Citation: 2009 TCC 268
Date: 20090522
Docket: 2004-3314(IT)G
BETWEEN:
VESNA SMITLENER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Jorré J.
Introduction
[1]
This is a trading case.
The key issue is whether the sale of 498 units in four buildings in Fort McMurray, Alberta, was on capital account or on income
account. I shall refer to the land and buildings as the River Park Glen
property or as River Park Glen.
[2]
There is a subsidiary
issue with respect to expenses for water and taxes in the amount of $197,935
that were disallowed by the Minister.
[3]
The Appellant was
assessed pursuant to section 160 of the Income Tax Act (the “ITA”)
in respect of amounts owed by her mother, Zlatica Smitlener (“Ms. Smitlener”).
The mother was reassessed
with respect to the gain on the sale of the River Park Glen units and the
expenses mentioned above.
[4]
The Appellant’s appeal
was limited to challenging the basis of the underlying assessment of her mother
regarding the two issues described.
Facts
[5]
Ms. Smitlener
acquired the River Park Glen property by an agreement made on September 9,
1995.
The sale closed on September 11, 1995 and the purchase price was
$12,450,000 consisting of:
a) $225,000 payable on or
before closing;
b) $7,636,000 by assuming
mortgages in favour of the Ontario Municipal Employees Retirement Board (“OMERS”)
and Northward Developments Ltd. (“Northward”); the Northward mortgage was a “dream
mortgage” ― half of it had no interest rate and half
of it had a very low interest rate of 1% or 2%;
c) $4,475,350 by assuming
a vendor take-back mortgage with a 10% interest rate;
d) $113,650 by assuming
certain liabilities.
[6]
The property consisted
of four buildings, for a total of 498 suites, as follows:
a) building No. 1:
112 townhouses with three bedrooms in each;
b) building No. 2:
96 suites, two thirds being three-bedroom and one third being two‑bedroom
apartments;
c) building No. 3:
149 suites, two thirds being two-bedroom and one third being one‑bedroom
apartments;
d) building No. 4:
141 suites, two thirds being two-bedroom and one third being one‑bedroom
apartments.
[7]
At the time of the
sale, the vendor was well advanced in the process of converting the River Park
Glen property into four distinct condominiums.
[8]
Clause 3.7(a) of the
Offer to Purchase and Interim Agreement
provides that the vendor will “. . . proceed with all due diligence to
complete, on behalf of the PURCHASER, registration . . .” of the condominiums.
The registration of each of the four buildings was done separately. Three registrations
were done over the course of 1996 and one in 1997.
[9]
Ms. Smitlener paid
over $100,000 in registration and surveying fees for the condominium plans. As well, a
further amount of $100,000 in fees for the condominium registration was paid to
the City of Wood Buffalo.
[10]
The vendor take-back
mortgage provided for a rapid schedule of principal repayments over a period of
two years. Specifically, it provided for the following repayments:
a) $75,000 on December 1,
1995;
b) $225,000 on December
7, 1995;
c) $300,000 on March 1,
1996;
d) $300,000 on June 1,
1996;
e) the balance on or
before September 1, 1997.
It also provided that there could be partial discharge
of the mortgage on the sale of condominium units provided that a certain amount
of repayment of the principal, calculated by formula, was made for each unit
sold. The repayment per unit would have to be at least $10,800 plus outstanding
interest not yet paid on the date of the partial discharge. When individual
units were sold, payments also had to be made to OMERS and Northward to obtain
partial discharges from them.
[11]
Clause 3.7(d) of the
Agreement also provided that the $75,000 principal repayment on December 1,
1995 would be postponed until a condominium plan had been registered for the
building with the townhouses, if that plan had not been registered as of that
date.
[12]
Similarly, the clause
provided for the postponement of $100,000 of the payment due on March 1, 1996
for each of the other three buildings for which a condominium plan had not been
registered on March 1. The postponement would be until such time as a plan
was registered for the particular building.
[13]
Finally, there was a
provision that if the vendor failed to obtain registration of all four
condominiums by April 1, 1996, then for each unit that had not been
divided into a separate condominium the principal remaining due would be
reduced by $5,000 per unit.
[14]
I note that the effect
of this last provision, had no condominium plans been successfully registered,
would have been to reduce the principal payable by $2,490,000. Put another way,
the effect would have been to reduce the purchase price from $12,450,001 to
$9,960,001, a 20% decrease in the price.
[15]
The entire purchase
price was financed. The purchaser not only took over the mortgages from OMERS
and Northward and obtained the vendor take-back mortgage, but the purchaser
obtained the funds for the $225,000 payment at closing from a loan made by Aaron
Acceptance Corporation. Ms. Smitlener’s mother’s house was used as
collateral for the Aaron Acceptance loan.
[16]
With respect to the
River Park Glen property, Ms. Smitlener testified:
It seemed like an ideal property for our family. At that point, in
’95 my daughter went through a divorce so she needed a job. We needed income. I
was getting older. I was looking for some retirement security for myself.
And I also at that time had two other children so this seemed like
an ideal family business to run, to work at, to live off and have future
security.
. . .
So the River Park Glen was purchased with intention of a long-term
rental income and a future security for the four of us, three of my children
and myself.
[17]
Exhibit A-5 reads, in
part, as follows:
TO: Mr. S. BUFTON
FROM: Z. SMITLENER
February 23, 2000
Re: Ft. McMurray townhouses
& apartments
First objection is to you arbitrarily chang[ing] the
classification from investment to business. This is objected on following
grounds:
- When I looked at the property it
was clear that the owners were losing in ex[c]ess of $60,000 per month, without
doing any repairs or renovations. The vacancy rate was 30% and there was no
hope to generate more income thru increased rents. But, what I had gambled on
was the capital appreciation thru upcoming announcem[en]ts about expansion in
tar sands oil fields. I figured that if I can hang on long enough till expected
influx of new workers poured into Ft. McMurray, I can realize a capital gain. Since this was a lot of units, it
made sense to cut it into pieces as it would be easier to sell. The gamble was
big, and had it not worked all my friends and family would have lost
everything. “The business” portion of your assessment is further shot down by
continued losses of operating the project, which you yourself gave a credit of
$1,243,272.00, even though it is still higher. Everything I ever did was to
pick up run down properties, fix them and hope for capital appreciation. . . .
[18]
In direct examination
Ms. Smitlener explained that the text of Exhibit A-5 provided the reason
why she sold the property and not the reason why she bought it.
[19]
At the time of
purchase, the previous owners were having financial difficulties. They had some
$225,000 in bills which they could not pay and needed to be paid immediately as
well as other liabilities which they could not pay and which Ms. Smitlener
assumed.
The previous owners were also losing in excess of $60,000 per month.
[20]
The previous owners had
150 vacant units, a 30% vacancy rate, at the time of the purchase by
Ms. Smitlener. At that time the general vacancy rate in Fort McMurray was 10%.
[21]
Ms. Smitlener said
they planned to get to a positive cash flow by lowering the vacancy rate to
10%. She also said that they cut the staff down from 17 to 12 persons
saving some $20,000 a month. The previous owners paid $150,000 a year in
management fees while she was only paying the Appellant $30,000, saving
$120,000 a year or $10,000 a month.
[22]
Ms. Smitlener
thought that with hard work they could bring the vacancy rate down to 10% and
make a go of it. Her plan was to establish six to 12 months of positive cash
flow and refinance.
[23]
Although she tried to
obtain refinancing and approached the Bank of Nova Scotia, People’s Trust and a
broker, she was unable to find someone who would do a first mortgage allowing
her to pay off everyone.
Ms. Smitlener testified that she kept trying to find such financing right
up to the final sale.
[24]
Things did not work out
as Ms. Smitlener expected. The 150 vacant units were not in good shape and,
although they reduced vacancies, the improvement came too late. There were
other unexpected expenses. The vendor started putting pressure on them when
payments were missed.
[25]
As a result
Ms. Smitlener retained a real estate agent and began selling townhouse
units. However, she hoped to keep much of the property.
[26]
The first sale of a
unit was in March 1996,
six months after the purchase of River Park Glen.
[27]
Subsequently, another
65 individual units were sold in 1996.
[28]
At the end of 1996,
16 months after the purchase, Property Team Inc. (“Property Team”) made
one offer for all remaining units in two tranches, the first with
196 units and a closing date of December 31, 1996 and the second with
237 units and a closing date of April 1, 1997.
[29]
Property Team would not
buy only part of the property. Ms. Smitlener stated that she did not want
to take their offer but that the vendor forced her to sell since the vendor
insisted on being paid out.
[30]
Ms. Smitlener
reported no rental income or loss in her 1996 return and reported a gross
rental income of $3,891,560.76 and a net loss of $1,243,272.25 in her 1997
return.
The figures reported in 1997 appear to include both 1996 and 1997. However, if
one takes account of two changes made by the Minister in assessing and not in
dispute,
the loss for the two years ― 19 months of operation ― is reduced to $936,829.94.
[31]
Prior to the River Park
Glen property acquisition, in 1991 or 1992, Ms. Smitlener purchased the
shares of Monashee Vineyards (“Monashee”) because she wanted to purchase the
200 acres of land owned by the company in British Columbia. Shortly afterwards she sold the parcels of land that
Monashee owned.
[32]
Ms. Smitlener had
the possibility of buying some apartments in Florida.
At one point she put down a deposit of US$100,000. No transaction ever came
about and she lost the deposit. The loss of the deposit was claimed as a
business expense by Monashee.
[33]
Subsequently to River Park
Glen, Ms. Smitlener bought a 24-unit townhouse property at 100 Mile House.
She intended that the units be sold and the transaction was reported on income
account.
[34]
With respect to the
expenses in dispute, Ms. Smitlener’s evidence was, in essence, that she
kept all the bills and she believes she reported the expenses correctly.
[35]
The Appellant testified
that she moved to Fort
McMurray once River Park Glen
was purchased. Ms. Smitlener remained in the Okanagan.
[36]
The Appellant looked
after the day-to-day management of the building including renting the units,
seeing to it that vacant units were fixed up and managing the staff. She had
minimal involvement with the registration of the condominium plans or the sale
of the units. Ms. Smitlener took care of all financial matters except some
day-to-day bill paying. Ms. Smitlener was the one who had the idea of
purchasing River Park Glen.
[37]
The Appellant’s
understanding of the reason for the purchase of River Park Glen was that it was
done to provide her with a long-term job. She had completed a master’s degree
in aeronautical science the year before but could not find a job.
[38]
Mr. William Bufton,
a Canada Revenue Agency employee, the auditor in this matter, testified as to
his reasons for the assessment. Among other things he testified as to why he
disallowed $197,935 of the claimed water and tax expenses. In the course of his
testimony on this point, Exhibit R-1 was produced and it eventually became
apparent that due to a computation error the amount disallowed should only have
been $129,588 and not $197,935.
Analysis
The water and tax expense issue
[39]
The Appellant’s
evidence on this point does not give me any reason to change the assessment.
However, there is the computational error referred to in the preceding
paragraph. That correction will be made to the assessment.
The trading issue
[40]
The question here is
whether Ms. Smitlener’s sale of River Park Glen was the disposition of an
investment or whether its acquisition and disposition was an adventure in the
nature of trade.
[41]
There have been
numerous cases in this area. The parties referred me to Happy Valley Farms
Ltd. v. M.N.R.
and the summary of the tests therein.
[42]
In determining whether
the property was acquired as an investment or not, one looks at a variety of
factors including the taxpayer’s intention, the taxpayer’s whole course of
conduct, the nature of the property, the property’s ability to produce income,
the length of ownership of the property, whether the taxpayer engaged in
similar transactions and the circumstances surrounding the sale.
[43]
There is also what is sometimes
referred to as the “secondary intention” test. Someone may purchase a property
with a dual intention that includes a secondary intention of selling it at a
profit. To have a “secondary intention” it is not sufficient that a person
could be induced to sell at a sufficiently high price; the possibility of
selling it at a profit must have been an operating motivation at the time of
acquisition.
[44]
In looking at the
taxpayer’s intention one must consider not only the stated intention as
expressed in testimony at trial, but one must consider the stated intention in
the context of all the circumstances and the whole course of conduct.
[45]
Ms. Smitlener’s
testimony was that she intended the purchase of River Glen Park to be a
long-term investment.
[46]
It is quite hard to see
how this could have been the case when one looks at all the surrounding
circumstances.
[47]
The whole of the
purchase was financed. At the time of acquisition the vendor was losing in
excess of $60,000 per month. Ms. Smitlener said that they expected to be
able to move to a positive cash flow by reducing the vacancy rate, by reducing
the number of employees and by making major savings on management fees since
the Appellant did the management at a much lower cost. Once they had a positive
cash flow they would refinance.
[48]
Even if the planned
revenue enhancing measures and the cost reduction efforts were entirely
successful it is hard to see how the planned measures could have produced a
positive cash flow. Renting an extra 100 units to bring the vacancy rate
down to the area average of 10% would have brought in about $50,000 per month, the cut in
employees saved $20,000 per month and the savings on the management contract
saved $10,000 per month.
[49]
While this would
produce an improvement of $80,000 a month, it is also necessary to take into
account the interest on the vendor take-back mortgage which, initially,
exceeded $35,000 per month and, once the first two instalments of principal
repayment were paid, would be about $35,000 per month.
[50]
Taking account the
interest on the vendor take-back mortgage, the result is a net improvement of
the order of $45,000 a month leaving a negative cash flow in excess of $15,000
a month without taking any account of the need to fund the scheduled payments
of the principal of the take-back mortgage. This was entirely foreseeable.
[51]
While
Ms. Smitlener said that the vendor kept forcing them, it does not appear
that the vendor was asking for anything other than payments in accordance with
the vendor take-back mortgage. Again, this was quite foreseeable.
[52]
It is also not clear
how refinancing, had it occurred, would have solved these problems. There was
no evidence that it was likely that if the property were refinanced combined
monthly interest and principal payments would fall to an extent that would
reduce monthly payments by over $15,000 so as to generate a positive cash flow.
It is worth recalling that the Northward mortgage was a “dream mortgage” with
very low interest rates.
[53]
Given that I found
Ms. Smitlener to be an intelligent and astute person, I have no doubt that
it would have been apparent to her that River Park Glen would have major and
continuing negative cash flow problems.
[54]
Looking at other
factors, it is clear that the property was not held for long. The first sale
was in March 1996, six months after the purchase. Given that no
condominium plan was registered prior to 1996, the first sale was soon
thereafter. The last sale was completed on April 1, 1997, 19 months
after purchase, but the agreement for that sale was made no later than the end
of 1996, 16 months after the purchase.
[55]
The Agreement and the
vendor take-back mortgage clearly contemplate registration of condominiums and
the possibility of the sale of units. Indeed, the effective purchase price
would have been $2,490,000 less if the vendor failed to successfully register
condominium plans for all the buildings.
[56]
Ms. Smitlener had
previously bought 200 acres of land in British Columbia by purchasing Monashee’s shares and shortly
thereafter sold that land. When she looked at buying a property in Florida and lost a US$100,000 deposit, Monashee claimed the
deposit as a business expense.
[57]
Looking at all these
circumstances, I cannot accept the stated intention that River Park Glen was
purchased as a long-term investment. Ms. Smitlener would have to have been
aware of the difficulties that would arise and could only have expected to
benefit from River Park Glen by selling it at a profit. River Park Glen was an adventure in the nature of trade.
[58]
This is confined by
Exhibit A-5. I am unable to accept Ms. Smitlener’s evidence that Exhibit
A-5 was an explanation of why she sold rather than an explanation of why she
bought; the wording simply does not support such a reading.
[59]
Indeed, in Exhibit A-5,
Ms. Smitlener summarizes well the situation:
. . . But, what I had gambled on was the capital
appreciation thru upcoming announcem[en]ts about expansion in tar sands oil
fields. I figured that if I can hang on long enough till expected influx of new
workers poured into Ft. McMurray, I can realize a capital gain.
Since this was a lot of units, it made sense to cut it into pieces as it would
be easier to sell. The gamble was big, and had it not worked all my friends and
family would have lost everything. . . .
Conclusion
[60]
For these reasons, the
appeal will be allowed only to correct the amount of the water and tax expenses.
Accordingly, the assessment, notice of which is dated June 26, 2003 and
bears number 34035, will be referred back to the Minister of National Revenue
for reconsideration and reassessment on the following basis:
For the purposes of determining the amounts
owed by the transferor, Zlatica Smitlener, within the meaning of subsection
160(1) of the ITA, in respect of the taxation year in which the property
was transferred or any preceding year, the amounts owed shall be determined as
if the transferor had been reassessed for her 1996 and 1997 taxation years on
the basis that the amount of water and tax expenses deductible were increased
by $68,350.
[61]
The Respondent has been
almost entirely successful and, accordingly, costs will be awarded to the
Respondent.
Signed at Ottawa, Canada, this 22nd day of May
2009.
"Gaston Jorré"
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