John Eldon Martin, George W Martin v. Minister of National Revenue, [1980] CTC 2043, 80 DTC 1052

Guy Tremblay:—This case was heard in Ottawa, Ontario, on December 6, 1978, on common evidence with the case of George W Martin (File No 77-346).

1. Point at Issue

According to the proceedings, the point is whether or not the appellant is correct in affirming that the fair market value of a parcel of land located in Ottawa and sold in February 1973 was $1,730,088. According to the respondent the fair market value on December 31, 1971, was $1,346,000 and the difference of $384,088 must be considered as interest and consequently as income for the appellant, despite the clause of the deed of sale to the effect that no interest was payable until the land had been developed, with then an interest of 8%. The respondent included an amount of $39,884.50 in the appellant’s income for the year 1974.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessment IS incorrect. This burden of proof results especially from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

However, the assessment in the present case is based under subsection 16(1) which requires that it is reasonable to consider a part of a payment as interest and include it in the income. This section is a charging section. Hence, if the evidence shows that there is doubt of the existing interest, the doubt must be interpreted in favour of the taxpayer.

3. Facts

3.01 The appellant and his brother, George W Martin, purchased for $40,000 in 1956 in fee simple as tenants in common 96.116 acres of real property composed of part of Lot 4, Concession 4, Rideau Front, in the City of Ottawa.

3.02 By an agreement dated on or about February 20,1973, (Exhibit A-3) the said parcel of land was sold by the taxpayer and his brother to Wesley M Nicol, a solicitor in trust and main shareholder of a building company. The agreed price was $18,000 per acre totalling $1,730,088 for the whole land.

3.03 On November 1972, the same purchaser had made another tender (Exhibit A-6), at the same price ($18,000 per acre), but with unacceptable conditions according to Mr Martin (page 33 of the transcript):

Well, he had a release clause in there which meant, amongst other things, that we weren’t satisfied with, that meant he could build along Albion Road, the front of our property, piece by piece, and then pay us acre by acre, and perhaps we would find ourselves blocked off, we couldn’t even get to the back of the farm. That is no good.

3.04 The terms of the second tender (Exhibit A-3) were considered as satisfactory. In sum, it was provided that:

(a) the mortgage became due and payable upon either (1) registration of a plan of subdivision, (2) sale of the land, or (3) issuance of a building permit;

(b) the mortgage contained a clause permitting prepayment of the principal amount at any time without notice or bonus or interest (except that interest would be payable after June 30, 1978, if the land was not then developed);

(c) no interest was payable on the mortgage unless the land was not developed in a manner to make the principal fall due (as set out in paragraph 6(a) above), in which case the mortgage was to be extended for two years with interest at the rate of 8% per annum;

(d) the purchaser was entitled to install services, remove topsoil, trees and buildings and carry out construction activities on the land notwithstanding that it was subject to the mortgage;

(e) the taxpayer and his brother were required to consent to registration of a plan of subdivision, and to execute all documents required in respect of installation of services and granting of development related easements.

3.05 In the first tender (Exhibit A-6) as in the signed agreement (Exhibit A-3) it was provided that “there shall be no interest payable on the said mortgage” except as stipulated in the signed agreement and summarized above.

3.06 The appellant never considered charging interest on the instalments that would be payable yearly (pp 35 and 36 of the transcript):

Q. Did you ever consider charging interest on the instalments that would be payable yearly?

A. Never. Our prime consideration was to sell to a reputable party, a builder perferably. We didn’t, you see, Mr Chairman, over the years when we were getting these phone calls and inquiries, this farm could have fallen into the hands of speculators, and it wasn’t meant to be. Mr Nicol was a builder, and he had, there was a 50% interest by Consumers’ Gas who had put this pipeline down Albion Road years ago. I mean, they were ready to go and develop that area, and they had a 50% interest in the purchase of this property, Mr Nicol representing his own interest.

Now, it was, in our estimate, a perfect sale, a builder and a utility company, ready to take off as soon as the plan would be available to go ahead and develop.

Q. But you made no demand for interest on these instalments?

A. No, none whatever.

Q. Could you reiterate what were all the reasons for not doing so?

A. For not having any interest clause? Well, it never, we didn’t think it was important. I told you what was important, to get a good buyer. Actually, the thought didn't cross our minds. We had what we wanted. We had a good buyer. There was a possibility of early development. South Keys, the village was filled. The only direction the community could spread would be to the east across Albion Road, and because of this, and because of the Income Tax Department’s making an issue of this, I think, I feel that it is, there is a moral issue at stake. We have a black mark against our name .. .

3.07 The appellant who had been retired since 1952, explained to the Board that before this year he and his brother had run a sawmill in Beauchesne, near Temiskaming, Quebec. He had then bought a timber limit and paid no interest. He had never before had any dealings with respect to buying land. He was a “neophyte” he said and knew nothing at all about real estate.

3.08 Concerning this question of interest, Mr York, the counsel of the appellant at the time of the sale of the subject property, testified the following facts (pp 63, 64 and 65 of the transcript):

Q. Did you ever discuss with Messrs Martin the aspect of interest or whether they should charge interest on the mortgage part of the transaction?

A. No, never any discussion, because this was part of the original agreement, that there would be no interest. They were quite happy and content with this. The agreement that was provided to me by Mr Nicol in February of 1973 provided for the annual payments of $100,000 on the anniversary date for four years, and the balance at the end of five years, and if he requested an extension by reason of the fact there was no development, then there was interest to run on that balance in the last two years only.

I might say that in my discussions with Mr Nicol he had anticipated very early development of the lands, and as I look back on it now I think that what had happened was that they got into a problem with the Green’s Creek collector sewer coming into the east end. Until that sewer was completed they couldn’t go ahead and get their plans of subdivision, and this was basically the reason for the delay of development.

Q. Now, Mr York, you say—you testified a substantial part of your practice comprises real estate and real estate law?

A. Yes.

Q. In your opinion, is it common to have non-interest bearing mortgages in transactions of the same nature of the kind . ..

A. Oh, very much so. I have one in mind at the present time where there is one mortgage for a million and something without interest; there is another mortgage of $2 million and something, without interest, both running on five to six-year terms, with annual payments only on account of principal. It is quite—a developer is not interested in paying interest; a developer wants to pay the lump sum payment annually.

Q. Now, with respect to the particular clause where interest is provided for if the balance of the mortgage is not paid in 1978, was that in the draft agreement of 1972 when it was forwarded to the Martins?

A. No, no. That was in the draft agreement that was sent to me by Mr Nicol in early February of 1973.

Q. So it was at Mr Nicol’s instance that that provision was in there?

A. Yes, very much so. I had no discussion with Mr Nicol after I called him following my consultation with the Martins on the original agreement to say we are not interested in bits and pieces, until this agreement was delivered to my office, in, it might have been February 10th, 11th, 12th—something like that—in 1973.

3.09 Concerning the price of $18,000 per acre the appellant had fixed it and he and his brother had a very short discussion about it with the purchaser (p 31 of the transcript):

Q. Did you ever negotiate price with Wesley Nicol when you were negotiating the sale of the farm?

A. Well, I don’t understand. How do you negotiate the sale without negotiating a price?

Q. No. I meant, did you haggle, in the local vernacular?

A. Oh, no. He tried to haggle. We were in his office, the second time we had seen him. Now, it was my third time. I’ve only seen him five times in my whole life; my brother, three times. The second time he had us in his office to negotiate the sale, and he was to draw up the agreement at the same time, and he said, “Now, I understand you want $18,000 an acre.”

Q. How did he know that?

A. Well, this was the price we had told him, and he said, “How about 17”, or I don’t know if he was going to say 17,500 or something like that, and my brother just got up and headed for the door. The price was 18, and that was it, so he called him back.

Q. Wes Nicol called your brother back?

A. Yeah, and that was it.

Q. And he agreed to your price of $18,000?

A. I said he was tough, and he knew it then.

Mr York, barrister and representative of the appellant in the agreement said in his testimony (p 63 of the transcript):

There was never any discussion, in my discussions with Mr Nicol, that it was less than $18,000. Mr Nicol had been advised by them it was $18,000 an acre; if it was less, don’t waste our time.

3.10 The appellant and his brother fixed the price at $18,000 on the following facts:

(a) In 1967, they had received a firm offer from a real estate company for $11,000;

(b) As a result of reading the newspapers (Globe and Mail, Ottawa Journal, Ottawa Citizen), it was evident to them at that time (pp 22 and 23 of the transcript);

that there was going to be a tremendous land development in Ottawa. The village, I suppose they call it, was South Keys, lying between Albion Road and Bank Street, in around the ’71 era was almost fully completed. That was a Campeau development.

And we had numerous calls from real estate people as to whether or not we were interested in selling.

Q. This is all around what year?

A. This is the early 70’s. My brother and I got regular calls from a concern called Marvin Greenberg, just like he had a monthly sheet on his calendar. He seemed to want to call at these intervals, and of course we did not want to sell.

(c) In cross-examination of the appellant, Mr Fortin, counsel for the respondent asked (p 43 of the transcript):

Q. Did you inquire about land prices, in other words prices that people were paying or asking for their land around your place?

A. We more or less relied upon newspaper reports and Minto Construction, for example, was looking out in Bell’s Corners I think back in ’69 or ’70, for $24,000 an acre; they settled for 17 /z, I believe. There were instances like that, that eventually was responsible for making our decision to sell at $18,000.

(d) The appellant explained that the City of Ottawa in 1969 and 1970 had a plan laid on, called Eastern Community of South Ottawa on the second floor of the City Hall. There was the soil test map (Exhibit A-5) and the plan of the whole area (Exhibit A-4). A letter dated September 25, 1970 was sent to the owners of the lands to invite them to a meeting.

The purpose of the meeting is to explain the development plan and to give an opportunity to the property owners within the development area and adjoining areas to express their views with respect to the proposal.

The subject property was part of the plan.

(e) In the soil test map, (Exhibit A-5) the test concerning Area E, (which is the subject property) reads as following:

AREA “E”

Slight to moderately increased foundation costs for low to medium dense light commercial and institutional, basementless and partial basement buildings.

Moderate to greatly increased foundation costs for low to medium density, light commercial and institutional, full basement buildings.

High density, heavy institutional and commercial, basementless to full basement buildings would require 30 to 50 ft piles.

Moderately increased costs for reads due to presence of frost acting soils.

Slightly to moderately increased costs for shallow underground services.

Bridges likely on piles 30 to 50 ft long.

Moderate to greatly increased costs for deep services.

The construction costs can be reduced significantly by lowering the groundwater say 6 to 10 ft with a storm drainage system.

Poor surface drainage.

Groundwater levels varied from 1 ft to 7 ft below present ground surface.

(f) The appellant in his testimony explained that in the middle sixties, his parcel of land, classified by the City of Ottawa as vacant land, was assessed at $100 per acre. In the early 1970’s they were assessed at $750 per acre “50% higher than the other” adjoining properties. (Mr Young: $100 pa; Campeau Corporation on Hawthorne Road: $500 pa; Laplante farm across Bank Street: $350 pa; Mr Patterson on Albion Road: $100 pa; Ottawa Hunt and Golf Club: $500 pa. In the township of Nepean and Gloucester, “it ran from $35 an acre to $150 an acre assessment”. The appellant explained he had this information from the assessment office in the City of Ottawa. The appellant also explained the reason for the fact that his firm was assessed higher than the others. We attributed this to the fact that the farm (appellant’s farm) (p 12 of the transcript):

abutted on Albion Road, and over the years the Consumers’ Gas people had installed their gas pipeline, the sewer was on Albion Road, the water pipes weredown Albion Road, the hydro had substations just across from the farm, just 66 feet away from the farm, and Bank Street had become a four-lane super road, and the Parkway was being built to the airport; the huge collector sewer running to Green’s Creek eastward had been constructed. I guess the city people just figured that with the services all available there it was worth this amount of assessment, and on top of that, of course, the land itself was A-1 prime farming land. There was a hogsback and sandy loam, and the soil test of 1969 showed that it was one of the better areas to be built upon in that vicinity.

I was present when the engineers were drilling out there, and they were a bit reluctant to show me any results. I guess all people that drill holes in the ground are. But I insisted, because I owned an interest in the property, and they showed me the cores, loam and some clay, and 20 feet below where they were drilling it was solid rock, and this apparently looked like it might have run in an east-west direction from the quarries over on McCarthy Raod.

So all in all, it was a very attractive property. In cross-examination, however, the appellant admitted that he had challenged the assessment of $750 before the court of revision. The court of revision reduced the assessment to $500.

(g) The appellant explained another point which set the price per acre at $18,000 (p 28 and 29 of the transcript):

A. What probably more than anything was the deciding factor in us setting the price on the farm was in the mid to late 60’s the Ontario Government offered lots to the general public in the Ottawa area—and mind you, they weren’t in the City of Ottawa; they were in the Township of Gloucester, in the Township of Nepean—and they called this, the Ontario Government called this plan the HOME plan, Home Ownership Made Easy plan. And I was able to go to both these locations and observe, before the lots were bid on by the—they weren’t bid on, they were selected—and I talked to the Ontario Government people and ascertained that in both cases, both in the Township of Gloucester and in the Township of Nepean, at Borden Farm and at North Beacon Hill, they had 4.38 lots to the acre; that is, after the road allowances were accounted for, playgrounds and parks and whatever else a developer has to set aside, and they were offering at North Beacon Hill these lots to the general public at $7,000, and it was first come first served.

And the people went a day or two before with their sleeping bags and tents; they all lined up; and they also told me that the servicing costs on those lots would amount to $3,000 in both cases, in Gloucester and Nepean. Now, this left the raw land value in the case of the Township of Gloucester at $4,000 for each lot. There were 4.38 of those to every acre set aside by the HOME people, and this brought this particular piece of land, the raw value, up to $17,500.

Now, because they were $500 more in the Township of Nepean, the raw land value amounted to $19,500, give or take a few dollars either way.

Now, at the same time they were selling them in Ottawa, around Ottawa—that was not in the City of Ottawa; that was on the outside. In Toronto they were asking $9,500, and I inquired and read about that, and the raw land value there was $29 V2 thousand per acre.

3.11 The respondent’s witness was Mr Rae McNamara, a real estate appraiser with Revenue Canada, and member of the Appraisal Institute of Canada. As Exhibit R-1, he presented an appraisal report and valuation analysis of the appellant’s parcel of land based on the market data approach. In this report, four sales are analyzed which can be summarized as follows:

3.12 Financing of each sales

The financing of each sale is as follows:

Sale Number 1

Financing: 106,566.66 due March 31, 1972 and 1973. Balance plus remaining interest

due March 31, 1974. Interest is at 8% per annum and is paid on March and September 31 of each year.

Sale Number 2

Financing: No interest until July 15, 1975 or a plan of subdivision is registered

whichever is earlier. Following this, interest is at 8% until July 15, 1980, termination date of mortgage.

Sale Number 3

Financing: $80,000 plus interest due March 1, 1974 to and including 1982—Interest 8 /2% per annum.

The purchaser of that parcel of land was Albion Real Estates Ltd, the same purchaser as the subject property.

Sale Number 4

Financing: $12,500 plus interest paid on February 1 and August 1 from 1974 to 1983 inclusively. Interest at 8% per annum.

3.13 After a comparative analysis of the appellant’s parcels of land and the 4 comparable sales, the appraiser arrives at the conclusion that the value of the subject’s parcels of land was $15,000 per acre on December 31, 1971.

3.14 Concerning the price of $18,000 per acre in 1973, the respondent’s counsel asked his witness the following questions (pp 80 to 81 of the transcript):

In other words, the price of $18,000 an acre, would you say that was a proper measure of the value of the property if one looks at the terms of that sale that took place?

A. I believe that’s correct, yes.

Q. What is in your view the acreage value?

A. Well, we didn’t undertake an appraisal in 1973, but if there is basically an arm’s length sale, and we have no reason to suspect that there is anything wrong with that particular sale, it is between two knowledgeable people, and the terms would meet the criteria of market sale and could probably be at market value.

However, the witness explained that when one has under his control virtually all the land needed for his project, then he would not be adverse to paying for the remaining properties a price higher than the market value. In such a case, he said that certain factors must be taken into account.

3.15 In his testimony, Mr McNamara explained that in the course of making the inquiry for his report, he asked the well-known builder Campeau: “Is this a common fact that sales do occur with non-interest bearing mortgages?” and the reply was that is is not unheard of, but it is not a common practice.

4. Law—Precendent Cases—Comments

4.1 Law

Subsection 16(1) of the Income Tax Act is the main section which the present case at bar involves. It reads as follows:

16.(1)Where a payment under a contract or other arrangement can reasonably be regarded as being in part a payment of interest or other payment of an income nature and in part a payment of a capital nature, the part of the payment that can reasonably be regarded as a payment of interest or other payment of an income nature shall, irrespective of when the contract or arrangement was made or the form or legal effect thereof, be included in computing the recipient’s income from property.

4.2 Precedent Cases

The parties referred to the following precedent cases;

1. David Friedman and Hyman Friedman v MNR, [1978] CTC 2809; 78 DTC 1599;

2. J Emile Groulx v MNR, 37 Tax ABC 1; 64 DTC 739;

3. MNR v J Emile Groulx, [1966] CTC 115; 66 DTC 5126;

4. J Emile Groulx v MNR, [1967] CTC 422; 67 DTC 5284;

5. André Baril and Dame Berthe Roy v MNR, [1957] Tax ABC 90; 57 DTC 222;

6. Wilfred R Carter v MNR, [1964] Tax ABC 174; 65 DTC 31;

7. Vanwest Logging Co Ltd v MNR, [1971] CTC 199; 71 DTC 5120;

8. Rodmon Construction Inc v Her Majesty the Queen, [1975] CTC 73; 75 DTC 5038.

4.3 Comments

4.3.1 Mr Martin’s credibility

The Board has the same opinion as the respondent’s counsel, Mr Fortin, concerning the credibility of Mr Martin. Mr Fortin said at the beginning of his argument “I would like to say at the outset that nothing turns on credibility of Mr Martin or his brother.”

4.3.2 Subsection 16(1) and Commercial Reality

The main and above condition provided by subsection 16(1) is to consider a part payment as interest when it is reasonable to arrive at such conclusion. In order to reach a decision one must look at the commercial realities of the situation, Walsh J in the Vanwest Logging Co Ltd case, (supra) (explains the criteria which must be considered to surround the commercial realities of the situation):

In order to reach a decision in the present case, based on the foregoing jurisprudence and in particular the judgment in the Groulx case (supra) it is evident that it will be necessary not only to look at the terms of the agreement reached between the parties, but also the course of the negotiations between them leading to it, to the relationship of the price paid to the apparant market value of the property at the time, and the common practice with respect to payment of interest on the sale of timber limits in order to reach a conclusion of fact on the question of whether it can reasonably be inferred that the instalment payments on account of the price contained an element of interest, or were entirely of a capital nature, as appellant claims.

4.3.3 Intention to avoid taxation

It is the Board’s opinion that it is not sufficient for the appellant to prove that he did not intend to avoid taxation in not providing interest to reverse the burden of proof.

Subsection 16(1) is not a section of Part XVI where tax evasion is provided. In that case the subjective aspect (intention) would be the most important.

Subsection 16(1) is a section of Part I. Hence the objective facts related to the commercial transaction must be considered first. If those objective facts reveal that it is reasonable that interest be a part payment, then it would be sufficient to make an assessment. However, if there is a reasonable doubt of the application of subsection 16(1), ie (that “a payment under a contract can reasonably be regarded as being in part a payment of interest”) it must be interpreted in favour of the appellant. Subsection 16(1) indeed is a charging section.

4.3.4 First Criterion: The terms agreement

The terms of the 1973 agreement (Exhibit A-3) are clear: there is no interest except as explained in paragraph 3.03 of the Facts. There are neither interest in the former agreement drafted in November 1972 (Exhibit A-6) (see paragraph 3.05 of the Facts).

4.3.5 Second Criterion: Negotiation between parties

The uncontradicted facts summarized in paragraphs 3.06, 3.07 and 3.08 of the facts speak by themselves. The interest between parties nor with the appellant nor with his then counsel Mr York was never discussed.

According to the evidence the basic motive of the appellant was to sell the subject’s parcels of land to a serious purchaser (see par 3.06).

4.3.6 Third Criterion: Fair Market Value

The aims of the respondent’s evidence was to demonstrate that the fair market value of the subject’s parcels of land in February 1973 was less than $18,000 per acre. In his appraisal report, Mr McNamara defined the market value as: “the amount that the property might be expected to realize if sold on the open market by a willing seller to a willing buyer, neither buyer nor seller acting under compulsion, both having full knowledge of the uses and purposes to which the property is adapted and for which it is capable of being used, and both exercising intelligent judgment”.

The conclusion of the report was that the fair market value of the subject’s parcels of land on December 31,1971 was $15,000 per acre, even if two comparable sales were made in July, 1973. Concerning the value in February 1973, the Board refers to the testimony of Mr McNamara quoted in paragraph 3.14 of the facts.

As the two parties are at arm’s length and they meet the conditions of the definition given above, it seems clear that the price of $18,000 per acre is the fair market value. However, at quite the same time in April 1973, the same purchaser, Albion Road Estates, bought the adjoining parcel (157 acres) for $12,000 according to Mr McNamara (Sale No 3) (see paragraph 3.12 of the facts) per acre. The parties are still at arm’s length; the parties meet the above given definition of the fair market value. Is the price of $12,000 per acre also the fair market value? Mr McNamara, the valuator of the main witness of the respondent, said the amount of $18,000 per acre paid for the subject property “could probably be at market value’’ (see paragraph 3.14). In trying to find a logical explanation of that question, the Board thinks that the personality of both parties undoubtedly influenced the price and conditions of agreement and consequently the fair market value. So in two different transactions, even if the parcels of land are adjacent, it is possible to have different prices which are fair market values. However, the financing of property of Sale No 3 included an interest of 8% % per annum. Concerning that point, however, the evidence is to the effect that in transactions of that nature it is not unheard of, even if it is not common practice, for a sale to be without interest (see paragraphs 3.08 and 3.14). The examination of the evidence leads the Board to the conclusion that the amount of $18,000 per acre was the fair market value, and consequently it is unreasonable to presume that there was a part payment of interest.

5. Conclusion

The appeal is allowed and the matter is referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeal allowed.