Spence Building Limited v. Minister of National Revenue, [1977] CTC 2104, 77 DTC 71

Delmer E Taylor:—This is an appeal from income tax assessments for the years 1972 and 1973. There is one matter at issue, common to both years, and that is the disallowance by the Minister of National Revenue of the appellant’s claim for the “small business deduction’’ provided under section 125 of the Income Tax Act. The position of the appellant is “that the time and effort necessarily expended in the building management qualifies the net rentals as active income’’. The respondent submits “that no portion of the amount shown as ‘Operating Profit’ on the appellant’s Profit and Loss Account for the 1972 and 1973 taxation years was income from an active business’’. The respondent relies, inter alia, on section 125 of the Income Tax Act, RSC 1952, c 148, as amended by section 1 of SC 1970-71-72, c 63.

The appellant is a company incorporated in 1961, holding the building now described as located at 910 Ridgeway Street, Thunder Bay, Ontario for use as a medical clinic. The building is the family home of one of the doctors in the medical clinic, Dr John B Spence, who is also president of the appellant company. The operation of the medical clinic is not a matter for review at this hearing, other than to say it was in the form of a partnership comprised of as many as twelve doctors at some periods since its incorporation, two of these doctors being the aforementioned Dr Spence and his brother-in-law, Dr Harley J Hughes, also one of the other shareholders in the appellant company during the taxation years in question. The two doctors, Dr Hughes and Dr Spence, each held one-third of the capital stock in the company, the other third being held within the extended Spence family. The clinic functioned separately from the building. However, the building at 910 Ridgeway Street was the physical location of the clinic, the total medical partnership paid a set rental to the appellant company (not each individual doctor) and the arrangements were formalized in a lease. The following documents were identified by the president of the appellant company and filed with the Board:

Exhibit A-1—letters patent of Spence Building Limited

Exhibit A-2—supplementary letters patent of Spence Building Limited

Exhibit A-3—a Lease between John Bruce Spence et al (the medical clinic partnership) and the appellant

The evidence of Dr Spence was essentially that the arrangements for the medical clinic required a great deal of attention from him to provide appropriate space for the doctors, to supervise renovations and repairs, to give proper security, administration, etc. From the Notice of Appeal the following quotation is taken:

Problems arose and are continuing to appear as to the building and its management because the premises are such an integral part of the medical clinic’s particular practice, which in its own way, has had to change progressively with the times.

Counsel for the respondent, through Dr Spence, introduced the following documents in cross-examination:

Exhibit R-1—agreement between the partners in the medical clinic dated December 15, 1971

Exhibit R-2—deed of land dated December 31, 1960 for the property involved

In addressing the question before it, the Board is of the opinion that the major, if not the only important item of evidence, is Exhibit A-3, the lease between the medical clinic partnership and the appellant company. The matter at issue is whether the term “active business’’ is applicable to the appellant. This would appear to dictate an examination of whether the role filled by the appellant should be defined as “business” and, if so, whether this was an “active” business. The Board is well aware that the subject of this hearing dealing with section 125 of the Act is one which has been explored and reviewed only to a limited extent. Therefore the Board takes into account the explanatory information available, and the earlier decided cases in searching for an interpretation of the section.

Department of National Revenue Interpretation Bulletin IT-72R, dated August 31, 1973, dealing with this matter would not have been available when the 1972 corporation tax return was filed, but it would have been available for the filing of the 1973 income tax return (and any amendments to the 1972 return which would have been appropriate after reading the Bulletin). It is recognized that the Bulletin provides only guidance and it does not take the place of the law, yet within that framework it should not be completely ignored. IT-72R, paragraph 8, reads as follows:

8. Corporations that derive income from rents are carrying on business but not necessarily an active business. Whether a corporation deriving virtually all its income from rentals is Carrying on an active business will depend on the extent of services supplied to tenants or the degree of attention the business requires. Either of these tests will qualify it. Where the services consist of nothing more than ordinary maintenance and operation such as cleaning, heating, supplying janitor service and appliances in working order, repairing furniture in public areas or rented to tenants, etc., they will not in themselves support the contention that there is an active business. Where services go beyond that, e.g. to include maid service, the serving of meals or drinks, the provision of linen, protective services or recreational facilities, normally there would be an active business. As to the attention the business requires, the business will be considered active if it is of such size or has such problems that an office is maintained with a telephone listing and clerical or managerial staff are employed on a full-time basis.

This explanation would seem to answer the first part of the matter at hand—whether deriving income from rents can be considered “business”. It appears to be answered in the affirmative. However, it is clear that no such acquiescence is forthcoming in this Bulletin with regard to the term “active”. The extent of services supplied to tenants, or the degree of attention the business requires, are the tests set forth in the Bulletin.

Leaving this Interpretation Bulletin for the moment, the Board takes note of two other decisions which clarify to a considerable degree the subject of this hearing. These are the decisions in Smithers Plaza Ltd v MNP, [1975] CTC 2171; 75 DTC 137, heard by the Hon Lucien Cardin, QC, then Assistant Chairman and now Chairman of this Board; and in Her Majesty the Queen v Rockmore Investments Ltd, [1976] CTC 291; 76 DTC 6156, heard before the Chief Justice and Pratte, J and Hyde, DJ of the Federal Court of Appeal. For reference purposes the following excerpt is quoted from the decision in Smithers Plaza Ltd (supra), at page 2173 [139]:

In my opinion investment in movable or immovable property on a longterm basis cannot in general be considered to be a profit-producing business enterprise. Whether the taxpayer invests in one or in a dozen rental properties, whether he leases the premises and collects the rent himself or has an agent to do it for him, whether or not he provides janitorial services, does not in my view change the nature of his investment if the services rendered are aimed at and limited to the leasing and the maintenance of his property and the structural upkeep of the leased premises. The provision of usual maintenance services and looking after their attending cost is, in my view, an integral and necessary part of a taxpayer’s investment in property, which gives rise, not to a business profit, but to rental income. I do not believe that the degree or the extent of the taxpayer’s activity in connection with the normal operation and maintenance of a long-term rental property can automatically transform the taxpayer’s investment in such property into an investment in a business. The nature of the two investments is, in my view, basically and fundamentally different and, for purposes of the Income Tax Act, should not be confused.

And from the decision in Rockmore Investments Ltd (supra) at page 293 [6157] the following is taken:

In considering whether there is an “active business” for the purposes of Part I, the first step is to decide whether there is a “business” within the meaning of that word. Section 248 provides that that word, when used in the Income Tax Act, includes ‘‘a profession, calling, trade, manufacture or undertaking of any kind whatever” and includes ‘‘an adventure or concern in the nature of trade” but does not include “an office or employment”. Furthermore the contrast in paragraph 3(a) of the Act between “business” and “property” as sources of income makes it clear, I think, that a line must be drawn, for the purposes of the Act, between mere investment in property (including mortgages) for the acquisition of income from that property and an activity or activities that constitute “an adventure or concern in the nature of trade” or a “trade” in the sense of those expressions in section 248 (supra). Apart from these provisions, I know of no special considerations to be taken into account from a legal point of view in deciding whether an activity or situation constitutes the carrying on of a business for the purposes of Part I of the Income Tax Act. Subject thereto, as I understand it, each problem that arises as to whether a business is or was being carried on must be solved as a question of fact having regard to the circumstances of the particular case.

Also from the judgment in Rockmore Investments Ltd (Supra), the Board notes with appreciation the following comments dealing with the application of the term “active” at page 293 [6157]:

Having reached that conclusion, the second question to be answered is whether the business that was being carried on was an “active” business within the intent of section 125. Obviously, the concept of “active” business is not used to exclude a business that is in an absolute state of suspension because subparagraph 125(1)(a)(i) is dealing with “income . . . from an active business” and it must be assumed that the word “active” was used to exclude some businesses having sufficient activity in the year to give rise to income. [Compare Clevite Development Limited v MNR, [1961] Ex CR 296; [1961] CTC 147; 61 DTC 1093.] More than that, as it seems to me, nothing can be said in a general way, at this stage, as to what is meant by the word “active” in subparagraph 125(1 )(a)(i). [As I read subparagraph 125(1 )(a)(i), the question is whether the “business” was ‘‘active’’ and the question as to how active the proprietor was in the business activities would not seem to be relevant. To me, this would seem self-evident and its statement does not constitute the enunciation of any general principle.] Each case must be dealt with by the fact finder according to the circumstances of the case. It may be that experience in the application of the provision will make evident other conclusions of a general nature that can be deduced from the Statute as to how the concept of “active” business is to be applied. I do not, myself, feel capable of deducing any such general conclusion at the present time.

The conclusion I reach from these two learned decisions is that it is not entirely certain, as implied by Interpretation Bulletin IT-72R, that income derived from rents is to be considered as “business” income. Indeed, the learned Justice in the Rockmore Investments Ltd case stated quite specifically “that a line must be drawn, for the purposes of the Act, between mere investment in property (including mortgages) for the acquisition of income from that property and an activity or activities that constitute ‘an adventure or concern in the nature of trade’ . . My reading of that phrase leads me to believe it is the “activity or activities” that determine if the matter under review can appropriately be termed a “business”.

The appellant did not deal specifically with the issue of whether or not the company was operating a “business” for purposes of the Act, dealing rather more explicitly with the fact that the business was an active business. In addition to examining the exhibits filed at the hearing, together with the verbal evidence, the Board has also reviewed the appellant corporation’s financial statements and tax returns for the years in question since these were made available.

From the documented sources the following can be determined regarding the appellant company:

(1) The company held only one asset—the real estate in question, the book value of which was $66,591 at December 31, 1972 (land and building).

(2) The building was leased at a fixed rental of $1,275 per month ($15,300 per year) for a period of 15 years commencing January 1, 1960. The operative clause in the lease is:

The Lessors and the Lessees hereby agree that the effect of this lease shall be that of a net lease at the rate of $1275.00 per month for the term of fifteen (15) years, and out of these rentals the owners shall be responsible only for insurance, taxes and structural repairs.

(3) The medical clinic partnership (The Spence Clinic) was the lessee of the building. Each individual doctor was not a separate lessee.

(4) The respective responsibilities of both parties was determined by the terms of the lease, as follows:

The said Lessee covenants with the said Lessor to pay rent and all light, water and telephone rates, and business tax, and all municipal or provincial or other license fees payable for carrying on any business carried on by it.

AND to repair, reasonable wear and tear and damage by fire, lightning and tempest only excepted.

AND that the said Lessor may enter and view state of repair.

AND that the said Lessee shall keep the said premises neat and clean.

AND that the said Lessee will repair, according to notice in writing, reasonable wear and tear and damage by fire, lightning and tempest only excepted.

AND will not assign or sub-let without leave.

AND will not carry on any business that shall be deemed a nuisance on Said premises.

AND that it will leave the premises in good repair, (reasonable wear and tear and damage by fire, lightning and tempest only excepted) and that the said Lessee shall repair and replace any plate glass or other glass in said premises which may be damaged or destroyed during its occupation of the same.

(5) The appellant company’s functions in 1972 and 1973 consisted of the collection of the rent from the clinic, and the payment of certain direct expense items. The clinic also contributed a portion of the total municipal taxes (approximately equal to the municipal business taxes) and a provision for depreciation was also made. By way of illustration the appellant’s profit and loss account for the year ended December 31, 1972 is reproduced:

SPENCE BUILDING LIMITED

PROFIT AND LOSS ACCOUNT

For the Year Ended December 31, 1972

Income

Rents Received—The Spence Clinic		$18,000.00
City Taxes—As per The Spence Clinic Lease		1,646.56	$19,646.56
Expenses
City of Thunder Bay—Taxes		3,655.67
Insurance		455.04
Accounting—1971 and 1972		270.00
Ontario Corporations Capital Tax		50.00
Mortgage Interest
—Sun Life Assurance Co.	$ 216.54
—Spence Estate	17.04
—Spence-Hughes-Spence	1,004.61	1,238.19
Depreciation
—Clinic Buildings 5%	$47,990.55	2,399.55	8,068.45
Operating Profit			$11,578.11
Less—Reserved For Income Taxes			2,923.47
Net Profit For Year			$ 8,654.64

From the above points it may reasonably be concluded that the operation of the appellant could be conducted, in theory at least, by the deposit in the appellant’s bank account of twelve rental cheques from the lessee, and perhaps a thirteenth for the portion of the municipal taxes; and by the issuance of eight cheques from the bank account, one each for municipal taxes, insurance, accounting, Ontario corporation capital tax, three for mortgage interest, and finally one, if necessary, for corporation income tax. It is possible that actual operations may have been slightly more extended than this, but under the terms of the lease such operations could not have been much more complicated. These expenditures would logically be those most necessary (almost the minimal ones) for the appellant to retain its title in the property and maintain its corporate charter. There was no opportunity nor requirement on the part of the appellant for renegotiation of any part of the lease or to deal with each medical clinic partner individually at any time during the entire period of 15 years. Except for “structural repairs’’ there was no responsibility on the lessor for the real estate from a physical viewpoint. In this connection there is some evidence that in 1972 a new furnace was installed at a cost of approximately $525, but there is no indication of other “major repairs’’. In summary, the terms and the implementation of this fixed 15-year lease with one tenant show the character of a long-term investment rather than an adventure in the nature of trade.

Having regard to the distinction indicated between “business’’ and “property’’ in section 3 of the Income Tax Act, and relating the facts in this case to the interpretation and differentiation provided in the two decisions cited earlier, this Board is of the opinion that the income of the appellant, which is the subject of this hearing, is from property and not from business, for purposes of the application of section 125 of the Income Tax Act.

There is no doubt from the evidence that the president, Dr Spence, did expend considerable time and effort on the matters of maintenance, renovation, administration, security, etc in the interest of a functioning business establishment. The business establishment involved, however, was clearly the medical clinic, not the appellant corporation. Dr Spence was the president of the appellant company but his personal activity cannot be confused with the alleged activity of the corporation. The Board recognizes in this that Dr Spence probably had no more direct responsibility than his other medical partners, but that barring his efforts, many important matters might have remained unattended. The functions themselves, however, were a result of his position as a partner in the medical clinic and did not flow from his position as president of the appellant corporation. A clause taken from the lease (Exhibit A-3) makes this clear:

The Lessees hereby covenant to maintain the buildings herein demised and to make all repairs, save and except structural repairs not required by the operations of the Clinic.

Viewing this part of the question, in the decision of Rockmore Investments Ltd (supra), the Chief Justice has added this explanatory comment, which has been reproduced earlier:

As I read subparagraph 125(1)(a)(i), the question is whether the “business” was “active” and the question as to how active the proprietor was in the business activities would not seem to be relevant. To me, this would seem self-evident and its statement does not constitute the enunciation of any general principle.

Having determined, therefore, that on the merits of its own activity, the appellant corporation earned its income from “property” rather than from “business”, the Board finds no basis for adjusting that posture by recognizing personal activity conducted outside the scope of the appellant’s responsibilities under the lease agreement.

According to the judgments in the cases I have cited in this decision, it is an examination of the “activity” or “activities” of the operation in question which forms the basis for determining whether the income of a corporation should be identified as from a “business” or a “property”. The review in this case of the various possible factors and characteristics in such “activity” or “activities” has provided little enlightenment on how any “corporate business income” (once having been identified as such) might be regarded as from other than an “active” business. The Chief Justice in the judgment in the Rockmore Investments Ltd Case demurred from giving any general conclusion on how the concept of “active” business is to be applied. The Board’s determination that the income in question in this appeal is from “property” and not from “business” leaves it unnecessary to pursue the matter of the “active” identification any further.

The appeal is dismissed.

Appeal dismissed.