Belley v. R., [1998] 3 CTC 2001

Lamarre T.C.J.:

This is an appeal from an assessment made against the appellant for the 1990 taxation year. The issue concerns the profit which he made on the sale in 1990 of real property located at 166 Maltais Street, Sept-Iles, Quebec. The appellant did not report this profit in his tax return for 1990. The Minister of National Revenue (“the Minister”), while auditing the appellant’s income, added business income of $95,370 to the appellant’s income for 1990. He also imposed a penalty of $12,637.30 on the appellant pursuant to s. 163(2) of the Income Tax Act (“the Act”).

The appellant is challenging this assessment on several points. First, he maintained that the profit made at the time of the sale was not $95,370 as the Minister alleged but $70,370.69. The $25,000 difference results from calculating the cost of the property. The appellant maintained that the cost was not $220,000 as assumed by the Minister, and as appears in the notarized contract of sale of June 4, 1990, but actually $245,000. He claimed that he had paid the purchaser $25,000 in cash at the time he had purchased the property.

Secondly, the appellant maintained that this profit was a capital gain within the meaning of the Act and not business income. He wished to deduct from this capital gain capital losses for the year and capital losses for previous years. Additionally, he claimed the right to a reserve under s. 40(1) of the Act. On this point, the appellant maintained that he had assumed a selling price balance of $95,000 at the time of the sale of the property, payable over a five-year period. The Minister challenged the right to the reserve assuming that the income in question was regarded as a capital gain. Finally, the appellant claimed the right to a capital gains deduction under s. 110.6(2) of the Act and argued that the penalty was unfairly imposed.

Facts

Four other persons testified in addition to the appellant. One was Jocelyn Gallant, owner of Pétroles Perreault Inc. (“Pétroles Perreault”), who bought the property at issue from the appellant. Claude Lalancette, a heavy machinery operator and co-shareholder with the appellant, Mr. Riverain of Constructions Industrielles Clément Belley (1990) Inc. (“Constructions Bel- ley”) and Roger Boudreau, a real estate broker concerned in the purchase and sale of the property, testified regarding the circumstances surrounding each of those transactions. Finally, Gilles Grégoire, an auditor for Revenue Canada, gave the version of the facts which he obtained in the course of his audit.

In 1990, the appellant was the principal shareholder of Constructions Belley, which operated a business in the field of industrial construction. He owned 70 per cent of the shares in the company. Claude Lalancette, his son- in-law at the time, held 24 per cent and a third person, Mr. Riverain, held 6 per cent. The appellant was also the sole shareholder in another company, Les Immeubles Cèbe Inc. (“Immeubles Cèbe”), which owned the land and building where the head office of Constructions Belley was located, at 520 Perreault in Sept-Iles. Immeubles Cèbe also held other property, including the two buildings adjoining 520 Perreault.

Early in 1990 the appellant and his co-shareholders in Constructions Belley agreed it was time to take a decision on the eventual move of their head office, since the building at 520 Perreault no longer seemed to suit the needs of the business. At that time, the trucks did not have access to the garage on the land and there was too little parking space. They therefore looked at two vacant lots with the idea of putting up buildings which would suit the needs of the business. This construction project did not go forward since in one case the land was not in an industrial zone and in the other the land was too expensive.

After these initial efforts, sometime in March 1990 the appellant contacted Roger Boudreau with whom he was doing business for a long time (among other things, Mr. Boudreau sold two other properties owned by Immeubles Cèbe, namely the building adjoining 520 Perreault and another property in Haute-Rive). Without giving him any specific mandate, the appellant asked Mr. Boudreau to let him know if he found property suitable for the needs of Constructions Belley.

At about the same time, Mr. Boudreau received a mandate from Jocelyn Gallant, whom he knew through his accountant. Mr. Gallant explained that Pétroles Perreault had purchased the Esso distribution network and another network from a private owner in February 1990 and that he then had an urgent need to relocate his fleet of trucks. He visited apparently two locations with Mr. Boudreau, but they were not suitable.

Furthermore, according to Mr. Boudreau’s testimony it was not until April 1990 that he had obtained a mandate from Mr. Gallant and not until June that it had occurred to him that the property on Maltais Street, the subject of the instant case, would suit the needs of Pétroles Perreault. Mr. Gallant had a budget of $400,000 for the purchase of a new property. He said in his testimony that Mr. Boudreau in fact suggested the Maltais Street property to him and that the asking price was $365,000.

Concurrently with his contract with Pétroles Perreault, Mr. Boudreau received another mandate on April 4, 1990, from Léonardo Ianni to sell the Maltais Street property for $265,000. It appeared from the evidence that at that time Mr. lanni was not yet owner of the property but had been given a promise of sale by the then owner, Neilson Excavation Inc. Mr. lanni accordingly undertook to purchase the property for $100,000. Mr. Ianni said he told Mr. Boudreau he had only bought the property to resell it at a profit as soon as possible. At that point Mr. Boudreau allegedly offered the property to the appellant. Mr. lanni allegedly then refused the appellant’s first offer made on behalf of Immeubles Cèbe on April 11, 1990 for $180,000. On the same day Mr. lanni made a counter-offer to the appellant for $245,000, $25,000 of which was payable in cash, [1] and the appellant allegedly accepted this counter-offer on April 12, 1990 (again on behalf of Im- meubles Cèbe). Subsequently, according to Mr. Boudreau’s testimony, Mr. lanni sent him a letter dated April 29, 1990 in which the latter said he no longer wished to honour the terms of the counter-offer since Mr. lanni had another more worthwhile purchaser in mind. Mr. Boudreau recommended that he contact a lawyer as he himself considered he was bound by the counter-offer. Mr. Boudreau indicated that Mr. lanni was very angry with him and had the impression that he had been deceived by his broker. Two days later, Mr. lanni finally agreed to adhere to his counter-offer, considering that he had already made a good profit.

On May 29, 1990, the National Bank of Canada (“the Bank”) made a financing offer to the appellant in the amount of $220,000. [2] The appellant thus borrowed this amount at a floating rate on June 1, 1990, a rate that was higher than if he had borrowed at a fixed rate, on a one-year term promissory note. [3] The appellant said he preferred to borrow at a floating rate as by this means he knew exactly the amount of capital he was repaying. On reading the Bank’s financing offer, [4] however, it can be seen that the borrower who borrows at a floating rate can repay all or part of the loan at any time without penalty, which is not possible in the case of a fixed rate loan. In the same offer the Bank indicated that the loan was to be used to finance the purchase of the Maltais Street property for $245,000. The Bank financed $220,000 and the appellant supplied $25,000 from his working capital. The Bank required the property as security as well as a further security of $80,000 supplied by Immeubles Cèbe. Earlier, the appellant mentioned that the Bank had refused to finance the purchase of the property by Immeubles Cèbe. That is why the property was purchased by the appellant himself on June 4, 1990. The price indicated in the contract of sale was $220,000. Mr. Boudreau said he gave the officiating notary instructions to indicate this price. He said the sum of $25,000 had certainly been paid to Mr. lanni by the appellant as, after the letter he had earlier received from Mr. lanni, the latter would never have agreed to sell the property for $220,000. The appellant, for his part, indicated that he had withdrawn $30,000 from his bank account on June 4, 1990 [5] and given Mr. lanni this sum in the presence of the notary and Mr. Boudreau. The sum of $30,000 included the $25,000 payable in cash on the price of the property and $5,000 used to pay for equipment which the appellant had purchased and which was located in the building.

According to the appellant and Mr. Lalancette, they had planned to move the Constructions Belley head office in July 1990, during the construction vacation. They said that the new building on Maltais Street was ideally suited for their needs as it formed a block opening onto four streets and, though not much larger than the existing building on Perreault Street, the building was taller and could accommodate a truck. The parking was also much bigger. However, although the property had previously been occupied by a construction business (Nielson Excavation Inc.), it had not been in use for about four or five years. Everyone agreed that the building needed repairing and repainting. No such repairs were done by the appellant between the date of the purchase offer in April 1990 and the date the contract of sale was concluded. The appellant explained this by saying that Mr. Boudreau had told him he should wait since he was not quite sure Mr. lanni would keep his word. At the same time, no effort was made to rent or sell the Perreault Street property either.

According to the appellant it was not until after this transaction was concluded on June 4, 1990 that he heard of Pétroles Perreault for the first time. He said Mr. Boudreau came to tell him that he had a purchaser at a very good price, some $375,000. The appellant, who said he bought the Maltais Street property to relocate his business, talked to his co-shareholder Mr. Lalancette about it and they both quickly agreed that they could not pass up such an offer. Accordingly, they gave Mr. Boudreau the green light the next day to meet with Mr. Gallant and to offer the property in question to him. The appellant indicated that as soon as Mr. Boudreau told him of the existence of Pétroles Perreault he wanted the matter to be arranged as soon as possible so he could know whether he should start the repair work. Accordingly, Mr. Boudreau organized a meeting between Mr. Gallant and the appellant. Both Mr. Gallant and the appellant agreed that the appellant would undertake certain renovation work. On July 11, 1990 Pétroles Perreault accordingly made an offer to purchase the Maltais Street property for $365,000, in which he specified that he had until August 11, 1990 to take up this offer, and this was agreed to by the appellant. [6] The appellant also undertook to make the necessary renovations to the building. Finally, Pétroles Perreault exercised its offer and the sale went through on September 18, 1990. Mr. Boudreau received $10,000 commission on the sale, paid by the appellant as agreed between them.

Once the sale had been concluded with Pétroles Perreault, Constructions Belley decided to keep its head office at 520 Perreault. A building adjoining 520 Perreault and owned by Immeubles Cèbe was demolished to provide parking and the existing premises renovated to make them more suitable (a new garage door was built so trucks could get in and a body shop created). This work cost a total of $13,510.22. [7]

Gilles Grégoire, auditor for Revenue Canada, mentioned in his testimony that the appellant had indicated to him at the time of the audit (which took place in June 1994) that he had a potential purchaser when he bought the Maltais Street property. He further indicated that the appellant had not only failed to report the profit on the sale of the Maltais Street property but also the interest on the balance of the selling price in subsequent years. The appellant explained this by saying it was a mistake. It was the Constructions Belley internal auditor who was responsible for sending all the papers for the business and the appellant’s personal papers to the accountant. He thought this file had simply not been sent to the accountant or, if it had been sent, the accountant had disregarded it in making up the appellant’s tax return. The latter mentioned that in signing his return he did not notice that the transaction was not included as, in any case, he received no money from the transaction in 1990 since he financed a large part of it, namely $95,000. He replaced his accountant the following year. The appellant said his statements of account should have been sent to the accountant and he did not understand why the interest was not reported. In any case, he relied on the accountant and he did not generally re-read his tax returns before signing them. In his notice of objection, the appellant gave another version. He said the reason he did not mention the transaction was that he thought that in any case it was covered by the capital gains exemption under the Act.

Analysis

Counsel for the appellant argued that at the outset the purpose of purchasing the property was simply to relocate the Constructions Belley headquarters. He argued that the mandates given to Mr. Boudreau should be treated separately and that the appellant should not be regarded as having had an intention to resell at a profit when he purchased the Maltais Street property simply because at the same time Mr. Boudreau had obtained a mandate from Pétroles Perreault to find him a site.

I do not share his view on this point. What I conclude from the evidence is that the appellant and Mr. Boudreau were people who knew each other very well and were in the habit of working together. Mr. Boudreau and the appellant both admitted that at the time the Maltais Street property was bought the appellant knew it was a good deal. Furthermore, the appellant made a purchase offer to Mr. lanni on the Maltais Street property at the same time Mr. Boudreau received the mandate from Pétroles Perreault. Mr. Boudreau said he was almost certain he did not get the mandate from Pétroles Perreault until after the appellant had made his offer to Mr. lanni. Mr. Gallant appeared to say that he gave his mandate to Mr. Boudreau as early as February 1990.

lam more inclined to believe Mr. Gallant’s version. The letter sent by Mr. lanni to Mr. Boudreau shortly after he accepted the $245,000 counteroffer, indicating that he could have sold to another purchaser for much more (counsel for the appellant mentioned a sum of $400,000, which could suggest that the purchaser might have been Pétroles Perreault), and the reaction of Mr. Boudreau, who was anxious to see the sale made to the appellant, make me more inclined to think that the appellant and Mr. Boudreau agreed that the appellant would purchase the property in question and resell it soon afterwards at a profit. Furthermore, the evidence disclosed that there was an agreement between the two of them that Mr. Boudreau would receive a $10,000 commission on the sale. In view of the friendship between them, I do not see how the appellant could not have known of the Pétroles Perreault purchasing plans. I also come to this conclusion because the appellant made no attempt to re-let or to sell the Perreault Street building and no steps were taken to repair the Maltais Street building.

Furthermore, it can be seen that the renovations made to the 520 Perreault head office were much less expensive than what the plan to move to Maltais Street would have cost. In my opinion, this confirms that all the appellant really intended was not to move to Maltais Street but to resell it at a profit in the near future. Mr. Grégoire’s testimony that at the time of the audit the appellant mentioned that he had a potential purchaser when he made the purchase thus seems to me to be quite plausible. Furthermore, the appellant took care to finance the purchase of the property with a one-year floating rate loan. Although he explained this by saying that it enabled him to know exactly how much capital he was repaying, it can easily be seen that this was a much better arrangement for him if he was intending to repay before the expiration of the term, and that is what actually happened. He was not subject to any penalty.

Moreover, even if I were to conclude that the appellant’s initial intent in the purchase was to relocate the Constructions Belley head office, it seems clear that he had in mind the possibility of reselling at a profit as the reason prompting him to enter into the transaction. The transaction was accordingly also one in the nature of trade. [8]

I therefore come to the conclusion that the appellant has not shown on a balance of probabilities that the transaction at issue resulted in the making of a capital gain. In my opinion, the transaction was speculative in nature and so taxable as business income. The questions of entitlement to a reserve and the carryover of capital losses thus do not arise in the instant case.

As to the question of the initial cost of the property, I consider that the appellant has shown on a balance of probabilities with the documents entered in evidence that he paid Mr. lanni $245,000 to purchase the property. The counter-offer of April 12, 1990, accepted by Mr. lanni and the appellant, constituted a mutual agreement between two parties. Furthermore, the bank document filed as Exhibit A-10 clearly shows that the amount was withdrawn from the appellant’s bank account on the day the deed of purchase was signed. Mr. lanni’s reaction, when he no longer wanted to sell because he had found another purchaser at a better price, in my opinion confirms that that amount actually was paid by the appellant when the property was purchased.

As to the imposition of the penalty under s. 163(2) of the Act, counsel for the appellant argued that this was simply an accidental oversight and that the appellant thought he had nothing to report since he had assumed a selling price balance and the transaction had actually not been profitable for him in 1990. The appellant replaced his accountant in later years and the transaction went unnoticed.

The respondent has the burden of showing on a balance of probabilities that the appellant failed to report the profit at issue knowingly or in circumstances amounting to gross negligence.

The concept of gross negligence has been analysed by the courts many times. The judgment on the question of penalties that is most often cited, and which was referred to by counsel for the respondent, is that of the Federal Court Trial Division in Venne v. R. [9] Strayer J. said the following about “gross negligence”: [10]

“Gross negligence” must be taken to involve greater neglect than simply a failure to use reasonable care. It must involve a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not.!! [11]

The explanations given by the appellant did not persuade me that he demonstrated simply a failure to use reasonable care in the circumstances. The fact that he did not look more closely at his tax returns and signed without examining them, relying exclusively on his accountants, seems to me to demonstrate indifference as to whether the law is complied with or not. Not only did the appellant not report the profit in question in 1990, he did nothing to ascertain whether the interest income generated from the selling price balance was entered in his tax return for subsequent years, although his capital losses were included in those returns. To use the language of Judge Dussault of this Court in Sigouin c. Ministre du Revenu national^ [12]

Thus, if the appellant did not “knowingly” fail to declare the rental and interest income, the absence of any effort whatever on his part constitutes, in my view, “gross negligence” within the meaning of subsection 163(2) of the Act.

I am persuaded by all the foregoing evidence that the appellant knowingly, or in circumstances amounting to gross negligence, failed to report the profit made by him in 1990 on the sale of the Maltais Street property.

For these reasons, the appeal is allowed and the assessment referred back to the Minister for reconsideration and reassessment on the basis that the adjusted cost base of the property at issue was $245,000 and the profit made on the sale was $70,370, which must be regarded as business income pursuant to the Act, not as a capital gain. The penalty under s. 163(2) of the Act is upheld, but must be recalculated accordingly.