David Ragobar v. Her Majesty the Queen (Informal Procedure), [1995] 1 CTC 2364

O’Connor J.T.C.C.:-This matter was heard in London, Ontario on June 23, 1994. It is an appeal pursuant to the informal procedure of this Court relative to the appellant’s 1987 taxation year.

Issue

The principal issue is whether the gain realized by the appellant on the sale in 1987 of his one third interest in a four unit building at 32 Askin Street in London, Ontario ("32 Askin") was a gain on income or capital account. A second issue is whether the appellant can benefit from the principal residence exemption since he occupied one of the units. A third issue is, even if the gain can be considered to be on capital account, did the appellant lose his right to a capital gains deduction pursuant to paragraph 110.6(6) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the "Act") because his return for the 1987 year was not filed on time.

Evidence was given by the appellant, by one of his partners, John Armstrong and by Mary Van Roestel, an appeals officer with Revenue Canada.

As to the second issue, it is clear that the unit occupied by the appellant was not his principal residence as he did not own that specific unit. The appellant and his two co-owner partners were a partnership and that partnership was the owner of 32 Askin. The appellant occupied one unit therein as a tenant or occupant.

The basic facts are revealed by the following extracts from the respondent’s reply to the notice of appeal:

6(a) the appellant on or about May 29, 1985, in partnership with John Armstrong and Grady Clarke (the "partnership"), purchased 32 Askin at a cost of $45,000;

(c) 32 Askin was a two story brick home...there were four units in the property;

(d) the purchase of 32 Askin was financed by a first mortgage of $34,000 and a second mortgage of $6,900;

(e) after acquiring 32 Askin, the partnership renovated the property at a cost of $9,003;

(f) the appellant occupied one unit of 32 Askin;

(g) on or about March 17, 1987 the partnership sold 32 Askin for $122,000....

Other relevant facts are:

— In 1987 the appellant was a social worker employed by the London & District Association for the Mentally Retarded and received a gross salary of $28,181.68.

— Other than 32 Askin the only other real estate transaction in which the appellant was involved was a purchase on August 1, 1987 with his wife and one Donald Campbell (a friend) of a rental property which was sold in 1991.

— Prior to the purchase of 32 Askin namely in May 1984 John Armstrong had acquired another property in London which he later sold in January 1988 at a substantial profit.

— After the purchase of 32 Askin Grady Clarke (who became a real estate agent in 1988) and Grady Clarke’s wife bought and sold several properties in London, generally at a profit.

Analysis

I propose to adopt the approach of Bowman J. in Thivy v. The Queen, [1993] 2 C.T.C. 2277, 93 D.T.C. 919 (T.C.C.), where he sets out the criteria adopted in previous "trading cases" and applied them to the facts of the Thivy case. The criteria as set out by Rouleau J. in Happy Valley Farms Ltd. v. The Queen, [1986] 2 C.T.C. 259, 86 D.T.C. 6421 (F.C.T.D.) are (at page 263 (D.T.C. 6423-24)):

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.

As to criterion 1, 32 Askin was an income producing property and according to the appellant’s testimony produced rentals sufficient to meet the expenses plus a small profit.

As to criterion 2, 32 Askin was held for approximately 21 1/2 months. In some cases this might be considered a "short time" but considering the reasons for the ultimate sale discussed below the period of time is not determinative in this case.

As to criterion 3, the only other real estate transaction of the appellant was his purchase of an interest in a rental property in 1987 which was only disposed of in 1991. I certainly do not consider that sufficient to qualify the appellant as a trader.

As to criterion 4, the appellant testified frankly that repairs and renovations probably exceeded the figure of $9,003 mentioned in the Reply but that these were necessary to provide improved parking and to make the units more attractive to prospective tenants.

As to criterion 5, the appellant testified that his lady friend became pregnant in 1986. They therefore decided to marry in the spring of 1987. He explained that the small unit he was living in was no place for a wife and child and that he decided to sell 32 Askin (or at least his interest therein), realize some cash and thus be able to acquire a better family residence. A miscarriage occurred but the wedding nevertheless went forward in April, 1987. In other words it was at the instigation of the appellant that 32 Askin was sold. Armstrong testified that he did not have sufficient cash to purchase the appellant’s share so it was decided to sell the entire property.

As to criterion 6, dealing with motive I found the appellant to be a very credible witness. He stated on several occasions that the acquisition of 32 Askin for him was to provide a "home" and was not acquired for resale purposes. He admitted that he paid an amount of $325 per month to the partnership for occupying his unit and that this in essence represented his share of the expenses. He considered himself as having rent-free accommodation and this was much better than paying rent to a third party. The appellant’s testimony was corroborated by Armstrong not only in this regard but also in regard to the reason why the property was sold in 1987.

The respondent points out that the acquisition of the property was highly leveraged and that the financing was in fact substantially increased when the property sold. This may be so and in some cases may point to a trading motive. However considering all of the other factual issues discussed above, the extent of the leverage is not that important.

The respondent also refers to the trading activities of Messrs. Armstrong and Clarke, the appellant’s partners. He argues for the application of the theory propounded in some cases, that if active partners are traders the passive ones will be painted with the same brush. Without analyzing that theory, I find that even if it is good law and even if the appellant’s partners were traders, the appellant was not such a passive partner as to justify the application of the theory. At acquisition he may have been somewhat passive. After that however he lived in 32 Askin, collected rents, participated in repairs and renovations, made deposits, did some bookkeeping, paid some bills and most importantly was the one who initiated the sale.

The respondent further argues the theory of "secondary intention" which some cases have relied on to find a trading activity. Again without analyzing that theory in depth, I cannot accept its application, given the facts of this case. The appellant acquired his interest "as a home". Both he and Armstrong stated that at time of acquisition resale was not on their minds nor even discussed.

Consequently I find that the gain realized by the appellant on the sale in 1987 of 32 Askin was on capital account, 1.e., the gain realized was a capital gain.

Unfortunately that conclusion does not end the matter because the appellant seeks to use the capital gains deduction provided for in section 110 of the Act and the respondent says the appellant cannot do so because he only filed his 1987 return in 1992 and subsection 110.6(6) of the Act states:

Notwithstanding subsections (2), (2.1) and (3), where an individual has a capital gain for a taxation year from the disposition of a capital property and knowingly Or under circumstances amounting to gross negligence

(a) fails to file a return of his income for the year within one year after the day on or before which he is required to file a return of his income for the year pursuant to section 150, or

(b) fails to report the capital gain in his return of income for the year required to be filed pursuant to section 150,

no amount may be deducted under this section in respect of the capital gain in computing his taxable income for that or any subsequent taxation year and the burden of establishing the facts justifying the denial of such amount under this section is on the Minister.

The appellant explained his failure to file on time as follows. With respect to his employment income the deductions made by his employer at source sufficiently covered the taxes on that income and therefore he naively thought no return was necessary. As to the capital gain on the sale of 32 Askin he again naively thought that one need not report such gains until one had exhausted the capital gains deduction limit. Of course the Act obliges taxpayers to file returns on time. The question in the present case, however, is did the appellant "knowingly or under circumstances amounting to gross negligence" fail to file his return and declare the capital gain in time?

I have examined most of the cases dealing with the meaning of the words in question but, as is often the case, none of them clearly match the facts of this case. I refer to Venne v. The Queen, [1984] C.T.C. 223, 84 D.T.C. 6247, where Strayer, J. of the Federal Court at pages 233-34 (D.T.C. 6255-56) stated:

(4) Imposition of penalties - As noted earlier, in order for the defendant to levy penalties under subsection 163(2) of the Income Tax Act it is necessary that the taxpayer have "knowingly, or under circumstances amounting to gross negligence...participated in, assented to or acquiesced in the making of” a false statement in a return, etc. The similar language of subsection 56(2) of the former Income Tax Act was interpreted by Cattanach J. in Udell v. M.N.R., [1969] C.T.C. 704, 70 D.T.C. 6019 (Ex. Ct.).

I take it to be a clear rule of construction that in the imposition of a tax or a duty, and still more of a penalty if there be any fair and reasonable doubt the statute is to be construed so as to give the party sought to be charged the benefit of the doubt.

In coming to this interpretation the learned judge had regard to the fact that the subsection in question is a penal provision and it must be interpreted restrictively so that if there is a reasonable interpretation which will avoid the penalty in a particular case that construction should be adopted. He concluded that the erroneous information in the returns was not included with the knowledge of the taxpayer nor could the gross negligence of the accountant be attributed to him.

It is also important to keep in mind in applying this subsection that by subsection 163(3) the burden of proof is on the defendant in justifying the assessment of a penalty.

I have come to the conclusion that the defendant has not sufficiently proven that the misstatements were made "knowingly" by the plaintiff in his tax returns for the years in question. I should note here, as it is relevant to the whole question of the application of penalties under subsection 163(2), that there seems to be a certain element of subjectivity recognized in the case law with respect to assessing the knowledge or gross negligence of a taxpayer with respect to misstatements in his returns: see, e.g., Howell v. M.N.R., [1981] C.T.C. 2241, 81 D.T.C. 230 (T.R.B.) at page 2245 (D.T.C. 234); J oris v. M.N.R., [1981] C.T.C. 2596, 81 D.T.C. 470 (T.R.B.), at page 2598 (D.T.C. 472). The taxpayer here is a man with a grade five education, working and paying taxes in a language which is not his first language nor that in which he was educated, a man who is more at ease in a garage than in an office. Not only do these factors militate against a finding that the misstatements in his returns were made knowingly by him, but also his entire course of conduct is not consistent with that of a person who had deliberately set out to conceal large amounts of taxable income. He kept what appear to be quite complete records of sales in his business, then turned these over to his bookkeeper. As far as one can judge from the evidence, all or most of the revenues from the business were deposited in the bank where the monies could readily be traced. He also lodged all but one or two of the mortgages on which he lent money with banks and trust companies which kept careful records, of the income earned from these “escrow mortgages". It is unlikely that a person planning to conceal income would have handled his affairs in this manner. Further it is hard to believe that he was consciously and effectively supervising his bookkeepers since a number of the errors made in his returns were to his disadvantage, even though more of them were to his advantage. I am therefore not able to conclude that the misstatements in the returns were made "knowingly" by the plaintiff.

With respect to the possibility of gross negligence, I have with some difficulty come to the conclusion that this has not been established either. "Gross negligence" must be taken to involve greater neglect than simply a failure to use reasonable care. It must involve a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not. I do not find that high degree of negligence in connection with the misstatements of business income. To be sure, the plaintiff did not exercise the care of a reasonable man and, as I have noted earlier, should have at least reviewed his tax returns before signing them. A reasonable man in doing so, having regard to other information available to him, would have been led to believe that something was amiss and would have pursued the matter further with his bookkeeper.

The foregoing cases dealt with penalties but I believe the same general principles apply to an interpretation of subsection 110.6(6).

A case similar to the present is Sigouin v. M.N.R., [1993] 2 C.T.C. 2760, 93 D.T.C. 210 (T.C.C.), where Dussault J.T.C.C. of this Court found the taxpayer grossly negligent for failing to report a capital gain. In that case however the taxpayer had reported a capital gain in an earlier taxation year and could not be heard to argue that he felt he need not report a gain in a subsequent year because he had not reached his capital gains deduction limit. The present case, I believe, is distinguishable from the Sigouin case as there were no previously reported capital gains.

The Court accepts the appellant’s explanation of why he failed to file on time and finds that he did not act knowingly or under circumstances amounting to gross negligence.

In conclusion the appeal is allowed and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with these reasons for judgment.

No costs are allowed.

Appeal allowed in part.