Victor M Prescott v. Minister of National Revenue, [1974] CTC 2150

The Chairman (orally: June 22, 1973):—This is an appeal by Victor M Prescott against an assessment of the Minister of National Revenue for the 1966 and 1967 taxation years. In his notice of appeal the appellant also appeals against the nil assessment for the 1968 taxation year and, at the outset, argued that all transactions were intertwined and that I should look at all three years rather than just the two years mentioned in the Minister’s reply. Counsel for the respondent says there is no appeal from the assessment for 1968 but, in any event, I think it is quite clear that the appellant has a definite interest in the assessment for the year 1968, which, as counsel for the respondent says, must be reached through the 1966 and 1967 years. Therefore, in rendering this judgment, I am taking all three years as being before me, and I do not see how I could, on the evidence that has been adduced, do otherwise.

This is almost a textbook situation, or the basis for a typical examination question that might be placed before an income tax student in law school. It covers about every aspect of transactions in real estate that deal with capital gain or taxable income, as well as dealing with an allowance to grubstakers under subsection 83(3) of the Income Tax Act as applicable at the pertinent times, and with whether or not an expense item charged against a partnership is a justifiable business expense.

First of all, I will deal with the appellant’s allegation that he received a capital gain or a non-taxable return in the case of moneys received by him as a result of grubstaking agreements with two persons, one a man by the name of Ed Jones and the other a man by the name of Deroux. There is no question whatsoever in my mind that the law is quite clear that there is a twofold onus on the person seeking to take advantage of the provisions of subsection 83(3). First of all he must prove that there was a grubstaking agreement entered into prior to the work being undertaken by the prospector; and, secondly, the prospector must in fact prospect in the normal, every day and generally accepted meaning of that term, whether he does it by the old-fashioned method of picking away at outcrops, or by modern geophysical means.

The appellant has been unable to produce either of the men who allegedly did the prospecting for him, but he has produced a statutory declaration by Mr Jones with reference to the claims described as “the M-l and M-C claims”. He has not been able to produce anything from Mr Deroux because he cannot locate him, and his evidence is that he made substantial efforts to try to locate him, even to the extent of utilizing the services of the RCMP.

I accept the evidence of the appellant as satisfying the first part of the onus and proving that he did enter into a grubstaking agreement and that he did pay the moneys that he has alleged to have paid. However, I cannot find that the second portion of the onus has been met, namely, that actual prospecting was in fact done by Jones or Deroux.

In this respect, I must say that evidence has been adduced through Mr Prescott that Jones and Deroux did inform him by telephone that they had prospected and had discovered claims that they thought should be staked and registered and, secondly, there is the statutory declaration by Jones supporting this allegation.

In the first instance, the evidence of Mr Prescott is hearsay evidence and is not admissible in a court of law. It is true that this Board is not bound by the technical rules of evidence, but, as a matter of policy, it has been the Board’s position that hearsay evidence that goes to the very heart of the issue and is not subject to scrutiny or cross-examination by the opposite party should not be admissible. The same applies to a statutory declaration of the type filed by counsel on behalf of Mr Prescott from Mr Jones. That statutory declaration, if I were to accept it, would in my view prove conclusively that the second part of the onus has been satisfied. However, to accept that document, which is one that would not be admissible in a court of law, would be to allow the appellant to succeed on a point on which the respondent had no opportunity to cross-examine and which he had no way of attacking. Therefore I must disregard both the hearsay evidence given by Mr Prescott and the statutory declaration by Mr Jones, and the appeal with respect to an allowable deduction under subsection 83(3) of the Act must be dismissed.

A more difficult aspect of this case, of course, is the real estate transaction. Apparently Mr Prescott is by profession a lawyer, although he has been engaged primarily in transactions in real estate throughout the fifties and the sixties. In one of the exhibits filed, he indicates that his legal practice is limited primarily to work on behalf of the interests of his own companies. He is president of one firm and vice-president of another which has an interest in gas wells, mining and other speculative interests, as well as in a patent for a nitric acid compound for the treatment of lumber to lessen or to do away with the sulphur smell generally associated with pulp and paper processing. In my view, he is by no means to be considered to be engaged in legal practice in the true sense of the word, but is primarily a real estate developer and land assembler.

The first of the transactions in question involves a small piece of property on South East Marine Drive situated opposite a small (by local standards) steel plant. The side of the road on which the appellant had purchased two houses in 1960 was zoned as residential at the time. Seeing that the other side of the road was zoned commercial, he anticipated that, if he was able to get a zone change for the property he had bought, he could then develop it as commercial. In the meantime, he moved into one house to live and apparently used the other house as an office. Within a matter of two or three months, the zone change was applied for, reviewed, and turned down by the municipal authorities, who pointed out to the appellant that it was a residential area. Not only did they refuse to change the zoning but they evicted him from the premises he was using as an office. He continued to maintain the property for some seven years but, as he put it, it was of no great financial benefit to him and he subsequently disposed of it to his father-in-law at a nominal profit of $2,500. This whole transaction, of course, smacks of speculation, of buying property which might become usable as commercial by virtue of its proximity to the steel plant. However, the property was held for some years and perhaps there are grounds for considering this to be a borderline question in this instance, as even learned counsel for the respondent admitted.

Therefore, without delving further into it, I would allow the appeal with respect to the South East Marine Drive property and find that the $2,500 profit on its sale should be treated as capital gain.

The plot becomes more intricate as we get into the properties that are in the central core of Vancouver. I should preface my remarks by saying that there is no doubt whatsoever that the appellant is in the real estate development and holding business. I believe he stated that he has 400 or 500 units in Vancouver, as well as some commercial property in which a department of the federal government is a tenant, so there is no question whatsoever but that he is in the business of obtaining revenue from real property.

The next property dealt with was the property owned by Haro Developments Limited (which has been referred to simply as “Haro”), a company incorporated by the appellant in association with Messrs Woodruff and Booth. Each took a 1/3 beneficial interest in the company, which was incorporated to erect a building at 1033 Haro Street, a location approximately two blocks from the Hotel Vancouver and, as I have said, in the downtown area. The property was paid for in cash in 1965. The three associates intended to build 75 studio suites in a 10-storey building, and they applied for and obtained a mortgage from an institutional lender. The building permit was obtained without difficulty and the building was proceeded with. As is so often the case, the cost exceeded the estimate and, in 1967, the appellant found himself in a position where his cash contribution was less than $10,000, the bank was owed approximately $60,000, and each of his associates had already contributed some $47,000 or $48,000 in cash. I would assume that they naturally turned to him for additional funds to bring his cash outlay at least to the extent of their own, since he had a one- third interest in the project. He says he was unable to obtain the money from his bank, and so he sold out to the other two partners— I use the word “partner” in the loose sense—each of whom took half of his holdings. He realized a gain of approximately $20,000 on this sale, and the question is whether it is a taxable gain or a capital gain free from taxation.

Again the whole transaction, which was spread over a period of two years (in which the building was constructed with nominal investment by him notwithstanding the figures shown on the income tax returns filed and which have been referred to by counsel for the respondent), leads me to believe that it was not a long-term investment project on the part of Mr Prescott, but was nothing more than a speculative proposition out of which he hoped to obtain a profit at the earliest opportunity.

I would therefore find that this profit was not a capital gain and, for that reason, is taxable as assessed by the Minister of National Revenue. Therefore the appeal with respect to the sale of appellant’s interest in Haro Developments Limited will be dismissed.

I turn now to the next property, and again I should preface my remarks by saying that Mr Prescott was involved in many corporations. He had a personal holding corporation and he also had others that served various functions. However, I think it is clear, in looking at the whole transaction, that notwithstanding the particular company that was involved, it was the individual who was the true force behind the vehicle utilized, whichever vehicle it might have been. Thus I am referring only to Mr Prescott, notwithstanding the fact that I am aware of the existence of New Jersey Development Limited, Ridge Development Limited, the First Canada Corporation, Prescott Construction Limited, and so on.

This issue was in connection with a development which was begun in or about 1963 and was completed in 1965, which again was in the central area of Vancouver. This was the New Jersey Development Limited and the Ridge Development Limited project, and consisted of two buildings: one of 92 suites and the other of 74 suites. The project was entered into by the appellant and a friend of his, a Mr Martini. One of the buildings later became known as The Martinique and, as subsequent events will indicate, that is the building which was eventually owned outright by Mr Martini.

What happened in that case was that the projects were proceeded with, were completed and, at some stage, each of the parties decided, for whatever reason, that he would like to own one of the buildings outright. Since each held a 50% interest in each of the companies, it was a question of a swap or trade-off between the parties. A realistic valuation was available because there had been a third party offer for the properties which had been turned down, and this formed the basis for arriving at the proper valuation at which to consummate the transaction between Mr Martini and Mr Prescott. Mr Martini, for sentimental or superstitious reasons, as Mr Prescott said, wanted to keep The Martinique, which had the larger number of suites, and therefore, in order to make the exchange an equal swap, he paid Mr Prescott the sum of approximately $28,000 to even off this transfer. The actual monetary payment was not made until a year or so later— perhaps in 1969. The question, of course, is whether this was a Capital receipt or income.

I have no hesitation whatsoever in finding, in that instance, that it was income in the hands of Mr Prescott, because all that the transaction did was to accelerate the profit that the appellant would have made over the long haul had he remained a 50% owner of both buildings. The fact that he chose to take his revenue in one lump sum by virtue of this swap does not, in my view, take it out of the class of investment income, and therefore the appeal with respect to the New Jersey and Ridge Development companies must be dismissed.

The final issue with respect to real estate involves property that was purchased in 1964 and consisted of a row of five houses with a total frontage of about 565 feet on Harwood Street in the ten hundred block. This property was two blocks south of Davie Street and half a block off Burrard, again in the heart of Vancouver. Mr Prescott’s avowed intention with respect to this property was to build an apartment building of one-bedroom or of studio-type apartments, although, as he stated, various other plans were considered. Several pro forma projected income statements were produced showing the different numbers of suites that could be obtained depending on the type decided upon, but nothing further transpired because, the appellant says, he was not able to get a mortgage in 1965. However, he continued to receive the projections filed as Exhibits A-18, A-19 and A-20, which project a steadily increasing prospective revenue depending on the type of project considered, but there is no evidence of any serious attempt to obtain institutional funds. Canada Life turned him down in 1965 and subsequently came back with a “purchase leaseback and equity position” proposition which to him made no sense whatsoever. So he allowed the property to remain undeveloped, although he did take the minimum steps of having some preliminary plans drawn by an architect in order to obtain the necessary building permit. None of these were, I think, referred to in the accountants’ statement at the “plans to permit” stage, and I quote: “To professional services at development permit stage, $4,000”, which was in April 1968, three years later.

The property was subsequently sold and the appellant made the usual assertion that it was not advertised for sale and that the offer received was unsolicited and fortuitous. In view of the appellant’s obvious participation in real estate in the downtown Vancouver area, I find this hard to accept, and his interest in this property would be readily ascertainable by any person interested in finding out who owned it.

In my view, this was again a purely speculative operation on the part of the appellant, who was extremely knowledgeable in regard to real estate developments in the area in which he was concerned, and I feel that this was no more than the realization of what he had had the astute business acumen to foresee. I find therefore that this was not by any stretch of the imagination a fortuitous and unforeseen offer, but one that had been counted upon to be an obvious eventuality in view of the area in which the undeveloped property was located.

Therefore the appeal must also fail in so far as the profit realized on the Harwood Street property is concerned.

This leaves me only with the question of a management fee paid to Park Royal Towers Limited. This project was developed on land leased by Park Royal Towers Limited, a company owned equally by the appellant and a Dr Allard, either individually or through vehicles chosen by them but never controlled by them. As I recall, it involved the construction of three towers, which were subsequently completed in 1968. For reasons recommended by their accountant, the property was then transferred out of the limited company, Park Royal Towers Limited, and into the hands of Dr Allard and the appellant in partnership, and after October 31, 1968 was operated by them as the Park Royal Towers partnership.

The evidence of Mr Prescott is that, prior to that time, Park Royal Towers Limited had employees and it did engage in renting and showing suites and seeing that the premises were clean, and apparently for assistance in preparing and supplying brochures, etc, for which the company paid. For this service, the partnership paid the company a management fee of $12,500. This fee was paid only up to the time the property was transferred, and the question is whether or not this fee was rightfully earned by the limited company and was a fair and reasonable expense to be charged against the partnership income. In other words, was it an expense paid out in the course of earning income?

Some of the evidence of Mr Prescott is rather vague, but I think this is explained by the fact that he had so many operations on the go. I think I can place sufficient reliance on his evidence to find that he has satisfied me that this was a reasonable sum for the partnership to pay and, on his evidence, it was clearly paid for services that would produce taxable income. I am therefore prepared, on the basis of his evidence, to allow the appeal with respect to his share of the $12,500 paid to Park Royal Towers Limited as a management fee, namely, $6,250.

In summary, the appeal will be allowed in part, the profit of $2,500 on the sale of the South East Marine Drive property is to be deleted from the appellant’s income for the 1967 taxation year, the amount of $6,250, being his half share of the $12,500 management fee paid to Park Royal Towers Limited by the partnership, is to be allowed as a deduction in the 1968 taxation year, and the matter is referred back to the respondent for reassessment accordingly.

In all other respects, the appeal is dismissed.

Appeal allowed In part.