Dartmouth Developments LTD v. Minister of National Revenue, [1979] CTC 2611, 79 DTC 545

M J Bonner:—This is an appeal from assessments of income tax for the appellant’s 1970 to 1973 taxation years inclusive. By these assessments the respondent treated as income amounts described as net revenue from the sales of certain residential building lots. The sales were made as a result of the exercise, by tenants of the lots, of options to purchase contained in their leases.

It was the appellant’s position that, although the lots were initially inventory or stock and trade of its business, there was a change in use or conversion of those lots to fixed capital assets as each lot was leased.

The parties filed an Agreed Statement of Facts as follows:

AGREED STATEMENT OF FACTS

The parties hereto, by their solicitors, admit the following facts, provided that the admission is made for the purposes of this appeal only and provided further that the parties may adduce further and other evidence relevant to the issues and not inconsistent with this agreement.

1. The appellant was incorporated on January 17,1962, under the laws of the Province of Manitoba, for the purpose of carrying on the general business of land assembly and development, which business it, in fact, did carry on from the year of its incorporation through to the end of its 1973 taxation year.

2. The appellant acquired acreage by land assembly located in the then City of Transcona (now part of Metropolitan Winnipeg), registered plans for subdivision in relation to the acreage, installed streets, sewers, pavement and other local improvements and between 1962 and 1968 had on hand for sale and/or lease 1098 serviced residential lots in a sub-division known as ‘Kensington Square’.

3. Of the total number of serviced residential lots, 869 were sold outright.

4. In the years 1962 to 1968, both inclusive, the appellant leased under 50 year land leases a total of 229 serviced residential lots as follows:

1962 — 3

1963 — 81

1964 — 41

1965 — 52

1966 — 37

1967 — 2

1968 — 13

229

5. In each instance the terms of the ground lease giving rise to the leasehold provided, inter alia:

(a) the ground rent was fixed at a set annual amount for the full 50 year term;

(b) the leasehold tenant was granted an irrevocable option to purchase the serviced residential lot leased thereunder at a fixed price set at the outset of the lease at any time during the term of the ground lease (ie 50 years);

(c) at the end of the term (ie 50 years), if the leasehold tenant has not exercised his purchase option, the leasehold rights expire, and any buildings built on the serviced residential lot leased thereunder become the property of the landlord.

The form of such ground lease is annexed as Schedule ‘A’.

6. The aforesaid ground leases were all registered in the Winnipeg Land Titles Office resulting in the issuance of certificates of leasehold title for each leased serviced residential lot.

7. The initial lease in each instance was entered into between the appellant as lessor and Metropolitan Construction Ltd as lessee, which built a house on each leased lot. When the house was sold to a home buyer, Metropolitan Construction Ltd assigned its interest in the lease to the home buyer.

8. Single family residences have been erected on each of the 229 leased serviced residential lots, the cost of the construction of which has been financed by loans from Central Mortgage and Housing Corporation (CMHC) upon the security, inter alia, of a real property mortgage registered against the leasehold title and assumed by each homeowner. In protection of its secured position, CMHC collects from each leasehold tenant, its mortgagor, (in addition to principal, interest and real property taxes) the annual ground rent due under such tenant’s ground lease and remits the same to the landlord (the appellant).

9. Each ground lease is freely assignable by the tenant (including the tenant’s option to purchase the serviced residential lot leased to him and/or her by the appellant) during the term thereof, and the tenant’s leasehold title is, similarly, freely transferable to subsequent purchasers of the residence erected on the said serviced lot.

10. The appellant, throughout the course of this development treated all revenue produced by sales of the serviced residential lots referred to in paragraph 3 herein as income and reported it as such and paid tax thereon.

11. Insofar as the leaseholds are concerned, in each instance the appellant removed the lots in question from inventory and transferred them to its capital account and carried them on its books as a capitalized fixed asset from the time of lease to the present date.

12. From the date of leasing to the present time and specifically during the years under assessment, all ground rents paid to the appellant by the ground lease tenants have been treated as income, reported as income and the tax thereon paid.

13. From the date that the serviced residential lots were ready for leasing, to the end of 1973, the last year under assessment six leasehold tenants (of the aforesaid total of 229) had exercised their purchase option as follows:

1970 — 2

1971 — 1

1972 — 1

1973 — 2

6

14. To the date of the hearing of this appeal 22 further leasehold tenants (out of the remaining total of 223) have exercised their purchase options as follows:

1974 — 8

1975 — 1

1976 — 5

1977 — 2

1978 — 6

22

15. The appellant, upon the exercise of their purchase options by ground lease tenants, treated the revenue therefrom as capital gains on the sales of capital assets.

16. By Notices of Assessment, all dated December 23, 1974, the appellant was reassessed by the respondent with respect to its aforesaid capital gain treatment of the net revenue it received upon the exercise of their purchase options by ground lease tenants by the addition of the following respective amounts, being the net proceeds of the lot purchases so made during the respective taxation years:

	Number of Lot	Net Proceeds Added
Taxation	Purchase Options	to Appellant’s
Year	Exercised	Taxable Income
1970	2	$7,121.42
1971	1	3,569.00
1972	1	3,400.00
1973	2	7,405.00

17. By Notices of Objection filed on June 25, 1975, the appellant objected to the said assessments.

18. On April 18, 1977, the respondent notified the appellant that it had confirmed the assessments for the 1970, 1971, 1972 and 1973 taxation years.

I have not reproduced the form of the ground lease in these reasons. Its terms, so far as they are relevant, are sufficiently described in the Agreed Statement of Facts.

In addition to the Agreed Statement of Facts, evidence was given by Abraham L Simkin, who was president of the appellant from its inception to the mid-1970’s. Mr Simkin’s evidence was that the appellant was incorporated to develop, under unified ownership, certain raw lands owned in part by one of the appellant’s shareholders and in part by the other shareholder. Development involved the steps outlined in paragraph 2 of the Agreed Statement of Facts. The resulting subdivision was known as Kensington Park.

In the beginning sale of the residential lots was contemplated. Leasing was not. An agreement was formed between the appellant and Metropolitan Homes Ltd (hereinafter called “Metropolitan”) for the sale by the appellant to Metropolitan of all of the lots. Leasing of some of the lots was a plan which developed later.

Miles Robinson was the principal of Metropolitan, and indirectly of one of two companies, each of which held half of the issued shares of the appellant. He sought ways of broadening the market for the homes built by Metropolitan. The plan involving the leasing of lots to Metropolitan was designed to make housing affordable to persons who would be unable to qualify for a mortgage loan of the size required in the case of outright purchase of house and land. After considering Mr Robinson’s proposal that Metropolitan be permitted to take lots by lease, the appellant agreed to lease not more than one-third of the lots in Kensington Park. Mr Simkin explained that the appellant had to invest funds to support the carrying of the leased lots. It was for that reason that the one-third limitation was imposed.

The appellant regarded leasing as an attractive investment proposal. At that time the rate of return on very secure investments such as NHA mortgages and government bonds was approximately 6%. On analysis of the leasing program the appellant concluded that it would earn an annual return by way of rent of 10 to 11V2 % if the return was calculated on the cost of the land leased. As a practical matter, payment of the rent was very well secured. The appellant’s reversion stood in priority to the CMHC mortgages. The mortgagee collected the rent from the lessee and paid the rent to the appellant annually in advance.

The rents were fixed by negotiation with CMHC. CMHC did not dictate what the rents would be, but took the position that if it found the rents to be excessive it would capitalize the excess and reduce the amount of the maximum mortgage loan available.

Mr Simkin stated that the most controversial term imposed by CMHC was the option provision which enabled the purchaser to buy the reversion, at any time during the 50 year term of the lease, at a fixed price. That price was the amount for which the lot would have sold if it had been sold at the time the lease was entered into.

The leasing program came to an end in 1968 when it became financially less attractive to the appellant. The appellant has made no effort to Stimulate the exercise of the options to purchase. The development of Kensington Park continued through 1972. At that time, because the market had become soft, some lots were sold to a company other than Metropolitan.

No evidence was adduced which elaborated on the facts set forth in paragraph 11 of the Agreed Statement of Facts. The manner in which the net proceeds referred to in paragraph 16 of the Agreement Statement of Facts was calculated was not explained.

The appellant’s counsel argued that when each lot was leased it was converted from inventory to a fixed asset. He submitted that each lot became, when leased, a part of the profit-yielding structure of the business, produc- ing a fixed annual rent for a term up to 50 years. The appellant put the power to sell the leased lots out of its hands for a full 50 year period, except on the exercise of the option. Payment of the rent was a virtual certainty. The annual return was very high. The lots, he said, were superb investments.

The respondent’s counsel argued that the leases were entered into as part of the appellant’s business and as part of a larger scheme for the sale, by Metropolitan, of the lots with buildings on them. He pointed out that Metropolitan and the appellant were interrelated because one shareholder was common to both, and the leasing scheme was entered into to help Metropolitan sell more houses. I do not think that the scope of the appellant’s business can be regarded as enlarged to include the business of Metropolitan simply because the man who owned all of the issued shares of Metropolitan also owned all of the issued shares of a company which held 50 percent of the shares of the appellant. Moreover, the evidence of Mr Simkin made it quite clear that the appellant decided to agree to Metropolitan’s leasing scheme on the basis of considerations related only to the financial welfare of the appellant.

The position of the appellant was based on the premise that it had two businesses, common to both of which was the operation of producing serviced lots. In one case the lots were sold forthwith. In the other they were leased and sold only as a result of the exercise by the lessee of his option. Counsel for the appellant referred to the following passage from the Reasons for Judgment of P H Maguire, DJ, in Her Majesty the Queen v Edmund Peachey Limited, [1978] CTC 606 at p 609; 78 DIC 6411 at 6414, and he argued that the act of entry into the leases was an act demonstrating a “definite change in position”:

The decision of Jackett, CJ, in Les Entreprises Chelsea Limitée v Minister of National Revenue, [1970] CTC 598; 70 DTC 6379, is of importance on one point, in my consideration of the issue here involved.

Jackett, CJ, states:

In my view, where one finds such a business, as long as there continues to be land of the original inventory of the business on the ownership of the company, it is reasonable to assume that the business has not been brought to an end in the absence of some evidence that something has been done to bring the business to an end, as, for example, where the corporation takes the land out of the business and dedicates it to the creation of some structure to be used as the capital asset of another business.

This example is undoubtedly only one of possibly several acts which can be interpreted as showing a definite change of position following which land so acquired can be deemed to have become a capital asset. It, however, requires some positive step or act to effect such change. No such step or act is found here.

The entry into the leasing scheme was not, in my view, a step which brought the appellant’s business to an end, nor did it mark the commencement of a new business separate and distinct from the one then existing. Viewed in perspective it was simply a step in the evolution of the existing business. It was one taken to accommodate, in a manner and to the extent acceptable to the appellant, a request made by a customer and it involved nothing more than an alternative scheme for the disposition of part of the stock in trade of the appellant’s business. The leasing program and the sale program operated concurrently. There was one business, the development of raw land and the disposition of serviced lots, by one or the other of two alternative means.

I can see no meaningful distinction between the appellant’s position and that of the appellants in The Gloucester Railway Carriage and Wagon Co Ltd v The Commissioners of Inland Revenue, 12 TC 720, and Canadian Kodak Sales Limited v MNR, [1954] CTC 375; 54 DTC 1194.

In the former case the appellant was a dealer in rolling stock, some of which it manufactured and some of which it purchased. For a period the rolling stock was in part sold and in part hired to the appellant’s customers. Subsequently, when it became advantageous to do so, the appellant sold the stock which had previously been hired. The appellant contended that the profit on such sales was a capital increment. Lord Dunedin, in delivering the unanimous judgment of the House of Lords, stated at p 748:

Now as regards the original profit when the wagon was entered with a calculated sum added to its cost on it, tax would automatically be charged in the year’s accounts, as it would enter in the revenue account as kept as profit on work done. But when in the long run on a sale a wagon which had been charged at a fictitious price—for it being all one business no money really passed—realised more than that price as it stood after depreciation and had been subtracted, then I think it is evident that the sum, being the difference between the sum realised and the sum as entered, minus depreciation, is just extra profit on which so far no tax has been levied.

The appellants argue that this is really a capital increment; and to say so they call these wagons plant of the hiring business. I am of the opinion that in calling them plant they really beg the whole question. The Commissioners have found—and I think it is the fact—that there was here one business. A wagon is none the less sold as an incident of the business of buying and selling because in the meantime before sold it has been utilized by being hired out. There is no Similarity whatever between these wagons and plant in the proper sense, eg, machinery, or between them and investments, the sale of which plant or investments at a price greater than that at which they had been acquired would be capital increment and not an item of income. I think that the appeal fails.

I indicated previously that paragraphs 11 and 16 of the Agreed Statement of Facts were not explained further during the evidence. I assume that the transfers in the appellant’s accounts were made either at cost or at figures less than those used in the calculation of net proceeds referred to in paragraph 16. The appellant was represented by a very able counsel who did not raise any alternative argument that the gains, if income, were wrongly computed. He did not suggest that the whole or any part of the gain on a lot, if on revenue account, was realized when the lease was entered into and not when the option was exercised.

The facts in the Kodak case are fully summarized in the headnote. At pp 379 and 380 Thorson, P, after rejecting arguments similar in substance to those advanced by the present appellant, stated:

On the contrary, I agree with the argument put forward by counsel for the respondent. He contended that the appellant was organized to be the selling instrument in Canada of the products of the Eastman Kodak Company, that its recor- daks were not fundamentally different in principle from the wide range of cameras and photographic equipment and supplies sold by it, that the decision to sell the recordaks was a business decision made for business reasons to increase the appellant’s sales and to increase its profits, that from the time of this decision the appellant was in the business of selling recordaks and that its profit therefrom was a profit from its business and taxable income within the meaning of the Act.

I need only add that nothing in the decision of the Federal Court in Her Majesty the Queen v Ball Brothers Limited, [1976] CTC 793; 77 DTC 5004, can have any bearing on the outcome of the present appeal. The issue in that case was whether the grant by the defendant, a building contractor, of an option to a lessee permitting the purchase by it of real property acquired by the defendant with a view to entry into the lease established that the defendant’s intention at the time of acquisition was to turn the property to account by sale. In the present case it was common ground that the lots were, prior to entry into the leases, the stock in trade of the appellant’s business.

The appeal must therefore be dismissed.

Appeal dismissed.