Her Majesty the Queen v. Ball Brothers Limited, [1976] CTC 793, 77 DTC 5004

Mahoney, J:—The issue in this case is whether the grant by the defendant of an option to a lessee to purchase an interest in real property, acquired with a view to the particular lease, conclusively establishes the defendant’s intention, on acquisition, to turn the property to account by its sale. The defendant, although a building contractor, has no history of trading in real property interests and, leaving aside the option, has discharged the “peculiar onus” on a builder in such circumstances.* [1] The disposition, while to the optionee, was not as a result of the exercise of the option and the defendant’s financial circumstances, at the time it accepted the optionee’s unsolicited offer, were such as amply to explain its decision to sell. If it were not for the existence of the option, I should have no hesitation in dismissing the plaintiff’s appeal from the decision of the Tax Review Board, which found the profit on disposition to have been a capital receipt, not income.

The defendant has been a general contractor, headquartered in Kitchener, Ontario, engaged in the construction of commercial, industrial and institutional buildings since 1930, successor to an unincorporated business begun in 1923. Between 1930 and 1958 inclusive it acquired and disposed of a number of interests in real property for a variety of business reasons. Its last disposition, prior to 1959, was in 1950 when it sold two houses acquired in 1930 from its unincorporated predecessor. Taking into account the number and nature of the pre- 1959 transactions and their time frame there is no basis for finding that the defendant was a trader in real estate. On the contrary, it appears all along to have maintained a modest portfolio of revenue properties as an adjunct to its construction business.

In the late 1950’s the defendant decided to expand its rental business with a view to stabilizing its income pattern, which displayed the wide variations typical of its industry. Ideally, it would build premises for particular clients and enter into long-term leases, thereby realizing both a profit on their construction and steady rental income. Where it built for its own account, it added the same mark-up to cost as it was currently adding on bids submitted to third parties. The mark-up was taken into its income in accordance with its regular accounting procedures as though it had actually been paid to it by a third party. The defendant has shown a profit on its rental business every year since 1966. Earlier reported losses are largely attributable to the fact that it claimed capital cost allowance at the full permitted rates.

In addition to the adult education centres discussed later, the defendant acquired an office building from a client in default in 1959. It bought land for and built premises for Imperial Plywood in 1959. It bought land for and erected a building for Bell Telephone in 1963, added to the building in 1967 and acquired additional land for it in 1968 and 1975. In 1974 it bought the land and buildings which it leased to Uni Royal. The Imperial Plywood property was sold to its lessee in 1964; the gain on its disposition was claimed and accepted as a capital receipt. The other properties are still owned and rented by the defendant. One of the opportunities which presented itself was the expansion, in the late 1960’s, of adult retraining and educational facilities stimulated by substantial support of both provincial and federal government funding.

In 1967 the defendant approached educational authorities at Waterloo, Ontario with a proposal which was accepted and, as a result, purchased land and erected a building on it which it leased to the authorities for the Waterloo Adult Education Centre and which it still owns. In 1968 it bought land for and built the Ottawa Adult Education Centre, which it still owns. In 1969 it bought land for and built Adult Education Centres at Brantford and Guelph. It still owns the Brantford Centre; it is the profit on the disposition of the Guelph Centre, sold in 1971, that is in issue. In 1971 the defendant bought land for and built the Stoney Creek Adult Education Centre, which it still owns. In each case, other than Waterloo, the provision of the centre followed a public tender call by the particular educational authority for the design and construction of a suitable structure on particular land, required to be acquired as stipulated in the tender call, and for the leasing of the completed premises to the authority with an option to it to purchase.

During the material period the authority responsible for the Guelph Adult Education Centre changed from the Guelph District Board of Education to the Board of Governors of the Conestoga College of Applied Arts and Technology. That change has no relevance to the issue and I will, for convenience, refer to the tender calling entity, the lessee and purchaser as “Conestoga”. The initial tender call had aborted and a recall closing September 30, 1968 was issued by Conestoga. Material provisions of the specifications were:

1. The Lessor shall undertake to construct a one-storey school building in accordance with the specifications contained herein. It will be the intent that the Lessor shall agree to enter into a lease agreement for this building in which he shall become the Lessor . . . .

2. The initial term of the lease is to be a ten-year period. The lease is to provide for renewal at the Lessee’s option for an additional term of five years at the same rent and conditions as the original lease; also provision must be in the lease to offer to sell the building to the Lessee at the end of either lease period at a stipulated sum.

8. ... An option agreement is enclosed indicating a 10-acre site which is available for this project. The submitting Contractor must tender (as per specifications) on this property but may also tender on other property that may be available to him.

10. It is suggested that the Bidding Contractor base his calculations on a building as per sketch layout accompanying the specifications. However, he may feel free to alter this layout where an improvement seems evident. If the latter case occurs, the Bidding Contractor must include in his initial submission a blueprint of his proposed layout.

The defendant’s bid was accepted and, in the result, a lease entered into for a term of 10 years from July 1, 1969 at an annual rent of $136,804.50 with a renewal option for a further 5 years at the same rent. The lease contained an option to Conestoga to buy the leased premises for $925,450 on June 30, 1979 or, if the renewal option were exercised, for $802,800 on June 30, 1984. The land cost $60,000 and the building $1,099,000 including the mark-up of slightly more than 3%. While it is conceivable that an allocation of the option price as between land and building might result in a gain on the land alone for tax purposes, clearly the exercise of the option at either price would result in a loss on the sale of the entire premises. I must have regard to the property as a whole and not to constituent parts which have a notional separate existence only because of capital cost allowance regulations.

The defendant lost $522,000 in its construction operation in 1970 while realizing a $77,000 profit on real property rentals. Its working capital fell almost $600,000 in the year, from $374,000 at December 31, 1969 to a $220,000 deficiency at December 31, 1970.

In late 1970 Conestoga apparently got the impression that substantial capital funding might be available prior to the end of its then current fiscal year. The system, then at least, was that while unexpended operating funds allocated by the provincial government might be carried forward to another fiscal period, capital funds could not; they had to be spent or, at least, firmly committed during the fiscal period or else they reverted and might not again become available. Except for a small amount of private source money, earmarked for scholarships and the like, Conestoga depended entirely on direct funding from the Ontario Government, and indirect funding from Canada through Ontario, for its operating and capital requirements. On November 27, 1970 Conestoga wrote the defendant inquiring ‘‘whether it would be possible to purchase the Guelph operation if money should become available to us” and, if so, “at what price”. The defendant indicated verbally in mid-January and by letter of February 4, 1971 that the price would be $1,500,000 plus whatever the mortgagee exacted in consideration of accepting pre-payment of the mortgage. The price was accepted and a written agreement for sale made March 30, 1971.

As at December 31, 1975 the defendant owned ten pieces of real estate, three of which are its head office and yards at Kitchener and Kingston, Ontario. The other seven, including one acquired since the sale of the Guelph Centre, are rental properties. Two of them, the Ottawa and Brantford Adult Education Centres, are subject to options granted under the same circumstances as that on the Guelph Centre. Bell Canada wanted an option but none was granted it.

The Board of Governors of Mohawk College of Applied Arts and Technology had also stipulated, in their tender call for the Stoney Creek facility, that an option be given them. The defendant was the successful tenderer, in January 1970, at an annual rental of $370,412 for 10 years with an option either to renew for 5 years at the same rent or to buy for $2,200,000. The land cost there was $195,000 and the building, including a 4% mark-up, cost $1,655,000. The defendant submitted two alternative proposals: one for a 10-year lease at $343,954 per annum, the other for 15 years at $293,684 per annum, both with 5-year renewal options at the same rent but without an option to purchase. The 15-year proposal was accepted. In early April 1971 Mohawk, perhaps aware of the same source of capital funds as Conestoga, approached the defendant through solicitors but the defendant did not respond.

The evidence is that the option prices on the Guelph Centre were such that the defendant, while recapturing a good deal of the capital cost allowance which would likely have been taken up to either date of exercise, would not have realized a profit. While true of the Guelph facility, it was certainly not true of the option price proposed for Stoney Creek—perhaps a ploy to discourage acceptance of that alternative. On the whole of the evidence I am led to the inference that the annual rental was a considerably more important factor than the option price in so far as the educational authorities were concerned. Be that as it may, the defendant’s evidence is that it did not want to grant the options and did not expect them to be exercised and the evidence of Conestoga’s Director of Finance is that, given the historic fact of shifting government priorities and its total dependence on that source of funding, there was no way Conestoga could plan on exercising an option until near the last moment when it could be determined whether that action and the consequent expenditure was a priority of the funding governments as well as Conestoga.

In each case, the design of the educational facility is such that it can be readily and economically adapted to commercial or industrial use. Standard modules are employed. The specification for the Guelph facility, which is the only one in evidence, would certainly permit this latitude of design to the contractor. Furthermore, the zoning of each site, prior to the defendant committing to construct the facility, was such that the desired alternate use would be permitted if necessary. Its letter to Conestoga of September 30, 1968 submitting its proposal stipulated that it was

contingent on the zoning of the property to permit the use of the land for your. desired purposes as well as for light industrial uses . . .

On the whole of the evidence, I should be entirely prepared to adopt as my own the findings of fact and conclusion comprising the last four paragraphs of the decision of the learned Member of the Tax Review Board, Mr St-Onge ([1975] CTC 2312 at 2315; 75 DTC 236 at 238), if I were not faced with the plaintiff's argument, which does not appear to have been made in the earlier hearing. That argument is that an option, however reluctantly granted, is irrefutable evidence of the optionor’s contemplation of the possibility of selling at the time it is granted. The inexorable extension of that is that where the option is granted, as here, contemporaneously with the acquisition by the optionor of the optioned asset, the optionor cannot deny that, at the very least, he had a secondary intention of selling that asset.

In this argument, the plaintiff relies on the decision of my brother Cattanach in R v Soalta Development Ltd, [1975] CTC 517; 75 DTC 5359,* [2] in respect of the “6th St Calgary” property, a judgment rendered some months after the decision of the Tax Review Board in this case. There, the taxpayer had acquired a parcel of land and then, so soon thereafter “as to be almost coincident” with the acquisition, commenced negotiations with a prospective tenant. The tenant insisted on an option to purchase; the taxpayer resisted vigorously but, in the result, vainly. An agreement was made whereby the taxpayer erected a building to the tenant’s specification and leased the completed premises to it for 20 years at a net annual rental of $15,000 with an option, exercisable during the first 10 years of the term. The option price was $185,000 if exercised the first year and reduced by $5,000 per year thereafter. It was exercised in the ninth year at $140,000.

Mr Justice Cattanach, applying the decision of the Supreme Court of Canada in MNR v Edgeley Farms Limited, [1969] SCR 603; [1969] CTC 313; 69 DTC 5228, at page 525 [5364], held as follows:

For the purposes of the present appeal with respect to the sale of the 6th St Property I repeat for the purpose of emphasis Mr Justice Judson's statement that “The option, in my opinion, is all important”. Obviously the option is an absolute indication of a willingness by the [optionor] to sell however unwilling that option may have been granted . . .

The passage from which the foregoing statement by Mr Justice Judson is taken, at pages 606-7 [315, 5229], is:

. . » The option, in my opinion, is all important. It was the method which the company adopted in putting through its real estate transactions. The property was in a rapidly developing area. The mortgages given back when the property was purchased provided for partial discharges on 5 acre lots. The option was granted within 17 months from the date of acquisition of the property and provided for the purchase of 10 acre parcels. The issue in this appeal is whether the company was selling its land in the course of the operation of a business for profit. It undoubtedly was and the gains in question are income.

The succinct statement that “The option, in my opinion, is all important” ought not to be taken out of its context; it must be read with the following sentence:

It was the method which the company adopted in putting through its real estate transactions.

The totality of that method is outlined in the balance of Mr Justice Judson’s statement.

In this case, the fact that the defendant granted the option to Conestoga demands explanation. If unexplained, the property optioned would have to be held “stock-in-trade” rather than a capital asset held as an investment. The defendant’s witnesses were credible and their evidence convincing. The option here was not a method the defendant “adopted in putting through its real estate transactions”. It was, in the circumstances, a condition necessarily attached to an asset on its acquisition which, if met, would require that that asset be sold.

If it is the law that the attachment of an option, which may or may not be exercised, to an interest in land ipse facto, regardless of surrounding circumstances, renders that interest stock-in-trade and not capital then surely redeemable or term securities, acquired in the market place at something less than their redemption price or face value, whose eventual mandatory disposition at a profit is virtually certain, rather than in the possible to probable range, are even less susceptible of being vehicles for capital investment. Such a proposition would be startling.

The granting of an option is obviously prima facie evidence of a willingness, at the time it is granted, to sell the optioned asset at the stipulated price and on the prescribed terms. However, what is necessary to constitute a transaction to be an adventure in the nature of trade is not just a willingness to sell under certain circumstances, which may very well be imputed to the purchaser in any case.* [3] A willingness to sell is only an essential ingredient of what is necessary, namely: an intention to resell at a profit.

It is apparent from the portion of his judgment in the Soalta case dealing with the “Edmonton property”, at page 525 [5365], that Mr Justice Cattanach was very much aware that the obvious conclusion to be drawn from the bare fact of the grant of an option is susceptible of considerable modification by evidence of the circumstances in which it was granted, although he did not find it necessary to say so in connection with the “6th St Calgary” transaction. Where the purchaser grants an option to resell property at a loss, it is by no means obvious that he contemplates its resale at a profit. On the contrary, the apparent result is that, for so long as the option is open to acceptance, he has foreclosed any opportunity to realize a profit on its disposition, with the distinct possibility that he may never have that opportunity.

Having regard to all of the circumstances, I am satisfied that the defendant acquired the Guelph Centre as an investment, that the possibility of its resale at a profit was not an operating motivation for the acquisition, and that the profit on its sale was a capital gain, not income. The action will be dismissed with costs.