Nechako Holdings LTD v. Minister of National Revenue, [1977] CTC 2152, 77 DTC 125

Delmer E Taylor:—This is an appeal from income tax reassessments for the years 1971 and 1972, resulting from an addition by the Minister of National Revenue to taxable income of an amount of $82,576.87 previously declared by the appellant as a non-taxable gain on the sale of assets. The respondent relies, inter alia, upon sections 3, 4 85B and 139 of the Income Tax Act, RSC 1952, c 148, and amendments, and upon section 20 of the Income Tax Act, SC 1970-71-72, c 63, as amended.

Facts

Nechako Holdings Ltd (hereinafter referred to as Nechako) was incorporated in 1963 pursuant to the laws of the Province of British Columbia. Nechako was controlled by Mr Robert A Lougheed, and in the course of the business, it held and partially developed certain land in Prince George, British Columbia, during and including the years 1963 to 1967. In 1970 the appellant, through Mr Lougheed, acquired a franchise for $7,500 to operate a “Mr Mike’s’’ restaurant in Chilliwack, British Columbia, and opened for business on April 1, 1970. The business, including the assets and franchise, was sold in October 1971, and it is the gain of $82,576.87 on the sale of the franchise, which, after appropriate allowances for special reserves under section 85B of the Income Tax Act, has given rise to these assessments.

Contention

It was the position of the appellant that:

(a) it acquired the subject property for the sole purpose of owning and operating it as a business and developing it into a revenueproducing investment;

(b) it accepted the unsolicited offer to purchase the restaurant since, as the offer approximated the equivalent of five years’ profits from the business, it was extremely attractive and, in effect, meant that the investment had matured:

(c) the proceeds of the sale of the subject property were properly treated by the appellant as having been received on capital account and, as such, not susceptible to income tax.

The respondent took the view that the acquisition of the franchise, the development of the restaurant and its profitable sale as a going concern, were in the course of a venture in the nature of trade.

Evidence

Evidence for the appellant corporation was given by Mr Donald Dunaway, an accountant; Mr Clifford Rich, the purchaser of the business; and Mr Lougheed himself. The following documents were submitted to the Board:

A-1 Tentative agreement between Donald Dunaway and Robert Lougheed;

A-2 Agreement—Mr Mike’s Protected Territory Franchise Agreement

—between R A Lougheed and D Dunaway, dated March 31, 1970;

A-3 Application for a licence or transfer of a licence or interest therein (under the Government of the Province of British Columbia Government Liquor Act) dated July 28, 1970:

A-4 Letter dated September 1, 1970, to R A Lougheed from Donald George Dunaway;

A-5 Figures (presumed) of an opening statement;

A-6 Letter dated August 30, 1970, to Mr Lougheed from Clifford Rich (offer to purchase Mr Mike’s);

A-7 Letter dated July 7, 1971 to Mr Lougheed from Clifford Rich (offer to purchase Mr Mike’s);

A-8 Letter dated November 29, 1971 to Mr Rich from Nechako Holdings Ltd;

A-9 Profit and Loss Statement of Mr Mike’s, Langley, BC (March 20/70 to Nov. 30/70);

A-10 Letter dated November 16, 1970 to Mr E Rowley, from R A Lougheed for Nechako Holdings;

A-11 Letter dated March 15, 1971 to Mrs Clara Graham from R A Lougheed;

A-12 Application for a Licence . . . (Government Liquor Act— Government of British Columbia) . . . d/Oct. 23/1970;

A-13 Letter dated February 5, 1971 to Mr V C Woodland from R A Lougheed;

A-14 Letter dated April 21, 1971 to R A Lougheed from Kincaid, Epstein & Company and Memorandum of Agreement dated February 27, 1970 between Barry Investments Ltd and Haan Construction Ltd, of the First Part, and Mr Mike’s North America Steak Franchise Ltd, of the Second Part;

A-15 Letter dated July 8, 1976 to Nechako Holdings Ltd from Kincaid, Epstein & Company and Surrender of Franchise Agreement dated July 9, 1976;

A-16 Sale of Assets to Chilliwack Steak House Ltd dated December 31, 1971;

A-17 Operating Statement of Mr Mike’s of Chilliwack dated December 1971;

A-18 Invoice (November 5, 1970) to R A Lougheed from Kinsman, MacDonald & Mott.

Mr Dunaway’s evidence was that he had entered into an agreement, and looked forward to a long association, with Mr Lougheed in the “Mr Mike’s’’ franchise restaurant field, and that only certain domestic difficulties had forced his early withdrawal from what he could see would become a success.

Mr Rich, the purchaser, had owned and still owns a butcher shop immediately adjacent to “Mr Mike’s’’ in Chilliwack, British Columbia, and he asserted that his interest in purchasing the restaurant stemmed from the potential he could see in it if it were operated well; and also as a direct outlet for the sale of steaks from his butcher shop. During cross-examination it also became evident that he had managed to obtain access to the financial statements and operating records of the restaurant, before making his final offer to purchase it. This fact was apparently new to Mr Lougheed, and disturbed him greatly.

Mr Lougheed’s own direct evidence was that the owners of the franchising company, “Mr Mike’s North America Steak House Ltd’’ (hereinafter referred to as “Mr Mike’s’’), had intended to equip and Operate the location themselves because a prior agreement with a proposed franchisee had fallen through and, almost at the last moment, they had been forced to step in and complete arrangements for opening the restaurant. It was, according to the witness, at this opportune time that he happened upon the scene, and made his arrangements with “Mr Mike’s’’, although he had been investigating the possibilities and examining possible restaurant locations in British Columbia for some time. After acquiring the franchise, he had invested about $40,000 in equipment and furniture. His intention had been to open several similar franchise restaurants in British Columbia and he had planned to develop them into a chain, providing him with long-term revenue. He gave as support on that point the information that “Mr Mike’s’’ had indeed spread out very widely, and that the purchaser of his own franchise (Mr Rich) now had a second “Mr Mike’s’’ restaurant of his own. Mr Lougheed further stated that in 1964 he had entered the general insurance field, and that this had been his major activity and source of income in the years in question in this appeal, ie 1971 and 1972. He also stated that the “Mr Mike’s” restaurant in question had been granted a liquor licence shortly after it opened in 1970. Finally, he added that since 1972, together with his son, he had established other franchise businesses in the fast-food lines and these were now showing signs of success.

Counsel for the respondent did not call witnesses but did introduce a document, the Memorandum of Association for Nechako Holdings Ltd—Exhibit R-1—which Memorandum is part of the incorporation proceedings of the appellant. Counsel also established in the cross-examination of Mr Lougheed that he (Lougheed), in conjunction with certain partners or other corporations in which he had been a shareholder, had participated in at least three ventures in the hotel or motel business, all in British Columbia, one in 1958 in Kimberley, a second in 1960 in Penticton, and a third in 1963 in Osoyoos. These were in addition to the previously noted involvement of the appellant corporation in the Prince George land development. The individual partners or the corporations in these earlier activities were either similar or identical to the proprietorship structure of the appellant corporation in this case, with Mr Lougheed always a major participant.

Argument

The contention of Mr Lougheed on behalf of the appellant was that none of the previous business activities of Nechako, nor any of his personal or other corporate business activities, should have any bearing on this particular transaction. He had simply seized on an opportunity to get a franchise, and build up a business in order to start a series of these “Mr Mike’s” restaurants since he had been greatly impressed with their potential for growth and profitability; and he had intended to operate the business himself, or at least with partners such as Mr Dunaway, originally. Only the demands of his own insurance clients, the unfortunate leaving of a managerpartner (Mr Dunaway), the bad experiences with trying to get a good replacement manager, the ‘‘absentee ownership” problem necessitating a great deal of travel and expense on his part, the requirement that the restaurant be well run to retain the franchise, and finally, the continuing proposals from the eventual purchaser, led him to sell, albeit at a profit.

Counsel for the respondent argued that this transaction was merely one more in a long series of such efforts, all successful, by the appellant corporation or its major shareholder Mr Lougheed, to buy a business with assets such as land, hotel, motel or other, build- up and develop the business, and then sell at a profit. In this case the asset acquired was a franchise but the principle of treating it only as an item of merchandise, available for sale at a profit, remained in the mind of Mr Lougheed. The appellant had opened the restaurant under the franchise, obtained equipment and importantly a liquor licence, operated it at a profit, and when the right opportunity, at the right price, came along, did what had always happened under the direction of Mr Lougheed, sold for a profit. According to counsel, Mr Lougheed had not intended to be in the restaurant business, he was rather in the business of buying and selling businesses. Counsel referred the Board to several cases and in particular one dealing with the same appellant. This case, Nechako Holdings Ltd v MNR, [1971] Tax ABC 940, 71 DTC 648, came before the Tax Appeal Board, the predecessor to this Board, and I quote an excerpt from pages 951 and 655 respectively of that judgment:

It was admitted by Mr Lougheed that the original subject property was quite adequate for the motel project contemplated and there was no Suggestion of any lack of money with which to proceed: indeed, quite the contrary was indicated. Yet, for some reason, the appellant chose not to proceed with its proposed project immediately but instead concerned itself with the prospect of acquiring, if possible, additional land. When this latter effort failed, the appellant lost no time in appointing an agent to sell the property. In fact the said agent was appointed several years before the possibility of acquiring additional property had definitely proved hopeless. Furthermore, a “For Sale” sign had been erected on the land. In all this, Mr. Lougheed was putting to good account his considerable experience in picking up desirable motel properties and turning them to account in a profitable manner.

After a full consideration of the evidence adduced, I am unable to detect any error on the part of the Minister in assessing the appellant as he did.

In my view, bearing in mind the history and prior experience of the president of the appellant company, the evidence, taken as a whole, leads to the conclusion that the Minister’s assessments must be confirmed and the appeal dismissed.

Findings

The Board accepts that the major shareholder of the appellant corporation, Mr Lougheed (if not this corporation itself) had a long and varied record of involvement in the business field, in which several businesses seem to have been “turned over’’ at a profit. The fact is recognized that this is the second time the appellant corporation has been before this Board (or its predecessor) on a matter essentially similar in both cases—capital gain or income—and that in a lengthy and detailed judgment given by the then Member, W O Davis, QC, the ruling went against the appellant. This acknowledged set of circumstances forms the background against which the respondent holds up the facts in this case, and in assessing the appellant, perceives no distinction—the shades of this last situation blending in perfectly with the patterns of the former. The Board, however, has been urged by Mr Lougheed to find and accept such a distinction, and it is therefore incumbent upon the Board, while remaining mindful of the similarities obviously considered substantial by the respondent, to set out and weigh any contrast which can be determined from the evidence.

First, there is no evidence that the appellant corporation, in its own right, was engaged in the years between 1967 and 1970 in any substantial business venture, or that, even accepting the “turn-over” pattern perceived to have existed by Mr Davis, in the earlier “Nechako” case, the company had continued such a questionable pattern of activities during these years. Second, there is no evidence that the major shareholder, Mr Lougheed, in his own right, was engaged in ventures of substance other than the pursuit of insurance business, from the year 1964 up until the events in 1970 leading to this appeal. He does retain an interest in some recreational property on which there are some nine cabins but there is no evidence that this is relevant or significant in this appeal. Neither Mr Lougheed nor the appellant appears to have been previously engaged directly in the restaurant business, and there is no indication that either one had been in the business of buying and selling franchises—quite a different, rather more intangible commodity, than land, a hotel or a motel. Third, Mr Lougheed’s explanation of his initial agreement with Mr Dunaway is plausible, and supported by Mr Dunaway. Fourth, he took over the franchise for $7,500 directly from “Mr Mike’s”, after an earlier agreement with another potential franchisee had failed. There is no evidence that “Mr Mike’s” considered the amount of $7,500 unreasonably low or that ‘‘Mr Mike’s” considered there was a possibility of selling the franchise soon at a great profit. It can be presumed that “Mr Mike’s” would have known as much or more about the restaurant’s possibilities as did Mr Lougheed, and the Board would find it difficult to accept that the experienced franchising company would have knowingly given up the opportunity for such great profit, in so short a time. Fifth, there is no evidence to connect Mr Lougheed and/or the appellant corporation with the eventual purchaser, Mr Rich, that could imply a “non-arm’s-length transaction”. The record of his interest in the restaurant, his first offer, its rejection and the reasons for, basis of and acceptance of his last offer, are all attested to both by Mr Lougheed and Mr Rich. Finally, Mr Rich has opened a second “Mr Mike’s” and he remains satisfied with his purchase; Mr Lougheed has remained in the restaurant and franchise field and is now in new businesses working with his son selling “fast food”.

For the Board to hold that the appellant, on a primary basis, or at least on a secondary basis at a very high level of consciousness, entered into this particular business with the intention of making a profit on the resale of the franchise, would require the complete rejection of whatever support for the appeal, on its own merits, was brought out in the evidence recited above. It would further necessitate the acceptance of a proposition which, as a principle, would be dangerously close to stating that, once having been adjudged liable for income tax under a given set of circumstances, the appellant should remain in continued jeopardy and that the earlier transactions should be the deciding factors under a new and allegedly separate set of circumstances.

Decision

The Board finds that the appellant, Nechako Holdings Ltd, has provided satisfactory evidence and testimony in support of its appeal that the gain realized on the sale of an operating franchise for a “Mr Mike’s’’ steak house restaurant in Chilliwack, British Columbia, should be regarded as on capital account rather than income account. The appeal for the years 1971 and 1972 is hereby allowed and the matter is referred back for reconsideration and reassessment accordingly.

Appeal allowed.