N. L. Brousseau Realty Co. Ltd. v. Minister of National Revenue, [1986] 1 CTC 2277, 86 DTC 1186

Sarchuk, T.C.J.:—The appellant N. L. Brousseau Realty Co. Ltd. (Brousseau Realty) is a corporation, duly incorporated under the laws of the province of Manitoba, and having its registered office on Rue St-Pierre, St. Norbert, Manitoba. In August 1976, Brousseau Realty acquired property at 2385 Pembina Highway, Winnipeg at which time it was vacant land. The appellant caused a building (Southwood Medical Centre) to be constructed on the site, which building was completed during 1977. The property was sold by the appellant in February 1979 to St. Norbert Lodges Ltd. for its fair market value.

At issue is whether or not the respondent was correct in treating the profit realized by the appellant in its 1979 taxation year from the disposition of the Southwood Medical Centre (the Centre) as income from a business rather than as a capital gain.

The appellant is a family concern which has carried on the business of selling real estate since 1962. N. L. Brousseau (now deceased) was the president and his four sons were officers and/or directors. All were substantially involved in the real estate business. Of the sons J. E. Brousseau appears to have been most directly involved (along with his father) in the construction and disposition of the Centre. He is a real estate broker in his own right and in addition to his involvement in the business affairs of the appellant is the sole owner of Brousseau Realty a comany which he incorporated in 1976.

During the late 1960s N. L. Brousseau became involved in nursing homes and as a result gradually began to reduce his activities in real estate and in the appellant. The nursing home business was operated through St. Norbert Lodges Ltd. and two other associated companies, the shares in which were held by various members of the Brousseau family.

In the period 1962-1979 the appellant acquired the Centre and three other properties. The first was an office building located at 340 Stafford Street, Winnipeg, which was purchased in the 1960s for its own use. The second was a property on Vermillion Street in Winnipeg which was sold in 1974 and the third was an eight-unit apartment block constructed by the appellant in 1977/78. The office building and the apartment block were listed for sale and were sold in 1979.

The genesis of the Centre can be traced to 1975 when N. L. Brousseau and Dr. Elliott (Elliott) first discussed the possibility of developing a medical clinic to be located near the recently constructed Victoria Hospital. According to J. E. Brousseau, Elliott was the spokesman for a group of doctors who were seeking a partnership or joint venture for the purpose of building such a clinic. By the spring of 1976 the discussions between the Brousseaus, Elliott and several other doctors disclosed a degree of interest sufficient to impel J. E. Brousseau to commence looking for an appropriate site. The plan as envisioned by the parties at that time would have had the appellant accept responsibility for the acquisition of the land and the construction of the building. Concurrent with the acquisition of the land the parties were to enter into a formal agreement and to incorporate a new company for the purpose of owning and managing the clinic as a rental property.

J. E. Brousseau located an appropriate site and proceeded to purchase it on behalf of the appellant. At about the same time the appellant commenced to prepare preliminary plans for discussion purposes. It was J. E. Brousseau's recollection that at the time he was negotiating the purchase of the property discussions were being held with the doctors relating to the price of the raw land and the cost of development. According to him the doctors' interest wavered at that point of time and for all practical purposes they backed out of the contemplated joint venture.

I note in passing that there are no minutes or memoranda relating to the discussions which took place at any of these meetings nor were any agreements or arrangements ever reduced to writing. None of the doctors involved in these preliminary negotiations testified.

The appellant decided to go ahead in any event, believing “that longterm benefits were automatic". The necessary plans were drawn up, the zoning variations were obtained and construction proceeded apace. The building was to have three floors with the top two specifically designed as medical offices. The first floor provided space for a dentist and pharmacy while the basement was reserved for laboratories and x-ray facilities.

Construction of the Centre began in August 1976. According to J. E. Brousseau, his father insisted that the construction be of the highest standard and as a result many expensive items such as Tyndall stone facing, mahogany trim and a sprinkler system (not required under the city by-laws) were included. He described these items as over improvements which subsequently created a problem in that their cost eventually forced the appellant to set a very high rent.

The Centre was completed late in 1977. Although several tenants took occupancy the appellant derived no rental revenue that year since it had been necessary to grant several months' rent free tenancy as an inducement to lease. In 1978 the appellant was only able to attain 50 per cent occupancy with the result that the rental income in that year was very low. Further inducements to prospective tenants were necessary and the appellant resorted to offering as much as six months occupancy free of rent. J. E. Brousseau was convinced that the over improvement to the building and the consequent high rents were the principal reason behind the appellant’s failure to quickly achieve an adequate level of occupancy.

During the same period N. L. Brousseau’s interest and involvement in the appellant had been substantially reduced and he decided to close the appellant down and to dispose of its assets. At the same time J. E. Brousseau's real estate company was becoming more active and from his perspective as well there was no purpose in continuing the existence of the appellant.

Mr. Scarrow, (Scarrow) an accountant, has been responsible for the preparation of the appellant’s financial statements for a number of years. He has also acted as an adviser to the appellant with respect to its business affairs. He testified that by 1979 N. L. Brousseau had effectively discontinued his involvement in the appellant’s real estate business. He recalled that there was a marked decrease in the earnings of the appellant from real estate commissions in 1976 and 1977 and that there was no real estate commission income at all in 1978. Recognizing that there was no further need for the appellant company he suggested to its directors that it be “deregistered" and that its properties be transferred to the “Lodge” group of companies. According to him the decision to close the appellant down was finalized in 1979.

The appellant, acting on that advice, decided that as part of the proposed winding up the office building and the Berry Street rental property would be sold. However, N. L. Brousseau insisted that the Centre be retained by the Brousseau family and as a result a decision was taken to transfer the Centre to St. Norbert Lodges Ltd. Scarrow impressed upon the appellant the need to precisely establish the consideration to be paid since it was not an arm's length transaction. To do so the appellant listed the Centre for sale and obtained the opinion of several real estate agents as to its value. As an incidental result of the listing the appellant received a verbal offer of $750,000 for the property which offer was rejected.

In February 1979 the Centre was transferred to St. Norbert Lodges Ltd. That same year the appellant permitted its broker's licence to lapse. The remaining assets, being the office and apartment buildings were sold shortly thereafter.

Counsel for the respondent submitted that the evidence adduced was consistent with the appellant having in its mind at the moment of acquisition the possibility of reselling as an operating motivation for the purchase. the Court's attention was directed to the expertise of the appellant’s offic- ers in the business of buying and selling land and their knowledge, which could be imputed to the appellant, that the land upon which the medical centre was sited was in an area of active development. The business activities of the appellant; the familiarity of its officers with the trend of real estate development in the City of Winnipeg; the appellant’s experience with land values and its previous course of conduct including the sale of the property on Vermillion Street in 1974 were submitted as facts supporting the respondent's assessment.

True the directors of the appellant at the relevant time were businessmen with substantial expertise in the real estate field. A logical inference might be that they knew from the outset that the appellant was possessed of an asset which could be realized when circumstances might dictate. That does not preclude a finding that the appellant, albeit active in real estate can, in certain circumstances, make a profit in the nature of a caital gain, even if real estate once again is involved.

It was further suggested that the short period of ownership, the advertising of the property for sale and the manner in which the project was financed were all indicative of an intention to resell the property rather than to use it as a Capital asset. These facts must be considered in the context of the evidence given by J. E. Brousseau. He stated that the advertising was done for the purpose of establishing fair market value and not with a view to selling the Centre. On this issue his evidence is consistent with Scarrow's evidence and with the fact that an offer was rejected. Brousseau also testified that the land was acquired for the avowed purpose of building a medical centre on it. That was done. Furthermore the financing which was obtained was not unusual, was not highly leveraged and is not, in the circumstances of this case, indicative of a trading intention.

The appellant’s assertion that it was in the process of being wound up and that as one consequence it determined to sell its assets (excepting the Centre) was challenged. It is a fact that notwithstanding the expressed intention to wind the appellant up the company still exists and that its financial statements for 1980 disclose revenues all of which were, according to Scarrow, fees earned by the appellant with respect to its management of the nursing homes.

Counsel for the respondent argued that there was little to distinguish between the case at bar and Fredericton Housing Ltd. v. The Queen, [1975] C.T.C. 537 at 541; 75 D.T.C. 5367 at 5370. In that case:

The appellant also urged that the appellant's business had become dormant following the transfer of current assets to the new company in August 1969 and that on that account the sale of the 80 acres some months later in a transaction not characteristic of the appellant’s previous business transactions could not be regarded as a transaction of or in the course of the appellant’s business.

The Court found:

In my opinion this contention is not supported by the facts. It may be accepted that by the time the 80 acres of Fraser land were sold the appellant’s activities in building and selling dwelling houses as well as in carrying out construction contracts were, as a result of the transaction with Fredericton Housing and Construction Limited, effectively at an end. Thereafter these activities were carried out by that company and transactions of the trading account of the appellant were fewer, perhaps negligible in number. But the appellant was not in the course of being wound up. It was still capable of carrying on business and it still had on hand a stock of unserviced and undeveloped land, including the Fraser property, which it had acquired for the purpose of turning it to account for profit by ultimately using it in its business. [Emphasis added.]

Clearly the Federal Court of Appeal was dealing with a substantially different fact situation. While the appellant N. L. Brousseau Realty Co. Ltd. can not be said to have been in the process of winding up in a strict legal sense and while it was still capable of carrying on business the fact remains that it only did so in an extremely limited sense. It is of some significance that it allowed its licence to lapse in 1979, a step which precluded it from acting as a real estate broker, which activity had been its main source of income. Furthermore, it disposed of all of its assets, and it did not, as was the case with Fredericton Housing Ltd., retain “a stock of unserviced and undeveloped land” which it had acquired for the purpose of resale.

On the evidence before me I have concluded that the subject property was not stock in trade or inventory and cannot be termed a trading asset of the appellant. I am satisfied that the primary intention of the appellant at the time of acquisition of the land was to develop the Centre in a joint venture with one or more doctors, which Centre was to be operated as a rental or revenue-producing investment. That conclusion however does not entirely resolve the issue. I must further consider whether or not the appellant had a secondary intention of reselling the property and whether this secondary intention was an operating motivation for the acquisition of the property.

Counsel for the respondent suggested that the appellant was prepared to press ahead and construct the Centre even after the doctors dropped out of the picture because the appellant, operated and managed as it was by shrewd and experienced real estate brokers, must have been aware of the resale potential inherent in such a development and was prepared ab initio to sell the property if the development and/or subsequent management of the Centre failed to meet expectations or if the right financial considerations were present.

The burden of disproving “secondary intention” rests upon the appellant. As has been noted on other occasions an appellant who is in the real estate or construction business faces a difficult task in demonstrating why a gain such as the one in issue should not be regarded as a profit of its business. An investment intention such as has been alleged in this case must be established by way of clear and compelling evidence. I believe that the appellant has met this burden.

The appellant’s intention rests in large part on the evidence of J. E. Brousseau. In keeping with a Court's obligation not to disbelieve a witness without valid reasons I have tested his evidence in terms of its consistency with all of the evidence adduced. He is an interested party and that fact has been taken into account. I observed his demeanour and considered his ability to recollect events which occurred a number of years ago. He was not discredited in cross-examination and indeed his testimony is corroborated in certain material aspects by other evidence including that of Scarrow.

All of the evidence is consistent with the expressed intention of the appellant to acquire a long-term investment. The financial statements disclose that the Centre had always been carried as a capital asset. It is clear from the evidence and from a review of the financial statements that from 1976 onward the appellant had a decreasing level of activity and that by 1979 there was very little reason to continue the appellant’s existence. It is of some significance as well that of the three properties held by the appellant in 1979 two were sold in arm's length transactions while the Centre was retained albeit by an associated company. There is no suggestion that it could not have been sold at a profit at the same time. The disposition of the Centre is not per se evidence of an intention to resell at a profit. I accept the argument advanced by counsel for the appellant that the intention of the appellant was to hold the property as an investment and that this intention is confirmed by the fact that there exists on the site a fully developed medical and dental centre which continues to be managed and operated as an investment by a related "sister corporation".

I have come to the conclusion that the existence of secondary intention cannot be supported on the facts. There is nothing in the evidence to justify my rejecting the sworn testimony of J. E. Brousseau as to the basis upon which the property was acquired and developed. Having accepted his evidence many of the factors relied upon by the respondent no longer give rise to an inference that resale at a profit was one of the reasons motivating the appellant when it acquired the property.

Accordingly the appeals with respect to the appellant’s 1979 and 1980 taxation years are allowed and the assessments are referred back to the respondent for reconsideration and reassessment on the basis that the profit realized from the sale of the Southwood Medical Centre constitutes a capital gain to the appellant.

Appeal allowed.