Richard P Fraleigh v. Minister of National Revenue, [1981] CTC 3038, [1981] DTC 944

D E Taylor:—This is an appeal heard in London, Ontario, on October 14, 1981, against an income tax assessment for the year 1977 in which the Minister of National Revenue assessed a gain of $206,643 realized on the sale of a parcel of real estate situated at 1224 Commissioners Road West, London, Ontario (the property), as on income rather than on capital account. The respondent relied, inter alia, upon section 9 of the Income Tax Act, SC 1970- 71-72, chapter 63, as amended.

The parties filed an agreed statement of facts, which sets out the fundamentals of the matter:

The parties hereto, by their respective solicitors, hereby admit the facts set out hereinafter and the documents attached hereto. The parties further agree that either party may produce evidence not inconsistent with this agreement at the hearing of this appeal.

The following facts are admitted by both parties:

(1) Mr Richard Paul Fraleigh, the taxpayer in this appeal, resides at RR #1, Arva, Ontario.

(2) Mr Fraleigh is engaged in the businesses of farming, breeding race horses, buying and selling and developing real estate.

(3) During the late 1960’s and early 1970’s Mr Fraleigh acquired a variety of real property interests both directly as an individual and indirectly through various corporations controlled by him. These properties included vacant land and single family residential houses held for resale, farm land which was used in Mr Fraleigh’s farming business, and income producing rental buildings. Some of these properties have been sold; others are still owned by Mr Fraleigh.

(4) On June 31, 1974 (sic) Mr Fraleigh acquired lot 45 of plan 563 for the City of London (otherwise known as 1224 Commissioners Road) for a total purchase price of $110,000. The property has a 248 foot frontage on the south side of Commissioners Road which is a major east/west thoroughfare. On the north side of Commissioners Road is a large public park. The property has a depth on one side of 463 feet and on the other side 359 feet. A one story building of

block and brick construction, consisting of approximately 6,000 square feet, occupies the front part of the property. Under a net lease with a remaining term of 9 years a grocery store business was being operated in the building at the time of the purchase by Mr Fraleigh.

(5) The purchase price of $110,000 was satisfied by the assumption of an existing mortgage in the amount of $64,000 and the payment of $46,000 cash. The mortgage had a remaining term of ten years at the time that Mr Fraleigh acquired the property and interest on the mortgage was at the rate of 7% per annum.

(6) At the time of its acquisition in 1974 the property at 1224 Commissioners Road was subject to a lease with a remaining term of 9 years and renewable at the lessee’s option for one additional term of 5 years subject to the lessee’s satisfactory performance of his obligations under the lease. The rent was

$10,000 annually or $833.33 monthly plus a percentage of sales in excess of a certain amount. In fact, sales never exceeded the minimum amount. The lessee was required to pay all property taxes, heat, water, electricity and insurance in

respect of the property and these obligations were guaranteed by M Loeb Limited.

(7) The fully guaranteed rent under the lease ($833.33 monthly) exceeded the

monthly payments required under the existing $64,000 mortgage ($769.50).

(8) The property was zoned for commercial use. After its sale by Mr Fraleigh a medical clinic was constructed on the rear portion of the property.

(9) In late 1975 and early 1976 steps were taken by Mr Fraleigh to construct an addition of approximately 6,000 square feet onto the existing building. A survey of the property was carried out and plans were drawn up for the construction of the addition.

(10) In 1977 Mr Fraleigh was contacted by one of his solicitors, who was also President of Victoria Hospital Corporation, about the possibility of Victoria Hospital Corporation acquiring the property at 1224 Commissioners Road for the purpose of constructing a family medical clinic.

(11) After detailed and prolonged negotiations which involved inter alia the cancellation of the existing lease on the property, and the waiver of the mortgage penalty by the mortgagee, an agreement of purchase and sale was entered into on July 25, 1977 for the sale of the property to Victoria Hospital

Corporation for a total purchase price of $325,000. In these negotiations with respect to the acquisition of the property by Victoria Hospital Corporation, the hospital took the most active role in contacting the mortgagee and generally in working out details regarding the sale.

(12) By virtue of an agreement dated November 26, 1974, Mr Fraleigh listed the property at 1224 Commissioners Road with B G Anrep Real Estate Limited for sale at the asking price of $300,000 Until February 26, 1975.

(13) On June 17, 1977 the property was again listed for sale with Jerry Pilkey Real Estate Limited for the asking price of $375,000 until June 23, 1977. This listing agreement was only for a period of 7 days.

(14) By virtue of a notice of reassessment dated April 20, 1979 the Minister of National Revenue has assessed tax for Mr Fraleigh’s 1977 taxation year on the basis of a profit from the sale of the property at 1224 Commissioners Road of $206,643.

(15) The taxpayer, Mr Fraleigh, contends that the profit from the sale of the property at 1224 Commissioners Road is a capital gain only one-half of which should be included in his income for the 1977 taxation year.

(16) The issue in this appeal is whether the profit of $206,643 on the sale of the property at 1224 Commissioners Road by Mr Fraleigh to Victoria Hospital Corporation in 1977 is a capital gain or income to the appellant.

Contentions

For the appellant:

— The circumstances of the sale were such that it was the acceptance of an unsolicited offer rather than a possible expropriation and unfavourable publicity, and therefore the sale should be classified as a capital gain, not an income gain.

For the respondent:

— The appellant acquired the subject property with the intention of selling it at a profit at the first favourable opportunity;

— The appellant did not acquire the subject property with an exclusive investment intention.

Evidence

Mr Fraleigh testified with regard to the agreed statement of facts, and indicated that it had been his belief at acquisition that he could enlarge the existing building, perhaps going to a height of seven floors. There was also the prospect of extending the existing building to the side of the property, or to construct multi-family residential units at the rear. A change in the city by-laws shortly after Fraleigh’s acquisition had forced the closing of the small retail store which was there when he acquired the property, but the lease was guaranteed by M Loeb Limited who continued to pay the rent even though the building was vacant. Efforts at building expansion, or new residential construction were always frustrated because of the requirement in the lease for Loeb to give consent to any such changes, particularly if they could affect access or right of way. Fraleigh had attempted informally to find new tenants for the building, but without success. Certain documents dealing with the real estate listings and the eventual sale were filed. The appellant gave explanations for the real estate listings, and for the eventual sale, which are dealt with later in the arguments by counsel. It was the appellant’s basic position that he would not have acquired for resale a property which earned sufficient revenue to finance the carrying costs, and was of a size and location permitting and encouraging expansion or development. He had sold because:

there was no assurance that the guarantor would continue to make the rent payments on the vacant property;

the property was falling into a state of disrepair because of the difficulty in maintaining it while vacant; and

since the offer was bening made by a “public agency” it was felt that there was no point in fighting the offer because the government could expropriate the property anyway if it really wanted it.

The lease guarantor unfortunately took advantage of the “forced sale” situation according to the appellant to extract a lease cancellation payment, even though the building was not being used, according to the appellant.

Argument

The case law referenced included:

Hiwako Investments Limited v The Queen, [1978] CTC 378; 78 DTC 6281;

Birmount Holdings Limited v The Queen, [1978] CTC 358; 78 DTC 6254;

S & S Properties Limited v The Queen, [1978] CTC 412; 78 DTC 6294;

Clemow Realty Limited v The Queen, [1976] CTC 129; 76 DTC 6094; Power v The Queen, [1975] CTC 580; 75 DTC 5388;

Bead Realties Limited v MNR, [1971] CTC 774; 71 DTC 5453;

Racine, Demers and Nolin v MNR, [1965] CTC 150; 65 DTC 5098,

Minister of National Revenue v Valclair Investment Company Limited, [1964] CTC 22; 64 DTC 5014;

Regin Properties Limited v MNR, [1979] CTC 2149; 79 DTC 156;

Sam Grossman v MNR, [1979] CTC 2132; 79 DTC 141.

Counsel for the appellant made some preliminary remarks regarding the inadequacy of the Minister’s pleadings, but moved on to the substance of his position which culminated in three aspects:

. . . there is nothing in the nature of real estate itself which precludes its characterization as an investment for income tax purposes.

I would like to . . . deal briefly with:

— the basic test to be applied in a case for distinguishing capital gains from ordinary income and then deal with the application of that test to the circumstances of this particular case . . .

— I would like to conclude by examining the doctrine of secondary intention.

Counsel noted:

. . . the taxpayer must succeed in his appeal if he shows that his sole intention in acquring the property and in dealing with the property and in disposing of the property was to make and realize an investment. . .

The basic test as established by the cases for determining whether the gain from the disposition of property constitutes a capital gain or ordinary business income is whether or not the taxpayer’s intention at the time that he acquired the property was to resell the property at a profit, to trade in the property in effect, or was his intention to make an investment.

Counsel also noted that in certain specific circumstances, looking only at the intent of the taxpayer at the date of acquisition if it could be established, might not be sufficient, and he referenced Regin Properties (supra). Accordingly, this led counsel to conclude that even if it could be shown by the respondent that the intention of Mr Fraleigh was to resell, this should not destroy his case. However, it was counsel’s further view that the appellant ran no such risk because the circumstances surrounding his acquisition of the property, his use of it during tenure, and the sale of it, all demonstrated that the purpose at acquisition was as an investment; and as support he emphasized:

(1) Mr Fraleigh testified that his intention in acquiring the property was to make a long-term investment . . .

(2) that the property in question was producing income which was in excess of the costs incurred on a monthy and yearly basis by Mr Fraleigh in respect of the property;

(3) that the income generated by the property was in fact guaranteed so that there was no risk that the property upon becoming vacant would not generate any further income . . .

(4) the financing that was in place with respect to the property was at an attractive and low rate and was on a relatively long-term basis. There was 10 years left to go on the mortgage.

(5) . . . that the property would not only carry itself but would generate a small surplus of income;

(6) there was the possibility of expansion to the existing building;

(7) there was the significant possibility of development, not immediate development, and Mr Fraleigh was quite frank in his testimony in indicating that he did not have the necessary financing to immediately develop the rear portion of the property, but that the property was certainly not just a suitable property for development of the rear portion but a prime property. It was right across from a major park. It was on a major thoroughfare, there was access, the zoning was appropriate, so that all of the factors which were necessary to making the property suitable for development were present except for the fact that financing was not currently available.

. . . It is important to realize that this was for Mr Fraleigh a long-term investment. This was not something that he intended to develop immediately. He realized when he purchased the property that there was an existing lease on the property which had a remaining term of some nine years. There was also a five-year renewal period in respect of that lease and therefore his right to deal with the property in terms of developing it was subject to the lessee’s consent if he was to develop it during that time. I think it should be pointed out that if Mr Fraleigh’s intention was to resell the property at a profit that any purchaser of the property would be similarly stuck with the same lease arrangements and that therefore it seems to me that someone acquiring this property at the time that Mr Fraleigh acquired it would realize that particular fact. Therefore, the property was only suitable as a longterm investment in fact, because the property would be acquired by purchase subject to the existing lease. Of course, there was always the possibility that perhaps some arrangement could be made with the lessee as to the termination of the lease, but once again I think as Mr Fraleigh’s testimony has indicated, for him this was a long-term investment. The fact that during the period he owned the property he did not negotiate with the lessee with respect to the cancellation of the lease simply indicates, I think, that the financing was not yet in place to allow him to go forward with his plans as to developing multi-family residences on the rear portion of the property.

. .. another factor which corroborates the taxpayer’s testimony as to his intention was the fact that serious plans were made to make an addition to the building, not simply a small addition to the building, but an addition which would double the size of the building in effect. Plans were drawn up, there was a survey completed with respect to the property but, as Mr Fraleigh testified, the lessee, the proposed lessee to the building, was unable to come up with the necessary financing and in fact that addition fell through. Mr Fraleigh also testified that he had several inquiries from potential purchasers all of which were turned down flatly, indicating once again that he was not interested in selling the property.

Dealing with the circumstances of the disposition, this was an unsolicited offer from the hospital. Mr. Fraleigh did not seek out the hospital and attempt to sell them the property. They came to him. . . . There was also the implicit threat of expropriation. There was the moral suasion, if I can call it that, of being a member of the community and making some contribution to the community and under those circumstances Mr Fraleigh was persuaded after his initial rejection and after learning that the hospital had not been able to obtain an alternative site, he was persuaded to sell the property to the hospital.

All of those circumstances . . . are consistent with the termination of an investment. This is not a circumstance in which a property turns out to be unprofitable and as a result of it becoming unprofitable, the taxpayer falls back on his secondary intention when he acquired the property — to resell it at profit. This is property in fact that never proved to be unprofitable. There are other reasons which led to the termination or the realization of Mr Fraleigh’s investment in the property.

In dealing with the listing agreement, counsel emphasized the testimony of Mr Fraleigh that the first one had been given as a favour to a friend attempting to improve his position in the real estate field. It was part of Fra- leigh’s normal business to deal with real estate agents and to keep on friendly terms with them. The price was exaggerated, beyond the realm of possibility. The second agreement was in reality a rental listing agreement, but it provided protection to the agent involved. The property was already leased, and to grant a rental listing agreement to an agent which would be called in fact a rental listing agreement, would be inconsistent. So, the rental listing agreement was drawn up as a sale listing agreement.

Mr Fraleigh did not want to sell the proeprty, but the real estate agent obviously wanted some form of protection or some form of evidence that if he arrived with a tenant to lease the building that he would have something to indicate that in fact there was an arrangement between himself and Mr Fraleigh, and the listing agreement does in fact indicate that Mr Fraleigh agreed that during the period of agreement he agrees not to rent the said property except through you, the above-named realtor with whom I shall enter into a rental listing agreement. So that there is at the very least something in the listing agreement which deals with the prospect of a rental of the property as opposed to a sale of the property. I would also point out . . . that this was a listing for a very short period of time.

In summation, counsel referenced the four points given in Grossman (Supra) at page 2145 which deal with factors to be considered in such a case. In counsel’s view, this appellant does not fall within any of these and therefore the gain was on capital account.

Counsel for the respondent agreed directly that there was nothing inherent in real estate which would disqualify its acquisition as an investment; that a real estate trader could have a capital gain on a land transaction; and that in the circumstances of this case, if it could be demonstrated that the appellant’s sole intention at the time of acquiring the property was investment, he might well succeed. It was the view of counsel that while the factors enumerated by Mr Arnold relating to the acquisition of the property could indicate that it was an investment, they fell far short of proving that it was such, and certainly not that it was the sole intention of the appellant. The same held true for the circumstances surrounding the sale. It was less than clear that the overtures had been made externally or that any public pressure had been exerted on the appellant. It was certainly not clear that he would have sold without a profit to be realized. But the critical problem facing the appellant, according to counsel for the respondent, was that no development had proceeded during tenure, and that two sale listing agreements had been signed. It was evident that no development could proceed without the concurrence of Loeb’s; and the explanations provided by the appellant regarding the listing agreement were unsupported by other evidence, and most unusual in their nature. The Regin case (supra) did not provide support for the appellant, indeed there was no real indication of “how he might use the property” — just generally that he had some plans for it. In total, the appellant had not eliminated as a motivation for purchase the possibility of resale, and his conduct during tenure and at sale of the property lent no support to his assertions.

Findings

The evidence to support an investment intention at acquisition, or frustration of that intention at sale, is scant indeed and the appellant’s case would remain at serious risk depending upon it, but the real problem facing this appellant is his conduct and use of the property during tenure as pointed out by counsel for the respondent. In view of his history and experience in the real estate field, the listing agreements cannot be ignored, and the explanations provided for their existence are inadequate. When this fact is cast against two primary and pre-existing deterrents to his alleged development

— that he needed the concurrence or a negotiated settlement with the lease guarantor before any development, and that he lacked the ready financing for the alleged development, this appellant has failed to meet the challenge facing him in the Minister’s assessment (see Trans-Canada Holdings Limited v MNR, [1980] CTC 2791; 80 DTC 1689.

In keeping with his normal and successful business practice, it is more probable that the appellant saw a real estate bargain which after acquisition could carry itself, and would permit him to wait for a purchaser ready to pay an acceptable price. I do not doubt that during tenure he made some limited efforts to make arrangements with the lease guarantor, and/or explore the possibilities of additional utilization of the property. However, those limited activities did not come to fruition, and they are just as consistent with the conduct of a knowledgeable realtor stabilizing an operation and exploring future possible uses to improve the attractiveness to a potential buyer of inventory property as they could be to support an assertion of long-range planning for the continued retention and utilization of an investment property. In the light of his own business history, knowledge and activity in the real estate field, the conduct of the appellant during tenure does not support his contention regarding the purpose for acquisition, nor the reasons for disposal.

Decision

The appeal is dismissed.

Appeal dismissed.