Ratna Arya and Uma Arya v. Her Majesty the Queen, [1994] 1 CTC 2911, 94 DTC 1526

Hamlyn, J.T.C.C.:—The appeals of Uma Arya and Ratna Arya are in relation to a gain realized by them in the 1988 taxation year as a result of the disposition of real property situated in the City of Owen Sound. These appeals were heard on common evidence. In essence the appeals turn on whether the gain realized ought to have been treated on income or capital account.

The issue primarily rests on what was the taxpayers' intention when the property was acquired and whether the taxpayers' stated intention at the time of acquisition was followed by a secondary motivating intention. In this case the Minister of National Revenue (the "Minister") has pled "one of the operating motives in the appellant’s acquisition of the property was the project of selling it at a profit".

Facts

Prior to the purchase of the subject lands the appellant Ratna Arya was a high school department head and an English teacher. He had encountered some difficulties at his workplace and eventually left his employment. As a result of the workplace problems Mr. Arya, prior to and during the period in question, sought an alternative source of income.

The appellant Uma Arya is the spouse of Ratna Arya and during the period in question looked after her family and did some part-time employment.

Mr. and Mrs. Arya after a period of time looking at existing businesses acquired a property as joint tenants in Owen Sound known as Parts of Lots 9 and 10, Range 6, E.G.R., 16th Street. The transaction closed on June 28, 1985. The property was sold by the appellants on October 31, 1988. The purchase price was $66,000 and the sale price was $525,000.

The appellants stated they acquired the property to own, develop and operate a motel with the intention the property would provide them with the sought after alternative income.

The property was not serviced, and was zoned for industrial use. The listing document indicated the property was 36.2 acres. This property was larger than required for the motel project but the appellants stated it was what was offered for sale and they bought the entire package. As stated, the property was not serviced although the listing agreement indicated that services existed to the western property border. The appel ants executed an unconditional offer to purchase and this offer was accepted by the vendor.

The appellants during the period between the offer to purchase and the closing date, found the costs to service the land from the western property border were significant and after the closing date the appellants found the servicing costs were beyond their financial capabilities ($400,000). Their solution was to have the city bring the services by another route closer to their intended project.

The appellant Ratna Arya (who was the chief witness on these appeals and operating mind of the appellants’ project) stated prior to the purchase he did not reveal his intention to build a motel except to a few close friends and did not seek professional advice. He maintained, throughout, the motel was his sole objective and the lands were not acquired for any other purpose. He further maintained the frustration of the project was after the closing and only then did he seek other alternatives.

Evidence on cross-examination of Mr. Arya indicated between the accepted offer to purchase and the closing date, the appellant Mr. Arya attended the Economic Development office for the City of Owen Sound and asked about other possible developments and zoning questions about the subject property. The Owen Sound economic development director undertook to advise him of any inquires about his land.

During the period of time between original acquisition and the subsequent sale, the appellants tried several ways to entice the City of Owen Sound to provide services including offering land for civic use in exchange for servicing.

Prior to purchasing the subject property the appellants had looked at several other motels and had in one case made an offer on a commercial strip mall in Markham. The offer to purchase for this property was placed before the Court. The offer was extensive with many changes schedules and additions to the basic document. Mr. Arya stated he prepared this offer with the help of the real estate agent; he sought throughout to guarantee his income and protect his investment. The offer was not accepted.

The appellant Uma Arya stated that all the decisions in relation to the purchase of the subject property were made by her husband. Although she did say she and her husband discussed the matters at length.

Three other witnesses were called; they and the appellant Uma Arya stated that Mr. Arya never discussed an alternative plan in the event the motel could not be built.

Jurisprudence

In Araz Developments Inc. v. Canada, [1993] 2 C.T.C. 2360, 93 D.T.C. 922, at page 2362 (D.T.C. 922), I found that:

The profit-motive by itself is not sufficient to distinguish between business income and capital gains since both traders and investors are in search of profit. In this regard, Thorson, J. in M.N.R. v. Taylor, [1956] C.T.C. 189, 56 D.T.C. 1125 (Ex. Ct.) at pages 211-12 (D.T.C. 1137), made the following comments:

The intention to sell the purchased property at a profit is not of itself a test of whether the profit is subject to tax for the intention to make a profit may be just as much the purpose of an investment transaction as of a trading one.

As to the distinction between an investor and a speculator, Dussault, J. of this Court stated in Tudino v. The Queen [1993] 2 C.T.C. 3037 at page 3039:

The mere thought that one might realize an investment in an advantageous manner if it is not suitable, or is no longer suitable, does not transform an investor into a speculator or a trader, nor the transaction itself, which is primarily a capital transaction, into a venture in the nature of trade.

In Araz, supra, I further stated at page 2362 (D.T.C. 923):

This principle follows from the reasoning in Californian Copper Syndicate Ltd. v. Harris (1904), 5 T.C. 159 at pages 165-66 (Scot. Ex. Ct. 2nd Div.):

It is quite a well-settled principle. . .that where the owner of an ordinary investment chooses to realise it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit. . .assessable to income tax. But it is equally well-established that enhanced values obtained from realisation or conversion of securities may be so assessable, where what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business.

Further, it was held in M.N.R. v. Foreign Power Securities Corp., [1967] S.C.R. 295 [1967] C.T.C. 116, 67 D.T.C.5084, that the determination of this issue rests, in part, upon the taxpayer's intention when acquiring the property.

Moreover, in appeals of this nature it is necessary to weigh the stated intention of the appellants against the conduct of the appellants in relation to the property in question. Mogan, J. in Bell v. M.N.R., [1989] 1 C.T.C. 2272, 89 D.T.C. 165 (T.C.C.) at pages 2279-80 (D.T.C. 170), found:

When the issue is capital gain or income as in these appeals, the appellants are required to testify and make a number of self-serving statements as to their intention at a particular time. In order for the appellants to succeed, such statements must be supported by objective evidence.

[Emphasis added.]

In terms of the evidence, no single factor is conclusively determinative of the issue and the surrounding circumstances must be considered, Taylor, supra at page 214 (D.T.C. 1139).

In addition to the primary intention, one must look at whether the taxpayer had, at the time of acquiring the property, a secondary intention in the event that the primary intention could not be carried out. The meaning and application of "secondary intention" was succinctly described in Racine v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098 (Ex. Ct.) at page 159 (D.T.C. 5103):

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.

This was further amplified in Crystal Glass Canada Ltd. v. The Queen, [1989] 1 C.T.C. 330, 89 D.T.C. 5143 (F.C.A.), where Mahoney, J. said at page 330 (D.T.C. 5143):

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.

(emphasis added)

In Snell Farms Ltd. v. Canada, [1991] 1 C.T.C. 5, 90 D.T.C.6693, Cullen, J. said at page 10:

. . that the relevant time for determining the intention of the taxpayer was at the time the option was acquired, not exercised.

[Emphasis added.]

Factors to be examined in the analysis of a possible secondary intention

In Happy Valley Farms Ltd. v. The Queen, [1986] 2 C.T.C. 259, 86 D.T.C. 6421 (F.C.T.D.), Rouleau, J. finds it is necessary to examine all the circumstances including the nature of the property sold, the length of the period of ownership, the frequency or number of similar transactions, the work expended on or in connection with the property realized, the circumstances that were responsible for the sale of the property and the motive (i.e.) the intention at the time of acquisition as inferred from the circumstances at that time. At page 264 (D.T.C. 6424) he states [quoting Racine, Demers & Nolin v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098 (Ex. Ct.) at page 159 (D.T.C. 5103)]:

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.

Analysis

The primary intention in the acquisition of this property by the appellants was to own, build and operate a motel.

The property as acquired did not have a zoning problem. All the evidence indicates the location was good location for the intended motel. The appellants were stopped only by the frustration of the high costs of servicing. It also would appear Mr. Arya tried to find a solution to the services problem through the help of other investors and attempts to involve the City of Owen Sound. Only after the failure of these efforts and some three years and four months later did the appellants dispose of the property.

The appellants had no prior real estate history other than home purchases. Also, the appellants had no prior business or loan history.

Most of the possible acquisitions looked at by the appellants prior to the subject property purchase and the properties looked at after the property purchase were motels. When they did make an offer on the commercial mall in Markham, Ontario, their major concern was income flow and protection.

The appellants proceeded on this business adventure without any advisors or background knowledge but with sincere commitment and determination.

I conclude Mr. and Mrs. Arya had sufficient financial resources to obtain other financing and complete the motel project as conceived as they had over $200,000 in assets available for a project that was projected between $400,000 and $600,000, however, the servicing costs ($400,000) were beyond their finances. They did show naivete in their approach to the investment in relation to the servicing costs at the time of acquisition but their later efforts to meet the costs through lobbying the City of Owen Sound, if successful, would have brought the project back to the original plan. On balance I conclude the appellants’ commitment and intention towards the motel project was realistic. The problem of the servicing costs, if resolved, would have the proposal within feasible parameters. This factor inhibited their further planning expenditures.

The two appellants did not have the sophistication of seasoned land or commercial developers at the time of acquisition. Mr. Arya was a high school English teacher and Mrs. Arya was a housewife. Their motel project was not a fanciful dream and it was borne out of necessity to find and provide an alternative source of income. The project was within their resources. The project did, however, encounter a frustration that was not apparent to them when they offered to purchase the property and that problem was beyond their resources. I have no reason to doubt the veracity of the appellants.

From the evidence, there are a few factors to indicate there was a secondary intention to market the property in the event of the first intention failing. Mr. Arya never discussed an alternative intention with his family or friends. The evidence of two witnesses whose other businesses included motel ownership and in one case motel operation was that Mr. Arya continually sought to involve them in the motel project and he never discussed alternative intentions.

The conduct of the taxpayers prior to, at, and immediately after the acquisition period does not indicate an operative motivating secondary intent to sell the land if the motel project failed.

Conclusion

The disposition of the subject property was on capital account.

Decision

The appeals are allowed and referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the disposition of the subject property was on capital account.

The appellants are entitled to their costs.

Appeals allowed.