Rudacel Investment Co. Ltd. v. Minister of National Revenue, [1992] 1 CTC 2235, 92 DTC 1118

Bowman, T.C.CJ.:—This appeal is from a reassessment of the appellant by the Minister of National Revenue under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") for its 1985 taxation year. The sole issue is whether a profit of $13,088,904 (Can.) realized upon the sale by the appellant of its common shares in a Texas company, Kinwest Development Corporation was a gain on revenue or on capital account.

The appellant was incorporated under the laws of Manitoba in 1956. In 1987 it was amalgamated with a number of other corporations. Shares were owned by members of the Simkin family or by their holding companies. The appellant forms part of a larger group of companies that is referred to in the evidence as the “Simkin Group”, all of which are controlled directly or indirectly by the Simkin family. The members of the Simkin Group that are relevant to this appeal are the appellant, Heritage Investments Co. Ltd., Kins Management Ltd., Winnipeg Photo Ltd. and Inter-continental Management Services Inc.

The principal witness for the appellant was Abraham Simkin who described in evidence not only the involvement of the Simkin Group and the transactions with which we are concerned in this case, but also the history of the Simkin family. Mr. Abraham Simkin, who described himself as a lawyer and a business executive, was called to the Manitoba bar in 1946. He was an impressive and credible witness and he gave his evidence in a straightforward and articulate manner. His father, a farmer, came to Winnipeg many years ago and started a fuel business which developed over the years into a trucking business. Between 1946 and 1961 the Simkin brothers, Abraham, Saul and Blackie built up a significant enterprise comprising six businesses, including heavy construction such as the construction of hydroelectric plants, bridges, house building, building materials and land development. In 1961, approximately 20 companies in the group amalgamated and went public to form British American Construction and Materials Ltd. (BACM). Since that time, they have grown into one of the larger companies in western Canada. In 1978, the brothers withdrew from the business and their holdings devolved to the appellant. At about this time it appears that the shares of BACM were sold to Genstar. The appellant was described as a holding company but it also engaged in land development.

Some time in 1978 or 1979 Mr. Abraham Simkin, who was no longer actively involved in the affairs of BACM, learned of a golf course that was in bankruptcy near Palm Springs, known as the "Cathedral Canyon Country Club” which owned about 450 acres and he regarded this as an opportunity to invest on a smaller scale than he had theretofore done. He also became aware of a piece of land of approximately 2,000 acres near Dallas, Texas owned by the Byer estate and known as the Big G Ranch. The property was strategically located close to the airport and to downtown Dallas and he saw this as a business opportunity as well. He and members of his staff in Palm Springs did a considerable amount of work to determine the feasibility of developing this tract of land. The property was tied up in the estates of a Mr. Byer and his wife Mabel. A substantial portion of the land that had been in the husband's estate had vested in a charity, the United Jewish Appeal. The portion in the wife's estate had not yet vested. It was decided to purchase the property. It is not necessary for me to outline the complex series of negotiations and court appearances leading up to the acquisition of the property. The Simkin family was not the only suitor but ultimately it prevailed.

In an early stage in the proceedings Great West Life Assurance Company was approached and invited to participate in the project. It had in the past been involved with the Simkin family in other projects and it expressed an interest. Ultimately in January of 1980 Kinwest acquired the property for a cost of approximately $40,000,000 including legal fees and payments to certain dissident beneficiaries under the Mabel Byer estate.

Under the initial allotment of shares from Kinwest on its organization, the Simkin group, consisting of the appellant, Heritage Investments Co. Ltd., Kins Management Ltd., Winnipeg Photo Ltd. and Inter-continental Management Services Inc., acquired 50 per cent of the common and preferred shares and Great West Life and its affiliate Vesma Services Incorporated (the Great West Life group), acquired 50 per cent. In addition, as part of the arrangement among the shareholders Great West agreed to provide Kinwest with a further amount of $20,000,000 by way of subordinated debt.

Under the original shareholders' agreement, the appellant was to manage and market the land owned by Kinwest. The intention was to service and improve the land by means of the installation of sewers, the construction of bridges and roads and to sell the improved property. It was not the intention of Kinwest to construct residential, commercial or industrial buildings on it.

Mr. Simkin testified that it has always been Great West's wish that a local Texas developer become involved in the project. As a result, Las Colinas Corporation in February of 1980 subscribed for 50,000 common shares of Kinwest at $101 per share, and 49,500 preferred shares at $100 per share for a total consideration of $10,000,000. The shares were issued by Kinwest to Las Colinas Corporation on February 15, 1980. Las Colinas had land in close proximity to the Kinwest project. The intention was to develop that land in conjunction with the Kinwest land. On February 1, 1980, Kinwest repurchased from the original shareholders a portion of their preferred shares so that in the result each of the three participants, Great West, the Simkin Group and Las Colinas had a one-third equity interest.

Under a management agreement of February 15, 1980 between Kinwest and Las Colinas, Las Colinas undertook to manage and market the land owned by Kinwest; none of the members of the Simkin Group were involved in the daily activities of Kinwest. An executive committee consisting of representatives of each of the three groups met regularly, received detailed reports of the progress of the operations of Kinwest and participated in major policy decisions relating to the company's business. Las Colinas was paid a management fee which was a percentage of the cost and of the sales and Mr. Simkin testified that these fees were typical in the industry. From this point on, Kinwest proceeded to develop and sell the land. Sewers, roads and bridges were built and between 1981 and 1985 approximately 50 per cent of the land was developed. No dividends were paid, in part because the profits from the sale of lands were reinvested in continuing development and in part because of the restrictions that Great West had imposed on the payment of dividends prior to repayment of principal and interest on its note. During this period as well Kinwest acquired approximately 400 additional contiguous acres which were considered appropriate to include in the overall development. Financing of the project was, in addition to the original amounts invested by the three groups, provided by substantial lines of credit from the Royal Bank of Canada. In 1981 and 1985 the sales and profits of Kinwest were large and the loan from Great West Life was paid off. In 1984 all of the preferred shares of Kinwest were redeemed.

In 1985, Las Colinas was in the process of raising money by means of a public issue and asked Mr. Simkin if the Simkin Group would be prepared to sell their shares. Projections had been prepared indicating a total value for the company that varied from about $93,000,000 to $99,000,000 depending upon the discount rate applied to the projected cash flow. In a result, on July 5, 1985, Las Colinas purchased all the common stock of Kinwest owned by Great West group, the appellant, Winnipeg Photo and Inter-continental Management Services Inc. The appellant for its shares received $9,800,000 US in cash. As well, on July 5, 1985, the remaining shareholders of Kinwest agreed to liquidate the company and to distribute the underlying property to its shareholders.

I need not deal with the manner in which the remaining members of the Simkin Group ultimately disposed of their shares. They participated in the liquidation and transferred the property received from Kinwest to Las Colinas. This method was evidently designed to permit certain of the shareholders to take advantage of the election permitted under subsection 93(1) of the Income Tax Act.

The case was fully and expertly argued by experienced counsel for both parties and no relevant authority or consideration was left unexplored. The issue is a fairly justiciable one but notwithstanding Mr. Shipley's persuasive and attractive presentation of the Crown's case I must conclude on the facts and on the authorities that the gain realized by the appellant is on capital account.

There was very little difference between the parties on the essential facts, although they parted company on certain inferences to be drawn from those facts and on the appropriate legal principles to be applied.

It was undisputed that the Simkin family, including Mr. Abraham Simkin, the guiding mind and driving force behind the family's involvement in the Kinwest project, was highly experienced in the land development business. The property that was owned, developed and sold by Kinwest was at all times inventory in its hands. From the outset Kinwest dealt with the property in precisely the manner in which Mr. Simkin intended: it developed, improved, serviced and sold it. Mr. Shipley invited me to accept these conclusions and I do so. Moreover, I accept his characterization of the project as "selfliquidating"—an expression used in a memorandum prepared when the project was being considered and accepted by Mr. Simkin. I understand this expression to mean that when the development and sale of the land was completed the profits that had not already been distributed would be distributed by way of dividend and Kinwest would be liquidated. This was expected to occur within 10 to 12 years. There was no evidence that Kinwest was expected to continue and engage in other land development projects. Counsel contended further, and I see no reason to disagree with him, that the appellant's objective was to maximize its profits and further, that it was a matter of indifference to the Simkin family whether the project proceeded through a partnership or through a corporation. It was at Great West's insistence that the latter format was adopted.

On the basis of these conclusions of fact Mr. Shipley has invited me to find that the acquisition and subsequent sale by the appellant of an 8.33 per cent minority interest in Kinwest was a business or an adventure in the nature of trade.

The evidence does not support the position that at the time of acquisition of the shares the possibility of their resale at a profit was an operating motivation, to use the frequently quoted words of Noël, J. in Racine v. M.N.R., [1965] C.T.C. 150, 65 D.T.C. 5098 (Ex. Ct.). Even if it did this would not, of itself, justify treating the gain as being on revenue account. In Irrigation Industries Ltd. v. M.N.R., [1962] C.T.C. 215, 62 D.T.C. 1131, the Supreme Court of Canada, both the majority and the dissenting minority, commented on the unsatisfactory nature of a test of taxability that depends upon an ascertainment of a taxpayer's subjective intention at a specific moment in time. At page 219 (D.T.C. 1132-33) Martland, J. speaking for the majority, said:

It is difficult to conceive of any case, in which securities are purchased, in which the purchaser does not have at least some intention of disposing of them if their value appreciates to the point where their sale appears to be financially desirable. If this is so, then any purchase and sale of securities must constitute an adventure in the nature of trade, unless it is attempted to ascertain whether the primary intention at the time of purchase is to retain the security or to sell it. This, however, leads to the difficulty mentioned by my brother Cartwright that the question of taxability is to be determined by seeking to ascertain the primary subjective intention of the purchaser at the time of purchase.

I cannot agree that the question as to whether or not an isolated transaction in securities is to constitute an adventure in the nature of trade can be determined solely upon that basis. In my opinion, a person who puts money into a business enterprise by the purchase of the shares of a company on an isolated occasion, and not as a part of his regular business, cannot be said to have engaged in an adventure in the nature of trade merely because the purchase was speculative in that, at that time, he did not intend to hold the shares indefinitely, but intended, if possible, to sell them at a profit as soon as he reasonably could. I think that there must be clearer indications of "trade" than this before it can be said that there has been an adventure in the nature of trade.

The second basis advanced for The Crown's position is that the use of the corporation Kinwest was simply an alternative method of putting through the appellant's real estate transaction. In this, of course, the judgment of the Supreme Court of Canada in Fraser v. M.N.R., [1964] C.T.C. 372, 64 D.T.C. 5224 must be considered.

The Fraser decision stands for nothing more than the common sense proposition that where a taxpayer holds a trading asset that he intends to sell at a profit he cannot convert what would otherwise be a trading gain into a capital gain by packaging the trading asset in a corporate shell and selling the shares.

Gibson, J. in Shipp v. M.N.R., [1967] C.T.C. 330, 67 D.T.C. 5222 (Ex. Ct.) stated the principle in Fraser in somewhat the same terms where he said at page 336 (D.T.C. 5226):

The principles of Ronald K. Fraser v. The Minister of National Revenue, (1964) S.C.R. 657 [64 C.T.C. 372], have no application here. Such principles apply when at the time of incorporation persons (1) have acquired real estate with the thought that it be sold as well as for income and (2) have caused a company to be incorporated for the express purpose of attempting to get profit on capital account which otherwise would be income.

Counsel for the Minister relied heavily on the decision of Heald, J. in Burgess v. M.N.R., [1973] C.T.C. 58, 73 D.T.C. 5040. That case,as well as McKinley v. M.N.R., [1974] C.T.C. 170, 74 D.T.C. 6138 and De Toro v. M.N.R., [1965] C.T.C. 321, 65 D.T.C. 5195 are merely applications of the principle in Fraser. They do not extend that principle to every case where a taxpayer invests in the capital stock of a corporation that itself carries on an active business of dealing in land.

Kinwest, a separate juridical entity, acquired land and engaged for five years in the business of developing and selling it. The shareholders’ ownership of shares in Kinwest was a capital investment in a business enterprise carried on by a separate legal entity. Kinwest's business and its profits from that business were its own and not those of its shareholders. That principle has been entrenched in our law for at least a century. The Fraser case neither erodes the principle nor blurs the distinction.

The appeal is therefore allowed with costs.

Appeal allowed.