Henry C Paetkau, Dianne Paetkau v. Minister of National Revenue, [1985] 1 CTC 2135, 85 DTC 149

Taylor, TCJ:—These appeals were heard on common evidence in Toronto, Ontario, on December 7, 1984 and related to the taxation years 1978 and 1981 for Henry Paetkau, and the years 1981 and 1982 for Dianne Paetkau, his wife. No question was raised by the Minister regarding the source of funds used for acquisitions in this matter, or the fact that each taxpayer apparently had independent financial resources. The notice of appeal of Henry Paetkau sets out the general framework of the appeal:

— The Taxpayer became attracted to rental real estate property in the United States for a number of reasons, including the lack of rent controls in the United States which had recently been introduced into Ontario; a favourable foreign exchange rate for the Canadian dollar versus its United States counterpart, the relative value of the investment opportunities in the United States as compared to Canada and the potential for positive cash flow from many of such investments.

— The Taxpayer accordingly embarked upon a detailed search for suitable real estate investments in the United States which would protect his capital and provide a positive cash flow. The Taxpayer investigated numerous opportunities, and after thoroughly researching prices, returns, the political and investing climates, he decided to invest in a project consisting of two apartment buildings near Seattle, Washington (hereinafter referred to as the “Lynnwood Kent Joint Venture’’).

— The Lynnwood Kent Joint Venture consisted of two complexes namely the Sherwood North apartments, and the Village Green apartments.

— The Sherwood North apartment complex consists of 240 modern apartment units on approximately 11 acres of landscaped grounds situate in Lynnwood, Washington.

— The Village Green apartments consist of 93 modern apartment units on approximately 5 acres of landscaped grounds in Kent, Washington.

— On May 13, 1976, the Taxpayer paid $50,000.00 (US dollars) for a 2.857% interest in the joint venture which owned Lynnwood Kent.

— The economic situation in the Seattle area began to deteriorate as employment in that area declined sharply because of the cutback in defence contracts for employers in the area. The vacancy rate in Seattle began to rise and the management of the Lynnwood Kent Joint Venture was concerned about a refinancing which was soon due. Accordingly, management of the Lynnwood Kent Joint Venture sold the Village Green apartments in November 1977, and Sherwood North apartments in February, 1978, in each case for cash plus a mortgage.

— The Taxpayer became interested in rental properties in Corpus Christie, in the State of Texas, one of the States in the United States of America, for the reasons outlined above. Accordingly, in February, 1978 and before the disposition of the Sherwood North apartments, he acquired a 2.50% interest in the LaPlaza Apartments joint venture (hereinafter called “LaPlaza Apartments”) for $35,000.00 (US dollars).

— Both the Lynnwood Kent Joint Venture and LaPlaza Apartments produced a positive cash flow during the time the properties were held.

— The Taxpayer’s share of the capital gain resulting from the dispositions by the Lynnwood Kent joint venture was $25,385.00 and he duly included one half of such gain in his income in his income tax return for 1978.

— The LaPlaza Apartments were sold in December 1981, in part for cash with the balance by way of a purchase money mortgage.

— The Taxpayer’s share of the capital gain from the disposition of the LaPlaza Apartments was $75,062.00. The Taxpayer duly included one half of such capital gain in his income tax return for his 1981 taxation year.

Dianne Paetkau was not involved in the Lynnwood project, but she did acquire a similar 2.5 per cent interest in LaPlaza with the same results as obtained for Henry.

For the Minister the situation was detailed in the reply to notice of appeal for Henry Paetkau, which also applied, to the necessary extent, to the appeal of Dianne Paetkau.

— The Respondent so reassessed the Appellant on the basis of the following findings or assumptions of facts:

— the Appellant acquired his 2.857% interest in “The Lynnwood-Kent Joint Venture” on terms and conditions set out in a written agreement amongst the members thereof;

— the agreement provided that the management of the Joint Venture was to be carried on by a Management Committee composed of certain designated members, of whom the Appeallant was not one and all of whom were companies in the real estate business;

— the agreement also provided that one of the express responsibilities of the Management Committee was to negotiate and carry out the sale of either or both of the two properties held by the joint venture prior to termination of the joint venture;

— the agreement further provided that the intention of the parties to the agreement was that the Joint Venture would have a limited life of five years, subject to any subsequent agreement for extension on consent of the members owning at least 70% of the capital of the venture;

— the Appellant acquired his 2.50% interest in the LaPlaza Apartments Joint Venture on terms and conditions set out in a written agreement amongst the members thereof;

— this agreement contained the same provisions as described in b), c) and d) hereof, respecting the management of the joint venture, the sale of the property prior to termination of the joint venture, and the five year limit for the life of the joint venture;

— at all material times, a primary intention of the Lynnwood Kent Joint Venture and the LaPlaza Apartments Joint Venture in acquiring holding and selling the properties respectively held by each joint venture, was the resale of the properties at a profit;

— a primary intention of the Appellant in acquiring his interest in the Lynnwood Kent Joint Venture and his interest in the LaPlaza Apartments Joint Venture was that of the respective Joint Ventures, namely to profit from the resale of the respective properties;

— the gain of $25,385.00 in 1978 and the gain of $75,062.00 in 1981 were profits accruing to the Appellant from adventures or concerns in the nature of trade.

In evidence, the appellants filed several documents which related to the reasons for their original investigation of the acquisitions at issue, and sets of financial statements for the ventures which were prepared by Ellis Foster and Company, Chartered Accountants of Vancouver, British Columbia. In my view the really critical documents were Exhibit A-1, a somewhat elementary “prospectus” regarding Lynnwood; Exhibit A-4, the agreement between the various “partners” in Lynnwood — (some 15 parties in all, some individual, some corporate); Exhibit A-9, a similar elementary “prospectus” regarding LaPlaza; and Exhibit A-10 — the agreement for LaPlaza — (some 14 parties, again partly individual, partly corporate). Certain significant clauses to be found in Exhibit A-4 are:

Clause (2.02)

For purposes of this Agreement, net income shall include both income from operations and also income from the gain on any sale of property, as determined by normal accounting practices.

Clause (3.01)

Management of the Joint Venture shall be carried on by a Management Committee consisting of Delco, Delbaar, Kalico and Lankasri (the “Management Committee’’) whose representatives on the Management Committee shall be Elgin White, Norman Dell’Agnese, Harold C Kalke and David Ingram.

Clause (6.01)

The Management Committee shall disburse to the Joint Venturers a sum equal to Ten (10%) percent per annum on the Capital of each Joint Venturer at least quarterly, from the net income from the Property or any other excess monies which the Management Committee feels is not required by it for the operation of the Joint Venture.

Clause (7.01)

Unless otherwise agreed in 7.02, it is the intention of the parties hereto that this Joint Venture shall have a limited life of five years from the date hereof. It is further the intention of the parties hereto that the Management Committee shall attempt to improve the Property during the term and increase the rental income of the Property to the benefit of the Joint Venture prior to the termination date of this Joint Venture.

Clause (7.02)

It is understood and agreed that this Joint Venture may be extended for more than five years from the date hereof upon the consent of Joint Venturers owning seventy

(70%) percent or more of the Capital entering into an extension agreement which extension agreement shall be binding on all of the Joint Venturers provided that the Agreement of consent for the extension is decided within 4 years of the date hereof.

Somewhat similar terms are to be found in the LaPlaza agreement:

Clause (2.02)

For purposes of this Agreement, net income shall include both income from operations and also income from the gain of any sale of property as determined by normal accounting practices.

Clause (3.01)

Management of the Joint Venture shall be carried on by a Management Committee consisting of Delco Developments Ltd (Delco) and Brimond Holdings Ltd (Brimond) whose representative on the Management Committee shall be Elgin C White and Brian Crammond.

Clause (3.02.08)

prior to termination of this Joint Venture negotiate and carry out the sale of the property and disburse monies to the members of the Joint Venture pursuant to article 2 hereof.

Clause (7.01)

Unless otherwise agreed in 7.02, it is the intention of the parties hereto that this Joint Venture shall have a limited life of five years from the date hereof. It is further the intention of the parties hereto that the Management Committee shall attempt to improve the property during the term and increase the rental income of the property to the benefit of the Joint Venture prior to the termination date of this Joint Venture.

Clause (7.02)

It is understood and agreed that this Joint Venture may be extended for more than five years from the date upon the consent of the joint venturers owning seventy percent

(70%) or more of the capital entering into an extension agreement which extension agreement shall be binding on all of the joint venturers provided that the agreement of consent for the extension is decided within four (4) years of the date hereof.

The reason only minimal factual information is provided above, is that, for all practical purposes the basis of these appeals is similar to that of Quelch et al v MNR, [1984] CTC 2669; 84 DTC 1551, and this was noted by both parties. It would appear that some of the participants involved — particularly in the management — were common to both this appeal and Quelch (supra). Reference is made in Exhibit A-l (supra) to the “management team” for this venture, being the same as that for the Highlander Apartments, prominently featured in Quelch (supra). Therefore the task before counsel for the appellants was to distinguish this case from Quelch (supra). In his attempt to do so counsel for the appellants relied upon the following points:

(1) . . . the sworn statements of the appellants regarding the reasons for investing.

(2) rejection of any “taxation by association” argument.

(3) the respondent’s tax treatment of an amount of recaptured capital cost allowance in the assessments.

While intriguing and novel, counsel’s argument on point (3) above was not persuasive to me, since as I understand it counsel asserted that because the Minister had not challenged the recaptured “capital cost allowance” reported by the appellants, the Minister had inferentially forgone his right to challenge the “capital gain” element of these appeals. I do not agree.

In these appeals some of the parties, who were part of the “joint ventures”, were indeed competent and experienced in the real estate field. The position of the appellants is that they were not aware of that expertise; or even if aware of it, the information would have had no effect on their determination to invest for income, notwithstanding that some others — particularly those on the “management committee” — had other intentions. The problem posed by these appeals may be: Can a taxpayer invest — as a very minor participant — in a venture, the operation and even disposition of which is entirely out of his control, and claim the investment was for the purpose of earning income, while those investors responsible for management and control of the venture intend a realization on capital at the earliest feasible time?

In Quelch (supra) one of the factors which led the Court to its conclusion, was that the appellants therein had made literally no investigation or examination of the revenue-producing prospects for the venture, and the information available to them was, at best, highly suspect. I do not find that to be an impediment in the instant appeals. Both Henry and Dianne Paetkau made a reasonable survey of investment prospects and, according to their testimony, selected these ventures from several possible options considered. The implication is that this selection was made as the best among many — we shall return later to that point! In addition, it should be noted that both of these appellants acted as individuals, and not through some trustee (see Quelch (supra)) although they had professional advice. To that degree the situation differs from Quelch (supra), that in that instance, those three appellants invested and accepted the obligation cited on 2672 and 1554 respectively:

— the Management Committee shall attempt to improve the Property during the term, increase the rental income and dispose of the Property at at (sic) a profit to the Joint Venture prior to the termination date of this Joint Venture.

There was a desire and intention on the part of that Management Committee (Quelch, (supra)) to sell at a profit at the earliest possible date. That particular clause (supra) did not exist in the instant case, but while the clauses noted above from the relevant agreements in these appeals may be somewhat more sophisticated, the direction can hardly be in doubt. In essence, both of these appellants say that they were content to invest the funds involved, and receive the income allegedly available from it, without regard to the prospect of sale of the real estate or any gain that might accrue therefrom.

Considerable attention was paid in argument to the specific adjective “primary” used by the Minister in the reply to notice of appeal (supra); counsel for the appellants contending that the evidence, particularly the testimony, showed that the major element in the minds of the taxpayers at acquisition was “investment for income”; counsel for the respondent contending that the opportunity for and profit from sale of the real estate could not have been out of the minds of the appellants. As I have noted in other cases, I do not find the “secondary intention” argument by any party as a very attractive one — it is extremely subjective. However, I do say that in this case, counsel for the appellants is attempting to place a very narrow interpretation on that phrase. He accepts that the appellants were aware of the prospect of “capital appreciation” and sale, (see quotes from Agreements above) and of the interest in such prospect by the “management committee” partners. As I read the agreements the critical phrase is 2.02 —

For purposes of this Agreement, net income shall include both income from operations and also income from the gain on any sale of property, as determined by normal accounting practices.

In effect, therefore it is the argument of counsel for the appellants that based on the testimony of the appellants, the Court should regard the “primary intention” as that of “income from operations” and disregard (or relegate to a lesser place) the “income from gain on the sale of property”. Conversely the Minister’s ver- sion of that clause is that ‘‘a primary intention .. . was the resale of properties at a profit” (reply to notice of appeal (supra)). I find no reason in these contrasting arguments (nor in the evidence or testimony relevant to them) for the Court to make the determination proposed by counsel for the appellants.

The appellants’ task in these appeals, is to overturn the Minister’s assumptions, and simply contending that “income from operations” was primary, as opposed to “income from the gain on any sale of property”, does not accomplish that. The appellants are challenged by the Minister’s assumptions to disprove that “income from the gain on any sale of the property” was ‘‘a primary intention”. On the basis of the written record there are no reasons to regard one objective as more “primary” than the other. I am certainly not persuaded that these relatively sophisticated taxpayers would have made the investments they did in the years involved, in a foreign jurisdiction, with no input to operation or management, with only the prospect of a 10 per cent return for Lynnwood, and 8 per cent for LaPlaza on investment proposed to them (not even guaranteed), particularly with the limited prospect for selling their interests as detailed in the sections of the agreements entitled “Transferability of Interest in Joint Venture”. They risked their funds, and in so doing they were trading money for an interest in a building, which in turn had the clear prospect of being traded for other (more) money. That is an adventure in the nature of trade, as clearly as I understand it.

Rather than relying on certain aspects of Quelch (supra), the appellants might be interested in another Court decision Hochachka et al v MNR, [1984] CTC 2773; 84 DTC 1673. In that case there were not quite as clear documented indications of the alternate intentions of the parties, as one finds in the instant appeals, and accordingly in Hochachka (supra) the Court gave serious original consideration to the protestations of the appellants. In fact, in Hochachka (supra), there is little if any indication of actual ownership of an interest in the real estate by the appellants. That is not the case in these appeals, since the opening clause of the agreements states:

WHEREAS

Each of the Joint Venturers hereto are purchasing an interest in and to The Sherwood North Apartments, (Village Green Apartments), (LaPlaza Apartments).

It was noted in Hochachka (supra) that the Minister had incurred some risk at the hearing by not supporting his basic assumptions after the testimony of the appellants (see 2775 and 1675). However, in this case, the documented record — the agreements — served that purpose for the Minister. I might add that if further reason for rejection of these appeals were required, one might readily look to the “taxation by association” basis so prominent and decisive in Hochachka (supra). It could be equally applicable here.

The process of investment in real estate partnerships such as this, under specific circumstances, may yield the tax shelter or capital gains benefits sought by taxpayers, but such circumstances do not seem to be simple to construct. In the instant appeals, even taking into account the rather ambiguous and conflicting language of the agreements noted above it cannot be said that the primary, let alone the sole objective of the appellants was investment for income.

The appeals are dismissed.

Appeals dismissed.