Morris Besney v. Her Majesty the Queen, [1974] CTC 54, 73 DTC 5592

Cattanach, J:—These are appeals from a decision of the Tax Review Board dated January 7, 1972 whereby it was held that the plaintiff herein was not entitled to deduct more than 50% of the capital cost allowance in respect of an apartment building in Edmonton, Alberta known as the Kennedy Towers, during his taxation years 1964 to 1967 being the years under review.

The cost of building the apartment building, excluding the cost of the acquisition of the land, was in the approximate amount of $1,200,000 upon which amount capital cost allowance was claimed on the declining balance at the annual rate of 4% on paving, 5% on the building and 20% on furniture all in accordance with the classes of property and the rates applicable thereto as outlined in Income Tax Regulation 1100 and Schedule B to the Regulations. There was no dispute between the parties as to the rates applicable nor as to the cost of the construction of the apartment.

It was accepted by the parties that the “cost” of construction coincided with the “capital cost” and in the circumstances of these particular appeals I can see no reason to question that assumption because there would appear to be no difference between the two when the property was acquired as a capital asset of a business as was the case in these appeals.

The dispute does arise as to what proportion of the cost of constructing the apartment on which the plaintiff is entitled to compute the capital cost allowance which he may deduct in computing his income.

In completing his tax returns for the taxation years in question the plaintiff claimed capital cost allowance at the appropriate annual rates on the total cost of the construction of the apartment, that is approximately $1,300,000 which amount is accepted as the capital cost thereof. Such claim was based on the premise that, in those years, the appellant was the sole owner of the entire project.

In assessing the plaintiff as he did the Minister did so on the premise that the plaintiff was the owner of an undivided half interest in the project and accordingly was entitled to claim capital cost allowance on 50% of the total cost of construction rather than on the whole thereof. Put another way the Minister’s contention is that the capital cost of the building to the appellant was one-half of the cost of the construction thereof.

The relevant provisions of the Income Tax Act and regulations thereunder are:

(1) Paragraph 11 (1)(a) which reads as follows:

11. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection(1) of section 12, the following amounts may be deducted in computing the income of a taxpayer for a taxation year:

(a) such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation;

(2) Regulation 1100(1) which reads in part as follows:

1100. (1) Under paragraph (a) of subsection (1) of section 11 of the Act, there is hereby allowed to a taxpayer, in computing his income from a business or property, as the case may be, deductions for each taxation year equal to

(a) such amounts as he may claim In respect of property of each of the

following classes in Schedule B not exceeding in respect of property

(i) of class 1,4%,

(iii) of class 3, 5%

(vill) of class 8, 20%,

The following are the facts.

The plaintiff is a medical practitioner. He had seen the advent of state medicine in England and anticipated that a health scheme would be introduced in the Province of Alberta. He concluded that it would be advantageous to make provision for his family from a source other than the practice of medicine. At this point I might say that I formed the distinct impression that the plaintiff was dedicated to his profession and was devoid of experience in the business field. His wife, who in all likelihood had more acute business instincts than the plaintiff, suggested that the plaintiff might buy property as being the root of all real wealth and went further in that suggestion, with which the plaintiff concurred, by adding that the plaintiff might discuss the prospect with her cousin, Milton Sorokin, who was an experienced contractor and developer who had brought five projects to completion.

Mr Sorokin had just completed a 28-suite apartment building and had an option on a site he considered suitable for a highrise apartment building. Apparently Mr Sorokin was long on experience but short on funds and accordingly he welcomed overtures made to him by the plaintiff in August 1963.

An agreement was reached between the plaintiff and Milton Sorokin, after discussions and bearing in mind that there was a family relationship, the substance of which was contained in a letter dated November 15, 1963 written by Mr Sorokin to the plaintiff and introduced in evidence as Exhibit P1.

In substance that agreement so outlined was that the plaintiff would out up the necessary money to buy the land. This the appellant did. He raised $115,000, approximately half of which he borrowed and bought the land.

On his part, and in consideration of the plaintiff putting up this money, Milton Sorokin undertook to arrange for financing by loans secured by first and second mortgages, to arrange for the construction of the apartment building and, on completion, to take over the management of the building and ensure that it was occupied to the extent that the rental revenue would meet all commitments.

The plaintiff was to receive a 50% interest in the building and Milton Sorokin or a company to be incorporated by him would receive the other 50% interest in the building.

Milton Sorokin undertook to transfer his 50% interest in the building to the plaintiff until such time as he had completed his part of the bargain. No transfer was ever made and registered under the Land ntles Act.

The agreement is particularly vague as to when Mr Sorokin would have completed his part of the bargain both in the letter dated November 15, 1963 in a more formal document when the agreement was reduced to writing on November 25, 1965 and in the oral evidence.

As I understand the arrangement it appears to have been that Sorokin would have performed his obligations when the apartment building produced sufficient income to meet all financial obligations as they became due. I would assume that the financial obligations would in- elude the payments on the long-term debts incurred such as principal and interest an first and second mortgages, bank indebtedness, payments on furnishings and appliances obtained on credit from the suppliers, as well as current operating expenses including municipal taxes.

In this event Mr Sorokin was confirmed in his ownership of a 50% interest in the project.

It would appear that repayment of the advance of $115,000 made by the plaintiff to acquire the land was not considered to be such a financial obligation.

However it was also understood that upon the rental revenues meeting all financial obligations that any surplus would be applied first to repayment of the advance made by the plaintiff and when that advance had been repaid in full, then the co-owners would share the profits equally.

As a vehicle through which his part of the bargain was to be carried out Mr Sorokin caused a company to be incorporated under the name of Milton Developments Ltd, hereinafter sometimes referred to as “Milton”.

The enterprise was fraught with difficulty from the outset. Mr Sorokin in his business as a developer had had extensive dealings with the Montreal Trust Company. It was with this lender that he arranged for financing of the project. He was given to understand and justifiably anticipated that the loan on the security of a first mortgage would be $1,100,000. When the loan was made the amount was reduced to $900,000 or $200,000 less than expected.

Interim financing was through advances from a chartered bank. The expected amount was $200,000 but that was reduced by the bank to $150,000. The advances from the bank were guaranteed by Atlantic Acceptance Corporation and that guarantee was to mature into a second mortgage.

Title to the land when it was acquired with the advance of $115,000 by the plaintiff was taken in the joint names of the plaintiff, Dr Besney, and Milton, each as owner of an undivided half-interest therein.

The mortgagors under the mortgage agreement with Montreal Trust Company as mortgagee were Dr Morris Besney, the plaintiff, and Milton Developments Ltd with Milton Sorokin and Dr Morris Besney as guarantors along with others who were subsequently released.

The plaintiff, Milton Developments Ltd and Milton Sorokin were also guarantors to the bank for the interim financing of the project along with Atlantic Acceptance Corporation which was to repay all such advances to the bank and accept a second mortgage on the property as security.

It was a covenant in the first mortgage agreement that insurance be carried on the building. The insured were the plaintiff and Milton. As is usual it was provided in the policy of the insurance that any loss incurred would be payable first to the first mortgagee, second to the second mortgagee, third to the supplier of major appliances, fourth to the bank and lastly to the insured.

On March 31, 1964 the plaintiff and Milton, executed, and subsequently registered, a declaration of partnership to the effect that the two signators carried on the business of apartment building owners in partnership under the firm name and style of John F Kennedy Towers and that the partnership had subsisted since February 1, 1964.

The first major catastrophe suffered by the partnership was the collapse of Atlantic Acceptance Corporation in June 1965.

The bank immediately called upon the plaintiff in his capacity as guarantor to repay the interim loan in the approximate amount of $130,000 forthwith.

This incident perturbed the plaintiff. He sought legal advice and was informed that he did not have sufficient protection.

Consequently the verbal arrangement between the plaintiff and Sorokin, the substance of which was outlined in the letter dated November 15, 1963 from Sorokin to the plaintiff, was embodied in a formal agreement which, while dated November 15, 1963, was not drafted and signed until November 25, 1965, or thereabouts.

The relevant provisions of that agreement are as follows:

1. Besney covenants and agrees to supply a maximum of ONE HUNDRED AND FIFTEEN THOUSAND DOLLARS ($115,000.00) towards the cost of acquiring the land and constructing the apartment building known as “JOHN F KENNEDY TOWERS” . . .

2. Sorokin and Milton covenant and agree to be solely responsible for the acquisition of the lands required, for the construction of the said apartment building in all respects until completion, for the management of the said building, and to arrange all financing required for the said project other than the funds to be contributed by Besney as aforesaid. PROVIDED HOWEVER, that all the costs for the said project, the type of construction, the terms of all financing, and the rental income and management methods are all to be approved and consented to by Besney from time to time, which approval and consent is not to be unreasonably withheld.

3. It is agreed by and between the parties hereto that the entire project is to be solely owned by Besney until Sorokin has fulfilled his covenants contained in paragraph 2 hereof and when the said apartment building generates sufficient income to meet all its financial obligations as and when they become due and payable Milton shall be deemed to have earned an undivided one- half interest in the said project.

4. Notwithstanding the foregoing, it is understood and confirmed by the parties hereto that prior to the parties hereto reaching the agreement herein set forth, Sorckin and Milton had made certain arrangements for a mortgage and other financing for the said project which involved Milton being shown as one of the owners thereof and Sorokin guaranteeing repayment of the funds to be borrowed, and accordingly it is agreed that the Title to the said project shall show that each of Milton and Besney own an undivided one-half interest therein, but only for the purpose of satisfying the representations made by Sorokin and Milton for the said financing, and in actual fact ownership of the said project rests completely with Besney until Milton has acquired an interest therein as hereinbefore provided.

5. It is agreed by and between the parties hereto that upon demand being made by Besney, at any time prior to Milton having earned its one-half interest in the said project, Milton will transfer Its registered ownership in the said project to Besney, but if such demand is made Milton shall be entitled to place a Caveat on the Title to the said project to protect the rights it has under this Agreement.

6. It is agreed by and between the parties hereto that in the event Milton acquires an undivided one-half interest in the said project as hereinbefore provided that all monies advanced to the project by Besney shall be repayable to him, out of all monies on hand from time to time which are not required to meet financial commitments of the project and Besney is to be repaid in full before any distribution of funds to the then owners Besney and Milton.

7. It is further agreed by and between the parties hereto that in the event Milton shall acquire an undivided one-half interest in the said project as hereinbefore provided, and in the event that a third party shall submit a bona fide offer in writing, ‘‘the offer’, to Besney and Milton, or either of them, for the purchase of any or all of an interest in the said project and neither Milton or Besney is prepared to accept such offer, . ..

(The procedure outlined in clause 7 is essentially that if one partner receives a bona fide offer of purchase the other partner is to be notified. If one partner refuses the offer then the other partner has the right to acquire the interest of the other partner.)

Upon the plaintiff being called to repay the bank loan which he had guaranteed, Mr Sorokin bestirred himself, no doubt at the plaintiff’s urging and obtained a loan of $150,000 from United Dominion Investment Ltd. I am not certain from the evidence whether the proceeds of this loan were used to satisfy the bank but in any event the bank deferred its demand upon the plaintiff for payment by him.

Further, because of the deficiencies in mortgage loans, the partnership became obligated to Universal Carpets for $50,000 for carpets installed which it arranged to repay at the rate of $1,000 a month.

Similar arrangements were made with General Electric as a supplier of major electrical appliances.

The building was not completed and ready for occupancy until four months after the scheduled completion date.

The apartment was situated in the university area as a result of which the tenants were persons employed at the university. As a consequence there were numerous vacancies during the university vacation term and the apartment was never filled to capacity.

Accordingly, during the taxation years in question in any event, the rental revenue from the apartment was never sufficient to meet all financial obligations incurred by the partnership with respect to the apartment.

In the letter dated November 15, 1963 from Sorokin to the plaintiff he states:

. . . I further agree and undertake to execute a transfer to you of my interest in the property until such time as I have done what I have agreed to you to do in regards to completing the development . . .

Such transfer was never made. At a much later time when the plaintiff demanded a transfer of Milton’s interest therein so that the certificate of title would show the plaintiff as the sole owner because the apartment had not generated sufficient revenue to meet its financial obligations Sorokin refused to do so because there were no funds to pay the transfer fee.

The statement in the letter of November 15, 1963 above quoted is at variance with clause 3 of the written agreement also dated November 15, 1963 but not reduced to writing until some two years later.

By virtue of that paragraph “the entire project is to be solely owned by Besney (the plaintiff) until Sorokin had fulfilled his covenants” that is, to ensure that the apartment produced sufficient revenue to meet all its financial obligations in which event “Milton shall be deemed to have earned an undivided one-half interest in the said project”.

The arrangement between Sorokin and the plaintiff was a private one between themselves. It was not disclosed to any creditor of the project. The plaintiff, Milton and Sorokin incurred joint and several liability as principals and guarantors to the first mortgage, the second mortgage, the bankers and for all other obligations incurred in financing and furnishing the project. The insurance was taken out on the building with the plaintiff and Milton being insured as owners. The certificate of title was in the names of the plaintiff and Milton as owners of an undivided half-interest.

Still further difficulties beset the project. The building was built by Buffalo Construction Limited, a company controlled by Milton Sorokin. On completion it was managed by Raemark Holdings Ltd, a company in which Milton Sorokin had a controlling interest.

During the operation of the apartment Raemark Holdings Ltd either neglected or was without funds from the project to pay the municipal taxes. The arrears of taxes came to the substantial and approximate amount of $37,000.

Under the terms of the first mortgage agreement default in payment of taxes is default under the mortgage and by virtue of that default the whole principal became payable.

Accordingly the mortgagee, Montreal Trust Company, began an action of foreclosure. The defendants in the action were the plaintiff herein, Morris Besney, and Milton Developments Ltd who were the mortgagors and whose interests were to be foreclosed.

To the plaintiff this was the last straw. He concluded it was best to sever his business relationship with Milton Sorokin in the Kennedy Towers project. To this end Milton released its equitable right to an undivided half-interest in the property and conveyed to the plaintiff its legal interest in the property in return for which the plaintiff assumed all liabilities incurred. This occurred in 1970.

Sorokin testified that he received no payment of money and that what he did, in effect, was to quit claim all his interest to the plaintiff although he persisted in his optimistic forecast that the project would eventually become a paying proposition.

In 1970, therefore, the plaintiff became the sole owner of the apartment building and from that time forward would, in all likelihood, be entitled to claim the whole of the capital cost allowances permitted but that is not the issue before me.

The issue before me is, upon the facts as set forth above, what proportion of the capital cost was the plaintiff entitled to claim in his 1964 to 1967 taxation years. Was he entitled to claim the whole thereof as contended by him or 50% thereof as contended by the Minister?

In my view that question falls to be decided upon a determination of the respective contributions made by Milton and the plaintiff to the cost of the construction of the apartment building which for the reasons expressed above is the capital cost thereof.

The evidence discloses that Milton Sorokin and the plaintiff entered into a joint venture in partnership to purchase land and build an apartment building of which Milton Sorokin (or a company controlled by him) and the plaintiff would ultimately be the owners of an undivided interest therein.

The plaintiff agreed to advance, and did advance, $115,000 to purchase the land. For his part Milton Sorokin, being a contractor and developer, agreed to use his experience in these fields in constructing and arranging the financing of the project. This he did.

In my view the assessment of these respective contributions were determined by the parties to the agreement to be equal for the reason that in the ultimate result each would be equal owners of the property and because in all other respects Milton Sorokin and the plaintiff assumed equal liability for financing and other obligations incurred. At all relevant times the plaintiff, Milton Developments Ltd and Milton Sorokin remained jointly and severally liable as principals and guarantors for all obligations incurred in financing the project.

Without attempting to characterize the nature of the advance of $115,000 made by the plaintiff to initiate the project it was referred to in evidence as an “investment” and also as a “loan”. Certainly it had some of the attributes of both. The plaintiff expected to receive a substantial return thereon which is characteristic of an investment but it was agreed by Milton Sorokin that the entire amount of the advance would be repaid to the plaintiff from the proceeds of the project before Sorokin would share in those proceeds with the plaintiff. Such element of repayment is akin to a loan to the partnership. If the advance is considered as analogous to a loan it would not be a contribution to the capital cost. If it is considered as an investment, the principal amount of which was to be recouped from the proceeds of the project then the consideration for making that investment is counter-balanced by Milton Sorokin’s contribution of his experience in arranging for the financing and construction of the building and in all other respects the parties to the arrangement also considered their respective contributions as equal.

Counsel for the plaintiff submitted the certificate of title is not conclusive. I do not disagree with that submission but acceptance of this submission does not resolve the matter in dispute.

The Land Titles Act, RSA 1970, c 198, provides that after a certificate of title has been granted for any land no instrument to pass any estate or interest in that land is effectual unless the instrument is duly registered.

Notwithstanding this provision it is well settled that such legislation does not prevent equitable estates and interests in land being created as at the time the interest giving birth to those rights is executed and that such interests will be recognized and protected in law even though not registered.

Counsel for the plaintiff accordingly contends that, by virtue of the agreement between the plaintiff and Milton Sorokin and particularly by clause 3 of the formal agreement dated November 15, 1963 but drafted and executed in November 1965 which provides that “the entire project is to be solely owned by Besney until Sorokin has fulfilled his covenants”, the plaintiff is the sole owner of the property despite the fact that the certificate of title to the land is in the names of the plaintiff and Milton Developments Ltd as owners of an undivided half-interest therein.

There have been numerous instances where an unregistered transfer of property has been held to be effective not only against the transferor but against third parties.

In Davidson v Davidson, [1946] SCR 115, the registered owner of land executed and delivered a transfer of it. The transfer was not registered nor was an application made to register it. Subsequent to the transfer judgments were recovered against the registered owner which were registered.

The provisions of the Land Registry Act of British Columbia, which are similar to those in effect in Alberta, were discussed by the Supreme Court. It was held that the statute did not change the common law rule that the execution creditor can only attach that interest which exists in an execution debtor and the registered owner having disposed of his entire interest at a time prior to the judgments, there was no interest upon which the judgment could attach. In effect the beneficial interest had passed to the unregistered transferee and the transferor was left with only a bare legal title.

However assuming that Milton Developments Ltd had transferred its undivided half-interest in the property in accordance with clause 3 of the written agreement dated November 15, 1963 to the plaintiff so that the plaintiff could become the sole owner shown on the certificate of title upon registration of a transfer to him, nevertheless, it is my view that under clause 3 Milton Developments Ltd retained an enforceable interest in the land, subject to the performance of certain conditions, in much the same way as a purchaser under an agreement for sale acquires an interest in land. Milton did not forego that interest until 1970 and the interest so retained by Milton would form the basis of a caveat. The implication in the letter of November 15, 1963 was that the transfer of the whole interest to the plaintiff would be for security reasons and as evidence of Sorokin’s good faith.

In my view both the plaintiff and Milton had an interest in the land at all relevant times, but the capital cost allowance which the plaintiff is entitled to claim as a deduction does not turn upon the proportionate interest in the land but upon the respective contributions to the capital cost made by the plaintiff and Sorokin. The evidence discloses that the parties accepted the respective contributions made by them as equal.

That being so the assumption by the Minister in assessing the plaintiff as he did, that the capital cost to the plaintiff of the project, at the times relevant to these appeals did not exceed 50% of the project, is not unwarranted.

Because of the conclusion I have reached it is not necessary for me to consider the alternative contention of the Minister that the plaintiff is not entitled to deduct an amount in excess of 50% of the capital cost allowances because to do so would unduly or artificially reduce the plaintiff’s income and that a greater deduction is precluded by subsection 137(1) of the Income Tax Act.

For the reasons given above the appeals are dismissed with costs.