Robert Percival Macmillan, Danilo Danzo v. Minister of National Revenue, [1983] CTC 2171, 83 DTC 171

D E Taylor:—These are appeals heard on common evidence in Victoria, British Columbia, on October 22, 1982, against income tax assessments for the years 1977 and 1978 in which the Minister of National Revenue consid- ered the gains realized by the appellants from certain real estate transactions as on income rather than on capital account. The respondent relied, inter alia, upon sections 3, 9 and 248(1) of the Income Tax Act, SC 1970-71- 72, c 63, and amendments.

While there were certain differences in the manner, and taxation years used individually by the appellants in reporting their separate shares of the amounts at issue, the first point to be decided is the same in the end analysis—whether any or all of the amounts involved should be treated as on capital account, the position asserted by the appellants. The various amounts at issue are substantial, but only become relevant in the event of any determination in favour of the appellants.

The notice of appeal of Mr MacMillan contains the following statements with which the Minister was in agreement:

2. In or about 1973 the Appellant, together with Danilo Danzo (herein called “Danzo”) and their company, DanMac Enterprises Company Limited, began acquiring certain parcels of undeveloped real property comprising two city blocks in Victoria, British Columbia. In 1975 those parcels of real property acquired by Dan- Mac Enterprises Company Limited were transferred to the Appellant and Danzo jointly. By the end of May 1976, all parcels of real property comprising the first city block (herein called “Block 1”), and some of the parcels of real property comprising the second city block (herein called “Block 2”) were owned by the Appellant and Danzo jointly.

3. In 1976, plans were completed for the construction of a revenue producing residential apartment complex on Block 1 (herein called “Block 1 Project”) and a land use contract was obtained to permit construction thereof.

In addition, the Minister agreed that:

— in December 1976, the Appellant and Danzo sold an undivided one half interest in the undeveloped Block 1 Project to Robert William Lineham and Terrence John Lineham (hereafter called the “Linehams”) (or the Builders).

— in December 1977, the Appellant and Danzo reacquired one-half of the Linehams’ undivided one-half interest in the partially developed Block 1 Project and sold to them the partially assembled and undeveloped Block 2 property.

— in September 1978, the Appellant and Danzo entered into an Option Agreement with the Linehams to reacquire Block 2.

— the Appellant and Darzo sold a portion of their interest in the Block 1 Project in November and December 1978 to various purchasers.

Contentions

Continuing to use the MacMillan appeal, the parties’ contentions are:

For the appellants:

13. The Appellant together with Danzo as co-owners began purchasing the various parcels of undeveloped real property which comprised Block 1 and Block 2 in 1973 for the purposes of assembling the entire two city blocks and developing thereon revenue producing residential and commercial buildings to be held for the purposes of earning income from property.

14. The sole reason for disposing of the undeveloped and partially assembled Block 2 property in December 1977 was to permit the Appellant and Danzo to settle their dispute with and terminate an unsatisfactory business relationship with the Builders and to protect their interests remaining in the Block 1 Project from further claims raised by creditors of the Builders.

15. The sole reason for disposing of the Appellant’s interest in the completed Block 1 Project in November and December of 1978 was to enable the Appellant and Danzo to satisfy the outstanding financial obligations affecting both the Block 1 Project and the Block 2 property so as to avoid foreclosure actions against both Blocks.

16. The gain realized by the Appellant in 1977 and 1978 from the disposition of his interests in both the Block 2 property and Block 1 project, respectively, is therefore a capital gain.

For the respondent:

— It was never the Appellant’s intention to retail all his interest in the property in question;

— the Appellant and Danzo were at all material times experienced developers with a history of involvement in real estate ventures and as such had knowledge of the real estate market;

— the Appellant and Danzo’s financial position and their equity in the Block 1 and Block 2 properties were not such as to force them to sell a large portion of their interest in the said properties;

— the Appellant and Danzo acquired the Block 1 and Block 2 properties with the intention of assembling, developing and selling a major portion of the project in the general course of a business transaction;

— in the alternative, the acquisition and development of the properties was a speculation in which the possibility of turning a portion of their interest in the properties to account for profit at an early stage was a major motivating factor.

Evidence and Argument

Both appellants testified regarding the transactions at issue, and the amounts involved were substantiated by an analysis from a chartered accountant, Mr L R Blower. Several documents related to the matter were introduced as evidence and examined by the Board. The points covered by counsel in argument and considered by the Board to be critical may be summarized as follows:

For the appellants:

It is true that we have here a situation where Mr Danzo is an experienced developer ... We have Mr MacMillan’s evidence that he became associated with Mr Danzo, and while Mr MacMillan had been a buyer of real estate . . . he had never really been able to sell it. He was an acquisitor but not a vendor, and not a flip artist in any way, shape or form. They became associated in 1970, in fact Mr Danzo was developing property next door to Mr MacMillan, and they entered into a transaction . . . a commercial property across the street, and it is significant to note they reported it as income later because, in their words, they held it for such a short period of time. They then incorporated as DanMac and had two further transactions involving the purchase, construction and sale of two four-suite apartment buildings. It is significant to note that this was recorded on an income basis because of the short holding period and because there was nothing in the transactions that indicated a long-term holding situation.

Now, that is where I suggest that we have a different situation here. We have the evidence of the situation from both taxpayers that this was a long-term investment. That is corroborated by the statement of the bank manager, and we also have the significant fact that the property was unique, it was well designed, it was expensive to construct and it was well constructed and very well located.

We then have several things intervening which I have described as the source of the frustrations. First of all, we have the deteriorating health of Mr Danzo..the draws were not working out in the way they had expected and there were some delays with cost over-run problems. . .; (they) didn’t know what the over-run was and that is why they hired Mr Blower. Mr Blower, as you have heard, was hired in January of 1978. The agreement, the separation agreement between the Linehams and Danzo and MacMillan, was September 30, 1977; .. .they were cash poor and asset rich, and even though they had all of these equity growths and substantial numbers around, they were secure but they didn’t have the dollars to pay the bank.

We have the demand by Lindholm for his $400,000 and this is also very complicated as that is where you have the Lineham agreement to separate Block One if they were given Block Two and if they bought Block Two, it turned out there was a $400,000 mortgage on it.

I think the facts that are important here are the series of frustrations, the cost over-runs, the terrible illwill created between the Linehams and the two taxpayers. In fact, they couldn’t live with them, with whatever you want to call it, theft or fraud or whatever it might be. They could no longer tolerate it, and therefore they did the only thing possible and that was to force them out of Block One and eventually re-acquire Block Two. But in so doing, they had to make amends with Lindholm with the mortgage; they had to make amends and make peace and deal with the banker, and they did the only thing under the circumstances that they could do.

Case law cited by counsel included:

Mary Wladyka and William Wladyka v MNR, [1980] CTC 2408; 80 DTC 1374;

Klausen Holdings Limited v MNR, [1980] CTC 2505; 80 DTC 1450;

La Cie d'Immeubles Courville Liée v MNR, [1980] CTC 2834; 80 DTC 1719;

South Shore Estates (Saltfleet) Limited v The Queen, [1981] CTC 252; 81 DTC 5181.

For the respondent:

And there is not a sufficient explanation that they ever meant to hold any portion of either Block One or Block Two for all time; they meant to only probably keep part of it but it was not just suitable, and the contract shows that their intention of an investment never applied 100 percent to either Block One or to Block Two. Perhaps they meant to keep more than this one-third that they (now hold) in Block One and the 75 percent in Block Two, but circumstances occurred which forced them to sell more.

It is my submission that the intention (was) to sell part, to finance all of their investment (which) was only part of this (total) project, and that that is borne out by what actually occurred in their dealings backward and forward in the use of Block Two to secure not all of Block One but 75 percent of Block One, and then the re-acquisition backwards and forwards. But there was always the reason to part with at least some of their holdings in Block One or in Block Two. Their financial situation was probably not very rosy, but whether they were really forced to sell, whether there was no way out, it seems that the moment the opportunity occurred, they did sell.

We have also the evidence.. .that these people have had experience in the real estate field. Mr Danzo owns the company that buys and sells and Mr MacMillan certainly had involvement with Mr Danzo in construction and sales in the apartments and has experience in the real estate field.

.. .as the case law indicates, not only do they have to prove they had an investment (intention), but they have to dispel any doubt that there was not another reason, another motivating force, and the onus is that much higher because of the fact that they have been involved (in the construction field).

I submit that when you look at all of the facts of this case, it is clear that even though there may have been an intention to hold part of the property as an investment, this intention did not apply to the whole of the property, that there was always the possibility of another motivating factor to be able to sell part of that interest in Block One.

Among case law cited were:

Morev Investments Limited et al v MNR, [1972] CTC 513; 72 DTC 6421; [1973] CTC 429; 73 DTC 5353 with reliance on the principle set out in the Racine et al case cited at [1965] CTC 150; 65 DTC 5098;

Hans Reicher and John W Bradstock v MNR, [1974] CTC 2131; 74 DTC 1098; [1975] CTC 178; 75 DTC 5050; [1975] CTC 659; 76 DTC 6001

Arnold Kostiner, Marsted Holdings Ltd, Hyman Fisher v MNR, [1978] CTC 3063; 78 DTC 1746.

Findings

The Minister’s position comes down to two basic reasons for the reassessments at issue:

(a) that the appellants did not intend to hold all of the real estate acquisitions (culminating finally in Blocks One and Two) but rather to retain that which they could out of the total, and use the proceeds from selling any excess for the purpose of financing their own remaining investments in the development; and/or

(b) that the appellants had been vitally involved with, and were completely familiar with the real estate and construction fields for many years.

There can be no doubt that point (b) above has been established—the appellants were candid and open about such involvement in the real estate and construction fields. There may have been some occurrences—Mr Dan- zo’s move to Victoria from another location, his failed efforts to develop some other projects, differences in type of various real estate endeavours, his failing health and the resultant minimizing of his business activity; Mr MacMillan’s prime interest in his restaurant property and adjacent acquisitions, and his more limited investment in smaller rental properties are also somewhat different than the transactions at issue. But on the whole, while perhaps neither appellant had engaged in a project precisely like the ones at issue here, or on such a grand scale, they should find no comfort in those distinctions. It can readily be assumed that they approached this venture with considerably more individual, and mutual, knowledge and expertise than two ordinary men picked at random. As counsel for the Minister has indicated, the road ahead for the appellants to maintain their entitlement to preferential capital gain treatment is made that much more difficult as a result. The question of intention (point (a) above) always is critical, but the onus on these appellants to disprove the hypothesis proposed by the Minister (that they financed their residual interest by judicious sales of certain properties or interests in the properties) becomes particularly acute. Each transaction must be examined and supported by the appellants on its own merits and in a manner which leaves virtually no intention other than the one they propose. That purpose, proposed by them, is that only the confluence and interaction of various events prevented them from attaining their alleged investment goal which was to develop and retain all of the real estate investment conceived for both Block One and Block Two.

Exhibit A-21 which deals with the sale of an undivided one-half interest in Block One to the “Linehams” is effective as of December 1976. The taxation year 1976 is not in issue in these appeals, but both parties have agreed that the Board is permitted to review that transaction to the degree it may have a bearing on the years under appeal (see New St James Ltd v MNR, [1966] CTC 305; 66 DTC 5241; and Radio Engineering Products Ltd v MNR, [1973] CTC 29; 73 DTC 5071). The reason given by the appellants for the sale to Linehams—and that which supports their proposition that the gain is on capital account (according to their appeals)—was that by December 1976, Mr Danzo (allegedly the more experienced of the two appellants in contract supervision) was in ill health and could not perform this management function. As I see it, that contention pre-supposes that Mr Danzo’s sole role, or at least major interest in the venture, was to act as construction supervisor. The evidence and testimony do not bear that out—he was just as active and interested, perhaps more so, than Mr MacMillan in the protracted and difficult acquisitions of various parcels of real estate which by then formed all of Block One and part of Block Two.

The appeal of Klausen Holdings Limited v MNR, [1980] CTC 2505; 80 DTC 1450 was cited by counsel for the appellants in support of the point that taxpayers involved in the construction field could hold and deal in real es- tate on capital account. When the active and experienced partner in the land purchasing in Klausen dropped out of the picture, the remaining partner was simply unable to continue—he had neither direct interest nor experience in the business operations proposed for the site. It cannot be said here that either MacMillan or Danzo abandoned the total project because of Danzo’s illness. No reason was advanced that would have prevented the appellants from simply obtaining the services of an experienced contract supervisor to take the place of Mr Danzo. Granted it might have been somewhat more costly, but completely possible. The reason advanced by the appellants for selling a part of their action to the Linehams is not impressive, when all they really needed was a supervising contractor. Counsel’s point that such “dual” activity is permissible is also made in the case of Valleypark Apartments Ltd v MNR, [1981] CTC 2277; 81 DTC 245, but in the case the utilization of the property was at all times consistent with only one objective—that proposed by the appellants therein. Exhibit A-4 dated July 1976 (five (5) months before the entry of Linehams) cannot be totally ignored. It represents an offer of purchase and sale between the appellants and another local developer called “The Isherwood’s”, even though it was not consummated.

A final point to note is that, as well as it can be determined from the evidence, the appellants had some $700,000 invested in the real estate acquisitions by 1976 and the proposed sale of one-half of the total holdings in Blocks One and Two to Isherwood (Exhibit A-4) was for $1,500,000, a very healthy potential profit; and the sale of only one-half of Block One to Linehams in December was for some $1,100,000, again a very attractive arrangement. It is also interesting to note that as late as 1977 and 1978, Danzo’s personal occupation was still being described in certain legal documents as “Building Contractor”.

There is no bar to the appellants putting together valuable blocks of property over a period of time and bringing in partners for whatever reason in the development, but I am satisfied that Mr Danzo’s ill health was not the only reason for the proposed sale to Isherwood’s in July 1976, and certainly not for the sale to Linehams in December 1976. What reason or reasons prompted that latter sale which is in issue here is not a determination which needs be made by this Board at this time—but its prima facie characteristics as a profitable sale of real property on income account has not been dispelled by the evidence in these appeals.

Turning to the second matter in dispute (the next sale, in 1977), we have a somewhat different basic situation. The two appellants (as one group) are now joined in a construction venture on Block One with the two Linehams (as a second group). A construction agency called RTL CONSTRUCTION CO LTD (RTL), controlled by the Linehams but also having as shareholders the two appellants, was formed and a contract drawn up in March 1977 between that company and the four owners of the property for construction of a building on Block One. It would appear that Mr MacMillan had an active role as Treasurer of RTL although it is not so clear that he performed very fully in that role. The required municipal land use contract had been acquired in 1976, mortgage financing up to approximately $3,000,000 had been arranged, and construction proceeded. According to the testimony at the hearing, RTL (basically the Linehams) had contracted to complete the construction for some $2,400,000. Danzo had always thought this estimate to be suspect but nevertheless went along with it—although he gave no explanation at the hearing for doing so. The several agreements made in December 1977 by which the appellants reacquired from Linehams total ownership of Block One (including construction improvements) and surrendered their interest in Block Two to Linehams are complicated and, to some degree, conflicting and unclear (Exhibits A-7, A-8, A-9 and A-10). Nevertheless, again the only question that arises is whether the gain made by the appellants (at least on paper on the transaction) was income or capital. The proposition put forward by the appellants in support of its capital characterization is based on three grounds: first, cost overruns on the property; second, relationship between the two groups had deteriorated; and third, the Linehams were not able to carry on their share of the financing. The testimony given to the Board was that the actual amount of the overrun was not known at the date of termination of arrangements between the Linehams and the appellants (December 1977), but that the appellants were very aware that much more than the $2,400,000 would be required to complete the project and that they simply found it absolutely necessary to get the Linehams out of the project in order to cut their expected losses to the minimum.

There is no evidence of dire cost overruns, or financial constraints on the Linehams in the agreements reflecting the sale transaction in December 1977. According to Exhibit A-7, the sale price of Block One was $3,500,000 and the Linehams were to receive two credits (one for $155,500 and one for $89,114) which then entered into their acquisition of Block Two for $857,250 (Exhibit A-8). Two paragraphs from Exhibit A-7 are worthy of quotation:

(a) The said credit of $155,500.00 is predicated on the assumption that the total costs for the construction of the building presently under construction upon the said Lot 1, Plan 30215, including insurance for the loan, all interest for financing the project, together with all costs of every nature and kind relating to the construction of the project shall not exceed the sum of $2,400,000.00. Accordingly, if the total costs shall exceed $2,400,000.00, then one-half of such additional costs shall be deducted from the said credit of $155,500.00 by adding the said one-half of the additional costs to the principal amount of the said second mortgage in favour of the Vendors on Block Two. If on the other hand, the total costs of the said project are less than the said $2,400,000.00, then one-half of such difference shall be credited to the Vendors by adding such sum to the said $155,500.00 with effect that such adjustment will be deducted from the principal sum of the said second mortgage on Block Two. The completion date of the project and the date for all adjustments relating to the cost of the project is April 30, 1978, save for adjustments of taxes and insurance which shall be adjusted as of the date of transfer of title, that is to say, December 30, 1977.

(b) The parties acknowledge and agree that the cost of the construction of the said building on Lot 1, Plan 30215, is the responsibility of the Joint Venture, whose principals in equal shares are Robert William Lineham, Terence John Lineham, Robert Percival Macmillan [sic] and Danilo Danzo. And it is agreed that the said credit of $89,114.00 abovementioned will be subject to adjustment (plus or minus) depending upon the statement of adjustments and report prepared by the joint accountants of the principals of the Joint Venture (ie Mr Ron Parrish for Messrs Robert and Terence Lineham and Mr Bruce Cale for Messrs Macmillan [sic] and Danzo). The certificate signed by both said accountants shall be accepted as final and binding upon all parties hereto as to the actual final adjustment figure, which certificate shall be delivered by said accountants on or before April 30, 1978, or such later date as all parties to this Agreement shall in writing agree.

As I see it, assuming the cost completion at or very near to the estimate of $2,400,000 even at December 1977 (and the above paragraphs do so in my view) and expecting receipt in due course of the $3,000,000 mortgage funds already arranged, there was nothing to which the Linehams could be expected to contribute which would indicate they “were unable to carry their share of the financing expenses of the Block One project”. I would suggest that if indeed the Linehams were having difficulty meetng their financial obligations, such difficulty arose out of the original December 1976 commitment to pay $1,100,000 for a one-half interest in the then undeveloped land of Block One, not from any obligation which arose out of the construction on Block One. Again I arrive at the same conclusion as for the December 1976 transaction—whatever were the reasons for the re-acquisition by the appellants of the Linehams’ one-half interest in Block One, and the sale to Linehams of Block Two in Decmeber 1977, such reasons are not to be found in the explanations provided at the hearing—that there were known substantial cost overruns in the construction, that these required “financing expenses” and that the Linehams could not meet their share of these expenses in December 1977, all of which allegedly resulted in the action taken by the appellants to save their investment. By this time, the property in Block One had been subject to at least four transactions: acquisition by DanMac; sale to the appellants from DanMac; sale of one-half to Linehams and reacquisition from the Linehams—the last two at least at incrementally increased values over and above original acquisition cost. The appellants had used both Block One and Block Two as mechanisms not unlike inventory items and, in the process, had realized gains—at least on paper. While they may not have had a clear intention of doing so way back at the time of the purchase by DanMac, and indeed they might have preferred that other courses of action presented themselves, they were not in the least averse to using the property in any manner which would be of eventual or even shortterm benefit to them, and they have not provided an explanation which would serve to undo the Minister’s assessments.

The third aspect of these appeals comprises the several smaller sales of part interest in Block One and the re-acquisition of the major interest in Block Two from the Linehams by the appellants. These transactions were explained to the Bord as founded in the cost overruns on Block One — eventually the total cost was established in 1978 as some $3,340,570 ($940,570 over the RTL estimate of 1976), and the formal demand from the Royal Bank for payment of a $561,000 loan made to the appellants in connection with the project arising out of the pre-1976 property acquisitions. The Linehams had also become party to this obligation as a result of the December 1976 purchase. I do not doubt that the cost of the construction on Block One when totalled up in 1978 was in excess of estimates made in 1976 and that arrangements for further financing from the appellants were acquired. I am not as certain that all the amounts included in that total cost (Exhibit A-2) are directly attributable thereto under the circumstances.

I am satisfied that the bank did demand payment of the $561,000 noted above but it is difficult to see how that could have any direct relationship to the cost overruns. The basis therefore again for the proposition of the appellants is that they were forced by the financial circumstances to sell the property interest shares in order to preserve their own investments. Without the prior history of using the subject properties as part of the profit-making process which has been detailed above, it is indeed possible that the appellants might lay some claim to the preferential capital gain treatment sought for the smaller property sales consummated in 1978. But I find it equally possible and probable that these were only a continuation of the same process—the view adopted by the Minister in the assessments. The result is then the same for these appellants with their history and background—they have not eliminated as reasonable and logical the position taken by the Minister that the gains were on income account in 1978, just as they were in 1977 and in 1976.

Summary

In addition to the case law cited by counsel in these appeals, all of which I have reviewed, I should like to make reference to Trans Canada Holdings Limited v MNR, [1980] CTC 2791; 80 DTC 1689. In that appeal, while some of the circumstances were different from these appeals, there are many similarities. In my view, the judgment upon which Trans Canada (supra) is based, Melcrete Construction Company Limited v Her Majesty The Queen, [1977] CTC 273; 77 DTC 5181, is the signal one to be faced and overcome by an appellant claiming a real estate capital gain when his own history, background and experience are demonstrably in that precise field for the express purpose of making a profit.

A recent Board decision (John B Ebbs v MNR, [1982] CTC 2114; 82 DTC 110, reinforces this point and a quotation therefrom is illuminating:

The appellants also allege that their project was frustrated by rising costs of construction and increasing interest rates. These increased costs could normally have been foreseen in the years under review and would have been taken into account, had a feasibility study of the project been made prior to the acquisition of the property. The increase of construction costs referred to by Mr Ebbs also applied to Mr Gazzo, a competitor who, it was rumoured, was to build a medicaldental building on the hospital property. Mr Ebbs alleges that these rumours were another factor which frustrated the partnership’s realization of their project. In my opinion, such rumours, by themselves, do not constitute an unforeseen insurmountable obstacle which would warrant the abandonment of a well-planned and well-organized project.

At the time the appellants listed their property for sale, the hospital was a reality and the development in the area was reasonably assured, whether or not Minto Construction went ahead with its townhouse project. Mr Ebbs’ contention was that Minto Construction’s decision not to proceed with the townhouse project at that time destroyed the project’s viability. I fail to see how Mr Ebbs and Mr Jensen, who were experienced in real estate values and potentials, would abort their intended project because of a decision of one developer in the area.

The last reasons which the appellants considered to have been a compelling factor in selling the property were personal and financial problems affecting Mr Walsh at that time. The financing of the project on the basis of the evidence was never seriously considered or discussed and Mr Walsh, who was not an active member of the new partnership, could easily have been replaced, had it been the partnership’s firm and sole intention of proceeding with the construction and operation of the medical-dental building.

The preponderance of the evidence, both prior to and after the acquisition of the Baseline property, does not lead me to conclude that the sole intention of the appellants was to build and operate a medical-dental building thereon. Nor do the reasons advanced as to why the property was sold in 1976 appear to me to constitute factors beyond the control of the appellants which completely frustrated their declared intention and rendered their project impossible to realize.

Decision

The appeals are dismissed.

Appeals dismissed.