Acro Developments Co Limited v. Minister of National Revenue, [1979] CTC 2839, 79 DTC 727

The Chairman:—This appeal of Aero Developments Co Limited is from income tax assessments dated May 1, 1975 and August 31,1976, in respect of the 1973 and 1974 taxation years respectively. For the 1973 taxation year the respondent added $461,143 to the appellant’s income and allowed a reserve of $301,582. He deducted from the appellant’s income the amount previously reported as a taxable capital gain. For the 1974 taxation year the respondent added to income the amount of $178,649 representing the mortgage reserve of $301,582 allowed in 1973, less the discount on the sale of the mortgage of $122,933.

Issue

The amounts in this appeal are not in dispute and the only issue to be determined for both taxation years is whether the profits derived from the sale of 7.25 acres of land is on capital or income account.

Facts

The appellant company was incorporated on August 2, 1969. Its shareholders were, at the pertinent time, Mr Arnold Kraag and a Mr Ray Lux—each holding 50% of the shares.

At the hearing only Mr Kraag gave evidence and, among other things, alleged that his was the dominant voice in the administration of the appellant company. Mr Lux, who had been a real estate salesman for Kelly & Kraag, was Stated to have been employed by the appellant company as well as by other related companies.

Mr Kraag, a civil engineer, came to Canada in 1950 and was employed as a real estate salesman. Subsequently, he acted as a real estate broker in the firm of Kelly & Kraag in which, for a time, he was the sole shareholder. During the period from 1953 to 1967, Mr Kraag was active in Oakville as a real estate broker operating in several fields: subdivision planning, land analyses, purchases and sales of land, and management of rental income properties. In 1960, he was engaged in the building and selling of single family houses—the raw land being purchased under the name of a development company, the houses being built under the name of a construction company and then being sold by Kelly & Kraag. In 1967, he became interested in high rise rental projects and built multiple dwellings in the form of apartment buildings and high rise apartments.

For the ease of operations, limited liability and minimum risks, it was Mr Kraag’s policy to incorporate separate companies for each project, thus a series of related corporations were created, all but one of which were engaged in real estate (Exhibit R-3).

Exhibit R-3:

401 LEASEHOLD LIMITED

Tax Information

December 31, 1976

Related Corporations— T2S(10)(a)(b)

Forster Properties Limited

Forster Construction Company Limited

Almic Associates Limited

Toroak Construction Limited

Acro Developments Company Limited

Forster Investments Co Limited

Forster Developments Limited

Forster Leasehold Limited

Forster Holdings Limited

Forster Homes Limited

Forster Building Corporation Limited

Forster Building Associates Limited

401 Leasehold Limited

The appellant company entered into an agreement of purchase and sale with Joseph and Bertha Kowal on December 22, 1970, for the acquisition by it of approximately seven acres of land in the Town of Burlington, Ontario, at a total price of $301,500 (Exhibit A-2).

The agreement provided that the transaction was to be completed on August 15, 1971, or at any time prior to that date at the option of the purchaser.

On August 20, 1971, by further agreement, the closing of the offer to purchase was extended to May 1, 1972, under specified conditions (Exhibit R-1).

On April 10, 1972, a third agreement was entered into by the parties to extend the closing date of the purchase and sale from May 1, 1972 of the previous agreement to July 1,1972 under additional conditions (Exhibit R-2).

At the time of entering into the first agreement of purchase and sale, the subject land was zoned “T-RL6”. Before the appellant could proceed with his alleged project of constructing for rental purposes some 135 townhouses, the transitional “T” affecting the zoning of the subject land had to be removed by an amending by-law. It was alleged that the extensions sought by the appellant and granted by the vendor were to provide sufficient time to have the Council of Burlington remove the transitional “T” by amending consolidated By-law No 4000-3 affecting the subject property. Mr Kraag alleges that prior to the appellant’s offer to purchase the land, he had consulted with Town Planners and the Town Manager of Burlington and had been informed that there would be no difficulty in removing the “T” from the official zoning. Indeed, the Planning Board in 1967 had advised the vendors, Mr and Mrs Kowal, that the Town was not interested in acquiring the subject land for park purposes and a study to amend the official plan recommended the development of a residential project on the property (Exhibit A-1, p 2).

However, in September of 1971, the Council advised the appellant company that applications to remove the “T” from T-RL6 zoned property would not be approved (Exhibit A-1, p 8). The matter was brought before the Ontario Municipal Board for a ruling at which were representatives of the appellant, the vendor, the Town of Burlington, and the “Save-the Lakeshore Association” which sought to use the land as a park. The Ontario Municipal Board recommended that the Municipality be ordered to pass a by-law removing the “T” from the subject land zoning. This decision of the Ontario Municipal Board was appealed the Lieutenant-Governor in Council by the Save-the-Lakeshore Association and opposed by the appellant company (Exhibit A-1). Counsel for the respondent objected to the filing of the exhibit on the ground that, although Exhibit A-1 may be proof that a petition had been filed with the Lieutenant-Governor in Council, it was not proof of the truth of the contents of that exhibit. The respondent’s objection was noted, but for purposes of these appeals it appears to me sufficient to establish that there did exist a series of time-consuming steps relative to the appellant’s application for a change in zoning of the subject property. Furthermore, the evidence given by Mr Kraag supports the pertinent evidence contained in Exhibit A-1.

The land was sold by the appellant in December of 1973 at a price of $950,000 and it is the profit realized on the sale of the land which is the subject matter of the present dispute.

The Appellant’s Contention

Counsel for the appellant contends that any alternative assumptions subsequently alleged by the respondent in argument, which are not contained in the reply, must be proven by the respondent. On the basis of the Minister’s reply, counsel suggests that the only onus the appellant has to meet is to establish to the satisfaction of the Board that the appellant purchased the property with the intention of developing it into an investment property.

In summarizing Mr Kraag’s evidence, counsel for the appellant admitted and classified his various real estate activities into three principal areas: the business of real estate broker, the business of purchasing land for development and sale, and the development of revenue-producing property to be retained as investment. He stated, however, that Mr Kraag never engaged in the purchase and sale of raw land but admitted that some properties had been purchased and sold after development. He referred particularly to the construction in 1967 by a sister company of the appellant of three high rise towers which had been developed as rental investment and managed as rental property. Financial pressure at a certain point in time forced the sale of two of the towers and the third was still held by Mr Kraag. Counsel for the appellant did not dispute any of the many transactions engaged in by Mr Kraag, under different corporate names referred to by the respondent in cross-examining Mr Kraag.

It was contended that the appellant company’s intention as reflected by Mr Kraag’s evidence, was to acquire the seven acres of land in Burlington for the purpose of constructing a substantial townhouse project for rental investment purposes. He suggests that Mr Kraag had, prior to signing the agreement of purchase, taken all reasonable measures to assure himself that there would be no difficulty in removing the “T” from the zoning that existed on the land at that time. Counsel stated that his hiring of engineers and architects, the wording and terms of the original purchase agreement and its subsequent extensions and all of Mr Kraag’s related actions are in keeping with his declared intention of having the appellant company acquire the land for the purpose of constructing a townhouse project as a rental income investment. He concludes that the sale of the property in 1973 was due to a contingency which could not have been reasonably foreseen at the time of signing the purchase agreement. The high cost of holding the property without knowing how long the Lieutenant-Governor in Council would require to render its decision on the petition forced the appellant to abandon his townhouse project and sell the property.

The Respondent's Contention

Counsel for the respondent, as a first step, contends that the appellant had, at the time of the purchase, what he termed a “flexible intention’’. He admits that the appellant might have had in mind the construction of townhouses but suggests that the appellant’s intention was flexible as to whether the townhouses were being built for rent or for resale. Again referring to the flexibility of the appellant’s intention, the respondent suggests that even though the appellant’s primary intention may have been to build townhouses, he had a very strong secondary intention of selling the land if the townhouse project could not be proceeded with.

Counsel referred to the long experience and the expertise of both Mr Kraag and Mr Lux in the field of real estate, which was admitted by the appellant, in dealing with the intention underlying the purchase by the appellant company of the subject land. Counsel raised the point that only Mr Kraag gave evidence and that the intention that Mr Lux may have had in having the appellant company purchase the land was never established.

Findings of Fact

Given the long experience of Mr Kraag in the field of real estate and the fact that he had engaged in the purchase and development of land for purposes of resale while also developing properties which were kept and are still being kept as investments, the Board must determine the appellant’s intention in purchasing the subject land largely on evidence which is directly related to the purchase and sale of the subject property.

On the basis of Mr Kraag’s testimony, and I was not given any valid reason to doubt his evidence, I accept that Mr Kraag, although owner of only a one half interest in the appellant company, was its motivating force and had the deciding voice in the company’s decisions.

Mr Kraag’s declared intention was that the land was purchased by the appellant for the purpose of building 135 townhouses to be kept as a rental producing investment. It is difficult, indeed if not impossible, to determine with any degree of certainty on the basis of the evidence adduced, whether the appellant intended to build the townhouses for rental purposes or for resale, particularly in the light of Mr Kraag’s prior activities. Mr Kraag’s declared intention of constructing the townhouses for rental purposes can neither be confirmed nor denied by the facts surrounding the transaction, and his declared statement of intention of building the townhouses for rental purposes, given under oath, must stand, if it is concluded that the land was purchased for the purpose of building townhouses.

The Minister’s reply to the notice of appeal reads in part:

5. In assessing the Appellant for tax with respect to the Appellant’s 1973 and 1974 taxation years, the Minister of National Revenue assumed that:

(a) the property was acquired for the purpose of trading or otherwise turning it to account by way of sale; and

(b) the profit realized by the Appellant on the sale of the property was income from a business or adventure in the nature of trade.

It is clear that the assessment was made on the assumption that the land was acquired for the purpose of trading. Paragraph 5(b) flows normally from paragraph 5(a). It does not, in my opinion, constitute an alternative pleading of a secondary intent.

In his cross-examination of Mr Kraag and in argument, counsel for the respondent interpreted the Minister’s assumption as referring to a “flexible intention” which encompassed not only the construction of townhouses for sale as opposed to rentals, with which I have already dealt, but also with a secondary intention of selling the property if the primary intention failed to materialize.

From the wording of the Minister’s assumption on which the assessment was based, it is difficult indeed to see any reference to an alternative pleading and even less to the assumption of a secondary intention. I was concerned when in argument the respondent obviously set out to establish the existence of a secondary intention without amending his reply. It seems obvious that if the respondent were generally permitted to introduce at the argument stage, no matter how subtly, assumptions of fact which are not clearly included in his reply, the usefulness of the Minister’s reply would be destroyed. The taxpayer would not know what he has to meet to sustain his appeal and the issue would not be properly joined.

The courts have repeatedly held that a secondary intention of turning acquired property to account to be considered as an assumption capable of affecting the assessment, must be proven to have existed in the mind of the taxpayer at the time of the acquisition, concurrently with some other declared intention, and must constitute one of the motivating factors in acquiring the property. Since they are based on different facts, it follows that a distinction must be made in the Minister’s pleadings between the assumption of a primary intention and that of a secondary intent.

I question the propriety in this appeal for the respondent to submit in argument that there existed a secondary intent when it is not included in the assumption on which the assessments were based. In this instance, the point, although sufficiently important to raise here, is of relatively little consequence since, on the basis of the evidence adduced in cross- examination, the respondent did not succeed in establishing to the satisfaction of the Board that the appellant had in his mind at the time of acquiring the subject land and as a motivating factor in its acquisition, the intention of selling the land at a profit if the primary intention failed to materialize.

I must therefore decide whether the appellant acquired the property for the purpose of building townhouses.

A quick summary of the facts is sufficient, in my opinion, to confirm the appellant’s declared intention. Mr Kraag, the spokesman for the appellant, was a credible witness and was unshaken in cross-examination. He readily admitted that he was experienced and knowledgeable in real estate and very much involved in the purchasing of land for development purposes, either for resale or as a rental income-producing investment.

Prior to acquiring the subject property, Mr Kraag knew that the property was zoned but had been informed by officers of the Municipal Planning Board that there would be no difficulty in removing the “T” from the zoning. The fact is that the Municipality had refused to acquire the subject land for park purposes in 1967 and appeared to favour a residential development (Exhibit A-1, p 2). Under the circumstances, Mr Kraag could reasonably expect that the zoning of the land would be amended.

Mr Kraag’s efforts in objecting to the Municipality’s decision not to amend the zoning by-law by applying to the Ontario Municipal Board, and his participation in opposing the appeal made by the Save-the-Lakeshore Association to the Lieutenant-Governor in Council, does not indicate the existence of a secondary intention of selling the land.

The wording of the agreement of purchase and sale and the extensions to the closing date of that agreement (Exhibit A-2, R-1 & R-2) are in keeping with the appellant’s intention of building townhouses. The inclusion of a partial discharge provision in the original agreement “for each lot or condominium townhouse unit’’ cannot, in my opinion, be accepted as tangible proof that the appellant’s intention was to sell the land as suggested by the respondent. The evidence was that such clauses were standard in such agreements of purchase and sale. It is also my understanding that partial discharges are also necessary if mortgage financing is to be obtained. The loan agreement between Lehndorff Management Limited and the appellant company for 1.2 million dollars dated October 3, 1972 (Exhibit A-3) refers specifically to the construction of a 135-unit townhouse project. The whole of the loan agreement, including the option (Exhibit A-3, p 5A, para 3.1) referred to by the respondent, has detailed references to the construction and management of the housing project. The option granted to the lender by the appellant does not necessarily indicate the appellant’s intention of selling the land. It could well be a form of guarantee of payment. The loan agreement, however, clearly confirms the appellant’s statement that the townhouses were to be built as a rental producing investment.

The retaining of architects, engineers and surveyors for preliminary work such as the site plan filed as Exhibit A-4, and the expenditures amounting to $34,082 in development costs for the years 1971, 1972 and 1973 (Exhibit A-5) which, except for the timing of the expenditures, are admitted by the respondent to have been incurred, have considerable weight in establishing that the appellant did intend to develop townhouses on the acquired land.

Mr Kraag could not have reasonably forseen the appeal to the Lieutenant- Governor in Council of the Ontario Municipal Board’s recommendation for amending the zoning of the appellant’s land, which he had valid reasons to believe would be amended by the Municipality very shortly after the purchase of the land. The delay of the Lieutenant-Governor in Council in ruling on the appeal and the high cost of holding the land, as indicated in the various agreements, was a valid reason for selling the property.

In conclusion, the evidence adduced is sufficient to establish to the satisfaction of the Board that the appellant acquired the land with the intention of developing it into a townhouse project. Mr Kraag, for the appellant, testified that the townhouses were to be built as a rental investment and there is nothing in the evidence which would warrant my setting aside that statement of Mr Kraag, given under oath. The sale of the land was forced by circumstances that had not been foreseen and could not have reasonably been foreseen at the time of the purchase. The respondent, if indeed it were open for him to do so, did not succeed in establishing that the appellant, at the time of the purchase, had a secondary intention of acquiring the land for purposes of resale or of otherwise turning it to account by way of sale.

Decision

For these reasons the appeal is allowed and the matter referred back to the Minister for reassessment of the appellant’s 1973 and 1974 taxation years on the basis that the profits realized in the disposition of the subject land in 1973 are in the nature of a capital gain.

Appeal allowed.