Vangipuram S. Ramachandran and Rolf F. Feldman v. Minister of National Revenue, [1986] 1 CTC 2099, 86 DTC 1069

Kempo, T.C.J.:—

Part I — Issue

The appellant Vangipuram S. Ramachandran (“Ramachandran”) and the appellant Rolf F. Feldman (“Feldman”) each appeals with respect to their respective 1977 and 1978 taxation years. The appeals were heard on common evidence. The common issue is whether the gain realized by each of the appellants on the purchase and subsequent sale of two rental properties is a Capital gain or business income.

While there are other factors involved in these appeals, the principal thrust of the respondent's position herein lies in the fact that the two appellants were associated with one Carlton Braithwaite (“Braithwaite”) whom, it was assumed, is an acknowledged trader in real estate (see paragraph 7(f) of the respondent's reply to notice of appeal).

Part II — Decision

The appeals of each of the appellants are dismissed for the reasons given in Part III hereof.

Part III — Reasons for Judgment

The two appellants are research scientists and have been friends and coworkers for the past 20 years. They had co-authored two books and 27 research papers. They were both employed by the National Research Council of Canada in Ottawa. Dr. Ramachandran is a chemical researcher of building materials and was head of the building materials section. Dr. Feldman is also in the research field of building materials. Prior to the acquisition of the two subject properties which will be described later, neither of these two individuals had had any experience in the management of rental properties.

Dr. Braithwaite had worked as an economist from 1967 until early 1983, originally with Statistics Canada and then with the Economic Council of Canada. He describes himself currently as being a self-employed businessman whose main goal has been to acquire a good portfolio of investment properties over time. He not only looks after his own properties but has given advice to others on the making of investments. He also is the sole shareholder in Uniprop Management Limited (“Uniprop Ltd?') which has had real property dealings.

The two properties, the sale of which is the subject matter of these appeals, are both located in Ottawa. A 16-unit apartment building, #105 Rosemount, (“Rosemount") had been purchased December 21, 1973 and was sold four and one-half years later, June 24, 1978, at a gain. Ownership thereof was 49 per cent as to Braithwaite, 40 per cent as to Feldman and 20 per cent as to Ramachandran. The property 1759-1809 Heron Road is comprised of 24 townhouse units (“Heron Road"), had been purchased September 30, 1974 and was sold three years later, August 31, 1977, at a gain. Dr. Braithwaite held a 50 per cent interest, Dr. Feldman held 35 per cent and Dr. Ramachandran held 15 per cent.

The following chronological capsulization of pertinent events described in the evidence provides a good overview of the course of conduct by the three individuals involved which the respondent submits is supportive of the subject gains being on account of business income rather than on the mere realization of the enhanced value of an investment, or capital.

I am fully aware that Dr. Braithwaite is not an appellant in these proceedings but rather that he has appeared and testified as a witness for and on behalf of the appellants. Unquestionably the respondent is relying heavily on the fact of Braithwaite’s involvement in the two subject properties which, as will be seen, became the tenth and fourteenth transaction in and of his property acquisition portfolio.

However, the totality of the objective facts is to be viewed in context with the stated subjective intention or goals of these three individuals as coowners of the two properties at hand. All three testified that they insisted on total unanimity in their relationship and that it was their understanding no one could or would dominate or control. At the outset of the hearing, and throughout, both Ramachandran and Feldman continuously emphasized that from the very beginning Braithwaite’s percentage of ownership was intended not to exceed theirs when combined, the reason advanced being that they wished to control their own destiny.

Dr. Braithwaite and some of his property dealings had been known to Feldman since 1970, but not to Ramachandran, prior to the purchase of Rosemount in December of 1973. It was Feldman and Braithwaite that had been actively seeking rental property to be acquired by the three individu- als; and it was they who had found and presented the two subject properties to Ramachandran for his involvement.

Dr. Braithwaite was to be active in financial and tenant relationship matters; Feldman and Ramachandran were to be active in general supervision and management. No one was to have been passive — all were to be active. All three stated their desire was to gain an investment portfolio of good rental property or properties which would yield, or would be capable of yielding, rental income.

At the time of acquisition all three were aware that rental property prices were rising. Dr. Ramachandran's recollection of the financing details of the two properties was vague. Drs. Feldman and Braithwaite were of the common view that it was good business practice to put as little money as you could into any venture, that maximum financing or borrowing should be utilized and that in an inflationary market any equity or operational losses should also be financed when possible thus freeing up money for further investments elsewhere. Initial operational losses or a break-even position would be acceptable because of anticipation of higher rental receipts due to good management, maintenance and improvements along with increasing property values pushing up rental rates. Suffice it to say that the evidence is entirely devoid of the existence of any contingency plans in the event of error or turn-around of these expectations.

As will be shown, the two properties were acquired with short-term financing and were in a short time subjected to refinancing up to if not greatly in excess of the purchase price. In one case part of the surplus money was admittedly to compensate the appellants and Braithwaite for their ongoing operational losses. It is these subjective type matters that are to be viewed and weighed against the objective facts.

The following Schedule is what I have been able to extrapolate from the evidence of Dr. Braithwaite as to his activities in the course of his stated purpose of building up a rental property portfolio. Most of the property is in or near Ottawa. A few may have been in Montreal.

* involvement via Uniprop Ltd.

(1) both Feldman and Ramachandran had an interest (is a subject property).

(2) both Feldman and Ramachandran had an interest.

(3) Feldman had an interest and he used sale proceeds in acquiring 200 Bronson.

(4) both Feldman and Ramachandran had an interest (is the other subject property).

(5) Feldman had an interest.

(6) Feldman had an interest.

The schedule indicates that in the period prior to December 21, 1973 (i.e. Rosemount) Dr. Braithwaite had acquired eight rental properties on his own account and one via Uniprop Ltd. He had sold two of the properties at a gain after a very short holding. In the one-year period following (i.e. 1974) Dr. Braithwaite acquired interests in five properties including Rosemount and Heron Road. The Kindersley property involved both Ramachandran and Feldman and the Ridgewood property involved Feldman. Also during 1974 he sold two properties at a gain which had been held for two to four years, and each of which had suffered operational losses. In 1975 he sold two properties at a gain. One was held for three years and had had operational losses. The other was breaking even but had been held for one year. In 1976, after four years of holding, he sold a property at a gain which had had operating losses and purchased three others. 1977 saw gains on selling three properties, two of which (including Heron Road) had operational losses for the one to three-year holding period, respectively. 1978 involved more purchases, some with quick turnovers, and the Rosemount sale. In 1979 he acquired three and sold three. Two were sold at a loss and had been held for five years with operational losses, and one after two years for a gain. The acquisitions and dispositions from 1980 are as shown on the Schedule.

Of the thirty or more properties acquired by Dr. Braithwaite in the 14- year period, there are very few remaining in his portfolio. All but two to four realized gains on disposition, and all but two showed break-even operations during the holding period. During pressing cross-examination, Dr. Braithwaite admitted that all properties were or had been heavily financed with a financing debt load well in excess of 50 per cent of rental revenue.

As stated earlier, Dr. Braithwaite is not an appellant in these proceedings. However, his involvement is one of the important matters to be considered with respect to the situation of the appellants at bar.

Another important factor to be considered in the case is the financing of the two subject properties and the stated reasons for sale.

The Rosemount property was purchased December 21, 1973 as follows: Some eight months later, in October of 1974, a third mortgage was placed thereon for $50,000. The total encumbrance was then in excess of the purchase price and all three mortgages were short-term. Approximately three years later, in 1977, the first mortgage was refinanced to $150,000 and the second for $25,000. Annual operating losses had been accruing. The appellants and Dr. Braithwaite were very vague and/or uncertain as to the purpose of the third mortgage placement in 1974 and more particularly as to the dispersal of the mortgage proceeds. There is a very strong inference from the evidence that the mortgage moneys went to each of the three individuals as a return of their respective part of the down payment plus shortfall operating losses which they had paid for. It was conceded that the financing debt-load contributed significantly to the operating losses. During the four and one-half year period of holding the operating losses amounted to $20,000. Some repairs and maintenance had been carried out with hopes of producing increased income. Rent controls came in in 1975, a new apartment building next door attracted the best tenants, rental-money thefts and vandalism occurred in the building as tenant-calibre fell. They said they may have considered putting in more money if things had gone better. Given these problems, and the prospect of future losses, they unanimously agreed to sell in 1978 when Dr. Feldman was approached by a realtor with a buyer.

However, long before the sale of Rosemount, but shortly before the third mortgage for $50,000 had been placed thereon in October of 1974, the appellants, along with Dr. Braithwaite, purchased the Heron Road townhouses on September 21, 1974. The financing details were as follows:

The land and buildings were purchased for $470,784 with $9,216 being for chattels, for a total price of $480,000. All three mortgages were short-term and were to expire in the spring of 1977. Drs. Feldman and Braithwaite maintained that the third mortgage of $50,000 was a blanket-financing mortgage as they recall mortgaging the equity in their respective principal residences in order to enable them to borrow these funds. In any event the payments on the third mortgage were made part of the operational expenses. As noted earlier Heron Road ran up losses totalling approximately $65,000 in the three years of holding.

Notwithstanding that Heron Road may have been acquired for far less than its true value (possibly $600,000 plus), faulty construction of the townhouses with little or no insulation caused no end of trouble with the resultant loss of tenants, especially in the winter. The structures had received pre-purchase visual inspection by a friend of the appellants, however the consequences of the lack of insulation were not known until experienced. Some money was spent in one year but to no avail. The real cost would have been $100,000 plus to have had a proper job done. Utility costs were high and rent controls were in. In 1977 an unsolicited offer to purchase came to Dr. Feldman via a realtor. He and Dr. Braithwaite negotiated the selling price of $725,000 which was too good to refuse. The sale was concluded August 30, 1977.

However there were certain pertinent events which happened during the spring of 1977. The Heron Road property was conveyed to a numbered company for purposes of new mortgage financing. Such had been required by Crown Life as mortgagee for the sum of $475,000 (which is the total purchase price some three years earlier) with the appellants and Dr. Braithwaite being guarantors thereof under Deed (Exhibit R-10). This mortgage was for a 24-year fixed-payment term at 10% per cent. The second mortgage on acquisition was also renewed at the lesser sum of $100,000. Therefore by the spring of 1977 (i.e. three years later) the mortgages totalled $575,000 which is $100,000 more than the acquisition price. Again, although memories were vague in this respect, there is a strong probability that the surplus mortgage moneys in this refinancing were disbursed to the appellants and Dr. Braithwaite in repayment of the accumulating operating losses and the borrowed down payment. Apparently this was of greater importance to the appellants than the repair and retention of the Heron Road property as an investment.

Therefore it is clear that for both Rosemount and Heron Road the mortgages had not been paid down, nor was there any intention to do so if the approach of Drs. Feldman and Braithwaite was to be followed. Events showed this to be the case as the mortgages, initially short-term, were in fact increased. Operating losses were not unknown to Dr. Braithwaite nor to Dr. Feldman. Their combined philosophy, together with the proven events, leads me to conclude that Drs. Feldman and Braithwaite were the combined and real dominant forces behind the acquisition and disposition of the two properties as clearly Dr. Ramachandran was in no position to go it alone. The unanimity of decision which was spoken of did occur in the context of the recited events as apparently no occasion arose for it to be otherwise. Thus the appellants’ real intentions, when viewed objectively, are tainted with those of Dr. Braithwaite. Dr. Feldman learned much from him, both before acquiring the first property, Rosemount, and thereafter as he became involved with Dr. Braithwaite in other properties within the same year as is seen from the aforementioned Schedule. And it is apparent that the overall methodology continued.

The whole and pertinent course of conduct of the appellants is to be viewed objectively as a backdrop to their stated subjective intentions. Present statements as to intention at the time of acquisition must be considered along with the objective facts. The subjective and objective should be reconcilable for the most part. Therefore each case is to be decided essentially on its own facts.

There is an inference to be drawn from the evidence as a whole that while Dr. Braithwaite did not have de jure control in the properties, the appellants were influenced by and acted upon his knowledge and experience of a possible profit on resale as well as the recognition of the capacity of the property to operate on a minimal-loss or break-even basis until it could be turned to a profit by sale.

Given all of the circumstances, the method and extent of financing, the short-term of holding, lack of perseverance when difficulties arose, consistency of operating losses largely related to the extent of financing, minimal personal equity investment and the knowledge and experience of Dr. Braithwaite which can be imputed to the appellants all suggest that they have failed to rebut the inferences of speculative motives at the time of and as a motivation for the purchases.

The appeals must therefore be dismissed.

Appeals dismissed.