Chateau Investments LTD v. Minister of National Revenue, [1981] CTC 3054, 81 DTC 920

John B Goetz:—This is an appeal with respect to the appellant’s 1977 taxation year.

Issue

The issue is whether the sale of the apartment building, known as Chateau Towers, was an adventure in the nature of trade or was on account of capital.

Findings

On the evidence before me, at all times relevant to this appeal, Mr Oren Grovum was an employee of Co-Op Trust Company of Canada (“Co-Op Trust”) who had obtained his Bachelor of Commerce degree and was a chartered accountant. His work with Co-Op Trust involved mortgaging, finances and the measure of interest for certain types of investments.

In 1972 Co-Op Trust became interested in the purchase of Chateau Towers, which at that time was owned by Ankorli Enterprises Ltd (“Ankorli”) and obtained a complete appraisal of Chateau Towers which was a highrise residential apartment building. Co-Op Trust, upon receiving such appraisal, was quite interested in purchasing the building as investment property but discovered that it could not, under its Charter, own such property without in fact occupying it.

Grovum’s interest was piqued by the appraisal report in that the construction of the building commenced somewhere in late 1968 or early 1969 and the people building it were in financial trouble. The Co-Op Trust appraisal showed that the value of the building, using the cost approach, was $755,000. Mr Grovum filed at least 36 exhibits, many of which were in his own handwriting, wherein he calculated the cost of an 85% first mortgage at 9% over a 30-year period, the remainder, $117,000 to be invested by the purchasers. In that Ankorli was virtually in receivership, Mr Grovum made an offer to their then solicitors to purchase the building for $780,000. This was on February 19, 1974 when he admitted there was a credit crunch. He calculated that the percentage return on the owners’ equity would be 10.6% after taking into account all financing charges and operating expenses. He gathered together with him his brother and his father, V R Henderson, D G Malcolm and one William Massey who was a farmer about ready to retire. Their total net worth was close to $712,000. C Grovum’s net worth (the father) was $123,000 and his age was 65; C D Grovum’s net worth was $54,000 and his age was 28; O W E Grovum’s net worth was $41,000 and his age was 32; V R Henderson’s net worth was $60,000 and his age was 32; D G Malcolm’s net worth was $76,000 and his age was 33; and W E Massey’s net worth was $358,000, and his age was 50.

In that the vacancy rate was .03 in 1973-1974, with the prospects of increasing rental, Grovum was very optimistic and gave his calculations to his friends to evaluate. They were all young men, most of whom were engineers or engineering professors. On making inquiries of mortgage companies, Grovum discovered that Mutual Life Assurance would advance funds at 9 /4%. This was in February 1974 and that company would give 85% financing. At about the same time they discovered that another offer had been made to a solicitor, Mr Jamieson, who now acted for all the creditors of Ankorli and it was with this gentleman that Grovum dealt thereafter. Mr Malcolm, a participating investor, seemed to be the person whom Grovum consulted with mostly and they felt that if they could increase their rentals, they would end up with a return of 13%. As of March 13, 1974, Mr Grovum’s calculations still showed a cash return of 12.8% on their investment. It was his evidence that he wanted an investment which would produce income to retire the mortgage and which would eventually set up a revenue project on a permanent basis. The reason for this approach was because Mr Govum had been sick for approximately two years, his illness eventually diagnosed as hypoglycemia. The settlement date for the purchase was to be June 1, 1974 but their offer had been refused and when Mr Jamieson came into the picture, he requested that the purchase price be raised to $790,000. Grovum then dealt with a mortgage broker by the name of Cumberland Mortgage Corporation Ltd (“Cumberland Mortgage”) through a person by the name of Cooper, whereby it was indicated that interest rates might run, for an 85% mortgage, between 9 /2-9 A%. His projection for a net return was still good and the documentation filed by him shows the careful way in which he went about attempting to calculate this.

As of March 13, 1974, Govum felt, after considering all factors, that the net return would be 12.8%. Most of the investors had to borrow the money to make up the down payment. By June 1974, interest rates had started to climb. It was Mr Grovum’s view that as an investment dealer that the credit crunch was only a temporary thing and that rates would fall again. In April 1974, his mortgage broker indicated that the rates had climbed to 10 /2% and that the initial loan would only be $615,000 and in nine months would be raised to $665,000. At that point in time he brought in Terry Mitchell, another engineer, who also brought in his father. Between them they contributed $70,000 to the down payment.

On April 22, 1974, Jamieson approved their offer and formal application was made to Cumberland Mortgage. In the initial offer to purchase through Ankorli’s solicitor, the sum of $4,000 was deposited with him which was requested to be turned over to Mr Jamieson. On June 3, 1974, Chateau Investments Ltd (a company incorporated by Grovum and his friends) entered into a purchase agreement with Ankorli whereby the sum of $8,000 had to be deposited forthwith and the purchase price was set at $816,000. The appellant, Chateau Investments Ltd, was also responsible for legal fees and interest at the rate of 11% per annum including June 1, 1974, which totalled $14,853.50 from June 1st to July 31, 1974, payable to Jamieson in trust. By this time, of course, they were committed to the purchase although Cumberland Mortgage in finally dealing with them agreed only to an initial advance of $575,000. Nevertheless, among the prolixity of memos and calculations all dated and initialled by Mr Grovum, he felt that as of June 6, there could be an 8.37% return. The group of purchasers, through Chateau Investments Ltd, put up the sum of $240,000 as a down payment. The transaction was finalized on August 8, 1974, and as of July 1974, had they withdrawn from the transaction, they would have lost over $36,000.

It can be readily seen that we have in this situation a group of individuals caught up in their enthusiasm to acquire a building that, in the long run, would produce income although they were aware that the initial period would be hard for them. They were suddenly faced with an expensive roof job, costing in excess of $20,000 and even though they increased the rent by $10 a month twice, once in 1974 and once in 1975, their sudden increase in operating costs cut down their margin of profit dramatically. In the spring of 1975, in the Province of Saskatchewan, talk was rampant from members of the Government that rent control would be imposed and some rents that had been increased would be rolled back. This added to the woes of these babes in the woods as they had been counting on regular rental increases to, at least, compensate for rising operating costs. Grovum was of the firm view that rents would fall again, a view which he shared with several others and, as he pointed out, within the last five or six months (1981) most so- called experts on interest rates felt that interest rates would continue to rise and not drop to any degree. Events have proved them all wrong. Likewise, events with respect to the rise or fall of interest, as far as Grovum was concerned, proved him incorrect. Most of the investors of the appellant had to borrow the money to make the down payment, even after mortgage rates had risen, and became quite worried and they met seeking how they could cut their losses.

A letter written to one Max Swartz, a real estate agent, was referred to by the respondent as seemingly indicating an early desire to dispose of the property. This was written by Mr Malcolm without the knowledge of the other partners. Swartz received the letter on the basis that he could establish through the real estate company that he was on the lookout for a large residential sale. In fact, Swartz never returned to the appellant with any information whereby they could give him an exclusive offer to sell. It was not until August 1975 that a listing agreement was entered into with Weber Bros. Realty Ltd for whom Swartz worked, for a selling price of $1,200,000. The appellant operated at a loss until it was able to dispose of the property on April 15, 1977, when it was alleged by the Crown that Chateau Towers was sold to Embarco Holdings Ltd for the sum of $1,140,000.

In assessing the appellant, the respondent relied, inter alia, upon section 3, subsections 4(1) and 9(1) of the Income Tax Act, SC 1970-71-72, c 63, as amended, and alleged that the appellant realized a net profit of $277,951.43 and attributed it as a net profit on the income for the 1977 taxation year.

I was completely impressed by the forthrightness of Mr Grovum and all of his supporting witnesses,and it is my view from the whole of their story that they indeed were frustrated as investors in income-producing property. None of them had any real estate experience or expertise whatsoever. Mr Grovum found, to his dismay that the field of dealing in real estate is far more complicated than the mere ascertaining of interest rates for mortgages.

I felt that, in looking at all the documentation, memoranda, etc, filed by the appellant, there was a continued bona fide effort to save their investment, to endure in face of difficulties with the unrealistic hope that eventually they would overcome their temporary financial setbacks and acquire a building that would be self-sustaining as far as financing was concerned and end up being an income-producing venture.

For the above reasons, the appeal is allowed and I refer the matter back to the respondent for reconsideration and reassessment.

Appeal allowed.