Leasehold Construction Corp. v. The Queen, 95 DTC 5470, [1995] 2 CTC 188 (FCTD)

Tremblay-Lamer J.:—This is an action commenced by the taxpayer to appeal from an income tax assessment made by the Minister of National Revenue for the 1979 taxation year. The plaintiff is a corporation in the commercial and industrial construction business. It built, held and sold the property known as Hawksbury Mall. The only issue is whether the profit generated from the sale of this shopping centre should be considered a Capital gain or income.

Leasehold Construction Corporation (hereinafter "Leasehold”) was created in 1959 as a federally incorporated company. The company has as its objectives the construction, operation and sale of real estate. Mr. Baird is presently the sole Leasehold shareholder. Mr. Baird acted as the company’s vice-president during the time in question and was intimately involved with the building, sale and operation of the shopping mall at issue. He was the only witness to appear at trial. I found his testimony very clear, concise, and very credible. None of his testimony was contradicted on cross-examination. Therefore, I take as true all of the evidence he provided.

Mr. Baird was familiar with the construction of shopping centres and commercial buildings, and concentrated Leasehold’s business in these two sectors of the market. In total, from 1960 to 1983, the plaintiff constructed 58 buildings. [1] These buildings fell into three categories. First, the largest proportion of properties were those constructed by the plaintiff without any financial commitment on its part. The company would build a building, including shopping centres, at the direction of a client. The client would own the land and building during construction and would pay the plaintiffs fees and expenses as they came due. Forty-two buildings of this type were constructed from 1960 to 1983.

Second, 11 of the 58 properties were constructed and owned by Leasehold. The construction was financed by bridge financing provided by financial institutions. As soon as construction was complete the buildings was sold. These building were specifically designed for their tenants, but were never owned by them. When the buildings were finished the plaintiff would sell the property to another party, usually an insurance company, that would then charge the tenant rent. While Leasehold did arrange the financing on these properties, it was only on a short-term basis and with the intention to unload the property as soon as a buyer could be found.

Third, five of the 58 properties were built and then held as investments. While the Crown disputed this category at trial, I am of the view that Leasehold did hold certain properties as investments. The plaintiff alleges that the Hawksbury Mall falls into this category as one of the five investment properties. These properties were held for long periods by Leasehold because of their superior locations and their ability to continuously provide a good return on investment. The plaintiff knew the real estate business and decided to invest its money in an area known to the owners. In fact, the plaintiff continues to hold three of these five properties to this day. The benefit of owning these properties was mainly the rent revenue that was forthcoming to the plaintiff. This source of revenue was dependable and profitable. In later years when one of these properties became less profitable as an investment, it was sold.

There is one property in particular worth mentioning, i.e., the Labrador City Mall. This shopping centre was constructed by the plaintiff and is owned by a separate company. The project was too big for Leasehold alone. Therefore, each of the two Leasehold shareholders individually bought 25 per cent of the shares of a third company that had as its sole purpose the construction and operation of the mall. The other 50 per cent of the new company was held by another firm. In this manner, the $10,000,000 cost of the projected could be spread about. Mr. Baird indicated at trial that he still held his 25 per cent share of the Labrador City Mall, and believed that his former partner’s widow continued to hold his partner’s share.

The Hawksbury Mall came into being at the instigation of A&P. Leasehold and A&P had been involved in many projects through the years. During the early 1970’s A&P asked Leasehold to investigate a site for a shopping centre in Hawksbury, among other locations. Leasehold looked over the area, found a 9.5 acre site, did a market survey, considered the industrial bases of the city, and concluded that a shopping mall was a good idea in Hawksbury. A&P agreed to participate in the project and subsequently Metropolitan Stores joined the project as a second anchor tenant. In December 1973 Leasehold bought the land after official tenancy agreements had been concluded with these anchor tenants. The plaintiff arranged long-term financing and began construction on April 5, 1974. According to Mr. Baird, the decision to hold the mall as an investment was taken after the anchor tenants had indicated their intention to join the project, but before the land was bought.

In November 1974 the mall opened and six months later almost all the retail space had been filled. The mall was anchored by A&P and Greenberg (a Metropolitan Stores subsidiary), contained a Royal Bank, and included 22 shops. In all, the plaintiff invested $330,000 in the project. The rest of the almost $2,000,000 cost was financed. With a cash flow $76,000, the mall appeared to be a good investment.

By 1978, the plaintiff was having second thoughts. The situation had changed in Hawksbury. One of the major employers was rumoured to be closing, another mall was opening in Hawksbury, and Leasehold was encountering problems with its tenants. When an unsolicited offer was made to buy the mall, Leasehold accepted. The deal included Leasehold managing the shopping centre for three and a half years because the purchaser did not have the necessary expertise to do so itself. Leasehold managed the mall through the leaseback period and watched its fortune’s decline. The fears of Mr. Baird were realized.

When the mall was sold the plaintiff considered the $200,000 profit on the sale to be a capital gain. The firm was reassessed and the Minister decided that the profit was either business income or income from an adventure in the nature of a trade. It is this decision that is being contested by the plaintiff.

Capital gain vs. income

The law is very clear on the question of capital gain vs. income. The intention of the taxpayer at the moment when the asset was created or purchased is determinative. If the taxpayer intended to hold the property as an investment, it is capital property. If the taxpayer intended to sell the property at a profit it yields income. The statute itself is unhelpful on this question. It is the jurisprudence that has extensively considered the question. The courts have consistently stated that if the intention of the taxpayer in creating the asset is to sell it at a profit, the asset cannot be capital property. Rouleau J. summarized some of the most often used criteria in Happy Valley Farms Ltd. v. The Queen, [1986] 2 C.T.C. 259, 86 D.T.C. 6421 (F.C.T.D.) at page 263 (D.T.C. 6423-24):

1. The nature of the property sold. Although virtually any form of property may be acquired to be dealt in, those forms of property, such as manufactured articles, which are generally the subject of trading only are rarely the subject of investment. Property which does not yield to its owner an income or personal enjoyment simply by virtue of its ownership is more likely to have been acquired for the purpose of sale than property that does.

2. The length of period of ownership. Generally, property meant to be dealt in is realized within a short time after acquisition. Nevertheless, there are many exceptions to this general rule.

3. The frequency or number of other similar transactions by the taxpayer. If the same sort of property has been sold in succession over a period of years or there are several sales at about the same date, a presumption arises that there has been dealing in respect of the property.

4. Work expended on or in connection with the property realized. If effort is put into bringing the property into a more marketable condition during the ownership of the taxpayer or if special efforts are made to find or attract purchasers (such as the opening of an office or advertising) there is some evidence of dealing in the property.

5. The circumstances that were responsible for the sale of the property. There may exist some explanation, such as a sudden emergency or an opportunity calling for ready money, that will preclude a finding that the plan of dealing in the property was what caused the original purchase.

6. Motive. The motive of the taxpayer is never irrelevant in any of these cases. The intention at the time of acquiring an asset as inferred from surrounding circumstances and direct evidence is one of the most important elements in determining whether a gain is of a capital or income nature.

While all of the above factors have been considered by the courts, it is the last one, the question of motive or intention which has been most developed. That, in addition to consideration of the taxpayer’s whole course of conduct while in possession of the asset, is what in the end generally influences the finding of the Court.

Even if the intention to sell is secondary, it is that intention that is paramount, and not the intention to hold the property as an investment. This secondary intention must have motivated the creation of the asset to be operative. Noël J. provided the following summary of the secondary intention test in Racine, Demers and Nolin v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098 (Ex. Ct.) at page 159 (D.T.C. 5103) as cited in Happy Valley Farms Ltd. v. The Queen, supra:

...the fact alone that a person buying a property with the aim of using it as capital could be induced to resell it if a sufficiently high price were offered to him, is not sufficient to change an acquisition of capital into an adventure in the nature of trade. In fact, this is not what must be understood by a ’’secondary intention" if one wants to utilize this term.

To give to a transaction which involves the acquisition of capital the double character of also being at the same time an adventure in the nature of trade, the purchaser must have in his mind, at the moment of the purchase, the possibility of reselling as an operating motivation for the acquisition; that is to say that he must have had in mind that upon a certain type of circumstances arising he had hopes of being able to resell it at a profit instead of using the thing purchased for purposes of capital. Generally speaking, a decision that such a motivation exists will have to be based on inferences flowing from circumstances sur- rounding the transaction rather than on direct evidence of what the purchaser had in mind.

In my view, the same criteria that apply to the primary intention of the taxpayer, also apply to any secondary intention.

As discussed above, in determining the taxpayer’s intention, the courts have looked to numerous criteria to provide guidance as to the intention of the taxpayer. None of the criteria are determinative, but they all contribute to the total picture. I note that the stated intention of the taxpayer is not conclusive. It is merely one more factor to consider.

Analysis

I agree with the plaintiff that its business as a real estate developer drew the Minister’s attention to its transactions. In general, a company that buys and sells property as a business must meet a heavy evidentiary burden to show that one particular transaction was not concluded in the ordinary course of that business. The plaintiff adduced evidence to show that on the basis of a number of criteria it intended to hold the Hawksbury Mall as an investment. The following factors are relevant in this case:

1. The taxpayer’s corporate objectives: Leasehold’s articles of incorporation indicate that it has the ability to buy land, construct buildings, lease its holdings and sell property. The Crown submits that these objectives indicate that it is always the intention of the company to sell property at a profit. Yet, at the time when these objectives were drafted, corporate objectives represented the limits of what a corporation could do. Hence, drafters tended to make the objectives as broad as possible. In my view, these written objectives do not deserve very much weight because of the greater significance of how the business actually operates. [2]

2. The business of the taxpayer: Leasehold frequently buys and sells real estate. The Crown appears to find it difficult to believe that a real estate developer can hold real estate as an investment. Counsel for the Crown even tried to cast doubt on the investment nature of the four non-contested properties listed as investments by the plaintiff. Even a land speculator can occasionally buy an investment property (S & S Properties Ltd. v. The Queen, [1978] C.T.C. 412, 78 D.T.C. 6294 (F.C.T.D.)). A land developer can do so as well.

3. The pattern of transactions: Leasehold constructed 58 buildings from 1960 to 1983, almost all of which have been sold. In all but five cases, the plaintiff reported the earnings on the sales as income. The plaintiff maintains that its properties come in different types. The three types are those listed above. The Crown submits that all the transactions had as operative factors the intention to sell at a profit. In effect, the Crown claims that the pattern is universal: All of the properties are bought and sold later at a profit. The intention is always the same, though occasionally the intention to sell at a profit is secondary. However, I cannot agree with the Crown. The fact is that presently Leasehold does hold properties as investments.

4. The type of financing: The Hawksbury Mall was built with long-term financing to Leasehold. None of the other properties were built with such financing. In the cases of buildings constructed and held by Leasehold until completion, the plaintiff only arranged bridge financing. For each project, a financial institution provided short-term financing until a buyer could be found for the building. In the majority of cases, the construction was financed by the client’s payments. In my view, in the circumstances, long-term financing indicates that the plaintiffs intention was to hold the mall as an investment.

5. The characteristics of the property as an investment: Sometimes the property itself indicates whether or not it was purchased as an investment. The other four investment properties of the plaintiff shared common characteristics: they were all extremely profitable investments. These buildings had excellent locations, and had specific features to recommend them. They had top quality, long-term tenants, and produced a steady cash flow in the form of rent. The Hawksbury Mall was a good investment for other reasons. The expected revenues were high: a cash flow of $76,000 and a return on investment of 27 per cent. The Hawksbury area was ripe for a shopping centre. The market study conducted by Leasehold indicated that all of the shopping in the city was conducted in the downtown area where building ages exceeded 30 years old. Moreover, the industrial mix and average income of the residents indicated that a mall was feasible. The economic situation prevalent at the time also made a shopping centre an attractive investment. During the 1970s inflation was a major concern and a shopping centre provided a form of inflation protection. Due to the ’’percentage of gross sales" portion of rent payments, when inflation operated to raise prices, rents rose as well. Thus, Leasehold’s revenues were partially protected against inflation. The tax situation also contributed to the investment potential of the mall. Leasehold was able to apply the depreciation of the mall (which was very high in the first few years) against its other income. Thus, it reduced its tax burden. Overall, the Hawksbury Mall was an excellent investment opportunity.

6. The length of the period of ownership: Leasehold held the shopping centre approximately four years. It managed the mall without ownership for a further three and a half years. While a long period of ownership is not conclusive, it is indicative of the plaintiffs intention not to turn over the property to a financial institutions immediately after completion.

7. Similar transactions: The pattern of transactions has already been discussed. Yet, there is one property that is somewhat similar to the Hawksbury Mall. In partnership with another company the principals of Leasehold built the Labrador City Mall. This shopping centre was built as an investment and is still held by the original owners. It is the only other shopping centre constructed by the plaintiff that was allegedly an investment. The fact that the Labrador City mall was similar in nature to that in Hawksbury is indicative of an intention to hold certain shopping centres as investments.

8. Work expended on the property: Usually if a property is made more marketable during the period of ownership, through improvements or special efforts to attract a purchaser, there is some evidence of dealing in the property (Happy Valley Farms Ltd. v. The Queen, supra). There were no such improvements in the case at bar. While Mr. Baird did testify that a number of changes were made to the property, he stressed that they were only regular maintenance and not special.

9. The circumstances surrounding the sale of the property’. In 1978 the plaintiff began to suspect that the Hawksbury Mall might be in trouble. A newer and bigger mall was slated to be built less than one mile from the Hawksbury Mall with Loblaws as its anchor tenant. This new mall’s owners were already approaching the plaintiffs tenants and asking them to consider changing locations. Moreover, one of Hawksbury’s major industries was rumoured to be preparing to close its doors. All of these factors were reflected in increasing problems with the mall’s tenants. It was at that moment that a real estate agent with whom Mr. Baird was familiar telephoned to enquire about the possibility that Leasehold might have property to sell. Mr. Baird informed the agent that the Hawksbury Mall might be available if the price was right. The buyer was a company to which Leasehold had sold property before. A deal was reached and the mall was sold. I do not find it important that Leasehold made an offer to sell instead of accepting an offer to purchase. [3] Mr. Baird explained that this anomaly existed only because of the peculiar nature of the transaction. Unusually in such a case, Mr. Baird was able to testify about whether his fears were well grounded as Leasehold continued to manage the mall after its sale. The shopping mall suffered a drastic increase in shop vacancies, as well as a large increase in empty square footage. By 1982, 29 per cent of the shops were vacant. The industry closure came about in 1982, [4] and a new shopping centre was built just down the road from Hawksbury Mall. Overall, Mr. Baird’s fears were realized.

10. The stated intention of the taxpayer: Mr. Baird indicated that by the time the land for the Hawksbury Mall was purchased the company had formed the intention to hold the property as an investment. While, as discussed above, this factor is not conclusive, I find it persuasive due to an important piece of evidence. The plaintiff produced a handwritten memorandum, in which he set out in May 1974 the reasons why a financial institution should provide longterm financing for the deal. This memorandum was later used as the basis for an application for financing. In my opinion, the memorandum clearly shows that Leasehold’s intention was to hold the property as an investment. There is no indication that the property is to be owned by others. The memorandum even begins, "The Centre will be owned by Leasehold Construction Corporation". It is not often that a taxpayer can produce a document created at the time in question attesting to the exact intention at issue.

Conclusion

In my view, taking into consideration all the factors discussed above, Leasehold intended to hold Hawksbury Mall as an investment at the time the asset came into existence. Therefore, the profit made by Leasehold on the sale of the shopping centre should have been considered by the Minister to be a capital gain.

The appeal is allowed and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the reasons for decision.

Appeal allowed.