Mohican Holdings Limited v. Minister of National Revenue, [1977] CTC 2212, 77 DTC 143

The Assistant Chairman:—Mohican Holdings Limited (sometimes hereinafter called either “Mohican” or the “appellant’’) has appealed to this Board from an assessment for tax for the 1971 taxation year. In that year, it sold a vacant piece of real property (hereinafter referred to as the “York-Adelaide property”) at a profit of $866,396.66. The appellant did not report that profit as income. The Minister of National Revenue, by Notice of Reassessment dated July 15, 1974, reassessed the appellant adding that amount to its income.

The appellant is a corporation, incorporated pursuant to the laws of the Province of Ontario. A solicitor in the Province of Ontario took instructions from a solicitor in the City of Hamburg, Germany, who was acting on behalf of Werner Otto, a German citizen. Mr Otto, in 1965, was a successful businessman operating a business known as “Otto Versand’’. Following World War II, Mr Otto commenced to sell shoes and was somewhat successful. In the late 1940s he expanded the type of merchandise he was selling and his business grew. The growth in his business led to the issuance of catalogues showing the articles which could be purchased from him. The evidence indicated that in the 1950s and 1960s the growth of the enterprise was so phenomenal that the business became the third largest mail-order house in the world. Initially Mr Otto was the sole proprietor and, following incorporation, he and his family owned all the issued shares. As time passed, their share ownership decreased. At the date of the hearing, Mr Otto and his family owned at least 50 per cent of the issued capital.

Mr Otto stated that in days gone by his grandfather had lost a fortune, his father had suffered the same fate, and he, himself, as a youth had gone through a similar experience. Realizing what some of his ancestors had gone through financially, he resolved that his children would not suffer, if he could prevent it, a similar fate. He resolved that on behalf of his children he would invest in a country other than Germany where there was security and stability and, in this respect, he chose Canada. He also determined that he would invest in real property which was easily managed with little risk attached to it and which would produce a good return. At this time (mid 1960) Mr Otto was married with five children. The children were minors then and some of them still were at the date of hearing. In furtherance of his plan, he instructed his German solicitor to take steps to cause five companies to be incorporated in Canada: each company was to be the investment vehicle for one of his children. An Ontario solicitor carried out the instructions of Mr Otto’s solicitor and, in the summer of 1965, Ontario Letters Patent were issued creating the appellant as well as four other companies.

Initially Mr Otto was the sole beneficial shareholder of each of the companies. Insofar as the appellant was concerned, one of Mr Otto’s daughters was, by the end of 1970, its sole shareholder. Mr Otto also caused a sixth company to be incorporated. It was a management company to manage the affairs of the other companies.

The appellant, to establish that the profit in question was not income from a business, put before the Board not only all the activities of the appellant, but also the activities of the four other companies. As to the appellant itself, on July 31, 1965, it acquired six apartment buildings at a purchase price of about $4,500,000. This property it still owns. On November 28, 1968, it acquired a parking lot, having an area of slightly in excess of 18,000 square feet, at the junction of York and Adelaide Streets, in the City of Toronto, in the Province of Ontario. The purchase price was just less than $750,000. The property was disposed of on March 1, 1971 for in excess of $1,600,000. The property was in the same state at the date of sale as it was when it was purchased. It is the profit from this transaction which gives rise to the present appeal. In September, 1971 a 205-suite apartment building at 66 Isabella Street in Toronto was purchased as a revenue-producing asset. It is still retained. In February, 1971 a parcel of land comprising 77 acres and known as “Appleby Industrial Park’’ was acquired for future development, subdividing, construction, leasing, etc. Services were put in on the property and about 30 acres were sold to finance the cost of the services. The balance, about 47 acres, is still retained. It is at this time non-revenue producing. The profit on the sale of the 30 acres was considered by the appellant to be taxable and was so reported. In July, 1971 another parcel of 26 acres known as “Humberline Industrial Park” was acquired for future development. As with the Appleby Industrial Park, services were put in on the property and about 14 acres were sold in 1974 to provide for the cost of those services. The profit on the transaction was considered by the appellant to be taxable income and was so reported. On a portion of the remaining 12 acres, a building was erected in 1975. The balance of the land is still vacant.

The other four companies whose corporate names are:

(a) Artemis Holdings Limited (sometimes hereinafter called “Artemis”),

(b) Frasmet Holdings Limited (sometimes hereinafter called “Frasmet”),

(c) Hanseatic Holdings Limited (sometimes hereinafter called “Hanseatic”), and

(d) Kamato Holdings Limited (sometimes hereinafter called “Kamato”),

had the transactions hereinafter set forth. All the land referred to in the transactions is in the general area of Toronto and Hamilton, Ontario.

There is yet another corporation which is occasionally referred to, namely, Melford Development Incorporated (sometimes hereinafter called “Melford”). The shareholders of this company are Mrs Otto and two of her children.

Artemis, in March, 1965, purchased two parcels of land within the City of Toronto. On one was an office building, which it still holds, and on the other was a 63-suite apartment building. The apartment building was only held for a little over a year when it was sold due to a poor investment return. The profit of less than $100,000 was considered a Capital gain. In conjunction with Melford, Artemis had a 25 per cent interest in a residential subdivision of about 16 acres. The property was acquired in October 1973, for development and, in 1976, it was being developed and sold. The profit with respect to the transaction, being in the neighbourhood of $2,000,000, was considered by Artemis to be taxable.

Frasmet, in June, 1966, acquired an office building in the City of Hamilton, in the Province of Ontario. It was then rented and is still owned today. In November 1968, it purchased two parking lots in downtown Toronto for a total cost in excess of $600,000 for development projects. They are still operated today as parking lots. In November 1969, 26.77 acres of land were purchased at a cost of about $290,000 in Burlington, Ontario, described as “Blair Industrial Park”. On a portion of the land, an industrial building was built, in 1971-72, which is leased. The balance of the land is still vacant. A further parcel of 77 acres, known as the “Richardson Farm”, also in Burlington, Ontario, was purchased in January 1970, in the name of Frasmet. This property should have been owned by the appellant and was, in February 1971, transferred to that company at cost. What happened to that land is referred to in the transactions relating to Mohican. In January 1972, a parcel of 90 acres known as “McCowan-Passmore farmland” in Scarborough, Ontario, was purchased for development of a residential subdivision at a cost just in excess of $1,000,000. Frasmet, after holding the property for about two years, believed that for political reasons a long delay in its development was indicated, and so sold the property in September 1974. The profit was about $2,750,000 which Frasmet considered to be taxable, and so reported it. In January 1972, it purchased an industrial site of 5.44 acres known as “Belfield Court” for construction and leasing. The purchase price was in excess of $250,000. Two industrial buildings and an office building were built on the land and leased. Some of the land is still vacant. None has been disposed of. In June 1973, an 84-acre parcel known as “Hi-Mar” was acquired for future development as industrial. It was combined with property owned by Melford in October 1973, and then sold. There was a profit of about $150,000 which it considered as taxable, and so reported it. A further parcel of 50 acres was acquired in the Dixie-401 area in August 1973, at a cost of $840,000. The land was designated industrial and it was to be developed, subdivided, with buildings constructed thereon and leased. In 1974, ten acres were sold for $760,500; in 1976, five acres for $350,000; and also in 1976, two acres were sold for $176,500. The profit from each of the above transactions was considered by Frasmet to be income, and either has been or will be reported as such. On some of the remaining property, one building was constructed and leased, one was built for a purchaser, and three buildings were, at the date of hearing, under construction for leasing. Some vacant land still remained.

Hanseatic, in 1963-64, purchased three buildings known as the “Brimclair Towers”, “Towers of York”, and “Braeburn Woods”, as well as 12 residential buildings for $5,600,000. The property is still retained as a revenue-producing property. It also purchased in November 1969, a 101-acre parcel of vacant land described as “White Oaks” in the Oakville, Ontario area. It is industrial land for subdividing, servicing, construction, and leasing. The purchase price was about $1,200,000. It is still vacant land producing no revenue.

Kamato, in June 1965, for over $600,000 purchased “Torlake Crescent”, being two industrial buildings, as a revenue-producing investment. It is still owned as such. At the same time, the “Prince Andrew Place’, also being two industrial buildings, was acquired for about $1,200,000 as a revenue-producing investment. It was disposed of in October 1969, at about $150,000 profit. Its main tenant was in financial difficulties and, when an unsolicited offer was received, it was accepted. Kamato considered the profit to be a capital gain and, after discussion with the Department of National Revenue, Taxation, they agreed with its position. In September 1965, a property known as the “Larkin Farm’, consisting of about 98 acres, was acquired at a cost of $172,000. It was acquired for future development and is so still held. It has produced no revenue. An apartment building at 100 Roehampton, consisting of 211 units, was purchased as an investment in January 1966, at a cost of about $2,800,000. I. is still held. An industrial area of 101 acres in the vicinity of Dixie Road at 401, in the County of York, was acquired in December 1971 for about $1,700,000. It was designated industrial and was to be subdivided for construction, leasing and selling of lots. Some of the land was serviced and, in 1974 and 1975, 37 acres were sold for a profit of about $800,000. The sale was to pay for the financing of the servicing as well as the debt service. Kamato reported the profit as a taxable profit. On some of the remaining acreage, three buildings were built and leased in 1975-76. The remaining vacant land is held for future use.

In addition to Mr Otto, evidence was given by Manfred Weidner who was the president of the appellant from 1972. He had been an auditor of the Otto Versand from 1959 and an employee since 1965. Kjeld Larsen also gave evidence. At the time of the hearing he was no longer employed by Mr Otto or any company with which Mr Otto was associated. He was a real estate consultant, and was vice-president of the appellant for the period April 1969 to April 1972. Mr Larsen stated that he spent considerable time in Canada as he was charged with the day-to-day operations of the five companies. His instructions, he stated, reflected the policy of the companies: he was to maintain existing investments and increase the long-term holdings for the benefit of the children of Mr Otto. Mr Larsen explained at some length the steps taken to try to develop an office building on the York-Adelaide property: the interview he had with respect to getting mortgage commitments, the discussions with banks in Germany, the discussions with officers of Cadillac Development Corporation Limited, the giving of notice to quit to the tenant of the property so that plans could be made to start building, and many other details. He also referred to the memorandum of proposed agreement between the appellant and Cadillac Commercial Properties Limited (hereinafter referred to as “CCP”), the project analysis, the outline of specifications for the building, and the drawings made of floor plans. The drawings were done by CCP but the appellant paid half the cost. Mortgage commitment was the problem: no lending agency would make a firm commitment so that the project could proceed. The steps above recounted commenced shortly after the property was purchased and terminated late in the 1970 calendar year.

According to Mr Larsen, the appellant, in the late 1970s, had to act fast because of the other office buildings in the same general area which would be coming on the market soon. He referred to those buildings in downtown Toronto known as the “Toronto-Dominion Centre”, “Commerce Court’, “Royal Trust Tower”, and the “First Canadian Place”. If the appellant’s building came on the market later than those buildings, as it appeared in late 1970 it would, then there might, not be the demand for office space.

In early November 1970, while in Germany, Mr Larsen received a phone call from a Toronto broker asking about the possibility of buying the property. Mr Larsen advised that the property was not for sale but the broker was adamant. The result was that Mr Larsen informed the broker that if he were serious, then he should submit an offer. Later an offer was submitted which was ultimately accepted, and the property was disposed of, producing the profit in question.

Considerable evidence was given by Dr Joergen Anderegg, a German businessman who has a PhD in economics. He was with the Otto Versand when the property in question was sold, but not when it was purchased. He, to the extent of his knowledge, corroborated the evidence of Mr Larsen. Dr Anderegg did say that the Otto Versand did own property, did buy property, and did sell property, but solely in connection with its catalogue business. It needed buildings to display its merchandise, as well as to store it. Likewise, as times changed, a place would be closed and sold while another one elsewhere was bought and opened.

From the corporate point of view, Dr Ewerwahn, a practising lawyer from Hamburg, Germany, also gave evidence. Dr Ewerwahn was a Doctor of Laws. Mr Otto and the Otto Versand had been his clients from about 1955, and it was he who instructed the Ontario counsel to set up the companies in Ontario previously referred to. Dr Ewerwahn indicated Mr Otto’s intention behind the incorporation of the various companies was that they could invest in real estate and produce income for his five children. During the course of the hearing, frequent reference was made to “the Beirat’’. It would appear that this was the name given to a group of people who had been selected by Mr Otto to advise him. Some witnesses left me with the impression that the decision of “the Beirat” as to whether or not something should be done (for example, buy a parcel of land), was binding on Mr Otto and he was required to do that which “the Beirat” directed, regardless of what he thought. I prefer to look at the Beirat as just skilled advisers to Mr Otto. Dr Ewerwahn stated, if I remember correctly, he could never recall Mr Otto being overruled by the Beirat. Mr Otto stated: “In my modest opinion, I have a great deal of influence on the Beirat.” Consequently, I regard the Beirat as a group of people who knew what Mr Otto had in mind, and they exercised their skills in advising him, knowing what his aims and ambitions were. Dr Ewerwahn, with Mr Otto, in June of 1968, saw a “for sale” sign on the property in question, which was then being operated as a parking lot. To both of them it appeared to have a good location in downtown Toronto. Advice was sought from a real estate broker and other properties were seen. In due course, the decision was made to buy the property for an office building. The question of re-sale at a profit was never considered by Dr Ewerwahn or Mr Otto. As for selling, it was realized, at the time of purchase, that the revenue the land produced under the lease to the parking-lot operator would not pay the carrying charges, so steps to build the building had to be taken rapidly. They were but, when financing could not be obtained within two years and an offer to buy was received, the decision was made that the land could no longer be held.

The property was not purchased before information was received concerning rents and the general market situation. The funds to acquire the property, as well as funds to pay off any mortgage, came from the profits of the mail-order business or from Mr Otto. Financing, at the time of acquisition, was not considered to be a risk.

Shortly after the property was acquired, the appellant entered into a fifteen-year lease with City Parking Canada Limited so that the lessee could operate a parking lot. The lease contained, inter alia, the following clauses:

1. The Tenant, may, upon not less than twelve (12) month’s written notice to the Landlord, surrender to the Landlord its interest in this Lease and in the demised premises, and the Landlord agrees to accept such surrender at the end of such 12-month period, provided that the Tenant is not in default hereunder.

2. If:

(a) The Landlord requires possession of the demised premises for the purpose of construction of a building or buildings on the whole or a substantial portion thereof; or

(b) the Landlord shall bona fide convey the demised premises;

the term of this Lease shall, at the option of the Landlord and upon sixty

(60) days’ written notice, be terminated, and the Tenant agrees to execute a Surrender of its interest in this Lease and in the demised premises.

Provided that the option of the Landlord to terminate the term of this Lease in the event of a conveyance of the demised premises shall not be exercisable during the first five (5) years of the term, but a bona fide purchaser from the Landlord may, at any time, exercise the option reserved to the Landlord in subparagraph (a) of this section.

It is to be recalled, Mr Larsen stated that while he was in Germany in early November 1970, he received a phone call from a real estate broker in Toronto asking about the possibility of buying the property. In summary fashion, Mr Larsen stated, if he wished to make an offer, he should put one in. In due course Mr Larsen said one was received. In cross-examination of Mr Larsen it was brought out that the ultimate purchaser, The Prudential Assurance Company Limited, was given an option to buy the property in question, which option was dated November 5, 1970. The option states: . shall be payable Forty Thousand Dollars ($40,000) in cash or by certified cheque to W H Bosley & Company Limited, agents for the Vendor. . . A unique clause in the option was also referred to in cross-examination. The clause reads as follows:

The option hereby granted shall be open for acceptance by the Purchaser up to but not after the 25th day of January, 1971, but shall not be open for acceptance prior to the 5th day of January, 1971, and may be accepted by a letter delivered to the Vendor left at the Office of L A Strauss, 360 Bay Street, Toronto, Solicitor for the Vendor.

The concluding paragraph of the option states:

THE Purchaser agrees to pay to W H Bosley & Company Limited the commission for its services in the negotiation of this transaction if, as and when the transaction is fully completed.

Mr Larsen also admitted that Exhibit R5 was the account the appellant received from its Ontario solicitor, Mr Strauss, and the attention of the Board was directed to the words in the account which I have italicized:

Re: York-Adelaide Lot

Sale to The Prudential Assurance Company Limited

TO PROFESSIONAL SERVICES rendered in connection with the sale of the above captioned property to The Prudential Assurance Company Limited including the negotiating of the Option to Purchase and several revisions thereof, lengthy discussions concerning area of subject lands, meetings with surveyors, negotiations with solicitors for Purchaser, preparation of closing documentation including revisions thereof and satisfying corporate requirements, and to satisfactorily completing the transaction, attending at closing and reporting thereon.

Mr Larsen, who signed the option agreement on behalf of the appellant, did not know who prepared it or why Bosley was referred to as acting for the vendor. It would appear the last clause in the option would indicate that, in reality, Bosley was acting for the purchaser since nothing further was shown that he was acting for the vendor. As to the option date and unusual clause, Mr Larsen could only suggest the document was prepared by someone on behalf of the purchaser and submitted to him and Mr Strauss by that person. While he and Mr Strauss signed the offer, and while Mr Strauss had a fair hand in the matter, he could not explain the several revisions. He did say that the option would not have been granted without the aproval of the board of the appellant.

The matter now becomes a question of fact. Did the profit which the appellant realized on the sale of the York-Adelaide property arise from an adventure in the nature of trade, so that the gain in question is income from a business? If the answer is in the affirmative, the appeal is to be dismissed, or if it is in the negative, the appeal is to be allowed. Did the appellant, when it acquired the York-Adelaide property, intend to turn it to account by way of trade, so that the profit on the sale is a business profit? Even if the answer to that proposition were in the negative, did the appellant have a secondary or alternative intent to so turn the property to account, so that the profit is taxable?

As mentioned previously, Mr Otto caused at least five companies to be incorporated and the dealings of each company in real estate were recounted. It is to be noted that among all those companies there were 23 transactions relating to land or land and buildings in the period from incorporation to the date of the hearing. Of the 23 transactions, nine transactions were the acquisition of property on which there were buildings which produced rental income. The other properties purchased were vacant. Of those other properties, including the subject property, which were allegedly acquired for future development, on five of them buildings have been constructed and leased. A portion of some of those parcels has been sold to provide financing for services. In such case the profit has been reported as taxable revenue. Some of the parcels acquired are still being held for future development. One parcel on which there was a building was sold after about a year as the return was too low. Another parcel of vacant land was sold after ownership of over two years as it appeared there would be difficulties in developing. The sale produced a profit which was reported as income. Another parcel which was revenue-producing was sold after over four years ownership because the prime tenant was in financial difficulties and there was a high vacancy rate. The subject property was the only one sold because of “frustration” and it was sold after ownership of over two years and after real, sincere efforts had been put forth to achieve the desired goal, ie [to] build an office building.

Mr Otto was obviously a competent businessman who surrounded himself with equally competent and qualified persons in many fields. There was no suggestion that he had any background as a trader in real estate and any dealings in real estate appear to have been caused by the mail-order business. Working for the companies was a man, Mr Larsen, who was experienced in real estate. Not only would I not consider this surprising, but rather I would be amazed if Mr Otto did not have such a person overlooking the property ownership of the various companies when one considered the purchase price of the properties owned by the various companies. While I can see a few inconsistencies in the appellant’s case which might suggest the profit realized was a trading profit to the appellant, I am of the view that the correct conclusion to reach is that the profit realized by the appellant on the sale of the York-Adelaide property did not constitute income from a business as that term is used in the Income Tax Act.

Hence the appeal is to be allowed.

Appeal allowed.