Minister of National Revenue v. Philip Mandelbaum and Albert Mandelbaum, [1962] CTC 165

THORSON, P.:—These are appeals from the decisions of the Income Tax Appeal Board, sub nom. No. 567 v. M.N.R. (1958), 20 Tax A.B.C. 252, in the case of the respondent Albert Mandelbaum, and sub nom. No. 568 v. M.N.R. (1958), 20 Tax A.B.C. 296, in the case of the respondent Philip Mandelbaum, each dated September 4, 1958, allowing in part the respective appeals of the respondents against their income tax assessments for 1953. With the consent of the parties the appeals were heard together.

The chief witness for the respondents was the respondent Albert Mandelbaum. His evidence was accepted by his brother the respondent Philip Mandelbaum. Since the respective rights and liabilities of the respondents are identical I shall, for convenience, refer to the respondent Albert Mandelbaum simply as the respondent and to the respondent Philip Mandelbaum simply as his brother.

The respondent and his brother were the owners of the shares of two corporations, namely, Ontario Lumber Company Limited, hereinafter called the lumber company, incorporated in 1935, and Sunnibilt Prefab Products Limited, hereinafter called Sunni- bilt, incorporated in 1959. Each owned half of the shares of each of these companies. The respondent was the president of the lumber company and the vice-president of Sunnibilt and his brother was the vice-president of the lumber company and the president of Sunnibilt. I gather from the evidence that, while the respondent and his brother were the managers of the two companies, the respondent took a more active part in the management than his brother did.

The issue in the appeals, put briefly, is whether a profit of $16,083.22 said to have been realized by each of the respondents in 1953 from their purchase from Sunnibilt of 77 mortgages and 148 conditional sale agreements was properly included in their respective income tax assessments for that year. That being so, it is important to set out the facts showing how the mortgages and agreements came into being and the circumstances under which they were purchased by the respondent and his brother so that the true nature of the transaction from which the profit was realized may be determined.

The business of the lumber company was to sell lumber to builders, general contractors, individual customers and Sunnibilt. The business of Sunnibilt was to manufacture and sell prefabricated buildings, such as houses, summer cottages and garages. At first Sunnibilt sold its products on a cash basis but as it moved along it sold on a time basis with a cash payment down and the balance payable over a period of time, taking a mortgage for the unpaid balance when a house or cottage was sold and a conditional sales agreement when it sold a garage. The time ran generally into a period of two years, the payments being on a monthly basis.

The manner in which Sunnibilt operated when it sold a prefabricated house or summer cottage on terms was illustrated by reference to a specific contract, dated November 16, 1951, filed as Exhibit 1. Under this contract Sunmibilt sold the purchaser a prefabricated house to be delivered during the week of April 14-19, 1952. The total purchase price was $3,724, which amount was made up as follows: price of prefabricated house, $2,815; cost of erection, $675; credit for return of blue prints, $20; carrying charge, $229 ; and mortgage fee, $25. These items made a total of $3,724 to which $30 was added on March 27, 1952, for a door. The purchaser paid a deposit of $200 with his order and on March 27, 1952, he made a cash payment of $980. This left a balance of $2,574 which was to be paid in monthly payments of $106 per month for 24 months. On March 29, 1952, the purchaser executed a mortgage on his property in favour of Sunnibilt for $2,574 to secure payment of this amount. The purchaser’s wife joined in the mortgage to bar her dower and the mortgage was registered in the appropriate registry office on April 12, 1952. Sunnibilt kept a ledger card for this transaction on which the purchaser was given credit for $30 when he paid for the door and for each of the monthly payments of $106 as they were made. The mortgage specified that no interest was to be paid. The respondent explained that the carrying charge was based on 5 per cent per year on the amount of the purchase price. This was a rough calculation and, according to the respondent, it worked out at a true interest rate of approximately 10% or 11% on the amount outstanding. The respondent stated that the transaction which has just been outlined was a typical one.

When Sunnibilt sold a prefabricated garage the procedure was a little different. A sample contract, dated November 21, 1951, was filed as Exhibit 5. Sunnibilt sold the purchaser a prefabricated garage for $348, which amount was made up as follows: price of the prefabricated garage, $262; cost of erection, $53 ; extras, $15 ; and carrying charges, $18. The purchaser paid a deposit of $25 with the order which left a balance of $323 which was to be paid in monthly payments of $19 per month. The purchaser then signed a conditional sale agreement with Sunnibilt for the payment of these monthly instalments and notice of the conditional sale contract was registered against the purchaser’s property in the appropriate registry office. The respondent explained that the carrying charge was roughly computed at $1 per month. No interest was payable under the conditional sales agreement except in case a payment should fall into arrears.

The manner in which Sunnibilt carried on its operations brought it into difficulties in its financing arrangements. The lumber company, which was its parent. company, had to borrow substantial sums of money from its bank, the Royal Bank of Canada, in order to finance the purchase of the large quantities of lumber which it sold to Sunnibilt for its prefabricated buildings and Sunnibilt in turn had to borrow substantial sums also from the same bank in order to finance its own operations. When Sunnibilt sold a prefabricated building, whether a house, summer cottage or garage, it entered the amount of the balance of the purchase price owing to it on its books as an account receivable. This amount included the carrying charge. The total amount of these accounts receivable at any given time was substantial. The Bank was critical of this method of doing business. It took the position that Sunnibilt was not in the mortgage or conditional sales agreement business and it informed Sunnibilt that it would not lend it as much money as it required if it continued its method of doing business. Thus it put pressure on Sunnibilt to dispose of its mortgages and conditional sales agreements. This pressure began in 1951 and continued in 1952. Consequently, the respondent and his brother tried to sell the mortgages and agreements. They entered into negotiations with several finance and mortgage companies but encountered problems which the respondent enumerated in part, namely, the re-sale value of the buildings that had been sold was low, the title of the mortgagor, which had not been searched, might not be satisfactory to a purchaser, there might be faulty construction where the purchaser had put up his prefabricated building himself and there was the fact, in the case of the summer cottages, that they could easily be removed. The negotiations failed to produce any results. No one would offer more than from 90 to 60 per cent of the amounts that were outstanding on the mortgages and agreements and, in addition, there was the prospect of substantial inspection and legal fees. As a matter of fact, no actual offer to purchase the mortgages and agreements was obtained.

The respondent stated that he and his brother tried to dispose of the mortgages and agreements because they knew that they were a burden to Sunnibilt and that when they had failed to do so they decided to purchase the mortgages and agreements themselves, and they did so at the end of 1952.

The circumstances under which they made the purchase were, to say the least, unusual. They purchased, in equal shares, all the mortgages and conditional sales agreements that Sunnibilt had. There were 77 mortgages having a total of $89,888.22 in amounts remaining unpaid under them and 148 conditional sales agreements having a total of $29,006.45 owing under them. These two totals came to $118,394.67. The amount which the respondent and his brother paid for the mortgages and agreements was $76,429.67 which, according to the respondent, they paid to Sunnibilt by cheques in equal amounts, but no cheques were produced. The amount of $76,429.67 was arrived at by deducting from the total of $118,394.67 the sum of $41,965 which w as said to be the amount of the doubtful debt reserve showing on Sunnibilt’s books as at December 31, 1951. There was no written agreement between the respondent and his brother on the one hand and Sunnibilt on the other evidencing the purchase, and they did not take any transfers of the mortgages or assignments of the agreements. After they had made the purchase they kept all the mortgages and agreements to their maturity. The debtors continued to make their payments to Sunnibilt which kept track of them on ledger cards for each transaction. As Sunnibilt made the collections it paid the amounts received to the respondent and his brother by monthly cheques, but no cheques were produced.

According to the respondent, the transaction conferred a benefit on Sunnibilt in that the reduction of the amount of its accounts receivable improved its balance sheet and its borrowing position. At the end of 1951 it had owed the Bank $41,700 but by the end of 1952 this indebtedness had been reduced to $5,000.

The respondent said that the purchase of Sunnibilt’s mortgages and agreements was the only transaction of the kind that he and his brother had ever entered into, that they had never before or since bought or sold mortgages or agreements or been associated with companies that dealt in them and that the only business in which they were engaged was the lumber business and the manufacture and sale of prefabricated buildings. This, of course, was in their capacity as owners and officers of the lumber company and Sunnibilt.

It was also disclosed that at the time the respondent and his brother purchased the mortgages and agreements Sunnibilt owed them a substantial sum for advances made by them to it.

On the respondent’s cross-examination there was further evidence relating to the transaction. Sunnibilt’s balance sheet for the year ending December 31, 1951, showed that its indebtedness to the respondent and his brother was $125,000, but by the end of 1952 this indebtedness had been reduced to $56,559.17. The difference of $68,440.83, according to the respondent, was paid to him and his brother by cheques from Sunnibilt. He admitted that the purchase of the mortgages and agreements from Sunni- bilt and its payments to them on account of its indebtedness to them were contemporaneous transactions. It appeared that in his evidence before the Income Tax Appeal Board the respondent stated that he and his brother had paid for the mortgages and agreements out of the loans payable to them by Sunnibilt, but before me the respondent stated positively that he and his brother issued cheques to Sunnibilt in the total amount of $76,429.67 and that Sunnibilt issued cheques to them in the total amount of $68,440.83. The cheques referred to were not produced but the respondent said that there must be entries in Sunnibilt’s books to prove what he said, but its books were not produced.

It was also shown during the cross-examination that when Sunnibilt required a mortgage to cover the balance owing by it on the sale of a house or summer cottage the purchaser simply brought in the deed of his property and the mortgage was prepared from it without any search of title being made and there was no inspection of the property. The standard provisions in the mortgage form for the payment of interest were all struck out and it was specified that the interest was at ‘‘nil’’. It was also shown that the summer cottages were in all parts of Ontario, many of them in areas remote from urban development and subject to fire and other hazards.

It also appeared that the debtors were not informed of any change in the ownership of mortgages and agreements and continued to make their payments to Sunnibilt. The respondent and his brother did not set up any books for themselves. It was not necessary to send out notices that payments were due by reason of the fact that when a person made a purchase from Sunnibilt he left post-dated cheques with it for the amounts of his instalment payments. The experience of Sunnibilt showed that there were no substantial losses. As the respondent put it, ‘‘one or two didn’t pay’’.

The evidence relating to the intention of the respondents in purchasing the mortgages and agreements is important. The respondent stated that their purpose in making the purchase was to relieve Sunnibilt from the pressure that the Bank was putting on it. And when he was asked whether it was their intention to make an investment his answer was that their original intention was not for the interest but to relieve the pressure put on them by the Bank. It is clear that they did not consider their purchase as an investment.

As appears from the notices of re-assessment, dated April 28, 1955, the Minister added to the amount of income reported by each individual in his income tax return for 1953 the sum of $16,083.22 as his share of the profit realized in 1953 from the purchase of the mortgages and agreements. It was found that the total profit on the transaction was $40,152.85 and that 80.11% of this, or $32,166.44, was realized in 1953, of which each respondent’s share was $16,083.22. Each of the respondents objected to the assessment levied against him but the Minister confirmed it and each respondent then appealed to the Income Tax Appeal Board which allowed their appeals, except as to the amounts of the payments received by each that represented interest, on the ground that the profit from the transaction was a capital accretion. It is from these decisions that the appeals to this Court were taken.

In my opinion, the appeals of the respondents against their income tax assessments for 1953 were wholly without merit. It was submitted on behalf of each respondent in his reply to the Minister’s notice of appeal that the mortgages and conditional sales agreements were purchased as an investment to yield a better-than-average rate of interest. There was no support for this submission. The purchase was not an investment in any sense of the term. No prudent person would have thought of purchasing Sunnibilt’s mortgages and conditional sales agreements as an investment if he had to look after the collection of the outstanding amounts himself. And, certainly, the respondent and his brother did not take any of the steps that a prudent investor would have taken. They did not take any transfers of the mortgages or assignments of the conditional sales agreements and could not have enforced payment of any of the amounts owing on them. There was no investigation of the titles of the mortgages and no inspection of any properties. The fact is that neither the respondent nor his brother considered that their purchase of the mortgages and agreements had been an investment and they did not make any such pretence. Nor did counsel for the respondents attempt to argue that it was an investment.

Counsel did, however, seek to salvage some of the profit from taxability by contending that the instalment payments owing under the mortgages and agreements could reasonably be regarded as being in part payments of interest and in part payments of capital within the meaning of Section 7 of the Income Tax Act, and that their amounts could and should have been included in the respondents’ income tax returns for 1953 only to the extent that they were payments of interest but that otherwise the payments were of a capital nature and their amounts were not taxable. In my opinion, Section 7 of the Act has no bearing on the facts of this case. As between the respondents and Sunnibilt there was nothing of a capital nature in any of the payments under the mortgages and agreements and I am ‘unable to see how any of the profit realized by the respondents from their purchase of the mortgages and agreements could possibly be regarded as an accretion of their capital.

On the evidence I have no hesitation in finding that their profit was subject to income tax as being profit from their business within the meaning of Sections 3 and 4 of the Income Tax Act, R.S.C. 1952, c. 148, which provide as follows:

“3. The income of a taxpayer for the purposes of this Part is his income for the year from all sources inside or outside Canada and, without restricting the generality of the foregoing, includes income for the year from all

(a) businesses,

(b) property, and

(c) offices and employments.

4. Subject to the other provisions of this Part, income from a business or property is the profit therefrom for the year.”

It has been held that the word “business” is a term of wide import: vide, for example, Smith v. Anderson (1880), 15 Ch. D. 247 at page 258. And, in my opinion, the business in which the respondents were engaged was wide enough to include the purchase from which they realized their profit. It was not correct to say, as the respondent did, that the only business in which he and his brother were engaged was the lumber business and the manufacture and sale of prefabricated buildings. Strictly speaking, it was the lumber company and Sunnibilt that were engaged in such businesses and the business of the respondents was the management of the two companies of which they owned all the shares and it was in the course of such management business that they purchased the mortgages and agreements. The evidence of the respondents puts it beyond dispute that he and his brother tried to dispose of the mortgages and agreements because they knew that they were a burden to Sunnibilt and that when they failed to do so they decided to purchase them themselves. The respondent was also specific in his statement that their purpose in making the purchase was to relieve Sunnibilt from the pressure that the Bank was putting on it. Even when counsel for the Minister sought to disturb this evidence by asking the respondent whether it was their intention to make an investment the respondent refused to alter it and said, in effect, that they were not concerned with the matter of interest but only with the pressure put on them by the Bank. It would, in my opinion, not be unreasonable to find that the respondents would not have purchased the mortgages and agreements at all if the Bank had not criticized Sunnibilt for its method of doing business and threatened it with a curtailment of credit if it continued its policy of selling its products on a deferred payment basis and put pressure on it to dispose of its mortgages and agreements. The respondent and his brother were concerned as Sunnibilt’s managers with its unsatisfactory accounts receivable position and the Bank’s adverse criticism of it and it was in the course of their management of Sunnibilt that they acted as they did in trying to sell the mortgages and agreements and finally deciding to purchase them themselves. Their actions were all in the course of their business as such managers and the profit realized by them was profit from such business activity on their part. It was the fact of such business that put them in the way of making the purchase from which they realized their profit. Their transaction was entered into in the course of their business as managers of Sunnibilt and the profit realized by them from it was profit from such business and as such subject to income tax.

There is another aspect of the matter that ought to be regarded. While it is true that when the respondent and his brother purchased the mortgages and agreements they improved Sunnibilt’s accounts receivable position and relieved it from the pressure put upon it by the Bank it should also be noted that they reduced Sunnibilt’s assets by the amount of the unpaid balances owing on the mortgages and agreements by the total amount of $118,- 394.67 less the sum of $76,429.67 which they paid to Sunnibilt and to the extent of the difference reduced the income that Sunnibilt would have received from the mortgages and agreements as the monthly payments on them came in and lessened its income tax liability accordingly. It would surely be an anomalous situation if the respondent and his brother, who were the managers of Sunnibilt and in complete control of it, could purchase all its accounts receivable from the sale of its prefabricated buildings at a substantial discount which was, in effect, what they did, and thereby reduce its income tax liability and at the same time be able to claim that the amount of the discount at which they had made the purchase which they realized when the payments under the mortgages and agreements were made as an accretion of their capital and, therefore, not subject to income tax. In my opinion, such a situation would not be possible.

In view of my finding it is, strictly speaking, not necessary to consider whether the respondents’ transaction in purchasing the mortgages and agreements was an adventure or concern in the nature of trade and, therefore, within the meaning of the term business” as defined by Section 139(1) (e) of the Act which reads as follows:

(e) ‘business’ includes a profession, calling, trade, manufacture or undertaking of any kind whatsoever and includes an adventure or concern in the nature of trade but does not include an office or employment.”

In M.N.R. v. Taylor, [1956] C.T.C. 189, I had occasion to consider the ambit of the expression ‘‘adventure or concern in the nature of trade’’ and, after reviewing the cases, expressed the opinion that the inclusion of the expression in the definition of “business” substantially enlarged the ambit of the kind of transaction the profits from which are subject to income tax. I was also of the view that it was not possible to determine the limits of the ambit of the term or lay down any single criterion for deciding whether a particular transaction was an adventure in the nature of trade for the answer in each case must depend on the facts and surrounding circumstances of the case. But the cases to which I referred indicated that there are some specific guides. One of these is that, if the transaction is of the same kind and carries on in the same way as a transaction of an ordinary trader or dealer in property of the same kind as the subject matter of the transaction it may fairly be called an adventure in the nature of trade. The decision of the Lord President in C.I.R. v. Livingston et al. (1926), 11 T.C. 538, and the decision in Rutledge v. C.I.R. (1929), 14 T.C. 490, support this view. Put more simply, it may be said that if a person deals with the commodity purchased by him in the same way as a dealer in it would ordinarily do such a dealing is a trading adventure: vide Lord Radcliffe’s reasons for judgment in Edwards v. Bair stow, [1955] 3 All E.R. 48 at page 58. Under the circumstances, it might reasonably be said that when the respondents purchased Sunnibilt’s mortgages and agreements their transaction was similar to the kind of transactions that dealers in mortgages and agreements engaged in. If the respondents had been able the sell the mortgages and agreements to one of the finance and mortgage companies with whom they negotiated the transaction into which the purchaser would have entered would have been similar to that into which the respondents entered themselves. It would, therefore, not be unreasonable to call their transaction an adventure in the nature of trade if that should be necessary.

There is no dispute about the amounts referred to or the computations.

In view of what I have said the Minister was plainly right in assessing each of the defendants as he did. It follows that the appeals herein must be allowed and the assessments restored. The Minister is also entitled to costs of the appeals to be taxed in the usual way with, of course, only one set of counsel fees to be divided and charged equally against each respondent.

Judgment accordingly.