S Wise Construction Limited v. Minister of National Revenue, [1982] CTC 2413, 82 DTC 1400

D E Taylor:—This is an appeal heard in Toronto, Ontario, on April 5, 1982 against income tax assessments for the years 1974, 1975 and 1976. In assessing the appellant, the Minister of National Revenue relied, inter alia, upon sections 3, 4, subsection 9(1), paragraphs 12(1 )(b), 20(1 )(n) and subsection 248(1) of the Income Tax Act, SC 1970-71-72, c 63, as amended.

The amounts at issue, and the appellant’s contentions regarding them are to be found in the Notice of Appeal:

(1) Interest, R Brown — 1974 — $2,600; 1975 — $2,600; 1976 — $2,575.

This amount represents interest on monies deposited into court. The court case was settled in the spring of 1979 and the judgement did not provide for any interest to be paid. All proceeds received on this judgement were taken into 1979 income when received. The DNR did not have this additional knowledge when it made its assessment, (see attached exhibit “A”)

(2) Mortgage Reserve — $34,243

S Wise Construction was audited by the DNR for the 1971-73 years, inclusive. The Department established a method of calculation, S 20(I)(N), for reserves on an average balance basis, which we have followed consistently. S 20(l)(N) of the Income Tax Act states that a reasonable reserve must be set up and we feel we have fully complied with the requirements of this section. The DNR is inconsistent in their attempt to force us to apply a new method of computation which is not defined in the Income Tax Act.

(3) 1974 — Greenberg Farm Sale — profit $444,279.11

This farm was purchased in 1953 and held for 21 years before it was sold. It has been recorded under fixed assets on the financial statements and never been referred to as an inventory item. Repeated applications for development of this property into an industrial subdivision (see attached exhibit “B”) were frustrated by lack of sewers and services. It was sold by the taxpayer’s corporation under an unsolicited offer in 1974.

Bulletin IT-197R appears to clearly define such a transaction as a capital gain. This is also confirmed in appeal number 4676484.

The contentions of the respondent were:

Re Item (1 ):

— From 1972 through the years in question, Mr Ross Brown occupied a house owned by the appellant.

— In 1972, a dispute arose between the appellant and Ross Brown over the Offer to Purchase this property;

— In the years 1974, 1975 and 1976 Ross Brown made payments into court on account of either mortgage interest or rent with respect to the said house:

— The amounts were properly included in the appellant’s income as amounts receivable by the appellant pursuant to paragraph 12(1 ) (c) of the Income Tax Act.

Re Item (2):

— The Appellant acquired its interest in the Greenberg Farm with a view to dealing In, trading in or otherwise turning the property to account for profit:

— In 1973, the Appellant sold its interest in the Greenberg Farm and realized a profit in the amount of $444,279.11, calculated as follows:

Proceeds of Disposition		$500,000.00
Less:	Adjusted Cost Base	$55,204.64
	Legal Fees	516.25
		55,720.89
		444,279.11
Less:	Reasonable Reserve
	Pursuant to S. 20(1 )(n).	382,080.34
		$ 62,198.77

— The Respondent allowed the amount of $382,080.34 as a reserve on the Greenberg Farm in the Appellant’s 1974, 1975 and 1976 taxation years;

— At all material times, the Appellant was in the business of selling lots and houses.

Re Item (3):

— The amount allowable to the Appellant as a reasonable reserve in its 1976 taxation year, with respect to amounts not yet due on the sale of lots and houses in 1974, 1975 and 1976 was calculated on the basis of the actual gross profit rather than on the basis of estimated or average gross profit (as submitted by the appellant).

Evidence

The document referenced above in connection with Item (1) as “(See attached Exhibit ‘A’)” was provided to the Board. It is a Supreme Court of Ontario judgment reading:

No. 1623/74

IN THE SUPREME COURT OF ONTARIO

THE HONOURABLE	)	FRIDAY, THE 23rd DAY OF FEBRUARY,
MR JUSTICE LABROSSE)		A.D. 1979.
BETWEEN:
		ROSS BROWN
		Plaintiff
		— and —

S WISE CONSTRUCTION LIMITED

Defendant

UPON the Application of the Defendant, S Wise Construction Limited, and upon reading the Affidavits of Symon Wise and Ronald Velanoff, filed; and upon hearing the counsels for all parties and it appearing that directions and interpretations are required with respect to the Judgment of The Honourable Mr Justice Labrosse, dated the 25th day of June, AD, 1976, and on consent of all parties;

1. IT IS ORDERED that the Defendant, S Wise Construction Limited is entitled to an adjustment with respect to the Insurance Premiums paid since March 23, 1973 to February 27, 1979, in the amount of $330.30;

2. AND IT IS FURTHER ORDERED that the Defendant, S Wise Construction Limited is entitled to an adjustment with respect to the Realty Taxes paid since March 23, 1973 to February 27, 1979, in the amount of $4,236.08;

3. AND IT IS FURTHER ORDERED that the Defendant, S Wise Construction Limited, is entitled to an adjustment with respect to interest accumulating on the Agreement of Sale mentioned in the Purchase Agreement dated the 23rd day of February, 1972, and on Insurance premiums and Realty Taxes from March 23, 1973 to February 27, 1979, in the amount of $5,500;

4. AND IT IS FURTHER ORDERED that all monies standing in Court in account Numbers W-6477 and W-6630, plus interest, be paid out of Court to Ross Brown.

5. AND IT IS FURTHER ORDERED that the costs of the Plaintiff, in this action

and in all interlocutory proceedings herein shall be borne by the Plaintiff.

Mr Symon Wise, President of the appellant company, testified regarding Item (1) that during the three years, the appellant had paid for the municipal taxes and insurance on the Brown property, but had received nothing on account of rent or interest until the implementation of the above judgment. During a lengthy period of dispute between those parties (Brown and Wise), Brown had paid into Court the amounts assessed by the Minister. These same amounts (and others for other years) had been paid back to Brown (see above judgment), and had not as such been paid to the appellant at any time. It was the understanding of Mr Wise that the amounts of insurance ($330.30) and taxes ($4,236.08) referenced in the judgment above had been charged off as corporation expenses in the relevant years. When the Brown matter was finally settled by the above judgment in 1979, the appellant company took into that year’s revenue (1979) the amounts received.

With respect to Item (2), there was no evidence or testimony advanced which would support the calculation made by the appellant either as reasonable or unreasonable, but only that it had been consistently followed as described.

Regarding Item (3), it was the testimony of Mr Wise that he had considered the prospect of industrial or residential construction on the Greenberg property, and retaining the buildings thus constructed as investments for long-term revenue production. The other evidence submitted consisted of the financial statements of the company back to the year 1954 (when the Greenberg property was purchased), records of the purchase agreement for the property and records of a court case dealing with the proposed subdividing and developing of the property, and a letter from the Town of Burling- ton dealing with a “proposed industrial subdivision”. The critical references in the above documentation are to subdivision, development and selling of the lots.

Findings

Dealing first with Item (3) — the Greenberg Farm — the testimony of the appellant, his business history, and the documentation provided point to only one conclusion — that the property was acquired for the purpose of sale, hopefully in the appellant’s mind after subdivision and development, but for sale nevertheless. There is no evidence to support a conclusion that his primary intention ever was to develop the property and keep the asset for long-term investment purposes, even though such a thought might have crossed his mind as a possibility. The Board would require something more substantial now than just the recollection of Mr Wise regarding intention to overturn the thrust of the documented record. That part of the appeal will be dismissed.

For Item (2) — the Mortgage Reserve — I recognize that there would be some difficulty in defining “reasonable” for purposes of the section of the Act under review, and this was emphasized by the agent for the appellant. However, to accept the proposition of the appellant in this case that a calculated “general average” reserve is reasonable would imply that the Minister’s precise calculation, based on an amount which could be attributed to each property sale was “unreasonable”, or at least “not as reasonable”. That would be a contradiction in terms in my view since it is axiomatic, as I see it, that “reasonable” should be based in accuracy to whatever degree possible or practical. The Minister’s calcuation is not an estimate — it is based on individual sales and mortgages taken back, at least as I understand the basis of the dispute. “Reasonable” can hardly be a choice selected from a range of possible options when a simple and direct method is available to reach a calculation which can be empirically substantiated. While “reasonable” may not always reach the level of “most reasonable”, the one here proposed falls far short of meeting the requirements of the relevant section of the Act when there is clearly a “more reasonable” calculation readily at hand. The argument that the Minister should continue to apply the method accepted by Revenue Canada in prior years is compelling indeed. A change from the established method cannot rest easily and comfortably with the Minister. Nevertheless, it is clear from the Minister’s position in this matter that, whatever the basis for the original earlier calculation, it is no longer adequate in view of the records of sale, costs and mortgages currently available. It is not incumbent on the Minister to pursue an assessment basis merely because it has been established in prior years, years for which the Board has no information as to possible problems of documentation or calculation. That part of the appeal will be dismissed.

Turning to Item (1), counsel for the Minister argued that since the learned judge of the Supreme Court of Ontario had seen fit to accord $5,500 of interest based on three things: the 1972 Agreement of Sale, the insurance premiums, and the realty taxes, the Board should regard the amounts paid into court by Brown as covering these interest calculations and that they should be prorated over the three years at issue. In my view, the evidence leads to the opposite conclusion — that the interest received in 1979 had no relation to “rent” but rather to the lack of payment in 1972 by Brown of the balance owing on the sale of the Brown property. The judge may have considered the amounts of insurance premiums and realty taxes involved as advances by the appellant to Brown, but whatever the rationale of the learned judge, the result does not point to the conclusion asserted by the Minister. In my view, there would be no reason for the appellant to consider as “receivable” any part of the $5,500 in any year earlier than 1979. Since the appropriate amount of the sums accorded by the Court in 1979 to the appellant has already been taken into income in that year (1979), there is no reason to increase the reported income of the appellant by the amounts of $2,600, $2,600 and $2,575 for the years 1974, 1975 and 1976 respectively, as was done by the respondent. That part of the appeal will be allowed.

Decision

The appeal will be allowed in part in order that the appellant’s income as assessed be reduced by amounts of $2,600, $2,600 and $2,575 for the years 1974, 1975 and 1976 respectively. In all other respects the appeal is dismissed. The entire matter is referred back to the respondent for reconsideration and reassessment in a manner not inconsistent with the above Reasons for Decision.

Appeal allowed in part.