Hiwako Investmenis Limited v. Minister of National Revenue, [1973] CTC 2142

The Chairman (orally):—This is an appeal by Hiwako Investments Ltd against reassessments of the Minister of National Revenue for the 1967 and 1968 taxation years. This is a case that falls into the classification referred to as “trading cases’’ and, although it is a case involving sums of some magnitude, the amounts involved are really not as important as the principle of whether or not the profit from the transaction is a capital gain or income. I am indebted to both counsel for the manner in which they have presented the evidence to me. It’s an old cliché that every case depends upon its own facts, and I think it is never more true than in a case of this type.

I think that I must include in this judgment some historical background of the principal shareholder of the appellant company, Mr Walter Koch, who is a man of very engaging character and one who certainly is worthy of great respect for the manner in which he has conducted himself over the years in spite of being in ill health in early middle age.

Mr Koch was born in Berlin in 1904, son of a father who was engaged in the dry-cell battery business, and he was obliged to take over the family business at the age of 21 on the death of his father in 1925. The business expanded into the British Isles and, by 1931, represented a substantial portion of the company’s total business. At that time it is a matter of historical record that Britain went off the gold standard and foreign businesses, including that of Mr Koch, were faced with an import duty of approximately 30%. It was decided that the only way to retain the extremely large portion of their business represented by their trade in England was to form a company that could operate within the sterling block of the British Isles. Mr Koch proceeded to obtain a rental property available through the British Government in Slough in England and formed an English company in which he held 50% of the stock and his English representative — I believe his name was Wiseman — held the other 50%. His business thrived and was purchased by Eveready, a well-known name in that field. The transaction was not made public, and Mr Koch stayed on as managing director of his former company and received £50,000 in cash and stock worth £150,000.

in the troubled times of the late 1930’s, Mr Koch felt that, since he was a German alien living in Britain and carrying a German passport, he should consider his position, and he took some of his funds and returned to Berlin, where he purchased two business properties that have been referred to as gift shops. He owned 80% or 90% of the shares in this business and gave the balance to two men who were familiar with gift shop operation and who would manage them for him. Finally, some three days before the outbreak of the war between Great Britain and Germany, he decided that he had best return to his homeland. At one stage, I thought I detected in his evidence that somewhere in the back of his mind he feared the possibility of internment because he was living in England on a German passport. In any event, he did return to his native Germany where he continued to operate the gift stores until 1942 when, as a result of the heavy bombing of Berlin, he decided to move with his family to Austria. By this time, of course, as I take it from his evidence, the inference is that this type of business was no longer permitted in view of the wartime needs of his country and, in any event, the premises were subsequently destroyed by the bombing.

Mr Koch remained in Austria until about 1947 or thereabouts, when he returned to the Black Forest area of Germany. (It may have been anywhere from 1945 to 1947.) At that time, he says, the military government was making loans to people who would reconstruct West Germany, as it later became, but that, in a small village in the Black Forest, there was no possibility of obtaining such a loan. He moved to Dusseldorf, which was a region in which he was able to obtain a reconstruction loan, re-entered the gift shop business, and I can only infer from the evidence that he operated it with some degree of SUCCESS.

In or about 1957, it was discovered that his health was not of the best. He had symptoms of diabetes and was told to go slow, and one can realize that this was a difficult order for a man of his age to comply with. He decided that he must change his way of life and he sold the gift shop business for half a million Deutsche marks and returned to West Berlin where one of his properties still existed. The other was in East Berlin and was something that was lost to him forever. He managed to sell the West Berlin property for a million DM and therefore was in a position to look for further means of obtaining a continuing source of income with the 1,500,000 DM that he now had from the two transactions.

He said in his evidence that he had two choices, as he saw it: one was to invest in stocks and live off the dividends, while the other was to invest in real estate. He chose the latter and, on cross-examination, he indicated a most rational reason for his choice, that being that to invest in stocks would present him with a yield of about 2 /2% whereas he could look forward to at least double that return from an investment in real estate. He therefore embarked on a series of purchases which resulted in the acquisition of some fifteen or sixteen houses in West Berlin at a time when properties and prices were reasonable, the uncertainty of the political future of the area was a deterrent to foreign investors, and he was able to accumulate these properties at obviously bargain rates. He says that these were houses built between 1900 and 1924. They were houses that were subject to rent control and allowed for a depreciation of only about 2 /2% per year, as well as being Subject to a gradual decrease in rent control over the years.

Mr Koch says that the market peaked in about 1964 at about the same time as he was having more problems with his health. This coincides, I think, with the historical acceptance of the permanence of West Berlin in the Western world and, having decided on advice that he should move to a milder climate, and having decided that Switzerland would be an appropriate place to locate, he proceeded to dispose of his properties. He did this over a period from about 1963-64 to about 1970, when he disposed of the last one. Certainly he disposed of the bulk of them prior to ’69.

There is filed as Exhibit A-1 a list of these sixteen properties. The last one, No 16 of A-1, was a different sort of investment. It came about as a result of the attempt to encourage the reconstruction of demolished areas of West Germany, and a 75% depreciation allowance was granted to those who would build the type of property that was envisaged by this reconstruction, but this property also was eventually sold.

The evidence is that the purchase price of 5,179,815 Deutsche marks finally mounted to some 15,862,666 DM by the time all sixteen properties had been disposed of, an accretion of some 11 million D marks, but one must assume or infer that this would not all be profit, because there would be additions and repairs and the normal upkeep of the properties over the years. However, the exhibit does not show the return on the investments by way of rental income, and one is led to the suspicion that the element of risk that made the properties so attractive to him in the late fifties and early sixties having disappeared by 1963 and 1964 had some effect on his decision to dispose of these properties.

He gives as his explanation that he did not wish to have “all his eggs in one basket” but wished to diversify, and about this time he saw an ad, sponsored by the Canadian Imperial Bank of Commerce, inviting investment inquiries in Canada. He also invested money in South Africa and Bahamas and, as a result of meetings with representatives of the Canadian Imperial Bank of Commerce, he came to Canada in either 1964 or 1965 to discuss the situation with them and to obtain advice from the German Consulate here as to a Germanspeaking lawyer who might assist him. He was put in touch with Mr Hans Dieter Bernhard, who has served him well over the years as his solicitor in this country. A couple of transactions were entered into, but fell through because the vendors could not produce the occupancy they sought or guaranteed in the offer of purchase and sale and the appellant company’s principal shareholder left on deposit in Canada some two to three hundred thousand dollars, awaiting, as he says, or as I infer or paraphrase his evidence, “the right investment”. He did buy a property in 1965 in Oakville which was bought for $1,033,947.37, which over the years did not prove to be a great success and was subsequently sold by him at a relatively small profit considering the time he held it and the amount of the sale price ($1,077,000) in 1969.

This then brings me to the property which gave rise to this appeal, which is the Toronto development known as Flemingdon Park, consisting of a large group of high rise apartments on the west side of the Don Mills Parkway, one of the main north-south arteries of Metropolitan Toronto in the East Central area of the city. What had happened was that the original builder had apparently run into financial difficulties and had overextended himself and, as we so often see with persons who conceive these visionary plans, failed to realize his project and was forced either into bankruptcy or certainly into insolvency with the result that he had to dispose of the property.

lt was purchased, apparently, by Central Park Estate Limited, a company controlled by the Reichman family, which is a family well known in the building trade in Toronto, whose members are associated with Olympia York, one of the largest development companies in the country. According to the evidence of Mr Koch, the Reichmans were only interested in retaining the unused land, and were interested in selling the 880 apartment suites that had already been constructed. For this reason, I think it is a reasonable inference that the purchase was completed at a price very advantageous to the appellant company, namely, about $9,300,000 — in round figures. There is evidence that the appellant’s principal shareholder, by means of a telephone call, was able to raise $500,000 from a bank in Frankfurt, a bank with which he had been dealing for 35 years, an event which indicates the strength of his credit rating with that bank.

Mr Koch says that he bought Flemingdon Park as an investment for his son-in-law, his family and his wife because of his own ill health. He proceeded to take over the penthouse or recreation area at one of the buildings, took over the manager — I think a man by the name of Osbourne — from the vendors to manage the premises, expended some $35,000 in refurbishing his office on top of one of the buildings, brought over the manager of his Oakville property, and entered into an arrangement with IBM for some $250 a month for a monthly cash print-out of the rents and expenses of the property.

The transaction was consummated by virtue of Exhibit A-3, a 184- page document containing the agreement and some other pertinent addenda relevant to the transaction. The evidence shows that Mr Koch did most, if not all, of the negotiation with the Reichmans through a Mr Friedman, who is a real estate broker in the City of Toronto, and a Mr Sypal, whose position is not exactly clear, but who, I infer, was an employee of Friedman. Mr Koch obtained a copy of the rental income, the expenses, and a statement showing a proposed return on his investment of some 13.6%. To him this was a very interesting proposition, and he completed the transaction on June 30, 1967. He then went home to Berlin and left Mr Osbourne and his management staff to run the operation.

In April of 1968, Mr Roberts, a shareholder and officer of Canadian Goldale Limited, a company which was listed on the Stock Exchange, although it has since changed its name to Hambro Canada (1969) Limited, and was generally interested in acquiring properties of the magnitude of Flemingdon Park, received information from an unnamed source to the effect that “it was too bad they weren’t around a few months earlier when Flemingdon Park went at such an advantageous price’. Roberts immediately began investigations and, within a very few days, contacted Mr Koch in Germany by telephone. This was done on a Monday. The following Friday, Roberts met Mr Koch in West Berlin, but not much came of that meeting. The next meeting was on Saturday, and again not much resulted. Mr Roberts says that, on Sunday, Mr Koch, and also, I believe, his wife, took Roberts and his associate on a tour of the city and they ended up back at the home of Mr Koch or in a hotel room. By this time, Mr Koch had agreed to sell the property and it was only a matter of arriving at terms.

Roberts was only interested in acquiring the property on a minimal down payment basis, with a large mortgage back to the appellant, and if it had been a question of cash to mortgages, his company would not have continued the negotiations. They had not had the figures in any great detail, but Roberts says Goldale was involved in many transactions, its officers had looked at the rental income, which they realized was low for the metropolitan area of the City of Toronto, and they also looked at the replacement value. They would not deal through a real estate agent because, as Mr Roberts said, they would not pay the kind of commission that was required, in fact it would have approximated the cash down-payment that they made on the purchase. Goldale did, in any event, purchase the property for $550,000 cash, with a mortgage back to the appellant company for approximately $1,400,000, with provision that the mortgage would be reduced to about $1,100,000 within a short period of time by payments of both interest and principal and the balance of the payments would cover interest only until 1975, when the mortgage was to be repaid in full. These, briefly — or perhaps not too briefly — are the facts as they have unfolded during the course of the hearing.

In these cases one must look at the facts adduced and see if one can determine the true intention of the principal shareholder of the appellant at the time the transaction of purchasing the property was entered into. That Mr Koch is a very astute businessman, experienced in the purchase and sale of real estate, is beyond question, in my mind. The very least, as has been said in higher courts, that an appellant can do in a trading case is to take the witness stand and proclaim his intention to have been of a purely investment nature, with no secondary intent and no desire to make a profit except through the revenue-producing ‘aspects of the property over an indefinite period of time. This has been done by Mr Koch in this case. There is no question in my mind that, at this stage, he believes this to be the case, and I must say that I have observed him in the witness box, and it is quite obvious that he is not a particularly well man. The transactions with which we are dealing took place in 1967 and 1968, and so, in appraising his evidence and that of others, I must try and find some support therein for his contention, or perhaps, on the other hand, find evidence that refutes what he is alleging today.

To put the appellant’s case briefly, it is, as I have said, that the property was purchased as an investment for the family of Mr Koch in the hope that it would produce a reasonable return over a long period of time. What then did he do — what was there in his actions — to convince me that this was really his intention? The leases provided according to Exhibit A-3 indicate that they were for one year only, and there is no evidence before me that any attempt was made to investigate the true potential rental income that could have been derived from this group of buildings except in the evidence of Mr Roberts, to whom it was patently evident that higher rents could have been charged and obtained.

Mr Roberts’ evidence was that his argument with regard to the difficulty of carrying on this operation as an absentee landlord had been a very telling one in persuading Mr Koch to sell because Mr Koch’s doctors had, according to him, advised him that he could not continue to make the trips to Canada. I find it rather strange that this had influenced him in view of the fact that he had expended some $35,000 and hired some three or four or five people to manage the apartments, as well as arranging to have janitors, or building superintendents as they are called in this day and age, for each building. As I have said, his history is one of making a gain on properties. He has explained in his evidence that after one has owned property in Germany for two years, the law entitles him to sell it and retain the profit as a capital gain. He says he discussed the question of capital gain with the Canadian bank representatives, who explained to him that there was still the possibility of a capital gain in this country.

if it was to be a true investment for the benefit of his family, I find it extremely difficult to comprehend why he would sell the property for a profit of about one million dollars when the entire profit was by way of a mortgage back from a company that he had never heard of through a man that he had never seen except for a couple of days and whom he would have had no opportunity to investigate except between the Friday and Sunday of Roberts’ visit to West Germany. If revenue from the property had really been his prime concern, these to me are not the actions of a prudent and astute investor such as appellant’s counsel would have me find Mr Koch to be.

That he is astute is beyond question. That he was interested in a profit on this transaction at the earliest opportunity permeates the whole set of facts in this case as I interpret them. In my view, his actions satisfy me that it was his hope for a capital accretion in the immediate future that led him to the purchase of Flemingdon Park. The old badges of a trader that are usually referred to, such as advertising, multiplicity of action and so on, contents of letters patent, and length of time that the property was held between purchase and sale, when taken individually are, to me, of no great significance, but must be looked at collectively in relation to the overall activity of the appellant There was no reason for him to sell such a good investment. There was no frustration. On the contrary, there was the opportunity of making substantially more than he stood to make on the actual annual income figures which he had been given at the time of purchase. Yet he made no attempt to acquire this extra revenue by renegotiating the leases and raising the rents. He made no attempt to do anything other than accept the first offer that came along.

By itself, as I have said, the length of time that the property was held is not conclusive, but when one looks at the magnitude of this sale, with an accretion of a million dollars over a nine-month period, one cannot, in all honesty, impute the intentions of an investor to this appellant. I am satisfied from the evidence that Mr Koch, as beneficial owner of the appellant company, was just as astute as Mr Roberts and his group, and could see the potential if he had wished to make use of Flemingdon Park purely as an investment. In this instance, time confirms my belief that the property was purchased, following a bankruptcy, from a company that, on Mr Koch’s own evidence, did not wish to retain the buildings, at a fortuitous price that would easily bring a profit in the not-too-distant future because, as Koch says, profits or accretions on buildings rise 8% to 10% a year. The fact that his bankers were prepared so easily and so readily to lend him money by virtue of a telephone call confirms in my mind that they knew that their money would be secure and would be returned to them within the short space of time that he indicated he would need it.

There is nothing in the evidence of any of the witnesses that would lead me to believe otherwise than I have set out. The sense of urgency in closing the transaction between Canadian Goldale and the appellant was a mutual one. They were both anxious to close. The undertakings (Exhibit A-13) that were given on the closing of the trans- action are indicative of undertakings that would be given only by parties that were both anxious that the deal should be speedily completed. As Mr Bernhard, a solicitor for Mr Koch, said in his evidence, both were prepared to give considerable leeway in order to close the deal.

On all the evidence, and after reviewing the documents filed (as I did last night), I can come to no other conclusion than that this was a venture in the nature of trade, that the profit therefrom was properly assessed as such by the Minister of National Revenue, and that the appeal must therefore be dismissed.

Appeal dismissed.