Citation: 2007TCC440
Date: 20070802
Docket: 2005-2887(IT)G
BETWEEN:
KURT ZAENKER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Miller J.
[1] Mr. Kurt Zaenker
appeals from reassessments of his 1997 and 1998 taxation years. The Minister of
National Revenue included interest income in those years from Mr. Zaenker’s
investments in Germany. Mr. Zaenker claimed he incurred business losses from two loans which
went bad, as well as from the disposition of a Hamburg, Germany property in 1997. The Minister
denied such business losses.
Facts
[2] Mr. Zaenker grew up
in Germany. He had an interest in
real estate at a young age. Notwithstanding his father’s protestations that his
son should maintain a career as a pastry chef in the family business, Mr.
Zaenker abandoned that task to pursue his keen interest in real estate. In the
late 1960s, in Germany, he took out his first licence as a real estate broker. For several years
he carried on that real estate brokerage, relying on advertising and word of
mouth to attract clients. He stated that he started making money right from the
outset.
[3] After seven or
eight years as a broker he realized that the money to be made was not as a
broker, but as the owner of properties. He therefore switched real estate
strategies in the mid-1970s and started buying and selling properties. He
developed a reputation for buying older, cheaper properties. He would then, in common
vernacular, flip them. The properties were mainly residential and primarily located
in Hamburg, Germany. Occasionally,
Mr. Zaenker would take the time to renovate a property: he gave the example of
a property listed for DM 700,000 which he acquired for DM 500,000, he fixed it
up over several years and sold it for DM 9,000,000. At the other end of the
spectrum was the example he gave of the purchase of a rundown building that he
acquired for DM 30,000. The property was painted and a few days later sold for
DM 90,000.
[4] Mr. Zaenker would
judge the saleability of a property with or without tenants, and if he believed
a property was more saleable without tenants, he would attempt to buy them out,
though this was not always possible. Mr. Zaenker found buyers by
advertising in the Hamburg papers. He was also known by reputation. He normally financed the
properties by mortgaging them. He indicated that in Germany a borrower with a good track
record, such as his, could obtain a mortgage for greater than the price of the
property. He maintained that he used this strategy in finding buyers who would
require little or no down payment to acquire his properties. He had a DM
6,000,000 line of credit at the Hamburg Savings Bank.
[5] Between 1975 and
1995, when Mr. Zaenker moved to Canada, he estimated that he had bought and sold approximately
140 properties in his own name. He clearly believed he had a talent for making
money on the sale of real estate.
[6] Between December
31, 1994 and August 1995, when Mr. Zaenker moved to Canada, he sold at least six properties. These
were townhouses or apartment properties, some of which he had held for 10
years. Monies earned from the sale of these properties went to reducing a
mortgage on a certain Hamburg property, the property that Mr. Zaenker maintained has
resulted in a business loss in 1997 of CA $1,754,068. The Hamburg property was the only
German property Mr. Zaenker still owned when he immigrated to Canada in August 1995.
[7] The purchase of the
Hamburg property was negotiated
by Mr. Zaenker in late 1993. The purchase price was DM 8,500,000 financed largely
by a DM 8,000,000 mortgage. Mr. Zaenker took possession in early 1994. He
described the property as a “beautiful property” in an excellent location. The
main floor housed a senior’s meeting place, a coffee shop and a Hi-Fi dealer.
On the first floor there was a dental office plus a large office divided into
many smaller spaces. The remaining three floors contained apartments. Mr.
Zaenker testified that, as was his practice, he tried to sell this
“collector’s” property, as he called it, right after he acquired the property. However,
as the rental income covered expenses he was in no rush. This situation changed
when his primary first floor tenant went bankrupt. He realized he could not
rent the space profitably, even if he upgraded the premises. He sold the property
in 1997 to a firm of tax consultants for the same price that he paid, DM 8,500,000.
In discharging the balance of the principal on the outstanding mortgage at the
time of sale, he was subjected to a prepayment penalty of DM 377,989 from the
Hamburg Savings Bank; such penalty was confirmed in correspondence dated March
13, 1997, from the bank.
[8] The parties agree
that the exchange rate at the time of Mr. Zaenker’s move to Canada in August
1995 was 1 DM = .97950 dollars, and in February 1997, at the time of the sale
of the Hamburg property was 1 DM =
.80912 dollars. Mr. Zaenker calculated his proceeds from the sale as being
DM 8,500,000 less the prepayment penalty of DM 377,989 for a net amount of DM
8,122,011 converted at the rate of .80912, which yields proceeds of disposition
of $6,571,681. Mr. Zaenker subtracts this from the value of the property in
1995, being DM 8,500,000, at rate of .97950 or $8,325,750, yielding a loss of CA $1,754,068.
Facts relating to loans
[9] Mr. Zaenker claims
to have made 25 to 30 loans while carrying on his real estate practice in Germany between 1975 and 1995.
He did not advertise to lend money. People knew he was a man of substance. He
would make loans depending on collateral, which he maintained had to be real
estate, or he would lend smaller amounts on the basis of an IOU. Some loans (three
or four) were what he termed bridge financing in real estate deals. He rarely
had to try and realize on his security.
Groth loan
[10] In 1994 Mr. Zaenker
was approached by Mr. Wilhelm Groth, a stranger, seeking to borrow funds on the
strength of a mortgage on a certain attractive property. Mr. Zaenker reviewed
the title to the property he believed was being offered as security. There were
numerous charges against the property, which Mr. Groth wanted to have cleared
up. Mr. Groth also wanted to do some improvements on the property. Mr. Zaenker felt
the property was worth approximately DM 1,000,000.
[11] Mr. Zaenker believed
Mr. Groth was hardworking, and proceeded to lend him DM 500,000 in several
instalments between May 17, 1994 and December 1995. In July 1995, Mr.
Zaenker obtained from Mr. Groth a loan agreement evidencing a loan for the DM
500,000, and also stating that a charge had been registered against the property
in Mr. Zaenker’s name. As it turned out, Mr. Zaenker’s charge was registered
against a different property, a property with little or no value. The property
Mr. Zaenker felt he had security against was not owned by Mr. Groth but owned
by other members of the Groth family. Mr. Groth made some interest payments
towards the loan, then halved the amount of such payments, and then stopped
making payments altogether. By the time Mr. Zaenker was living in Canada he was not receiving
any further payments from Mr. Groth. He commenced foreclosure proceedings in
1997, but realized that the property charged was worth little. Mr. Groth advised
Mr. Zaenker he had nothing. The foreclosure finalized in 1998 did not
yield sufficient funds to cover Mr. Zaenker’s costs.
Puteick loan
[12] In December 1994,
Mr. Zaenker lent Mr. and Mrs. Puteick DM 100,000 at 3% interest for 18 months.
Mr. Zaenker knew the Puteicks as neighbours in the small community where Mr.
Zaenker had a weekend residence. Mr. Zaenker took no security as he believed Mr.
Puteick was “a clean man”. For a brief period of time, Mrs. Puteick provided
housekeeping services in lieu of paying interest. Following an illness, Mr.
Puteick died in 1996. In May 1999, Mrs. Puteick provided a written acknowledgement
of the debt to Mr. Zaenker. He bought out the Postal Bank’s mortgage on the
Puteicks’ property to put himself in a position to foreclose on the
property, which he did. He then allowed the Puteick family to remain in the
home. He recovered none of the DM 100,000 debt owed to him.
Move to Canada
[13] Mr. Zaenker
immigrated to Canada in August 1995. He made a couple of trips to Canada prior to this looking for a suitable
property, and he opted to buy a property in Nova Scotia. He proceeded to
acquire 75 or 80 properties in Nova Scotia, all but one being vacant land. In 1996, he moved
to Kamloops,
British Columbia, where he acquired a property for development, which ultimately was not
developed but sold as vacant land. He bought a couple of other commercial
properties in Kamloops in 1997 along with a parking lot. After a serious bout with cancer in
1997 and 1998, he resumed his real estate practice with a couple of single
family dwelling purchases in 2000.
Issues
[14] The issues are:
(i) Are
the losses on the Groth and Puteick loans deductible in 1997 and 1998,
respectively, pursuant to paragraph 20(1)(p) of Income Tax Act?
(ii) Did
the disposition of the Hamburg property result in a non-capital loss in 1997; if so, what
was the amount of the loss?
(iii) If
there were non-capital losses incurred by the Appellant in 1997, can he carry
forward any of such unutilized loses to be deducted against 1998 income?
Analysis
[15] Paragraph 20(1)(p)
of the Act reads as follows:
20(1) Notwithstanding paragraphs 18(1)(a), 18(1)(b)
and 18(1)(h), in computing a taxpayer's income for a taxation year from
a business or property, there may be deducted such of the following amounts as
are wholly applicable to that source or such part of the following amounts as
may reasonably be regarded as applicable thereto
(p) the total of
(i) all
debts owing to the taxpayer that are established by the taxpayer to have become
bad debts in the year and that have been included in computing the taxpayer's
income for the year or a preceding taxation year, and
(ii) all
amounts each of which is that part of the amortized cost to the taxpayer at the
end of the year of a loan or lending asset (other than a mark-to-market
property, as defined in subsection 142.2(1)) that is established in the year by
the taxpayer to have become uncollectible and that,
(A) where
the taxpayer is an insurer or a taxpayer whose ordinary business includes the
lending of money, was made or acquired in the ordinary course of the taxpayer's
business of insurance or the lending of money, or
(B) where
the taxpayer is a financial institution (as defined in subsection 142.2(1)) in
the year, is a specified debt obligation (as defined in that subsection) of the
taxpayer;
[16] As Justice Teskey
noted in the case of Whitland Construction Co. v. Canada, that for paragraph 20(1)(p) to
apply, four conditions must be met:
(i) there must be a
loan;
(ii) the loan must
have been made in the ordinary course of business;
(iii)
the
loan must have been made by a taxpayer whose ordinary business included lending
of money; and
(iv)
the
loan must be established to have become uncollectible in the year.
Chief Justice Bowman, in the case
of Loman Warehousing Ltd. v. Canada,
further refined the third condition. He stated:
25 The
expression "whose ordinary business includes the lending of money"
requires a determination of just what the taxpayer's "ordinary
business" is. The ordinary business of the appellant is warehousing, not
lending money to other companies in the group. Some effect must be given to the
word "ordinary". It implies that the business of lending money be one
of the ways in which the company as an ordinary part of its business operations
earns its income. It also implies that the lending of money be identifiable as
a business. I agree that the participation in the MNA, in which a company in
the group, depending upon whether on a given day it is in a credit or debit
position, may loan or borrow funds is an incident of its business. The
appellant's argument equates the words "whose ordinary business includes
the lending of money" to the words "in whose business the lending of
money is an incident." I do not think the two expressions cover the same
territory.
[17] Mr. Zaenker did make
loans to Mr. Groth and the Puteicks. However, with respect to the Puteick loan,
I find such loan was not made in the ordinary course of business. Mr. Zaenker
was helping neighbours. This was evident by his pre-existing relationship with
the Puteick family, his attaching a low interest rate to the debt, his acceptance
of housekeeping services instead of interest, the lack of security, the
sympathy for the family arising from Mr. Puteick’s illness and death, which
kept him from seeking payments and his ultimate acquisition of the Puteick
property so that he could allow the Puteicks to remain resident thereon. This
was a personal, not a commercial matter. It was not a loan in the ordinary
course of business.
[18] With respect to the Groth
loan, I find that it was made in the ordinary course of business, although the
lack of documentation until well after the first several loan payments were
made to Mr. Zaenker casts some doubt on the loan being in the ordinary course
of business. Yet, Mr. Groth was a stranger, Mr. Zaenker did ultimately
take a charge against a property (albeit the wrong property) and market
interest rates were charged.
[19] The more pertinent
question is whether the third condition has been met. Did Mr. Zaenker’s
ordinary business include the lending of money? Mr. Zaenker’s business was
real estate – he bought and sold properties. Any loans he made would normally
have a real estate element to them. Mr. Zaenker provided little evidence of the
25 or so loans that he indicated he made over a 20‑year period. He did
not advertise as a lender. The possibility of making loans arose either through
his real estate connections or simply because he was known as a man of
substance.
[20] I believe Chief
Justice Bowman’s comments in Loman are applicable here. Those loans
which were not made on a personal basis (as I have found the Puteick loan was)
were incidental to Mr. Zaenker’s ordinary business, which was dealing in real
estate. His ordinary business did not include the lending of money.
[21] I am further
strengthened in this view that Mr. Zaenker’s ordinary business did not include
the lending of money by the lack of evidence of other loans he had made over
the previous 25 years. Given that of the two loans under consideration before
me, one I have found is clearly personal, I am not prepared to accept that, without
any other evidence, the approximate 20 other loans were all of a commercial
nature. The small number over a long period of time, plus this lack of
evidence, plus my reading of the circumstances surrounding these loans leads me
to the conclusion that the lending of money was not part of Mr. Zaenker’s
ordinary business.
Hamburg property
[22] Mr. Zaenker was in
the business of buying and selling real property. Some of those properties he
rented while holding them before sale; others he did not. He certainly did not
view his business as being divided between the flipping of properties and the
renting of properties.
[23] A number of factors
have been developed in the jurisprudence over the years to address the question
of income versus capital:
–
the nature of the property sold;
–
length of the period of ownership;
–
frequency and the numbers of transactions;
–
the work expended on or in connection with the property;
–
the circumstances responsible for the sale itself; and
–
the motive or intent of the taxpayer when the property was
acquired.
This last factor is considered key
in the determination.
Nature of property sold
[24] The Hamburg property was partly
residential and partly commercial real estate. This was not dissimilar from
other properties held by Mr. Zaenker. The difficulty lies not so much in the
nature of the property, real estate, as the purpose for which the property was
held. I am influenced by Mr. Zaenker’s comments that he had an instinct for
determining when a property was more saleable, with or without tenants. It left
the impression that rent was incidental to the holding of real property as
inventory.
[25] The Respondent
suggested that the Hamburg property was dissimilar from the properties held for resale, which were
primarily residential, and that the Hamburg property was more similar to the rental properties
sold by Mr. Zaenker just before he immigrated. The Respondent’s theory was that
Mr. Zaenker had two businesses; one being the purchase and sale of single
family dwellings; the second being income from rental properties. I do not
agree that the evidence suggests this theory. Mr. Zaenker referred to acquiring
mainly residential properties, but never equated that to single family houses.
Apartment buildings are also residential properties. I do not accept that the
business can be split according to the nature of the property. The facts are
that some properties, whatever their nature, were rented for longer or shorter
periods and some were not rented at all. There was not a great deal of evidence
of the nature of the 140 or so properties sold by Mr. Zaenker over the 20
years. The Hamburg property itself was a
mixture of residential and commercial, though three of five floors were
residential. I draw no inference from this.
[26] The Respondent referred
to the six properties sold in 1994 as rental properties. Apart from the
suggestion some might have been held for 10 years, there is not enough detailed
evidence on these properties to conclude they were not inventory to Mr.
Zaenker. Certainly, to accept Mr. Zaenker’s explanation of his modus
operandi, all real properties were
held as inventory; they were not distinguishable on the basis of their nature.
[27] All to say, the nature of the property as partly
commercial and partly residential does not inexorably point to a finding of
capital or inventory. I must consider the other factors.
Length of period of ownership
[28] There is no magic in
the time period. Certainly a property held for 20 years would point to
capital while a property turned over in a few months might suggest inventory.
But this is a factor that cannot be viewed in isolation. A period of
holding for three years in isolation is simply not determinative. It must be
considered that Mr. Zaenker had a long history of buying and selling property;
he was a real estate broker; he was very successful at reselling properties at
a profit; he often mortgaged properties to the maximum extent possible. The
length of ownership, viewed in light of all these other factors, is not
determinative one way or the other.
Frequency of similar transactions
[29] Mr. Zaenker bought
and sold 140 properties over 20 years and became a wealthy man because of it.
This clearly points to a finding the Hamburg property was another in his stable of real estate
inventory. This is what Mr. Zaenker did. As he put it, he had a basic instinct
for turning real estate profitably. The Hamburg property appears to have been his
only loss.
Work expended on the property
[30] There is some evidence
that Mr. Zaenker expended approximately DM 200,000 on improving the
staircases in the property. When he lost his major commercial tenant, he
believed the cost to renovate further would not justify continuing to hold the
property.
Circumstances responsible for the sale
of the property
[31] Mr. Zaenker
determined the time was right to sell when the commercial tenant went bankrupt,
though his evidence was that he sought to sell the property immediately after
acquiring it, but was in no rush as the rent covered the expenses. When that
situation changed, he believed he could minimize his losses by selling for what
he paid for the property – DM 8,500,000, which he did. Someone in the business
of earning rental income would presumably put more effort into finding
replacement tenants.
Intention at the time of
acquisition of the property
[32] Mr. Zaenker’s stated
intention was that at the time he acquired the property, he intended to resell
it at a profit. He testified that he made it known at that time that the
property was available. He indicated it was not necessary to list the property,
as it is in Canada. His contacts and reputation were sufficient to search out prospective
buyers. He confirmed that he tried to sell in 1994 before leaving the country,
but he was in no rush as the cash flow was good. When that cash flow
diminished, he sold. I believe Mr. Zaenker. I am satisfied his business was
reselling properties at a profit, and the Hamburg property was simply one of
those properties, indeed the only property on which he failed to make a profit.
[33] The Respondent
argues that the length of ownership (three years), combined with the nature of
the property and the fact the sale was triggered by changed circumstances,
point away from Mr. Zaenker’s stated intention, but point more to an intention
of a long-term holding, a holding on capital account. I find that his history
of buying and selling properties, the fact such sales included similar
properties, the sale of the property rather than seeking a replacement tenant
all support Mr. Zaenker’s stated intention from the outset. I found Mr. Zaenker
an extremely straightforward individual with a passion for real estate and some
evident pride in his ability to assess the likelihood of profit on resale.
While there are factors that point both ways, I am swayed ultimately by Mr.
Zaenker’s evidence that the Hamburg property was acquired as inventory and its disposition has
led to a loss on income account.
[34] The amount of the
loss is determined (relying on subsection 128.1(1) of the Act) as the
amount of DM 8,500,000, being the value of the property upon arriving in
Canada, at the rate at that time, less the proceeds of disposition of DM
8,122,011 at the 1997 exchange rate. This yields a loss in Canadian dollars of
$1,754,068. This loss reflects the actual loss arising from the prepayment
penalty. It also reflects a significant foreign exchange loss. The foreign
exchange loss is on income account on the basis that it derives its nature from
the nature of the underlying disposition.
[35] The parties
addressed the issue of secondary intention, referring to the case of Regal
Heights Ltd. v. M.N.R.
It is unnecessary to consider the doctrine of secondary intention, as I am
satisfied that Mr. Zaenker had a primary intention to resell the Hamburg property at a profit. If
I had to resort to the principle from Regal Heights, I would have no
difficulty in concluding that, even if Mr. Zaenker's primary intention had
been the rental income, he had every intention to obtain profit from the
disposition of this valuable, “beautiful” property at the opportune moment.
[36] Before concluding, I
will address briefly the parties’ reliance on Mr. Zaenker’s behaviour upon
immigrating to Canada. Both sides suggested Mr. Zaenker’s subsequent behaviour supported
their respective positions. The Respondent argued that Mr. Zaenker’s Canadian
real estate dealings were fundamentally different from his German dealings, as
in Canada he bought property,
mainly vacant land, for a longer term investment, while in Germany he bought and sold
single family homes. Notwithstanding my different view of the evidence regarding
the nature of the properties sold in Germany, I fail to see how Mr.
Zaenker’s subsequent real estate dealings bear negatively on a determination of
income versus capital nature of the Hamburg property. The Appellant’s counsel argues that one
of the biggest points in his client’s favour is his subsequent speculative
Canadian real estate purchases. While I agree his actions are more supportive
of a finding that he dealt in real estate, again it is subsequent activity on
which I rely marginally.
[37] The appeal is
allowed and referred back to the Minister for reconsideration and reassessment
on the basis that Mr. Zaenker is entitled to a non-capital loss in 1997 on the
disposition of the Hamburg property in the amount of $1,754,068. Any unutilized non-capital losses
in 1997 would be available for carry forward to 1998. The Appellant is entitled
to his costs.
Signed at Ottawa, Canada, this 2nd day of August 2007.
“Campbell J. Miller”
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