DR Laszlo D Bakos, Jeannette Bakos v. Minister of National Revenue, [1984] CTC 2555

St-Onge, TCJ [ORALLY]:—The appeals of Dr Laszlo D Bakos and his wife Jeannette Bakos were heard on common evidence on January 31 and February 1, 1984, at the city of Vancouver, British Columbia.

The issue was whether the gain on the sale of land is capital or income in the appellants’ 1979 taxation year.

The respondent reassessed the appellants on the following assumptions of fact. Paragraph 6 of the reply to the notice of appeal for Dr Bakos reads as follows:

6. In reassessing the Appellant for his 1979 taxation year, the Respondent, the Minister of National Revenue, relied on the following assumptions of fact, inter alia:

(a) the Appellant and his wife purchased the said property in 1978 for $340,000. — and sold the same approximately 9 months later for $720,000.00 realizing a profit of $380,000.00;

(b) the said property was zoned for agricultural use at the time of purchase and

rental income realized over the period of ownership from such use was $700.00;

(c) the property was purchased with the knowledge and expectation of an increase in value and that expectation was realized;

(d) the property was purchased for its resale value rather than investment potential and at the time of purchase the Appellant had in mind the possibility of reselling at a profit as an operating motivation for the purchase;

(e) the Appellant purchased with a portion of the profit from the sale of the said lands an I.A.A.C. for $24,587.36.

At the hearing Dr Bakos testified as follows. In 1957, he left Hungary and two years later he qualified himself as a medical doctor in Canada. In 1969, he joined a group of radiologists in British Columbia. His first venture was the selling of his home in Regina, Saskatchewan, when he decided to practise in British Columbia. Later, he made an investment of $100,000 in an enterprise in North of Edmonton, Alberta and incurred a considerable loss.

As may be seen, the appellant has no history in real estate transactions for the purpose of earning income. Around 1977, he decided to become semi-retired for two reasons:

1. The nature of his work (radiology) was too dangerous and after so many years of practice he was more inclined to cancer;

2. he was injured (fracture of vertebrae) in an airplane accident. He underwent five medical operations between 1972 and 1973 (double vision and disfunction of his hearing).

With his wife, he decided to study in order to find another source of income. They read financial journals, books and met many experienced people, such as Mr Laidley, an engineer in Alberta and Mr Larry Homer, a real estate developer who had developed various shopping centres, and finally decided that the best investment would be in the buying of an industrial park.

There was no question of buying in British Columbia because of the political situation, the numerous labour problems and also because the land was way overpriced.

On the other hand, there was a tremendous boom in Edmonton in the field of oil and gas, mainly heavy oil development such as Tar Sands.

The appellant made a number of trips to a relative in Edmonton, a Mr Fisher, in 1976 and 1977. He spent a week there, rented a car and visited some 12 properties. He did look for industrial property because it was more flexible, it had good return for a long-term investment. The subject property had a sign “For Sale’’. He did contact the real estate agent, Mr Stallybrass. The latter explained to him that although the property was zoned agricultural land, it was close to industrial land and it was to become an area for industrial parks. The Alberta government at that time had passed a law to allow cities to plan and design industrial areas for future development. The asking price of the subject property was over $400,000. He made a first offer of $280,000 and then a counter offer was made of $400,000. Finally, the parties agreed to $340,000.

The appellant had a line of credit of some $250,000 at the Bank of Commerce. The vendor agreed to a mortgage of $175,000 to be paid in five years by a yearly instalment at an interest of 10 per cent. An appraisal of the property was prepared in order to obtain a loan from the bank. Before buying he had also received the advice of his relative, an experienced businessman in Edmonton in the field of drilling for oil. According to him, the subject property was a perfect location for the development of an industrial park because of:

1. the transportation facilities; it was close to airport, railway and highway;

and

2. also because it was in the vicinity of a very prosperous industrial park, the Nisku Park Development.

In order to prove this assertion, counsel for the appellant filed as Exhibit A-9, an extract of a publication which reads as follows:

NISKU BUSINESS PARK — What began 10 years ago as a search for a place to locate a modest electrical supply business has blossomed into a more than 1,400-acre development, said to be “Canada’s largest, fastest-growing industrial park.”

In 1970, the Sparrow brothers — Murrey, Jim, Don and Bert — were looking for a place to locate their oilfield supply company, Sparrow Electric Ltd., when Murrey came across 80 acres of land east of Highway 2 and opposite the Edmonton International Airport.

The brothers reasoned that if they liked the site as a location for their business, maybe others would like it too.

And others did. More than 270 businesses have already purchased land in the park, currently priced at $50,000 to $70,000 per acre. In 1979 alone, 50 companies opened new facilities in the park valued at more than $15 million.

The Sparrows, Don says, have followed a policy of “when we sell an acre, we buy an acre (for future development)”.

Dr Bakos also received the advice of Larry Homer, the manager of a substantial national home development.

In order to achieve his industrial park development, the appellant took the following steps:

1. He attended two public meetings, one on May 8, 1978 at Fultonvale Auditorium and the other in a school house.

2. He hired an engineer by the name of Mr Baba to make an application to rezone the property as light industrial; the cost was $1,100.

3. He also hired Mr Kovacs, a design consultant who designed various plans to show what could be achieved with the land; the cost was $2,400.

Apparently, during the appellant’s negotiations to obtain the rezoning, he received many offers by telephone to purchase his land (Exhibit A-17 mentions some seven names but there is no offer in writing). Finally, when he learned that he could not obtain a rezoning of his land, he decided to sell after only nine months of holding. The appellant also explained that the vendor stopped paying on October 15, 1982 and that he still owes a balance of $394,765.

Proceedings were taken against the debtor and one day he may have to repossess the land. After the sale the appellant acquired another property in the Cold Lake area for the same purpose (industrial park). The property was in the area of a several-billion-dollar project, but that project was cancelled and he still owns the land which has decreased in value. He also testified that if he repossessed the subject property now that it is in the Leduc County, he would try to develop it as an industrial park and it would be financed by his own income or in association with his medical partners on a piecemeal basis.

At the end of his testimony, Dr Bakos explained that he had borrowed $170,000 from the bank and pledged his home to secure that loan. Mr Ben Fisher, explained his tremendous activity in the business of digging for oil. Now he has his own company which has its head office in Nisku Industrial Park. For a while, he was chairman of a group of 50 businessmen of Nisku Industrial Park in order to get better services from the Public Utility Board. On a casual basis, he discussed about an industrial park with Dr Bakos and told him that the property he intended to buy was in a very attractive location. Like the Nisku Industrial Park it had the three advantages:

1. road access;

2. railway; and

3. air services.

He was not aware of the type of development the appellant intended to do, nor did he know about the zoning. As to the Nisku Industrial Park, the Sparrow brothers developed it and sold acres on the lease purchase agreement. Actually his company has purchased the property from the Sparrow brothers. Mrs Bakos corroborated her husband’s testimony.

Counsel for the respondent called two witnesses:

1. Mr D L Makale, a professional town planner;

2. Mr Elmar Haas, chairman of the committee which had to study applications requesting a change in zoning and make recommendations to the council.

Mr D L Makale explained that there were two levels to change the zoning. First it had to be approved by the Edmonton Planning Control Board and, secondly, by the Regional Planning Commission. The appellant’s application never got the recommendation from the first level because first there was no question of putting 600 acres of good agricultural land into light industrial land and, secondly, there was no need to put so many acres in industrial land. Consequently, the second step was never taken and it was final because there was no appeal. Furthermore, to obtain the second step it would have needed two thirds of the 19 municipalities within the boundaries of Edmonton.

He admitted that it would have been reasonable for a layman to have the expectation of rezoning but he further said that it would have been prudent to seek the advice at the right place before buying to develop an industrial park.

Mr Haas testified that most developers, prior to proceeding with the development, would communicate with him to know the potential of a property; that it was common knowledge at that time that the policy of preservation of farm land would prevent utilization of good agricultural land for industry. In his submission, counsel for the appellant summarized in some 14 points the evidence adduced. There is no need for me to repeat these facts as I have already summarized them, but he has insisted on two important points:

1. That the owners of industrial parks usually lease to tenants, and then he read an extract from Exhibit A-22 at 147, and I quote:

Industrial parks, large tracts of land owned by a single developer and planned to accommodate one-storey factories and warehouses sprawling over acres of land, are a third major postwar innovation of the developers in Canada. As in medieval fiefdoms, businesses located in industrial parks are usually not owners of the land their premises are built on. Perhaps it’s not surprising to discover that one of Canada’s first large industrial parks was developed near Vancouver by the Duke of Westminster, owner of one of the largest and oldest estates in Britain.

2. The appellants were frustrated because of the failure to obtain an industrial zoning. Counsel for the appellants argued that Dr Bakos did everything possible to obtain an industrial zoning: he retained an engineer, a design consultant, and it was reasonable for a layman such as Dr Bakos to believe that he had a chance to get the said zoning. All the factors indicated that the location could become industrial.

Counsel for the appellant referred the Court to the following cases, on frustration:

1. Valley Vu Realty (Ottawa) Ltd v MNR, [1983] CTC 2238; 83 DTC 217;

2. Les Immeubles Roussin Ltée v MNR, [1982] CTC 2668; 82 DTC 1683;

3. Belvedere Park Development Co Ltd v The Queen, [1983] CTC 171; 83 DTC 5214.

This last case is distinguishable from the case at bar since the taxpayer’s company acquired 14.9 acres of land for development into a residential and commercial subdivision, whereas in the case at bar, the appellant acquired 80 acres for an industrial park which requires a substantial cash flow to realize such a project.

Counsel for the appellant terminated his submission by saying:

1. the intention for investment is clearly present;

2. frustration was the reason for selling;

3. subsequent events showed that the appellant still has the same intention to own an industrial park.

The respondent’s submissions

Counsel for the respondent argued that the clear intentions mentioned by counsel for the appellant that the appellant’s intention could not be carried out without an industrial zoning:

1. Before acquiring it the appellant knew that the land was agricultural. He knew also about the existence of a policy of preservation of farm land.

2. There was no finance arrangement to achieve an industrial park development.

3. After the buying, the appellant’s conduct was also consistent to that of preparing the land for selling.

4. The writing on the cover of Exhibit A-11 is clear evidence that the appellant’s primary intention was to sell land.

5. The subsequent events have no relevance to substantiate the appellant’s intention.

6. The appellant’s course of conduct after the acquisition of the land shows that he did everything to increase the value of the land for the purpose of selling it at profit.

7. In the case at bar there was no assurance that the zoning would be changed.

It is obvious from the evidence adduced that the development of an industrial park of 80 acres required the selling of land. The owners of Nisku Industrial Park purchased 80 acres to relocate a business, whereas the appellant in the case at bar did not have this motive. In spite of this incentive to buy, the Sparrow brothers had to sell acreage in order to develop the industrial park which has had such substantial success. Furthermore, it is in evidence that when they leased the land it was on a lease-purchase basis. Consequently, it appears impossible to develop an industrial park without the possibility of selling land.

In his testimony, Dr Bakos testified that when he intended to take semi- retirement he was looking for another source of income. The court is convinced that right from the beginning, the appellant’s intention was to sell part of the land in order to earn additional income. As a matter of fact, Dr Bakos never explained how he was to develop his light industrial park except that he wrote in Exhibit A-11 “Buy — build to suit lease with option to buy after initial acceptance — lease & rent for income”. But the appellant’s financial means did not show that he was able to build warehouses at a cost of some $400,000 each, for the purpose of renting them, and at the same time make the payments for the acquisition of the land, without selling a great number of acres.

Right from the beginning, the simple fact that the appellant wanted to develop an industrial park indicates that it was an adventure in the nature of trade and a very risky one since he was not certain how to obtain the rezoning of his land. He was fortunate enough to sell his whole 80 acres by almost doubling the price he paid for it after only a nine-month holding, but later he was less fortunate by not receiving the payments from the purchaser. However, there is a consolation

— the appellants are going to be taxed only on the net profit they received. If the appellants repossess the land, this Court may have to rule on this issue in the future.

For all these reasons, the appeals are dismissed.

Appeals dismissed.

Tax Court of Canada (Taylor, TCJ), June 5, 1984.

Income tax — Federal — Income Tax Act, RSC 1952, c 148 (am SC 1970-71-72, c 63) —

The taxpayer corporation carried on two business activities: the provision and distribution of building supplies and the breeding and racing of horses. Its horse activities had resulted in considerable losses each year from 1973 to 1978. The corporation sought to deduct its 1977 horse-related losses, $112,784, from other income in its 1977 taxation year. It contended that the deduction was not restricted by the provisions of section 31 of the Act, on the ground that the provision of building supplies and the breeding and racing of horses were interconnected operations of one business activity and did not represent different sources of income. It further argued that rather than farming losses as such, the horse activity losses were advertising and promotional expenses incurred to earn income from the business as a whole.

HELD:

The question in issue was whether a corporation, partly engaged in farming activities, can avoid the restrictive provision of section 31 by calling a farming loss a form of “promotion or advertising” rather than a “loss”, for the benefit of a non-farming business it also operates. Farming is a separate and distinct source of income and is so treated in the Act. It is not the same source of income as a building supply activity. The loss from one source is not deductible as an expense item from the profit of the other. Appeal dismissed.

D C Nathanson for the appellant.

R E Taylor for the respondent.

Taylor, TCJ:—This is an appeal heard in Toronto, Ontario, on January 18, 1984 against an income tax assessment for the year 1977.

The point at issue as detailed in the notice of appeal was:

5. The Appellant states that the losses relating to its horse breeding and racing operation were incurred in the course of and as an integral part of the Appellant’s profit making enterprise as a whole and as such, were incurred to earn income.

6. The Appellant states that the provision of building supplies and the breeding and racing of thoroughbred horses are inter-connected operations in the context of the Appellant’s business and together constitute its chief source of income.

10. The Appellant respectfully submits that, inasmuch as its chief source of income for the 1977 taxation year was a combination of thoroughbred horse breeding and racing and the provision of building supplies, section 31 of the Income Tax Act did not operate to constrain the taxpayer from deducting the loss that it sustained in connection with thoroughbred horse breeding and racing in the said year.

For the respondent the position was:

(e) that the amount of $112,784.00 sought to be deducted by the Appellant was in respect of losses resulting from the Appellant’s race-horse business;

(f) that the said race-horse business, in the taxation years immediately preceding the 1977 taxation year and in the immediately following year, suffered losses in the following amounts:

1972	18,496.00
1973	58,652.00
1974	76,414.00
1975	43,774.00
1976	270,522.00
1978	148,572.00

(g) that, in the 1977 taxation year, the Appellant’s race-horse business did not constitute the Appellant’s chief source of income either alone, or in combination with any other source of income.

A chartered accountant witness for the appellant, Mr Kates and counsel for the appellant, put forward for the Court’s consideration that the process of preparing a statement of income and expenses itself for any business amounted to a system of “netting” that is producing a net financial result. Accordingly simply “netting”, all the related income and expenses for the corporation could be viewed as a very similar process. The appropriate definition of the term “combination” in section 31 of the Act was also touched upon by counsel for the appellant. The fundamental position of the appellant however was described by counsel as:

. . . it would be my submission that in view of the intertwining or the interconnection of the horse-racing activity for the specific purpose that it was engaged in with the sale of building supplies that the revenue from the sale of horses per se should be treated as revenue from what I would call the business within the meaning of section 4(l)(a), that is, if one were to look at the source one would look at the business as being the source and describe the business as the total enterprise carried on by the corporation and simply regard the revenue derived from the sale of horses or the winning of purses as being ancillary to or necessarily incidental to or tied up with the sale of building supplies. There is a functional, at least on the evidence, a functional interconnection between the two in the same way, for example, that in the Marsh and McLellan case the Federal Court of Appeal has held that interest income which is incidental to the business is really part and parcel of the same business and there is to be no separation of the sources so in either view of the matter from an accounting presentation point of view I do not think and it is my submission that 4(1 )(a) would not stand as an obstacle to treating the expenses in question as being in the nature of advertising.

So in the case at bar I would simply submit that the expenses incurred in engaging in horse breeding and horse-racing on the evidence constituted net of associated revenue expenses which can fairly be characterized as advertising and promotional expenses which are deductible in computing income from the business carried on by the appellant corporation Blair Supply Co. Ltd.

I know of no other reported case that would even tangentially deal with this issue other than the Olympia Floor and Wall Tile (Quebec) Limited case which in itself to my recollection was a unique case and which has not certainly in the reported decisions repeated itself. But the Olympia Floor and Wall Tile case has not been alluded to, however, in a number of other cases not involving this type of fact situation but involving, for example, gratuitous payments . . .

There is a connection and the connection that does exist on the evidence has relevance as I mentioned earlier, that the expenses incurred in the horse-racing activity can properly be viewed as an expense incurred in the course and for the purpose of earning income from the business, however that business may be characterized. You can characterize it as the building supply business; you can characterize it as the building supply business with a little horse-racing involved; you can characterize it as just the business of the corporation and the horse-racing activity as having an advertising and promotional purpose.

. . . When we are dealing with such things as advertising and promotion one cannot relate every expenditure to a specific item of revenue or even to a source of revenue.

It is difficult to show, it is impossible to show really a direct causal relationship between any business promotion or advertising expense and an item of revenue but that on the basis of all the jurisprudence of which I am aware is not an impediment to claiming an expense of that nature as a proper business expense.

Clearly a taxpayer corporation can carry on as a part of its total business operation, the business of farming, with profits and losses from other nonfarming businesses, and combine the net profits from that business in order to produce one net profit (or loss) for the year. It seems to me that the same corporation cannot combine a farming loss with similar other non-farming profits or losses without surmounting the restrictive provisions of section 31 of the Income Tax Act. The question which has been posed in this appeal is whether a corporation can avoid the restrictive provision of section 31 by calling the farming loss not a “loss” but a form of “promotion or advertising” for the benefit of the non-farming business it also operates.

Paragraph 31(l)(a) of the Act provides for a situation where a taxpayer has more than one source of farming operation, simply put he operates more than one farm:

aggregate of his losses for the year — from all farming businesses carried on by him — exceeds the aggregate of his incomes — from all such businesses.

From Moldowan v The Queen, [1977] CTC 310; 77 DTC 5213 also I would assert that it was in the minds of the legislators that such a farmer (with more than one farming operation) should not be prohibited from netting “his farm losses and incomes — that is he should not be required to report as income the total of the gains realized on the profitable operation(s) while being restricted to a limit of $5000 as a “farm loss” from the unprofitable operation(s)”.

The separate portion of the Act which deals specifically with farmers, and the calculation of their income for tax purposes, is basically an option to report on the “cash” or “accrual” method. In general, that portion of the Act covers sections 28 to 30. These sections of the Act are followed immediately in section 31 by the heading: “Loss from farming where chief source of income not farming”. The thrust of the appellant’s proposition in this appeal would be to negate the provisions of section 31 of the Act. This appeal might be dismissed simply on the basis that the inclusion of the separate “farming” provisions in the Act (refer- enced above) section 28 to 31 mandates for that business of farming the risk of encountering the restrictions in section 31, but that answer seems somehow to me only to beg the question. In my view the real problem in the proposition of this taxpayer corporation is that it negates the “farming business” as a “source” of income. That is, it is inherent in the act of dropping the term “farm loss” and substituting therefore the term “promotion and advertising”, that the expense items which constitute the basis for the loss are transferred from one source of income to a separate and different source of income. That would be inconsistent with, indeed in direct opposition to the specific provisions of section 3, and 4 of the Income Tax Act, which must govern and overrule all others, unless so stated. One might pick from section 3 just the following:

(a) determine the aggregate of amounts each of which is the taxpayer’s income — from a source —

and from subsection 4(1)

(a) — and was allowed no deduction in computing his income for the taxation year except such deductions as may reasonably be regarded as wholly applicable to that source —

and from subsection 4(3)

— all deductions allowed in computing the income of a taxpayer for a taxation year — shall be deem to be applicable either wholly or in part to a particular source —

[Emphasis added]

The appellant did not show that the “farming” operation in question should not be considered a “source”, and therefore the appeal must fail.

I am conscious of the earlier jurisprudence noted in this judgment, by counsel for the appellant, but I do not find therein any rationale for extending the comments of the learned judges in those cases to provide the relief sought by this taxpayer today. In this matter, the Minister did not challenge the “business” nature of the farming operation, even though the losses were continued and consistent, therefore it warrants the appellation “source”. Certain other activities may not be so easily distinguishable as is farming under the Act, and therefore more difficult to call a “source”. Because of that, the judgment in this matter cannot be taken to apply unreservedly to all similar sets of circumstances. Such other business possibilities were alluded to, in certain comments by the parties and, for example, one could imagine a manufacturing company sponsoring a hockey team which loses money and proposing a net taxation result somewhat analagous to that at issue in this appeal. This judgment cannot be viewed as providing any perspective for the result which could obtain in that theoretical situation.

The source of income to which the expenditures constituting the farming loss at issue in this appeal, while part of the overall business activity of the corporation, is not the same source of income as the main building supply business of this corporation. This is the situation for income tax purposes even though it might well be argued that the horse-racing activity did produce useful and productive contacts for the building-supply business. The loss from the one source is not deductible as an expense item from the profit from the other source. I would note in closing, that while Combined Appraisers and Consultants Ltd v MNR, [1983] CTC 2606; 83 DTC 543 deals with quite a different section of the Act, it does touch on much the same thrust as is raised in the instant appeal. It could have some merit in support of this judgment.

The appeal is dismissed.

Appeal dismissed.