Combined Appraisers and Consultants Co LTD v. Minister of National Revenue, [1979] CTC 2970, 79 DTC 770

Delmer E Taylor [TRANSLATION]:—This is an appeal heard in the City of St John’s Newfoundland, on July 13, 1979, against an income tax assessment in which the Minister of National Revenue disallowed an amount of $7,618.09 claimed by the taxpayer as a rental loss in the year 1975. In assessing the appellant, the respondent relied, inter alia, on paragraph 20(1)(a) of the Income Tax Act, SC 1970-71-72, c 63 and subsections 1100(11) and 1100(12) of the Income Tax Regulations thereunder.

Background

The appellant (hereinafter referred to as the “Company’ or “Combined”) is a corporation under the laws of the Province of Newfoundland which earned income during the year in question from real estate appraisals, property rentals and property sales.

Contentions

The position of the appellant in the notice of appeal was as follows:

.. .(I) have prepared the attached revenue analysis for the years 1972 to 1976. As can be seen from this analysis, the construction component has consistently eclipsed the appraisal component to the extent that in June 1976 we could in fact state that Combined Appraisers was a construction company which did appraisals rather than the reverse. That this was evident can be seen from the decision by Mr Kirkland to incorporate a separate company, Craftsman Homes Ltd, effective June 1976. This decision was taken prior to your review.

The main problem appeas to be in 1975 when $150,271 of construction, at cost, was transferred to rental properties. This was done because of poor market conditions at the time rather than to create a base of rental property and one of these houses was subsequently sold in 1976. The type of transfer from work-in-process to rental property as occurred in 1975 would seem to be the logic behind the exemption to construction companies as it allows them to soften some of the effects of market slowdowns in that section of the economy.

For the respondent, in earlier correspondence, the issue was summarized as follows:

With regard to the loss for 1975 from real estate rentals of $7,618.09, which was created by capital cost allowance on Class 6 assets, your contention is that this IS a valid charge against business income by virtue of Regulation 1100(12). That regulation applies where a corporation’s principal business was leasing, rental, development, sale, or any combination thereof. In resolving the question of what is the principal business of a company, consideration has to be given to the following:—

(1) Degree of activity

—Time spent by employees on various activities

—Size of sources of income

(2) Degree of net profit

In 1975, the company sold two houses and capitalized four others. The six houses were constructed by the company at a cost of approximately $250,000. All the work (with the exception of Mr Kirkland’s time) was done by outside contractors on a contract basis. The contribution to net profit from the construction and real estate rental operation would be small, considering the rental operation showed a loss, $7,618.09, and the real estate operation showed a gross ratio of approximately $50,000 (which is overstated because of omissions in opening inventory) before allocating any expenses.

For the same year, 1975, the company earned appraisal fees of $112,000. Two appraisers were employed in addition to Mr Kirkland, plus one steno who typed the appraisal reports. The majority of the net revenue reported for the year appears to have been generated from this source.

The above data indicates to us that appraisals formed the principal business of the company in the light of the considerations which should be made (ie degree of activity and degree of net profit). A comparison of gross revenue which you have submitted with your letter of September 20,1976, is not a conclusive test in view of the fact you are comparing units selling for $40,000 to $50,000 each with services generating about $100 for each appraisal.

And from the reply to the notice of appeal:

the principal business of the appellant corporation during the 1975 taxation year was real estate appraising;

in the 1975 taxation year the appellant was not a corporation whose principal business was the leasing, rental, development or sale, or any combination thereof, of real property owned by it.

Evidence

The Board was provided with financial statements of the corporation and during testimony for the appellant by the Company president Mr G Kirkland and by Mr Thomas P Conway, a chartered accountant, several additional documents were filed by the appellant, of which the following are significant and reproduced:

COMBINED APPRAISERS AND CONSULTANTS COMPANY LTD INCOME STATEMENT

FOR THE YEAR ENDED JUNE 16, 1975

Construction Rentals Appraisals Total Total

& others

Revenues (net)	$96,121		$ 12,198	$112,023	$220,342
Cost of Goods Sold		45,368	—	—	45,368
Gross Margin	$50,753		$ 12,198	$112,023	$174,974
Operating Expenses
Salaries & wages	$	700	$	$31,686	$32,386
Director’s wages	23,994		7,500	19,006	50,500
Supplementary wage costs		205	—	1,026	1,231
Advertising		—	294	178	472
Interest & bank charges		(147)	5,879	(167)	5,565
Account & audit		1,550	190	1,760	3,500
Membership fees		100	—	352	452
Stationery & postage		—	—	3,885	3,885
Rent		198	—	1,782	1,980
Telephone, heat & light		139	641	1,252	2,032
Travel entertainment			—	7,324	7,324
Travel & entertainment		—
Repairs & maintenance		68	—	615	683
Municipal taxes		9	1,436	82	1,527
Depreciation		1,501	11,458	1,601	14,560
Vehicle operating		338	—	3,045	3,383
Miscellaneous		141	108	1,272	1,521
Bad debts		—	—	225	225
Donations		15	—	135	150
Equipment rental		43	—	385	428
	28,854		27,506	75,444	131,804
Contribution to Net Income	$21,899		$(15,308)	$36,579	$ 43,170

COMBINED APPRAISERS AND CONSULTANTS COMPANY LTD Notes re Distribution of 1975 Income Statement

1. Salaries and wages. 10% of Mrs O’Neil’s salary (7,000) charged to construction two appraisers charged to appraisals. Distribution of office staff and expenses has been on the basis /w construction and 90% appraisals as the value of the office work tends to support this distribution.

2. Directors’ wages. George Kirkland 55.8% (using man hours spent on construction) charged to construction. Mary Kirkland charged to rentals as she arranged all rentals with prospective tenants.

3. Supplementary wage costs. /6 charted to construction.

4. Advertising. None charged to construction as there were no construction ads. Rentals had specific ads.

5. Interest & bank charges. Mortgages interest charged to rentals. Other interest net of interest income and distributed on the basis of gross revenues.

6. Accounting & audit fee distributed on the basis of gross revenues.

7. Membership fees. $100 for HUDAC—balance to appraisals.

8. Stationery & postage. All distributed to appraisals, negligible amount required for other two areas.

9. Rent. Distributed as for office salaries /io - /io.

10. Telephone. Distributed as for office salaries /io - /io. Heat and light—specific for rentals.

11. Travel & entertainment. All charged to appraisals, none specific to others.

12. Repairs and maintenance. /io - /io.

13. Municipal taxes— general. /w- /io, rentals are specific.

14. Depreciation. Rentals as per housing. Construction /io of depreciation on office equipment $58, 55.8% of motor vehicle $1,357 and 100% of contractors’ moveable equipment $86 ($150).

15. Vehicle operating, miscellaneous, donations and equipment rental, /io- /w.

16. Bad debts. All to appraisals as no receivables for construction.

COMBINATION APPRAISERS & CONSULTANTS CO LTD DATA RE TAX APPEAL

Percent of Revenue per Business

Construction	Rent		Appraisals	Other	Total
1972	—	—	45.8	54.2	100.0
1973	75.6	—	24.4	—	100.0
1974	63.4	—	35.7	.9	100.0
1975	66.5	3.3	29.9	0.3	100.0
(includes 150,271 transferred to rentals)
1976	69.3	3.6	26.5	0.6	100.0
1977	36.6	13.7	44.4	5.3	100.0
(includes sales by Craftsman Homes)
1978	41.2	9.1	48.4	1.3	100.0
(includes sales by Craftsman Homes)
1979	72.8	5.5	19.4	2.3	100.0

(includes Empire)

Percent of Assets Employed
1972			100.0		100.0
1973	65.6	—	34.4	-	100.0
1974	59.6	—	40.4		100.0
1975	39.1	51.7	9.2		100.0
1976	8.1	64.3	27.6		100.0
1977	33.4	48.8	17.8		100.0
(includes Craftsman)
1978	33.0	42.4	24.6		100.0
(includes Craftsman)
1979	25.0	72.3	2.7		100.0
(includes Empire)

Argument

Counsel for the appellant summarized the main points to be compared and contrasted between the two elements of the business conducted by Combined. The president Mr Kirkland proceeded shortly after the year under review to segregate these elements of his various operations through the incorporation of other companies. Minor reference was made to jurisprudence in which the appellant’s case could find support.

Counsel for the respondent reviewed the many aspects of the operations which had been covered at the hearing upon which the Board could readily reach a conclusion that the principal business of Combined in 1975 at least had remained the appraisal work. The following case law was referred to the Board:

American Metal Company of Canada Limited v MNR, [1952] CTC 502; 52 DTC 1180;

Dillman Oil Properties Ltd v MNR, 40 Tax ABC 17; 66 DTC 2;

MNR v Consolidated Mogul Mines Limited, [1968] CTC 429; 68 DTC 5284;

Sogemines Development Company Limited v MNR, [1972] CTC 284; 72 DTC 6254;

MWA Gas and Oil Limited v MNR, [1974] CTC 140; 74 DTC 6123.

Findings

Mr Conway’s major evidence in Exhibits A-12 and A-17 referenced above should be viewed in the light of comments made by the Board in The Canada Trust Company v MNR, [1979] CTC 2199; 79 DTC 177. It was indicated in that decision that such statistical information serves only a limited purpose as noted:

At pp 2209 and 185 respectively:

In my view, Regulation 1100(4) cannot be dealt with on purely mathematical grounds. Rather, the relevant wording of Regulation 1100(4) might be interpreted to ask the question: ‘What was the principal purpose of the building during the year?’. In the instant case, that question can be made even more specific: ‘Would the building have been constructed solely rental purposes, with no consideration given to its use to house the local office and (possibly) the head of office operations?’

AT pp 2209 and 185 respectively:

A brief review of the data available to the Board relative to these factors indicates to me that it would be so preponderantly in the direction of showing that the “principal business” in this building was trust company operations rather than rentals, as to render superfluous any detailed analysis.

Paraphrasing Canada Trust (supra), one might ask: “What was the principal purpose of Combined’s business activity in 1975?” Clearly, the principal purpose was not rental—the company by its own admission got into the rental field by default—it could not sell the houses it constructed. Regulation 1100(12) does not deal with “income”, “profit” or “loss”, it refers to “business”. In addition, that “business” must have been the principal business of the corporation “throughout the year”. I would hold without difficulty that the appellant was not in the rental business at the commencement of its 1975 fiscal year, and therefore could not have been in that business “throughout the year”. Whether or not the statistical data prepared by the appellant has merit, the inclusion therein of the rental element in support of the “construction” perspective does not accord with the requirements of Regulation 1100(12).

There was, however, a conscious intent on the part of the appellant to be in the development business, including the sale of houses. It is evident to the Board that during the period under review this part of Combined was being pursued aggressively by the management of the Company, and it would appear that in the years subsequent to 1975 Mr Kirkland has been eminently successful in this aspect of his business interest. It might well be argued that he (as a principal shareholder) is now in the “construction business—albeit using several different companies spun off as entities from Combined. The appellant corporation in years after 1975, generally has restricted itself to activity in the real estate appraisal and rental fields. The crux of the problem before the Board, therefore, is—during 1975, was the activity of the appellant (development and sale of real estate) the principal purpose of the Company, or should such designation be accorded to the appraisal portion of the business?

The trust of the Minister’s basis for the re-assessment was that:

With regard to the loss for 1975 from real estate rentals of $7,618.09, which was created by capital cost allowance on Class 6 assets, . . . In resolving the question of what is the principal business of a company, consideration has to be given to the following:

(1) Degree of activity

—Time spent by employees on various activities

—Size of sources of income

(2) Degree of net profit . . .*

It was contended by the Minister that the above criteria were all inclusive, nor was it explained how “consideration” would be given, but it would be reasonable for the appellant to conclude that showing that the major portion of each item mentioned above rested with “construction” rather than “appraisal” would be satisfactory. Extracting from Exhibit A-17 the specific portions applicable to the year under review, we note:

Percentage of Revenue

Percentage of Assets

per Business		Employed
Construction	66.5 (includes 150,271
	transferred to rentals)	39.1
Rent	3.3	51.7
		51.7
Appraisals	29.9	9.2
		9.2
Other	.3	—
Total	100.0	100.0
		100.0

The Board has already expressed the view that such calculations serve only a limited purpose in this appeal but there are aspects of even these calculations which do not support the appellant’s contentions:

—The inter-company transfers of housing units from the “sale” element to the “rental” element during the year should not be used for the production of this data. The appellant was not in the rental business “throughout the year”, and rental revenue earned might be shown as “other” income for comparison purposes, but at least it should not be totalled with “sale” income.

—There is no relationship between the “assets” in the sa/es business and the “assets” in the appraisal business. The first does not represent assets used for the production of income in any business—it represents the inventory for sale.

—The only assets used for the production of income in either business were those of office equipment and motor vehicles. Little evidence was adduced assigning any particular percentage of such use in either direction other than that which might be inferred from a review of the expense distribution on Exhibit A-12. This would tend to show the greater portion of use was related to the appraisal business—a fact at least not favourable to the appellant. However, in my view, the total amount of these assets (at cost less than $15,000) is so relatively negligible as to be of little value in any case to the appellant. The asset base percentage (51.7) shown for rent is of course eliminated due to the earlier comments regarding the requirement in Regulation 1100(12) of “throughout the year”.

—Whether or not some valid comparison could be made by the appellant between the so-called “construction” and “appraisal” elements of the business considering assets employed as some form of capital investment was not made clear at the Board.

—The gross amounts (see Exhibit A-12) for comparison purposes for the year 1975 for “Revenue from business” after re-arranging the “sales” and “rent” distribution as indicated above would become:

—On this basis (above) it is evident that the construction revenue no longer is more than 50% of the total (whether or not that would be significant), and this would remain true even if the rental revenue were included with construction revenue. An even more dramatic change takes place if the “Gross Margin” figures are used, which would be at least somewhat more comparable with appraisal revenue since these are

In summary therefore, while Exhibit A-17 provides no basis upon which the appellant can support its claim, an examination of Exhibit A-12 is totally destructive of that claim. By the “Contribution to Net Income’’ figures provided by the appellant a net income for the “construction” business of $6,591 ($12,899 - $15,308) can be supported as opposed to the net income for appraisals of $36,579. Using the Minister’s claim that no net loss should be permitted as a result of depreciation charged on the “rental” segment of the business, the respective net income contribution amounts, as shown on Exhibit A-12, are still very unfavourable to the appellant.

The Board also notes with interest that in the preparation of Exhibit A-12, the appellant included two amounts of expense ($7,500 and $190), additional to those included in the original rental income and expenditure statement for the corporation financial statements which produced the loss of $7,618.09. While no corroborative evidence was adduced at the hearing to support the claim inherent in these amounts—that $7,500 of director’s fees and $190 of accounting and audit charges were attributable to earning the rental income, if correct, that could mean that the entire depreciation charge of $11,458 should be added back to income by the Minister rather than merely the $7,618.09 presently in dispute.

On all counts the appellant has failed to demonstrate that the principal business of the Company throughout the year 1975 was any combination of leasing, rental, development or sale of real estate. In my view the company’s own evidence, even though largely mathematical in nature, supports the Minister’s position.

Decision

The appeal is dismissed.

Appeal dismissed.