Wahoski v. R., [1996] 1 CTC 2844, 96 DTC 3206 (Informal Procedure)

Rowe D.J.T.C.C.: — The appellant, Garry Wahoski appealed from an assessment of income tax for his 1990, 1991 and 1992 taxation years. In each of those years the Minister of National Revenue (the “Minister”) increased the appellant’s business income by adding in certain amounts. The appellant stated that he did not wish to pursue that aspect of his appeal, including the assessment of penalties pursuant to subsection 163(2) of the Income Tax Act (the “Act”) as they related to the failure to report certain amounts of business income for the 1990, 1991 and 1992 taxation years.

In assessing the appellant for his 1992 taxation year, the Minister included into income, profit realized from the disposition of two building lots owned by him and his brother, Ron Wahoski, in the area of Westbank, British Columbia. Garry Wahoski and Ron Wahoski - the appellant in 95-560(IT)I with respect to his 1992 taxation year — each held a 50% interest in Lots 6 & 7 on Gates Road in the Glenrosa subdivision. Both appellants were assessed a penalty for failing to report the profit from the sale of lots on account of income. In fact, neither appellant reported the disposition in returns of income. The appellant, Garry Wahoski, is the spouse of Kathy Wahoski and she appealed — 95-64(IT)I — from an assessment with respect to her 1990, 1991 and 1992 taxation years in which the Minister disallowed certain child tax credits as claimed. It was agreed by the appellant, Kathy Wahoski, that her appeal would follow the result of Garry Wahoski’s appeal. Garry Wahoski and Ron Wahoski agreed to have their appeals heard together.

Garry Wahoski testified he is a carpet installer. In August, 1989 he and his wife, Kathy Wahoski, moved to Kelowna, British Columbia. They looked at Lots 6 & 7 in the Glenrosa subdivision at Westbank, British Columbia but decided not to build at that time. Instead, they purchased a house on Scott Crescent in Kelowna. However, they advised Ron Wahoski and the senior Wahoskis - parents to Garry and Ron - of the two lots. On April 2, 1990 Ron Wahoski and the parents put up the sum of $29,900 for the purchase price of each lot and the lots were purchased jointly by Garry Wahoski and Ron Wahoski on the basis of each having a 50% ownership in each lot, which were registered by separate title. In accordance with the terms and conditions set by the municipality of Westbank, the Wahoskis, as purchasers of vacant lots, were required to construct suitable residences on said lots within a period of one year. Ron Wahoski owned a business in Maple Ridge, British Columbia and later decided that he would be staying there instead of relocating to Kelowna. Garry Wahoski stated that both lots had been listed for sale as early as June 20, 1990 with the same Realtor that had sold the properties to them but the properties did not sell. As a result, he and Ron Wahoski decided to keep the properties and by September, 1991, Garry Wahoski began constructing a residence on Lot 7 and excavating and installing a foundation on Lot 6. On July 3, 1991 Garry Wahoski and Kathy Wahoski listed their home on Scott Crescent so that this property - their matrimonial residence - and Lot 7 were up for sale at the same time on the basis that whichever one sold, the other property would serve as their principal residence. Lot 7, with a completed residence, sold on January 13, 1992, pursuant to a listing agreement dated July 16, 1991. Lot 6 was listed on February 13, 1992 and sold on May 12, 1992. The structure was only a foundation ready for framing. At this time, the senior Wahoskis were living at Ron Wahoski’s home in Abbotsford. Garry Wahoski stated that part of the decision to build residences on the lots was that the developer had the option to repurchase the lots at 95% of the original purchase price in the event of default by them of the requirement to construct buildings within one year. It was necessary for him and Ron to obtain a mortgage from a bank to complete construction of the house on Lot 7. After Lot 7 was sold and the debts were paid, the proceeds together with the profit later realized from the sale of Lot 6 were split 50-50 between him and Ron. Garry Wahoski stated he is not a house builder and had to hire subcontractors to perform the necessary work. The project caused him a considerable amount of stress and he stated he did not report his share of the profits from the sale of the lots as he thought they were capital gains. As for his state of mind during the building period, he commented that it was often a “blank”. He used the proceeds from the sales to invest with his brother, Ron, in a rental property, a fourplex.

In cross-examination, Garry Wahoski stated that in October, 1989 he began working as a carpet installer in Kelowna and that about 30-40% of his time was spent in laying carpet inside new houses. Lots 6 & 7 were the subject of an interim agreement of purchase dated January, 1990 in the sum of $29,900 each and the deal closed on April 3, 1990. By mid-June both lots were listed for sale, each at the selling price of $39,900 and the extra money was required to pay real estate commissions and legal fees. In order to buy the fourplex, Garry Wahoski stated he and Kathy Wahoski mortgaged their family residence on Scott Crescent. He stated that he was aware of the building boom and rapid economic growth occurring in the Kelowna area and Lots 6 & 7 were view lots. He identified a Vendor’s Statement of Adjustments re Lot 6 and Lot 7 which was filed as Exhibit R-1. He identified a letter - Exhibit R-2 - dated December 21, 1993 from Mrs. S.A. Talion at Revenue Canada in which the gain on both lots was calculated at a total of $21,926. One half of that gain, $10,963, was added to his 1992 income together with the assessment of a penalty for underreporting income.

The appellant, Ron Wahoski, testified he resides in Maple Ridge, British Columbia and is a businessman. He wanted to sell his business and in 1990 was interested in moving to Kelowna. With his brother Garry, he decided to purchase a 50% interest in Lots 6 & 7. His parents were living in his home at Abbotsford and he thought he could live in one house with his parents occupying the bottom portion. He knew about the requirement to build on the property with one year but Garry looked after the construction of the house on Lot 7 and the pouring of the foundation on Lot 6. He stated he did not have much input into the actual construction on the properties. After the lots were sold, he used his share of the proceeds to invest in a rental property but did not think that any profit had been realized from the transactions. On December 21, 1993 he received a letter from Mrs. Talion at Revenue Canada advising that the profit - $10,963 - was being added into his 1992 income together with an assessment of a penalty. He never before had any real property other than his principal residence and it was only after Mrs. Talion had done the accounting that he realized he and Garry had made a profit from selling the two lots. He stated that Garry had arranged the construction loan at the bank and he merely signed the necessary papers to expedite the arrangement. He wanted to operate, in Kelowna, a smaller business than the one he owns at Maple Ridge. He doubts that he ever referred, in the course of his conversations with Mrs. Talion, to the two lots as being purchased for the purpose of erecting “spec homes”.

In cross-examination, Ron Wahoski stated he used $10,000 of his own money and his father loaned to Garry and him the sum of $50,000 to purchase the two lots. He identified a financial statement - Exhibit R-3 - of his business, Cass Floors (1981) Ltd. for 1993 and agreed that it had gross sales over $2.1 million in 1992. He stated that, at the time of purchasing the lots, he was aware of rising real estate prices in the Kelowna area. He knew his parents would move to Kelowna only if he were able to move there.

Ken Wahoski testified he lives in Mission, British Columbia and is retired. He sold a house there in 1988 and he and his wife purchased a truck and fifth wheel to do some travelling as they were unsure where they would settle during their retirement. He agreed to lend his boys the sum of $50,000 to purchase Lots 6 & 7. During a visit to Westbank, he realized the house being built on Lot 7 was too large, expensive, and it had stairs. When the lots were sold, it did not matter to him that Garry made a profit as he had to do the work to construct the house.

In cross-examination, Ken Wahoski stated that he did not inquire about the cost of building the house but it was apparent the house was too big for his use.

Ian Fletcher testified he is a licensed Realtor, residing in Kelowna. On a referral from a Realtor in Maple Ridge, he met Garry and Kathy Wahoski and sold them the house on Scott Crescent. At the time, in 1989, he made notes that Garry’s brother and parents wanted to move to Kelowna and that the brother was interested in a small commercial property. He identified the interim agreements, dated January 24, 1990, - Exhibits A-4 and A-5 - relating to the two lots, 6 and 7. Each offer is entitled “Garry Wahoski and or Nominee” and it was his understanding that one lot was being purchased for his father and one for his brother. Fletcher suggested to Garry Wahoski that Lot 6 would be a suitable building site for his parents because it was not as steep as Lot 7. The original offer by Garry Wahoski to purchase the lots was made “subject to” approval by his parents and this condition was later removed. At all times he understood Garry to have been acting on behalf of members of his family. Fletcher said he introduced Garry to a banker for the purpose of obtaining a mortgage on the Scott Crescent property and also for a builder’s loan to finance construction of the house on Lot 7. He understood that Garry was very nervous about having to construct houses on the lots within one year and also recalled hearing from Garry or Kathy that some member of the family was no longer going to be moving to Kelowna. The bank began pressuring Garry for repayment, the market softened and Lot 7 did not sell. He advised Kathy Wahoski to obtain Garry’s permission to list their family home on Scott Crescent which would provide them with another option in order to raise funds. In his opinion, Lot 7 was very steep terrain and the house had too many stairs. In order to facilitate the eventual sale, the real estate commission was reduced.

There are two issues present in these appeals. One is whether or not the profit from the sales of Lots 6 and 7 is on account of capital or income. The other is whether or not the Minister’s assessment of a penalty under subsection 163(2) of the Act against either or both of the appellants, Garry Wahoski and Ron Wahoski, is justified on the basis that either or both of them, by failing to report the gain in the 1992 return of income, were grossly negligent.

It is apparent that one of the factors which caused the Minister to regard the sale of Lots 6 and 7 as a disposition on account of income was the listing of those properties for sale within two or three months of acquisition. As well, both Ron Wahoski and Garry Wahoski were in the carpet business and were well acquainted with certain aspects of new house construction and the rising real estate market in Kelowna.

In the case of Racine v. Minister of National Revenue, [1965] C.T.C 150, 65 D.T.C. 5098, Noél, J. of the Exchequer Court of Canada - as it then was - dealt with taxpayers who had purchased a business and resold it at a profit. At page 5103 of his judgment Noél J. stated:

In examining this question whether the appellants had, at the time of the purchase, what has sometimes been called a “secondary intention” of reselling the commercial enterprise if circumstances made that desirable, it is important to consider what this idea involves. It is not, in fact, sufficient to find merely that if a purchaser had stopped to think at the moment of the purchase, he would be obliged to admit that if at the conclusion of the purchase an attractive offer were made to him he would resell it, for every person buying a house for his family, a painting for his house, machinery for his business or a building for his factory would be obliged to admit, if this person were honest and if the transaction were not based exclusively on a sentimental attachment, that if he were offered a sufficiently high price a moment after the purchase, he would resell. Thus, it appears that 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 surrounding the transaction rather than on direct evidence of what the purchaser had in mind.

At page 5105, Noél J. continued:

The inference of an intention to make a profit by a rapid resale can also flow from the fact that the purchaser did, in fact, resell almost immediately at a profit, but only if there exists no satisfactory explanation for this rapid resale. The appellants in this case give an explanation for the rapid resale which I find believable and which I accept.

The secondary intention test was the subject of the decision of the Federal Court of Appeal in Crystal Glass Canada Ltd. v. R., [1989] 1 C.T.C. 330, 89 D.T.C. 5143. The entire judgment of Mahoney, J.A., speaking for the Court, is as follows:

Mahoney J. (orally) —: The learned trial judge misstated the test of secondary intention propounded in Racine et al. v. Minister of National Revenue, 65 D.T.C. 5098, when he asked himself “did Mr. Bean have in his mind the thought that he might sell at a profit?”. Secondary intention requires not only the thought of sale at a profit but that the prospect of such a sale be an operating motivation in the acquisition of the capital property.

That misstatement of the test taken with his failure to find facts that brought the transaction within the test, that is his failure to find that the prospect of the resale of Crystal Manor at a profit had, in fact, been an operating motivation in its acquisition, leads us to conclude that the learned trial judge erred in law in finding that the disposition of Crystal Manor resulted in a trading profit.

The appeal will be allowed with costs here and in the Trial Division. The Appellant’s 1971 income tax return will be referred back to the Minister of National Revenue for reassessment on the basis that the gain on the sale of Crystal Manor was a gain on capital account.

Neither Garry Wahoski or Ron Wahoski were individuals with a history of buying and selling properties, other than their own principal residences. I am satisfied that the motivation to acquire Lots 6 and 7 in the Glenrosa subdivision was for purposes of the family being able to live in close proximity in an attractive area. Ron Wahoski wanted to sell his large and profitable business in Maple Ridge and then relocate to Kelowna where he would operate on a smaller scale. Mr. and Mrs. Wahoski, parents of Garry and Ron, were entering the retirement phase of their lives and were also looking for a new place to live. The purchase and sale of Lots 6 and 7 by Ron Wahoski and Garry Wahoski was not an adventure in the nature of trade nor otherwise a transaction on account of income. Rather, the gain for both the appellants was a gain on capital account.

At the outset of his appeal, Garry Wahoski admitted the Minister had been correct in including into business income for the 1990, 1991 and 1992 taxation years certain amounts that he had not reported in his returns of income as a result of having overstated business expense. He also admitted the Minister had been correct in assessing penalties on this unreported business income as a self-employed carpet installer.

Having regard to the unreported gain on the sale of Lots 6 and 7, I am satisfied the evidence adduced by the respondent justifies the imposition of the penalty imposed by the Minister with respect to that sum of money. It is clear that Garry Wahoski was well aware of the need to properly report business income and accepted the penalty for not having done so. It was apparent from his evidence that he deliberately put out of his mind the transactions surrounding the sale of Lots 6 and 7, especially the hassle involving the construction of the house of Lot 7. For a considerable period of time before that property sold, there was pressure being applied by the bank who had advanced funds for the construction of the house. Garry Wahoski, relieved to have finally gotten out of the Glenrosa deals with a profit - which he promptly re-invested with Ron Wahoski in a rental fourplex - convinced himself that he had not really made a profit after all and that he deserved something for all of his troubles.

The penalty imposed against Ron Wahoski under subsection 163(2) for not having reported the gain is also justified on the evidence adduced by the respondent who carried the burden of proof. Ron Wahoski is an experienced businessman, operating a business which has grossed more than $2 million per year. He did not concern himself many of the details of the construction of the house on Lot 7 but he participated in obtaining the builder’s loan and executed the necessary documents to facilitate the sale of both lots and vendor’s statements were provided in each instance. He also chose to ignore the profit and neglected to report the gain on his return of income, as did Garry Wahoski. Both of them did so under circumstances which constitute gross negligence within the language of the provision, the relevant portion of which reads as follows:

163(2) False statements or omissions. Every person who, knowingly, or under circumstances amounting to gross negligence in the carrying out of any duty or obligation imposed by or under this Act, has made or has participated in, assented to or acquiesced in the making of, a false statement or omission in a return, form, certificate, statement or answer (in this section referred to as a “return”) filed or made in respect of a taxation year as required by or under this act or a regulation, is liable to a penalty.

The following results flow from these reasons.

Garry Wahoski — 95-66(IT)I — the appeal for his 1990 and 1991 taxation year is dismissed. The appeal for the 1992 taxation year is allowed, without costs, as follows: the assessment for the 1992 taxation year is referred back to the Minister for reconsideration and reassessment on the basis the gain realized from the sales of Lots 6 and 7, Glenrosa subdivision, Westbank, British Columbia be treated as a gain on account of capital. He is entitled to no further relief.

Ron Wahoski — 95-560(IT)I - the appeal for his 1992 taxation year is allowed, without costs, and the assessment is referred back to the Minister for reconsideration and reassessment on the basis the gain realized from the sales of Lots 6 and 7, Glenrosa subdivision, Westbank, British Columbia be treated as a gain on account of capital. He is entitled to no further relief.

Kathy Wahoski — 95-64(IT)I — the appeal for her 1990 and 1991 taxation year is dismissed. The appeal for her 1992 taxation year is allowed, without costs, and the assessment is referred back to the Minister for reconsideration and reassessment on the basis her claim for a child tax credit for the 1992 taxation year be recalculated as a consequence of the change in the amount of her husband’s income flowing from the decision in his appeal — 95-66(IT)I.

Appeal for 1992 taxation year allowed.