Étoile Immobililière S.A. v. MNR, 92 DTC 1984, [1992] 2 CTC 2367 (TCC)

Lamarre Proulx, T.C.C.J.:—This is an appeal from the tax assessments of the respondent, the Minister of National Revenue (the" Minister”), for the year 1988. Two assessments are in issue, the first made under section 115 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and the second made under section 216 of the Act.

The issue is whether the appellants rental income is income from a property or from a business. In the respondent's view, it was income from a property; in the appellant's opinion, from a business.

The applicable provisions of the Act are subsections 2(3) and 115(1) and section 216 of the Act.

The facts on which the respondent relied in assessing the appellant are described in paragraph 19 in the reply to the notice of appeal and are as follows:

(a) During the relevant periods, the appellant was a corporation not resident in Canada;

(b) During its taxation year, which ended August 25, 1988, the appellant disposed of a real property located in Canada. It being a taxable Canadian property, the appellant, in so doing, realized a taxable capital gain of $361,151, as follows:

Taxable capital gain $669,772 x 1/2 x 182/362 days	$256,089
Plus
$669,772 X 2/3 X 56/238 days	$105,062
Taxable capital gain	$361,151

(c) During the relevant taxation years, the appellant also did not operate a business in Canada, but instead derived income from property here;

(d) For the purposes of section 115 of the Income Tax Act, the taxable income which the appellant earned in Canada during its 1988 taxation year was $361,151, as follows:

Taxable capital gain	$361,151
Loss from the year or from a previous year from
a business operated in Canada	— —
Taxable income	$361,151

(e) For the purposes of section 216 of the Income Tax Act, the taxable income of the appellant for its 1988 taxation year is nil, the latter having derived an income from property equal to zero during that same taxation year.

[Translation.]

The amount of the appellants rental loss for the year in issue, the amount of $392,141, was not challenged.

Legal context of this appeal

To understand the proceedings in this appeal, one must refer to the taxation of corporations under Quebec's income tax legislation. Section 22 of the Taxation Act (R.S.Q.), c. 1-3 reads as follows:

Every person who is an individual resident in Quebec on the last day of a taxation year or that is a corporation having an establishment in Quebec at any time in a taxation year shall pay a tax on his taxable income for such taxation year.

Section 12 of that same Act describes what an establishment is:

The establishment of a taxpayer means a fixed place where he carries on his business or, if there is no such place, his main place of business. An establishment also includes an office, a branch, mine, oil well, farm, woodland, factory, warehouse or workshop.

When a corporation has an establishment in Quebec, it is subject to a tax on capital. Section 1131 of the same Act reads as follows:

Any corporation having an establishment in Quebec at any time in a taxation year must pay, in respect of that year, a tax on its paid-up capital shown in the books and financial statements submitted to the shareholders for that taxation year.

Sections 1131 to 1135 inclusive of this Act indicate the amount of tax to be paid, and sections 1136 to 1141.3 of the same Act indicate the way to compute paid-up capital.

One realizes from reading these sections that a corporation which conducts a business in Quebec must pay a tax on capital. It is therefore in a corporation's interest to claim that renting real estate does not constitute a business. Furthermore, there is no part in the Quebec statute equivalent to Part XIII of the Act, a fact that means that a non-resident's income from the rental of real property located in Quebec is not subject to the Quebec Taxation Act. To be subject to that Act, the non-resident must conduct a business. The tax collector in Quebec therefore has an interest in claiming that a corporation whose activity is renting property derives its income from a rental business and not only from rental properties.

However, the tax on capital provided under the Quebec Act for a corporation, resident or not, conducting a business in Quebec was the only determining factor in the appellant's decision to present its income as property income rather than business income because the appellant made no profits during these years.

Let us now consider the statutory provisions that apply at the federal level. Subsection 2(3) of the Act, which applies to non-residents, reads as follows:

Where a person who is not taxable under subsection (1) for a taxation year

(a) was employed in Canada,

(b) carried on a business in Canada, or

(c) disposed of a taxable Canadian property,

at any time in the year or a previous year, an income tax shall be paid as hereinafter required upon his taxable income earned in Canada for the year determined in accordance with Division D.

Division D, consisting of sections 115 and 116, provides the method for computing taxable income earned in Canada by non-residents. That division does not apply to income from property. Income from property for nonresidents is taxed under Part XIII of the Act, which includes, in particular, paragraph 212(1)(d) of the Act, which reads as follows:

(1) Every non-resident person shall pay an income tax of 25 per cent on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or in lieu of payment of, or in satisfaction of,

(d) rent, royalty or similar payment, including, but not so as to restrict the generality of the foregoing, any payment . . . .

A person subject to section 212 of the Act may, however, make a choice concerning rent under section 216 of the Act. A non-resident may choose to be taxed on the net rental income rather than pay a 25 per cent tax on gross rental income. It is this choice which the appellant had exercised for the six or seven preceding years. It was therefore assessed in application of this section. For the year 1988, it asks to be assessed entirely under section 115.

As emphasized by counsel for the respondent, section 805 of the Income Tax Regulations (the Regulations”) must be mentioned in order to provide a complete picture of the application of sections 115 and 212 of the Act. This section provides that, where a non-resident carries on a business, he is not taxable under Part XIII of the Act on amounts arising in particular from the renting of property which may reasonably be attributed to the business which he carries on in Canada. This provision means that, if a non-resident person carries on a rental business in Canada, he will not be taxed under both sections 115 and 212 of the Act.

As regards the tax payable under the federal Act, it ultimately made no difference whether the appellant considered his income as income from a property or as income from a business during the years of operation since expenses were always greater than receipts, as mentioned above. As regards the provincial statute, it was in the appellants interest to consider its income as property income because, as such, it was not subject to the Quebec Taxation Act and thus not subject to the tax on capital.

However, the distinction between business income and property income makes a big difference at the federal level when assets are sold because, if the appellant continues to present his rental income as property income, the capital gain is taxable under section 115 of the Act and the property income is taxable under section 212 of the Act. It is therefore in its interest to consider its income as business income rather than property income for the last year, that in which the sale took place, because it can thus deduct the rental losses from the capital gain under section 115 of the Act.

Quebec did not agree with the appellant's determination of the nature of the income during the years of operation and assessed the appellant as a corporation carrying on a business in Quebec, and thus subject to the tax on capital. The appellant's accountants studied the situation and came to the conclusion that it was better to accept Quebec's point of view; that is to say that, given the extent of the rental activities, the income was truly business income, not income from property.

For the year 1988, the appellant thus did not make a choice under section 216 of the Act, but filed its tax return under section 115 of the Act. In that taxation year, it reported a business loss of $392,141 and a taxable capital gain of $446,517. However, the respondent revised this taxable capital gain to the amount of $361,151. Thus, there is no dispute as to the quantum. The appellant has losses from its rental activities in the amount of $392,141, and the taxable capital gain is $361,151.

The issue is therefore to determine whether the appellant's income was business income or property income.

Evidence

Mr. Jean-Jacques Laura ns testified for the appellant. The appellant is a corporation not resident in Canada. It was incorporated on December 2, 1980, under the corporate law of Panama, as the certificate of incorporation, Exhibit A-1, attests. Its directors are Swiss. The appellant’s main object was to acquire and administer property. To this end, it acquired rental properties located in Dollard-des-Ormeaux on February 2, 1981. At issue was a real property complex comprising 158 units spread over an area of eight acres. This property was the appellants sole asset in Canada. The witness, Mr. Laurans, was originally one of the appellants directors. At the time of the hearing, he was no longer a director of the appellant, but a senior executive of a real property management company, Alfid Services Immobiliers Ltée ("Alfid"). This company took over management of the rental complex on October 15, 1983. From that moment on, repairs were more intensive and, during the years of possession, reached a cumulative amount of more than $1,000,000. Substantial deterioration and negative criticism had been the reason for the change in administration.

Mr. Laurans had prepared a description of the rental property in question and the activities relating thereto with a view to the hearing of this case. I reproduce the entire text here:

ETOILE IMMOBILIERE

Summary for Mr. Normandin and Mrs. Joyce Mazure

March 9, 1992

In its very conception, the "Terrasse West Island” property in Dollard des Ormeaux differs from an income building, even a large one.

It is a real property complex of 158 townhouses implanted in adjoining rows of approximately 30, thus in five phases, on a lot of several hectares (29,500m ). Within each phase, there exist corridors providing access to both the houses and indoor parking areas, and each phase is linked to the rest of the property by a series of outside roads. The property of course includes landscaped areas, outdoor parking lots for visitors, playgrounds, a large outdoor pool, various entrances to the indoor parking areas, fenced terraces for each house and large common lawns.

It is in fact a private village within the city of Dollard des Ormeaux.

Managing such a village naturally bears only a distant relationship to traditional real property management. To be convinced of this fact, one need only to point to:

—surveillance and maintenance personnel in each of the phases (caretakers);

—coordination personnel for the entire property (maintenance man, supervisor, rental officer);

—contract surveillance personnel to limit vandalism (security guard with dog, etc.) outdoors and indoors;

—pool operation staff (lifeguard);

—maintenance personnel for common areas (lawn, flowers, snow removal, fences, lights, etc.);

-accounting personnel to consolidate the active operation of more than 158 separate entities (158 roofs, 158 fences, etc.) within a single company.

Furthermore, since the"Terrasse West Island" property suffered from a chronic lack of maintenance until 1983, a special renovation ana restructuring campaign had to be undertaken starting in 1984 and was completed in 1988 with the sale of the property. During that time, the village’s operation required special efforts (litigation, summonses, negotiations with the city, the mortgage lenders, etc.) of which the reports attached hereto provide an idea.

Lastly, the alert reader need only to consult the property's financial statements and compare them with those of other buildings under conventional management to be convinced that operation of the "Terrasse West Island” property required constant use of human and intellectual resources beyond all proportion to the norm.

Jean-Jacques Laurans

[Translation.]

The property in question was a large rental property which was built in five phases and which contained a large underground parking area. There were walkways, playgrounds and a large outdoor pool. Each of the townhouses had a small yard. Access to the houses was through long corridors. Rents had to be collected and the houses rented. Forty per cent of tenants might move during the year. A full-time lifeguard was required for the pool.

There were the flowerbeds, the lawn and alleys to maintain, and 150 roofs and kilometres of fences. In short, still according to the witness, it was a small village to be administered. Since there were security and vandalism problems, a patrol with dogs had to be provided.

The witness explained that, given the configuration of the rental complex, which consisted of row houses, not an apartment building, more employees, greater services and a more extensive security system were required than for an apartment building. The employees were the employees of Alfid, not of the appellant. Exhibit A-5 describes this comparison between the standard management services provided for a 150-apartment building and the“ Terrasse West Island" property of the same size:

ÉTOILE IMMOBILIÉRE

Summary for Mr. Normandin and Mrs. Joyce Mazure

March 9, 1992

Comparison between standard management services provided fora 150-apartment building and the "Terrasse West Island" property of the same size

150 apartment buildings	"Terrasse West Island” property
(a) Employees
2 caretakers	6 caretakers
1 caretaker's apartment	3 caretaker's houses
	2 service men
	1 rental officer
	1 lifeguard
1 supervisor for 5 buildings	1 full-time supervisor
1 accounting employee for 5 buildings	1 full-time accounting employee
(b) Services
Indoor maintenance	Indoor maintenance
	Outdoor maintenance
	Pool maintenance
	Road maintenance
	Lawn maintenance
	Snow removal
	Playground maintenance
	Outdoor lighting maintenance
(c) Security
1 security/fire system	5 security/fire system
	Outdoor security patrol
1 intercom system	5 intercom systems
1 roof	158 patios
	158 fences
	158 roofs
1 heating and hot water system etc.	5 heating and hot water systems etc.
	[Translation.]

The units were rented unfurnished. The leases signed by the tenants were the leases of the Régie du logement of the government of Quebec. The supplementary clauses usually mentioned that heating was included, as well as the water tax, and that an indoor parking space was included. The stove and refrigerator belonged either to the tenants or to the lessor. Screens were provided. There was a mixed system for the washers and dryers. Some belonged to a private corporation, others were operated by the appellant itself.

The selling price was $7,200,000, the purchase price $4,200,000.

I have considered the following decisions from the case law cited by the appellant:

Canadian Marconi Co. v. The Queen, [1986] 2 S.C.R. 522, [1986] 2 C.T.C. 465,

86 D.T.C. 6526;

King George Hotels Ltd. v. The Queen, [1981] C.T.C. 78 (F.C.T.D.); [1981] C.T.C.

87, 81 D.T.C. 5082 (F.C.A.);

The Queen v. Cadboro Bay Holdings Ltd., [1977] C.T.C. 186, 77 D.T.C. 5115;

Radke Bros. Construction Co. v. M.N.R., [1975] C.T.C. 2187, 75 D.T.C. 149;

Weintraub v. M.N.R., [1972] C.T.C. 2199, 72 D.T.C. 1167.

I have considered the following decisions from the case law and doctrine cited by the respondent:

Wertman v. M.N.R., [1964] C.T.C. 252, 64 D.T.C. 5158:

Walsh and Micay v. M.N.R., [1965] C.T.C. 478, 65 D.T.C. 5293;

Smithers Plaza Ltd. v. M.N.R., [1975] C.T.C. 2171, 75 D.T.C. 137;

Buonincontri v. The Queen, [1985] 1 C.T.C. 370, 85 D.T.C. 5277;

Burri v. The Queen, [1985] 2 C.T.C. 42, 85 D.T.C. 5287;

The Queen v. Canada Southern Railway, [1986] 1 C.T.C. 284, 86 D.T.C. 6097;

E.S.G. Holdings Ltd. v. The Queen, [1976] C.T.C. 295, 76 D.T.C. 6158;

Canemro Anstalt v. Sous-Ministre du Revenu du Québec, Provincial Court

No. 500-02-020973-850;

Yvy Real Estate Corporation S.A. v. Sous-Ministre du Québec, [1988] R.D.F.Q.

50 (under appeal).

John Durnford, “The distinction between income from business and income from property and the concept of carrying on a business”, (1991) 39 C.T.J. 1131.

As regards the case law concerning the qualification of income from the renting of property, I wish, first, to cite the remarks of Judge Noël in Hollinger v. M.N.R., [1972] C.T.C. 592, 73 D.T.C. 5003, at page 599 (D.T.C. 5008):

. . . If income from property has any meaning at all, it can only mean the production of revenue from the use of such property which produces income without the active and extensive business-like intervention of its owner or someone on his behalf. I have in mind, for instance, property such as bonds or debentures or shares or real property which do not require the exertion of much activity or energy in order to produce the revenue . . . .

In the learned Judge Noel's view, property income is therefore that produced without extensive business-like intervention by the owner. I also wish to cite the remarks of Madame Justice Wilson of the Supreme Court of Canada in a judgment delivered in 1986, and thus a recent judgment, in Canadian Marconi, cited above, at pages 468 and 470 (D.T.C. 527-28 and 531-32):

The distinction between income from a business and income from property is a difficult one to draw but it is one which the Act compels us to make. There are two reasons for the difficulty. First, the terms "business" and "property" are broadly and loosely defined in subsection 248(1) of the Income Tax Act. As a consequence the definitions on a fair reading can be construed in such a way as to overlap. Second, persons or corporations generally engaged in trading-type activity often use property as a means of earning income. On first reflection this sort of income could realistically be considered either business income or property income. The observation of Thurlow, J. (as he then was) in Wertman v. M.N.R., [1964] C.T.C. 252, 64 D.T.C. 5158 (Ex. Ct.), at page 5167, that cases are “readily conceivable where particular income may be accurately described as income from property and just as accurately regarded as income from a business” is frequently apposite. The Courts have handled the difficult task of deciding whether a particular receipt is business income or property income by applying certain set criteria or indicia of trading activity and, in the case of a corporate taxpayer, by applying a presumption in favour of the characterization of its income as income from a business. I shall examine these in reverse order.

As I have indicated, the presumption that income earned by a corporate taxpayer in the exercise of its duly authorized objects is income from a business is rebuttable. For example, in Sutton Lumber and Trading Co. v. M.N.R., [1953] 2 S.C.R. 77, [1953] C.T.C. 237, 53 D.T.C. 1158, the appellant successfully rebutted the presumption and in Burn v. The Queen, [1985] 2 C.T.C. 42, 85 D.T.C. 5287 (F.C.T.D.), Strayer, J., although questioning the existence of the presumption (page 46-47, D.T.C. 5289-90), held that if such existed it was rebutted on the facts before him. The question whether particular income is income from business or property remains a question of fact in every case. However, the fact that a particular taxpayer is a corporation is a very relevant matter to be considered because of the existence of the presumption and its implications in terms of the evidentiary burden resting on the appellant . . . .

The evidence at trial was far from offsetting the effect of the presumption; indeed, if anything, it tended to support it. It is trite law that the characterization of income as income from a business or income from property must be made from an examination of the taxpayer's whole course of conduct viewed in the light of surrounding circumstances: see Cragg v. M.N.R., [1952] Ex. C.R. 40, [1951] C.T.C. 322, per Thorson, P. at page 46 (C.T.C. 327). In following this method Courts have examined the number of transactions, their volume, their frequency, the turnover of the investments and the nature of the investments themselves. In this case the Federal Court of Appeal noted the extensive activities of C.M.C.'s employees in purchasing short-term investments, the large number and high value of those transactions, the high proportion which the interest earned bore to the total income of the company and the high proportion which the total value of the investments bore to the total value of C.M.C.'s assets . . . .

Madame Justice Wilson states that, in determining whether income derives from a business or from property, the courts have relied on the presumption that a corporation's income from activities consistent with its objects is business income. This presumption is rebuttable, however. The taxpayer's general conduct, which confirms or rebuts the presumption, must therefore be examined. The extent of the activities, their volume and their frequency are factors that tend to indicate business activities.

Ryan, J. of the Federal Court of Appeal states the following in The Queen v. Canada Southern Railway Co., cited above, at page 281 (C.T.C. 293, D.T.C. 6104):

Rental income is an obvious example. Rents from property are generally considered to be income from property, but not if the owner so manages the renting as to make a business of it.

[Emphasis added.]

Must the activities be carried on by the appellant itself?

In E.S.G. Holdings Ltd., cited above, the Chief Justice of the Federal Court of Appeal states the following, at page 296 (D.T.C. 6159):

With respect, I do not agree that there is any material difference in principle, in so far as the carrying on of an active business by a corporation is concerned, between carrying it on through the agency of officers or servants of the corporation and carrying it on through the agency of an independent contractor. The question is whether the taxpayer's "income" is "from an active business” and, in my view, the answer must be the same in both cases.

Counsel for the respondent does not question this statement by the learned judge. He states that, if the Court concludes that the management company carried on enough activities pertaining to the rental property for them to be able to be called business activities, that is sufficient. The activities need not be carried on by the appellant itself, but may be carried on on its behalf by an intermediary.

Counsel for the respondent notes that a 49-unit apartment building was in issue in Wertman, supra, a 121-unit building was in issue in Walsh and Micay, supra and that, in Burri, supra, although the number of units was not mentioned, there appeared to have been many units and access to a pool.

It is certain that a relatively extensive activity was carried on by the owners in these decisions and that the Courts found in these cases that the income was from property, not from business. However, there are other decisions in which it was found that rental income was income from business and not from property, as in The Queen v. Cadboro Bay Holdings Ltd., supra and King George Hotel v. The Queen, supra.

I am of the view that the recent Supreme Court decision in Marconi sets out the path to follow in this kind of decision to be made. On the one hand, account must be taken of the rebuttable presumption that a corporation's income is business income if that income derives from an activity consistent with its object, and, on the other hand, consideration must be given to the scope of the corporation's activities which confirms or rebuts this presumption.

In this perspective, since the appellant is a corporation, since its income derives from activities consistent with its object, and since the scope of its activities carried on to maintain, to promote, to improve and to manage the rental complex spread over a number of acres confirms the said presumption, the appellant's income is business income.

I would have come to the same conclusion even if this presumption did not exist. The income arose from an extensive and organized activity and was not a mere, almost natural income from property. The evidence revealed that, had it not been for the management company's rental and sound administrative effort, as well as the continuing effort put into repairs and maintenance of the property, the rental income and the value of the complex would have quickly declined. It was as a result of a constant day-to-day effort that the complex attained a certain profitability and a state of good order. Furthermore, because of the very nature of the real property complex, with its rows of rental units, its vast corridors, the roof surface, small gardens, alleys, pool, number of employees, numerous tasks to be performed, not to mention security, one cannot say this was passively earned property income, but rather income arising from the active, unremitting, extensive effort of a business.

The appeal is allowed with costs.

Appeal allowed.