Robert G Finley v. Minister of National Revenue, [1984] CTC 2636

St-Onge, TCJ [ORALLY]:—The appeal of Mr Robert G Finley was heard on May 10, 1984 at the city of Saskatoon, Saskatchewan.

The issue is whether the gain on the sale of all of his rights and interest to the stone and gravel found on certain land is income or of a capital nature in the appellant’s 1976, 1977 and 1978 taxation years and, if it is a capital gain, is he entitled to a reserve under subparagraph 40(2)(a)(ii) of the Income Tax Act, 1970- 71-72, c. 63 as amended.

The facts of this appeal are well set forth in the appellant’s written submission which reads as follows:

A. FACTS

Even if the Minister of National Revenue is permitted to file a Reply to the Appellant’s Notice of Appeal, the following facts are admitted:

(1) The Appellant is a Canadian taxpayer who at all material times has been a resident of Saskatoon, Saskatchewan, and is appealing his assessments for the taxation years 1976, 1977 and 1978.

(2) In 1960, Hugh Albert Riddell (herein called “Riddell”) entered into an agreement with one Harold Latrace (herein called “Latrace”) granting to Latrace the right to remove stone and gravel from various parcels of land near Saskatoon, Sasktchewan including:

(i) W /2 of Section 24, in Township 37, Range 5, W3, containing 320 acres, more or less;

(ii) SW A of Section 25, in Township 37, Range 5, W3, containing 160 acres, more or less;

(iii) A part of the NE A of Section 25, Township 37, Range 5, W3, containing 59 acres, more or less.

(3) At the time of the said Agreement in 1960, Latrace failed to have filed a Caveat or any other instrument to reflect his interest in the said land pursuant to the 1960 Agreement.

(4) In February of 1964 Riddell sold the W /2 of 24-37-5 W3 to the Appellant by way of an Agreement for Sale. On Feb. 11/64, the Appellant registered a Cavet on the said W A, indicating his interest under the Agreement for Sale. On April 1, 1964 the property was transferred into the Appellant’s name.

(5) In April of 1964 Riddell sold to the Appellant the SW /4 of 25-37-5 W3. The

said SW /4 was transferred into the Appellant’s name on the 29th of April, 1964.

(6) In January of 1965, Riddell sold to the Appellant a portion of the NE A of 25-37-5 W3. On January 14, 1965 this parcel of land was transferred into the Appellant’s name.

(7) At the time all of the above property was transferred into the Appellant’s name, Latrace had still not registered a Caveat based on his rights under the 1960 Agreement with Riddell.

(8) On June 10, 1965, Latrace registered a Caveat on all three of the said parcels of land claiming his interest under the 1960 Agreement with Riddell.

(9) Although the Respondent has not admitted the following facts, the Appellant, in his Notice of Appeal, alleges as follows:

(i) Shortly after the Caveats were filed, Latrace approached the Appellant and indicated that the Caveats had been filed and that Latrace intended to exercise his right to remove stone and gravel from the property. The Appellant refused to recognize that Latrace had any rights in the land.

(ii) The matter lay dormant for period of approximately ten years afer which time Latrace’s solicitor communicated to the Appellant that Latrace intended to exercise his alleged rights under the 1960 agreement with Riddell and he intended to begin removing stone and gravel forthwith.

(iii) The Appellant retained a solicitor who denied Latrace’s right to the removal of stone and gravel from the lands.

(iv) After about a year of negotiations the solicitors for the Appellant and for Latrace negotiated an agreement whereby the stone and gravel would be shared by Latrace and the Appellant.

(10) Although the respondent does not, in his Reply to the Notice of Appeal, admit this fact, it is submitted that the evidence will show that the Appellant sold to Sandco Gravel Limited (herein called “Sandco”) all of his right and interest to the stone and gravel found on the said lands. The agreement between the Appellant and Sandco was dated July 29, 1976, and the purchase price was $100,000.00, payable one year after demand, provided that no amount would be payable towards the purchase price for a period of at least two years plus one day from July 29, 1976.

(11) In paragraph 5 of his Notice of Appeal, the Appellant maintains that the purchase price of $100,000.00 was based on the fair market value of the Appellant’s share of the gravel and stone based upon test results and as estimated by Latrace. The Respondent does not appear to dispute this.

(See paragraph A3, Reply to Notice of Appeal).

(12) The respondent admits that the shareholders of Sandco since the date of incorporation are as follows:

(a) W Brent Cotter, Halifax, Nova Scotia	100 Class B Common
	voting shares
(b) Chapter Management Ltd (formerly Bell Enterprises	100 Class A Common
Ltd.)	nonvoting shares

(13) The Respondent also admits that W Brent Cotter is a trustee who holds his 100 Class B Common voting shares in trust for the Appellant’s children. W Brent Cotter is not related to the Appellant and he presently resides at 54 Parkhill Road, Halifax, Nova Scotia, B3P 1R5. The trust agreement between the Appellant and W Brent Cotter was dated July 29, 1976.

(14) In July of 1976 Sandco and Latrace’s nominee, L & L Gravel and Ranching Company Ltd, entered into a joint venture agreement to exploit the stone and gravel on the land.

(15) The Appellant reported the sale of his sand and gravel rights as a disposition of capital property and claimed a reserve pursuant to subparagraph 40( l)(a)(ii) of the Income Tax Act.

(16) On June 2, 1981, the Appellant’s 1976, 1977 and 1978 tax returns were reassessed and the sale was included as income and paragraph 20(1 )(n) reserve allowed.

(17) On Feb 5, 1982, a notice of confirmation was issued by the Minister whereby the assessments for the taxation years 1976, 1977 and 1978 were confirmed on the basis that the disposal of the gravel and stone rights was in the nature of a concern or trade with a view to profit, and therefore taxable as income.

The respondent reassessed the appellant on the following grounds as stated at paragraphs 5 and 6 of the reply to the notice of appeal which read as follows:

5. In so assessing the Appellant’s income for 1976, 1977 and 1978 taxation years as set out in the Notice of Appeal herein, the Minister added the following amounts to the Appellant’s income:

1976 nil — after adding proceeds of $100,000 and allowing a.s. 20(1 )(n) reserve of $100,000.00

1977 $2,204 — after adding the previous year’s s. 20(1)(n) reserve of $100,000 and allowing a s. 20(l)(n) reserve of $97,796.00.

1978 $3,889 — after adding the previous year’s s. 20(l)(n) reserve of $97,796.00 and allowing a s. 20(l)(n) reserve of $93,907.

6. In so assessing the Appellant’s income, the Respondent assumed, inter alia, as follows:

(a) at the time of the purchase in 1964, the Appellant knew of the 1960 agreement

between Latrace and Riddell which was not registered against “the land’’;

(b) the Appellant was not in the business of excavating sand and gravel;

(c) the Appellant acquired sand and gravel rights attached to “the land’’ with a speculative intent to turn the said sand and gravel rights to account for profit by sale, which intent was carried out.

At the hearing the appellant, a lawyer, testified as follows. In 1964, he learned from a newspaper that the land under review was for sale and he acquired it. At that time, his sole intention was to raise cattle. He had already raised cattle from 1953 to 1961 and he was also the owner of some other farm land.

At the time of the purchase of the land from Mr Riddell, he knew that there was an agreement between the latter and Mr Latrace but he was not interested in the gravel pit and, for this reason, he was able to reduce the asking price. His intention was to acquire the land that he still owns today.

Mr Latrace then approached him to discuss about his interest in the gravel but the appellant challenged his authority and there was no other development for ten years.

Ten years later, Mr Latrace saw a lawyer and the parties, through their respective solicitors, came to an agreement by which each party become the owner of 50 per cent of the gravel rights.

The appellant did absolutely nothing to develop the gravel and the land with the gravel thereunder has always been used to graze cattle or to grow crops of hay. He had never been in the business of selling sand and gravel or rights and options and the company, Sandco Gravel Limited (“Sandco”) did not do any excavation for gravel.

The appellant has never been a shareholder of or received a salary from Sandco, and Mr Cotter his associate in his law firm, owned the voting shares of the said company.

In 1976, the appellant sold his rights to Sandco for $100,000 and, in the same year, L & L Gravel and Ranching Company Ltd and Sandco Gravel Limited signed an agreement to determine how the gravel would be exploited or removed. Following this agreement, the appellant received some $12,000 from Sandco in 1977 and 1978. He reported the gain as capital and claimed a reserve.

Upon cross-examination, counsel for the respondent filed the agreement between L & L Gravel and Ranching Limited and Argo Rock Limited (as Exhibit R-2) in which document the appellant had signed for Sandco to give the right to remove the gravel from the land.

Counsel for the appellant presented the following written submissions to the Court which read as follows:

B. ISSUES IN THE APPEAL

(1) Did the sale of the land and gravel rights, on July 29, 1976, from the Appellant to Sandco constitute a disposition on account of capital, or did monies received by the Appellant constitute income in the appellant’s hands?;

It is the position of the Appellant that he realized a capital gain for Income Tax purposes, with respect to the sale of the sand and gravel rights to Sandco, in an amount equal to the excess of the fair market value of the sand and gravel rights as of July 26, 1976, over the greater of the original cost to the Appellant of the sand rights portion of the farming land and the value thereof as of December 31, 1971. One half of the capital gain is subject to income tax in the appellant’s hands as a taxable capital gain, but by virtue of the reserve provisions of subparagraph 40( l)(a)(iii) of the Income Tax Act, the incident of taxation arises pro rata to the portion of the balance on the sale paid to the Appellant by Sandco.

The Appellant submits the following reasons in support of the submission that this disposition gives rise to a capital gains treatment in his hands;

(1) His activities with respect to the farm land and the accompanying mining rights have been consistent with that of an investor and not a trader of land or mining rights;

(2) The sale to Sandco cannot reasonably be considered to be either a lease giving rise to ordinary income (royalty or rental payments) nor payments which could be subject to the provisions of paragraph 12(l)(g) of the Income Tax Act; the thrust of paragraph 12(l)(g) is to treat, as ordinary income, payments made in respect of the sale of property where the payments to be made on the balance of the sale are dependent on the production or use to which the Purchaser puts the property. If one examines the agreement in question, it will become clear that the agreement does not render the payment of any part of the purchase price dependent or conditional upon any fixed unit of production or to any amount of quantity of total production of sand and gravel. (Unlike the case of Fryer v MNR (1960), 25 Tax ABC 356) Quite properly, in the present case, the Respondent has not in any way relied on Section 12(1)(g).

(3) The agreement clearly reflects the intention of the Appellant on one hand to sell, and Sandco on the other hand to purchase, unequivocally, all of the rights and interest to the sand and gravel rights. See:

Sparrow v MNR 57 DTC 453;

#229 v MNR 55 DTC 63.

The substance of the agreement for sale does not create any semblance of a landlord and tenant relationship between the Vendor and the Purchaser, nor does it establish any terms, conditions or contingencies which are not inherent to the out and out sale of property, such as a definite period of time for exploitation of the mining rights.

(4) Finally, the agreement does not provide for any type of periodical payment which may sometimes be interpreted as constituting a rental payment or a payment relating to production or use.

In making the fundamental distinction between income and capital, our courts have consistently upheld the position that “income is fruit only and never the tree”. Notwithstanding the general principle as stated, there are certain exceptions, for example those contained in paragraph 12(l)(g) of The Income Tax Act, specifically bringing into the computation of income amounts received that were dependent on the use of or production from property, whether or not they were instalments of the sale price of the property.

There are other exceptions to the general rule, namely where a taxpayer receives money in respect of the sale of land in the course of his business, for example where a taxpayer regularly inventories land, such as a developer would do.

As to the distinction between income and capital, see:

#145 v MNR 10 Tax ABC 69;

Imperial Oil Ltd v MNR, [1972] CTC 455;

In the Imperial Oil case, a profit of eight million two hundred thousand dollars on the sale of gas storage leases was held to be a capital gain.

Basically the test seems to be, “is an investment being carried on’’? To determine this, it is necessary to look at the intention of the taxpayer and his whole course of conduct in dealing with the item in question. The intention test deals with the taxpayer’s intention at the time he acquired the object of the transaction as well as at the time of its disposition.

The Canadian definition of carrying on business has extended the general concept of a “business” by including as part of that definition the words “an adventure or concern in the nature of trade”; see:

Section 248(1) of The Income Tax Act.

It appears that the respondent is relying on Section 248(1).

It is respectfully submitted that any profit that arose in this instance did not arise as a result of carrying on business or from an adventure in the nature of a trade. See for example:

#341 v MNR 15 Tax ABC 103;

Todd v MNR 15 Tax ABC 42;

In both of the above cases the taxpayer was successful. The key in both judgments seems have been the absence of commercial activity and the presence of proved investing intent.

The Appellant specifically relies on the case of Robitaille v Minister of Finance 60 DTC 612. In that case the Appellant obtained an emphyteutic lease of property containing an undeveloped quarry of granite. He then sold to a company of which his father was President, for $58,000.00, an option on rights to quarry resulting from the lease. It was held that the amounts received by the Appellant from the granite company for the right to quarry the property were capital receipts.

It is difficult to understand the position taken by the Minister of National Revenue, that a one-time sale of the gravel rights by a lawyer to a company which is a separate legal entity can be construed as an adventure in the nature of trade. The Appellant’s course of conduct was and is not that of an act of trade or in rights or options and the transaction was not carried out in the manner of a person ordinarily trading in rights. It will be noted that Mr Finley purchased the land in the early 60’s, more than ten years prior to the sale of the rights. The land was used for the business of farming directly by Mr Finley and indirectly by a now defunct corporation, over the course of the 15 year period. It was difficult to conceptionalize how his conduct could result in the sale of rights representing an adventure in the nature of trade or a business.

Further, it is useful to examine the criteria set forth in interpretation bulletin #IT- 218, dated May 26, 1975 including the following factors:

(1) The period of ownership (in this case a lengthy period of ownership);

(2) The frequency of similar transactions (this was a completely isolated transaction);

(3) Improvement and development work (in this case nothing was done);

(4) Reasons for and nature of sale (this was a result of something unanticipated at

the time of purchase, rather than an active campaign to sell the property;

(5) The relation of the taxpayer’s ordinary business (there is no relation at all).

Further, if one examines the criteria set forth in interpretation bulletin //IT-423, dated October 10, 1978, it will be seen that the sale in question clearly constituted a capital transaction rather than income in the taxpayer’s hands.

Interpretation bulletin //IT-459 also bears on this point.

2. If the transaction was capital in nature, does section 40(2)(a)(ii) of the Income Tax Act prevent the Appellant from claiming a reserve?

Assuming the Appellant is successful in establishing that the sale of the sand and gravel rights was capital in nature, then the court may still consider it necessary to deal with the submissions of the Respondent contained in paragraph B-9 of the Reply, namely that if the gain from the sale of the land and gravel rights was on account of capital, the Appellant is not entitled to a capital reserve as claimed due to the restrictive provision of Section 40(2)(a)(ii) such that the Purchaser, Sandco, was controlled directly or indirectly by the Appellant.

It is respectfully submitted that it is significant that at no point prior to May 1 of 1984 has the Respondent maintained in any way, shape or form that the Appellant was not entitled to a capital reserve, and it appears that this is an unfortunate tactic designed to intimidate the Appellant.

In any event, it is respectfully submitted that the Appellant does not have a controlling interest in Sandco. The Respondent has admitted that the Appellant owns a controlling interest in Chapter Management Ltd, the corporation which holds 50% of the common shares of Sandco, however, these are nonvoting shares. The remaining 50% is owned by a trust with the voting control exercised by a trustee who is not related to Mr Finley. Even though Mr Finley’s children are the beneficiaries of the trust they cannot exercise control over its operation. The directors are the persons who direct the activities of the company. In this case, the Appellant is not a Director of Sandco. The Appellant’s 50% interest does not diminish the power of the directors nor make the property or assets of Sandco his as distinct from the corporation. The business of Sandco is certainly not the Appellant’s business.

Further, if one examines the terms of the trust agreement, and in particular paragraph 13 thereof, it will be seen that there is no provision whereby the Appellant could discharge or replace Mr Cotter as trustee. Even though the Appellant could appoint a new trustee in the event that Mr Cotter resigned, the terms of the trust provide that “all questions requiring action by the trustees shall be determined by the majority of the trustees for the time being in office, such majority to include at least one trustee who is not the settlor". Accordingly, the Appellant could at no time be regarded as having “de jure“ control over Sandco. Since the directors control the activities of Sandco, Mr Finley could not be regarded as exercising even ‘‘de facto” control over Sandco.

The Appellant relies on the recent decision in Lusita Holdings Ltd v The Queen (82 DTC 6297), which addressed the issue of control. Mr Justice Mahoney, of the Federal Court trial division reaffirmed the concept of “de jure” control as established by the Supreme Court of Canada in Vina Rug (Canada) Ltd v MNR (1968), SCR 193. In that case, the relevant individual was found to have “de facto control” as a result of his ability to require his co-trustee to resign. However, as there were always to be two trustees by virtue of the trust and the relevant statutes governing trusts, the individual did not have “de jure” control. In the present case, the Appellant does not even have the power to require trustees to resign.

We also wish to draw the court’s attention to the case of Scandia Plate Ltd v Her Majesty the. Queen, [1982] CTC 431 (FCTD, Cattanach, J). In that case, the court was dealing with the issue of control, and although dealing with Section 125(6)(a) of The Income Tax Act, the wording is virtually identical to that contained in Section 40(2)(a)(ii). The court concluded that the word “control”, whether direct or indirect, means “de jure control” and not “de facto” control.

For all the foregoing reasons, it is respectfully submitted that the sale of the sand and gravel rights was on account of capital, and that the restrictive provision of Section 40(2)(a)(ii) does not apply, and that the Appellant is accordingly entitled to a capital reserve as claimed.

Counsel for the respondent argued that the appellant dealt with the assets as a trade and referred the Court to the following cases:

1. Mary Orlando v MNR, [1962] CTC 108; 62 DTC 1064;

2. MNR v Henry J Freud, [1968] CTC 438; 68 DTC 5279;

3. Ronald K Fraser v MNR, [1963] CTC 130; 63 DTC 1083;

4. Myrl S Gee v MNR, [1971] Tax ABC 354; 71 DTC 260.

Then, on the question of reserve, he referred the Court to the case of:

5. Robson Leather Company Ltd v MNR, [1971] CTC 132; 77 DTC 5106.

According to the evidence adduced, it is obvious that the appellant, at no time whatsoever, did act as trader when he acquired or sold the gravel rights. At all times, the appellant’s conduct was that of an owner of an asset when he disposed of it.

The principle enunciated in my decision in that of Myrl S. Gee, (supra), finds its application in the present appeal.

As to the question of reserve, the documents filed show that the appellant did not control the company, Sandco, and that the voting shares of the said company were in the name of Mr Cotter, who held them for the appellant’s children. Mr potter was the only one who could vote at the board’s meetings.

Section 13 of the trust agreement shows that the appellant could do nothing to remove Mr Cotter as a trustee, even if section 15 of the said agreement allowed him to appoint another trustee.

As may be seen, the appellant did not have the power de jure to control and, consequently, he should be entitled to get his reserve.

This Court is in complete agreement with the written submission filed by counsel for the appellant.

For these reasons, the appeal is allowed.

Appeal allowed.