Bernard Roberge v. Minister of National Revenue, [1978] CTC 2551, [1978] DTC 1401

Guy Tremblay [TRANSLATION]:—The case at bar was heard at Quebec City, Quebec, on April 6, 1977.

1. Summary

It must be decided:

(a) whether there is justification for the increase established by the respondent, according to the net worth method, of additional income amounting to $17,286.98 for the 1969, 1970, 1971 and 1972 taxation years combined;

(b) whether proceeds from the sale of 2 lots constitute income or a capital gain;

(c) whether the 25% penalty for fraud or gross negligence is justified.

2. Burden of proof

The appellant has the burden of showing that the respondent’s assessments are incorrect. This burden of proof derives not from one particular section of the Income Tax Act but from a number of judicial decisions, one of which is the judgment delivered by the Supreme Court of Canada in R W S Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

As regards the penalty, the respondent has the burden of showing that the appellant is guilty of fraud or gross negligence.

3. Facts

3.1 The appellant operates a hardware store in Black Lake, Quebec, in a building erected in the autumn of 1976.

3.2 Prior to this, he operated the same type of business in the basement of his residence. Earlier still, he had carried on this business for several years in another building in conjunction with a gas station which belonged and still belongs to him.

3.3 During the period 1969 to 1972, the appellant was married and had 2 minor children.

3.4 In 1971 a company known as ‘‘Les Immeubles Bernard Roberge Inc” was incorporated, with the appellant as principal shareholder. The company’s main activity is selling prefabricated houses. The other shareholders are his wife, his brother-in-law (a lumber clerk) and a Mr Toupin, who operates a linen business.

3.5 In all, the company sold 10 prefabricated houses. Sometimes the buyer built his own foundation and constructed the house himself. Sometimes Les Immeubles Bernard Roberge Inc hired the services of a contractor to build the foundation and the house.

3.6 The company did not sell land, only the prefabricated house. The buyer of the house already owned some land.

3.7 The company existed for 3 or 4 years and was then dissolved.

3.8 The respondent considered profit from the sale of 2 lots to be income. The appellant maintains it is a capital gain.

To simplify the work of investigation, it was agreed that evidence would be presented separately and they would be called “lot No 1” and “lot No 2”. We retain these names in the judgment.

Lot No 1

3.9 On January 14, 1964 the appellant purchased from Dame Denise Girard for $5,000 a piece of land on the fourth range of Thetford township. This land, the area of which is approximately 1,200,000 square feet, was supposed to contain a stand of timber which would yield a substantial return when cut, according to the vendor’s husband, Mr Yvon Roy.

3.10 The appellant, relying on Mr Roy’s word, did not inspect the said property until 6 months later. He then discovered that the wood on it, a few aspens and maples, could not for all practical purposes be logged for profit. It was later proved, by a person who bought part of the lot, that the wood was buried [sic] or given away as firewood.

3.11 The appellant had never before purchased a stand of timber nor contracted in this business. He admitted that in practice he knows nothing about the business.

3.12 The appellant did not cultivate the land or put it up for sale; he simply kept it until July 29, 1969. On that date he sold a piece of it, with an area of about 125,000 square feet, for $3,000. However, in addition to the price, the buyer transferred a strip twenty feet wide to make it possible to enlarge one end of the road which divided the appellant’s land in two.

3.13 A Mr Beaudoin, who owned a lot adjacent to the lot which was purchased, sold it all to Apalache Inc.

3.14 The profit derived from this sale was considered a capital gain by the respondent.

3.15 On July 13, 1971, the Government of Quebec purchased from the appellant for $2,390 a part of the land with an area of about 70,200 square feet. This purchase was made with a view to eliminating a bend in the regional road.

3.16 The respondent considered the profit resulting from this sale to be a capital gain.

3.17 In June of 1971 the appellant, wishing to request the municipality of Thetford South to extend water and sewage systems to his property, had a surveyor, Henri Perreault, draw up a plan for subdividing his land purchased in 1964. This plan was produced as Exhibit A-5.

3.18 The municipality refused to comply with the request. “If you want to have water and sewers, do it yourself,” they are supposed to have replied to the appellant, according to his own testimony. In 1977, the water and sewage systems have still not been installed.

3.19 On March 20, 1972, the appellant sold to Morne Enterprises Inc for $42,872.50 a part of the property having an area of 342,980 square feet. The buyer took an option to purchase another lot of about the same area as the first piece, and adjoining it.

3.20 The company purchased the property with a view to using it for a trailer park.

3.21 The sale was made after several months of negotiations between the notaries of the two parties involved. The company was offering 0.60¢ a square foot, while the appellant was asking 0.20¢. They agreed on 0.121/2 0 a square foot.

3.22 The parties to the contract did not know each other before the negotiations. The appellant did not advertise this sale.

3.23 In his testimony Mr Paul Emile Roy, president of Apalache Industries Ltée and Morne Enterprises Ltée, stated that the price paid for the property, namely $42,872.50, was rather high but that was the price.

3.24 The appellant kept a strip, 66 feet wide separating into two parts the road which had been sold. The appellant further undertook to transfer it to the municipality to build a road.

In case this did not take place, the appellant established over this Strip a perpetual right of way ‘‘on foot, by car or otherwise”.

3.25 The respondent considers profit on the sale of this lot as income.

Lot No 2

3.26 On September 8, 1970 the appellant purchased 2 adjacent plots of land in the township of Thetford. These plots are situated two and One-half miles from Lot No 1.

3.27 As appears from the official cadastral survey (Exhibit A-8), the first plot of land, belonging to Mr L A Landry (contract, Exhibit A-7, lot 26-G-41-1), has a depth of 69.5 feet and a length of 400 feet situated along Boulevard Smith, Route 1. The second plot of land, purchased from Mr Laval Turcotte (contract, Exhibit A-6, lot 26-F-25-2), is 279 feet deep and 400 feet wide. It is adjacent to the first plot but Situated behind it, looking from Boulevard Smith. The dimensions of both are therefore about 350 feet deep by 400 feet long.

3.28 The first plot was bought for $5,560 and the second for $8,716.16. Both owners were strangers to the appellant.

3.29 The appellant bought these plots of land to build a hardware store. He had been running a business of this kind out of his gas bar for five years. These plots of land located in the business section near Boulevard Smith were far more suitable than Lot No 1, situated two and a half miles farther, and without water or sewers.

3.30 However, this property later proved to be impossible to develop economically, because land fill alone for the property would cost $63,000. Plans for building the hardware store on this spot were abandoned.

3.31 Toward the end of 1970, the appellant met with a notary, Mr Gardner, and a Mr Toupin, a linen merchant, to form a company with the aim of building a shopping centre.

3.32 Les Immeubles de I’Amiante Inc was formed as a company on January 8, 1971. The applicants and provisional shareholders in* the company were Laval Turcotte, Maurice Faucher and Laval Gardner. The appellant also became a shareholder in the company.

3.33 The theoretical main objective of the company reads as follows in the letters patent:

1. (a) to buy, rent and acquire by exchange or otherwise parcels of land or rights over such parcels of land, and the buildings or outbuildings constructed on them; to sell, rent, exchange, mortgage or otherwise dispose of all or part of such land or buildings, and to obtain the necessary guarantees for this;

(b) to erect buildings and deal in construction materials;

(c) to obtain mortgages to guarantee payment of any balance of the selling price of real estate sold by the company, and to transfer the said mortgages in any manner;

(d) to improve, alter and manage the real estate listed above;

(e) to guarantee or otherwise assist in the execution of contracts or mortgages undertaken or given by persons, firms or corporations with which the company does business, and to assume these contracts and mortgages in default of payment;

(f) to prepare sites for the construction of buildings, and to build, repair, improve, furnish and maintain all types of buildings.

3.34 In practice, the company’s objective was to build a shopping centre.

3.35 The company intended to use Lot No 2, plus an adjacent property belonging to Mr Laval Turcotte.

3.36 Disagreement arose in the company on the subject of these properties, and as a result the appellant withdrew from it. From the 11 photocopies of minutes of directors’ meetings held between March 10, 1971 and August 4, 1973, and produced as Exhibit A-11, it appears that from March 10, 1971 to October 6, 1971 the appellant was at least not a member of the board of directors. His name appears in the minutes of the meeting of January 14; 1972 as chairman. He is still chairman. According to the appellant’s testimony, on the advice of a lawyer, Mr Bergeron, he agreed to take back shares in the company, and he then acquired the majority of them.

3.37 It appears from the minutes of March 10, 1971, that the company decided to buy 2 properties: one from Laval Turcotte for the price of $7,000, paid “by means of 70 common shares from the capital stock of Les Immeubles de I’Amiante Inc”; the other from the appellant at the price of $20,000, payable in cash. The appellant received $5,723.84 at that time, as the balance was payable to the mortgage creditors.

As regards the future shopping centre, it appears from extracts from the minutes that, inter alia:

(a) on March 10, 1971, leases were prepared for future tenants;

(b) on April 9, 1971, responsibility for drawing up plans and estimates was entrusted to Rigid Structures Inc, for a price not to exceed $1,500;

(c) Rochette, Rocheford and Pineau Ltée, a firm of engineering consultants, were entrusted with drawing up “plans and estimates concerning mechanics (heating, electricity and plumbing)”;

(d) the directors were authorized to sell common and preferred shares to the general public;

(e) on April 20, 1971, tenders for filling the land were called;

(f) on June 7, 1971, commissions were given to any director who found a tenant:

(g) liability insurance was taken out in the amount of one million dollars:

(h) on July 31, 1971, the contract for filling the balance of the property not already filled was awarded to a Mr Fréchette;

(i) on August 17, 1971, public tenders were called in the newspapers;

(j) on October 6, 1971, the final proposal to build the shopping centre on the company’s property was rejected; it was unanimously decided to buy a piece of land from Laval Turcotte for 0.50¢ a square foot, provided he would buy the company’s property for 0.75¢ a square foot and the federation of Co-op stores would sign a lease:

(k) on January 14, 1972, the appellant bought shares for $500; Messrs Paul Toupin and Jean Gardner each bought shares for $3,000;

(l) on August 4, 1973, with a view of paying the accounts of the company, which had no income, 5 people, including the appellant, bought $800 worth of shares each. A 3-month option was given to a person who wished to buy the property for $140,000, half of it payable in company shares.

3.38 The respondent considers the profit derived from the sale of Lot No 2 to be an income.

Increase by net worth

3.39 The appellant admitted an increase of $5,360 in the cost of living for the 4 years concerned, taken together (1969—$200; 1970—$2,300; 1971—$260; 1972—$2,600). Counsel for the appellant explained that this admission was made to avoid accounting work which would cost more than the taxes involved.

This admission reduces to $11,925 the sum of $17,285 in additional income estimated by the respondent, not including profits from Lots No 1 and No 2.

3.40 For the years in question, taxable income declared and amounts added (not considering gains resulting from the sale of property) read as follows:

3.41 Using a revised balance sheet for the years 1968 to 1972, prepared by the respondent and produced as Exhibit A-10, an accountant who was a witness for the appellant, Mr Ouellet, showed the acquisition of assets for various years for the sum of $11,925, including inter alia:

3.42 As regards the additional income of $11,925, the appellant said that he does not admit to it, but he submitted that it would have cost too much to prepare an adequate defence.

4. Particular points at issue

Are the sums of $4,865.32 and $4,865 taxable as income? Should the sum of $17,285 (or rather $11,925, since $5,360 has been admitted (para 3.39)) be considered additional income? Should the penalty of 25% be upheld?

5. Act, precedents and comments

5.1 The sections of the Act concerned in the base at bar are 4, 46(6), 56(2) and 139(1)(a) of the old Act and 9(1), 152(7), 163(2) and 248(1) of the new Act. They will be cited below if necessary.

5.2 The following precedents, part of which were cited by counsel, were examined by the Board:

(1) MNR v James A Taylor, [1956] CTC 189; 56 DTC 1125;

(2) Californian Cooper Syndicate v Harris (1904), TC 159;

(3) MNR v Valclair Investment Co Ltd, [1964] CTC 22: 64 DTC 5014;

(4) Hope Hardware & Building Supply Co Ltd v MNR, [1967] CTC 120; 67 DTC 5085;

(5) Bronze Memorials Ltd v MNR, [1967] CTC 41; 67 DTC 5052;

(6) Charles Emile Marquis v MNR, [1972] CTC 2398: 72 DTC 1328;

(7) Georgia Gulf Estates Ltd v MNR, [1968] CTC 10; 68 DTC 5026;

(8) John S Davidson v MNR, [1968] CTC 136; 68 DTC 5086;

(9) Napoléon St-Hilaire v MNR, [1973] CTC 2064; 73 DTC 54;

(10) Robert D Tate et al v Her Majesty The Queen, [1974] CTC 731; 74 DTC 6559;

(11) Progress Management Co Ltd v Her Majesty The Queen, [1975] CTC 244; 75 DTC 5174;

(12) Roy M Power v Her Majesty The Queen, [1975] CTC 580; 75 DTC 5388;

(13) Ball Brothers Ltd v MNR, [1975] CTC 2312; 75 DTC 236;

(14) Grant P Kyllo v MNR, [1975] CTC 2243; 75 DTC 194;

(15) Golden Oak Investments Ltd v MNR, [1975] CTC 2220; 75 DTC 180.

(16) Investors Leaseholds Ltd v MNR, [1976] CTC 2211; 76 DTC 1163;

(17) John Cragg v MNR, [1951] CTC 322; 52 DTC 1004;

(18) Regal Heights Ltd v MNR, [1960] CTC 384; 60 DTC 1270;

(19) Clemow Realty Ltd v Her Majesty The Queen, [1976] CTC 129; 76 DTC 6094;

(20) Vaughn Theodore Neilson et al v MNR, [1976] CTC 2032: 76 DTC 1035;

(21) Hans Reicher v Her Majesty The Queen, 76 DTC 6001;

(22) Glengate Investments Ltd v MNR, 31 Tax ABC 369; 63 DTC 322;

(23) No 145 v MNR, 10 Tax ABC 69; 54 DTC 110:

(24) John Cyril Williscroft v MNR, 7 Tax ABC 118; 52 DTC 344.

5.3 Lot No 1

In examining facts to determine whether or not a capital gain is involved, the courts have always considered the objective test and the subjective test, without necessarily always using these terms.

The objective test concerns the object of the transaction. There are objects which by their very nature are commercial, that is to say that if they are purchased in fairly large quantity, they can only have been bought for resale. In the main, this includes all goods purchased for personal consumption or use: food, clothing, and so on. If someone buys 500 suits and sells them at a profit, the profit is considered to be income. Even if this person invoked the subjective standard, saying that he was not a clothing merchant and this was his only transaction, the transaction would still be considered a commercial venture because of the object of the transaction, which is considered to* be of a cOmmercial nature. To take extreme cases which are well known, the purchase of a freight train full of toilet paper and a freight train full of alcoholic beverages were held to be purchases made for the purpose of resale. By their very nature, these objects cannot be bought for personal use except in limited quantities. In these cases, the courts could not be convinced of such a fact, and the profit resulting from resale was held to be income and not a capital gain.

On the other hand, some objects are considered a priori to be long-term investments by their nature. The principal example is the purchase of land. In the case at bar, we are dealing with land.

Unless the subjective test (taxpayer’s intention and conduct, relation between the transaction and the taxpayer’s business, number of transactions and whether repeated, duration of ownership of the property) contradicts the presumptions of the objective test, profits derived from resale should be considered capital gains.

The appellant, a hardware merchant and the operator of a gas station (which has little to do with the purchase and sale of land), sold the property in question on March 20, 1972, more than 8 years after the purchase date (January 1964). The sale of two pieces of the property in 1969 and 1971, described in paragraphs. 3.12 and 3.15, cannot be considered representative sales allowing us to conclude that profit derived from the sale of a third piece of the same property in 1972 should be declared income.

Furthermore, the fact that no advertising was done to sell the lots, and the buyer took the first steps toward purchasing the land, confirms that this was a capital gain. The respondent emphasized particularly the fact that the appellant bought the land for purposes of logging, even though there was hardly any timber on the said property to yield a profit. According to the respondent, he must have purchased it for the tacit purpose of reselling it. This idea is supposed to be supported by the fact that in 1971 the appellant had plans made for subdividing his land in order to request the municipality of Thetford South to provide it with water and sewage systems, which the municipality refused. In his testimony, the appellant stated that he was deceived as to the potential value of the timber on this property when he bought it. The Board believes that the appellant may have been naïve but it has no reason to doubt his word. Furthermore, the object in question is a piece of land, which is in itself a sign of long-term investment. As for the request for water and sewage systems in 1971 (7 years after purchase), the appellant was doubtless trying to obtain a better return. In theory, if he had received such an authorization there is no doubt that the property would have increased in value. Trying to secure a greater return is not necessarily the sign of a commercial enterprise.

Finally, the Board considers that the following two facts are not Significant:

(1) the fact that in 1971 the appellant was the principal shareholder in Les Immeubles Bernard Roberge Inc, a company whose main activity was to sell 10 prefabricated houses without lots (paragraphs 3.4, 3.5 and 3.6):

(2) and the fact that on March 10, 1971 the appellant sold to Les Immeubles de I’Amiante Inc (a company in which he no longer held shares at the time of the sale) a lot which was supposed to be used for building a shopping centre (paragraphs 3.32 and 3.34), regardless of whether the profit derived from this latter sale is ultimately considered in this judgment to be a capital gain or income.

In the case of Lot No 1 the Board concludes, because of the preponderance of the facts involved, that the profits represent a capital gain.

5.4 Lot No 2

This lot (paragraphs 3.26 and 3.27), which is also presumed to be by its nature a long-term investment purchase, was acquired in 1970; according to the evidence (paragraph 3.29), the intention was to build a hardware store on this property. Normally the Board should not doubt this evidence. However, the reason for abandoning plans for the hardware store was that it would have cost $63,000 for landfill, or more than 5 times the cost of the land. Could not such a cost have been foreseen?—or was this land purchased for another reason? Since 1964, when an imprudent purchase was made for logging purposes, had not the appellant acquired any experience? Early in 1971, the appellant and 2 other people formed a company, Les Immeubles de I’Amiante Inc, to which he sold the lot 3 months later for $20,000. This company, the practical purpose of which was to build a shopping centre in which he could locate his hardware store, later made visible efforts to build one (paragraph 3.37). As it turned out, the first two properties purchased, including the appellant’s, were not suitable for this purpose. The company tried to sell them. Thus the sale took place barely a year later. However, this lot was not the only one purchased by the company. A second piece of land, adjoining the appellant’s property, was also acquired at the same time. Following a disagreement at the beginning of March 1971, the appellant withdrew from the company. At the time when the property was purchased, the appellant was no longer part of the company.

He returned to it in January 1972 and reinvested in 1973, along with 4 other people, in an attempt to pay the company’s debts and sell the lots.

Should the formation of this company, Les Immeubles de I’Amiante Inc, and the sale of the lot, be considered a change of investment or significant grounds for determining that this is a business selling real estate? Even with the previous sales, the Board cannot conclude that this is a business selling real estate. Is it not an adventure in the nature of trade?

This seems to be a borderline case. Nevertheless, by examining the details of the evidence, one can arrive at a fairly accurate idea. The company was formed, inter alia, by the appellant and another merchant. Both of them wished to locate their businesses in the shopping centre which was to be built. The reason is economically justifiable, and for the appellant, it answered the purpose for which he had originally bought the lot known as No 2. There is no doubt that this was also a good way for him to try to sell Lot No 2, at a profit if possible.

It appears to the Board that these are the actions of a man who was trying to solve two problems: to establish his hardware business and at the same time to try and sell a piece of land. This land had a landfill problem on the one hand, but on the other hand it was well situated (paragraph 3.29). Is the second intention significant enough to indicate an adventure in the nature of trade? The Board is much inclined to answer yes, especially when it considers the rather short time, 13 months, during which he owned the property and the doubt which was raised concerning the appellant’s intention in buying the land.

On still closer examination, it must be realized that when Lot No 2 was purchased by Les Immeubles de I’Amiante Inc, the appellant was no longer a company shareholder; therefore the transaction was conducted at arm’s length. As for the duration of ownership, this duration is significant in so far as it reveals the taxpayer’s intention when buying the land. In the case at bar, is it not just as significant, or more so, in determining his intention of establishing his hardware business?

The respondent stressed the objectives contained in the letters patent of Les Immeubles de I’Amiante Inc (paragraph 3.38). These purposes range from buying land to maintaining buildings, and include constructing buildings, dealing in construction materials and administering real estate. Firstly, the Board believes that the description of companies’ objectives in letters patent is so broad nowadays that it no longer has the significance it may have had 25 years ago. Secondly, the letters patent are only an indication: what is important is what the company actually did, not what it could do. Finally, in the case at bar, Les Immeubles de I’Amiante Inc is not the appellant, and he did not hold shares in it at the time when Lot No 2 was sold.

On weighing all the probabilities (objective and subjective tests), the Board concludes that this was not even an adventure in the nature of trade, and the profit is therefore a capital gain.

5.5 Net worth: $11,925

The appellant did not think it advisable (paragraph 3.42) to present evidence. He had the burden of proof. The Board therefore maintains the assessment on this point.

5.6 The penalty of 25%

The penalty of 25% applies to undeclared income. An amount of $5,360 was admitted. Since no evidence was adduced by the appellant on this point for the $11,925, the assessment was upheld. As regards the penalty, the burden of proof rests with the respondent under subsections 163(2) and (3) of the new Act and 62(3) of the Income Tax Application Rule^, 1971.

The respondent has not presented any particular proof, but the Board agrees with his counsel, who submitted that there is at least gross negligence when undeclared income varies over the years between 40 and 80% of declared income (paragraph 3.40). The penalty of 25% is upheld.

6. Conclusion

The appeal is allowed in part and the matter is referred back to the respondent for reassessment in accordance with the reasons for judgment.

Appeal allowed in part.