Her Majesty the Queen v. Audrey Cold Storage Limited and Freda Limited, [1976] CTC 665, 76 DTC 6401

Gibson, J:—These appeals from a decision of the Tax Review Board dated June 29, 1973 were heard on common evidence and relate to reassessments for the 1964 taxation year of the four corporations, Audrey Cold Storage Limited, Freda Limited, Heleis Storage Limited and Marksim Storage Limited.

During the relevant years, 1960 to 1964, these four corporations carried on a warehousing business in partnership under the name “Ayer Storage (Ontario)”. The fiscal period of the partnership ended July 31.

In June 1960 a company by the name of Ayer Storage (Toronto) Limited purchased from Gutta Percha & Rubber Limited certain property consisting of about 7 acres of land and 19 buildings, situate on O’Hara Avenue in Toronto for $460,000, allocating the purchase price between land and buildings as follows:

As expressed in the pleadings and disclosed in the evidence, Ayer Storage (Toronto) Limited as Ivanhoe Storage Limited (having changed its name on November 5, 1961) on February 9, 1962:

(a) received $110,000 from Gutta Percha & Rubber Limited as damages in respect of the property which it allocated so as to reduce the cost thereof as follows:

(b) transferred the property at the undepreciated capital cost in its books of account, being

to its shareholder (the four said corporate partners) who thereafter held the property in partnership under the name Ayer Storage (Ontario) in the following respective interests:

(a) Ivanhoe Storage Limited or the partners had claimed capital cost allowance in respect of the buildings on the said property as follows:

(b) the partnership had made an addition to the buildings of $1,099 some time between July 31, 1963 and September 15, 1963,

sold the property in an arm’s length transaction to Combo Construction Limited and Joseph Zentil by agreement on June 3, 1963, effective September 15, 1963, for $680,000, title being taken in the name West Toronto Towers Ltd.

The partnership in its financial statements for the year ended July 31, 1964

(a) reported $589,515 as a gain on sale of land but did not bring same into income on the basis that it was a “capital transaction”;

(b) claimed $262,418 as a “terminal loss” in respect of the buildings on the property on the basis that only land was sold; and

(c) showed a loss for the year of $38,898.08 which was arrived at by deducting the “terminal loss” in paragraph (b) above from the remaining income.

In 1960 possession was obtained of only some of the buildings for the business, but finally possession was obtained of all the buildings when Gutta Percha & Rubber Limited and its tenant finally moved out. In doing so, the latter damaged certain buildings, making them unusable for dry warehousing business. In the litigation against Gutta Percha the said above referred to $110,000 damages was obtained in a settlement.

The partnership calculated its gain on capital account and “terminal loss” as follows:

The Minister of National Revenue reassessed the corporate partners in respect to each of their respective 1964 taxable income on the assumption that their respective proportionate gain on the sale of the so-called Gutta Percha property in the total sum of $313,343.20 was on income account and not on capital account: and also disallowed to the partners their respective share of the claimed “terminal loss” of $262,418 on the assumption that the property was not depreciable property; and also disallowed as a deduction in computing the respective income of the partners for their respective 1963 taxation year, their share of the $13,753.63 capital cost allowance claimed by the partnership.

As also expressed in the pleadings, and disclosed in the evidence, certain of the relevant facts were as follows:

By agreement dated December 31, 1958 the four corporate partners and their respective interests in the “Ayer Storage (Ontario)” partner ship were as follows:

During the years 1959 to 1963 inclusive, the partnership operated a cold storage warehouse at 1377 The Queensway in Etobicoke Township at the west end of Metropolitan Toronto.

A Mr M G Lawrence was one of the principals having directly or indirectly a substantial financial interest in Freda Limited, one of the corporate partners. On April 12, 1960, Mr Lawrence signed an offer to purchase certain property located in the City of Toronto from Gutta Percha the said above referred to $110,000 damages was obtained in accepted.

The purchase of the Gutta Percha property was completed on or about June 30, 1960; the purchase price was reduced by $40,000 to $460,000 because the vendor was not able to satisfy certain requisitions on title; and upon the direction of M G Lawrence title was taken in the name of Ayer Storage (Toronto) Ltd (a limited company and not the partnership described above). The issued and outstanding shares of Ayer Storage (Toronto) Ltd were beneficially held by the principals of the four corporate partners in the same ratio and proportion as their respective corporate interests in the partnership.

A portion of the property was put to a warehousing use by the Ayer Storage (Ontario) partnership immediately after the transaction closed in the summer of 1960.

Part of the premises was leased back to Gutta Percha under lease agreements expiring September 1, 1960, December 1, 1960 and December 31, 1961. In September 1961 Gutta Percha vacated the premises removing all of its heavy manufacturing machinery. In so doing, Gutta Percha caused substantial structural damage to certain buildings, making them unsuitable for a dry storage warehouse.

Ayer Storage (Toronto) Ltd commenced an action in the Supreme Court of Ontario to compel Gutta Percha to restore the damaged buildings to their condition prior to the removal of the machinery. This action was settled upon Gutta Percha’s undertaking to pay damages in the amount of $110,000 which it did.

By supplementary letters patent dated November 3, 1961 the name of Ayer Storage (Toronto) Ltd was changed to Ivanhoe Storage Limited. By agreement dated February 9, 1962 Ivanhoe Storage Limited transferred the Gutta Percha property at its undepreciated capital cost to the Ayer Storage (Ontario) partnership.

Commencing in 1960 the partenrship hired a manager, a Mr Turner, to run its dry storage warehouse on the Gutta Percha property; it advertised to attract warehousing customers; it acquired certain equipment (mainly pallets and forklift trucks) to carry on a dry storage warehousing business; and within a year had occupied some substantial space with the goods of warehousing customers.

After a certain length of time, after the partnership decided that it did not wish to carry on a dry warehousing business on the premises, the partnership applied to the City of Toronto to have the area rezoned to permit the construction of one or more apartment buildings and commissioned an architect to prepare conceptual plans and a model of a possible development. Eventually the City of Toronto rezoned the area to permit the use of the Gutta Percha property as a site for apartment buildings.

On June 3, 1963 the partners of Ayer Storage (Ontario) received from Combo Construction Limited and one Joseph Zentil an offer to purchase the Guita Percha property for a price of $680,000. The offer was accepted and by deed dated September 11, 1963 the land was transferred to the purchaser.

When the Gutta Percha property was purchased in the summer of 1960, the purchase price of $460,000 was allocated between land and buildings on the basis of $51,000 as cost of land and $409,000 as cost of buildings. The damages of $110,000 recovered from Gutia Percha were also allocated between land and buildings on the basis of $11,000 referable to land and $99,000 referable to buildings. The resulting adjusted cost of $350,000 was therefore allocated on the partnership’s books as follows:

The partnership alleges that the damages of $110,000 recovered from Guita Percha should have been allocated entirely to the buildings because that amount was paid in respect of damage to the buildings.

Before the sale of the Gutta Percha property in September 1963 the partnership demolished all of the buildings which had been erected thereon. The partnership credited the entire proceeds of the sale to land and did not credit any amount of such proceeds of sale to buildings.

On July 31, 1964 Audrey Cold Storage Limited (“Audrey”) and. Freda Limited (“Freda”) sold their respective 15% and. 35% interests in the Ayer Storage (Ontario) partnership to Ivanhoe Storage Limited (“Ivanhoe”). The pleadings allege that because the partnership continued with Ivanhoe owning the consolidated 50% partnership interest formerly owned by Audrey and Freda, Audrey and Freda had ceased to be members of the Ayer Storage (Ontario) partnership before the end of the partnership’s 1964 fiscal year as at the end of July 31, 1964.

The pleadings further allege that Marksim Storage Limited (“Marksim”), together with Heleis Storage Limited (“Heleis”) and Ivanhoe as the only three members of the partnership at the end of the partnership’s 1964 fiscal period reported the capital gain and deducted the “terminal loss” in the financial statements of the partnership and in their respective income tax returns for the 1964 taxation year.

When filing their respective income tax returns for the 1964 taxation year, no partner acknowledged as income any part of the gain on the disposition of the Gutta Percha property, nor did either of the partners Audrey Cold Storage Limited or Freda Limited claim any portion of the alleged “terminal loss” as deductible in computing their respective income on the basis that each ceased to be a member of the Ayer Storage (Ontario) partnership before the end of the partnership’s 1964 fiscal year.

By Notices of Assessment dated May 17, 1968 and July 24, 1972 the Minister of National Revenue included in computing the income of the four original partners (Audrey, Freda, Heleis and Marksim) for the 1964 taxation year their purported proportionate share of the gain realized upon the sale of the Gutta Percha property and disallowed as a deduction their purported proportionate share of the “terminal loss”.

There are three issues in this appeal, namely:

1. Was the gain of $313,343 on income account or on capital account?

2. Was there a so-called “terminal loss’ and if so, what was the correct amount of it?

3. Did Audrey Cold Storage Limited and Freda Limited cease to be partners of the partnership on July 31, 1964; and if they did, is each of them accountable for income tax purposes for any of the gain on the disposition of the Gutta Percha property by the partnership, if the Court should find such gain was on income account?

As io the first issue, namely, whether the said gain was on income account or on Capital account,* [1] the events which took place and the state of mind of the participants in 1960 when the property was acquired are relevant.

In this case, the reassessments were made in 1968 by which the Minister claimed the gain was on income account. Because the Minister in his reassessment could only go back four years, only the capital cost allowance claimed by the partnership in 1963 of $13,754 was disallowed. This produced on reassessments a net gain therefore of $313,343 for taxation purposes to the partners.

As a consequence of making such reassessments, the Minister at the same time disallowed the “terminal loss” of $262,418 which follows from the Minister’s assumption that the property was acquired in 1960 by the partnership either as “inventory or the commodity for [an] adventure in the nature of trade” to use the characterization of Collier. J of the subject property in Norton Investments Limited v The Queen (Supra).

The problem the Court is faced with is to make the determination of this issue of fact based on the evidence adduced in 1976.

M G Lawrence, one of the principals having an interest in the corporation partner Freda Limited and who was the person who made substantially all the decisions for the partnership, in his evidence, said that his intention in purchasing this so-called Gutta Percha property was to conduct a dry warehousing business on it. He disavowed that he had any “secondary intention” at that time. He, through the said corporate partner and the partnership, was engaged at the material time and almost to date, in the warehousing business, mainly the cold storage warehousing business.

Mr Cassells, an employee of the partnership and an associate of Mr Lawrence since the mid-1950’s and who was a former employee of Terminal Warehousing Limited, Toronto, a business engaged in very substantial warehousing activities, gave evidence that prior to its purchase by the partnership, he had looked at the Gutta Percha property for Terminal Warehousing Limited for warehousing purposes and advised that company against acquiring it. He also said he advised Mr Lawrence against acquiring it for such purpose, but that Mr Lawrence proceeded anyway.

A Mr Turner, an experienced warehousing operator, was hired from a competitor by Mr Cassells (a friend of his) and was employed by the partnership after the Gutta Percha property was acquired to operate a dry warehousing business on it. He had previously, prior to 1960, operated for Howell Warehousing Limited a dry warehousing business in two of the buildings on the Gutta Percha property. Mr Turner’s evidence was that he thought that the Gutta Percha property with its 19 buildings would be satisfactory premises for conducting a dry warehousing business and honestly believed in 1960 that the business carried on there would be a success.

In fact, the business was not a success. One of the main reasons for its lack of success was the fact that access from the streets leading to it was difficult for tractors with trailers in length up to 45 feet. Some time around 1960 apparently it became the practice to use larger trailers up to that length, whereas before that date the trailers were shorter and could be navigated through the narrow streets in proximity to the Gutta Percha property without difficulty and as a consequence at that time access to the property was not difficult.

After it was decided not to carry on a warehousing business on the Gutta Percha property, Mr Lawrence made a number of efforts to put the premises to alternative uses as mentioned above. He was very aggressive and imaginative and succeeded where another person might not have. In the process of finding a satisfactory alternative use for the property, a zone change was arranged which made it possible to utilize the property for residential purposes as a result of which it became possible to accomplish the sale of the property for the purpose of constructing a large apartment [building] on it, which the evidence disclosed probably consisted of about 700 units. For the purpose of such construction, it was necessary to tear down all the 19 buildings on the Gutta Percha property. The contract of purchase and sale required the vendor to deliver vacant land to the purchaser on closing. This purchase and sale took place in the latter part of 1963.

No evidence was adduced by the defendant on this issue other than a letter which some assessor for the Department of National Revenue obtained from the solicitors for the partnership dated September 26, 1967. In that letter, the solicitors wrote to the tax assessor who spoke to them, giving, among other things, their memory of attempts made to dispose of the Gutta Percha property.

The only other evidence adduced was documentary evidence which in the main gave details of the various transactions, description of the property and so on.

Having carefully considered all of the evidence adduced on this appeal and after making all reasonable inferences from it, in my view, from the evidence, the primary and only intention in 1960 for which the subject property was acquired was to enable the partnership to carry on upon it a warehousing business. There was oral evidence adduced that at that time there was no “secondary intention” within the meaning of the cases and no inference of such is made from any of the other oral and documentary evidence adduced. (In this connection, a reasonable question to pose might be whether or not if there had been a loss on the disposal of this subject property in this matter, a deduction would have been allowed from income if claimed.)

On the second issue of the deductibility or not of the so-called “terminal loss”, the situation, as stated, was that when the Gutta Percha property was sold all the buildings had been demolished and vacant land only was delivered to the purchaser on closing. In fact, this was a condition of the contract of purchase and sale, see Exhibit 61.

The partners in their tax returns, on the basis that there were no buildings on the land when they sold it attributed to the proceeds of the disposition no value to the buildings. Prior to that time, the partnership considered the buildings capital property, and had claimed capital cost allowance. At the time of the disposition the undepreciated capital cost allowance in respect to the buildings was $262,418. In the fiscal year 1964, the partnership, having disposed of all the buildings had no other depreciable capital assets in the relevant classes of the Regulations, claimed a write-off as a so-called “terminal loss” under Regulation 1100(2) the amount of the undepreciated capital cost allowance of the buildings, namely $262,418 (in their accounts and tax returns therefore not allocating any part of the proceeds of the sale to the buildings).

Regulation 1100(2) at the relevant time read as follows:

1100. (2) Where, in a taxation year, otherwise than on death, all property of a prescribed class that had not previously been disposed of or transferred to another class has been disposed of or transferred to another class and the taxpayer has no property of that class at the end of the taxation year, the taxpayer is hereby allowed a deduction for the year equal to the amount remaining, if any, after deducting the amount, determined under section 1107 in respect of the class, from the undepreciated capital cost to him of property of that class at the expiration of the taxation year.

Paragraph 20(6)(g) of the Income Tax Act at the relevant time read as follows:

20. (6) For the purpose of this section and regulations made under paragraph (a) of subsection (1) of section 11, the following rules apply:

(g) where an amount can reasonably be regarded as being in part the consideration for disposition of depreciable property of a taxpayer of a prescribed class and as being in part consideration for something else, the part of the amount that can reasonably be regarded as being the consideration for such disposition shall be deemed to be the proceeds of disposition of depreciable property of that class irrespective of the form or legal effect of the contract or agreement; and the person to whom the depreciable property was disposed of shall be deemed to have acquired the property at a capital cost to him equal to the same part of that amount; and

Subparagraph 20(5)(c)(ii) of the Act at the relevant time read as follows:

20. (5) In this section and regulations made under paragraph (a) of subsection (1) of section 11,

(c) “proceeds of disposition” of property include,

(ii) compensation for property damaged, destroyed, taken or injuriously affected, either lawfully or unlawfully, or under statutory authority or otherwise,

lt was submitted by the defendant that the proceeds of this disposition did include some compensation for the buildings that were taken down prior to the closing of the sale of the property in 1964.

(In view of the finding that the proceeds of the disposition were on capital account, the submission that the corporate taxpayers had no depreciable property and that therefore there could be no so-called “terminal loss” is untenable.)

It was also submitted that the proper principles to be considered in applying the above mentioned provisions of the Act and regulations in force at the relevant time were enunciated in the following cases: MNR v Steen Realty Ltd, [1964] CTC 133 at 136-7; 64 DTC 5081 at 9083-4; Emco Ltd v MNR, [1968] CTC 457 at 463-4; 68 DTC 5310 at 5315; Canadian Propane Gas & Oil Ltd v MNR, [1972] CTC 566 at 575 and 577-8; 73 DTC 5019 at 5026 and 5028-9; MNR v Malloney’s Studio Ltd, [1975] CTC 542 at 552-3; 75 DTC 5377 at 5384-5; Gateway Lodge Limited v MNR, [1967] CTC 199; 67 DTC 5138; Robert Adolphe Stanley v MNR, [1967] Tax ABC 1048; 67 DTC 700; [1969] CTC 430; 69 DTC 5286; [1972] CTC 34; 72 DTC 6004; and Diggon-Hibben Limited v The King, [1949] SCR 712.

In my view, the jurisprudence indicates that the question that should be asked in determining this issue is whether or not there was in fact a disposition of the buildings when the purchase and sale of the subject property was completed. For this purpose, it is proper for the Court to consider as one of the factors in all the circumstances of the case whether or not at the time of disposal there was any value to the owners of the buildings.* [2]

In this case, as Exhibit 61, the contract of purchase and sale, indicates there was an intention on the part of the purchaser to build an apartment building. consisting of approximately 700 units. The purchaser acquired this property and the vendor sold it for $680,000 which, per apartment unit, made the price paid for the land relatively low. In bargaining at arm’s length for the total consideration for this property, in my view, the purchaser had in mind only how low a unit cost of land per apartment unit could obtain. It was not interested in the buildings and attributed no value to them. The vendors in the same arm’s length transaction which resulted in this agreement of purchase and sale of the subject property also bargained for the best price they could get for the property and undoubtedly knew at the material time that the purchaser wished to obtain the property for as low a price for land per apartment unit as possible; and also knew that there was no value to them (the vendors) of the buildings which they could use to obtain a greater price for the property with the biulings on it than the market price of the land alone. In other words, the actual contract of purchase and sale did not give the vendors any sum of money over and above the market price for vacant land.t [3] In fact, it gave them less. The vendors had to pay money to have the buildings torn down so as to comply with one of the conditions of the contract of purchase and sale, namely, to deliver vacant possession of the land only on closing.

On this evidence, it is in my view impossible to come to any other conclusion than that the value to the partnership owners of the buildings at the moment they signed the contract of purchase and sale of this property in 1964 was nil.

Accordingly, the partners were correct in allocating the proceeds of the disposition of this property entirely to land and are entitled to the so-called “terminal loss” deduction of $262,418.

As to the third issue, in view of the finding that the gain was on capital account, it is not necessary to determine whether or not the partners Audrey Cold Storage Limited and Freda Limited should be required to account as their income any part of the gain from the proceeds of the disposition of the subject property.

The appeals are therefore allowed with costs and the reassessments are referred back for further reassessments not inconsistent with these reasons.