Arthur Hailey Limited v. Minister of National Revenue, [1978] CTC 2059, 78 DTC 1058

A W Prociuk:—The appellant, Arthur Hailey Limited, appeals from the respondent’s reassessment of its income for the taxation year 1970 wherein additional tax in the sum of $6,592.31 was levied by reason of the fact that the respondent assessed on the basis that the appellant was not a non-resident investment corporation as defined in subsection (4) of section 70 of the Income Tax Act in that year. In filing its return for the taxation year 1970, the appellant had duly elected in prescribed manner to be taxed under this section, the rate of which was 15% of its taxable income. The appellant’s ground of appeal is that it was a non-resident investment corporation as defined in the Act. Subsection (4) of section 70 of the Act reads as follows:

70. (4) In this Act, a “non-resident-owned investment corporation” means a corporation incorporated in Canada that during the whole of the taxation year in respect of which the expression is being applied complied with the following conditions:

(a) at least 95% of the aggregate value of its issued shares and all of its bonds, debentures and other funded indebtedness were

(i) beneficially owned by non-resident persons,

(ii) owned by trustees for the benefit of non-resident persons or their unborn issue, or

(iii) owned by a corporation, whether incorporated in Canada or elsewhere, at least 95% of the aggregate value of the issued shares of which and all of the bonds, debentures and other funded indebtedness of which were beneficially owned by non-resident persons or owned by trustees for the benefit of non-resident persons or their unborn issue or by several such corporations;

(b) its income was derived from

(i) ownership of or trading or dealing in bonds, shares, debentures, mortgages, hypothecs, bills; notes or other similar property or any interest therein,

(ii) lending money with or without security,

(iii) rents, hire of chattels, charterparty fees or remunerations, annuities, royalties, interest or dividends, or

(iv) estates or trusts;

(ba) not more than 10% of its gross revenue was derived from rents, hire of chattels or charterparty fees or charterparty remunerations;

(c) its principal business was not

(i) the making of loans, or

(ii) trading or dealing in bonds, shares, debentures, mortgages, hypothecs,

bills, notes or other similar property or any interest therein;

(d) it has, not later than 90 days after the commencement of the taxation year, elected in prescribed manner to be taxed under this section; and

(e) it has not, before the taxation year, revoked in a prescribed manner the elections so made by it.

Mr Arthur Hailey, of Nassau, Bahamas, testified on behalf of the appellant. He stated that the appellant’s income consisted of royalties from the marketing of books written and supplied to it by him, dividends, interest and rents. It owned an undivided 17.289% interest in a partnership which owned an apartment complex known as the Queensview Apartments; and an undivided 10.60% interest in a partnership which owned an apartment complex known as the Elphin Apartments, both in Ottawa, Ontario.

Pursuant to the terms of the agreement in each partnership the appellant received $14,846.43 from Queensview Apartments as its share, and the sum of $202 from Elphin Apartments as its share for the said taxation year.

Exhibit A-4 is a summary of the appellant’s income for the taxation year 1970 and reads as follows:

SUMMARY

Queensview Apartments Partnership

Gross Rentals		$734,894
Expenses		637,559
Net Earnings		$ 97,335
Arthur Hailey Ltd. share from
1 January 1970 - 19 November 1970
@ 17.289% =
				$14,846
Elphin Apartments Partnership
Gross Rentals		$298,007
Expenses		299,586
Loss		($1,579)
Interest			3,734
Net Earnings		$	2,155
Arthur Hailey Ltd. share from
1 January 1970 - 19 November 1970
@ 10.60% =±-				202
English Property
Rentals				700
			TOTAL:	$15,748
	.
Arthur Hailey Ltd
Gross Revenue
Literary Royalties	$214,202.65
Dividends		2,127.82
Interest		9,290.18
Rents: — Queensview Partnership		14,846.43
— Elphin Partnership			202.
— English Property			700.
Gross Revenue	$241,359.08
Rents as percentage of Gross Revenue				15,748.43	.
			241,359.08

It was agreed that there were only two beneficial shareholders in the appellant company, Arthur Hailey and his wife Sheila Hailey, both non-residents of Canada at the material time. The issue herein revolves around paragraph (ba) of subsection (4) of section 70.

The appellant states that the revenue which it was entitled to receive and did receive as a member of the two partnerships was $15,748 and that it is $6.52% of its gross revenue of $241,359.08.

The respondent takes the position that the appellant was not in partnership business whatsoever; that there, in fact, was no partnership but merely a co-ownership with others of two rental properties and therefore it is not entitled to deduct rental expenses at partnership level but that its accounting should reflect its proportionate co-owner’s share of gross rental receipts which is $140,654. Its total gross income then becomes $366,275. Its rental income is then 38.4% of its gross income and since it by far exceeds the limit set forth in paragraph (ba) (supra) it is not entitled to be treated as a non-resident investment corporation.

The issue, therefore, is to determine whether or not there was a partnership business and what was gross revenue to the appellant in the said year.

Exhibit A-2 is a copy of the partnership agreement relating to Queensview Apartments and a parking lot. It is dated May 24, 1967 and there are six partners of which the appellant is one. I quote paragraphs 1, 2 and part of paragraph 3:

1. SAID PARTIES AGREE to enter into a partnership effective as of the 24th day of May, 1967, under the firm name and style of “QUEENSVIEW APARTMENTS COMPANY” (hereinafter called the “Partnership”) until the partnership is determined as hereinafter set forth.

2. THE PARTNERSHIP BUSINESS through J J Brown is the purchasing, acquiring, holding, administration and renting of certain apartment buildings and a parking lot described for municipal purposes as 191-219 Bell Street and a lot on Louisa Street in the City of Ottawa, and more particularly described in a deed to J J Brown in trust, registered in the Registry Office for the Registry Division of the City of Ottawa as No. 527835.

3. EACH PARTNER SHALL share in the profits and expenses and liabilities of the said property described in the preceding paragraph in accordance . . . .

J J Brown or his nominee was in charge of administration, management and rental of the property. He was to keep proper books of account and records; and, he was to appoint the auditors for the partnership.

Paragraph 7 of the said agreement reads as follows:

7. ON THE FIRST day of each and every year an account shall be taken of the partnership property, stocks, credits, and liabilities, and any profit as determined by the Auditor shall be paid immediately to the partners.

The agreement goes on to include other usual clauses found in a properly and carefully drawn up document which I find this to be.

Exhibit A-3 is a copy of the financial statement of Queensview Apartments for the taxation year 1970, prepared by a firm of chartered accountants acting as auditors for Queensview Apartments. I reproduce here the page dealing with rental income and expenses because, in my view, the expenses involved cogently reflect the nature of the work in this enterprise:

QUEENSVIEW APARTMENTS

STATEMENT OF EARNINGS AND OWNERS’ EQUITY YEAR ENDED DECEMBER 31, 1970

	1970	1969 1969
.
RENTAL INCOME	734,894	702,015
EXPENSES
Advertising	2,994	2,729
Bad debts and collection costs	1,088	926
Bus and car	5,050	4,434
Cablevision	10,689	3,170
Cleaning supplies	2,943	3,759
Elevator maintenance and repairs	5,975	6,770
Employees’ benefits	5,848	5,923
Equipment maintenance and repairs	3,713	2,242
General	3,615	3,077
Hydro, gas and water	73,537	75,746
Insurance	3,896	3,692
Interest and bank charges	13,194	6,988
Maintenance and repairs	21,876	20,216
Management fees	29,396	28,056
Mortgage interest	210,516	216,715
Parking lot	—	728
Printing, postage and stationery	1,622	2,391
Professional fees	4,819	4,498
Property taxes	125,285	118,217
Redecorating and painting	4,880	4,451
Refuse disposal	3,313	4,446
Salaries and wages	90,680	79,326
Security	9,003	8,664
Telephone	1,575	1,621
Travel	2,052	1,426
	637,559	610,211
NET EARNINGS FOR THE YEAR (note 1)	97,335	91,804
Owners’ Equity, beginning of year	434,429	242,625
	531,764	334,429
Capital contribution (withdrawal)	(33,333)	100,000
OWNERS’ EQUITY, END OF YEAR	$498,431	$434,429

Exhibit A-5 is a partnership agreement dated July 15, 1968 with respect to “Elphin Apartments”. There are twelve partners, of which the appellant is one. In this agreement J J Brown is referred to as the “trustee” but in all other respects the terms of the agreement are the same as in Exhibit A-2.

Exhibit A-6 is a copy of the financial statements for the taxation year 1970 in respect of Elphin Apartments. It is prepared by the same firm of chartered accountants and the format used is the same as in Exhibit A-3.

In each case the agreement spells out carefully and precisely the rights, liabilities, duties and obligations of each member. Each member could, on a 48-hour notice in writing to J J Brown, obtain access to the records and books of account of the partnership. In each case paragraph 7 of the agreement entitles a member to receive his or its proportionate share of the net profit or assume a proportionate share of the loss as determined by the auditors. I do not think that the respondent could lawfully change or disregard the terms of the agreement which is binding on the members and mutually enforceable unless the document is a sham and drafted for the purpose of evading taxes, which it is not. I would accordingly hold that the agreements are valid documents and binding on the member signatories thereto.

The question as to the characterization of income from these two properties, that is whether it is receipts from letting of real property or receipts from a business, was ably argued at some length by both counsel. As stated earlier counsel for the respondent maintained that this was not a business but merely a co-ownership of property.

In Wertman v MNR, [1964] CTC 252 at 262; 64 DTC 5159 at 5165, the respondent’s position was as follows:

The Minister’s case for applying Section 21(4) is that the concepts of income from property and income from business are not mutually exclusive but blend completely and that while the rentals derived from the Park Strand can be regarded as income from property, they can and should also be regarded as income from the business of leasing apartments in the Park Strand which was a business in which the appellant and his wife were partners.

The question of fact to be determined after viewing all the evidence, is whether or not the appellant in the instant case was a member in the partnership business of renting suites and parking lot spaces in. the two apartment blocks.

Paragraph 11 of each agreement reads as follows:

11. FOR THE PURPOSES of the partnership, the law of Ontario shall apply and any litigation over the partnership shall be before the Courts of the Province of Ontario.

The Partnership Act of the Province of Ontario defines “partnership” as “the relation that subsists between persons carrying on a business in common with a view to profit”.

Mr Hailey stated that in each case J J Brown put the partnership together so to speak. Each partner agreed to contribute a certain percentage of the capital required to go into rental business. Each member executed the partnership agreements and thenceforth they were in business. In each case the administration and management of the business was left in the hands of J J Brown or his nominee. The partners received the financial statements and their respective shares of profit.

Mr Hailey stated that neither he nor his wife ever saw the apartment blocks nor made the effort on behalf of the appellant, to inspect the accounts and records as same were maintained by J J Brown. As far as the appellant was concerned it was an investment for making profit. As nearly as he could say the other partners viewed the venture in pretty much the same light.

In Hollinger v MNR, [1972] CTC 592 at 600; 73 DTC 5003 at 5009, Noel, ACJ states:

It is possible that, in some cases, the holding of property in joint tenancy, tenancy in common or other form of joint ownership, may not in itself create a partnership. However, when there is a clear business operation conducted and a receipt of a share of profits such as here, there can, in my view, be no question that the amounts received by the appellant are income from a business and not from property.

Let’s assume for a moment that each partnership agreement was in fact a Canadian-controlled private corporation and the matter in issue was ‘the small business deduction” under subsection (1) of section 125 of the current Income Tax Act. In the light of recent judicial decisions and I refer particularly to Her Majesty the Queen v Rockmore Investments Ltd, [1976] CTC 291; 76 DTC 6156; ESG Holdings Ltd v Her Majesty the Queen, [1976] CTC 295; 76 DTC 6158; Her Majesty the Queen v MRT Investments Limited, [1976] CTC 294; 76 DTC 6158; Her Majesty the Queen v Cadboro Bay Holdings Ltd, [1977] CTC 186; 77 DTC 5115, there can hardly be any doubt that the decision would be that the appellant’s rental income was income from an active business and that the provisions of subsection 125(1) of the Act apply.

In the instant case, the evidence clearly establishes that this was income from a business. The appellant’s gross income was the amount that was allocated to it by the auditors duly authorized in that behalf by the agreement in each case. Accordingly, the appellant did not derive more than 10% of its gross revenue from rents. It is therefore a non-resident-owned [investment] corporation within the meaning of the Income Tax Act and entitled to special tax rate applicable herein.

The appeal is allowed and the matter is referred back to the respondent for reassessment.

Appeal allowed.