Reich Hotels LTD v. Minister of National Revenue, [1982] CTC 2334, 82 DTC 1297

John B Goetz:—This is an appeal with respect to the appellant’s 1976, 1977 and 1978 taxatioin years. The appeal relates to the purchase and sale of various hotels by the appellant and the respondent maintains that the profits from the sales of these hotels were income from a business within the meaning of subsection 248(1) of the Income Tax Act, SC 1970-71-72, c 63, as amended. The appellant, on the other hand, maintains that the acquisition of hotel properties was to acquire capital assets which could be operated to produce income in the ordinary course of its business.

At the outset counsel for the respondent advised that there were nil assessments for the taxation years 1976 and 1977 and filed a letter (Exhibit A-1) from the Minister to that effect.

The respondent, in paragraph 4 of his Reply to Notice of Appeal, alleged as follows:

4. In the period from August 1, 1972, to March 31, 1979, the Appellant bought, operated and sold the following hotels in the Province of Alberta:

(a)	Alberta Beach Hotel
	Purchased August/72	$	243,249
	Sold in 1973/74 fiscal year		267,876
	Capital gain reported on 1974 return		23,401
(b)	Royal Hotel Ponoka
	Purchased February 1/74	$	585,193
	Sold April 1975		660,000
	Capital gain reported on 1976 return		45,407
(c)	Innisfail Hotel
	Purchased September/75	$	500,000
	Sold January 1976		580,000
	Capital gain reported on 1977 return		12,800
(d)	Lethbridge Hotel
	Purchased November/76	$	975,000
	Sold November 1977	1,100,000
	Capital gain reported on 1978 return		108,162
(e)	Stettler Hotel
	Purchased March/78	$	711,000
	Sold February 1979		837,000
	Capital gain		26,000

The appellant’s agent, Henry Reich, was engaged in a family trucking business for a number of years and was a shareholder, but mainly acted as a “grease monkey” and sometimes drove a bus. In that family problems arose, he sold out his interest in the trucking business for $25,000 and was involved in a restrictive covenant prohibiting him from getting into competing trucking business. He had a grade 10 education and in an attempt to find a source of income he perused the business opportunity advertisements in the Edmonton Journal, involving various listings by real estate firms. He became interested in a hotel at Swanhills which did service trucking industry around oil wells in the oil fields in that area but he did not have sufficient funds to make the purchase.

In August 1972 Mr Reich was approached by one Manning N Tanner who operated a real estate business specializing in the sale of hotels. In August 1972 Mr Reich was convinced that the purchase of what is known as the “Alberta Beach Hotel” was a good investment for a purchase price of $243,249 and that Tanner (a member of Manning’s firm), who had experience in hotel management, would run the business until Mr Reich passed his apprenticeship. The appellant paid $37,000 as his portion of the purchase price and Manning Realty invested $23,000. Mr Reich incorporated a company known as “Reich Hotels Ltd” and the Alberta Beach Hotel was registered in the company name.

The objects of the appellant in the memorandum of association were to operate hotels, restaurants, etc but did not involve in any way real estate. They were able to purchase the hotel as the previous owners had reached an age when they could no longer operate same. Mr Reich moved his family into the hotel and worked in the hotel until it was sold in December 1973. He ran into problems with Mr Tanner about the operation of the hotel in which the division of shares was 50% to Reich and 25% to each of Manning and Tanner. The problems with Tanner became insurmountable, and as a result, Mr Reich decided to exercise a buy/sell agreement and listed the property for sale with a real estate firm. A modest profit was made on the sale of the hotel.

Mr Reich was advised by an hotel sales expert of City Savings & Trust to invest his funds in the purchase of the Royal Hotel at Ponoka, Alberta, which he did on February 1, 1974. He did not have sufficient funds to pur- chase the hotel but Fred Zapps, a friend, contributed $89,000 towards the purchase price as did Mr Reich. The balance of the purchase price was dealt with by the assumption of a first mortgage by the appellant company and a second mortgage in the amount of $153,000 was held by the vendors. Mr Reich gave Zapps a fixed and floating charge debenture for Zapps’ investment in the hotel. Again, he ran into problems with Zapps who knew nothing about the hotel business but insisted on interfering with the operation of the hotel. Mr Reich had moved his family to Ponoka with the view of making it his permanent home, but the problems with Zapps impelled him to put the hotel up for sale, which was sold in April 1975. The appellant reported a capital gain of $45,407 on the sale of this hotel.

After seeing an owner’s advertisement in the newspaper, Mr Reich decided to purchase the Innisfail Hotel in September 1975. The purchase price was $500,000. He borrowed money from the bank, invested some of his own, and borrowed $350,000 from the Provincial Treasury Branch. When he first checked out this hotel, Mr Reich saw the owner drinking in the lounge with the customers and felt that, observing the general operation, he could improve it considerably. Unfortunately, business was not what he expected and he decided to move elsewhere. His family still lived in Ponoka and moved to Innisfail in June 1975. They could not find an appropriate home, and two weeks later Mr Reich bought a smaller house in Ponoka where they still reside.

Mr Reich was again approached by a realtor who urged him to buy the hotel in Grande Prairie. He visited the owner a number of times who indicated his willingness to sell but would not commit himself to anything in writing. It was the owner’s suggestion that they work together for six months and see how they got along. This arrangement did not satisfy the appellant. The Innisfail Hotel was sold in January 1976 and negotiatioins were discontinued with respect to the purchase of the hotel in Grande Prairie.

In November 1976 the appellant purchased the Lethbridge Hotel for a purchase price of $975,000. The purchase was financed by paying $175,000 of the appellant’s money, $25,000 from a loan at the bank and $50,000 from Mr Reich’s brother-in-law. The balance was secured by two small mortgages which would be carried by the previous owner. The financial statements of the Lethbridge Hotel, on examination by its accountants, showed operating profits and would appear to have been a viable operation. Within two months business dropped dramatically in that other hotels had begun to install dance floor shows which apparently had been the main attraction of the Lethbridge Hotel at the time of purchase. One of the reasons given for the sale of the Lethbridge Hotel is that a customer told Mr Reich his wife would no longer go there because she understood that prostitution was prevalent there. I do not consider this situation necessarily unique to the Lethbridge Hotel. Furthermore, business was on a downturn in Lethbridge and Mr Reich decided that the appellant had erred in making the purchase; the property was listed with a realtor in June 1977 and it was sold in November 1977 for $1,100.000.

In March 1978 the appellant purchased the Stettler hotel for $711,000 which carried five mortgages, two of which had to be paid forthwith on purchase. The appellant borrowed $496,000 from the Provincial Treasury Branch; the balance of the purchase price was composed of its own money. The Stettler Hotel had been what is called “an old brewery” hotel, very well constructed but requiring extensive renovations. The appellant was able to carry itself while expending funds in improving the hotel’s condition. Mr Reich continued to manage the Stettler Hotel but found that the operation of the hotel was more than he bargained for with respect to the number of working hours per day that was required of him. Eventually, it was operating at a loss because of the expenditures involved in renovations requested by the Liquor Commission. He sold the Stettler Hotel in February 1979 for $837,000.

In May 1979 the appellant purchased the High Level Hotel, which appeared to be a good operation although only one-half of the bar stools were in use. The appellant made a reasonable income and Mr Reich, as with all the other hotels (other than Bow Island), was the manager. The sum of $1,000,000 was paid for this hotel and the appellant has been offered over $2,000 for the purchase of it. It has declined to do that in that Mr Reich feels that this hotel is solid and useful as a long-term investment. The appellant is now in the process of building a 75-room new motor-hotel near High Level.

Paragraph 4 of the Reply to Notice of Appeal as referred to above sets out clearly the progression in the appellant upgrading its capital assets. On the whole its profit or gain from sale was modest.

In June 1978 a realtor told Mr Reich that he could buy a hotel on Bow Island for $450,000 and make a “quick turnover” and if the appellant purchased the same he could make $100,000. The appellant took possession for a year, had it managed by a friend from Lethbridge, and sold it in July 1979 for $475,000. the appellant had never been engaged in any other dealings in real estate other than those cited above.

Throughout most of the hotel dealings, Mr Reich accepted advice from one Gary Davidge, CA, and from Paul Langlois, who practised law in Edmonton, but is now a businessman in Victoria. It was through the accountant that the appellant was able to get a mortgage to pay out the Zapp debenture with respect to the Royal Hotel at Ponoka.

Mr Reich, from the time of his leaving the trucking business, which was the only work he knew at the time, and entering into the hotel field, seems to have indicated that he is a very determined and dogged person. At first the sequence and frequency of purchases and sales of hotels would seem to support the Crown’s proposition that the acquisition of the hotels was a speculation with the possibility of turning them to account for profit was really engaged in an adventure or concern in the nature of trade. Mr Reich has now developed over the years, an expertise in the management of hotels, and now is the owner and manager of a hotel worth at least $2,000,000. This certainty is a progression upwards in the improving of his total business operations of operating hotels to produce income. To me, the appellant’s whole course of conduct is consistent with its desire to acquire properties to improve and move its business upwards and to acquire a larger total investment in the hotel business. See The Queen v Grant Kyllo, [1976] CTC 409; 76 DTC 6235.

Mr Reich, the witness of the appellant, was not shaken in any way in cross-examination and I accept his evidence as the reasons for purchases and sales of the different hotels. It is to be noted that all of the money acquired from the sale of one hotel was applied to the purchase of another and larger hotel and seemingly more lucrative investment in the hotel business. In Paul Racine, Amédée Demers and Francois Nolin v MNR, [1965] CTC 150; 65 DTC 5098, at 162 and 5105 respectively, it is stated:

The inference of an intention to make a profit by a rapid resale can also flow from the fact that the purchaser did, in fact, resell almost immediately at a profit, but only if there exists no satisfactory explanation for this rapid resale.

If this explanation is accepted, and I accept it entirely, the rapid resale after the purchase does not give rise to any inference that this resale with profit was one of the reasons motivating the appellants when they acquired the business.

I do not consider these purchases and sales of the various hotels, albeit in a relatively short period of time, as being motivated with the view of speculation and turning the acquisition of the hotels to account for profit. On the contrary, the appellant has proven itself. Although the manager, Mr Reich, has little education, he is an astute businessman, willing to accept the advice of his accountants and lawyers as to when to mortgage, when to sell and when to buy. Now, apparently, he is in a position to act entirely on his own, having developed an expertise in the operation of hotels. The appellant’s whole course of conduct is more consistent with that which is maintained by the appellant, namely, to acquire capital assets to produce income in the ordinary course of the operation of its hotel business.

In that the respondent submitted that the appeal with respect to the 1976 and 1977 taxation years should be quashed, as no tax was assessed for those years, decision will go accordingly.

There is, however, one purchase and sale, namely, the Bow Island Hotel, that involved, in Mr Reich’s own words, an acquisition for a “quick turnover”. This is the only hotel in the succession of acquisitions that was not managed and operated by the appellant. This transaction has all the earmarks of an adventure in the nature of trade and the profits arising from its sale were on account of income and I so hold.

The appellant is allowed in part and the matter referred back to the respondent for reconsideration and reassessment.

Appeal allowed in part.