Swire Enterprises Limited v. Minister of National Revenue, [1980] CTC 2107, 80 DTC 1109

The Chairman:—The appeal of Swire Enterprises Limited is from a reassessment dated January 26, 1977, by which the Minister disallowed capital cost allowance in the amount of $346.13 in the 1974 taxation year and also disallowed a terminal loss in the amount of $24,312.99 and demolition costs of $1,200 in the 1975 taxation year in respect of a house situated on Gage Avenue and Mohawk Road in the City of Hamilton, Ontario.

Summary of Facts

The appellant company was incorporated in May 1962 (Exhibit A-1) and was engaged in the restaurant and take-out food business and operated several Colonel Sanders’ Kentucky Fried Chicken locations in the Hamilton area. One of these location was situated in a plaza on Mohawk Road. In March of 1973 the appellant company whose 10-year franchise with Colonel Sanders in that location was drawing to a close, was advised that a freestanding building was more in keeping with that company’s requirements.

The appellant company, in order to retain its franchise, became interested in purchasing a Shell Oil service station situated across the street from the plaza and which Colonel Sanders considered as an appropriate site for an outlet location. Mr Douglas Swire, the President of the appellant company, learned through a real estate agent that Shell Oil had options to purchase certain lots on which the service station was located, as well as another lot on which was constructed an old house consisting of three self- contained rented apartments. The Shell Oil Company agreed to take up the options and convey the two properties to the appellant. It is common ground that the service station could not be purchased separately from the old house.

It was alleged by the appellant company that prior to making an offer to Shell Oil Company for the properties, Mr Swire had approached the owner of a TV repair shop also situated in the plaza with a view of selling him the rental property as a new site for his shop. The owner was interested and a price of $50,000 for the land and building was discussed and agreed to. This tentative agreement between Mr Swire and the TV shop owner was not disputed by the respondent.

On Novembear 13, 1973, the appellant company made an offer to purchase the said properties for $98,000 (Exhibit A-2) the price having been negotiated between Mr Swire’s real estate agent and the Montreal Trust.

After closing the transaction, Mr Swire was advised that a problem arose in that lot 36, on which the rental property was located, and lots 37 and 38, on which the service station was located, were fused into one parcel (Exhibit A-3).

An application was made to the City of Hamilton for the severance of lot 36. However, the severance could be obtained only on the condition that the appellant cede to the Municipality certain footage of land around and about the take-out restaurant for municipal purposes. By releasing the footage required by the Municipality, there would not have been sufficient land to operate a take-out restaurant adequately. Mr Swire refused to do so and the severance of lot 36 was not permitted.

At the time of the purchase of the property by the appellant the house on lot 36 was rented (Exhibit A-4). Mr Swire allegedly advised the tenants that they need not move as a result of the sale. However, he had never visited the building until March of 1974 when one of the tenants moved out. Only at that time did Mr Swire visit the apartment and did he have an estimate made of the cost of the necessary repairs to the house. He found that a cost of $8,000 was too expensive for the repairs on the house at a time when considerable expenses were being made on renovating the take-out restaurant. Rather, he decided to tear down the old house and so advised his tenants and the building was demolished in September 1974. The appellant company did not need lot 36 for the operation of the take-out restaurant and subsequently the appellant company had a rental building consisting of two stores constructed on lot 36 which it continued to lease. The testimony of Mr Biil Brooks, general manager of the appellant company, confirmed Mr Swire’s evidence.

The respondent presented as a witness, Mr M J Elliot, a real estate broker, a member of the American Society of Appraisers and Governor of the Canadian branch of that Society. Mr Elliot had been active in real estate for some 17 years and was at the time of the hearing, self employed. It is my understanding that Mr Elliot had been retained by Shell Oil in connection with the sale of the service station and was asked to determine the market value of both properties based on their highest and best use.

With reference to the house, Mr Elliot declared having made a cursory inspection and found the house to be between 35 and 40 years old, in a rundown condition and badly in need of repairs. He placed the value of the house and the land at between $35,000 and $37,000. Since the land was zoned commercial he believed that a value of $16,000 for the house and $24,000 for the land would not be unreasonable.

Issue

The basic question before the Board is whether or not lot 36 and the house situated thereon were acquired by the appellant for the purpose of earning income.

Submissions

In support of the position that the appellant acquired the rental property for the purpose of earning income, it was suggested that the appellant had a dual intention: first to sell the property, or secondly, failing that, to continue to rent the property.

The appellant company’s second position is that the property was acquired as a trading asset and the loss incurred in demolishing the building after it was found that it could not be sold should be considered as a deductible loss of income.

The third submission made by the appellant company is, that if the property was acquired only for the purpose of trading, the appellant company once the sale proved to be impossible, changed the use to which the property was to be put and pursuant to paragraph 13(7)(b) of the Income Tax Act, SC 1970-71-72, c 63, as amended, the property became a capital propery on which capital cost allowances and a capital loss could be claimed.

The respondent, in argument, advised the Board that the Minister was not relying on paragraph 8 of his Reply, which was an alternative argument to the effect that the appellant was not entitled to a terminal loss because he had not attempted to dispose of the property. The respondent advised that the decision of the Federal Court on which the Minister had relied, Compagnie Immobilière BCN Limitée v Her Majesty The Queen, [1976] CTC 282; 76 DTC 6153, and which held that the words “were disposed of’’ in paragraphs 20(1)(c) and (d) do not apply where a property was destroyed, was overturned by the Supreme Court of Canada, [1979] CTC 71; 79 DTC 5086.

The respondent made three principal submissions:

1. That the appellant did not acquire lot 36 and the house for the purpose of gaining or producing income but that he had no choice but to accept that property to acquire the service station which he wanted to convert into a free-standing Kentucky Fried Chicken outlet as required by his franchise. The respondent submits that it was not the appellant’s intention to go into the rental business when he acquired the property on January 15, 1974.

2. That the trading asset which the appellant claims to have acquired was lot 36 and the building thereon. By tearing down the building the appellant is still left with the land as an asset which he had not yet disposed of. It is the respondent’s contention that an income loss or gain can only be determined when he has disposed of the land.

3. Referring to paragraph 13(7)(b) of the Income Tax Act, cited by the appellant, the respondent questions whether there was any change in the use made by the appellant of the subject property from the moment he acquired it and submits that the appellant at no time commenced a rental business.

Findings

It was generally agreed that the appellant, in order to acquire the service Station as an outlet for his principal business, had no alternative but to acquire the whole parcel of land consisting of lots 37 and 38 on which the service station was erected and lot 36 on which the rental building stood. There is also agreement, that prior to the acquisition of the whole parcel, the appellant having no need for the land and the rental building on lot 36, had made a firm arrangement to sell that property for $50,000.

It is necessary in determining this issue to continously bear in mind the appellant’s principal objective in entering into the transaction with the Shell Oil Company. If the appellant had a dual intention at the time of acquisition, as suggested by the appellant, it was to acquire the service station and sell the rental property. The appellant’s intention of continuing to rent the property on lot 36 could only have been a vague possibility which did not even warrant an inspection of the building before the purchase was made or a briefing on the rental income it was producing, nor was renting the building a motivating factor in acquring the property.

It appears to me quite clear that the appellant purchased the whole parcel from Shell Oil Company to meet the location requirements of its principal business and to sell that portion of the property which it did not need at a profit to help in the financing of the service station renovations. In my opinion, the appellant acquired lot 36 and the rental building for the purpose of gaining or producing, if not an investment or rental income, certainly a business or trading income. Had the appellant been successful in selling that property there can be no doubt, as was suggested by the appellant, that the company would have been taxed on the profits.

The fact is, however, that the appellant could not and did not sell lot 36 and the rental building. There was therefore no trade, no trading income and no trading losses. This, of course, does not alter the fact that that property had been acquired for the purpose of gaining or producing income from resale.

Because lot 36 could not be severed, a problem which the appellant could not have reasonably foreseen at the time of purchase, he was left, irrespective of paragraph 13(7)(b) with bona fide capital assets which he had not intended to retain and which he did not need for this business.

I do not believe that it would be realistic in the circumstances of this appeal to consider the acquisition and the disposition of the rental property independently of the appellant’s concern and investment in finding a Suitable site and establishing an outlet for his principal business. Since the appellant company was already engaged in renovating the service station, it was not an unreasonable business decision for the appellant to look into the possibility of continuing to rent the building or in some way reduce the expenses relating to what had inadvertently become an investment in a capital asset. However, whether the appellant continued to rent the property or not is immaterial for the purposes of this appeal because the assets were nevertheless acquired for the purpose of earning income within the meaning of the Income Tax Regulation 1102(1)(c) which, in my opinion, is not restricted to rental income. In the circumstances, capital cost allowances on the appellant’s Class 6 building would normally be allowed and on the disposition of the assets a gain should be taxed or a loss allowed. Whether the building should have been rented, or sold and moved (since the land could not be severed) as suggested by the respondent or whether it should have been demolished was a business decision, which in my view could best be taken by the appellant company in relation to its effect on the appellant’s principal business. Whatever decision was taken by the appellant however did not change the nature of the asset or the purpose for which it was acquired.

The respondent in support of his contentions cited J Clark & Son Limited v MNR, 18 Tax ABC 196; 57 DTC 567; Stanley J Merrett v MNR, 18 Tax ABC 344; 58 DTC 88; Frederick R Phillips v MNR, 28 Tax ABC 81; 61 DIC 677; Ben's Limited v MNR, [1955] CTC 249; 55 DTC 1152; Burrows Motors Limited v MNR, 12 Tax ABC 294; 55 DTC 172.

In all these cases the alleged primary purpose of gaining or producing income from the acquisition of rental properties was proven to be unfounded, the true purpose and intention being the acquisition and use of the land for purposes other than renting the building constructed thereon.

In the present appeal the Board is satisfied on the basis of the evidence that at the time of purchase the company’s sole intention in acquiring lot 36 and the rental building was for the purpose of gaining or producing income from its resale. The cases cited by the respondent have, in my opinion, no application to the present case.

The Board concludes that lot 36 and the building thereon were acquired by the appellant for the purpose of earning and producing income from their sale. The sale having been frustrated through no fault of the appellant, the property constituted a capital asset for the appellant and capital cost allowance on the building from the time of its acquisition to the time of Its demolition, in the amount of $346.13, is deductible.

For economic and business reasons the appellant disposed of the building by demolition and sustained a capital loss. Although the appellant claimed a terminal loss of $24,312.99, no evidence was adduced to support that figure. Mr Elliot, who appraised the subject property stated in evidence that $16,000 would be a reasonable value for the house. The Board, therefore, has not been given sufficient evidence to determine the exact amount of the capital loss sustained. The cost of disposing of the capital asset in the amount of $1,200 by way of demolition is also deductible.

The appeal is therefore allowed in part and referred back to the Minister for reconsideration and reassessment according to the above reasons and by taking into account that the loss sustained by the appellant, yet to be determined, is capital in nature.

Appeal allowed in part.