Alexander Cole Ltd. v. MNR, 90 DTC 1894, [1990] 2 CTC 2437 (TCC)

Teskey, T.C.J.:—The appellant appeals his reassessment for the taxation year 1980 dated April 21, 1983.

Issues

The two issues in this appeal are whether:

(1) Income received by Rogar, Inc., (“Rogar”) a wholly owned foreign subsidiary of the appellant, is active business income, and

(2) Whether the reallocation of $41,680 of income earned in Canada was business income or earnings from Canadian investments.

Facts

Issue 1

The appellant is a corporation incorporated pursuant to the laws of the province of Ontario with a place of business in Toronto, Ontario. It is a privately held corporation. Alexander Cole is the president and the majority shareholder. Its fiscal year-end is July 31. Rogar is a corporation constituted in 1972 under the laws of the State of Florida one of the United States of America and its principal place of business being in Florida. All issued and outstanding shares always have been and are held by the appellant. Rogar's fiscal year-end is December 31.

In 1973 Rogar entered into a limited U.S. partnership for the purposes of purchasing vacant land and building Margate Fashion Centre Ltd. (“Margate Fashion"), a strip shopping centre. The appellant owned a 75 per cent interest in this partnership, 15 per cent of the limited partnership was owned by Joseph Cohen, a cousin of Alexander Cole, and Geoffrey Cipes, a Florida real estate broker, owned the remaining ten per cent.

In May of 1973, the appellant entered into a further limited U.S. partnership with nine others for the purpose of buying a small commercial project consisting of five stores in Coral Springs, Florida. This project was referred to as the Springs Building ("Springs"). The main tenant of this group of five stores was a 7-Eleven. Rogar had a 30 per cent interest in this limited partnership.

In January 1974, the appellant entered into a further limited U.S. partnership known as Margate Shoppes and Offices Ltd. ("Margate Shoppes"). Vacant properties were purchased and developed into stores and offices. There were nine limited partners of which Rogar was one holding a 20 per cent interest.

These three commercial groups of properties were all managed by a management company who maintained the various buildings, negotiated leases with tenants, collected the rents generally performing all the normal tasks of operating and managing shopping centres. By 1977 these three commercial properties had all run into difficulties. The largest property, Margate Fashion, had drainage problems with water forming at the rear entrance of the shops after each rain and youths in the area were climbing onto the roofs and were punching holes in the roofs causing severe damage to the interior of the buildings and to the tenants' inventory. The 7-Eleven tenant in the Springs complex did not renew its lease and vacated the premises. Margate Shoppes ran into trouble and had a 50 per cent vacancy. The manager of theses complexes refused to renew its management agreement with the limited partnerships. The limited partnerships were unable to enter into satisfactory management contracts with its existing manager and/or alternative management companies. As a result of these problems it was decided that the properties would be sold. Sales took a long time to negotiate and the partnerships had to set very favourable terms in order to entice a purchaser. When each property was sold, in order to put the deal together, the vendors had to take small down payments and large wrap-around mortgages each for a term of 30 years and each for an interest rate of 1 /2 per cent higher than the first mortgages on each of the properties. It is the net income on these three mortgages after payment of the interest on the wrapped-around existing first mortgages that is in issue in this case.

Alexander Cole was the only witness concerning this issue. He was born December 18, 1906, and gave his occupation as “investor”.

Alexander Cole was asked the following questions:

Q. What is your background? What professional experience do you have?

A. I've been in the carpet business since 1932 and I sold out my business in 1964 and I’ve been involved in real estate, stocks, mortgages.

When each of these three real estate adventures were sold the limited partnership was dissolved. The wrap-around mortgage payments were paid to Cipes Real Estate who made the appropriate payments on the existing first mortgages and then distributed the surplus to each of the former partners according to their percentage.

Alexander Cole, during the period of 1973 to 1980, spent six months a year in Miami, Florida.

The three sales were reported as capital sales.

Although Alexander Cole gave evidence in chief and was cross-examined thereon, there was really no other significant evidence presented to the Court on Issue 1. When asked about the 1980 financial statement of the appellant, in particular Schedule I thereto, he identified the loans of Benjamin Pape and Commodore Investments as mortgage loan.

Mr. Alexander Cole was asked the following questions and gave the following answers:

Q. In what context were these loans made?

A. In what context?

Q. Were people asking you for money or were you—A. No, no. We knew the principals of these places and we would enquire from them if there were any mortgages that we could participate in - when I say "we", Alexander Cole Ltd.— and as a result of my enquiries, we got into these mortgages.

He was further asked:

Q. Did you get into any loans and mortgages in the past, prior to 1980?

A. Yes. Oh, heavens, yes. I’ve been in it since 1955.

Q. You've been lending money since 1955?

A. Yes. Yes.

Q. How many loans would you say you would have in one year at a given time?

A. I have had as many as twenty loans on mortgages at one given time.

Q. They were all mortgages loans or sometimes—A. Mostly mortgages loans and there were periods where I would have moneys invested in real estate.

Q. And there was no salary expense. By 1979, Rogar had sold the bulk of its real estate interests, had it not? These were the three big interests that it had?

A. Yes.

Q. And all it did thereafter was earn interest income, did it not?

A. Yes.

Q. There was no salary expense that was associated with the earning of this interest income, was there?

A. No.

Q. Sir, am I correct in saying that none of the interest that was earned was reinvested; it was used to pay back loans to Alexander Cole Ltd.? Is that, in fact, what happened to it?

A. Yes.

Analysis

Issue 1

The Court has no hesitancy in finding that the income received from the operating of these three commercial strip shopping centre enterprises was active business income. There was no evidence that would indicate that Rogar was in the business of buying and selling commercial enterprises. Therefore the Court finds that Rogar, prior to 1980, was in the business of developing commercial properties, holding commercial properties as capital assets and earning income therefrom.

Sections 91 and 95 are those sections of the Income Tax Act, R.S.C. 1952, c. 148 (am S.C. 1970-71-72, c. 63) (the "Act") which deal with foreign accrual property income (FAPI). The appellant argues that the activities of Rogar fall within the principals of the cases that have been decided under sections 125 and 129 which also deal with active business income.

Alternatively, the appellant argues that if the Court determines that its activities do not fall into the definition of active business income as enunciated by the existing case law under sections 125 and 129, that the Court ought to widen the definition of active business income since sections 91 and 95 are tax avoidance sections.

Alternatively the income was incidental to the active business of owning and operating the three commercial adventures.

The appellant relies heavily upon the Supreme Court of Canada decision of Canadian Marconi Co. v. The Queen, [1986] 2 S.C.R. 522; [1986] 2 C.T.C. 465; 86 D.T.C. 6526 in regards to the presumption that income of a corporation taxpayer is earned from an active business. Marconi had sold part of its active business for $18,000,000 and the income therefrom was considered by the Supreme Court to be part of the active business. In that case considerable energy and effort was expended by Marconi in keeping the money invested in short-term interest bearing securities. About 20 per cent of the working hours of a senior company officer was involved in the management and at any one time there was as many as twelve employees involved in the management of the investment income. The rebuttable presumption in Marconi was dealt with at length by my brother Judge Mogan in Ben Barbary Co. v. M.N.R., [1989] 1 C.T.C. 2364; 89 D.T.C. 242. I adopt fully his reasoning therein.

The appellant also relies upon the Federal Court-Trial Division decision of Freeway Properties Inc. v. The Queen, [1985] 1 C.T.C. 222; 85 D.T.C. 5183. In the Freeway case the Court was dealing with a company that sold inventory and in order to accommodate the sale of inventory it took back a mortgage and the question was whether the interest on the mortgage was from an active business. The Court said that the mortgage was inextricably linked with the sale and that there was a close interdependence between the sale and the mortgage. The Court considered that the interest payable on the mortgage was to be considered as part and parcel of the active business of the taxpayer.

Counsel for the respondent distinguishes the Freeway case in that Freeway was the sale of inventory whereas the sales herein were of capital assets. The Court accepts this distinction even though the three wrap-around mortgages were inextricably linked with the sales and that there was a close interdependence between the sales and the mortgages.

The Court is satisfied that whether a business is active or inactive is one of facts dependant on the circumstances of each case and that the resolution depends on the Court's view of the true nature of the business based on the facts of the particular case before it. The quantum of activity may very well vary from case to case but still it is necessary for the Court to weigh all the evidence to characterize the quality of the particular business. My authority for this is the Federal Court of Appeal decision of King George Hotels Ltd. v. The Queen, [1981] C.T.C. 87; 81 D.T.C. 5082.

Counsel for the appellant has asked the Court to find as a fact that Rogar changed its business approach and entered into an active investment business when it sold these properties. This the Court declines to do. Alexander Cole gave no evidence which would support such a finding.

The Court herein is driven to the conclusion that during the years 1977-1978-1979, Rogar made a business decision to get out of the active business of owning and managing commercial shopping and office enterprises. It must be kept in mind that the driving force behind the appellant and therefore behind Rogar was the principal Alexander Cole who in 1977 was 71 years of age. There is no evidence before me to allow the Court to determine that Rogar was entering into an active investment business. The evidence of Alexander Cole destroyed whatever presumption that existed to his benefit. On review of the meagre evidence presented to the Court, it concludes that the holding of the three wrap-around mortgages was not an active business therefore the income therefrom was not income from an active business.

The fact that the mortgages were the result of selling capital assets of active businesses is of no assistance to the appellant. The active businesses ceased upon the sale of the capital assets. It cannot be said that the mortgages were incidental to the active businesses. The cases that the Court was referred to on incidental use are of very little benefit.

Facts

Issue 2

Two witnesses were called by the appellant and gave evidence pertinent to Issue 2. Alexander Cole gave evidence the vast majority of which has been summarized previously. He also stated that in 1980 there were three loans, one in favour of Hodor Investments Ltd. for $13,578, one to Benjamin Pape Associates Ltd. for $44,578 and one to Commodore Investments Ltd. for $52,950 for a total $111,106. The Commodore Investments Ltd. loan was received in full on September 18, 1980, the Benjamin Pape Associates Ltd. mortgage was foreclosed. The total interest income for that year received by the appellant was $61,183, all but $1,500 of this was from short-term deposits.

Evidence was also given on behalf of the appellant by Charlotte Haber a chartered accountant. She produced a ledger sheet for part of the period that dealt with term deposits. The evidence was really of very little help as she really did not know what was behind the ledger sheet. It indicates and the Court has no hesitancy in finding as a fact that the term deposits were short-terms deposits of varying lengths between 30 and 60 days. The ledger sheet seems to indicate that on July 31, 1980, the year-end, that there was some $975,000 of terms deposits whereas the balance sheet showed only $563,500.

Entered as exhibits were the balance sheets of Alexander Cole Ltd. for 1976, 1977, 1978, 1979, 1980, 1981 and 1982. The loans outstanding on these balance sheets were shown as follows:

It is also known that in 1973 the appellant loaned Joe Cohen, Alexander Cole's cousin, $21,000 at ten per cent to assist him in buying into Margate Fashion.

Analysis

Issue 2

It was from this meagre evidence that the Court was asked to determine that the appellant was in the active business of loaning money. He relies upon M.R.T. Investments Ltd., E.S.G. Holdings Ltd. and Rockmore Investments Ltd. v. The Queen, [1975] C.T.C. 354; 75 D.T.C. 5224; affd in part [1976] C.T.C. 291; 76 D.T.C. 6156; revd in part [1976] C.T.C. 294; 76 D.T.C. 6158 as his authority. These cases are entirely different in factual background to the case at bar. In those three cases none of the companies dealt in conventional mortgages at conventional rates of interest; the loans were made through independent agents who referred potential borrowers to the corporations, the borrowers were unable to obtain loans through normal commercial channels. The companies have their own loan application forms. Because of the high risk involved in the loans, careful investigation was necessary; often prolonged negotiations took place as to the terms. All three companies showed continued increase in the value of their mortgages outstanding and their gross incomes since the day they started business. The companies were always looking for new agents to increase their lending business, the principals visited the properties after obtaining outside appraisals as to value, whereas in this case the only evidence before me is that which has been previously summarized or quoted.

The Court can only categorize the actions of the appellant as that of a successful businessman retired from active business, managing his invest- ments. There is not a shred of evidence to indicate that the activity of the appellant was nothing more than that of managing its own investments. It was not in the active investment business. The financial statements for Alexander Cole Ltd. and the evidence of Alexander Cole more than rebuts any presumption in favour of the appellant.

Decision

For the reasons set out above the appeal is dismissed.

Appeal dismissed.