Debco Construction LTD v. Minister of National Revenue, [1972] CTC 2003, [1972] DTC 1032

J O Weldon:—This appeal with respect to the appellant’s 1967 taxation year was heard at Victoria, BC, on September 17 and 18, 1970 under the Tax Appeal Board as it was then constituted.

Three individuals each a builder in his own right of many years’ experience joined together to incorporate the appellant Debco Construction Ltd (“Debco”) on October 10, 1961. Its first fiscal period ended September 30, 1962. The name “Debco” was made up of the first letter of each of the surnames of its three founders (also its shareholders) — “D” for Doricott, “e” for Eusanio and “b” for Brotherston, “co” being, of course, the abbreviation of the word “company”. Previous to the incorporation of Debco, Doricott had been in the construction business for about 35 years, Brotherston had been in the same type of business for well over 25 years and Eusanio had also been in the same type of business for a lengthy but unspecified period of time. Any one of the three men named above was, apparently, qualified to take charge of the construction of a house or commercial building. The total authorized share capital of Debco is $10,000 made up of 9,000 7% non-cumulative preferred shares of $1 each par value and 1,000 common shares of $1 each par value of which only one common share was issued to each of the said three shareholders. Thus, their total investment in Debco was the nominal sum of $3. In that regard, it should be observed that the appellant’s balance sheet as at September 30, 1967, covering the taxation year under appeal, contains the following inexplicable item under the heading of share capital — ‘Issued & Fully Paid: 3 Common Shares (par value $1.00) $99.00”. According to the evidence of Brotherston, it can be taken that he and his two co-shareholders were also the original directors and officers of Debco, and that they were still its shareholders, directors and officers as of September 30, 1967, the end of its 1967 taxation year now under appeal.

The taxability of a real estate profit of $19,623.27, admittedly made by the appellant corporation in its 1967 taxation year on the sale of a building and the land pertinent thereto situated on Kidson Road in Nanaimo, BC, is the sole issue to be decided in this appeal. The position taken by the Minister is that his disputed assessment is maintainable and should be confirmed by the Board on the ground that the aforesaid profit has been properly included in computing the taxpayer’s income in accordance with the provisions of sections 3 and 4 and paragraph 139(1)(e) of the Income Tax Act, RSC 1952, c 148 as amended. On the other hand, the position taken by the appellant is that it sought to create and did create a capital asset, namely a commercial building 48 feet by 137 feet divided into five units which it used in its business (actually only one of the said five units appears to have been so used at any given time) and later disposed of at a profit, and that the said profit should, accordingly, be treated as a non-taxable capital gain and not as a taxable profit made in a business or trading transaction. At the hearing of the appeal, E G Woollard, CA, acted as agent for the appellant and T E Jackson, Esq, acted as counsel for the Minister.

The evidence and other material before the Board in this matter indicate: that Doricott, Eusanio and Brotherston started up, “as people do”, as a small contracting business working from their individual houses and basements and storing their building materials, tools and miscellaneous equipment with whoever had the most space to store it; that they incorporated their construction company Debco on October 10, 1961 as already mentioned; that, when they found they were being successful in 1962, “they acquired a piece of land on which to build a building to set up business”; that the construction of a building was commenced in December, 1962 not only for the use of their construction business but also to accommodate a few tenants; that Debco moved into unit No 3 of the 5 units in the building in February, 1963 (it thereby occupied a floor area of about 1/5 of 6,500 square feet or say 1,300 square feet); that, as business increased in the course of time, Debco found that it needed a larger building and also outside space for storing its building materials, forms, equipment, and so on, which it did not have in connection with its first building mentioned above and, accordingly, moved completely out of that building on or about April 15, 1966 (it was then making use of unit No 1 of the said building) after an occupancy of about 3 years and one or two months; that Debco then moved directly into and took over, as lessee, a 2-storey building with ample outside storage for its requirements which Debco, itself, had constructed in 1966 for its shareholders Eusanio and Brotherston, as owners, containing 6,800 square feet situated very roughly about 75 feet south of the 5-unit building which it had sold as outlined above; that Debco was successful almost immediately in renting unit No 1 after it had vacated the premises; that Debco was approached by one of its tenants in its fiscal period extending from September 30, 1966 to September 30, 1967 who offered to buy the property and, apparently, it immediately decided to accept the offer so made; that the particulars of the sale (taken from the notice of appeal) are as follows —

The total cost of the buildings sold was $24,376.73 and the sale price was $42,000.00, resulting in a gain of $17,623.27 in addition to which the land sold for $6,000 cost $4,000, resulting in a total gain of $19,623.27. It is this gain which is the subject of the re-assessment and of this appeal;

that altogether Debco held the said building as landlord and part user following its completion from about March 1, 1963 to about March 30, 1967 taking the middle point of the fiscal period spelled out above for want of a specific sale date, or for an overall period of a little over 4 years.

There appears to be two questions to be considered in seeking the proper disposition of this appeal, first, would it be correct to treat the real estate activities of Debco at all relevant times as being separate and distinct from its shareholders, and secondly, would it be correct to treat the real estate profit of $19,623.27 realized by Debco in its 1967 taxation year as a non-taxable capital gain as contended by it. With regard to the first question set out above, it should be observed: that it is readily apparent from a review of all the evidence before me, especially the evidence set out above as to the shareholders’ trivial investment of $3 in Debco which gives it the unmistakeable appearance of an empty shell, that the legal corporate entity Debco has only had a superficial existence separate from its three shareholders; that the activities carried on by them in Debco’s name at all relevant times should be regarded, in effect, as those of its shareholders, and that Debco has, in other words, been used by its shareholders as a vehicle to serve their own joint or several personal purposes. Thus, the first question set out above should, in my view, be answered in the negative and, accordingly, the nature of Debco’s sale transaction under scrutiny herein should be decided in the light of not only its own real estate activities but also in the light of the real estate activities engaged in by its three shareholders Doricott, Eusanio and Brotherston.

In the above connection, it should be noted that Mr Jackson, in cross-examining David Brotherston, president of Debco and the only witness called on its behalf, set out to obtain from him particulars of the real estate transactions which he had had with Debco and his two co-shareholders Doricott and Eusanio. When Mr Jackson discovered to his chagrin that Mr Brotherston had not prepared himself to give the above-mentioned information in the course of his testimony, and that his memory was generally extremely vague as to his various real estate activities — Mr Brotherston being a builder had been involved, of course, in quite a few transactions — he (Mr Jackson) commented with good and sufficient reason in my view:

I have considered that everything relating to the company and its immediate shareholders is so closely tied together as to make it relevant.

In appeals involving the taxability of a profit realized in a real estate transaction, it has clearly been recognized for some time that particulars of other real estate transactions engaged in by an appellant before and after the transaction under scrutiny are relevant in determining the character of the aforesaid profit. As a matter of fact, appellants in real estate cases have become more or less accustomed to volunteering particulars of their various real estate transactions for the information of the Board. It should be noted for the record that, in accordance with an arrangement made between Mr Woollard and Mr Jackson during the hearing of the appeal, memoranda were subsequently filed with the Board on behalf of the appellant (being received by the Board on January 25, 1971 several months after the hearing) showing how Debco, Doricott, Eusanio and Brotherston were involved singly or severally in one way or another in 12 real estate transactions. To further indicate the nature of the appellant’s business, it might be mentioned that it is associated under the Act with another corporation known as Debco Homes Ltd the business of which is to build and sell homes.

That brings me to the second question set out in the paragraph immediately preceding the above paragraph, namely, would it be correct to treat the real estate profit of $19,623.27 realized by Debco in its 1967 taxation year as a non-taxable capital gain as contended by it. The answer to that question should also, in my view, be answered in the negative for the following reasons:

1. On the basis of Mr. Brotherston’s evidence, Debco’s first building was obviously not designed to meet the requirements of a construction company, was not suitable for its purposes and was only used for the first few years as a stop-gap until Debco became established in its business. He referred to Debco as “being crowded out and not having room for our stock or equipment or even working room so far as the shop was concerned”. Mr Brotherston then went on to explain: that they had problems such as no yard space to store materials; that, while there was a small office, “it would only hold one person and then if anybody else came in there was no room for that person to occupy any desk”. Asked by me why he didn’t move out the tenants and knock out the walls, Mr Brotherston replied:

There were other reasons we could not knock the walls out. It was constructed in a way so each one was an individual building and there was no way to knock them down satisfactorily. Then it would never have been what would have made a good workable building, it still would not have done the job. The heating wasn’t set up for a shop and it did not meet the fire regulations. So we put in hot water heating in the place we were going into. We changed the heating system and then we had space on the outside of the building which we did not have for stock of any kind.

and —

It was not constructed right. In the other one (i.e. the 2nd building) there were no posts in it, it was clear floor space. This other one (i.e. the 1st building) was built, shall we say, in a much simpler way with walls and posts, and it didn’t give us working room that we had in the new building.

In reply to my further question as to what he did about the situation, Mr Brotherston stated:

Well, one of the partners and myself had bought this piece of property adjoining and we decided to rent the property to the construction company (Debco) for storage space at the start. Then we decided to put up a building that would be more suitable for that type of work.

The above witness generally made it clear to the Board that Debco was actually using, as lessee, part of the lands on which the second building was later constructed by its shareholders Eusanio and Brotherston for the storage of materials, forms, and so on, in between construction jobs, and that there was no land available in connection with the first building for that purpose.

2. While Debco alleged in its notice of appeal that it had acquired land and had built the building under scrutiny herein for the occupation of tenants as well as for its own occupation as a construction company, it failed to convince me that the above building was intended to be and was being held as a capital asset for rental purposes for the simple reason that it did not offer any plausible explanation for selling the building when it appeared to be satisfactorily and almost completely rented at the time of the sale. it should also be observed: that, in noting the amount of the profit of $19,623.27 produced on the sale of the building, it should be borne in mind that Debco — a construction company — had built the building for itself on part of a parcel of land acquired earlier by it; that the holding of the building by Debco appears to have been almost entirely tied in with the limited use which it was able to make of the building as a construction company, and that, when Debco moved out of the building, it appears to have accepted the first offer that was made therefor which was made, of course, by one of its tenants.

3. Since it has already been decided herein that the trading activities of Debco’s shareholders are attributable to it in determining the nature of its business and, since it also built and sold houses on its own account in addition to the constructing of commercial buildings under specific contracts, Debco was faced in this appeal with discharging the heavy onus — (which usually falls on a taxpayer dealing in real estate) of showing that the sale transaction in question stood out by itself and was distinguishable from all its other real estate transactions — which it was clearly unsuccessful in doing.

For a recent decision of the Board where a construction company was successful in making a capital gain in the realization of a property held for its own use, reference should be had to Ben Bruinsma and Sons Limited v MNR, [1971] Tax ABC 1105. Without going into a lot of detail, the facts in the Bruinsma case plainly indicate an orderly credible sequence of events, a long period of holding of the property in question, especially if account is taken of the period of holding of the proprietorship which preceded the incorporation of the taxpayer, the complete adequacy of the building sold, the acceptable and plausible reason for selling, and the subsequent construction of a new construction building similar to the one sold.

In the result, for the reasons and observations set out above, the appeal with respect to the 1967 taxation year should be dismissed and the relevant assessment confirmed.

Appeal dismissed.