Michael William Zahorchak v. Minister of National Revenue, [1979] CTC 3136, 79 DTC 902

M J Bonner:—The issue in this appeal from an assessment of income tax for the 1970 taxation year is whether the profit realized by the appellant upon the disposition of a lease of a drive-in theatre is income.

The appellant is and at all relevant times was an entrepreneur in the theatre business. Between 1947 and 1970 he was interested in the operation of sixteen theatres located in the Niagara Penninsula and in Alberta. In most cases the theatres were operated by corporations. The appellant or his wife held substantial share interests in those corporations or in their parent corporations. In some cases the appellant or one of the corporations owned the land and building used as a theatre; in other cases the operation was carried on in leased premises. It was not shown that the appellant had any history of either trading in land (whether leasehold or freehold) or of dealing in theatre businesses.

The appellant’s interest in the theatre business in Alberta commenced in 1963 with the acquisition of the Corral Drive-In Theatre of Calgary. It was operated by a company called Southwood Drive-In Limited (hereinafter called “Southwood”). Most of the shares in Southwood were owned by a group which comprised the appellant, his wife, Daniel Monson and his wife. The group held some Southwood shares directly and the rest indirectly through a corporation. Daniel Monson was solicitor for and a business associate of the appellant. By the end of 1968 Southwood had four other theatres in Calgary. From the outset the appellant found the Corral operation to be successful and, based on that experience, he developed an interest in expanding the Alberta theatre operations into Edmonton.

In the fall of 1968 an opportunity arose for the acquisition of the Belmont Drive-In Theatre in Edmonton. The appellant saw the Belmont as a means of pursuing his desire to expand into the Edmonton area. On November 28, 1968, the Belmont Theatre was leased by the owner to Daniel Monson as trustee for a term of five years. The lease contained an option to renew for a further five year term. By assignment bearing the same date the lease was assigned by Mr Monson to himself and the appellant, each as to an undivided one-half interest.

At this point in the history of events I might observe that considerable cross-examination was directed to the question when the first assignment of the lease was executed. The affidavit of execution was not sworn until June 25, 1970. The appellant, who was the only witness called at the hearing of this appeal, was frank in admitting that, although he thought the assignment was executed on the date which it bore, he was not certain. I am inclined to think, although not much turns on it, that the execution of the assignment took place on November 30. The unshaken evidence of the appellant was that the Belmont Theatre was acquired by him and Mr Monson and operated by them throughout the entire 1969 season. Financial statements of the operation for the year ended December 31, 1969, which were apparently prepared on March 26,1970, describe the theatre as a joint venture of the appellant and Mr Monson.

When first considering the possiblity of leasing the Belmont Theater the appellant hoped that Southwood would lease and operate it. However, the theatre was dilapidated. The financial statements of prior years showed poor results.* [1] The theatre had been on the market for a number of years. As a result, two of the minority shareholders of Southwood, Messrs. Posen and Solway, objected to the appellant’s plan, or at least they did not agree. The appellant and Mr Monson were not able (or at least believed they were not able), by reason of a voting trust agreement, to impose their wills on the minority shareholders. At the time the lease was entered into the appellant still hoped that he would be able to persuade Messrs Posen and Solway to agree that Southwood should take the lease (by assignment) and operate the theatre. The appellant stated that it was his plan that if Southwood did not take the lease he and Mr Monson would operate the theatre until they had a chance to form a company which would then take over the lease. The appellant pursued the Belmont acquisition as a first step in the planned expansion in the Edmonton area and he proposed to incorporate a company to operate it if he could not persuade the minority shareholders of Southwood to agree that Southwood should do so. In short, the appellant was determined to obtain the Belmont for operation by Southwood if possible and, if not, by another company in which he would hold substantial interest as shareholder. Operation by himself and Mr Monson was intended to be an interim measure.

As it turned out the appellant was unable to persuade Southwood to acquire the Belmont Theatre. During the 1969 season the theatre was operated for the account of the appellant and Mr Monson by a company, Monall Properties Limited (hereinafter called “Monall”), which was controlled by them and their spouses. The result was successful. The appellant and Mr Monson earned what the appellant described as a “nice profit”.

Early in 1970 a new company, National Canadian Cinemas Limited (hereinafter called “National”), was formed. Sixty-one percent of the shares of National were owned by Monall. The remainder of the shares were owned by unrelated persons, including a company which loaned money to National. National acquired the Belmont and three other theatres in Edmonton. The lease of the Belmont was assigned by the appellant and Mr Monson to National by assignment dated June 1,1970. National paid a consideration of $63,000 to the appellant and Mr Monson for the assignment. It is the appellant’s one-half share in that consideration which is in issue in this appeal.

The appellant testified that National’s minority shareholders did not want him to be in competition with the company and thus they insisted that the Belmont be transferred to the company. Although the appellant would have been prepared at the outset to assign the lease of the Belmont to Southwood for no or nominal consideration, he was not prepared to do so in the case of National because the successful operation of the theatre during the 1969 season had demonstrated that the lease was of value.

Before proceeding further I may note that the appellant’s evidence was not inherently incredible. It was not inconsistent with the documentary evidence, except as noted previously. The appellant’s evidence in chief was not shaken on cross-examination. There is, in short, no basis for refusing to accept the appellant’s version of the facts.

A conclusion that the profit in question here is income from a business must depend on one of two findings:

(a) that the appellant’s business included trading in theatre businesses, or

(b) that, in acquiring the Belmont, the appellant was engaged in an adventure involving the purchase of the theatre business with the intention of reselling the business itself.

The evidence, in my view, does not justify the making of either such finding. The appellant or the corporations which he controlled looked to profit from the operation of the various theatre businesses, not from their resale. In the case of the Belmont, counsel for the respondent correctly described the intention of the appellant on November 28, 1968, as “flexible”. However, that flexibility, as I see it, was the result of indecision on the question of the identity of the long run operator of the theatre. The decision to be made did not involve the question whether the theatre was to be kept and operated or resold for profit. The proposition advanced by counsel for the respondent which was that in order for the appellant to succeed he must establish that he had an exclusive intent to hold and operate for an idenfinite period goes too far. No case referred to by the respondent, and no case of which I am aware, supports a suggestion that the mere presence of an intention to change the manner of holding a profit-making structure from personal to corporate is sufficient to identify any gain realized on such change as in- come. As I see it, if a gain in such circumstances is to be income the intention to realize a gain upon the change must be a part of a profit-making scheme. There was no such scheme here.

The appeal will therefore be allowed and the reassessment referred back to the respondent for reconsideration and reassessment on the basis that the gain realized by the appellant upon the assignment of the lease of the Belmont Theatre is a gain on capital account.

Appeal allowed.