Aaron Gelber and Norman Sternthal v. Minister of National Revenue, [1991] 2 CTC 2319, 91 DTC 1030

Rip, T.C.J.:—Aaron Gelber ("Gelber") and Norman Sternthal ("Sternthal") appeal from assessments with respect to their 1982 taxation year in which the Minister of National Revenue ("Minister"), the respondent, disallowed expenses deducted by each of them in computing income on the basis the amounts deducted were not outlays or expenses made or incurred for the purpose of gaining or producing income from a business or property, in accordance with paragraph 18(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

The appeals were heard on common evidence. Sternthal was the principal witness for the appellants.

Gelber and Sternthal are brothers-in-law. They have been in the construction business in Montreal since about 1960 when they incorporated Fairway Construction Inc. (“Fairway”). In their first venture Fairway constructed for sale single family homes on a golf course that had been previously purchased by a related corporation, Elmcrest Realties Ltd. ("Elmcrest"), in Dorval, Quebec. In 1966, the appellants and two of Sternthal’s brothers built a 227 townhouse rental project called "Lakeshore Villa”, which they still own.

Fairway was, and is, a contractor; it holds a licence to carry on a business as a general contractor and towards this end engages subcontractors for the various projects. It also arranges financing.

With respect to Lakeshore Villa and at least two other properties, a 74-unit townhouse property called Beacon Hill Villa, and a six-storey office building called Fairway Centre, Fairway acquired the land, arranged the financing and built the project. On completion of each of the projects the ownership of the property was transferred to the appellants as co-owners. [3] Sternthal stated that there were advantages in initially holding the property in Fairway. One advantage was that it facilitated financing since lenders prefer a corporation as mortgagor, even when the mortgage is personally guaranteed by the coowners of the property, since in Quebec corporations do not have the right to pay off a mortgage after five years, as does an individual. Fairway had also built up a relationship with subcontractors and this relationship facilitated construction. Another advantage in having a corporation build a project was the limited liability inherent in a corporation.

Fairway acquired the land on which the Beacon Hill Villa was built on May 5, 1970 and on December 31, 1971, when construction was completed by Fairway, it transferred the ownership of the property to the individual purchasers.

In filing his amended income tax return for1971 [4] Sternthal claimed a net loss for tax purposes from Beacon Hill Villa of $29,458; this amount included income of $6,768 and capital cost allowance of $36,226. An auditor's report for the seven months ended December 31, 1971 was prepared for the owners of Beacon Hill Villa on the basis the owners owned the property throughout the seven-month period.

Similarly, Fairway transferred ownership of Fairway Centre to Sternthal and Gelber on April 25, 1972, once construction was completed. Fairway had acquired the land on February 5, 1971. Sternthal testified that Fairway had negotiated a lease with the Department of Public Works, Canada for a post office at Fairway Centre for the period April 1, 1972 to March 31, 1992 and that the rent collected for April, 1972 was included in the income of the appellants. I have reviewed Sternthal’s income tax return for 1972 and have been unable to find any reference to Fairway Centre. On page 66 of Exhibit A-A6 income from four properties is reported under the heading “Rental Income" but there is no reference to income from Fairway Centre.

Two other projects followed the same procedure. Land for an office building at Queen Mary and Côte des Neiges Roads in Montreal was purchased by Fairway in 1973 and once construction of the building was completed, Fairway transferred ownership of the property on December 2,1975 to the appellants. Sternthal reported rental income from the property in his 1975 tax return; a schedule attached to the tax return reflects that Gelber claimed a greater capital cost allowance than Sternthal thus resulting in a loss to Gelber for tax purposes.

The other project, on Atwater Avenue in Montreal, was a 307-unit apartment building which Fairway sold, again after construction, to the appellants on December 2,1975. In his 1975 income tax return Sternthal claimed a rental loss of $92,204 from this property.

Sternthal stated that from 1970 to the date of trial Fairway did not own for its own account any land and had not earned any significant profit from construction. Fairway acted strictly as agent for Gelber and him. Fairway did contract for "two small construction jobs. . . not for us”, said Sternthal, and made a “small profit". Fairway has had no rental income, he said. Sternthal explained when a property was transferred from Fairway to Gelber and him the consideration included costs of construction and a nominal amount of overhead.

The balance sheets of Fairway for fiscal periods during which construction took place, reflect an asset "Construction in Progress” and liabilities for bank advances and mortgages payable. For example, with respect to Fairway's 1974 fiscal year, when it was building the Queen Mary and Côte des Neiges Roads and the Atwater Avenue buildings, the construction in progress for the two buildings aggregate $3,567,154; bank advances total $1,342,088 and mortgages payable aggregates $820,523 with respect to these two projects. The underlying lands are not shown as separate assets on the balance sheet. Nowhere in the financial statements is it noted that Sternthal and Gelber are also liable on the loans or that Fairway is not the owner of the properties but acts only as agent for the absolute owners Sternthal and Gelber.

The property that is in issue, Place Ste-Marie, consists of 40 townhouses which were built for sale as condominium units. [5] As at date of trial only 15 of the units had been sold; the other 25 units were being rented.

Fairway purchased the Place Ste-Marie land from a related corporation in February, 1982 and ownership purportedly was transferred to the appellants on December 7, 1982, after completion of construction. The related corporation acquired the land in 1954.

Before completion of construction of the townhouses of Place Ste-Marie, a unit was sold to an erstwhile player with the Montreal Expos Baseball Club who, according to Sternthal, was in a rush to buy. At the time of the sale, the property was still registered in the name of Fairway and Fairway was a party to the transaction. The Declaration of Co-Ownership took place “just before” the sale to the baseball player. The profit on the sale of the townhouse unit was approximately $6,000. Sternthal testified that "we decided to keep the profit (in Fairway) as a construction fee for building the condominium" rather than recording it as profit to Gelber and himself. Sternthal stated that the usual practice was to record rents from a property prior to its transfer of ownership as rentals to Gelber and him or apply the rents to reduce costs of construction.

In cross-examination counsel for the respondent asked Sternthal why he and Gelber did not appear in the Act of Sale on the purchase of the land by Fairway, since Sternthal executed the deed as officer of Fairway. Sternthal replied that "during the risk period during construction (we) used Fairway on our behalf". He declared the intention was that "we will become owners of the property once construction is completed".

Sternthal declared that the Place Ste-Marie project was acquired and built in the same manner as the earlier projects: that is, Fairway buys the land, arranges financing either externally or internally through another Sternthal family owned corporation, builds the building and then transfers the building to him and Gelber. During construction of Place Ste-Marie municipal tax bills were sent to, and paid by, Fairway and were then included in the total costs.

The Declaration of Co-Ownership was signed on August 4, 198 by Fairway. In the Declaration Fairway declared it is the proprietor of the property. The Declaration also states "each co-owner will have the right to bring an action against the declarant and to recover the jointly and severally bails of. . . (any budget). . . deficit.” There is no indication in the Declaration that persons other than the declarant may be proprietors of the property. Sternthal stated he signed the Declaration for Fairway as its President “without going over the clauses". The notary told Sternthal, he said, the document was in the standard form and he signed it. “It was the first condo I did. . .”. When counsel for the respondent asked him whether he was aware of the clause stating the coowners had rights against the declarant only, Sternthal replied, "Is it wrong to protect myself?".

In filing their 1982 tax returns Sternthal and Gelber each reported a loss from Place Ste-Marie in the amount of $328,215. On April 15, 1983 unaudited financial statements for Place Ste-Marie were prepared. The balance sheet was prepared as at December 31, 1982; the statements of income and owners capital were for the one-month period ended December 31, 1982. The statement entitled "Cost of Revenue Producing Property Under Construction For Income Tax Purposes describes the cost of the property to be $2,972,368; from this amount were deducted amounts capitalized to the building for accounting purposes but deductible for tax purposes, such as interest during construction, marketing and leasing, and landscaping.

Interest on funds borrowed during construction was included in the purchase price when the title to property was transferred to the appellants. The books of Fairway record advances during construction to Fairway and not to Sternthal and Gelber. Fairway's fiscal year end is April 30. The balance sheet of Fairway as at April 30, 1982, while construction of Place Ste-Marie was taking place, reflects an asset, "Construction in Progress" in the amount of $2,387,177 and liabilities of accounts payable and accrued liabilities and a loan payable to an affiliated company aggregating $2,687,055. The balance sheet of Fairway reflects the asset of April 30, 1983, a loan receivable of $3,117,134, being the amount owed to it by the appellants on the acquisition of Place Ste-Marie; the loan from the affiliated company had been increased. The note to the balance sheet as at April 30, 1983 describes a related party transaction to include “sale of a condominium project to the shareholders". In Sternthal’s view the description should read "transfer of title" of condominium project to the shareholders and not "sale".

Sternthal advised that no written agreements exist between him and Gelber with respect to any of the properties they own together.

Mr. Michel Rolko, employed by Fairway as an internal auditor, explained how he calculated the purchase price on the sale of Place Ste-Marie. All costs of construction were entered in a journal and were included in the purchase price. The cost of land was also included in the purchase price. Charged to the appellants as costs of construction for accounting purposes were all expenses after the first tenant moved into a townhouse before construction was completed; these costs included electricity, insurance, taxes and interest; rents collected during the period were applied to the purchase price.

Mr. Réjean Roy, C.A. is a member of the firm of auditors of Fairway and for many years has prepared the personal tax returns of the appellants. He explained that in the various projects such as Beacon Hill Villa and Queen Mary and Côte des Neiges Roads building, for example, the costs of construction are shown as an asset of Fairway since Fairway incurred the costs. He testified that he understood the intention of the co-owners of Beacon Hill Villa was that they were to own the property from the beginning of operations, that is, from the time the building was completed. This was the reason the financial statements of Beacon Hill Villa were made for a seven-month period. He also explained that frequently tenants enter a buildin before the completion, that is, before the commencement of operations, and in such a case the rentals are attributed to the individual owners. Later, after prodding by Mr. Ryan, appellant's counsel, he testified it was intended the appellants own the properties from the first day of construction of the particular building. Roy cited, as an example, the Atwater Avenue building in which rents for the four months prior to the transfer of ownership to the appellants were included in their income. Roy also explained that if Fairway had not held the property on its own account he would have shown a cost for land and costs of construction separately, either in the balance sheet or on a note to the balance sheet.

The issue before me is one of fact. My finding of fact is dependent on the evidence adduced at trial. Counsel for the appellants advised that if I were to find that Gelber and Sternthal were not owners of Place Ste-Marie from the very start of construction I would be finding as well that Sternthal was not a credible witness. Counsel argued Sternthal was a credible witness.

Sternthal is neither a lawyer nor an accountant; he is a businessman. A businessman makes decisions as to what he intends to do with his: money. Unfortunately it does not necessarily follow that just because one intends some action to be done, that intended action results. It may well be that Sternthal and Gelber intended to own the Place Ste-Marie land at the moment it was acquired in 1982 by Fairway. In fact Sternthal's evidence was that he and Gelber intended to cause Fairway to do what it had done for them in the past, that is, acquire land, arrange financing and construct a building, and once construction was complete, transfer title to them as co-owners of the land and improvements. In preparing tax returns for past years they had claimed they were owners of property and in computing their incomes for tax purposes they deducted various costs of construction notwithstanding the property was registered in the name of Fairway. I have no problem accepting the bulk of Sternthal’s evidence; I have no problem in holding a person in whose name title to a property is registered is not necessarily the owner of that property; I have no problem in finding the purchase price for the property included all costs of construction and that if Gelber and Sternthal owned the property from the start of construction of the townhouses the amounts they claimed as expenses were legitimate expenses.

The treatment for tax purposes of expenses claimed in earlier years is not before me and I am not bound by how the respondent may have treated similar claims in previous years; after all, the respondent is not the arbiter of what is right or wrong in tax law. I am only interested in the 1982 taxation year and whether the appellants were correct in deducting expenses of construction of Place Ste-Marie on the basis they were co-owners of the property from the time the construction of the townhouses began.

The only indication that Gelber and Sternthal may have owned the Place Ste-Marie property from the start of construction is the evidence of Sternthal that that was his intention; he also stated, however, that ownership would be transferred only after construction was complete. Roy at first declared the appellants’ ownership of the property was to take effect once the building started in operation, that is, when the building was completed and available for tenants. He also explained that in previous projects some tenants moved into a project before completion.

All documentary evidence supports the basis of the assessments being appealed. There was no documentation such as insurance policies taken out by the owners of Place Ste-Marie during construction before me. The Court was advised such policies were not available at date of trial. The statement of income included in the financial statements for the owners of Place Ste-Marie for 1982 was prepared for the one-month period ended December 31, 1982. In my view if the appellants owned Place Ste-Marie prior to December, 1982 it would have been proper for the accountants to have prepared the statement of income for the whole period during which the appellants owned the property. Since the statement reports income from only one month in 1982 it is not unreasonable to conclude the property was owned by the appellants for only that month.

I also refer to the financial statements of Fairway for 1982. Fairway's fiscal year ends on April 30. Fairway’s balance sheet as at April 30th, 1982 describes an asset "Construction in Progress". A note with respect to accounting policies for "Construction in Progress" states "[t]he company capitalizes all direct costs relating to the condominium project under development. In addition, indirect costs including interest and property taxes are also capitalized". Fairway's accounts payable and accrued liabilities and loan payable to an affiliated company are liabilities of Fairway. There is no note in the financial statements the assets and liabilities are not those of Fairway. There is no note to the reader that the owners of the property are Gelber and Sternthal and Fairway is the registered owner of the property as nominee or prête nom for Gelber and Sternthal. Indeed, if Fairway was simply the contractor of Place Ste-Marie the amount of cost of construction would have been shown as an amount receivable on the balance sheet. I do not accept Roy's reasons for not characterizing the amount as a receivable. If Fairway incurred the costs for another person, then that person is indebted to Fairway and Fairway should show this asset as an amount receivable. If, on the other hand, Fairway owned the property, then the amounts should be described as "costs of construction", as they were. A reader of the financial statements of Fairway would conclude with reason Fairway owned Place Ste-Marie as at April 30, 1982.

Representations in the financial statements of Fairway and the Declaration of Co-Ownership are to the effect Fairway was the proprietor of the property known as Place Ste-Marie. These representations, let it not be forgotten, were made to third parties: to the respondent as part of the income tax returns of the appellants, and to the world by way of registration. The testimony at trial was to the effect this was not the intention of the appellants.

In his evidence Sternthal stated Fairway held the property as owner during construction in order to protect Gelber and himself. I have no doubt this is true. But one cannot be not an owner of property for one purpose—for protection from personal liability during construction—and be an owner for another purpose—for tax purposes. In the same way a person cannot simultaneously inhale and exhale, a person cannot simultaneously own and not own a property. An owner of a property owns the property throughout the time he is owner, for good and for bad. A person must decide what is more important, protection from potential liability and have a corporation own the property during construction, or potential tax deductions and have oneself own the property during construction. The decision is to be made prior to construction.

I have not found the Minister to have made any error in making the assessments and they ought not to be disturbed.

The appeals are dismissed.

Appeals dismissed.