive Inns.

In the years 1962 to 1969 Burger King added ten further outlets in Edmonton, all operating under the Burger King name and all carrying on business on the same basis. The expansion in each instance was financed out of existing store income coupled with loans from various institutions as required. In each and every case the land and property was acquired by Dairy Drive Inn Ltd, and the management was provided by the Burger King partnership.

The appellants resigned from Imperial Oil in 1965 as a result of refusals by certain lending institutions to advance further funds for expansion. It was suggested to them that perhaps they did not have enough confidence in themselves to leave Imperial Oil. This less than voluntary retirement cost both of the appellants some of their pension benefits.

In the early 1970s the business ran into difficulties with the Kentucky Fried Chicken franchisors. According to Mr Jarvis in previous years if a location suitable for expansion was available they would communicate with Kentucky Fried Chicken and a franchise would automatically be granted to them. Now Kentucky Fried Chicken indicated that it would not grant any further franchises unless Burger King was prepared to agree to change the nature of its operation to sell chicken products only. Kentucky Fried Chicken became quite hostile and commenced a campaign of harassment threatening cancellation of franchises as and when the various contracts expired. It became apparent to the appellants by 1971/72 that they had reason to be concerned about any future relationship with Kentucky Fried Chicken and consequently had good cause to worry about their own future since chicken sales accounted for approximately 50 per cent of their business volume. In 1972 in an effort to get back on good terms with Kentucky Fried Chicken one location was built to Kentucky Fried Chicken specifications, but even then Burger King was refused a franchise.

Mr Jarvis testified that as a result of these incidents both appellants became concerned about their personal future. He said that after twenty years neither he nor Mr Rae had too much in the way of personal assets and they felt the need for some security in the event that Burger King lost Kentucky Fried Chicken. An added concern was that, acting upon legal advice, both appellants had entered into arrangements described by Mr Jarvis as an “estate freeze” as a result of which most of the equity in Dairy Drive Inn Ltd was owned by their respective spouses and children. These arrangements left Messrs Rae and Jarvis with a 17.73 per cent interest each in Dairy Drive Inn Ltd (Exhibit A-8). Mr Jarvis did concede that in actual fact the control of the operation remained with them.

By 1974 the relationship with Kentucky Fried Chicken had deteriorated to the extent that two senior officers of the franchisor began operating Kentucky Fried Chicken franchises in Edmonton. In addition, renewals of franchise contracts for several Burger King locations were denied.

It was in this atmosphere that the appellants considered the acquisition of some property personally, as Mr Jarvis stated to provide them with security in the event their worst fears were to occur. A farm property mid-way between the City of Edmonton and the Town of St Albert, located just off the old St Albert trail came to their attention. Mr Jarvis testified that there was no indication that this would be a rapidly expanding area. After purchase the farm operation continued under a 7, - */ crop sharing arrangement with the vendor Mr Clarence Hayes, with Mr Jarvis going out two or three times a year to look at the crop. Otherwise neither he nor Mr Rae had an active interest in the operation of the farm.

Mr Jarvis stated that even if the property failed to produce a profit (which in fact was the case during the relevant years) they were in a position to carry the financing costs indefinitely.

By 1976 the relationship with Kentucky Fried Chicken had become even more difficult. The appellants formed a Kentucky Fried Chicken franchisee’s association and the dispute raged on. The franchisor continued to insist on the elimination of all products other than chicken from Kentucky Fried Chicken operations in Western Canada. That same year the Burger King operating companies were sued since they had continued to use the Kentucky Fried Chicken trade mark following cancellation of their franchises. A counter suit for damages was launched. Finally in 1977 an agreement was reached whereby the Burger King partnership agreed to conform to Kentucky Fried Chicken site specifications and agreed to expend the sum of approximately $1,000,000 to up-grade its outlets to Kentucky Fried Chicken requirements. Burger King also agreed that no further expansion would take place until reconstruction was carried out in accordance with the settlement.

According to Mr Jarvis it was at this time that the appellants received the unsolicited offer for the purchase of the farm property. He said that since the Kentucky Fried Chicken problem had been resolved and they now had a new ten-year franchise agreement, they personally had acquired security for the future and thus the farm property became surplus. He added that the unsolicited offer provided them with profits in excess of $1,000,000 coincidentally the amount needed for the renovations agreed to by Burger King. There was no evidence, however, that the profits were put to any such use.

In the course of cross-examination it became obvious that both appellants had extensive experience in the acquisition of properties for Dairy Drive Inn Ltd. There were three property transactions in 1973, five in 1974 and nine in 1975, all of which were reported as capital transactions. Furthermore, between 1968 and 1975 the appellants, acting for one or another of their companies, bought and sold four properties in transactions which were essentially speculative, involving raw land. These dispositions were also properly reported for income tax purposes. There was also evidence that Dairy Drive Inn Ltd earned a gross profit on land sales in 1976 but off-hand Mr Jarvis could not recall the transactions referred to.

As to the source of the purchase moneys ($50,000 each) Mr Jarvis testified that it was a repayment to them by their companies of shareholders’ advances made by them over the years. The balance of the purchase price was by way of a mortgage in the sum of $236,192 to the vendor calling for yearly payments of $35,454.07. Rental income from the crop-sharing agreement in the relevant years was $1,750 per year, consequently the appellants annually subsidized the operation by approximately $32,000. Mr Jarvis said that he was not concerned, the farm was not his livelihood and since the sole purpose for purchasing the farm was to provide security for his old age the additional annual costs were quite acceptable to him and to Mr Rae.

Mr Jarvis stated that when property was acquired for their companies they would take all reasonable steps to examine its potential. Rather surprisingly he maintained that in relation to this personal acquisition of the farm lands no such inquiries were made. They had no plans for the development of the farm, neither at the time of purchase nor later; no steps were taken at any time to subdivide or to zone the property. According to Mr Jarvis they had no idea of their future with Kentucky Fried Chicken but he said that if franchises were cancelled in the future at that point in time perhaps they would have considered subdividing and selling the property. As an alternative he said they might have considered selling off pieces of the land, for example ten lots per year. When asked how the farm property was to provide security for them he said they had “no game plans for the land’’. He did add that common sense dictated that if two cities (Edmonton and St Albert) are to grow they would in all probability grow towards each other. This he said was a factor taken into account by them.

The appellants contend that they did not embark on an adventure in the nature of trade; that they are not in the business of buying and selling land and that this was an isolated purchase with a holding of approximately four and a half years and as such should be treated as a capital transaction.

It was argued that the sale was not so closely associated with the normal business of the appellants as to be viewed as a business act by itself. They emphasized that the land transactions of Dairy Drive Inn Ltd fell into two categories, those with direct relationship to the drive-in operation and those required for protective reasons or expansion. Such purchases and dispositions were reported as capital transactions and accepted as such by the respondent. Others were treated as a realization of income. The appellants contend that a favourable inference should be drawn from the fact that in their corporate activities they were very careful to distinguish between profit earning and capital acquisitions.

Counsel submitted this property was acquired by the appellants personally; was not in any way related to their business; and was seen by them as a form of long-term financial security to protect their livelihood. The perceived threat of a loss of their Kentucky Fried Chicken franchises made it wise to consider a longterm investment in their own names. In this context the estate planning had relevance by virtue of the fact that the appellants had “given away” 7; of their equity in Dairy Drive Inn Ltd to their families and as a result were worried about their own security.

It was also argued that retention of the property for four years established that the property was not dealt with in a speculative manner. No steps were taken as might be taken by a trader; there was no enhancement of the property, no advertising for sale, no listing for sale, no steps to subdivide; and significantly, the sale arose out of an unsolicited offer. The appellants contend that such a sale at an enhanced price does not necessarily bring the profit into their hands as business income.

The respondent’s position is that the only inference which can be drawn from the evidence is that at the time of acquisition one of the major motivating factors was the possibility of turning this property to account by resale. The appellants were the directing minds and wills of Dairy Drive Inn Ltd and, given that corporation’s numerous involvements in the purchase and sale of property they, the appellants, are inevitably fixed with an extensive knowledge of the real estate market. The respondent submits that the acquisition was made by two sophisticated businessmen knowledgeable in real estate and in business and acting with the benefit of expert business and tax advice. The respondent contends that it would be wrong to ignore such activities and the knowledge and expertise acquired by the appellants and to say the transaction was an isolated occurrence.

It was not suggested that either of the appellants were traders or speculators in their personal capacity. The evidence adduced was intended to demonstrate their knowledge and experience as it might reflect on their intention at the time of the purchase of the farm.

It was submitted that the farm land was not acquired as a resource for retirement income but rather for its obvious potential for resale. The activities of the appellants were not entirely consistent with their purported need for security or for a long-term means of livelihood. The following items were specifically referred to:

(a) they had other apparent sources of retirement funds;

(b) they were the beneficiaries of a deferred profit sharing plan (Exhibit A-6);

(c) each retained a portion of an Imperial Oil employee pension plan;

(d) each had a Registered Retirement Savings Plan;

(e) each had a substantial portfolio of “blue chip” stocks.

The respondent argued that as a major motivation at the time of purchase both appellants had a view of the possible resale of this property. None of the indices of investment were present, there was nothing to enable an inference to be drawn that this was in fact a long term investment. There was no clear evidence by the appellants as to what was intended by them for the land, there were never any serious or fixed intentions to develop the property, there was no evidence of frustration of any plans and, contrary to their normal practice, they made no examination of the farm property prior to purchase to determine its investment potential.

The basic factual question in this case is what the appellants’ intentions were at the time they entered into this transaction. This intention can more accurately be deduced from the appellants’ conduct than from their stated intention which is retrospective and can in many instances be an unreliable guide. It is necessary for me to determine whether or not the appellants’ course of conduct as viewed in its entirety is consistent with their avowed intention to invest. Was the farm property in St Albert acquired by the appellants with the intention of holding or using it to produce income or was there such an absence of an investment purpose, coupled with an intention to resell at a profit, sufficient to characterize this transaction as a speculative venture in the nature of a trade?

Counsel for the appellants relied upon:

MNR v Valclair Investment Co Ltd, [1964] CTC 22; 64 DTC 5014;

MNR v Muzly Lawee and Naimae Lawee, [1972] CTC 359; 72 DTC 6342;

Stefan Jachimowicz v MNR, [1976] CTC 2309; 76 DTC 1241.

The Valclair case, (supra), was put forward by the appellants to support the following propositions:

1. That the amount of return on investment was not important and that it could vary circumstances and the fact of a minimal return did not necessarily characterize an investment as an adventure in the nature of a trade.

2. That there was not a great degree of risk since the appellants were in the unusual position of having adequate assets in the form of cash and could afford to “adopt a safe and passive attitude in respect of the property while allowing the impact of an expanding city population to make its presence felt”’.

3. That the purchase of raw land is one of the oldest types of long term investment.

The Lawee case, (supra), was cited to demonstrate that the appellants’ conduct was not speculative in nature. Mr Justice Cattanach was cited at 6352:

A speculator in land looks for quick turnovers and puts up only the minimum amount of money that will ensure control of the land. Frequently the purchase is made with money borrowed at a higher rate of interest. There is the compulsion to use little money and there is the compulsion to realize forthwith and pass on to further purchases.

The appellants say that their conduct with respect to their property was consistent with investment as a motive and that they did not act as speculators as described by Mr Justice Cattanach.

The appellants cited Jachimowicz v MNR, (supra), in support of their argument that the usual badges of trade were not present in this transaction and that the appellants’ course of conduct was such that could lead only to the inference that the land was held as an investment.

All of these cases, and the same can be said for those submitted by respondent’s counsel, were decided on their own specific and peculiar facts and cannot be taken as setting out any basic principles applicable to all such transactions.

Certain difficulties arise from the appellants’ position. It may well be that the amount of return is not an absolute requirement to characterize a transaction as an investment, and that in some instances as long as the asset is susceptible of yielding an annual return, albeit minimal, this factor would be of assistance in qualifying such an asset as an investment.

Again, it may well be that in certain fact situations a property bought with the express purpose of resale at a profit might not be considered an adventure in the nature of trade.

But these general statements made in relation to substantially different fact situations are of little assistance to this Court. Here we have appellants who are successful businessmen with a substantial appreciation of the real estate market. They did know that the farm land was in an area with a vast potential for development and the consequent potential for increase in value. It seems inconceivable that one of the principal motivating factors in the purchase of the farm property was not the intention to resell at a profit.

On my analysis there is a dearth of evidence establishing any investment purpose as alleged by the appellants. The asset acquired by the appellants was not something which might readily be called an investment asset. Certainly it does not fall into the same category as corporate shares.

It is a matter of common knowledge that in the past several decades there has been an extremely rapid expansion of our cities into rural areas, so-called bedroom communities have been developed; satellite cities have been built, all creating a healthy market for the enterprising and knowledgeable risk-taker. The appellants were not unaware of this. Mr Jarvis in his testimony conceded that St Albert was a bedroom community which was very small at that time but stated that common sense dictated that if two cities are to grow they will grow towards each other.

The appellants’ avowed purpose in acquiring the farm property, as a hedge against a possible loss of income resulting from the ongoing dispute with Kentucky Fried Chicken and as a source of retirement income is difficult to accept. The evidence as to how this purchase was to provide such future income was vague and poorly defined. The appellants were not novices, in acquiring properties for their companies they gave much thought and deliberation to each acquisition, purchasing locations for the purpose of rounding out a land assembly for a drive-in site, to expand their business into Saskatchewan, for expansion of a particular site, to increase a parking area for future use, to build an office building to contain a headquarters, and to consolidate a catering business and banquet room facility. In relation to raw land purchases on behalf of their companies Mr Jarvis was perhaps a little less specific but his evidence was that several of the purchases were made because they knew the land would go up in value within a reasonable time frame. The fact of the matter is that both appellants knew that Edmonton was growing and that the prospects for increased land values could readily be anticipated.

If they had truly conceived of the farm land as a source of retirement income I am satisfied that the appellants would have had something more in mind than the vague and ill-defined possibilities put forward by Mr Jarvis.

The asset was not an income producing investment and would continue to require substantial annual subsidy payments by the appellants. The appellants” alleged desire for providing themselves with a source of future income in the event they lost the Kentucky Fried Chicken franchise does not square with this fact. While the farm was not a potential source of replacement income, it was on the other hand a potential source of profit based on the possibility of a fairly prompt resale.

The evidence tendered that the land was intended to be held for a long period of time was less than convincing. It is difficult to accept that the carrying costs would have been an acceptable burden for an extended period of time. It is particularly difficult to accept such statement if one accepts at face value the appellants’ concerns about a potential drop of 50 per cent or more of the gross sales of the Burger King operations with a consequential diminution of their earnings.

I have grave doubts that the appellants’ intention was to purchase the farm property to provide income security, to provide for their families and to provide security for their old age.

Taking the evidence as a whole it is my view that the nature of the transaction was an adventure in the nature of trade and was not a long-term capital investment. There is no persuasive evidence to the contrary and the appellants have not, at the very least, discharged the onus upon them. The appeals are dismissed.

Appeals dismissed.