Harold Duncan v. Minister of National Revenue, [1977] CTC 2004, 77 DTC 6

The Assistant Chairman:—In 1973 a parcel of land in which the appellant had a one-third interest was sold at an amount in excess of cost. Negotiations for the parcel started in 1966, with a downpayment late in that year, and title was acquired in July 1967, and its disposition in 1973 produced, in the view of the appellant, a capital gain. The quantum of the gain, as computed by the vendors, was determined at $66,603.06, or $22,201.02 for the appellant. To determine the amount of the gain, the vendors reduced the selling price ($284,700) by the selling cost ($21,096.94) and the Valuation Day value of the property ($197,000). The appellant reported as a capital gain the amount of $22,201.02, being one-third of that gain, and added to his income for his 1973 taxation year the taxable portion thereof, namely, $11,100.51. The respondent, after considering the matter, was of the view that the acquisition and disposition of the property by the appellant and the other two parties was an adventure in the nature of trade, and so the profit from the transaction was a profit from a business with the result that one-third of that profit was added to the income of the appellant after deducting from income the amount which the appellant had reported as a taxable capital gain. Following an objection to the assessment by the appellant and the expiry of more than 180 days from the date of the objection without the Minister having notified the appellant in any respect, the appellant appealed to this Board. The appellant contended the profit was not a profit from a business, but rather a capital gain. The respondent’s reply was on an alternative basis. The Reply to the Notice of Appeal stated the profit was a profit from a business and the assessment was correct. It continued, however, stating that, should it be held that the profit was not a profit arising from an adventure in the nature of trade, then, of course, there was a capital gain. There was, however, a clear divergence between the parties as to the value of the property on Valuation Day. As stated, the vendors, in total, contended that that value was $197,000, while the Minister of National Revenue took the position it was $130,000.

Because of the positions taken by the parties, it is incumbent on the Board to determine whether or not the profit was a profit arising from an adventure in the nature of trade. The parties agree that, if the profit is a trading profit, the assessment is correct. Should the Board find the profit is a trading profit, then the appeal is to be dismissed. However, should the Board hold the profit did not arise from an adventure in the nature of trade, then the Board must continue its inquiry and determine the amount of the capital gain. In this respect the parties. in effect, agree that at this point the only real question for determination is the value of the property on Valuation Day.

There were three parties interested in the parcel of land, the sale of which produced the profit which gave rise to the assessment in issue. The appellant, who was one of the parties, was an employee of Jack Serwa, or a company controlled by him, from 1949 to 1966, except for the years 1958 to 1962. After 1966 he became an employee of another company, which other company took over the business of Mr Serwa’s company. The other two parties were two daughters of Mr Serwa: a Mrs Large, and a Miss Serwa who, after her assessment was issued, became Mrs Potts. To fully appreciate the owning of the land in question by the appellant and his two co-owners, the activity of Jack Serwa must be understood. Mr Serwa, in the 1940’s, was in the trucking business and the sawmill business in Manitoba. In 1945 he moved with his family to Kelowna, British Columbia, and ultimately got into the construction business. His business pertained to road clearing, excavation, demolishing buildings, removing debris, building parking lots, etc. The business was carried on as a proprietorship until about 1954, when he caused a company, Serwa Bulldozing Co Ltd, to be incorporated, to which he sold his business. He was the controlling shareholder of the company but his wife, four daughters, and son each had shares. At this time (1954) the family lived at 1144 Pacific Avenue in Kelowna on a parcel of land about an acre in size. All trucks used in the business, as well as other equipment, were kept at that property. When the family moved to that address, the home was about a mile from downtown Kelowna and was also a good distance from other houses. With the passage of time, residences were built nearby and the area became somewhat congested with the building of a shopping centre not too far away. As the area became more residential, there were complaints as to the noise and business activity around the home, as the house was the office of the firm and the equipment was kept on the property. In 1957 the business activity was moved about a mile away, to Moody Road, still in the City of Kelowna.

The property to which the business moved was on the south side of Moody Road and abutted Burns Road on the west. The area was rural farm land with no residences or buildings around it at the time. When Mr Serwa was looking for an area to which the business could be moved, he was interested in rocky land which could produce gravel, as it was used to a great extent in the company’s road building business as well as in its parking lot work, in addition to being used as a fill at excavated sites. At the time the business was moved, the lot to which it moved was only one lot; however, some time later it was subdivided into five lots. Lot 1 was owned by Mrs Large and faced on Burns Road; Lot 2 was owned by Mrs Potts; Lot 3 was owned by their brother Clifford Serwa, on which he built a home; Lot 4 was owned by Mr Serwa’s company, on which was erected a shop and office; and Lot A was owned by Clifford Serwa. Lots 1 and 2 were acquired by Mrs Large and Mrs Potts on the advice of their father so that they could receive royalties from the sale of gravel on the lots. In due course gravel was extracted from each lot and the pits thereby created were filled level with the surrounding land with material from excavation jobs. After the gravel from Lots 1 and 2 was exhausted, gravel extraction from Lot A commenced. The property, the profit from the sale of which gives rise to the assessment in dispute (herein called “Lot C’’), is on the north side of Moody Road and opposite part of Lot 3 and part of Lot A. Lot C’s westerly boundary is about 600 feet east of Burns Road.

Mrs Large attended the University of British Columbia and, in due course, became a qualified teacher and later taught. She married Mr Large while he was still an engineering student. After graduation, he worked for the Department of Highways at various locations in the Province of British Columbia until 1966. He left that department in that year and caused a company to be incorporated so that he could go into the construction business. The company was the Serwa Bulldozing Co Ltd—the same name as the company which Mr Serwa caused to be incorporated in 1954. This latter company, at this time, changed its name. The new company took over the business of the old company and, in 1967, it bought the old company’s equipment. Only Lot 4 of the previously mentioned lots was sold to the new company.

Lot C, the subject property, in 1966 was part of a farm owned by Archie Bredin. Mr Bredin, in 1966, approached Mr Serwa to buy the whole farm, which consisted of about 85 acres. Gravel was the only interest of Mr Serwa and the gravel on Lot A was about 80% used up. It was known by the appellant, an employee for many years of the old company and in 1966 an employee of the new company, that it was quite likely Lot C contained gravel, as there were outcroppings on the surface of the land as well as gravel on Lot A, which is across the road from Lot C. He also had found gravel in a creek on the north side of Lot C. Before buying the land, no test borings were made as all persons were satisfied gravel was there. Another feature of the area was that Moody Road ran to a dead end at the boundary line of Lot A, which would indicate no traffic on the road, and Lot © would provide a buffer against encroachment by residents of the other property. Mrs Large and her sister, Mrs Potts, substantially relied on their father’s advice and were interested in buying. Mrs Large thought of putting a home on the property after the gravel had been removed and the pit filled in. Harold Duncan, the appellant, was approached to see whether or not he would acquire a portion of the land. The reason for approaching him was, if he bought some of the property, it would connect him more closely with the business and the chances were he would stay with the new company. Mr Duncan stated that it would give him a place for a home and a place from which he hoped, on his retirement, he could run a business. Following negotiations, Lot C, consisting of 9.5 acres, was purchased with each of Mrs Large, her sister Helen (now. Mrs Potts) and Harold Duncan having a one-third interest. The property was taken in the name of Mrs Large. The parties drew straws to determine what portion each would have and, if I recall correctly, Mrs Large had the westerly one-third, Mr Duncan the middle one-third and Mrs Potts the easterly portion.

At this time (1967) the three purchasers agreed with Clifford Serwa (who was the brother of Mrs Large and Mrs Potts), who owned Lot A, that no gravel would be taken from Lot C until Lot A was exhausted. By 1971 crushing had finished on Lot A and the gravel was stockpiled: it was not used until 1974. Consumption of the gravel from Lot A was not as rapid as expected since the jobs which needed gravel were closer to other pits. Cost of trucking was not only an important cost but a large one, and so pits nearest jobs were used. Some topsoil was taken from the property and sold for about $1,000. Other than this, the property produced no revenue for any of its owners while they owned it.

In the fall of 1972 Mrs Large received a telephone call from a real estate agent endeavouring to buy 2 /2 acres of Lot C. Neither at this time, nor at any time, had the property been advertised for sale, nor had it been listed with any agent. The answer was no. The agent came back again and again, and finally offered to buy all the property for $25,000 an acre. To slow him down, as she was confident he would not buy, she stated she would sell the property for $30,000 an acre. The agent departed but some time later returned and stated his client would buy at that price. The next demand was cash, which was agreed to. The zoning of the property at all times was unclear, but it did appear to be rural. In any event, the purchaser’s agent inserted a clause in the agreement of purchase and sale as follows: “This sale is subject to Govt Dept’s approval for Commercial Use of above land on or before 18 July 1973.’’ The purchase was duly completed. It turned out the purchaser was the Insurance Corporation of British Columbia. The proceeds of sale were divided equally between the three owners.

While Mrs Large appeared to give the bulk of the factual evidence, both Mrs Potts and Mr Duncan also gave evidence. The evidence was similar throughout except, of course, each one gave that which he knew. Mrs Potts, at the time of the purchase, was only 16 years of age and admitted she relied on her father’s advice entirely.

As to a background in dealing in real estate, I believe one could readily summarize all other real estate transactions of the owners of Lot C by saying that they really have had no dealings in real estate. A home was bought and sold, gravel pits were bought and are still used. The area where Lot C was located was farming country. In 1966 residences were a good distance away and it was not until the early 1970’s that the area around Lot C started to be developed. I cannot see how one could suggest that the land was purchased for future development. It clearly was purchased because it contained gravel and there was an operator nearby who could use it. It is correct to say that it was not expected the gravel would be used immediately after the land was purchased, but it was expected it would be in production in the near future as Lot A was, at the time of purchase, about 80% exhausted. I cannot see, in the circumstances, any badges of trade in connection with the buying and selling of this property, and so I hold that, in so far as the assessment appealed from adds profit on the sale of this lot to the income of the appellant, the appeal is allowed.

As mentioned, the appellant contended that the transaction produced a capital gain and reported that gain accordingly. The appellant contended that the valuation of the whole property on Valuation Day was $197,000, which produced a total gain of $66,603.06 with one-third to the appellant. The Minister of National Revenue’s alternative position was that, if the saie resulted in a capital gain, the Valuation Day value was $130,000. This resulted in a total gain of $133,603.06, the appellant’s share being $44,534.35. It is clear that the only problem remaining is the determination of the value of the property on Valuation Day, as both parties have taken a position that that value exceeded the purchase price of the property.

Written submissions were filed by each counsel, and the appellant’s counsel, in his submission, in effect takes the position that since the Minister assumed in making the assessment under appeal that the profit realized on the transaction in question was profit from an adventure in the nature of trade, he, the Minister, made no assumption with respect to the quantum of the capital gain and, consequently, no assumption as to the Valuation Day value of the property. Such being the case, the appellant contends that the onus is on the Minister to show that the Valuation Day value as determined by the appellant is incorrect, rather than the appellant having to show the Minister’s position, taken as an alternative in the Reply to the Notice of Appeal, is incorrect. Because all of the evidence was submitted without reference to this position, I shall consider the question of valuation without reference to onus.

Each party called a person whom they presented as a real estate expert. In both cases, the other party accepted that the person called was an expert. Each expert had prepared a schedule which showed sales in the calendar years 1970, 1971 and 1972 for the purpose of giving his opinion as to the value of the property in question. All sales were in the general area of Lot C. Both experts, in effect, Stated that the sales in the 1970 year were shown solely for information. They were not used in their valuation as they were too remote from Valuation Day. Both experts described the property, the surrounding area, the use to which they thought the property could be put, the discount factor or factors which should be considered, and ended up by giving their opinion as to the value of the land. The land in question, as has been mentioned, consisted of approximately 9.5 acres. The appellant’s appraiser pointed out that, in so far as size was concerned, there was no other parcel in his schedule of this size, although there was one sale in 1970 of just over 6V2 acres. and one in June and one in August 1972, of 5 /2 acres and 6 acres respectively. With one exception, all other parcels sold in 1971 and 1972 were less than 2 acres.

The respondent’s valuator had placed great reliance on a sale shown in his schedule as No 11: the sale date was May 1972; the selling price was $110,000; the size was 8.94 acres or 389,426 square feet. The price per acre was thus $12,304.25 or, per square foot $0.413. If I recall that valuation evidence correctly, he stated that, in his final judgment, parcel No 11 in his schedule weighed the greatest in forming his opinion as to the value of the land in question. It was brought out in cross-examination that the transfer (or sale) of parcel No 11 in May of 1972 was actually not a sale in 1972 but rather the giving of a deed or transfer after an agreement for sale had been satisfied. An agreement for sale was entered into in October 1969 between two parties respecting certain land on certain terms and conditions. By deed dated May 15, 1972 the vendor, in the agreement of sale, conveyed the land to the purchaser in the same agreement. The purchaser, which was a corporation, had at the time of the deed in May 1972 changed its corporate name, which change was reflected in the description of the purchaser. This transaction in 1972 was given great weight by the respondent’s valuator. Clearly it was not a transaction of 1972, but rather one of 1969 and, by the statement of both valuators, even 1970 transactions should be ignored. It was for this reason the appellant’s valuator did not make reference to this transaction.

On the schedule of land transactions of the valuator for the respondent was another transaction, No 15. It was a sale in September 1972 for $25,864. The land was shown as 2.571 acres and 111,993 square feet, with a price per acre of $10,059.90, and per square foot of $0.231. It turns out, however, that the acreage of the parcel was not 2.571 acres, nor 111,993 square feet, but rather, it was 1.3 acres and 56,628 square feet. The result is the price per acre would be $19,895, or $0.456 per square foot. Making these two changes in the respondent’s valuation schedule, the price per acre over the period 1971-72 would be $18,238 rather than $16,991.50, or $0.418 rather than $0.390 per square foot.

In reaching his conclusion as to value, the appellant’s valuator ascertained a value per acre of comparable 1- to 4-acre parcels and adjusted the result for size by 7/2%. On his figure this produced a value of $17,390 per acre for the subject parcel. To check, he assumed the property was subdivided into four equal lots, estimated the cost of so doing, and then, using the value based on comparable 1- to 4-acre parcels, he reduced it by his estimated costs, which gave a value of $17,483 per acre. He then estimates the value at $17,450 per acre for a valuation of $165,600. The respondent’s valuator, realizing that sale No 11 is most comparable at $0.282 per square foot and considering the value of the property to be less than the 1971-72 average, reduces the average by 20%, being “adjustment for size, topography,—location—20%’’, to arrive at his figure. There is no indication of how much of that 20% is to size, how much to topography, or how much to location. The appellant’s valuator allows 7.5% adjustment for size. He also made the comment: “Most of the comparable sales listed are very similar to the subject property in so far as type, location and potential use is concerned.’’ It would appear that, if the average price of the respondent’s valuator were corrected for the errors mentioned previously, and if the adjustment were only 7.5% instead of 20%, the two valuations would be very close: $165,600 to $160,000. Considering the two appraisals submitted and how they reflect the appraisers’ approach to the problem, and considering the manner in which each of those persons gave evidence, I prefer the appraisal of the appellant, and find the market value of the property in question on December 31, 1971 to be $165,600.

The appellant submits that that does not finally determine the value of the property at December 31, 1971. In effect, the appellant submits that one must look at the property and realize that it is not just land, but gravel as well, and that that gravel on that date had a value of $32,000, which amount must be added to the sum of $165,600 to produce a value for the subject property on December 31, 1971 of $197,600, which he rounded to $197,000. In ascertaining the value of this land, does one consider only its highest and best use, or does one consider its highest and best use and then add to that figure the value of the gravel which the land could produce? Accepting that the purchaser was not buying the property for gravel, he would consider, in ascertaining his purchase price, the highest and best use to which he could then put that property. The appellant’s appraiser, in his appraisal, stated: “It is therefore felt that commercial land value represented highest and best use of the land.’’ If I recall the evidence correctly, the sales which were used as a basis for arriving at a value to be used to determine the valuation of the subject property were nearby sales of commercial land. No evidence was given as to the value of a gravel pit where the gravel had been exhausted. Another point to recall is that the excavation of gravel on Lot A had ceased, and in 1971 gravel was stockpiled at that lot. While gravel in the location of Lot C may have had a substantial value in 1966, it would appear it did not have that value in 1971 and the gravel on Lot A had not moved as expected. I am of the view that the value of $165,600 attributed to the parcel of land in question as at December 31, 1971 is its full value.

The result is that the appeal is allowed and the assessment remitted to the respondent to be varied on the basis that the profit arising from the sale of Lot C was not a business profit, but was a capital gain. The quantum of the capital gain is to be determined on the basis that the value of Lot C on December 31, 1971 was $165,600.

Appeal allowed.