S & S Properties LTD v. Her Majesty the Queen, [1978] CTC 412, 78 DTC 6294

Walsh, J:—This is an appeal from the decision of the Tax Review Board dated March 25, 1977, dismissing plaintiff’s appeal from an income tax assessment for its 1973 taxation year. In assessing plaintiff the Minister of National Revenue had included in its income profits from the sale of real estate amounting to $30,952 as an adventure in the nature of trade. Plaintiff contends that it should have been treated as Capital gain. On or about May 19, 1970, plaintiff was incorporated under the name of Workinteen Properties Limited and its name was changed to S & S Properties Ltd about February 1971. Charles Sherwood, its President and chief shareholder had originally been in the meat business in Alberta until 1958. He came to British Columbia, purchased a 4 acre commercial property in Mill Bay operating a service station with a small restaurant on it. He had had difficulties with his wife and she had put a lien on the property to protect her interest and as a result of this Imperial Oil Limited from whom he had borrowed in connection with the purchase of the property would not allow him to make further drawings on the loan so he sold it. When he had come to British Columbia he had some $60,000 cash plus his home in Alberta. After the separation from his wife he went to the United States. It had been his intention when he bought the Mill Bay property to treat it as an investment to provide revenue for his eventual retirement. According to his evidence his wife was alcoholic. He suffered a slight loss on the sale of the Mill Bay property which was treated as an income loss and the Minister made no objection to this, but it was explained that there was no practical significance to this as he had no taxable income against which to claim the loss as he had been out of the country, and in any event it is not the loss from the sale of that property which is an issue in the present case. The only significance of this evidence is that plaintiff now seeks to have the gain on the sale of the subject property, which is referred to as the Brentwood Property, treated in a different manner with the profits being taxed as capital gain.

He and his wife came together again and in 1966 they purchased the Brentwood property with the alleged intent of developing it as a small shopping centre. A concrete block building of some 8,000 square feet was constructed to accommodate eight stores but only half the area was completed and rented because at the time there was no municipal sewage service on the property and the building regulations prevented him from developing more than 4,000 square feet on septic tanks. One of the four tenants was a branch of the^ Royal Bank of Canada. It was his intention to finish the building when the sewers were extended to that area which he had verbal assurance would take place within two years although it was nearly five years before they were actually completed. He still had income of about $1,000 a month from the sale of the Mill Bay property and his wife was teaching school so he considered that they had sufficient income to complete the building, doing some of the work himself. His wife’s drinking problems became worse and she stopped ‘teaching which made it difficult ‘to carry on with his development plans for the property, especially since two of the tenants got into financial difficulties and did not pay their rent. He wished to retain control of the property as an investment by taking in an associate but his wife refused to sell her half share unless he also sold his. He got around this by incorporating Workinteen Properties Limited and inducing an old friend Ernest Smith he had known for many years in Alberta to join him in the project. The property was sold to the company in July 1970 for $80,000 but debts outstanding against the property reduced Mrs Sherwood’s share to some $25,000 to $30,000 which amounts Smith undertook to put into the company by paying $10,000 down and $250 a month for five years. Amounts Smith paid to the company were immediately paid out to Mrs Sherwood in payment for her share of the sale price.

Smith, who also testified, stated that in May 1970 he had come to Victoria and opened a health food store there and was in a good financial position. The money he was to put up however was only sufficient to buy his share of the property and not to provide any additional capital for its further development. Unfortunately he also had difficulties with his wife at about the same time. In the latter part of 1970 Sherwood agreed to buy him out. Eventually Smith went into personal bankruptcy in 1978.

Sherwood mortgaged the property by virtue of a second mortgage to pay back Smith’s $10,000 down payment and, he himself now had to take on the $250 monthly payments which were to be made to Mrs Sherwood for five years. He had estimated that it would cost $22,000 to finish the buildings but because of inflation his estimate in 1972 was that this would have increased to $45,000. He had had an option for a wedge shaped piece of property in front of subject property which was very important as it would give access to the main highway West Saanich Road. This option was good for six months for $25,000 but by 1972 the price of this property had now gone up to $40,000. His intention had been to eventually put a second story in the existing building, and use the wedge shaped property fronting on the road for parking. Although the sewers came through in 1971 he did not connect them as he felt that the property was still about two years away. from being ready for full commercial development and he did not wish to put any more money into it at that time. The revenue from the rental of the stores was sufficient to carry the property but not to provide for further development. To provide additional income for himself he obtained a realtor’s license and worked for Block Brothers, selling real estate from 1968 to 1972, but his accountant testified that he only earned commissions totalling $18,500 in the five year period, and in no year over $5,400 gross. In 1971 his employers Block Brothers told him they thought they had a customer who would buy the property from him for $115,000. His wife was in hospital in Duncan at the time and he went to her and got a sale offer signed, but on his return from Duncan he was told that the deal had fallen through. Although the auditor for the Department of National Revenue considered this as a listing for sale Sherwood insisted that he did not consider this a listing, but merely that he would have been willing to sell at that time as a result of an unsolicited offer in view" of his financial difficulties.

Soon after he heard of another good property which was coming on the market which was available for a subdivision. He had no money to develop this property but felt he could buy it and sell at a profit. He was able to borrow $80;000 from a credit union, and borrowed $2,000 from his daughter on the security of the subdivision property as well as on the subject property. Part of the loan from the credit union was used to pay off the Industrial Development Bank mortgage of $38,000 on the subject property and the second mortgage of some $17,000. In due course he sold this subdivision property to D F Hanley Limited making a profit of $15,000 which he declared and on which he paid tax. In the autumn of 1972 D F Hanle/ Limited offered him $120,000 for the subject property, which he refused as he still wanted to develop it as an investment himself. After recalculating the amount of his expenses however, when they increased their offer by $5,000 he sold to them in 1973, and it was the gain on this transaction which the Minister is now assessing for income tax.

The witness Sherwood testified as to various other real estate transactions in which he has been involved. In 1972 he bought an old house on Emerson Street in Victoria which he resold for a profit of $3,000 which he declared as income and on which he paid tax. On another occasion he bought an inexpensive house and two lots using his Veterans Land Act credits and lived there for a year. This was before the purchase of the Brentwood property. Later he was told that he could not use his VLA credits for this and was forced to sell it in 1970. In 1972 he had also bought a house on Prior Street which he considered to be a bargain and intended to fix it up to live in. Eventually he sold it however at a profit of $800, but in order to make the sale he had to arrange some deal with Block Brothers whereby he was forced to buy a lot at Shawnigan Lake which he eventually sold at a loss of $1,000. He declared neither that loss nor the profit on the sale of the Prior Street property, saying that one set off the other.

In summary he had twice tried to establish a source of income for his retirement, first at the Mill Bay property and subsequently at Brentwood but failed both times. While he was aware that the Brentwood property was in a developing area when he bought it he insists that he never wanted to sell it and was obliged to do so by change in financial circumstances. The purchaser D F Hanley Limited who had bought the new subdivision property from him, which he had always intended to sell at a profit as he could not afford to develop it himself, bought the subject property from him as the result of an unsolicited offer, which he initially refused until it was increased. He took exception to certain statements made in a letter by Mr Bosdet, the auditor for the Minister. He denied stating to him that he had always intended to put the property up for sale once the sewer was completed, stating that the auditor must have misunderstood his statement, confusing the subject property with the subdivision development property which he had bought intending to resell at a profit, which he did and paid tax on it.

Mr Bosdet himself testified and admitted that at one interview the reason Sherwood gave for buying the property was that it was to provide retirement income but that this was frustrated due to his difficult financial problems and marital problems with his wife.

Mr Sherwood also strongly denied a statement in the letter from Mr Bosdet to his auditor that he had said that the property was listed for sale with Block Brothers for one year after the sewers were installed. Mr Bosdet had also stated in the same letter that he had numerous real estate transactions none of which had been reported on his income tax return, whereas, as his evidence indicates at least two had been reported on which he had paid tax. These statements have also been denied in writing in a letter written by Mr Sherwood to a solicitor for the Department of Justice on February 16, 1977. He could not recall having stated to Mr Bosdet that he could not understand why the Brentwood property was not treated in the same manner as the subdivision property on his tax return prepared by his auditor, Mr Creed.

Mr Creed testified and explained certain erroneous statements made in the Notice of Objection which he had prepared for Mr Sherwood’s signature. At the time Mr Sherwood was working in the North country as an air force security officer for 84 days at a time. As he was leaving the next day he had him sign a Notice in blank. He had been doing the accounting for the company for the three previous years and had correspondence with the Department and files on hand with which to prepare the Notice of Objection. When Mr Sherwood was sent a copy of the Notice however he pointed out that the property had never been listed for sale in 1971 as was stated in Paragraph 9. This statement had been taken by the witness Creed from Mr Bosdet’s letter, so is merely repeating what Mr Sherwood contends was a misunderstanding Mr Bosdet had with respect to the listing. The witness Creed also admitted that he had merely assumed that the property had been listed for sale in 1972 as that was when the offer to purchase from D F Hanley Limited had been made.

I believe that certain conclusions of fact can be drawn. Mr Sherwood undoubtedly had some experience in dealing with real estate, both as a result of his work as a realtor and his experience in various real estate transactions. He was undoubtedly alert in foreseeing the potential of a property which could be acquired at a good price and resold at a profit, and indulged in and paid tax on at least two such transactions. Even a trader in real estate, however, and this was certainly not Mr Sherwood’s principal occupation, can in certain circumstances, make a profit in the nature of capital gain, even if real estate is involved.

In the case of T K Sales Ltd v MNR, [1973] CTC 340 at 344; 73 DTC 5284, at 344 [5286] I had occasion to state:

Against this appellant contends that even a trader can make a Capital gain on sale of a property, when the property in question was acquired by him for the purpose of producing income and not with a view of resale at a profit, or even with the secondary intention at the time of acquisition of doing so, should the original intention of operating the property to produce income be frustrated and a sufficiently good offer be received, as in the case of Regal Heights v MNR, [1960] CTC 384; 60 DTC 1270.

In the case of Elgin Cooper Realties Ltd v MNR, [1969] CTC 426; 69 DTC 5276, an apartment building had been built using new methods of construction with intent of producing investment income. Various construction problems were encountered and it was sold at a profit, Jackett, P, as he then was, stated:

Mr Shenkman, who is now fifty-eight years of age, has been, since his youth, the owner of apartment properties, industrial properties and other real estate, which he has managed for a rental income. In addition, he has acquired many properties for development or speculative purposes. It is common ground that, while many acquisitions of the latter class have resulted, or will result, in profits that are profits from ventures in the nature of trade, the dispositions of apartment blocks or industrial properties that he acquired and held for rental purposes would properly be regarded as changes in income producing investments even if such dispositions resulted in profits.

It is the motivation at the time of purchase which is important and when the original motivation of Mr Sherwood at the time the property was purchased by him and his wife in 1967 was frustrated by marital problems and her illness there is nothing to indicate that when the plaintiff S & S Properties Limited (formerly Workinteen Properties Limited) purchased the property in July 1970 the intention had been changed. Mr Sherwood had taken Mr Smith in as an associate to buy out Mrs Sherwood’s interest and still was hopeful of continuing with the development of the property with a view to deriving retirement income therefrom. This was not an unrealistic prospect or one which appeared to be beyond their means at the time. Perhaps Mr Smith misled Mr Sherwood somewhat as to his financial resources, and it was Mr Smith’s own marital problems which forced Mr Sherwood to buy him out and put Mr Sherwood into financial difficulties, aggravated by increase in building costs, so that he was unable to carry out his plans to complete the development of the property for rental income.

Mr Sherwood’s evidence as to the intention of the partners (which represents the intention of plaintiff) who were both equal shareholders after Smith bought out Mrs Sherwood’s interest (though subsequently Sherwood himself was the sole shareholder), was corroborated by Mr Smith. In the case of Ronald Francis Theres Maclsaac v MNR, [1974] CTC 576; 74 DTC 6380, Chief Justice Jackett stated at 578 [6381]:

This latter evidence was not challenged or contradicted and no objection of any kind was taken thereto. The question, in my view, is whether it rebuts the assumption of the respondent, on which he based the assessment, that the property “was acquired for the purpose of being turned to account at a profit”. Had the other two persons involved also been called each to say on his own behalf that the reason for the purchase was to acquire a permanent investment for his retirement, in my view, in the context, in the absence of challenge or contradiction, the evidence would rebut the assumption that the property was acquired for the purpose of being turned to account at a profit. That assumption would also have been rebutted if the appellant had, by unchallenged and uncontradicted evidence, testified that the joint purpose of all three in acquiring the property was to acquire it aS a revenue-producing investment for their retirement.

In the case of Hans Reicher v R, [1975] CTC 659; 76 DTC 6001, at 665 [6005] Le Dain, J stated:

No attempt was made by cross-examination or otherwise to challenge the testimony of the appellant or that of his partner, King, that they had. formed no such intention at any time prior to the date on which construction of the building was commenced, nor was there any such challenge of the appellant’s testimony that he was unable to find alternative financing arrangements to extricate him from his financial difficulties.

In the case of Roy M Power v R, [1975] CTC 580; 75 DTC 5389, Addy, J stated at 584 [5391]:

. . . The only direct evidence of what a person has in mind at any given time must necessarily come from a statement by that person either at the trial or orally or in writing to another person and any such expression of intention is most relevant and important, especially when given under oath at the trial by the person whose intention is at issue and after the statement of such intention has been thoroughly tested by cross-examination in the light of his actions both before and after the event in question.

Again at 585 [5392] he stated:

. . . Yet, one cannot say that, as a matter of law, every land developer is precluded from establishing that in a particular case there was no primary or secondary intention to speculate, anymore than in a case such as the one at Bar where a mature man has never previously resold a piece of real estate at a profit, is one precluded from finding that, on his very first venture in this sphere, he did in fact have the intention of reselling at a profit when he originally purchased the lands. The issue of intention must therefore be resolved by a careful weighing of all of the admissible evidence which is in any way relevant to that issue and the person or body charged with finding the facts must refrain from considering each piece of evidence independently but must examine it in the light of all the other evidence both direct and circumstantial.

In the present case both Sherwood and Smith were cross-examined and their evidence as to their intention was uncontradicted.

The fact that plaintiff was undoubtedly aware that the property was going up in value and therefore might have had some secondary intention at the time he bought it is not in itself sufficient to negate his uncontradicted evidence. Perhaps the best expression of secondary intention is found in the case of Paul Racine, Amédée Demers and François Nolin v MNR, [1965] CTC 150; 65 DTC 5098, in which Noël, J, as he then was, stated at 159 [5103]:

In examining this question whether the appellants had, at the time of the purchase, what has sometimes been called a “secondary intention” of reselling the commercial enterprise if circumstances made that desirable, it is important to consider what this idea involves. It is not, in fact, sufficient to find merely that if a purchaser, had stopped to think at the moment of the purchase, he would be obliged to admit that if at the conclusion of the purchase an attractive offer were made to him he would resell it, for every person buying a house for his family, a painting for his house, machinery for his business or a building for his factory would be obliged to admit, if this person were honest and if the transaction were not based exclusively on a sentimental attachment, that if he were offered a sufficiently high price a moment after the purchase, he would resell. Thus, it appears that the fact alone that a person buying a property with the aim of using it as capital could be induced to resell it if a sufficiently high price were offered to him, is not sufficient to change an acquisition of capital into an adventure in the nature of trade. In fact, this is not what must be understood by a “secondary intention” if one wants to utilize this term.

To give to a transaction which involves the acquisition of capital the double character of also being at the same time an adventure in the nature of trade, the purchaser must have in his mind, at the moment of the purchase, the possibility of reselling as an operating motivation for the acquisition; that is to say that he must have had in mind that upon a certain type of circumstances arising he had hopes of being able to resell it at a profit instead of using the thing purchased for purposes of capital.

At 162 [5105] he stated:

Nevertheless I can find nothing in the evidence to justify my rejecting the sworn testimony of the appellants in regard to the explanations which they gave to justify the resale of the business so soon after acquiring it, and here also their testimony in this regard was not questioned in cross- examination.

If this explanation is accepted, and I accept it entirely, the rapid resale after the purchase does not give rise to any inference that this resale with profit was one of the reasons motivating the appellants when they acquired the business.

In the well-known case of Irrigation Industries Limited v MN Ft, [1962] CTC 215; 62 DTC 1131, Martland, J at 224 [1135] referred with approval to the statement of principle by Lord Buckmaster in Leeming v Jones, [1930] AC 415 at 420 in which he stated:

an accretion to capital does not become income merely because the original capital was invested in the hope and expectation that it would rise in value; if it does so rise, its realization does not make it income.

This was carried further by Kearney, J in the case of MNR v Valclair Investment Company Limited, [1964] CTC 22: 64 DTC 5014, in which he applied the same principle to land.

In the Queen v Stanfold Investment Corporation, [1974] CTC 19: 74 DTC 6035, it was stated at 26 [6040]:

The mere fact that it was general knowledge at the time of the purchase that the area in question, which eventually became part of the City of Laval, was developing rapidly and that a person buying land there would most likely find that it would increase in value, is not sufficient, in my view, to indicate that this was the secondary intention of defendant at the time the purchase was made. On the contrary, the evidence discloses that the sole intention was that the defendant would develop the property itself as a revenue-producing investment and the mere fact that defendant no doubt realized that there was little, if any, risk of loss and on the other hand a reasonable expectation of profit even if its intention was frustrated and it was forced to sell the land, is not in my view sufficient to establish that this was a secondary intention of defendant at the time of the purchase. Knowledge and intention are not synonymous.

Other cases dealing with frustrated intention are Bead Realties Ltd v MNR, [1971] CTC 774; 71 DTC 5453; Point Pleasant Investments Limited v MNR, [1968] Tax ABC 1227; 69 DTC 43, and Clemow Realty Limited v The Queen, [1976] CTC 129; 76 DTC 6094, in which at 140 [6102] I stated:

However whatever change of intention plaintiff might have had forced upon it in 1964 is not relevant since it is the intention at the time of purchase which is important, and there is nothing to indicate that at that time there was any secondary intention to sell even the portion of the property zoned as single residential, despite the fact that Mr Sirotek’s interest was restricted to commercial, apartment house and possibly row housing developments.

I find that on the facts of the present case it is doubtful whether plaintiff ever had any secondary intention with respect to the subject property and, even if it did, this by itself does not make the subsequent sale and the profit derived therefrom a profit arising from an adventure in the nature of trade since it was as a result of the frustrated intention of the company, as represented by Mr Sherwood the controlling shareholder, resulting from matters entirely beyond his control which led to the sale. While profits from some of his other real estate dealings were therefore quite properly declared by him and taxed as profits resulting from adventures in the nature of trade, the profits arising from the sale of the subject property should be considered as resulting from the sale of an investment and be considered as capital gains.

The appeal is therefore maintained with costs and the assessment referred back to defendant for reassessment on the basis of treating the profits from the sale of the subject property as capital gains.