Thomas Company (Niagara) LTD v. Minister of National Revenue, [1984] CTC 2733, [1984] DTC 1641

Christie, CJTC:—By three notices of reassessment, all dated September 3, 1982, the respondent reassessed Thomas Company (Niagara) Ltd (“Niagara”) in respect of its 1979, 1980 and 1981 taxation years. He reduced claimed capital cost allowance by $14,835, $32,041 and $32,254 respectively. The first issue is whether these reassessments are correct.

Paragraph 18(l)(b) of the Income Tax Act, RSC 1952, c 148, (“the Act”), which is in Part I thereof, provides that in computing the income of a taxpayer from a business or property no deduction shall be made in respect of an outlay Or payment on account of capital except as expressly permitted by Part I. Paragraph 20(1 )(a) which is also in Part I states that in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amount as is wholly applicable to that source, namely, such part of or amount in respect of the capital cost to the taxpayer of property as is allowed by regulation. In disallowing the amounts mentioned, the respondent relied on subsection 1100(11) of the Income Tax Regulations (“the Regulations”). What is relevant therein to this appeal provides that a taxpayer’s annual capital cost allowance on all his rental properties combined shall not exceed his net income from those properties before deducting capital cost allowance. The effect of the subsection is that: “Capital cost allowance cannot be used to create an overall loss on the operation of rental properties that can be offset against the taxpayer’s income from other sources.” See Harris, Canadian Income Taxation, 3rd (1983) edition, at 194. Important exceptions to the limitations imposed by subsection 1100(11) are to be found in subsection 1100(12) of the Regulations. They exist for the benefit of corporations. One of them is that subsection 1100(11) does not apply in respect of a taxation year of a taxpayer that was, throughout the year, a corporation whose principal business was the leasing, rental, development or sale, or any combination thereof, of real property owned by it. The appellant’s position is that it is within the ambit of these provisions of subsection 1100(12).

Niagara was incorporated on August 2, 1961. At that time it acquired the assets and assumed the liabilities of Thomas Construction, a sole proprietorship owned and managed by Mr Gerald Thomas. Mr Thomas is president, general manager and principal shareholder of Niagara. He was the only witness to testify at the hearing.

During the taxation year 1979 there were five divisions of Niagara, namely: (1) construction; (2) Lamplighter Motel (“the motel”); (3) Tomco Services, which is a laundering business (“the laundry”); (4) rental properties; and (5) Niagara Pro Hardware (“the hardware store”). This was reduced to four divisions in the 1980 taxation year by the sale of the motel on May 18, 1979. Niagara’s taxation year, for the years under review, ended on April 30.

The motel was designed and constructed by Niagara on leased land on Ferry Street in Niagara Falls. Construction commenced in 1961 and was completed by 1962. In 1964 the property on which the laundry is located was purchased. It is at the intersection of Jefferson Street and Palmer Avenue in Niagara Falls. It was occupied by a large factory-type building of reinforced concrete with a parking area. The building was described as a shell. A major portion of it was converted into the laundry which became operational in 1965. There was an addition to it late in that year. The laundry occupied some 11,720 square feet. In 1972 Niagara purchased another property in Niagara Falls on Chrysler Avenue and the hardware store was located on this site in 1973 in a new building. These rental properties were described in evidence. In 1965 the upstairs portion of the laundry was converted into offices. They occupied approximately 1,800 square feet. In 1968 a duplex was constructed on the same site as the laundry. At the time the Chrysler Avenue property was purchased there was a building on it. The ground floor was converted to law offices and apartments were constructed above. There was also a house on the property which was converted in 1972 into a two-family dwelling for rent. In 1974 Niagara purchased a lot on Morrison Street in Niagara Falls and constructed a duplex on it for rent. In 1975 it purchased an old partially-rented factory in Fort Erie which was converted into 14 apartments by 1980. In 1976 a house contiguous to the Chrysler Avenue property was purchased for rental purposes. In 1981 plans for a store, an apartment and a storage area in Fort Erie were formulated and construction got under way in 1982. Mr Thomas said that, as of the date of the hearing, all of Niagara’s rental properties were rented except the store, the building of which commenced in 1982, in Fort Erie and the storage area there. Neither is quite ready to rent.

Much of the evidence given by Mr Thomas was elicited from him in a disorganized fashion. Additionally, some of it was quite irrelevant. The result is that, to a significant degree, it is not of much assistance in resolving the issues in this appeal. Fortunately, there was other evidence before the Court besides the testimony of Mr Thomas which is of some help. I refer to the material forwarded to the Court pursuant to subsection 170(2) of the Act. It contained Niagara’s income tax returns for 1979, 1980 and 1981 which included financial statements of Niagara for the fiscal years ending April 30, 1979, 1980 and 1981, prepared by a firm of chartered accountants. The returns were scrutinized by Mr Thomas and he did not challenge their veracity. The financial statements show this regarding the various divisions of Niagara’s business undertaking with respect to the value of gross transactions during fiscal 1978 and the fiscal periods mentioned:

Further, they show this regarding net earnings (loss) for fiscal 1978 and the fiscal periods mentioned:

They also show that these amounts were paid under the heading of wages in relation to the various divisions of Niagara during fiscal 1978 and the fiscal periods mentioned:

The phrase “principal business” in the context of subsection 1100(12) is not capable of precise and succinct definition. Which business is principal in respect of a corporation that, in addition to being engaged in the leasing, rental, development or sale, or any combination thereof, of real property owned by it, is also engaged in one or more businesses of a different kind is a question to be determined according to the facts of each case. In order to correctly determine that question, a number of criteria should be examined in relation to each of the corporation’s businesses providing, of course, that evidence relating to them is introduced at the hearing. These criteria have been suggested, although they do not purport to be an exhaustive enumeration: profits, volume and value of gross sales or transactions, assets, capital employed and the time, attention and effort expended by the employees, agents or officers of the corporation. See Combined Appraisers and Consultants Ltd v MNR, [1983] CTC 2606, 83 DTC 543.

Considerable emphasis was placed upon Mr Thomas’s primary interests, skills and devotion of time and energy in relation to Niagara. He made it clear that they all related to the construction aspect and, perhaps, to some extent, to the management of the rental properties. He said he planned, designed and built models and “any kind of a building”. He did not purport to have any expertise in respect of the operation of a motel, a laundry or a hardware store nor did he exercise any day-to-day managerial responsibilities regarding them. He said that he spent “practically no time” on the motel, laundry and hardware store beyond studying financial statements. While the cardinal focus of interest, ability and time of an individual who is the major shareholder, president and general manager of a corporation is unquestionably relevant in determining the principal business of a multi-faceted corporation, it is by no means conclusive. To treat it as such would be to ignore that a person who is a shareholder of a corporation and the corporation are separate and distinct legal entities. The “primary goal” of Niagara was said to be developing old buildings and lots. While being a corporation of the kind described in subsection 1100(12) of the Regulations may be the ultimate goal of Niagara, what must be decided on this appeal is its status regarding “principal business” during its 1979, 1980 and 1981 taxation years. While I believe that status in relation to subsection 1100(12) can, depending on the facts, shift from one taxation year to another, I do not regard the evidence in this case as establishing such an occurrence.

In my opinion, the only combination of divisions in Niagara that could bring it within subsection 1100(12) is construction and rental properties. The motel is excluded if for no other reason than that it was constructed on leased land. In the absence of evidence that the usual rule of law that a building is part of the freehold on which it is located has been abrogated, I can only assume that when the motel was built, it became part of real property on which it was constructed and consequently was not real property owned by Niagara: Plan A Leasing Limited v The Queen, [1976] CTC 261; 76 DTC 6159. The laundry and hardware store cannot form part of the necessary combination for reasons that are obvious. The evidence regarding what proportion, if any, of construction was devoted to the kind of activities described in subsection 1100(12) is obscure. Mr Thomas spoke of designing and building for customers, at least in the 1960s. He later said, however, that he did not tender on construction jobs and that he purchased property and developed it. In any event, giving Niagara any benefit of the doubt respecting the obscurity referred to and giving full weight to the rental properties’ aspect of its business, I am satisfied that Niagara is not a corporation of the kind described in subsection 1100(12) of the Regulations. This result follows when regard is had to the evidence as a whole and to the criteria mentioned.

The second issue to be dealt with relates to Niagara’s 1980 taxation year. As previously mentioned, the motel was sold on May 18, 1979. In its return of income, Niagara claimed that the fair market value of the motel on Valuation Day, December 31, 1971, was $239,220. In making his reassessment, the respondent reduced this to $146,000, thereby increasing the amount of taxable capital gain. Prior to the hearing Mr Armitage, who appeared as agent for Niagara, informed counsel for the respondent that he would not be calling expert evidence regarding the fair market value of Niagara’s interest in the motel on December 31, 1971. Mr Armitage did attempt to make reference, during the course of the hearing, to an appraisal report that had been prepared in this regard, but he was informed by the Court that, in the absence of the author of the report being made available for cross-examination under oath, Niagara could not rely on it.

Mr Thomas testified that, in his opinion, the value of Niagara’s interest in the motel on Valuation Day was in the order of $240,000. He arrived at that amount by employing two figures as salient points. The first was $150,000 (rounded), being the cost of constructing the motel which, as already indicated, commenced in 1961 and was completed in 1962. The second was $320,000, being the sale price of the motel on May 18, 1979. Mr Thomas made the key assumption that the increase in value of $170,000 accrued evenly over the intervening 17-year period at the rate of $10,000 per annum. He then calculated the appreciation from 1962 to 1971 as $10,000 per annum which, when added to $150,000, results in a Valuation Day figure of $240,000.

This approach certainly has a degree of appeal, especially having regard to the cloud of uncertainty in accuracy that is so often, regardless of the method adopted, associated with the retrospective determination of the fair market value of property, which is what is involved in determining fair market value on Valuation Day. I cannot, however, accept it. Mr Thomas’s pivotal assumption is flawed. It is notorious that it cannot be correctly said that it is a general rule in markets where property such as real estate and securities are bought and sold that appreciation in the value of such property over a period of years accrues evenly.

As I understand it, in ascertaining the value of property on Valuation Day, the law requires that I, in effect, assume the existence of those relevant circumstances which would have obtained if I had been fixed with the responsibility of making the determination on that day. If so, it follows that in weighing evidence one is confined to what would have been available to him on Valuation Day in determining fair market value within the meaning of the definition of that phrase approved by McIntyre, J of the Supreme Court of British Columbia (as he then was) in Re Mann, [1972] 5 WWR 23 at 27. This judgment was unsuccessfully appealed to the British Columbia Court of Appeal and the Supreme Court of Canada: [1973] 4 WWR 425, [1974] SCR v. The definition reads:

Fair market value is the highest price available estimated in terms of money which a willing seller may obtain for the property in an open and unrestricted market from a willing, knowledgeable purchaser acting at arm’s length.

While the basic rule is that reliance cannot be placed upon evidence of facts which came into existence after Valuation Day, this does not exclude all evidence which, if it had been given on that day, would have been regarded as prescient in nature. I see no reason why evidence of facts arising after Valuation Day should not be considered if they were reasonably and substantially predictable on that day and it is a reasonable expectation that the willing seller or purchaser referred to in the definition would have taken them into consideration.

The appeal is dismissed.

Appeal dismissed.

Stanley R Kurisko, Appellant,