Kadon Development Corporation v. Minister of National Revenue, [1981] CTC 2665, 81 DTC 604

The Chairman:—The appeal of Kadon Development Corporation is from an assessment with respect to the 1977 taxation year by which the Minister considered as income the appellant’s active business profit in the amount of $33,878 realized from the sale of a property situated at 731-733 Lindsay Road, Richmond, British Columbia. The appellant, in its income tax return, had treated the profit as a capital gain and reported a taxable capital gain of $16,938 as investment income.

The appellant is incorporated under the British Columbia Companies Act. Its business is the development of real estate for resale and its sole shareholders at the material time were Mr R Ens and Mr D Quiring, both of whom were experienced licensed real estate agents.

On April 5, 1975, the appellant purchased land at 731-733 Lindsay Road in Richmond by way of an interim agreement (Exhibit R-3). A building permit for the construction of a duplex on the subject land was obtained in May 1975. However, a 4-plex was constructed instead, which was completed in May 1976. On December 15, 1976, the property was sold by way of an interim agreement.

It is my understanding that the appellant had purchased four other properties on which a duplex and three single family dwellings had been built, concurrent with the construction of the 4-plex. The duplex and the single family dwellings, in keeping with the appellant’s operations, were sold prior to their substantial completion. It is alleged that the 4-plex was completed and indeed that it was the only property ever built by the appellant that was rented and on the disposition of which a capital gain was claimed. It is also alleged that the 4-plex is the only construction which the appellant financed by a draw mortgage.

Submissions

It is the appellant’s contention that the 4-plex (the subject) was acquired solely for investment purposes, at the suggestion of its chartered accountant, Mr T C Wilson, who suggested that the retention of the property by the appellant would provide a tax advantage to the appellant and help in financing its operations by providing equity as well as providing a long-term retiring plan for the appellant’s two shareholders.

It was alleged that the 4-plex was of superior construction to that of the properties built for resale. Better materials were used and the property was landscaped in keeping with the appellant’s intention of keeping the property as a long-term investment. The construction of the 4-plex was more expensive as indeed was the insurance on the property (Exhibit A-2). There does not appear to be any dispute that the four suites were rented immediately after completion to the date of sale.

In December 1976, an offer was made by a real estate agent for the purchase of the 4-plex, which the appellant refused, stating that the property was not for sale. The agent was persistent in making offers and finally raised the offer to a point where the appellant felt it could not refuse and the property was sold.

The respondent contends that both Mr Ens and Mr Quiring, as experienced real estate experts, had purchased, constructed and sold the 4-plex, as they did for the other adjacent properties, as part of their business and that the motivating reason in acquiring the land and constructing the 4-plex thereon was the expectation that it would eventually be sold as part of the appellant’s ordinary business operations.

The respondent suggests that the appellant did not invest too much money in the 4-plex but rather built equity with what was a good rental cash flow which would be capable of carrying the mortgage. The respondent filed as Exhibit R-1 a credit application form of the Toronto Dominion Bank in which the bank manager, Mr D R Pain, states in part:

As can be noted from the enclosed Construction Programme and Builder’s Financial Statement, the Company is able to complete construction of the Second Ave. residence without resorting to Bank borrowing, and with the completion date being June 30th, 1976 it is anticipated that the $54,000 equity in this property should be available from the sale of this residence in July 1976. In addition, a further $25,000 is being injected into the Company by way of a 2nd Mortgage being placed on the duplex at 732 Linsay Road, Richmond, B.C., which is being retained by the Company as a long term investment. The duplex has been 4- plexed and with a monthly income in excess of $1,300 being derived from this source, the Company’s accountant indicated that a 2nd Mortgage should be placed on the property in order to alleviate income taxes in view of the present regulation which does not permit depreciation being charged against a revenue property to create a loss for income tax purposes. We vigorously solicited this 2nd Mortgage business, and were successful in obtaining a $25,000 (net) TDPL in the name of Ronald Ens and thus provided the Bank with a 13.5% return and perhaps more importantly our client was pleased to obtain second mortgage funds at this rate which included life insurance on one of the Company’s principals.

Without going into the details of what appears to me to be a legally acceptable business practice, there is nothing in the above which contradicts the declared intention of the appellant, as stated by Mr Quiring, its representative, of keeping the 4-plex as an investment. Nor do I see anything therein which would justify the determination that the property was acquired for resale, as part of the appellant’s ordinary business.

In his reply to the notice of appeal, the respondent points out that the appellant purchased the subject land for $34,000 by way of an interim agreement dated April 5, 1975 (Exhibit R-3). In the interim agreement, it is stated: “The Principals of Kadon Development Corporation are licensed real estate salesmen and are purchasing this property for construction and/or resale.”

This interim agreement, as I understand it, was signed in compliance with section 28 of the Real Estate Act and was subsequently formalized by a deed made in pursuance of the Short Form of Deeds Act on April 17, 1975 (Exhibit A-1).

The evidence is that the appellant constructed other buildings on the property which he sold. The wording of the interim agreement, in my opinion, does not rule out the possibility of retaining the 4-plex as an investment property, as stated under oath by Mr D Quiring and confirmed by Mr T C Wilson, the appellant’s chartered accountant.

The fact that the appellant built a 4-plex in a zone which permitted the construction of nothing greater than a duplex may be of concern to the municipal authorities of Richmond but, for purposes of this appeal, it really adds nothing in the determination as to whether the 4-plex was built for investment purposes or for resale.

There is of course no question that the burden of proof rests on the appellant and since the shareholders of the appellant, whose business is the development of real estate for resale, are experienced real estate agents, the Board must carefully scrutinize the appellant’s claim that the profit realized from the sale of one of its properties is a capital gain.

Notwithstanding the above, the appellant and its shareholders cannot automatically be excluded from acquiring property as a long-term investment. The Board cannot ignore the declared intention that the appellant acquired the land and built the 4-plex as a long-term investment. Some weight must be given to the evidence that the 4-plex was better built, furnished and treated differently than properties built for resale. The profits realized from the sale of all of its other properties were reported by the appellant as business income. In my opinion, on the balance of probabilities, the subject property was acquired for purposes of investment for the reasons stated by both Mr Quiring and Mr Wilson. That the sale of the property in December of 1976 was the result of an unsolicited offer remained undisputed.

The evidence is that the property was not advertised or listed for sale. The real estate agent who made an offer to purchase the 4-plex was advised that the property was not for sale and it is only after other offers had been made that the price was raised to a point that it could not reasonably be refused.

In conclusion I find, on the evidence and on balance of probabilities, that the appellant’s intention at the time of acquisition of the land and the construction of the 4-plex was to keep it as a long-term rental investment. The appellant has, in my opinion, succeeded in establishing that the assumptions on which the Minister based his assessment are insufficient, incomplete and ill-founded.

The appeal is therefore allowed and the matter referred back to the Minister for reassessment on the basis that the profits realized from the disposition of the subject property is in the nature of a capital gain.

Appeal allowed.