Douglas H Sherman v. Minister of National Revenue, [1973] CTC 192, 73 DTC 5164

Heald, J:—These are appeals from reassessments of income tax payable for the taxation year 1967 in which the Minister of National Revenue seeks to tax as income, the gain realized on the disposition of certain real property owned jointly by two brothers, Douglas H Sherman and James B Sherman. Douglas H Sherman is the appellant in action No T-1515-72. James B Sherman died in 1970 and the plaintiffs in action No T-1537-72 are the executors of his estate.

Counsel agreed at the trial that both actions should be tried on common evidence. Douglas Sherman testified that he was 54 years old, had lived all of his life in Peel County, Ontario, excepting for five years during World War II when he served with the Canadian Armed Forces overseas. On his return from overseas in 1946 he went into the sand and gravel processing business in the same area, operating first in his own name, and, after 1949, in the name of Springbank Sand and Gravel Limited (hereafter Springbank), a private company substantially owned and controlled by him. He was wholly occupied in said sand and gravel business until 1964 when he sold Springbank. For a year thereafter he managed Springbank for its new owner. From 1965 to 1970 he sold mutual funds. Since 1970 he has been a real estate salesman.

His brother, James B Sherman, now deceased, was also born in Peel County, Ontario and lived all of his life there. He was 56 at the time of his death. After leaving school he worked for a while with his father in the coal business but by 1945 had established his own business of producing, supplying and dealing in sand and gravel. He incorporated said business under the name of Sherman Sand and Gravel Limited (hereafter Sherman Sand), also in 1949. Said private Ontario corporation was substantially owned and controlled by him. Like his brother, he was wholly occupied in his business of producing, supplying and dealing in sand and gravel until 1964 when he sold Sherman Sand. During the period from 1946 until 1964, neither brother had any other occupation or outside business interests. In 1955 each of the brothers purchased a gravel property at Caledon, Ontario, some 30 miles away from their place of business. Both of these properties were on the same railroad line and were purchased by the brothers so that they would have a future supply of gravel when the gravel pits which they owned near their place of business were depleted. Douglas Sherman still owns his Caledon gravel property. James Sherman sold his Caledon gravel property for about the same price he paid for it in 1968. Other than the Caledon gravel pits and several other gravel pits near the brothers’ place of business, neither of the brothers were involved in any real estate ventures other than the purchase of their own homes.

The two brothers ran their gravel businesses together, the one more or less complementing the other.

In April of 1956 Sherman Sand purchased a parcel of land on Wolfdale Road in the town of Mississauga (hereinafter referred to as the Harper Farm) comprising approximately 24 acres for the purpose of obtaining a stockpiling area and retail sales outlet for its sand and gravel products when its existing local gravel pits were depleted. This Harper Farm property was on the same railroad line as the Caledon gravel pits owned by the two Sherman brothers. The plan for the future was to transport the gravel from both Caledon gravel pits by rail to the Harper Farm property for stockpiling and retail sale. The previous owner of the Harper Farm had used it mostly for pasture, but, at the time of purchase by Sherman Sand, in 1956, it was zoned for heavy industrial use allowing outside storage, thus permitting the widest possible industrial use. The Harper Farm property is situated on tne west side of Wolfdale Road, immediately south of the mainline of the Canadian Pacific Railway. In 1956 the area generally was being farmed, although there were already two industrial buildings to the wes’i, there was a coal yard nearby, there were several small industrial buildings on the east side of Wolfdale Road, there were from ten to twenty small industrial buildings on Mavis Road, the first street to the east and a large industrial operation owned by Domtar was situated nearby.

After acquisition in 1956, the Harper Farm property was not used immediately for gravel storage because the local gravel pits owned by the two brothers were not yet depleted and it was not yet necessary to ship the gravel from the Caledon pits to the Harper farm property for storage and sale. Thus the Harper Farm property remained vacant and idle. In January of 1962 the Toronto Township Planning Board wrote to Sherman Sand and other affected landowners to the effect that the Planning Board was considering re-zoning a 159- acre parcel of land comprising most of the area bounded by Dundas Street, the CPR tracks, Wolfdale Road and Erindale Station Road from industrial to residential. This proposed re-zoning included the Harper Farm property owned by Sherman Sand. James B Sherman immediately made a vigorous protest in writing to the Planning Board. This letter reads as follows:

It is with great concern that we view the suggestion proposed in your letter of January 24, 1962. We purchased approximately 25 acres of industrial land on the west side of Wolfdale Road immediately south of the CNR right of way some six years ago. At the time of purchase, the Planning Board Office of Toronto Township assured us the property could be held and used at our discretion for the stockpiling and sale of gravel products. It was made clear at the time, that this outlet was to be used to support the purchase of two gravel farms, north of here located adjacent to the same railroad line.

We feel we must point out that to rezone this property now, would not only reduce the value of the land far below what we paid for it at industrial prices but would also sterilize our gravel investments in Caledon.

We find it difficult to understand why property abutting a railroad track could even be considered for dwellings, when it appears so logical an environment for industrial sites.

In our opinion, to rezone this land from industrial to residential would do a grave injustice to the residents of Toronto Township and as well would mean a very substantial financial loss to our Company.

The majority of the other affected owners protested in like fashion and as a result, the proposed re-zoning was dropped. The planning officials advised the Shermans that the re-zoning would not take place at that time and “maybe never”.

In 1964 the two Sherman brothers decided to retire from the sand and gravel business completely, to dispose of their respective interests in Springbank and Sherman Sand and apply the proceeds of disposition to the acquisition of suitable investment.

In March of 1964 the two Sherman brothers and their wives, being the owners of all the shares of Springbank and Sherman Sand, sold said shares to Messrs A F Berrill and Victor A Trustrum and their wives for a cash consideration of $267,500. The agreement of sale also provided for payment in the future to the Shermans for preference shares previously issued to them by said companies in the amount of $145,000 payable at the rate of $40,000 per year commencing in 1964.

lt was a further term of this agreement that the two Sherman brothers would, on date of closing, purchase from Sherman Sand the Harper Farm property for a price of $100,000, which sale did, in fact, take place. A F Berrill testified that he and his associates were not interested in retaining the Harper Farm property because it did not figure in their future plans for the two gravel businesses. Douglas Sherman testified that he and his brother purchased the Harper Farm property with the sole intention of finding an industrial lessee who would be agreeable to having the Shermans build to his specifications on a long term lease basis. They had sold their businesses and thus ceased to have regular income. Their sole intention, at the time of acquisition, was to utilize the Harper Farm property as an income producing investment to replace the income which they had been receiving from their gravel businesses. At the time of said purchase, the property was unserviced by sewer and water, but did have electricity and telephone services. At that time the nearest housing was about three-quarters of a mile away to the south along the Dundas Highway. The only other housing development in the area was the Erindale-Woodlands development, the nearest houses then constructed in said development being about 1 /2 miles to the west of the Harper Farm.

In furtherance of their stated intention, the Shermans contacted several real estate firms inquiring about prospective industrial tenants who would be interested in a long-term build-to-lease proposition. Douglas Sherman’s contacts with these various real estate firms during the period from 1964 to 1966 were solely and exclusively on the basis of building to lease and not sale. This was his evidence and said evidence was confirmed by the evidence of two of the salesmen involved. Mr James S Potter, the president of an industrial real estate firm testified that, sometime in 1965 or 1966, he was searching for property for a client, property with industrial zoning permitting open storage, with proximity to a railroad, that he became aware of the Harper Farm property and accordingly contacted Douglas Sherman with an inquiry as to whether or not the property was for sale. His evidence was that Douglas Sherman advised him that “there was no way the property was going to be sold”. Sherman advised him of their plans for building-to-lease and since Potter was in the industrial real estate business, he asked Sherman to send him further information on the Harper Farm as a potential site for a building-to-lease proposition. He said that Sherman categorically refused to sell and, for that reason, they never got around to discussing or mentioning a possible price.

Mr Jack Kennedy, presently employed by the Canada Trust Company as an industrial and commercial manager, testified that in 1966 he was employed as an industrial and commercial real estate salesman with a real estate firm. He said that on July 20, 1966 (he is certain of the date because he has kept a diary for the past nine or ten years of all of his business activities which diary he produced when giving evidence) he telephoned James B Sherman inquiring if the Harper Farm was for sale. James Sherman advised him that the Harper Farm was not for sale but that they would be interested in leasing it. Kennedy also called Douglas Sherman later the same day. Douglas Sherman told him also that the property was not for sale, that they were contemplating the construction of an industrial building requiring about 200,000 square feet and mentioned the Canadian Pacific Railway as being interested in such a proposal. Kennedy testified that since his interested client wanted only to purchase industrial property, he did not pursue the matter any further with the Shermans.

Douglas Sherman testified that a number of verbal discussions took place during this period with one of the agents concerning the possibility of the Canadian Pacific Railway being interested in having them build a warehouse on this property on a long term lease basis. Sherman said that he liked the possibility of consummating such a proposition with the Canadian Pacific Railway because CPR was the kind of industrial tenant they were looking for, that is, an industrial lessee with a “triple A covenant” which would enable them to get fuller financing on construction than would be the case with a tenant with a lesser credit rating. The fact that there were no sewer and water services on the property at this time was not a stumbling block because they were able to use wells and septic tanks as other industrial buildings in the area were doing.

During this period a number of agents wanted to list the property for sale. The Shermans refused to list it for sale nor did they offer it for sale. Meanwhile industrial buildings continued to be erected to the east, to the north and northeast of the Harper Farm.

During 1966 the Sherman brothers became aware that the Planning Commission was making a study of the area and were again considering re-zoning the Harper Farm area to residential single family dwellings. Douglas Sherman says that once again, he and his brother objected to such a proposed re-zoning. However, by the fall of 1966 it became pretty obvious that the residential re-zoning was going to take place. Because it would be impossible for them to achieve their industrial investment purpose after re-zoning and because neither of them had any experience in housing or residential development, they decided to sell the Harper Farm property. The sale took place in November of 1966 for a total price of $336,000, each brother thereby realizing a gain of $118,000. It is the nature of this gain that is the subject matter of these appeals. Subsequent thereto, subject property was re-zoned for single family dwellings and there is now a housing development on the Harper Farm property.

In cases of this kind, the Court must consider the relevant facts as of the time of purchase together with the subsequent events including statements by the taxpayers themselves in determining whether the only possibility that motivated the acquisition was the ultimate creation and retention of the property for an investment purpose.

Counsel for the respondent submitted that the objective facts and circumstances at the time of purchase and thereafter negative the sworn testimony of Douglas Sherman that the sole intention of his brother and himself at the time of purchase was to build an industrial building for lease on a long term basis.

Counsel argues that the whole success of the plan of the Sherman brothers hinged on their obtaining “triple A” tenants; that not one single prospective tenant made a concrete proposal; that prior to or at the time of purchase in 1964 neither of the Shermans had made any inquiries as to whether there were any prospective, interested tenants; that no inquiries were made of any financial institutions nor were any plans or sketches prepared; that the attempt at re-zoning in 1962 should have alerted them to the possibility that another such attempt might occur at a later date; that all the discussions with prospective tenants were quite tentative and at a purely exploratory stage; and that for these reasons the purchase in 1964 was nothing more than a mere speculation.

With deference, I am not able to so interpret the evidence before me. Neither of the Sherman brothers have a “trading” history or background. They were in the gravel business in Peel County for a good many years and devoted all of their time and effort to those businesses. I accept Douglas Sherman’s evidence as to the reasons why Sherman Sand acquired the Harper Farm in the first instance. It is only prudent and reasonable that gravel operators should look to a time in the future when their gravel resources nearby would be depleted and when it would be necessary for them to ship the gravel a distance of 30 miles into the Metro Toronto area. The Harper Farm property was a logical acquisition in the circumstances. There was evidence to the effect that other gravel businesses had similar stockpiling and sales outlet premises in the same general area. The Shermans operated successful businesses as witness the fact that, when they sold the two businesses, the purchase price exceeded $400,000. Respondent’s counsel attaches significance to the fact that they made no inquiries about prospective tenants at or before purchase. I find nothing unusual in this. The Shermans knew this area well, they had seen a good many industrial businesses established all around this property over the years, they were successful businessmen; and they were convinced that the best way to replace their gravel income was to construct an industrial building for lease. That their intention was reasonable in the circumstances is confirmed by the witness Potter who impressed me as being most knowledgeable in industrial real estate matters in this area.

Potter said that the Harper Farm property was an ideal industrial site and that the planning officers made a “bad mistake” when they changed the zoning to residential. He said that he never thought that the residential re-zoning would come to pass because in his words “it made no sense”, the property was directly abutting on the main line of the CPR and it was almost completely surrounded by existing industrial buildings and zoning. In cross-examination, he said that the plan of the Sherman brothers for this property was reasonable and logical. He said it would not have been prudent for them to put up a speculative building first and then go looking for tenants because experience has proven that it is far better to get the tenant first and then erect the building tailored to the particular requirements of that tenant.

He said that, in his opinion, it was a tragedy to see properties like this converted to residential use. He said that the plan of the Shermans for the property was “absolutely solid”. He estimated that the Sherman brothers, by not being able to keep this land as industrial property, were suffering a loss of income of at least $60,000 a year. I do not attach any significance to the fact that there was an attempt to re-zone in 1962. The Shermans strenuously objected to this along with the other owners and there was no re-zoning at that time. The planning officials gave them a fair amount of assurance at that time that their industrial zoning was secure. Both Potter and Kennedy said they were very surprised when they learned of the re-zoning. Both of these witnesses were in the real estate business in the area and were quite knowledgeable concerning same. If they did not expect it, surely, two businessmen in the area could not have expected or anticipated it in an area almost surrounded with industrial development. There was also evidence from the Town Planner, David Williams, who also said that in 1964 he could not foresee such a re-zoning.

Respondent’s counsel said that the whole proposal hinged on their obtaining “triple A” tenants. I do not believe the evidence goes that far. The evidence is that they were striving for “triple A” tenants but I do not think it is reasonable to infer from the evidence that if they were not successful in obtaining “triple A” tenants that the project would have had to be abandoned. These two brothers and their wives had just received $267,500 in cash for their businesses. It is true that they immediately paid back $100,000 for the Harper Farm but this still left them substantial cash. Furthermore, they were going to be receiving an additional $145,000 over the next four years. I believe that before too long, but for the re-zoning, they would have been successful in interesting a prospective tenant in a building to lease proposal and that because of their rather substantial private resources, they would have been able to manage the financing even if they had to accept someone with a lesser credit standing than a “triple A” tenant.

In many of the trading cases that have come before this Court, the objective circumstances have been such that they clearly contradict the intention expressed in the sworn testimony of the taxpayer. This, however, is not such a case. In this case, we have, as we do in many of these cases, the sworn testimony of the taxpayer that the sole intention at time of purchase was to utilize subject property as an income producing investment. I found Douglas Sherman to be a most credible witness indeed. I believe him to be a prudent and successful businessman. I accept his evidence on sole intention at time of purchase. Moreover, his evidence is corroborated by the testimony of Messrs Potter and Kennedy who tried to buy the property soon after the Sherman brothers acquired it. They were told by both brothers that it was not for sale and that it was being held for investment. The course of conduct of both brothers throughout is consistent with an investment intention and inconsistent with a trading intention. I can find nothing in the evidence to substantiate respondent’s contention of an alternative or secondary intention. In the case of Racine, Demers and Nolin v MNR, [1965] CTC 150 at 159; 65 DTC 5098 at 5103, Noël, J (now Associate Chief Justice) said:

In examining this question whether the appellants had, at the time of the purchase, what has sometimes been called a “secondary intention’’ of reselling the commercial enterprise if circumstances made that desirable, it is important to consider what this idea involves. It is not, in fact, sufficient to find merely that if a purchaser had stopped to think at the moment of the purchase, he would be obliged to admit that if at the conclusion of the purchase an attractive offer were made to him he would resell it, for every person buying a house for his family, a painting for his house, machinery for his business or a building for his factory would be obliged to admit, if this person were honest and if the transaction were not based exclusively on a sentimental attachment, that if he were offered a sufficiently high price a moment after the purchase, he would resell. Thus, it appears that the fact alone that a person buying a property with the aim of using it as capital could be induced to resell it if a sufficiently high price were offered to him, is not sufficient to change an acquisition of capital into an adventure in the nature of trade. In fact, this is not what must be understood by a “secondary intention” if one wants to utilize this term.

To give to a transaction which involves the acquisition of capital the double character of also being at the same time an adventure in the nature of trade, the purchaser must have in his mind, at the moment of the purchase, the possibility of reselling as an operating motivation for the acquisition; that is to say that he must have had in mind that upon a certain type of circumstances arising he had hopes of being able to resell it at a profit instead of using the thing purchased for purposes of capital. Generally speaking, a decision that such a motivation exists will have to be based on inferences flowing from circumstances surrounding the transaction rather than on direct evidence of what the purchaser had in mind.

I can find nothing in the evidence here that would justify me in finding that these taxpayers had in their minds, at the moment of purchase, the possibility of reselling as an operating motivation for the acquisition.

Respondent’s counsel relied heavily on the case of Regal Heights Limited v MNR, [1960] SCR 902; [1960] CTC 384; 60 DTC 1270. In that case, land was purchased for the purpose of developing a large shopping centre. The establishment of the centre was dependent on the negotiation of a lease with a major department store. When these negotiations failed, the shopping centre plan was dropped and the land sold resulting in a gain which was held to be taxable. Mr Justice Judson said at page 906 [389, 1272]:

. . . There is no evidence that any such store did anything more than listen to the promoters’ ideas. There is, understandably, no evidence of any intention on the part of these promoters to build regardless of the outcome of these negotiations. . . .

In the case at bar, there is corroborative evidence by the two real estate salesmen, Potter and Kennedy, that the Sherman brothers had a firm intention to build for investment, that this intention continued until it was frustrated by an unexpected re-zoning of the property. In this case also, in my view of the evidence, the Sherman brothers did have sufficient financial resources of their own to enable them to bring their plan to fruition. There were two other differences in the Regal Heights case (supra). The company’s memorandum of association listed as one of its objects the sale of property. There was also evidence in that case by one Gerhart Feil that shortly after acquisition, one of the principals of the appellant company had turned down an offer of sale but had made a counter-proposal to sell.

I therefore have the view that the facts of the Regal Heights case are substantially different from the facts and circumstances in the case at bar.

Respondent also relied on the case of MNR v Pine Ridge Property Ltd, [1971] CTC 752; 71 DTC 5392. However, again, the facts of that case are substantially different from the facts in the case at bar. Two of the company’s four shareholders were real estate agents with a trading history and there was evidence of an intention to resell the property at a profit.

Respondent also referred to the Supreme Court case of Vaughan Construction Co Ltd v MNR, [1970] CTC 350; 70 DTC 6268. Here again, the facts are quite different. Vaughan, the appellant’s sole shareholder was a trader in real estate. The stated objects of the company included dealing in land. Additionally, the evidence did not show a firm resolve to hold the property as a source of income. Vaughan in his evidence said that the purpose of acquisition was as a kind of speculation, that what he had in mind as development was the sale of lots and possible development of part of the property by the appellant; and that in view of the developments in the area, it would not take long to dispose of the property in lots.

Respondent also submitted that if the brothers’ sole intention was to develop the property for investment income, there was nothing to stop them from proceeding with a residential development for income. Douglas Sherman’s explanation was that they had no information or expertise on a residential development, that they felt much more comfortable with industrial usage and when the re-zoning became inevitable, they felt they had no option but to sell. I accept this explanation as being credible and reasonable. The re-zoning would not permit apartment house development, being restricted to single family dwellings. The Shermans had no experience whatsoever in real estate developments. If they had been traders, they might well have decided to subdivide and sell lots. The fact that they did not want to get involved in such an operation further corroborates Douglas Sherman’s sworn testimony that the sole intention at time of purchase was an investment intention.

For the above reasons, I am satisfied, on the evidence, that at all relevant times, the sole intention of the two Sherman brothers was an investment intention and not a trading one.

Both appeals are therefore allowed with costs and the reassessments in question for the 1967 taxation year are referred back to the Minister for reassessment not inconsistent with these reasons.