Hays Farms International Limited v. Minister of National Revenue, [1980] CTC 2975, 80 DTC 1887

M J Bonner:—This is an appeal from an assessment of income tax for the appellant’s 1974 taxation year. The first issue is whether the gain realized on the sale of the appellant’s one-half interest in part of Lot 15, Concession 1, SDS, Oakville, (the Phillips farm) was income or whether it was on capital account. If, as the appellant contends, the gain is on capital account a second question arises, namely, the value of that farm on V-Day. The appellant filed its income tax return for 1974 on the basis that both the proceeds of disposition and the adjusted cost base of the property were $558,473 and that it sustained a loss of $33,960 as a result of certain costs.

The appellant pleaded that the Phillips farm was acquired to protect and expand its farming business and that it was sold due to a working capital deficiency. It pleaded, too, that the sale resulted as well from the desire of its co-owner to sell.

The respondent assessed on the basis that, and pleaded that, the gain on the sale of the Phillips farm was income. He pleaded also that, in any event, fair market value of the farm on V-Day was $9,760 per acre.

The co-owner was a corporation known as Uranium Truck Lines (1965) Limited, in respect of which the appellant’s counsel said, “There is no dispute that it is a developer’’.

The appellant acquired the Phillips farm pursuant to an agreement of purchase and sale dated September 29, 1967.

At the outset it is necessary to describe the location of and identify a number of properties to which reference was made in the evidence. All were suited in Trafalgar Township and later became part of the Town of Oakville. Highway No 5 (Dundas Street) runs in an east-west direction between Trafalgar Road on the east and the Sixth Line on the west. On the south side of Highway No 5 there are four farms which have relevance to this appeal. On the east there is the Post farm, forming part of Lot 13, Concession 1, SDS. Lying to the west of the Post farm is a farm known as the “main’’ farm, which runs the full width of Lot 14, Concession 1, SDS, and extends from Highway No 5 on the north to Upper Middle Road on the south. Immediately to the west of the main farm is the Fleming farm which occupies the north part of Lot 15, Concession 1, SDS. To the south of the Fleming farm is the Phillips farm, extending from the southerly boundary of the Fleming farm to Upper Middle Road. The westerly boundary of the Fleming and Phillips farms is a road known as the Sixth Line. The Fleming farm, main farm and Post farm were sometimes collectively referred to as “the four hundred acres”.

On the north side of Highway No 5 and immediately west of Trafalgar Road lies the Hudelson farm, which forms part of Township Lot 13. Immediately west of the Hudelson farm is the Wilf Hall farm. Also relevant is a parcel of 20 acres lying in the southeast corner of the Wilf Hall farm, which parcel was referred to as “the Motor City lands”. The Wilf Hall and Hudelson farms and the Motor City lands have a total area of about 188 acres.

Trafalgar Road was, in 1967, the north-south spine of the Town of Oakville. Upper Middle Road then formed the northerly boundary of the developed area of the Town.

The principal individual involved in this appeal is Thomas E Hays. He, with his brother Harry, first came to the Oakville area in 1947. Harry Hays purchased the main farm in that year. At that time, and before, the two carried on a business of farming and dealing in cattle. That business was carried on not only in the Oakville area, but also in western Canada.-The brothers decided in 1948 to divide the business between them by liquidating the company which carried on the business and by distributing the eastern assets to Thomas Hays and the western assets to Harry Hays. That process took some time, but in 1954 an Ontario company, Hays Farms Limited, was incorporated and the assets acquired by Thomas Hays were transferred to it, save for real estate. The main farm, which had been owned from 1947 until 1956 by Harry Hays in trust for the company, was conveyed by him to Thomas Hays in 1956. Thomas Hays leased it to the new company which he controlled. The new company carried on the business of exporting cattle, selling them at auction, breeding them and growing hay and grain. To do so it used not only the main farm, but also a number of other farms in the Oakville area which it occupied as tenant. Large areas of land were needed for pasture and for hay and grain growing operations.

In 1957 Mr Hays conveyed the main farm to Hays Farms Limited which, up to that time, was the corporate organization carrying on the farming business. Also in 1957 Hays Farms Limited entered into an agreement to purchase a majority of the common shares of a company which had hitherto been its competitor in the livestock export business, International Livestock Exporters Ltd (hereinafter called “International” or “the appellant”).

One of the provisions of that agreement called for the employment by Hays Farms Limited of one Dennis E Hall and for the grant of an option entitling Mr Hall to purchase a minority block of shares in International. Mr Hall was, at all relevant times after 1957, a key man in the livestock export operation.

One of the assets of International at the time of the purchase of its shares by Hays Farms Limited was the Wilf Hall farm, a parcel of about 80 acres. In 1962 the Motor City lands were sold by International to a Mr Hudelson, then owner of the Hudelson farm. As a result of that transaction, and possibly a loan of monies as well, International acquired a mortgage which, I believe, was first in priority on the Motor City lands and third in priority on the adjacent Hudelson farm.

In February of 1961 a fire destroyed all the farm buildings on the main farm, together with a stack of ten thousand bales of hay used to feed cattle held pending export. A number of valuable cattle were destroyed as well. Insurance did not fully cover the loss and the fire was something of a financial disaster for Hays Farms Limited.

Mr Hays approached his bank for a loan to assist in the urgent task of rebuilding. He was refused. He had a friend, Steve Roman, who was said to be a man of considerable wealth. Mr Roman and Mr Hays shared an interest in the breeding of cattle. Mr Hays approached Mr Roman for financial aid in the form of a loan. Mr Roman told Mr Hays that he would like him to have not just the 200 of the main farm, but also another 200 acres. Mr Roman offered to go into “partnership” with Mr Hays. He caused Denison Mines Limited, a company which he apparently controlled, to lend $125,000 to Hays Farms Limited.

In the summer of 1962 Hays Farms Limited bought the Post farm and the Fleming farm. A corporate and business reorganization ensued, the main relevant results of which were:

(a) the Post, Fleming and main farms (the four hundred acres) were owned by Tomar Farms Limited (Hays Farms Limited under a new name), ultimate ownership (through another company) resting 50% in Mr Hays and 50% in Denison Mines Limited;

(b) the appellant, formerly International Livestock Exporters Limited, was renamed; and

(c) the appellant commenced to carry on the entire farming and export business, using the following land:

1. the 400 acres under a lease from Tomar,

2. the Wilf Hall farm, and

3. various other farms in the Oakville area, including the Phillips farm, which were from time to time available to it under tenancy arrangements.

Mr Hays subsequently faced another situation giving rise to a need for money. The mortgage on the Motor City lands and the Hudelson farm went into default. In order to protect the appellant’s investment it was necessary to redeem prior mortgages and foreclose subsequent encumbrances. Mr Hays arranged to obtain the money needed to do so from another friend, a Mr Seedhouse. Precise details of this transaction were not given in evidence, but a final order of foreclosure was registered in 1966 and the lands which had been subject to the mortgage were conveyed by the appellant to itself and Mr Seedhouse in 1967.

In considering the appellant’s plea that it acquired the Phillips farm in order to protect and expand its farming business it is relevant to observe that, as a result of the acquisitions already described:

(a) Tomar owned the 400 acres on the south side of Highway No 9, including the auction and quarantine facilities and corrals and pens covering an area of 20 to 30 acres; and

(b) the appellant and Mr Seedhouse owned approximately one 188 acres on the north side of Highway No 5.

In 1967 all named farms, both on the north and south sides of Highway No 5, were sold. As a result the appellant was in a somewhat insecure position because no land suitable for its cattle export and associated farming operations remained in the hands either of Mr Hays or of any company even partially controlled by him. Although raw land suitable for pasture and for hay and grain production seems to have been readily available on a rental basis, the sale by Tomar included the facilities mentioned previously which had been rebuilt at great expense following the fire only six years before.

Mr Hays testified that he was confident that for at least 20 years he would be able to rent the properties which had been sold. He said he felt that development was at least that far off. The purchasers were evidently either land developers or speculators and had no immediate use for the land. Those purchasers, however, were prepared to lease only on a year-to- year basis. Thus, Mr Hays stated that in purchasing the Phillips farm he was mindful that the lease on the 400 acres could run out and that the basement of the house on the Phillips farm could be used as an office and the barn could be used for purposes of the auction and export operations. There was no direct indication in evidence whether extensive and costly improvements would be necessary to adapt the existing facilities on the Phillips farm for the possible intended use. Having regard to the size of loss caused by the fire, I believe that such adaptation would be very costly.

As to other reasons for the purchase of the Phillips farm, Mr Hays testified that it was very important to keep the appellant’s operations in the same area in order to retain the services of employees who had worked for the appellant for many years. Another reason was that a railway yard which was located only a short distance east of Trafalgar Road was heavily used by the appellant to ship cattle. Ready access to railway facilities was im- portant to the appellant. Mr Hays’ son, Thomas C Hays, suggested that the appellant had built up an international reputation connected with the very location where operations had been conducted over the years and that any change in location, even to the other side of the highway, would be detrimental*. [1]

In weighing the reasons thus advanced for the purchase of the Phillips farm the obvious question is, “Why sell the other land, especially the four hundred acres, in the first place?”. Mr Hays testified that the sale was not due to any pressure from Mr Roman. Rather, he said it was to raise money to pay off a bank loan. The evidence established that Mr Hays and the appellant had severe problems with the bank in 1965 and not in 1968. Mr Routery, a member of the firm of auditors of the appellant and Tomar, was called by the appellant to give evidence. He stated that he was not sure why the appellant sold and suggested that it might have been because “notes” (mortgages) to Guaranty Trust and Concord Finance were about to come due. He added, however, that he thought they could have been refinanced. The cash paid on the closing of the sale was, according to Mr Routery, used to retire the mortgages and the balance of the sale price was secured by mortgage which did not fall due until 1975. There was no evidence that any effort was made to sever and retain that part of the 400 acres on which were erected the buildings and other improvements necessary to the continued operation of the appellant’s farming business.

The sale of the 400 acres does not appear to have resulted from pressing need of the sort that one would expect to find if Mr Hays had been determined to continue the business indefinitely in the same area and if he had been uncertain as to security of the lease back. The lands north of Highway No 5, although less important to the continued operation of the appellant, were also sold without any apparent opposition from Mr Hays. Quite simply a developer, Accord Realty, approached Mr Seedhouse with an offer of $2,000 per acre, being a price which Mr Hays said exceeded the value for farming. Mr Seedhouse advised Mr Hays of the offer. Apparently Mr Seedhouse wanted to sell. On cross-examination Mr Hays admitted that there was no particular reason for selling and that he just “went along” with what Mr Seedhouse wanted to do. In short, if the Phillips farm was bought with the pleaded objective in view, then the purchase appears to be in the nature of treatment for a self-inflicted wound.

Other reasons advanced by Mr Hays for the purchase of the Phillips farm were:

(a) the farm had an artesian well, providing the most reliable supply of water in the area; and

(b) Mr Hays wanted Mr Hall, the key employee mentioned previously, to move from his home in the developed part of Oakville into the house on the Phillips farm.

As to the second reason Mr Hays said his objective was to have Mr Hall closer to the centre of the appellant’s activities. As to the artesian well, Mr Hays said it was “the number one reason”. I do not think it was and the appellant’s counsel, in argument, did not suggest it was. Mr Hays recounted an incident in which the well on the 400 acres ran dry during a drought and the water necessary for the cattle was available only from the Phillips farm well. There was no evidence, however, that the incident gave rise to any effort to search for other water sources on the 400 acres. Furthermore, Mr Hays testified that he would not have purchased the Phillips farm had he not sold the 400 acres. That being so, the well could hardly have been the “number one reason”.

The agreement to purchase the Phillips farm was formed on September 29, 1967. Mr Hays stated the the appellant had been renting the farm for many years. In 1965 Mr Phillips died. Following his death Mrs Phillips offered to sell the farm to Mr Hays. Because the appellant had the use of the property under a lease, Mr Hays initially declined. The agreement of purchase and sale was entered into after the formation of the agreement to sell the 400 acres, but before the closing of that sale. The purchase price paid to Mrs Phillips was $3,000 per acre, the same price as had been paid to Tomar for the 400 acres. As to that rate per acre, Mr Hays said, “That’s too expensive to be farming”. He added that a real estate boom was affecting prices in the area.

Mr Hays approached Mr Roman for a loan to assist in the purchase. Mr Roman did not agree to lend money but did agree to join in the purchase. In the result money was forthcoming on the basis that Uranium Truck Lines (1965) Limited (hereinafter called “Uranium Truck”), one of Mr Roman’s companies, became one-half owner. Mr Hays testified that he did not know what Uranium Truck’s business was and that he had to go along with the terms offered, otherwise he could not get the money from Mr Roman.

The arrangements between the appellant and Uranium Truck were Set for- the in a written agreement, Exhibit A-24. Basically, the appellant and Uranium Truck each paid one-half of the amount due on closing and of mortgage payments, both principal and interest. The agreement provided that the appellant was to pay all expenses for maintenance, upkeep, local improvements and realty taxes in return for possession of the property. Where two persons spend a substantial sum of money to acquire property and only one can derive benefits so long as the property is held, it seems obvious that at least one must be looking to resale. The agreement between the appellant and Uranium Truck was concerned, almost exclusively, with the rights of the parties on resale. There was a clause which required either party, upon receipt of an offer, to notify the other and afford the opportunity to purchase. A further clause permitted the appellant, if an offer was received which both wished to accept, to purchase the existing buildings and a maximum of five acres surrounding them, providing the purchaser did not insist on having the whole property. If the Phillips farm was bought with the pleaded object in view, the agreement with Uranium Truck was far from ideal as regards achievement of that object. Notwithstanding, there was no evidence of any attempt to negotiate terms more suited to the stated objective.

Early in 1972 T F Hansford, a real estate agent, tendered an offer to the appellant to purchase the Phillips farm. There was some conflict between the evidence of Mr Hansford that of Bonnie Hays, daughter of T E Hays, as to whether Miss Hays sought offers at a named price or whether the offer was wholly Mr Hansford’s idea. It is not necessary to decide who was correct. It is sufficient to note that the offer was not simply rejected. Mr Hays, Jr, wrote to Mr Hansford in April of 1972 indicating that “our partners” are prepared to entertain an offer on certain terms which he named. The negotiations did not proceed further.

In the Spring of 1973 another offer to pruchase was presented by the witnness Douglass Gray, a real estate broker who acted on behalf of a client named Dixtor Investments Limited (hereinafter called “Dixtor”). The Phillips farm was never listed for sale. Although at the time when the initial approach was made to Mr Hays the latter was not encouraging, he did not refuse to treat. He referred Mr Gray to his son. The son dealt with Mr Roman and with Dixtor during negotiations which lasted over a period of several months. It appears that the appellant and Uranium Truck were not unwilling to sell. Rather, the time was taken in negotiating terms of sale other than price. In the end an agreement of purchase and sale was formed on September 11, 1973.

It should be noted tha Thomas E Hays was plainly the directing mind and will of the appellant. Unless the Dixtor offer was, as alleged in paragraph 5 of the notice of appeal, accepted “due to the desire of Uranium Truck Lines Limited to dispose of its interest in the property” (and not one witness said that such was the case) then the decision to sell was made by Mr Hays alone. Mr Hays testified that he thought the decision to sell was made because his daughter, Bonnie, had just received her real estate license and a million dollar deal would help get her started. He testified further that he had nothing to do with any sale, that his son Tom was involved. Finally, in answer to a leading question from his counsel, he agreed that in 1970 to 1973 the appellant suffered from a working capital deficiency. He did not Suggest that the working capital deficiency caused him to decide to sell. When the sale was concluded, matters were so arranged as to secure a commission for Bonnie Hays.

In a case such as this the circumstances surrounding a sale are significant to the extent that they shed light on the reasons advanced for the purchase. I find nothing in those circumstances which is particularly supportive of the objectives which are alleged to have led to the purchase.

A farm bought and used by a farmer for purposes of farming is a classic example of a capital asset. Any gain realized on the sale of a farm in such circumstances is a gain on capital account. Such gain does not become income simply because a gain on resale is foreseen or intended.

such a case is to be distinguished from one in which a person buys land with a view to possible future use as a generator of income, whether as a farm or as a Site for the errection of a revenue producing building or plant. In such a case, depending on surrounding circumstances, a secondary intention may be inferred. Secondary intention, as referred to in the authorities, involves acquisition with a view to resale at a profit in the course of an operation similar to that carried on by a speculator or dealer in land. The intention is described as secondary because it is seen to coexist with a more important objective involving use as a Capital asset of the property about to be purchased. A conclusion that such a secondary intention exists is much less likely to be drawn in the case of land which is in a state capable of generating a return as capital, one hopes, usually will.

In this case the directing mind and will of the appellant was T E Hays. He alone signed the offer to purchase the Phillips farm. For this reason one cannot infer from the association with Uranium Truck, which was formed after the agreement to purchase was signed, that a primary intent or secon- dary intent to resell at a profit existed at the time of purchase. Thus, the intention of Mr Hays alone is significant. For this reason I disregard some of the evidence which was directed toward establishing what Mr Hays’ intention at various times might have been. For example, evidence of working capital shortages at the time of purchase and at the time of sale might have had significance, but did not because it was evident from what Mr Hays said that such shortages had no bearing on the formulation of his decisions to buy and to sell.

In argument on behalf of the appellant the greatest emphasis was laid on factors which tended to indicate that the appellant’s objective in buying was to ensure that its business would continue to be carried on despite the sale of the 400 acres. In this respect the case appears to be more one of prospective future use of the asset in question rather than one of the immediate use. The property was used between the time of purchase and the time of sale only for purposes of pasture and the growing of hay. It had been used for the purposes for a number of years under lease. Having regard to the price paid and Mr Hays’ remarks, it is obvious that hay and pasture uses were primarily of an interim nature and that if the property is to be regarded as a capital asset it can only be so regarded in relation to plans relating to its use in the event that the lease on the 400 acres were to run out.

Counsel for the appellant contended that the circumstances surrounding the sale show a consistency of intention on the part of the appellant to treat the property as an important capital asset. He pointed out that the evidence of Roger Cooper, the accountant who succeeded Mr Routery, established that the appellant, in 1973, suffered from a working capital deficiency which was rectified by the sale. Although Mr Cooper gave evidence to that effect, there was no evidence that a recommendation to sell was made on that basis or that a decision to sell rested on that basis. Counsel contended further that in 1973 the long term life of the appellant was in doubt. Mr Hays, Jr, said exactly that. The evidence established that the health of Dennis Hall, a key employee, had begun to suffer serious deterioration by 1973. The evidence established, too, that T C Hays was, by 1973, firmly established in the practice of law and was unlikely to take up farming when his father, then 60 years of age, ultimately decided to retire. Such developments tended to indicate that the necessity to retain the Phillips farm as a form of protection against termination of the lease of the 400 acres had diminished subsequent to the time of purchase. There was no evidence, however, that any such development had a bearing on the decision to sell.

While I very much doubt Mr Hays’ evidence that the securing of a commission for his daughter was foremost in his mind when he decided to sell, I do find that there was no evidence of the emergence between 1967 and 1972, when the appellant first exhibited a willingness to sell, of an effective basis for a change in the reasoning which is said to have led to the decision to buy in the first place. The changed circumstances described in evidence did not appear to have caused Mr Hays to decide to sell. The only conclusion I can reach is that the decision was reached long before 1972. On all of the evidence I cannot conclude that the respondent was wrong in proceeding on the basis that the gain in question was income from an adventure in the nature of trade.

The appeal is therefore dismissed.

Appeal dismissed.

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