Stephen R Harper, Thomas S Kelleher v. Minister of National Revenue, [1980] CTC 2300, [1980] DTC 1257

Guy Tremblay:—This case was heard in common evidence with the case of Thomas S Kelleher (77-1287) at the City of Toronto, Ontario, on June 27, 1979. The case was taken under advisement after the written submissions were received on November 2, 1979.

1. Point at Issue

The problem is whether the appellant is correct in considering as non- taxable or at least taxable as a capital gain, the profit from a transfer of a property made in 1973, which property bought in 1971 is located in the City of Kitchener, Ontario. The contention of the respondent is that the transfer is a sale, and that the profit must be considered as income because it was derived from land speculation.

2. Burden of Proof

The burden is on the appellant to show that the respondent’s assessment is incorrect. This burden of proof results specifically 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.

3. The Facts

3.01 At all material times relevant to this appeal, the appellant was a lawyer practising in the City of Kitchener in the law firm known as Harper, Villemaire, Nowak, Kelleher, Bryson.

3.02 By an agreement of purchase and sale dated March 8, 1971, (Exhibit A-2) the appellant and T S Kelleher agreed to purchase the properties from John and Anne Taylor for $63,000 (land: $25,000; building: $38,000).

3.03 This agreement was completed four days later by a deed dated March 12,1971, and registered on March 16,1971, as Instrument Number 443390 in the Registry Office for the Registry Division of Waterloo North (no 58). The appellant and T S Kelleher, a partner in the law firm, acquired in partnership property interest in a building and certain lands composed of part of lot number 12 and part of lot number 13 on the south side of King Street East.

3.04 The lands were acquired by the appellant and T S Kelleher, for a consideration of $63,000 subject to adjustments, and at the same time, a first mortgage with the Toronto-Dominion Bank, King and Frederick Branch, for $48,000 was registered.

3.05 The appellant and T S Kelleher paid approximately a total sum of $16,000 cash on the purchase of the said lands, monies which had been borrowed from the aforementioned bank.

3.06 The subject property, was leased to one Mr Oberlerchner. The tenant was in the florist business, but had prospective plans to put a discotheque in the rear of the building and boutiques in the front part of the building. This concept, however, was new in the area. The lease was for one year at a rental fee of $1,200 per month. Mr Kelleher, however, had prepared a 10-year lease, but after discussion the partners arrived at the conclusion that a one- year lease was better in the circumstances. There was an agreement about the lease before the purchase of the subject property, although the actual rental fee was arrived at only after the acquisition of the subject property.

3.07 Within approximately ten or twelve months after the purchase of the Subject property, the said Mr Oberlerchner went bankrupt thereby interrupting the tenancy.

3.08 Mr Kelleher, co-owner of the said property, was an employee of the appellant’s firm and Mr Oberlerchner was not only a tenant in florist business, but the appellant’s client who participated in the acquisition of the property. On pages 8, 9, 19 and 20 Mr Kelleher testified about that and about the circumstances surrounding the acquisition of the subject property. Because of the importance of those circumstances, it is necessary to quote the testimony.

At p 19, Mr Kelleher states:

The only thing that was in my mind when acquiring the property was I was employed by this firm for approximately ten months. I knew Mr Harper had a reputation for being a good commercial lawyer. My name had been put on the letterhead of the firm and quite frankly, the senior partner of the firm was asking me to enter into a commercial situation with him and to be very candid about it, I felt it was within my own best interests to do so. I was concerned at the time because I recently graduated from the bar admission course. I had significant debts at the time and I think this goes to answer another issue that has been raised by the Crown and that is why no personal funds were used for a downpayment.

At p 20 of the transcript:

THE CHAIRMAN: Were you an active partner or a silent partner in the association?

THE WITNESS: I was not a partner at all in the firm at that time.

THE CHAIRMAN: But in the association, in the purchase of the property. I mean all the time you were the owner of the property.

THE WITNESS: Neither one of us was an active participant in the acquisition of the property to the extent of locating a property. Mr Oberlerchner did that. We only took part in arranging the financing at the bank which they went along with and attending at the closing of the transaction. That is the only participation we had with respect to this property whatsoever.

I am not certain, but I don’t think Mr Harper saw the property before we closed it.

On pp 8 and 9, Mr Kelleher gave more explanations concerning the participation of Mr Oberlerchner and the circumstances surrounding the immediate acquisition of property:

MR HARPER: Q. Now then Mr Chairman, with respect to (g), 6(g) (of the respondent reply), the Reply suggests that after the purchase of the lands, Mr Kelleher and myself agreed to lease the lands to one Ronald Oberlerchner and I would like to ask Mr Kelleher to elaborate on the point of whether after is in fact an accurate point.

A. No, that is not correct, Mr Chairman. As I recall the facts, Mr Oberlerchner had been a long time client of Mr Harper and prior to the acquisition of this property, he was actively seeking properties in various parts of the city to carry on a business as his previous business had been expropriated for a highway and he approached Mr Harper and discussed this matter with him. Subsequently he tried to obtain various properties and was not able to arrange financing on his own. He approached Mr Harper and asked him if he would assist with the situation. Mr Harper then approached me and I was an employed lawyer at the time. I had been with the firm approximately ten months and the position he put to me at the time, that is, Mr Harper, was that this client wanted Mr Harper to either assist him in financing or in fact purchase a building and lease it to Mr Oberlerchner for his business.

There was an agreement to that and the understanding was that Mr Oberlerchner was to search around and find an appropriate building and by that I mean we had no choice in the sense that we were not out actively looking for a location. Mr Oberlerchner picked it. We did not. Mr Harper had no or I had no part in that.

Q. The point, Mr Kelleher, that I think is pertinent is—

A. The agreement to lease took place before.

Q. The agreement to lease the property took place before the property was purchased.

3.09 The subject property was located on the easterly side of Kitchener.

3.10 Two months after the acquisition of the subject property, the local newspaper, the Kitchener-Waterloo Record on June 25, 1971 (Exhibit A-1) published the news of a commercial development located on the westerly side of Kitchener in the downtown area of the City, known as the Eaton’s Market Square. In fact, the plan was to sell Kitchener City Hall and replace the market building for a $15 million office and commercial development. 3.11 In their testimony, the appellants and Mr Kelleher affirmed that the plans of the said development were not known to them and that they were even secret.

3.12 In an article, however, (Exhibit A-1) written in Kitchener-Waterloo Record on June 25,1971 and entitled “Public” ‘not kept out of city plans’ ”’ it is written:

Citizens of Kitchener have not been shut out of urban renewal discussions as some critics of a $15 million downtown development claim.

“It has not just been council meeting in secret. It has been a citizens’ urban renewal committee meeting as well,” William Thomson, Kitchener planning director, said today.

The said committee had been formed 9 years before. Fifty citizens had been chosen to be members of that committee in view to formulate an urban renewal plan for downtown Kitchener. “They represent the two universities, the church, real estate, developers, all the news media, city council and the planning board.” The plan was approved at an Ontario Municipal Board hearing. It was a public hearing and only one citizen appeared to protest.

3.13 After the departure of Mr Oberlerchner as tenant, the appellants tried without success to rent the building during the next two years. The evidence is clear that they did not try to sell, but to rent. They spent substantial money to maintain the building for rent, and to find a tenant who would be able to carry out the prospective plans of Mr Oberlerchner. When the financing of the subject property became necessary the mortgagee, Heller-Natofin Canada Limited required, because the building was vacant and unrented, additional securities for the contemplated mortgage financing.

To facilitate the financing it was decided by the appellants to transfer in November 1973 the subject property to Tartan Securities Limited, an Ontario provincial company, in which each appellant held 25% of the issued shares. This company owned land as well as mortgages, chattels and other investments. The mortgage took as additional security other assets of Tartan Securities Limited. According to the appellant, the transfer was made for $185,00 (transcript p 98). It seems that the transfer was not done by deed. Indeed, no exhibit was filed about that transfer. As the circumstances of that transfer are important, it is necessary to quote the testimonies (transcript pp 21, 30, 31 and 32).

At p 21, Mr Kellehner states:

The transfer to Tartan Securities was to facilitate the financing and to put it perhaps a little more strongly, was that the demand of the bank at that stage that something be done. So we looked around for various sources of funding and we came up with a mortgage that although perhaps looking at it today I might not take. We had no choice. There was a large finder’s fee involved and we had payments, but there was a question where we simply had no choice.

At pp 30, 31 and 32 it reads as follows:

THE CHAIRMAN: Just a question before you continue. Before you sold the said property in 1977, the company owned it?

MR HARPER: Tartan Securities Limited owned it and it was never transferred.

THE CHAIRMAN: And Mr Dixon had 50% interest in it?

MR HARPER: Mr Dixon and presumably Mr Kelleher. I no longer had anything to do with Tartan Securities.

MR KELLEHER: It has always been an understanding between Mr Dixon, Mr Harper and myself when Mr Harper was involved with this particular property would not affect Mr Dixon in any way whatsoever and in 1977 when the property was sold, that was still the case. We are attempting to work out a way for me to isolate him from that transaction and as far as the company is concerned because our attitude was initially and still is today that that particular property has nothing whatsoever to do with our company. It was transferred there as a favour to Mr Harper and myself to help us finance the difficulty we were in at the time and to pay off our debts and the agreement then and now was that Mr Dixon or Tartan Securities if you will will not be affected by it in any way whatsoever.

THE CHAIRMAN: There was not a written settlement between Mr Dixon at that time or a verbal settlement?

MR KELLEHER: It has not been settled. There are still chartered accountants trying to figure out what has to be done because initially, I think as Mr Harper indicated, we felt since it was only a transfer for that purpose, we shouldn't even have to file capital gains, but our then accountants told us we should do that and in essence caused the problem down the trail because of the subsequent sale.

3.14 Both parties agreed that in the month of December 1971, the fair market value of the property was appraised at $151,700. It was also proven that before the purchase, the appellants retained the firm of Snider, Huget and March, a firm of engineers and architects in the City of Kitchener to report on the condition of the building. The report was to the effect that the building was extremely sound, was of steel and concrete construction and the boiler was in good working condition.

3.15 Mr and Mrs Taylor, who sold the subject property to the appellant in 1971, had bought it 16 years before at $58,000 (transcript, p 98). They wanted to retire to Florida and decided to sell the property. It had been for sale for six or eight months before being purchased by the appellant for $63,000. The appellant thought it was worth $150,000 at that time. “I thought we got the buy of the century” he said in his testimony.

3.16 After the refinancing by Tartan, the appellants continued without success their efforts to rent. They also spent a substantial amount of money to maintain the property and kept it in good condition to meet the requirements of the lenders. Finally, the building was sold in 1977 for $150,000.

3.17 In subparagraphs (I) and (m) of the reply to the notice of appeal, the respondent alleged:

(i) at all times material to this appeal, the Appellant had been an active and experienced trader in real estate, and thereafter has actively carried on the business of buying and selling for a profit;

(m) at all times material to this appeal, and thereafter, the Appellants was involved in the corporate operations and real property dealings of several companies, some of which are the following:

(i) J C Contractors Limited;

(ii) Manatee Properties Ltd;

(iii) Proman Properties Ltd;

(iv) 267495 Ontario Limited;

(v) Upper Canada Investments Incorporated;

(vi) Conestoga Overseas Investments;

(vii) Conestoga Overseas Investments Incorporated;

(viii) International Holdings Incorporated.

3.18 In his testimony (on p 99 of the transcript) the appellant testified about the allegations of subparagraph (I) of the reply to the notice of appeal:

MR KERR: Q. When you purchased, you indicated you hired an architect and an engineer.

A. That’s right.

Q. Did you retain a qualified real estate appraiser?

A. No

Q. So you were basing your decision that you got a bargain on your own knowledge of real estate values in the area at the time?

A. That’s right. I had been a lawyer there for a number of years.

Q. And were involved in real estate for a number of years?

A. I think for a lot of people, yes.

3.19 Concerning the allegations of subparagraph (m) of the reply to the notice of appeal, the evidence given by the appellant was to be the effect that:

(a) the appellant was the solicitor of J C Contractors Limited but was not a shareholder and had no interest in that company (transcript p 41);

(b) the appellant owned 50% of the shares of Manatee Properties Ltd, an investment company incorporated in 1974. (This company has never bought and sold properties). The appellant is the president. Another shareholder is Jerry Cybalski who is the main shareholder of J C Contractors Limited (transcript p 42);

(c) Proman Properties Ltd is a half-owned subsidiary of Manatee Properties Ltd. Incorporated in 1975, Proman is in the land development business, ie purchase and development of lands for sale to house builders (transcript pp 43 and 44);

(d) 267495 Ontario Limited was incorporated in 1974 or 1975 for the specific purpose of developing a subdivision in the City of Waterloo. It is now defunct. Proman Properties Limited owned 52% of the said company, Jerry Cybalski 16%, the appellant 16%, and Mr George Ellis 16%;

(e) The Upper Canada Investments (owned by the appellant 50% and Mr Cybalski 50%) was incorporated in 1974 or 1975 for the purpose of investments in the State of Florida. It went bankrupt. It held certain options on properties which were transferrd to Conestoga Overseas Investments Incorporated, its creditor (transcript pp 45, 46 and 51);

(f) the appellant owns 5% of the stock of Conestoga Overseas Investments Incorporated which was incorporated in 1974 or 1975. The object of this corporation was to purchase and sell a motel. Nineteen other people (among them Messrs Cybalski and Ellis) are the other shareholders. Some are from the Maritime Provinces. The options transferred from Upper Canada Investments Incorporated were on land located in Braeton, a city north of Sarasota in the State of Florida;

(g) the company, Conestoga Overseas Investments Incorporated is different from Conestoga Overseas Investments, which was owned by the appellant and Mr Cybalski. It purchased property in Manatee County, Florida for $603,900 in 1972 and sold it seven months later in the Fall of 1972 for one million dollars to Conestoga Overseas Investments Incorporated. Six months later, it was resold for $1,755,000, after the vendor ceased to carry on business (transcript pp 50 to 54), to a Dr Golub of New York City. The purchaser defaulted on his mortgage. All of the shareholders of the seller, Conestoga Overseas Investments Incorporated, effectively lost a portion of their investment;

(h) International Holdings Incorporated (which appears in subparagraph m), viii of the reply to the notice of appeal, quoted above) must be changed to Intercontinental Holdings Limited. It owns the Goldengate Motel in Florida. The appellant was not a shareholder of that company which went bankrupt in 1976;

(i) the appellant has financial interests in 39 Weber Street East Limited which owns the office building where the appellant’s law office is located. The building was sold to a lawyer, Sidney Burnstein. The charter of the company was surrendered (transcript pp 57 and 58);

(j) the appellant is also a shareholder in Contemporary Developments which owns the premises at 82 Weber Street East in Kitchener, Ontario, the present office of the appellant. This company also owns shares in Tri- Dimensional Holdings Limited which is the owner of a vacant property in Waterloo, Ontario, purchased in 1976 (transcript p 59);

(k) the appellant also has interests in Little Five Limited (which involved in limited dividend apartment buildings) and in Cable Head Estates Limited incorporated in 1976 which owns a farm in Prince Edward Island (transcript p 60);

(l) before 1972 the appellant was also a co-owner of three apartment buildings in Woodstock, Ontario. They were sold after the Income Tax Act was amended (transcript p 61). The other co-owner was one of his former partners, a Mr Villemaire;

(m) in 1968 or 1969, the appellant also held a partnership in Delhar Enterprises Limited which developed a residential subdivision in the east end of Kitchener, Ontario. It bought undeveloped land, subdivided and serviced it and sold the lots (transcript p 62);

(n) in addition to owning a cottage and a personal home, the appellant owns a property at Sunset Street in Kitchener, Ontario;

(o) in the early seventies, he also owned a few small apartment buildings in Kitchener.

3.20 On the advice of his accountants, the appellant considered the transfer of the property to Tartan as a sale and the profit of $61,000 ($185,000 - $63,000 = $122,000; Harper $61,000; Kelleher $61,000) as a capital gain.

Such capital gain was declared in the presonal return of the appellant filed for the taxation year 1973 and a reserve for the same amount was claimed as deduction. During the year 1974, the mortgage was fully paid. The appellant included the capital gain in his income.

3.21 By notice of reassessment dated June 28, 1976, for the taxation year 1974, the respondent, considering the profit of the transaction as a commercial income, made the following adjustments:

Add: Reserve claimed against the sale of

the King Street property	$61,000
Less: Taxable capital gains reported	8,325
	$52,675

4. Law—Precedent Cases—Comments

4.1 Law

The main sections of the Income Tax Act involved in the present case are sections 3, 4, 9 and 248. They will be quoted if necessary.

4.2 Precedent cases

The parties referred to the following cases:

1. California Copper Syndicate v Harris, [1904] 5 TC 159;

2. Irrigation Industries Ltd v MNR, [1962] CTC 215; 62 DTC 1131;

3. Harmony Investments Ltd v MNR, 32 TAX ABC 421; 63 DTC 638;

4. Aidershot Shopping Plaza Ltd v MNR, [1965] CTC 31; 64 DTC 151;

5. Paul Racine, Amédée Demers and François Nolin v MNR, [1965] CTC 150; 65 DTC 5098;

6. Robert D Tate et al v The Queen, [1974] CTC 731; 74 DTC 6559;

7. Mastino Developments Ltd v The Queen, [1975] CTC 529; 75 DTC 5353.

4.3 Comments

Two questions are involved in the present case.

ls the transfer to Tartan a real transaction and hence a taxable transaction?

If that question is answered in the affirmative, the other question is: Is the profit a capital gain or an income?

4.3.1 Is the transfer to Tartan a real transaction?

Important facts, given in the evidence, are in favour of a negative answer to the question: the transfer was a favour to the appellants, and hence Mr Dixon (the main shareholder) and Tartan should not have been and in fact were not affected by the transfer. Tartan only helped give a more secure financial background. It seems Tartan did not spend money to pay the mortgage; the appellant and Mr Kelleher paid everything. However, in the Board’s opinion, the appellant did not reverse the burden of proof. No written deed between the appellant and Tartan was filed as an exhibit, and the deed of the sale of the property in 1977 also would have been necessary. If the appellant was sincere in his contention, the testimony of Mr Dixon and also the filing of the financial statements of Tartan would have been useful. The Board cannot say the conclusion it would have arrived at, but it would have been in a better position to make a decision.

With the evidence adduced before it, the Board concludes that the transfer must be considered as a real transaction, indeed as a Sale to Tartan and technically done at arms-length, under section 85 of the Income Tax Act and at the fair market value of $185,000 as adduced by the evidence. Under the said section 85, it would have been possible for the appellant to transfer the property at a lower price, and hence avoid taxation, but according to the evidence, he chose to transfer it at the fair market value. Maybe this choice was done so that Tartan would not be affected by the transaction. Maybe it could be an element in favour of the appellant’s thesis that the transfer to Tartan is not a real transaction. However, with the evidence adduced, the transfer must be considered as a real transaction with a profit of $12,000.

4.3.2 Is the profit a capital gain or an income?

4.3.2.1 The major factors given by the courts or “badges of trade” given by the Royal Commission on taxation to determine whether a profit is a capital gain or a business income, are well known: (1) intention, (2) the relation of transaction to the taxpayer’s business, (3) nature of transaction and assets involved, (4) the length of the period of ownership, (5) the frequency of Similar transactions, (6) the circumstances that surround realisation, (7) the corporation objects.

The evidence in the present case mainly concerns the following factors: intention, relation of transaction to taxpayers’ business and circumstances surrounding the acquisition and the realisation of the subject property.

4.3.2.2 The appellants clearly affirm that their intention was to keep the Subject property and rent it. For them it was an investment.

On one hand, the Board at first glance has no reason to doubt the credibility of the appellant and the credibility of his associate, Mr Kelleher. On the other hand, if the Board in a case of that nature is bound by the word of the appellant concerning his original intention, the conclusion would be all the the same: capital gain. Other factors must be considered and especially the circumstances surrounding the acquisition of the property. They are described in detail in paragraphs 3.02 to 3.08.

4.3.2.3 The appellant and Mr Kelleher purchased the property in good faith even if they “were not out actively looking for a location” and left the responsibility for finding a property to Mr Oberlerchner. In fact, the building was examined before the purchase by a firm of engineers and architects who found the building extremely sound and solid (par 3.14).

The fact that the associates borrowed money from the bank to pay the first account of $16,000 cannot be an element against them. The evidence was that Mr Kelleher had no money. As he refused to let Mr Harper lend him the money he had to borrow the $16,000 from the bank. It seems to the Board, that this indicates good business ethics on the part of the employee, Mr Kelleher, and for Mr Harper, it was also a good business principle to borrow the money from the bank to purchase the property rather than to use his own money, since the interest is deductible. In the Board’s opinion, the one- year lease to Mr Oberlerchner was prudent considering the prospective plans of the tenant (par 3.06). However, if the said prospective plans, (known by the appellant before the purchase) had materialized the investment would have proven a good one.

The evidence indeed is to the effect that during the two years after the bankruptcy of the tenant, the appellant tried not to sell the property, but to find somebody who would be able to succeed where the first tenant had gone bankrupt. It was difficult to keep the property and they had to refinance it. According to the evidence, efforts were made to carry out Mr Oberlerchner’s prospective plans. After the refinancing, however, it seems that the commercial developments on the westerly side of Kitchener had no great influcence on the easterly side where the subject property was located. Six years after the start of the said development, the subject property which had a fair market value of $151,500 in December 1971 was sold for $150,000.

4.3.2.4 Maybe the appellant and his associates thought the development in the west would be an incentive to develop the east. They testified, however, they did not know the development was coming. The Board takes into consideration the declaration quoted in part in paragraph 3.12 and made by Mr William Thomson, Kitchener planning director concerning the fact that the public was mostly unaware of future city plans.

As is written at the beginning of the article, Mr Thomson made the declaration in order to rebut criticism from the public. Hence it is clear, that even if the municipal council formed a 50-member Citizens’ Committee in 1962, and even if one citizen appeared at the Ontario Municipal Board hearing to protest, the general public were probably unaware of the project. The Board cannot conclude that the appellants knew of the future development because the municipal council had met all the legal requirements concerning publicity. The appellants testified they did not know of the future development; the Board believes them. In any way, this development in western part of Kitchener did not influence the development in eastern part of Kitchener.

4.3.2.5 The last and not the least factor in the case at bar is the relation between the subject’s transaction and the appellant’s business, specifically his participation in the twelve companies and partnerships described in paragraph 3.19. Some are investment companies (as the one involved in the purchase and sale of a motel), but others (Proman Properties Ltd, 267495 Ontario Limited, Delhar Enterprises Limited, etc) have been involved in land development business since 1968. He has also purchased and sold buildings many times. The profits were then probably considered as capital gain.

At first glance, upon considering the different aspects of the case, it is very difficult not to arrive at the conclusion that the appellant’s intention was to purchase and sell at the first opportunity, but other evidence shows that this is a very special case.

On one hand, it is true that the subject property was by itself a potential investment. Moreover, if the prospective plans had materialized, the property would have become a commercial center. These prospective plans along with the report of the engineers and architects concerning the building and its low price (‘‘the buy of the century’ par 3.15) certainly influenced the decision of the appellant to purchase the property.

The evidence indicates that from the end of 1971 to 1977 the owners of the property did not make a cent from it. The evidence shows that during all that time he tried only to rent it. If the appellant had bought the property to sell at the first opportunity, he would have sold it before 1977.

It is true that, following my decision above (par 4.3.1) he sold it to Tartan. Special circumstances, however, obliged him to sell (or transfer) it to Tartan. Finally, taking into account those special circumstances, the Board concludes that the profit must be considered as a capital gain despite the importance of the commercial background of the appellant.

The Board, however, believes that even if the conclusion had been different for the appellant (ie if the Board had declared the profit from the sale as income and not as a Capital gain) the conclusion for the co-appellant, Mr Kelleher would have been that the profit was a capital gain in a sense.

Mr Kelleher, indeed, according to the evidence had no particular connection with property business. Moreover, the Board does not think that Mr Kelleher was a silent partner. Before the purchase, he discussed with Mr Harper the possibility of borrowing money from the bank and gained his point. He also discussed the lease with Mr Harper, and Mr Harper convinced him that borrowing from the bank would be preferable.

The evidence is not to the effect that Mr Harper alone tried to rent the building after the bankruptcy of the first tenant. On the contrary, both had made efforts to do so.

5. Conclusion

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

Appeal allowed.