King George Hotels Limited and Cavalier Enterprises LTD v. Her Majesty the Queen, [1981] CTC 78

Smith, DJ:—The issues in these two cases are the same, save for differences in the amounts of money involved. It was agreed by the parties that the two cases be heard together and that the evidence given to the Court apply equally to both cases.

The Plaintiff companies both operate hotels in the City of Saskatoon in Saskatchewan. They were assessed by the Department of National Revenue, confirmed by the Minister, for income tax for the years 1973, 1974, 1975 and 1976, in respect of income derived by them from certain properties in the City of Saskatoon which were owned by them and leased to tenants. The plaintiffs claim that the net rentals received from the properties in question was income from an inactive business, that it was therefore “Canadian Investment Income” as that term is defined in subsection 129(4) of the Income Tax Act, that they were entitled to the refunds authorized by section 129, and that they had allowed for those refunds on their income tax returns for each of those years, as they had done in previous years when no question had been raised about the propriety of doing so. The defendant submits that the business of leasing these properties and collection of the rentals therefrom was not an inactive business but an active business, that the net rentals received were not “Investment Income” under subsection 129(4), that section 129 was therefore not the applicable section, that 125 was the applicable section and that the assessment by the Department of National Revenue had been made accordingly.

I note that both sections 125 and 129 are concerned with private corporations only. Nowhere in the pleadings or exhibits or in the parol evidence is there a positive statement that the plaintiffs are private corporations. However I feel quite safe in assuming that they are such. In the first place, counsel for the parties both referred to sections 125 and 129 of the Income Tax Act as the sections applicable to these cases. No question was raised about the status of the plaintiffs as private corporations. Further, in Exhibit P-1 (the amalgamation agreement between King George Hotels and Stanley Motel Ltd, dated December 10, 1960) and also in Exhibit P-4 (the amalgamation agreement between Cavalier Motor Hotel Ltd and three other companies, dated June 7, 1971, which resulted, inter alia, in the creation of the plaintiff, Cavalier Enterprises Ltd, under its present name), there are, in paragraph 5(3), (4) and (5), typical indicia of a private corporation, viz: limitation of the number of members (shareholders) to not more than 50, prohibition of any invitation to subscribe for shares or debentures, and prohibition of the transfer of any shares or interest in the company to any person unless the prior express sanction and consent of the board of directors has been obtained. There is no doubt in my mind that the plaintiffs are private corporations.

The real question to be answered in these two cases is whether the net rental income referred to supra was income from an active business or income from an inactive business. This is readily seen from reading some of the provisions of sections 125 and 129 of the Income Tax Act. Section 125 is headed “Small Business Deduction”. Subsection (1) describes four amounts, 25% of the least of them being deductible from the tax otherwise payable. The subsection reads, in part, as follows:

125.(1) There may be deducted from the tax otherwise payable under this Part for a taxation year by a corporation that was, throughout the year, a Canadian- controlled private corporation, an amount equal to 25% of the least of

(a) the amount, if any, by which

(i) the aggregate of all amounts each of which is the income of the corporation for the year from an active business carried on in Canada, exceeds

(ii) the aggregate of all amounts each of which is a loss of the corporation for the year from an active business carried on in Canada.

section 129 is headed “Dividend Refund to Private Corporations”. In subsection (1) it describes two amounts, the lesser of which is refundable. In doing so it uses the term “refundable dividend tax on hand.” This term is defined in subsection (3), where, in subsections (a) and (b)(i) the term “Canadian investment income” is used. Then, by paragraph (4)(a) “Canadian Investment Income” is defined in three subparagraphs, the last of which reads:

(iii) all amounts each of which is the corporation’s income for the year (other than exempt income) from a source in Canada that is a business other than an active business, determined, for greater certainty, after deducting all outlays and expenses deductible in computing the corporation’s income for the year to the extent that they may reasonably be regarded as having been made or incurred for the purpose of earning the income from that business.

In past years there have been many judicial decisions in which a distinction has been drawn between income from property and income from a business. Thus where a taxpayer has simply been an owner of property from which he has received rent or other income, for which he has expended no effort or scarcely any effort, the income has been held to be income from property, but where the taxpayer is a corporation whose sole or prime purpose is the acquisition and leasing of property, the corporation, in carrying out that purpose, has been held to be engaged in business and the rents received by it have been held to be income from business. However, it was not until 1972, with the enactment of sections 125 and 129 that the expressions “income from an active business” and “income from other than an inactive business” became part of our statutory income tax law. In the present cases the plaintiffs do not contend that the leasing of property owned by them and the receipt of the rentals therefrom was not a business, but that it was an inactive business.

There is no definition in the Income Tax Act of the terms “active business” and “inactive business”. It is therefore left to the courts, through their decisions in cases brought before them, to work out the full meaning of what Parliament intended by those terms. In the few years since 1972 there have been several cases in which this matter has been considered. The opinions expressed in those cases have not been in total agreement, but the approach taken by the courts is quite clear. They have not attempted to lay down any rigid interpretation of the two terms, but have taken the position that in each case the facts and circumstances must be examined, to determine whether the business in question is active or inactive. They have, however, gone further, as we shall see.

I refer first to The Queen v Cad boro Bay Holdings, Ltd, [1977] CTC 186; 77 DTC 5115, a decision of Gibson, J in the Trial Division of this court, on appeal from the Tax Review Board. In that case the defendant, a private corporation, operated a small shopping centre, with seven separate tenants, one of them a Canadian bank, and earned income from those tenants. Through its principal officer it negotiated all the leases, took care of complaints from tenants, arranged for the maintenance of the shopping centre and did all the things necessary to run the shopping centre. Some activity on the defendant’s part was required almost daily. The rental income was mainly for use of the property, but also to a much lesser extent it was for services and other things supplied, such as heat, repairs, etc, by the landlord.

In the course of his judgment, Gibson, J referred to judgments of the Federal Court of Appeal in three cases in April, 1976, stating that they were of assistance and authority in adjudicating the case before him. These cases are:

The Queen v Rockmore Investments Ltd, [1976] CTC 291; 76 DTC 6156;

ES G Holdings v The Queen, [1976] CTC 295; 76 DTC 6158; and

The Queen v M.R.T. Investments Ltd, [1976] CTC 294; 76 DTC 6158.

At 196 of the CTC report Gibson J quoted at some length from the Court of Appeal judgment in the Rockmore case. At the bottom of the page the following paragraph from 293-294, of the CTC report in Rockmore was quoted, in part;

. . . the second question to be answered is whether the business that was being carried on was an “active” business within the intent of section 125. Obviously, the concept of “active” business is not used to exclude a business that is in an absolute state of suspension because subparagraph 125(1 )(a)(i) is dealing with “income . . . from an active business”, and it must be assumed that the word “active” was used to exclude some businesses having sufficient activity in the year to give rise to income. More than that, as it seems to me, nothing can be said ina general way, at this stage, as to what is meant by the word “active” in subparagraph 125(1 )(a)(i). Each case must be dealt with by the fact finder according to the circumstances of the case . . .

The court in the Rockmore case found that the respondent was “actively carrying on business in the year 1972,” and that its income for that year was therefore “income . . . from an active business.”

At 198 of the CTC report of the Cadboro case, Gibson J said that in attempting to ascertain the intention of Parliament in using the concept of “active” business the question is “what quantum of activity must there be a taxation year that gives rise to income that should be categorized as income from an ‘active business’ within the meaning of section 125. Nowhere in the Income Tax Act is there an indicium of how much that quantum must be.”

He went on to say:

In the absence of any indicia, and in order that there may be certainty and no confusion on this point, as a matter of construction ‘if the words used are ambiguous, the court should choose an interpretation which will be consistent with the smooth working of the system which the statute purports to be regulating; and that alternative is to be rejected which will introduce uncertainty, friction or confusion into the working of the system.

As authority for the quoted rule of construction he cited Trans-Canada Investment Corporation Ltd v MNR, [1953] Ex CR 292; [1953] CTC 353; 53 CTC 1227, affirmed [1956] SCR 49; [1955] CTC 275; 55 DTC 1191, adopting language in the Privy Council decision on an appeal from the Supreme Court of Canada in Shannon Realties Ltd v Ville de St Michel, [1924] AC 185 at 192.

He then said (199 of the CTC report):

Accordingly, implementing this principle it must be assumed judicially, in interpreting the meaning of section 125 and its relationship with section 129 and with the whole scheme of the Income Tax Act, that any quantum of business activity that gives rise to income in a taxation year for a private corporation in Canada is sufficient to make mandatory the characterization of such income as income from an “active business carried on in Canada.”

It can be argued that what is said in the foregoing quotation may be considered to some extent obiter, as going further than was needed for the decision in the Cadboro case, which resulted in the corporation’s appeal being dismissed. The facts in that case, as found by the learned judge, seem to indicate something more than minimal business activity by the corporation in earning the income. Even so, the opinion expressed carries a good deal of persuasive weight, as it is the opinion of an experienced judge, arrived at logically, after a careful review of the relevant statutory rules, the facts and much of the jurisprudence.

In all three of the cases mentioned supra and referred to by Gibson, J in the Cadboro case, viz: The Queen v Rockmore, ESG Holdings v The Queen, and The Queen v MRT Investments, the business of the companies was that of moneylending, mainly on the security of the mortgages. The three cases were tried together before Walsh, J in the Trial Division of this court. This was the first occasion in which the court was faced with the problem of determining what constitutes an “active business” for the purposes of the small business deductions under section 125. The conclusions of the learned judge are well stated in the headnote (see [1975] CTC 354):

HELD: There was nothing in section 125 to justify a conclusion that a corporation whose entire income came from investments could not be considered as carrying on an “active business” when the making of investments was the very purpose for which it was incorporated. It was a question of fact, founded on a literal interpretation of the words “active business”, whether the operations in question were active business operations or not. Here the acquisition of mortgages to obtain income was part and parcel of the carrying on of a business or scheme for profit making. The fact that the plaintiffs were not paying salaries, nor rental for the use of office space or equipment, nor did they have employees of their own, did not necessarily indicate that they were not carrying on active business. There was little doubt that all three companies were actively carrying on business but on the facts only the plaintiffs MRT and Rockmore were carrying on a “active business” by themselves, and their appeals (from the Tax Review Board) were allowed. In the case of ESG, however, whose business was merely turned over to another company without further intervention or supervision, it could not be said that the plaintiff was itself carrying on an “active business” and its appeal was dismissed.

The Court of Appeal agreed with the trial judge’s findings in the MRT and Rockmore cases but differed with his reasons for dismising the ESG appeal. On this point, Jackett, CJ, in an unanimous decision of the Court of Appeal, said, at 296 of the CTC report of the ESG appeal:

With respect, I do not agree that there is any material difference in principle, in so far as the carrying on of an active business by a corporation is concerned, between carrying It on through the agency of officers or servants of the corporation and carrying it on through the agency of an independent contractor. The question is whether the taxpayer’s “income” is from “an active business carried on in Canada” within the meaning of those words in subparagraph 125(1)(a)(i) of the Income Tax Act.

Before leaving consideration of the Rockmore case it is desirable to refer to a footnote at 294 of the CTC report of that case. Near the end of the extract quoted supra from 293 and 294, immediately following the reference to subparagraph 125( 1 )(a)(i), there is a mark +, indicating a footnote. The footnote is at the bottom of 294 and reads:

As I read subparagraph (1)(a)(i), the question is whether the “business” was “active” and the question as to how active the proprietor was in the business activities would not seem to be relevant. To me, this would seem self-evident and its statement does not constitute the enunciation of any general principle.

Counsel for the plaintiffs argued that this footnote was a note by an editor, was therefore not part of the judgment and was not authoritative. Counsel for the defendant contended that the footnote was made by Jackett, CJ who delivered the judgment. I agree with him. There is nothing to indicate an editor had anything to do with the footnote. It is most unlikely that an editor would introduce a footnote in the middle of a paragraph of a judgment, expressing his own opinion on the point being discussed in the judgment, without indicating that the footnote was written by him. In this instance the unlikelihood of such an action is very apparent, because there is an editorial note, clearly marked as such, starting on the first page of the report. What is to my mind completely decisive of the matter is the fact that the footnote fits clearly into what Jackett, CJ said in the sentences immediately prior to the point where the footnote is indicated and into what he Said in the balance of the paragraph. In my view the footnote is unquestionably the work of the Chief Justice and must be held to be a part of the judgment of the court.

I should also mention one additional statement by Gibson, J in the Cad- boro Bay case. On 197 of the CTC report of that case there is the following paragraph, in brackets:

(“For reasons that are stated later in this judgment, what is income from ‘a business other than an active business’ must mean income from a business that is in an ‘absolute state of suspension’ — see quotation from The Queen v Rockmore Investments Limited, that is, devoid of any quantum of business activity, but which has some asset which produces income.”)

With great respect, if my understanding of what is said in the paragraph just quoted is correct, it defines “a business other than an active business”, ie: an inactive business, more narrowly than the discussion of it by the Federal Court of Appeal in the Rockmore case indicates.

Among the many cases referred to by counsel is one which I think it desirable to refer to here because in that case, differing from the decisions in the cases discussed supra, the tribunal concluded on the fact that “assuming but not deciding that the income the appellant earned in 1976 was income from a business, I am of the view that it was not income from an active business.”

The case is Transregent Holdings Ltd v MNR. It is a decision of the Tax Review Board, dated February 13, 1980, [1980] CTC 2221; 80 DTC 1212.

The decision was written by F J Dubrule, Assistant Chairman. In it he reviewed the law and discussed several earlier judicial decisions and one of the Tax Review Board. In particular, dealing with the Cadboro Bay case, he quoted from Gibson, J’s judgment the essential facts (summarized earlier in these reason) and comparing them with the facts before him said, at 10 of the typewritten decision:

The facts in this case as I find them are: there was only one tenant; the landlord did not have any concern with the complaints of the tenants; nor did it arrange for the maintenance of the property; nor did it do anything with respect to the running of the property except that, those things which were to be done by the tenant at the tenants expense, were supervised by the landlord. As far as daily activity was concerned, while there was evidence that officers of the appellant did things on the property, eg: supervise snow removal, lawn cutting, and the repairing of the roof after finding a workman to do so, that activity was much removed from “almost daily”. I doubt that these activities could be held to be “almost monthly”. As I view the facts of this appeal, it is entirely different from the facts in the Cadboro Bay Case.

Counsel for the plaintiffs in the cases before me relied to a considerable extent on the Transregent decision, submitting that the facts in these cases were more nearly comparable to those in the Transregent case than to those in the Cadboro Bay case and other cited cases where the court had come to a different conclusion. So far as the law is concerned, the decision of the Federal Court of Appeal is binding on this court, but the decision of the Tax Review Board is not. Its value depends on the persuasive quality of its reasoning.

In all cases where the decision rests on whether a business is “active” or “inactive” the prime consideration is a proper understanding of the facts and the conclusion to which these facts point. It therefore becomes necessary to state the facts in the present cases more fully than I have yet done.

At the outset I refer to Ex P-1 and Ex P-4, mentioned earlier. Ex P-1 is the amalgamation agreement between King George Hotels Limited and Stanley Motel Ltd. Ex P-4 is the amalgamation between Cavalier Motor Hotel Ltd and three other companies. The names of the amalgated companies are stated to be, respectively, King George Hotels Limited and Cavalier Enterprises Ltd. These are the present names of the plaintiffs.

In the agreements the objects of the amalgamated companies are set out, in terms which are practically identical, in paragraph 4 of each agreement. The objects which are of some relevance to the present cases are stated in subparagraphs (a) and (g), which read:

(a) To carry on in the City of Saskatoon, in the Province of Saskatchewan, or elsewhere, the business of hotel, motel, motor hotel, auto-court, auto-parkade, and trailer camp.

(g) To appropriate any part of parts of the property of the Company for the purpose of and to build or let shops, offices, and other places of business, and to use or lease any part of the property of the Company not required for the

purposes aforesaid for any purposes for which it may be conveniently used or let.

Subparagraphs (b) to (f) deal with the hotel business and businesses ancillary thereto, including the supply of food, confectionery and tobacco, obtaining and using liquor licenses, operating a service station and gasoline sales station.

Subparagraph (h) should also be quoted. It reads:

(h) For the purposes aforesaid to purchase or otherwise acquire land at the City of Saskatoon, aforesaid, or elsewhere and proceed with the construction on the said land of such buildings and premises as the Company may determine in order to carry out all or any of the objects aforesaid.

It is clear from subparagraphs (g) and (h) that in addition to the hotel business, each of the plaintiffs possessed, as an express object, the power to build and let premises as shops, offices and other places of business. This is one of the purposes for which the former companies expressly agreed to amalgamate. In my view, the plaintiffs acted correctly in not claiming that what they were doing in leasing premises and collecting rent was not a business at all. Since the objects of each company were clearly business purposes, to earn income, and since the leasing of premises by them was done for the purpose of earning income, I do not think it could be argued successfully that in acting in pursuance of one of those express objects, they were not “carrying on business”. As stated earlier, the real question is whether that business was “active” or “inactive”.

The only person who was called as a witness at the trial was Donald R Leier. He is the president of both plaintiffs and also of J JP Management Services Ltd, whose function will be indicated below. He and his brothers and sister held, at all relevant times, the great majority of the shares of all three companies. Donald R Leier was and still is manager of J P Management Services Ltd, in which he holds 50% of the shares, which company, for convenience, is herein generally referred to as J P. The plaintiff companies are generally referred to respectively as King George and Cavalier. Donald R Leier is paid a salary by JP P and is also paid $50 per year by King George, but receives no salary from Cavalier.

The leases with which we are concerned all relate to premises located in one or other of three buildings situate on portions of the land described as Lots 16 to 25, both inclusive, all in Block 149 in the City of Saskatoon in the Province of Saskatchewan, according to a plan of record in the Land Titles Office for the Saskatoon Land Registration District as No (Q 2) C 195.

Exhibit P-7 is a master lease for 10 years of all the land described in the foregoing paragraph, from Cavalier to King George, at a rental of $228,000 for the first year, payable $19,000 monthly. Under the lease King George has the right to assign or sublet all or any part of the demised premises and all the leases in question herein have been made by it (through the agency of J P) to various tenants for various business enterprises. The King George Hotel itself is one of the buildings on part of the described land, as are the King George Arcade and the King George Parkade. Some of the premises leased to tenants by King George are in the hotel, but most of them are in the Arcade, or Parkade, and one is a lease to the Royal Bank of a building known as the Royal Bank building. Some of the stalls in the Parkade are also leased on a monthly basis.

While the plaintiffs operate their own hotels, the overall management of the plaintiff companies is not handled by King George or Cavalier, but is in the hands of J P as it has been since about 1965. Both King George and Cavalier pay JP P for its services. Donald R Leier, as manager of J P, looks after this business himself, including the leased premises. In nearly all instances he negotiates with prospective tenants both for new leases and for renewals, settles the rent and other terms and draws the leases. When vacancies occur there is generally a new tenant either waiting or readily available to take over the vacated premises. In the rare instances where this is not so, J JP engages McClocklin Real Estate Limited to find a tenant. The experience has been that, practically speaking, all these premises have been fully occupied at all times.

Cavalier owns the land and buildings of the King George Hotel, including the Arcade, and also the Royal Bank building. The net income from the commercial leases we are concerned with is turned over the Cavalier, which has always shown it as inactive income on its income tax returns.

Under the leases the tenants are responsible for taking care of the buildings, including the replacement of plate glass windows. They pay the electricity bills for their premises. The lessor is responsible for structural defects in the buildings, including the replacement or repair of broken or leaking water or gas pipes, electric wiring or fixtures, lavatories, radiators, heating and air-conditioning apparatus, but is not responsible for damage to persons or property in the premises, whether caused by non-repair, disrepair, or negligence of the lessor, its servants or agents, unless the lessor disregards a reasonable notice thereof and fails to repair. The tenants undertake to repair damage caused by the misuse of any of the foregoing or by any negligence of the lessee.

The lessor is responsible for supplying adequate heat to the demised premises. In the few premises that do not have bathrooms the tenants are accorded the right to use the public facilities of the hotel. The lessor is responsible for hallways and interior approaches to leased premises. On the other hand the tenants are responsible for removing snow and ice from their premises and for cleaning windows.

One marked difference between these cases and the Transregent Holdings case is that there was only one tenant in the Transregent case whereas in the present cases there are, as indicated by Exhibits P-8 to P-26 about a dozen premises, perhaps more, leased to as many separate tenants.

Mr Leier stated that about 5% of the total income of King George was from the commercial rentals, varying from about $90,000 to $104,000 per year. The balance was from the hotel business proper, ie: rooms, meals and beverages, varying from about $1,800,000 to $2,000,000 per year. The net income from the leases is about 40% to 50% of the gross, while that from the hotel business is about 20% to 30% of the gross. In the result the net rental from the leases is about 10% of total net income. Assuming that these figures are approximately correct, it is clear that the income from the leases is not insignificant.

The fee paid to J JP by King George and Cavalier, is in both cases, a lump sum fee for all J P’s services, and is not broken down so as to show separate charges for the leasing business. The amounts of the fees charged to them are not disclosed in the evidence.

Mr Leier stated that the time devoted by J P to work in connection with the leases averages about one hour per month or twelve hours per year. It is not clear whether these times refer to the work of Mr Leier alone or include work by stenographers or other employees of J P. Mr Leier said J P had five employees during the years in question. If all the time worked by all five employees of JP P is included, the time required for the work is very short.

The leases vary in length from six to ten double spaced pages of typewritten foolscap. Many of the clauses in them are similar, but there are many differences due to the nature of the tenant’s business and the location of the particular premises. In some leases there are escalator clauses, under which the tenant is required to pay a specified portion of increases in taxes and fuel costs for the building in which the tenant is located. In one there are special over-ride provisions which call for increased rental payments related to increases in the tenant’s volume of business. These things require the attention of J P from time to time. In one case J P assisted a new tenant who was opening a beauty parlour by lending her the money to renovate and decorate the premises. These are examples of services rendered by JP P in connection with the leases.

The activities of J JP in connection with the leases must be treated, in so far as these cases are concerned, as activities of King George. Those activi- ties, according to the evidence, are not extensive or onerous, and they do not require daily attention. In total, however, with other activities, they involve a not inconsiderable amount of activity. I consider the facts and circumstance here to be clearly distinguishable from those in the Transregent case. In my view they are more nearly in line with those in the Cadboro Bay case, and certainly within the language used in that case and those cited therein, more particularly in the Federal Court of Appeal decision in the Rockmore case, in describing what the term “active business” means.

My conclusion is that the income from the leased premises received by J P for King George for the years 1973, 1974, 1975 and 1976 was income from an active business and it remained income from an active business when remitted to Cavalier.

I have read the judgments in all the cases cited to be by counsel, and also other judgments referred to in those judgments. I have found nothing in any of them to alter my view of the law as applied to the facts of these cases.

The appeals from the assessments are dismissed, with one set of costs to the defendant.