Bell T.CJ.:
Issue: (L10/R5154/T0/BT0) test_marked_paragraph_end (436) 1.000 0530_7615_7743
This appeal concerns the Appellant’s 1989, 1990 and 1991 taxation years. The issue is whether shares of Lloyd Investments Ltd. (“LIL”) disposed of by the Appellant in his 1989 taxation year were “qualified small business corporation” shares within the meaning of subsection 110.6(1) of the Income Tax Act (“Act”) at the date of disposition . If they were, the Appellant would be entitled to a capital gains deduction under subsection 110.6(2.1)
Facts: (L10/R5140/T0/BT0) test_marked_paragraph_end (292) 1.081 0531_1719_1849
The Appellant had been in the real estate industry for approximately forty years and had been involved in the business of real property administration and management. He is a licensed real estate broker and property manager holding a Real Property Administrator designation (R.P.A.). He had purchased a number of older properties in Regina, Saskatchewan and had refurbished them and developed them into commercial buildings. He is a member of the Builders, Owners and Managers Association (BOMA) and has been a director and president of that organization.
In 1979 LIL purchased the Boulevard Plaza shopping centre in Beaconsfield, Quebec. It was a new project and not yet completed and was sold by the owners who wished to leave that province. It consisted of 32,000 square feet in two connected buildings and a free standing McDonald’s restaurant. LIL finished the shopping centre and, through the services of the Appellant, entered into leases with the tenants it procured. The Appellant described LIL’s activities as leasing and supervising construction. He testified that he had negotiated with the tenants, that he looked after the deficiencies in construction and dealt with neighbours who had complaints about the shopping centre and its activities. He said that he prepared all working drawings for tenants’ space except for one tenant who had its own designer, that he had to change the demising walls and ceilings for air condition purposes and that he supervised all sub-trades working on the centre. He gave evidence about repairing cracks in the paving lot, cleaning the parking lot, testing sprinklers frequently, cleaning fencing, staining wood and tending to flower beds. He said that he was responsible for co-ordinating all of these and other activities. He also testified that he regularly spoke to the tenants to be sure that they were satisfied, that he had a great deal of work in the leasing area and had ongoing problems with Hydro Quebec, et cetera. Appellant’s counsel entered approximately one thousand documents in evidence having to do with administrative matters. The Appellant testified that these were less than ten percent of the records of the company.
The Appellant also testified that LIL had never managed other properties and that after he had become sole owner of LIL it had earned no money other than rental revenue. Although its income source was described in its relevant financial statements as “rental and management fees” it was clear from direct and cross-examination of the Appellant that almost all of LIL’s income was rent.
Analysis and Conclusion: (L18/R3584/T0/BT0) test_linespace (316>256.00) 1.023 0532_1671_1805
Subsection 110(2.1) allows a deduction from a taxpayer’s capital gain from the disposition of shares. These shares are defined in subsection 110.6(1) as being, inter alia, shares of the capital stock of a “small business corporation” [s. 110.6(l)(«)] more than 50% of the fair market value of the assets of which are attributable to assets used in an active business [s. 110.6(l)(c)(i)].
The term “small business corporation” is defined in subsection 110.6(1) of the Act as:
“Small business corporation”; at any particular time, means, a particular corporation that is a Canadian-controlled private corporation all or substantially all of the fair market value of the assets of which at that time is attributable to assets that were
(a) used in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it, ... (italics added)
The term “active business” is also defined in subsection 110.6(1) of the Act as:
“active business”, in relation to any business carried on by a taxpayer resident in Canada, means any business carried on by the taxpayer other than a specified investment business or a personal services business; (italics added)
A “specified investment business” is defined in paragraph 125(7)(c) as follows:
“specified investment business” carried on by a corporation in a taxation year means a business (other than a business carried on by a credit union or a business of leasing property other than real property) the principal purpose of which is to derive income from property (including interest, dividends, rents or royalties), unless
(i) the corporation employs in the business throughout the year more than five full-time employees, or
(11) in the course of carrying on an active business, any other corporation associated with it provides managerial, administrative, financial, maintenance or other similar services to the corporation in the year and the corporation could reasonably be expected to require more than five full-time employees if those services had not been provided; [Emphasis added.]
In order for the shares to qualify as qualified small business corporation shares, the corporation must not be engaged in a specified investment business. Since LIL did not employ more than five people, the only matter in issue is whether or not the principal purpose of LIL was to derive income from property (including interest, dividends, rents or royalties).
Counsel for the Appellant considered paragraph 125(7)(c) and noted that it contained the expression “income from property”. Counsel submitted that the use of this expression was significant for two reasons. First, the term “income from property” has a long legislative and jurisprudential history and it must be presumed that if Parliament had wished to depart from the accepted meaning of the term, it would have used clear language to do so. Second, the parenthetical clause, “including interest, dividends, rents or royalties”, was not added with the intent of making a substantive change to the original provision which referred only to “income from property”. Counsel’s basic point was that since Parliament had used the very well understood tax concept “income from property”, it intended that the meaning which had been ascribed to that term in the jurisprudence should be reflected in paragraph 125(7)(e).
However, paragraph 125(7)(e) does not refer to “income from property” alone. It refers to a business the principal purpose of which is to derive income from property. The jurisprudence distinguishing income from business and income from property is of little or no assistance here. Paragraph 125(7)(e) sets up an entirely new test, namely, whether the principal purpose of the business is to derive income from property.
It appears that counsel’s position that because of the inclusion of the term “income from property” in the definition of specified investment business that term was not capable of an ordinary meaning interpretation. He submitted that it was necessary to analyze the purpose of the pertinent legislation in order to explain what type of business would be a specified investment business. He said that the meaning of that term is found by examining the intention of Parliament in enacting section 129. It contains the refundable dividend tax on hand (“RDTOH”) mechanism constituting part of the Act's integration rules. Subsection 129(4.1) deems income from a specified investment business to be Canadian investment income for the purposes of section 129. Counsel contended that the RDTOH provisions were designed to provide a measure of integration to avoid double taxation of portfolio investments in Canada. He submitted that since specified investment businesses are afforded the benefit of the RDTOH rules and since these rules were designed to prevent double taxation of portfolio investments, therefore income from a specified investment business must be equivalent to income from portfolio investments. He submitted that, since portfolio investments represent passive accretions to wealth, a specified investment business must be a business producing passive income. Counsel then pointed to the substantial activity, as evidenced by the number of exhibits, conducted by the Appellant to support his contention that LIL did not earn passive income and, therefore, its activities were not a specified investment business.
Counsel provided no support for his assumption that the RDTOH provisions were implemented to avoid the double taxation of portfolio investments alone. The RDTOH provisions apply to the corporation’s entire investment income, not only the portfolio element of that income. It seems more probable that Parliament’s intention in including a corporation’s income from a “specified investment business” as part of that corporation’s investment income is that it had decided that income from a business which meets the criteria in paragraph 125(7)(e), no matter how arbitrary, should not be treated as active business income.
Counsel then cited a series of cases which pre-dated the introduction of a “specified investment business” and which dealt with the issue of whether the income was from business or from property and which did not consider the revised meaning of “active business income”. Appellant’s counsel sought to apply the income from business versus income from property test instead of dealing directly with the test provided by the definition of specified investment business. That test is whether the principal purpose of LIL’s business was to derive income from property (including interest, dividends, rents or royalties).
Judge Bowman considered the meaning of “principal purpose” in Prosperous Investments Ltd. v. Minister of National Revenue, (sub nom. Sinclair v. Minister of National Revenue) [1992] 1 C.T.C. 2218, (sub nom. Ed Sinclair Construction & Supplies Ltd. v. Minister of National Revenue) 92 D.T.C. 1163 at page 2221 (D.T.C. 1165).
... the sole question is whether the “principal purpose” of its business was to derive income from property. At first blush the section would appear to contain a contradiction in terms if one regards the two sources of income, business and property, as mutually exclusive (see, for example, Wertman v. M.N.R., 64 D.T.C. 5158; Walsh and Micay v. M.N.R., 65 D.T.C. 5923 [5293]). They are, however, not mutually exclusive. It is obvious that an individual or a corporation can actively engage in a business whose sources of revenue such as interest or rentals are property. This is implicit in paragraph 125(6)(/i) and is consistent with the decision of the Supreme Court of Canada in Canadian Marconi Company v. Her Majesty the Queen, 86 D.T.C. 2526[6526].
In determining the “principal purpose” of a business carried on by a corporation the stated object of the person who carries it on is not necessarily the only, or even the most important, criterion. Of critical importance is what the corporation in fact does and what its sources of income are.
Judge Bowman proceeded to analyze the taxpayer’s financial statements in which he noted that the mortgage receivables and rent items made up well over fifty percent of the value of the company’s assets. Furthermore, the principal portion of the revenues of the taxpayer was derived from rentals and interest and by far the preponderant part of the corporation’s capital was devoted to rental properties and mortgages. His Honour concluded at page 2222 (D.T.C. 1166):
Accordingly, I conclude that the principal purpose of the business of Prosperous Investments insofar as it related to interest and rentals was to derive income from property. Mr. Sinclair argued that the company carried on an active business with respect to the rental properties and mortgages that it held. I would agree with him were it not for the exclusion of these sources of income in the definition of active business.
LIL’s financial statements show that real property rentals represented almost all of the corporation’s revenue. Further, its only significant asset was Boulevard shopping centre, the rental property.
Appellant’s counsel has made the same argument as appears to have been made in Ed Sinclair Construction, namely, that the corporation carried on the active business of property management, a portion of the revenues of this business being income from rent. As held in that case, this argument might be accepted were it not for the exclusion of such income from the definition of active business income.
It is my conclusion that the principal purpose of LIL’s business was to derive income from property and that it therefore carried on a specified investment business. Accordingly since LIL’s business was not an active business, it was not a small business corporation. The result is that the shares of LIL were not qualified small business corporation shares when disposed of in 1989 and that the Appellant is not entitled to the capital gains deduction sought.
The appeal is dismissed with costs to the Respondent.
Appeal dismissed.
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