364256 Ontario Limited, 343877 Ontario Limited and 343878 Ontario Limited v Minister of National Revenue, [1993] 2 CTC 2146, 93 DTC 787

Mogan, T.C.C.J.:—The appeals of 343877 Ontario Ltd. v. M.N.R. and 343878 Ontario Ltd. v. M.N.R. and 364256 Ontario Ltd. v. M.N.R. were heard together on common evidence. The facts in all three appeals are similar in that each corporate appellant purchased a residential apartment building; held it for a few years; and then realized a gain upon its sale. The issues in all three appeals are identical as to whether the gain on sale has the character of capital or income. All three corporate appellants are controlled by a single individual, John David Philp, a lawyer practising in the City of Toronto. Mr. Philp is the individual who made all relevant decisions for or on behalf of each appellant corporation. For convenience, each appellant shall be identified and referred to by the last three digits in its corporate name as: No. 877, No. 878 and No. 256.

Counsel for the appellants put the matter very succinctly when he stated at the commencement of the hearing that "this case is really about Mr. David Philp and his investments in real estate". Mr. Philp was called to the bar of Ontario in 1957 and has practised law primarily in the area of criminal and civil litigation. In the late 1970s he went through a traumatic divorce which required almost all of his non-liquid assets to be transferred to his former wife. He then embarked upon a program to acquire properties to generate income and to create a retirement pool. Exhibit A-1 in these appeals is a graph prepared by Mr. Philp showing the apartment buildings which he has purchased directly or indirectly (through a corporation) and either alone or with other copurchasers. I will summarize below his evidence concerning the various apartment buildings. Table A contains a list of the apartment buildings which have been purchased and sold. Table B contains a list of the apartment buildings which Mr. Philp still owned (alone or with others) at the time of hearing these appeals. All properties are within Metropolitan Toronto unless otherwise indicated.

Table A: Properties purchased and sold

1. 35 Jane Street: 18 suites

Purchased October 1976

100 per cent owned by Mr. Philp

Sold May 1980

2. 650 Bathurst Street: 28 suites

Purchased September 1976

Acquired on 50-50 basis with Mr. Philp’s law partner, Oscar Fonseca 50 per cent owned by No. 877 (one of the appellant's)

Sold October 1980

3. 778 Broadview Avenue: 36 suites

Purchased August 1977

100 per cent owned by No. 256 (one of the appellant's)

Sold January 1983

4. 110 Maitland: 36 suites

Purchased in 1978

Acquired on 50-50 basis with law partner, Oscar Fonseca

50 per cent owned by Mr. Philp

Sold in Spring of 1986

5. 451 Bloor Street: 40 suites

Purchased in 1980 with proceeds from sales of 35 Jane Street and 1650 Bathurst Street

100 per cent owned by No. 878 (one of the appellant’s)

Sold February 1983

6. 433 Jarvis Street: 133 suites

437 Jarvis Street: 78 suites

Purchased July 1984 with proceeds from sales of 778 Broadview Avenue and 451 Bloor Street

Owned 50 per cent by Mr. Philp and 50 per cent by Mr. Gupta (first properties acquired by Mr. Philp with Mr. Gupta)

Sold in Spring of 1986

7. Brampton Properties: 2,587 suites

Purchased in Spring of 1986 with proceeds from the sale of 110 Maitland Street and part of the proceeds from the sales of 433 and 437 Jarvis Street

Owned 25 per cent by Mr. Philp, 25 per cent by Mr. Gupta and 50 per cent by Highmark Properties

Sold in 1988

8. 160 Jamieson Ave/1430 King St.: 100 suites

Purchased in June 1986 with Mr. Gupta with part of the proceeds from the sales of 433 and 437 Jarvis Street

Sold April 1987

9. 38 Thorncliffe: 70 suites

Purchased in 1986 with Mr. Gupta with remainder of the proceeds from the sales of 433 and 437 Jarvis Street

Sold in 1987

10. Glen Everest: 40 suites

Purchased in September 1987 with Mr. Gupta

Sold March 1989

11. 25 Fisherville: 214 suites

Purchased in 1988 with Mr. Gupta

Sold in 1990

12. 125 Allan Street: 70 suites

Purchased in 1988

100 per cent owned by Mr. Philp

Sold in 1989

Table B: Properties purchased and held

1. 262 Jarvis Street: 70 suites

Purchased 1984

2. 415 Kerr Street, Oakville: 70 suites

Purchased 1988

3. 3801 Lawrence Avenue East: 80 suites

Purchased 1988

4, 26 Park Street: 86 suites

Purchased 1989

5. 38 Clarence Street: 40 suites

Purchased 1989

6. 30 Tullamore: 60 suites

Purchased 1989

7. 50 South Forster: 40 suites

Purchased 1989

8. Cadillac Properties: 5,600 suites

Purchased Fall 1987/Spring 1988

Mr, Philp is a /s partner in the ownership of many high quality buildings and a

‘4 partner in two specific projects (Roseberry Square and University City)

NOTE: In Table B, the first seven buildings are managed by Mr. Philp's wife from her office at 262 Jarvis Street. The large buildings within the Cadillac Properties Group are all managed by Highmark Properties, a professional property management company.

The properties in Table B (other than 262 Jarvis Street) were purchased with proceeds from the sales of 160 Jamieson Avenue/1430 King Street, 38 Thorn- cliffe, Glen Everest, 25 Fisherville and the Brampton Properties. Mr. Philp stated that the buildings he first acquired in the late 1970s produced very modest income but the buildings which he held when these appeals were heard were of better quality and produced significant income. He has now reached his goal because he has what he needs by way of income from rental properties. His wife is able to manage the properties which he owns alone; and one of his adult children is employed in that management.

In cross-examination, counsel for the respondent produced a document entitled “John David Philp Trading Summary" (Exhibit R-1) prepared by an employee of Revenue Canada, Taxation. Mr. Philp confirmed that the substance of the financial information in Exhibit R-1 was accurate, and I do not regard the title of R-1 as prejudicing these appeals. Also entered as exhibits R-2, R-3 and R-4 were the financial statements of No. 877, No. 256 and No. 878 respectively. I will attempt to summarize what appears to be the most relevant financial information in those four exhibits R-1 to R-4:

*Depreciation (CCA) of approximately $2,300 deducted only in fiscal 1977 and 1978.

Mr. Philp stated that 1650 Bathurst Street was sold because the building was old and required significant renovations likereplacing the fixtures in all the bathrooms. He and Mr. Fonseca had not realized the state of disrepair when they purchased the property.

*Depreciation (CCA) deducted in fiscal 1980, 1981 and 1982 of $10,146, $4,287 and $15,264 respectively.

The building at 778 Broadview was about 60 or 70 years old; the suites were small and many of them were bachelors. Mr. Philp said that the building attracted tenants whom he described as "riffraff" and who were rowdy and difficult to deal with.

Having regard to the financial information summarized above, it is obvious that the three buildings owned by the three corporate appellants did not produce any significant income. Even if one were to regard depreciation as a basis for cash flow, No. 877 received no more than $2,100 in net cash over the period 1977 to 1980 because the actual loss of $2,551 in 1980 would absorb the $2,300 depreciation from 1978 and $200 from the 1977 depreciation. A net cash return of only $2,100 over four years is an insignificant return on a property which cost $419,000. Similarly, No. 878 showed no profit at all in the period 1980 to 1982 while deducting only $888 in depreciation. Again, this is negligible cash flow from a property which cost $600,000. Although No. 256 showed a small profit of $1,527 in 1979 when no depreciation was deducted, there was cash flow of approximately $29,700 from depreciation in the years 1980 to 1982.

If a person makes an outlay of capital to acquire a particular rental property with a view to holding it as an investment, he should be able to compare the rate of return on his invested capital with the rate available from alternative properties like other real estate, equity shares, preferred shares and fixed rate instruments. In other words, details should be important to a genuine investor. In these three buildings, operating expenses were very high in relation to revenues. If Mr. Philp knew this fact before the purchases, he should have planned for renovations to earn higher rents or reduce expenses. And if he did not know this fact, how can he say that the buildings were purchased to earn income without knowing the precarious state of the income? Reasonable diligence prior to the purchases or appropriate conditions in the purchase agreements could have disclosed that one building needed significant renovations and a second building had small suites and rowdy tenants. Mr. Philp was not aware of these problems until after the properties had been purchased. I therefore conclude that he did not pay much attention to detail when purchasing these three properties. Whatever his intentions may have been, it is a fact that the buildings purchased by the three corporate appellants did not earn any income.

Although Mr. Philp stated that one corporate appellant had performed significant renovations to upgrade its building to increase its potential for income, the financial statements of that appellant did not support his claim. No. 877 held 1650 Bathurst Street for four years and then sold it realizing a gain of 20 per cent above cost. There was no evidence that the building was demolished after 1980 and I assume that the person who purchased the property from No. 877 was faced with the same renovation problem but starting from a higher cost base. Another example is the purchase of 451 Bloor Street by No. 878. It was held for just three years; produced no income; and was then sold for a gain exceeding 50 per cent of its cost to No. 878. Here again, in the absence of any evidence that the building was demolished after 1983, I assume that the purchaser of 451 Bloor Street in 1983 was faced with the problem of upgrading the building to increase revenues and possibly reduce annual expenses while starting from a cost base 50 per cent higher than the cost to No. 878. Mr. Philp stated that the Province of Ontario introduced rent controls around 1976 or 1977 (about the time he started to acquire the buildings in issue) but the existence of rent controls was never put forward as a reason for the absence of profit from these buildings. Even if the buildings were purchased by the corporate appellants with inadequate diligence and physical examination, other purchasers were prepared to acquire these same buildings within a few years at a higher cost presumably in the expectation or hope of earning income.

Mr. Philp may now have achieved his goal of holding rental properties as investments like the properties listed in Table B above. In these appeals, I am not required to determine the character of the properties which he now holds. I am required to decide only the character of the three properties in the hands of the three appellants. Were they acquired as investments on capital account or were they acquired for resale on revenue account? I have concluded that the properties at 1650 Bathurst Street, 778 Broadview Avenue and 451 Bloor Street were acquired by the respective appellants for resale on revenue account. I cannot persuade myself that these properties were purchased as investments to yield rental income when their potential to earn a profit was so marginal at the time when each was purchased, and when so little was done during the brief periods of ownership to increase the profit potential.

If it is Mr. Philp’s intention to be a genuine investor in rental real estate, that intention was only a long-term goal during the years when these three properties were acquired (1976 to 1980) because, in my opinion, they were acquired for resale. Each building produced little or no income and each building appears to have been sold as soon as there was a significant appreciation in its market value. My conclusion in this matter is reinforced by the relatively short period during which Mr. Philp owned some of the other properties listed in Table A above. It's a long lane that knows no turnings. The lane which Mr. Philp is travelling to reach his destination as an investor in rental real estate commenced with a detour into trading activities. The three appeals herein, heard together on common evidence, are dismissed.

Appeals dismissed.