Recreation Holdings LTD v. Minister of National Revenue, [1974] CTC 2059

The Chairman (orally: October 18, 1972):—This is an appeal by Recreation Holdings Ltd against the reassessment of the Minister of National Revenue for the 1969 taxation year, wherein the gain made on the sale of certain property in the City of Edmonton known as “the Rec property” has been designated by the Minister as taxable income, whereas the appellant has regarded it as a capital gain.

Briefly, the facts are that, as far back as 1947, the Prefontaine family has operated the Recreation Bowling Academy in the subject property, which consists of two bowling alleys with, subsequently, some stores on the ground floor. In the course of this operation, Mr Marcel Prefontaine, one of the two sons in the family, in which there were also three girls, used to work at the alleys in the summertime, when he was available, doing every conceivable job connected with the enterprise. Apparently, the father and the other son Henry worked at the operation on a full-time, permanent basis.

In 1947 each floor consisted of about 15,000 square feet of floor space with 16 alleys to each floor. There were also some billiard and snooker tables.

In 1953 some alterations were made to the premises and it was turned into an office building downstairs with the bowling alley operation continuing upstairs.

The five children subsequently bought out their parents’ interest on an equal basis, each acquiring 20% of the stock in the company, which was known as Recreation Investments Limited. Later on, the eldest of the sisters, then Marcel Prefontaine, and finally the two younger sisters were bought out by Henry Prefontaine, so that, by 1964, he owned all the shares of Recreation Investments Limited.

During the course of my judgment, I shall refer to “Investments”, meaning Recreation Investments Limited: “Holdings”, meaning Recreation Holdings Ltd; and “Rousseau”, meaning the ultimate purchaser of the property in the sale that led to the assessment in question.

Apparently Marcel and the oldest sister received cash for their interests, but the two younger sisters were owed $100,000 each. Either legally or morally—and the evidence is inconclusive as to the legal aspect—Marcel felt some obligation to see that the two younger sisters were protected and would eventually be paid what was owing to them. With the proceeds of sale from his interest, Marcel left the city of Edmonton and went to West Vancouver, where he entered the hotel business, with a partner, and achieved some degree of success in that venture.

His brother Henry continued to operate the Rec property and, in 1965, he branched out and bought a hotel in Kamloops, BC. However, by 1967 I believe it was, his financial position was somewhat precarious as, according to the evidence, Henry had at that time, current obligations, long-term debts to the two younger sisters and, one might infer, long-term obligations in respect of the Kamloops hotel.

Although it was never specifically stated, but was obliquely referred to throughout the evidence, the purchase by Henry of the family shares in “Investments” involved a first mortgage back on the property and a second mortgage to the two younger sisters. As I say, Henry’s financial situation was so bad that in 1968 he contemplated selling the Rec property. A Mr Matthews, who since about 1967 had acted as auditor for “Investments” and had had some association with the Prefontaine family over the years, contacted Mr Marcel Prefontaine and apprised him of the fact that his brother Henry was considering selling “Investments”, whereupon Marcel immediately suggested that they try to put together a group to purchase the property from his brother before it was sold to a third party. He said he wished to ensure that the interests of his sisters would be protected, because, if a stranger were to purchase the property, Marcel would have no control over what might then take place and the sisters, although protected by a second mortgage, might have the asset dissipated to such an extent that they might not receive that to which they were entitled.

Suffice it to say that the sale was eventually completed. The figures in question are set out in paragraph 3(c) of the reply to the notice of appeal and are not in dispute. Recreation Holdings Ltd purchased the property for $756,500 and the sale was completed as of October 31, 1967. Then, on March 14, 1968 “Holdings” sold the property to Rousseau for $890,000. All of this took place within a space of five months, negotiations to sell to Rousseau commencing in January of 1968.

If I have failed to mention it, “Holdings” was a company incorporated by the group that was put together by Marcel Prefontaine and comprising four individuals, namely, Marcel himself, his hotel partner Espo, the accountant Matthews, and a brother-in-law by the name of Dewar. I do not know what the authorized capitalization of the company was, but 300 shares were issued, of which 49 were distributed to Marcel, 100 to Espo, 121 to Matthews and the remaining 30 to Dewar. Three of the four put up money to purchase the property. Matthews received his shares without paying more than the nominal price of the shares upon issue, which I believe was about $1 per share.

The reassessment came about, I presume, because of some very suspicious circumstances, and I shall recite them as I recall them from the evidence of the witnesses who testified (all of whom were called by the appellant), namely, Marcel Prefontaine; Rodney Matthews, the auditor in charge of the accounts: and Theodore Rousseau, the ultimate purchaser, who bought the Rec property through a corporation of which he was principal shareholder.

Matthews was given 40% of the issued capital stock of the company without, as I say, having to put any money in. The property was sold within a very short space of time at a substantial profit as a result of “an unbelievable offer”, according to the witnesses Prefontaine and Matthews. As I say, the sale was made to Rousseau through his corporate entity.

Rousseau was the next-door neighbour of Mr Matthews. In the month following the purchase of “Investments” by “Holdings”, Mr Rousseau disposed of the last of his drive-in restaurants, two of which were “Chicken Delight” outlets and the third a hamburger operation. According to the evidence, Rousseau instigated a discussion with Matthews and asked him whether, being an accountant, he knew of any businesses that Rousseau and his partner might get into now that they had some capital available. Since the manager of the Rec billiard parlour was proving somewhat less than satisfactory, Matthews mentioned it to Rousseau and suggested that Rousseau might consider taking over the management of the billiards establishment.

A short time later, in about the middle of January, Marcel Prefontaine appeared on the scene in Edmonton and met Mr Rousseau, I believe for the first time, on the Rec premises. Mr Rousseau, I think in the form of a direct question, asked Mr Prefontaine whether the Rec property was for sale, to which Mr Prefontaine replied, in effect, that anything was for sale, including his own car, “if the price was right”. He then said that they wanted $900,000 for the property. As I say, the sale was subsequently completed for $890,000.

Matthews got 40% of the shares of the appellant company because he was the only one of the shareholders who would be in Edmonton, the others all being absentee landlords, so to speak. Matthews was to keep his eye on the premises and to see that they were properly kept up. He was to collect the rents and see that the daily cash receipts from the billiards operation, which totalled over $100,000 in the course of a year, were properly accounted for.

One cannot help but ask oneself why Matthews was to get such a large share and why all of a sudden his next-door neighbour turned out to be the angel that always appears in a trading case. It is the thrust of the Crown’s case that this property was purchased with a view to resale at a profit at the earliest possible opportunity, or, alternatively, that an extra step was taken to prevent maximum recapture on the capital assets in the sale from “Investments” through “Holdings” to Rousseau via his corporate vehicle.

Matthews was cross-examined at some length. He is a man who has practised in this city as a chartered accountant for some years. He was a partner in a firm of chartered accountants and is now a part- time private practitioner and corporate accountant.

His evidence was that, so far as he was concerned, a tremendous amount of work would have been required of him over a period of at least seven to ten years before he would begin to reap his reward. He would not share in the profits of the company until the shareholders’ loans, none of which he had made, were paid back. I can only assume that he, as an experienced accountant, worked out the arithmetic required to arrive at the conclusion that seven to ten years would have to elapse before he received any benefit from the Rec property. He said that he would not have taken any less percentage and that one of the partners had objected to his getting as much as he did. However, there is no evidence that he was actually asked to take any less.

Marcel Prefontaine explained that he was really only interested in protecting his sisters’ interests. He said that when the offer was made he felt he could not turn it down. He did not have to worry about his sisters any longer, because he still had a 30% interest in the “Rousseau” purchase because, in the result, Rousseau and his partner could not come up with sufficient cash to close the transaction. Obviously, he said, if the sisters were secured as second mortgagees in a purchase price of $756,000, certainly their security would not be diminished at all when the property was sold for $890,000. Marcel Prefontaine’s evidence was that he had no intention of staying in Edmonton, and that he would not have engaged and involved Matthews to the extent that he did had he planned to remain there.

One cannot help but jump immediately to the conclusion that Marcel Prefontaine wished to dispose of this property at the earliest possible moment, take his profit, and go back to his hotel operation in British Columbia. To do so, one has to ignore completely the set of facts that surround this whole transaction. First of all, if he intended to turn the property over at a profit, and if this was a scheme, why did he give Matthews such a large investment in it? Why wouldn’t he keep it for himself? Did Matthews have a connection with Rousseau? Was that the quid pro quo for putting Rousseau into the deal?

To find an affirmative answer to that proposition, I would have to disregard the evidence of Rousseau, who, in his examination-in-chief, said that he did not have the money to enter into this venture until after “Investments” had purchased the property.

The evidence of Matthews was that there was no extensive socializing between himself and Rousseau. He had learned that Rousseau had divested himself of his restaurant businesses through his (Matthews’) daughter, who was a friend of Rousseau’s daughter. There is nothing in the evidence to connect Rousseau and Matthews and lead me to the conclusion that there was a conspiracy, a connivance, or a scheme afoot on their part to get this property from Henry Prefontaine, for whom ‘Matthews acted as auditor, at a rock bottom price, in order to sell it at a substantial profit a short while later.

Matthews stated in his evidence that he is a professional man, that he would be derelict in his duty, would have a conflict of interest, and his professional integrity would be damaged beyond repair, were he to be a party to such a conspiracy. I cannot agree more.

The onus in these cases is always upon the appellant, but it is an onus of adducing evidence to explain the transaction. It is the simple onus of proving, on a preponderance of evidence and not “beyond reasonable doubt”, that the transaction in question in a trading case was a legitimate one and resulted in a capital gain as alleged by the appellant.

In my view, once the appellant has satisfied this onus through the testimony of the witnesses that he has put before the Board and has tilted the scales in his own favour, then the onus shifts to the Minister of National Revenue to show that his reassessment is right in law and in fact and to disprove or break down the appellant’s explanation.

Counsel for the Minister, as always, has very persuasively pointed out the loose ends in the appellant’s case. In my view, it requires more from the respondent than an attack by counsel upon the evidence and argument of the appellant to justify the reassessment that has been made, once the appellant’s explanation has been accepted, if it is accepted, by the Board or the Court. No attempt has been made in this case, as is true of almost every trading case, to adduce evidence on behalf of the Minister of National Revenue in an effort to cast doubt on the veracity or integrity of the witnesses called by the appellant.

There were many answers given by Mr Marcel Prefontaine that displeased me. He forgot many things, even to the extent that one began to wonder how deeply he had searched his memory for the answers. But I found corroboration of much that he said in the evidence of Mr Matthews and, to a lesser extent, in the testimony of Mr Rousseau.

On the evidence, I am unable to find that a man of the professional training and experience of Matthews has come before this Board and perjured himself or in any way given testimony that has been challenged or is beyond belief. Notwithstanding the obvious suspicions that beset me throughout much of this case, on reviewing the evidence of Matthews, Prefontaine and Rousseau I am satisfied that it was a fortuitous sale. Although the transaction occurred within a very short time after the purchase of the property by “Holdings”, the officers of that company did not take the initiative in the subsequent sale nor did they back away from it when the opportunity to realize a suitable profit came about.

As for witnesses who might have been called but were not, I can only assume, as is the general rule in a court of law, that they were not called because their testimony would not have assisted or advanced the case of the party who might have called them. This comment applies as much to the respondent as to the appellant.

As I say, I am satisfied, on the evidence before me, that this was a fortuitous gain, and that the appellant was right in regarding it as a capital accretion. The appeal is therefore allowed, the Minister’s reassessment set aside, and the matter referred back for reassessment deleting the profit made on the sale of the Rec property from the income of the appellant company for the 1969 taxation year.

Appeal allowed.