Porter Land Ltd. v. Minister of National Revenue, [1986] 1 CTC 2481, 86 DTC 1348

Sarchuk, T.C.J.:—This is an appeal by Porter Land Ltd. from reassessments in respect of its 1981 and 1982 taxation years.

The appellant was incorporated under the laws of Canada in or about the year 1912. It is a taxable Canadian corporation as that term is defined in paragraph 89(1)(i), a private corporation as that term is defined in paragraph 89(1)(f) and a Canadian controlled private corporation as that term is defined in paragraph 125(6)(a). In computing its tax payable pursuant to Part I of the Income Tax Act for its 1981 and 1982 taxation years, the appellant deducted certain amounts pursuant to subsection 125(1). By notices of reassessment dated March 19, 1984, the respondent reassessed the appellant for additional taxes in those years in the amounts of $17,443.41 and $22,272.01 respectively.

The issue in this appeal is whether the principal purpose of the business carried on by the appellant during its 1981 and 1982 taxation years was to derive income from property and that therefore such business was a specified investment business within the meaning of paragraph 125(6)(h) of the Income Tax Act with the result that the “small business deduction” claimed by the appellant was properly disallowed by the respondent on reassessment; or, whether during its 1981 and 1982 taxation years, the appellant carried on an active business in Canada as that term is defined in paragraph 125(6)(b) of the Act and was therefore entitled to the “small business deduction” permitted by subsection 125(1) as alleged by the appellant.

Paragraph 125(6)(h), which is crucial to the determination of this appeal reads:

125(6) In this section and section 129. . . .

(h) “specified investment business” carried on by a corporation in a taxation year means a business (other than a business carried on by a credit union or a business of leasing property other than real property) the principal purpose of which is to derive income from property (including interest, dividends, rents or royalties), unless the corporation employs in the business throughout the year more than five full-time employees who are not specified shareholders of the corporation or persons related thereto.

The appellant maintains its head office in Calgary and all of the shareholders reside there. Its assets are located in the provinces of Alberta and Saskatchewan and consist of, inter alia, approximately 23,000 acres of farm land located in the Weyburn and Carlisle districts in Saskatchewan and two substantial parcels of farm land located in Alberta. Porter Land has no office in Saskatchewan, its operations there being supervised by a single employee, Mr. B. Dyck (Dyck), who works out of his personal residence. He is neither an officer nor a shareholder of the appellant. Dyck's functions are to manage the farm lands, to select the operators, to enter into share crop and other agreements on behalf of the appellant and to compile financial data and material for the chief executive officer and directors. In addition to the services he provides to the appellant, Dyck owns and operates an insurance brokerage business and a management business which provides agricultural services to the farm community.

Porter Land derives its revenue from three different sources. The respondent has admitted as a fact that each source of income constituted a separate business in the taxation years in question. As disclosed by its financial statements for those years the sources are:

(a) Contract Farming (Sch. 1 Ex. A-1): Income from this operation is derived by Porter Land from certain land that it farmed itself by contracting with various people to do all of the necessary work. The acreage farmed in this manner varies from year to year but normally forms only a small portion of the total land owned. In 1981 and 1982 no more than 2,500 acres were farmed in this manner.

(b) Farm Management (Sch. 2 Ex. A-1): The appellant managed farms owned by third parties and charged a management fee equal to ten per cent of the owners’ share of the crop.

(c) Tenant Farming (Sch. 3 & 4 Ex. A-1):* [1] The appellant’s main source of revenue is its tenant farming operations in which the appellant’s land is farmed by independent operators who have entered into share-crop agreements with Porter Land. In recent years Porter Land contracted with an average of 42 to 44 farmers annually. The revenue produced by these tenant farming operations is the crux of the issue before the Court.

In every instance of tenant farming an independent operator farmed land for the appellant pursuant to a formal agreement entered into by the parties. This agreement, a form document captioned “Farm Lease”, was developed over the years by the appellant, and was “touched-up” by its lawyers in 1970. It has been in use in its present form since that time. One such lease entered into by the appellant and Laurence A. Dennis on February 28, 1981 with respect to the 1981 crop year was tendered as representative of the crop sharing agreements utilized during the relevant taxation years. (Ex. A-4).

Mr. J. E. Porter the president and chief executive officer of the appellant testified that a form of farm lease had been used by the appellant for many years and that most of the refinements and amendments to the document which had been made over the years were designed to ensure that the operator and the appellant could readily recognize their respective responsibilities and mutual objectives. In recent years the appellant entered into these agreements for a term of one year rather than for longer terms as had been the previous custom. This practice was implemented to give the appellant greater control over the quality and efficiency of its operators.

The yearly rental usually stipulated in a farm lease is “a full one-third share of the whole crop of grain grown on the leased land”. Pursuant to the terms of the lease each lessee was to provide all of the labour, the equipment, machinery, and the seed required. The lease specifically provided that the cost of the seed and the harvesting costs are to be borne by the lessee. He alone is responsible for obtaining Saskatchewan government crop insurance. The lessee is also responsible for obtaining and holding the requisite permit books from the Canadian Wheat Board.

Appellant's counsel contended that although the agreement in question is called a farm lease and the parties thereto are described as lessor and lessee, it conferred no right to exclusive possession of the land described therein. As a result it lacked an essential element of a demise and failed to create the relationship of landlord and tenant between the parties. In support of this proposition counsel referred to a number of authorities including MacKlem v. MacKlem et al. (1890), 19 O.R. 482; West against Atherton (1853), 7 N.B.R. 653; Park v. Humphrey (1864), 14 U.C.C.P. 209 (C.A.); Sayles et al. v. Wilson et al., 222 Pacific Reporter 1020 (Wyo) (1924); Atwood v. Freund, 263 North Western Reporter 180 (Wisc.) (1935).

In MacKlem v. Macklem et al., the issue to be determined was whether a beneficiary under a will had taken actual possession of certain real estate which real estate was worked on shares by a third party. The arrangement between them was made without lease and was merely for the one season. The Court held that actual possession and occupation by the beneficiary was consistent with and satisfied by the possession of a servant or caretaker or even a worker on shares.

In West against Atherton, another parol agreement was at issue. The Court held in part that “a person working a farm on the shares, and occupying part of the house jointly with owner of the farm, has not such a tenancy as to prevent the owner from maintaining an action for trespass to the land.”

Another parol “crop sharing" agreement was considered by the courts in Park v. Humphrey. In its judgment that Court stated at 213:

Looking at this agreement, we construe it, not as a letting of the land on shares, by which a term and possession of it were acquired by Millard and Brown, but as a* contract for remuneration for their care and labour in growing the crops, to be performed by them as Park directed.

Two American cases were cited: Sayles et al. v. Wilson et al. and Atwood v. Freund. In both decisions the American courts held that agreements, which on their face appeared to be leases, were in fact “croppers contracts" and created nothing more than a relationship of landlord and cropper, a cropper being one who, having no interest in the land, works in consideration of a portion of the crop. In the Atwood case the Court drew a distinction between a cropper’s contract and a lease, stating that in the case of a lease possession of the land is in the lessee, while in a croppers contract possession is in the landowner. The Court found that while a cropper may live on the land such possession as he has is incident to the performance of his contract of service. The Court further held that the landowner "had the right to enter on the land at all times, and to do or cause to be done any work thereon he deemed necessary.”

In the Sayles case the Court found that a contract although stating that it was a lease, but which did not give the lessee exclusive possession of the premises but only the right to raise certain hay thereon created the relation of landowner and cropper. This Court stated:

It is very clear from the evidence that Thayer was not in fact to have exclusive possession of the premises or any further possession than what might be necessary to the work to be performed by him under the contract.

In Brockville v. Dobbie & Ritchie, 64 O.L.R. 75; [1929] 3 D.L.R. 583 the Court held that an agreement, although it provided for the payment of rent and was contended to be a sub-lease, was not a demise of the property because the document did not confer a right of exclusive occupation.

All of these cases can be distinguished on their particular facts. However, it would be wrong to dismiss them out of hand for this reason. No doubt in certain circumstances, as counsel argued, an agreement which is called a lease by the parties, may be found to be a contract of an entirely different nature. The cases cited are examples of such circumstances.

Counsel further attempted to support this proposition by referring to the evidence of Porter and to, inter alia, clauses 8, 12, 17, 21 and 22 of the “Farm Lease”. According to Porter the shareholders always considered the appellant’s land holdings to be the “family farm”. Protection and preservation of the soil was very important and these clauses were designed to give the appellant as much control as possible over the land. Restrictions and conditions were necessary to ensure that the operators managed the farm properly, that they planted the appropriate crops at the appropriate times and that they tilled the soil in a proper manner to prevent erosion. All of this was done with the objective of maintaining a productive capital asset. According to Porter clause 22 was specifically drafted to give the appellant the right to instruct the lessees’ employees, thereby giving it absolute control over all of the lessees’ farming operations and by extension the land upon which these operations were carried on.

The submission of the appellant is that although the document appears to be and contains the words of a lease the restrictions and reservations found in these clauses makes clear that exclusive possession was not granted to the tenant.

I do not agree that it is so. A grant of possession may be found although the parties have agreed to certain reservations or restrictions of the purpose for which possession may be used.

There is implied in leases of agricultural lands a covenant to cultivate in a good and husband-like manner in accordance with the custom of the country where the premises lie: Wedd v. Porter, [1916] 2 K.B. 91; [1916-17] All E.R. 803 (C.A.); Skrypnek v. Huculak, [1947] 1 W.W.R. 713 (Alta. S.C.). Furthermore, it is a common practise of conveyancers, not only to insert in leases an express covenant "to use and occupy the premises in a good husband-like manner” but also to include special terms such as covenants to crop and summer fallow; to break land; to use straw on demised premises; to rid the land of weeds; to fence; and even covenants limiting the amount of land to be cleared for agricultural purposes. In my view the restrictions contained in the clauses cited by counsel for the appellant do not make necessary a finding that the grant by the appellant did not confer the right of exclusive possession to the lessee.

Counsel further contended that clause 18 of the agreement, which reads:

The Lessor, . . . may, at any time or times in the lease year in which this lease is to terminate either by lapse of time or by notice pursuant to the terms hereof, enter upon and take possession of any portion of the said land, other than pasture, on which at the time of such entry and taking possession no crop is growing or is in that year to be grown, and may cultivate the same.

establishes that a degree of possession was retained by the appellant such as to preclude a finding that the tenant had an exclusive right to possession.

In my view this argument is not well founded. There is no reason for the lessor to insist upon the inclusion of clauses granting him the right of re-entry if exclusive possession has never been granted to the tenant by the terms of the agreement.

All of these arguments must be considered in the context of the provisions of The Landlord and Tenant Act, R.S.S. 1978, c. L-6, and in particular sections 10(2) and 10(8) thereof which read:

10(2) A right of re-entry or forfeiture under a proviso or stipulation in a lease, for a breach of any covenant or condition in the lease other than a proviso in respect of the payment of rent, shall not be enforceable by action or otherwise, unless and until:

(a) the lessor serves on the lessee a notice specifying the particular breach complained of and if the breach is capable of remedy requiring the lessee to remedy the breach, and, in any case, requiring the lessee to make compensation in money for the breach; and

(b) the lessee fails, within a reasonable time thereafter, to remedy the breach, if it is capable of remedy, and to make reasonable compensation in money to the satisfaction of lessor for the breach. (Emphasis added.]

10(8) This section applies to all leases, notwithstanding any stipulation in the lease to the contrary.

In my view both the language of the lease and the provisions of The Landlord and Tenant Act support a finding that the lessee had exclusive possession. I am reinforced in this view by a decision of the Saskatchewan Court of Appeal, Dalton v. Eaton et al, [1924] 1 D.L.R. 493; [1924] 1 W.W.R. 246. The agreement in issue in the Dalton case was a crop-share arrangement rather similar in its terms to the lease between the appellant and Dennis. It required the tenants to farm the land; to furnish all teams, implements and machinery; to cultivate the land; to furnish the seed; to pay for the threshing and to deliver the crop. The agreement also gave the landlord rights of re-entry similar to those in the case at bar.

One of the issues to be determined by the Court was whether or not the agreement in question constituted a lease of the land therein specified. Mr. Justice Lamont stated at 494 (W.W.R. 248):

In my opinion the agreement in question constitutes a lease, as found by the trial Judge, and that for the following reasons: (1) The parties themselves refer to it as a lease; although that would not be conclusive. . . .

Also, the document contains a provision against sub-letting without the written consent of the plaintiff. (2) The Eatons were given possession of the land, and the reasonable inference from certain clauses in the agreement is, that their posses- sion was exclusive. The agreement provides that the Eatons would, after harvest, "plough such parts of said land suitable for the succeeding crop as shall be ploughed at the time the parties of the first part take possession thereof.” Also the following:

"And the second party or his agent shall have the right to enter upon said premises at any time, without injury to the standing crops, for the purpose of making any improvements, or to prepare for the succeeding crop. It is also agreed that in case said party of first part neglects or fails to perform any of the conditions and terms of this contract on his part to be done and performed then said party of second part is hereby authorised and empowered to enter upon said premises and take full and absolute possession of the same. . . .”

And the last paragraph of the agreement is as follows: — “The party of the second part hereby reserves the right to enter upon the said premises in the fall of 1924, as soon as the crops shall have been removed, to plow back so much and such parts of the said premises as may be suitable for a succeeding crop.”

These provisions, giving the plaintiff a right to re-enter upon the lands and re-take possession thereof, were entirely unnecessary unless the plaintiff had given to the Eatons the exclusive possession of the land. They are consistent only with the fact that the plaintiff had parted with his right of possession. [Emphasis added.]

In Glenwood Lumber Co. v. Phillips, [1904] A.C. 405, Lord Davey said at p. 408: — "If the effect of the instrument is to give the holder an exclusive right of occupation of the land, though subject to certain reservations or to a restriction of the purposes for which it may be used, it is in law a demise of the land itself.” See also McLean v. Dinning et al (1922), 63 D.L.R. 507, 15 S.L.R. 187.

I am therefore of opinion the trial Judge was right in holding that the document constituted a lease, and that the rent reserved therein was one-third of the crop.

It is abundantly clear that the appellant's contention that exclusive possesion of the land had not been granted to the lessee cannot be upheld.

Appellant’s counsel also contended that the agreement was in substance a partnership or joint venture agreement, the sole object of which was to carry on the business of farming the land together for the purpose of earning profit. He did not assert that the agreement was a croppers contract or any other form of service contract but stated:

. . . it is somewhere between a passive type of landlord arrangement and an employment for services, somewhere in the middle of that. It is more like a joint venture.

In his presentation counsel used the terms "partnership" and "joint venture" interchangeably. He ultimately described the relationship between the appellant and a tenant as:

I say that it is a joint venture. I say there is (sic) two parties, one putting up labour and one putting up land. They are going into business together to share the profits of that combining (sic).

This argument is not tenable. The relationship between Porter Land and its lessees is not that of partnership nor is it a joint venture. There is no evidence before the Court from which it could be concluded that Dennis (or any other lessee) intended to carry on business with the appellant. There is nothing in the manner in which they dealt with each other, or with third parties to suggest such a relationship. None of the hallmarks of partnership exist in the case at bar.

The evidence as a whole leads inescapably to the conclusion that the agreements entered into by the appellant and its operators, as exemplified by the Dennis agreement, are leases. There was a demise of the farm land to the lessee which gave him the exclusive right of occupation of the land. He was under an obligation to pay rent, in the primary meaning of that word, and that too is evidence of a demise. The income earned by the appellant from these tenant farming operations is derived by it not from the activity of farming but from the use of the appellant’s right of occupation by the lessees who pay for the use of the property.

I have concluded that the primary purpose of the tenant farming operation carried on by the appellant during its 1981 and 1982 taxation years was to derive income from property. Therefore it is a specified investment business within the meaning of paragraph 125(6)(h) of the Income Tax Act and accordingly the “small business deduction” was properly disallowed by the respondent.

The appeal with respect to the 1981 taxation year is dismissed.

With respect to the contract and farm management business carried on by Porter Land, respondent’s counsel consented to judgment on the basis that pursuant to the provisions of subsection 125(1) of the Act the appellant is entitled to a “small business deduction” in its 1982 taxation year in the amount of $12,163. The reassessment for the 1982 taxation year is therefore referred back to the respondent for reconsideration and reassessment on that basis.

There will be no costs allowed.

Appeal allowed in part.