Norman May, Seymour Hecht v. Minister of National Revenue, [1980] CTC 2457

M J Bonner:—I will now give my decision in the Hecht and May appeals. I have prepared one set of reasons for all appeals. The appellant Hecht appeals from assessments of tax and penalties for the 1973 and 1974 taxation years. In the case of Mr May, this is an appeal from a 1974 assessment only.

Mr Hecht’s appeals were heard on common evidence with the appeal of his friend and associate, Norman May. The first issue is whether the gain realized by Mr Hecht in 1973 from the sale of a house on Abbeywood Trail in the City of North York (then Borough of North York) was income. The appellant contended that this gain was on capital account and that the gain was a gain on the sale of a principal residence. The respondent assessed tax on the basis that the gain formed part of the appellant’s income for the year and he levied the penalty under subsection 163(2) of the Income Tax Act in respect of the inclusion.

On November 16, 1972, Mr Hecht entered into an agreement with W B Sullivan Construction Limited to purchase a house under construction on Abbeywood Trail. At that time the appellant lived in rented premises on Crimson Millway, less than a mile away. It was, he said, his intention that the house would become his family home.

The agreement of purchase and sale called for closing on February 28, 1973. Around February 21, 1973, the appellant received a letter from Sullivan Construction notifying him that Sullivan was exercising its option under the agreement of purchase and sale to extend the closing date to March 28, 1973. About that time the appellant Hecht was becoming dissatisfied with his employment and he commenced to look for a business which he could purchase. In March of 1973 he commenced negotiations which culminated in the formation, on May 4, 1973, of an agreement which is Exhibit A-4 for the purchase of all of the issued shares of a company known as Distinctive Upholstering Ltd.

On April 14,1973, the appellant agreed to sell the Abbeywood Trail home to George Della Rocca. The appellant stated that he sold the house in the course of cashing in his savings to buy Distinctive. There was no evidence as to what efforts, if any, were made by the appellant to sell the house and as to when these efforts commenced. The appellant did say that he decided to sell the beginning of April, 1973.

The Distinctive transaction was scheduled to close on May 31,1973, and $60,000 in cash was due on the closing. It was clear that the sale of the Abbeywood property assisted the appellant Hecht in completing the purchase of the shares of Distinctive in two ways, namely, it gave rise to a profit and it freed the balance which would otherwise have become due on closing of the Abbeywood purchase, thus making more cash available.

Mr Hecht testified that in buying Distinctive he liquidated assets necessary to complete the purchase, but he did have some assets left uncoverted. The evidence of Mr Hecht was vague in two areas which struck me as somewhat critical: (a) financial detail as to whether the sale of the Abbeywood house was made necessary by the then proposed Distinctive deal, and (b) the stage reached in the negotiation of the purchase of Distinctive at the time that the sale to Della Rocca took place. It should be noted that the agreement to sell to Della Rocca was made on April 14, 1973, and the agreement to purchase Distinctive was not signed until May 4, 1973. I note too that the purchase from Sullivan and the sale to Della Rocca ultimately took place on the same day, May 31, 1973.

It appears that the proceeds from the sale of the Abbeywood property were not in fact used, at least directly, in the purchase of the Distinctive shares. In short, the impact of the Distinctive deal on the decision to sell the Abbeywood house was not established as clearly as it might have been.

The appellant never lived in the Abbeywood house. The transfer of the title was made directly by Sullivan to Della Rocca, pursuant to a direction given by Mr Hecht. Land transfer tax was thus avoided.

A single family dwelling is not normally the sort of property which is utilized in the course of a speculation. The purchase, particularly by a person who occupies rented premises, of a dwelling followed by a resale, even a speedy resale when explained by satisfactory reasons, would normally lead to the conclusion that the transaction is one on capital account.

On the other hand, the entry into an agreement to purchase followed by a speedy resale prior to the completion of the agreement tends to have the appearance of a speculation unless the reason for a change in direction is fairly plainly established. Were there no other evidence I would have great difficulty in determining, on the balance of probabilities, whether one of the factors which motivated the appellant to agree to purchase the Abbeywood house was resale for profit.

However, the appellant’s subsequent conduct has led me to conclude that the purchase and resale of the Abbeywood property was the first of a series of speculative real estate ventures undertaken by him. Evidence of the appellant’s subsequent transactions is relevant to show a course of conduct. In this regard I would refer to the decision of the Supreme Court of Canada in G W Golden Construction Limited v MNR, [1967] CTC 111; 67 DTC 5080.

By agreement formed November 24, 1973, Mr Hecht agreed to purchase 45 Magpie Crescent from a builder named Silwis Development. That house was then under construction. Mr Hecht made a deposit of $5,000, using money he borrowed from Distinctive and he agreed to pay the balance in cash on the date fixed for closing, June 20, 1974. Mr Hecht did in fact complete that purchase and he lives in that house today. That house is in the same general area as the Abbeywood Trail house and his action in this respect bears out his stated desire to buy a dwelling in the same general area as the rented premises on Crimson Millway in which the appellant first lived when he moved to Toronto.

Mr Hecht’s neighbour and friend on Crimson Millway was the appellant Norman May. Mr May is a solicitor. He had moved from Montreal to Toronto in July of 1971. He had been looking somewhat casually for a house in the area for a period. He explained that in 1973 and early 1974 the real estate market began to “heat up”. He decided that despite the apparently high prices of dwellings the situation would become worse and he should therefore buy. Both Mr Hecht and Mr May and their wives had looked at houses in the area south of York Mills Road, which was being developed by Sullivan Construction. For the Mays a two-storey house was less desirable than a bungalow because of the surgical removal of Mrs May’s knee cap. That created a problem for Mrs May in negotiating stairs.

Sullivan Construction offered one bungalow model in either a two bedroom or three bedroom configuration, but the number of bedrooms was not large enough for Mr May’s family. The Sullivan houses, for the time being, were out of the question because Sullivan, at least initially, was not prepared to vary the standard plans offered by it.

In February of 1974 Mrs Hecht and Mr May visited a trailer which served as a sales office for houses built on Magpie Crescent by a builder named J M Peebles Limited. Magpie is a street just north of York Mills Road and just a relatively short distance east of Crimson Millway. Peebles had three partially constructed houses available for sale at the time of that visit. During the time that Mrs Hecht and Mr May spent in the trailer on that day some twenty to thirty prospective purchasers visited the trailer. That day was February 3, 1974.

On that day Mrs Hecht, as agent for her husband and Mr May, completed an offer to purchase all three Peebles houses for $345,000. The offer was accepted on February 4. Closing was scheduled for June 29, 1974. The agreement called for a $15,000 deposit with the balance payable in cash on closing.

It will be observed that Mr Hecht had, at that point, already agreed to buy the other house up the street at 45 Magpie Crescent.

Mr Hecht testified that after entering into the agreement to buy 45 Magpie from Silwis he had become aware of a potential problem with drainage from lands to the west of the Silwis house and he feared a leaky basement. He discussed the situation with Silwis and received assurance that the problem would be solved or avoided by grading. He had a warranty in his agreement with Silwis that the basement would be dry and waterproof for a period of one year from the date of closing. Notwithstanding this, he and his wife started to look for another house so that they would be able to live in the area. Mr Hecht stated that he was aware that prices on this street had escalated and he knew that he could “get out of” the Silwis purchase one way or another. The Peebles houses, by reason of their location, did not share the potential drainage problem of the Silwis house.

Mr Hecht therefore, in response to mere suggestions of a potential drainage problem, did not testify that he sought engineering or other professional assistance, but rather he seemed to rely on rising real estate prices and simply bought a half interest in three more houses.

I cannot conclude that Mr Hecht’s action in purchasing an interest in the three Peebles houses was anything other than a speculation. His ready entry into the Peebles transaction under the circumstances mentioned above, and the manner in which he and Mr May dealt with the rights which they acquired under the agreement with Peebles by selling their assignment prior to completion and conveyance of title, lead me to that conclusion.

Furthermore, these factors, when considered with the evidence mentioned earlier, suggest that the Abbeywood purchase was the first of a number of speculations in single family dwellings undertaken by Mr Hecht.

I may say in reaching this conclusion I am not unmindful of the warning expressed by President Thorson in John Cragg v MNR, [1951] CTC 322; 52 DTC 1004 at 327 [1007] as follows where His Lordship says:

There is, I think, no doubt that each of the profits made by the appellant could, by itself, have been properly considered a capital gain and the Court must be careful before it decides that a series of profits, each one of which would by itself have been a capital gain, has become profit or gain from a business. Such a decision cannot depend solely on the number of transactions in the series, or the period of time in which they occurred, or the amount of profit made, or the kind of property involved. Nor can it rest on statements of intention on the part of the taxpayer. The question in each case is what is the proper deduction to be drawn from the taxpayer’s whole course of conduct viewed in the light of all the circumstances. The conclusion in each case must be one of fact.

However, on all the evidence that is the only conclusion which appears open to me on the balance of probabilities.

Returning then to Mr May and the Peebles purchase, Mr May bought despite his wife’s medical problem. All three Peebles houses were two storey models. Mr May did not testify that there were no bungalows available in the desired area, nor did he suggest that there were no lots for sale on which a bungalow could be built within that area. His evidence was that as a result of professional work done for Sullivan he became acquainted with Sullivan’s president, a Mr Prusac, in March of 1974. Mr Prusac agreed to get Sullivan to build a version of their standard bungalow, but modified in the interior to provide five bedrooms, which Mr May required. That deviation from the previous inflexibile Sullivan policy of refusing requests for modification was, Mr May said, startling to those of the Sullivan organization. Although no formal agreement was made between Mr May and Sullivan for the purchase of the modified bungalow upon its completion construction did proceed and Mr May did buy it in the following summer, (July 26, 1974). He still lives in that house today. The purchase price of that Sullivan bungalow was $102,800, $60,000 of which was financed by mortgage.

The arrangement between Mr Hecht and Mr May regarding the Peebles houses was rather informal. Mr May was to take the house on Lot 11. Mr Hecht bought Lot 13, and Lot 14 was the house which the two appellants decided to “have on hold’’, to use their words.

Mr May and, I believe, Mr Hecht had friends in the Montreal area who were aware of the housing situation in Toronto and had asked them to keep an eye out because they, the friends, might be interested. The purchase of Lot 14, however, was not the result of any specific instructions from any such friends. The resale of Lot 14 was admittedly intended. Mr May gave no evidence of any attempt to arrange a mortgage to assist in the financing of the purchase by him of the Peebles house chosen for his occupancy. I infer that a mortgage might well have been necessary in light of the manner in which the purchase ultimately made by Mr May from Sullivan was financed.

Mr May and Mr Hecht entered into an agreement on April 1, 1974, to assign their interest in the two Peebles houses on Lots 14 and 13 to one Spencer Black at a gross profit of $20,000 per house. They entered into an agreement also on April 1, 1974, to sell the third Peebles house on Lot 11 for a gross profit of $18,500. In each case disputes with the purchasers led Mr Hecht and Mr May to agree to close on the basis of somewhat reduced prices.

The purchase of one surplus house, coupled with the knowledge that prices were escalating rapidly, coupled as well with the absence of evidence of unsuccessful attempts to locate a bungalow and further coupled with the absence of evidence of any attempt to arrange financing or alternative evidence that financing was not necessary, and finally the speed with which Mr May’s interest in the Peebles agreement was sold, are all factors which lead me to conclude that the gain realized by Mr May was on revenue account.

The respondent assessed tax for the 1974 taxation year of Mr Hecht and Mr May by adding to declared income of each his respective share of the gain realized on the disposition of the Peebles properties. The respondent was not, in my view, wrong in doing so.

The respondent assessed penalties as well under subsection 163(2) of the Act against Messrs May and Hecht in respect of their omissions to report the Peebles gains for 1974.1 mentioned previously that a penalty was assessed under the same subsection for 1973 with respect to the failure by Mr Hecht to report the gain on Abbeywood.

All of the relevant returns of income were prepared by chartered accountants. None of the accountants was informed of the gains. It was the position of Mr May that he could allocate all his share of the Peebles gain on the house or to the house which he had intended to occupy. He regarded the gain on the house which he intended to occupy as a gain on a principal residence.

Mr Hecht did not inform his accountant of the gains in either 1973 or 1974 because he regarded them as gains on the sale of principal residences.

Mr May argued that paragraph 54(g) of the Act, in defining “principal residence”, was less than clear and that he understood that as a matter of administrative practice the Department of National Revenue did not require that any election be filed.

It seems to me that even a layman who has agreed to buy a house, but who did not complete the purchase and move in, might well feel compelled to inquire further before concluding that a house which he might have occupied, but never did occupy, was his principal residence.

Neither Mr Hecht nor Mr May was an unsophisticated person. Mr Hecht was an experienced businessman and Mr May is a practising lawyer and former law professor.

I believe that they should, before relying on an exempting provision, have looked at paragraph 54(g) or have obtained professional advice. What each did was in effect take the position that his gain was exempt in circumstances where the taking of such a position could not be justified, even on a layman’s interpretation of the words “principal residence”.

Furthermore, I do not see how Mr May can say, with any justification, that paragraph 54(g) is unclear in respect, at least, of the necessity to occupy a dwelling claimed as a principal residence.

The two failures of Mr Hecht to report and one failure of Mr May to report can, in my view, only have occurred in circumstances amounting to gross negligence. All three appeals must therefore be dismissed.

Appeals dismissed.