Bardot Realty Limited and Joleen Investments Limited v. Minister of National Revenue, [1972] CTC 98, 72 DTC 6079

Walsh, J:—The facts of these two cases, which were heard together, are identical. Three companies were originally involved, the third being Terry Heights Realty Limited, which, however, paid its tax assessment for the year in question without protest. The fact that it did so can in no way prejudice the appeals of the other two companies. Each of the three companies was beneficially owned by one of the married daughters of Matthew Elman who managed them for his daughters in consultation with them and, in fact, had set them up as part of an estate planning scheme to provide for them, the three charters being acquired, one for each daughter, through his attorney. The business of each of the three companies was identical, namely the lending of money, some of which was borrowed from the bank and some from Elman himself, to third parties on the security of promissory notes, mortgage liens and similar agreements. Neither Mr Elman, his daughters nor any of the companies had ever engaged in the business of buying or selling land although the objects clauses of all three companies were sufficiently broad to enable them to do so should they so desire.

In about the year 1963 Mr Elman was approached by the attorney of three developers, namely Bernard Benjamin, Joseph Gordon and David Leifer, who controlled a company by the name of Brimfield Investments Limited, with a request to loan them $65,000 by way of a mortgage on property which they had an option to purchase in St Catharines and on which they proposed to build a number of townhouses. He was shown plans and a commitment to them from Standard Life Assurance Company to eventually lend them some $880,000 as primary lender, and a further tentative agreement with the Metropolitan Trust Company for temporary financing in the amount of about $500,000. These commitments convinced him that the proposal was a serious one, and he had had satisfactory business relationships with the three individuals concerned previously, but he did not wish to lend the money to buy the bare land on the basis of a short term mortgage. The developers themselves had apparently only put up $500 of their own money for the option plus whatever other expenses they had incurred in connection with their preliminary plans and negotiations with the lending companies. He therefore turned down the initial proposal.

Subsequently they approached him again with another proposai by virtue of which, if he would undertake to lend them the $65,000 which they required to take up their option on the property before it expired on August 15, they would undertake to repay him the sum of $70,200 in two months with interest at 12%. This bonus or premium was calculated on the basis of $50 per house on each of the houses which they proposed to build on the property in question, but the manner in which it was calculated is of no significance in the present case, as there is no suggestion that Elman or any of the three companies he managed had entered into any sort of partnership with Brimfield Investments Limited nor that they had at any time themselves been builders or developers. As security for repayment of this loan of $65,000, Brimfield Investments Limited signed a note in the amount of $70,200 with interest at 12% payable on demand and Joseph Gordon, Bernard Benjamin and David Leifer jointly and severally signed the note as guarantors. As further security title to the property was taken in the name of Bardot Realty Limited, Joleen Investments Limited and Terry Heights Realty Limited by virtue of a direction given to the vendors by Messrs Benjamin, Gordon and Leifer. This direction, the promissory note, and the conveyance were all executed on August 15, 1963 and on the same date an agreement was made between Bardot Realty Limited, Joleen Investments Limited and Terry Heights Realty Limited on the one hand and Brimfield Investments Limited, Bernard Benjamin, Joseph Gordon and David Leifer on the other hand, giving Brimfield an option to purchase the lands back for the price of $70,200 subject to adjustments at any time up to October 15, 1963. The agreement provided that in this event the promissory note would be delivered to Brimfield for cancellation and interest thereon waived, but if the option was not exercised by that date then the note would immediately become due and payable and, furthermore, that Brimfield and Benjamin, Gordon and Leifer would indemnify Bardot Realty Limited, Joleen Investments Limited and Terry Heights Realty Limited for any costs, expenses or losses incurred by them in any sale of the land, which sale they could make either by private sale or by public auction.

Brimfield: Investments Limited made default in payment of the loan and their option to repurchase the property accordingly expired on October 15, 1963, but Mr Elman testified that although he kept pressing them for payment he did not wish to avail himself of their default in order to retain the property. All he was interested in was securing repayment of the loan together with the $5,200 premium and the interest due, and there is nothing in his conduct or in the evidence to contradict this. He was not unduly concerned when no building took place during the winter months but in May 1964 he saw a letter from the Public Works Department of the City of St Catharines which indicated that difficulties had arisen in connection with the installation of the sewers and utilities and he was given to understand by the borrowers that these might now cost about $130,000 instead of the $15,000 they had anticipated. Finally they indicated to him that they were not going to proceed with the project at all, and on September 18, 1964 Brimfield Investments Limited entered into a quit claim deed with Bardot Realty Limited, Joleen Investments Limited and Terry Heights Realty Limited whereby the former divested itself of all interest of whatsoever kind which it had in the above-mentioned property in consideration of which the three lending companies released it from any of its obligations as set out in the agreement between them of August 15, 1963. No specific mention was made of the promissory note and it would appear that the effect of this quit claim agreement was that Brimfield Investments Limited would no longer be liable to make good any expenses or losses incurred by the lending companies in the resale of the property which they were now retaining, but that Messrs Benjamin, Gordon and Leifer might still be liable on the promissory note. It is not necessary to reach a conclusion on this point, however, to decide the present case.

At this stage, according to Mr Elman’s evidence, he did not know what to do with the property which the companies he was managing had no desire to retain, not being developers or in the business of buying and selling real estate. He realized that it should be sold but had no idea whether this would result in the recovery of the $65,000 loaned or not. It was conceded at the hearing before me that if the sale of the property had resulted in the companies recovering the $65,000 loaned together with the $5,200 bonus and the interest, the sums received by way of bonus and interest would be taxable income in the hands of the companies. It is the excess over and above these sums which resulted from the resale of the property by them that appellants contend should be treated as capital gain.

While Mr Elman was still deciding what to do he was approached in October by a Mr David Gallo who indicated that he was interested in buying the property and asked him how much money he had tied up in it. Mr Elman, being a shrewd bargainer, mentioned a figure of $100,000 and Mr Gallo then asked him if he would be interested in selling it for $130,000. Needless to say, Mr Elman accepted with alacrity and the sale was completed on October 20, 1964, resulting in the three companies sharing a profit of $65,000 as a result of this fortuitous sale. What had happened was that Mr Gallo had apparently learned that Brock University was about to be built in the vicinity of this property in St Catharines resulting in a sharp increase in the value of it. Mr Elman did not know this at the time of the sale and it can be assumed that Messrs Benjamin, Gordon and Leifer had no knowledge of this development either or they would not have abandoned the property. It is true that their option to repurchase same had already expired the preceding October but as Mr Elman indicated, and there is nothing to dispute his evidence, all he wanted was to get his $70,200 plus 12% interest and on payment of this would gladly have made over the property to Brimfield Investments Limited at any time, even after their option to repurchase had expired.

It seems clear that the acquisition of the title in the property by Bardot Realty Limited, Joleen Investments Limited and Terry Heights Realty Limited was inextricably associated with the lending transaction made by them in the normal course of their business and can in no way be assimilated in its effects to the purchase of a piece of land by them as an investment. Despite this, appellants argue that the profit subsequently realized from the sale of this property as the result of an unsolicited offer made because of developments which had taken place which were unforeseeable at the time they acquired the property should be treated as a capital gain on disposal of an investment. They contend that the profit cannot be considered as having resulted from an adventure in the nature of trade since the sale of real estate was not normally a part of their business and they did nothing whatsoever to promote or advance this sale, the profit being in the nature of a windfall.

It is of interest to note how this transaction was treated in the books of appellants. In its 1963 balance sheet, appellant Joleen Investments Limited shows among current assets an amount of $21,615.11 as “inventory — land (at cost)”. In its 1964 balance sheet this item disappears and is replaced under current assets by an item “mortgage receivable $33,333” (it should be pointed out here that on the sale to Gallo for $130,000, the sum of $29,474.38 was paid prior to or at the closing after allowing for tax adjustments, the balance of $100,000 remaining on the property by way of mortgage). On the liability side of the balance sheet we find under “retained earnings” the item “gain on realization of loan $21,530”. The identical figures appear under the same headings in the 1963 and 1964 balance sheets of Bardot Realty Limited. It is evident that each of the appellants took one-third of the cost price of the land ($65,000) into its inventory of current assets in 1963 ($21,605.11, evidently after some small adjustments), that in the year 1964 after the land was sold and, in addition to the down payment, they now held a mortgage for $100,000, they each took one-third or $33,333 into current assets as a mortgage receivable, and that each company considered that the difference between the amount loaned of $65,000 and the sale price of $130,000 amounting to $65,000 represented a gain on realization of the loan, each company’s one-third interest (after adjustments) being shown in the amount of $21,530 as a separate item under “retained earnings” rather than being included in the net profit for the year.

By assessments dated March 12, 1969 each of the appellants was reassessed by respondent in respect of its 1964 taxation year by the addition to its declared income of this sum of $21,530 and after Notices of Objection filed on April 15, 1969, these reassessments were confirmed by the Minister on March 5, 1970. As a result of these reassessments Joleen was assessed tax of $2,878.20, an increase of $2,583.20 over the $295 declared, and Bardot was assessed $2,051.52. It is against these reassessments that the present appeals have been brought.

There are various ways in which a lender can obtain security for the repayment of his loan. He can content himself with taking merely the promissory note of the borrower, he can demand that the note be endorsed or guaranteed by third persons, he can require that collateral of some sort be deposited as security, he can take a mortgage on the real property of the borrower, or he can take title to the real property of the borrower (or, as in the present case, property which the borrower proposes to purchase) and by a collateral agreement agree to reconvey same to the borrower on the fulfilment of the terms of the loan. In the present case the lenders chose to combine several forms of security for repayment of the amount loaned and the premium for making same. Not only did they take a note from the primary borrower, Brimfield Investments Limited, but, as is quite usual, required that this note be co-signed as guarantors by the three individuals who controlled that company. In addition to this they took title to the property in their own corporate names and by collateral agreement gave the borrowers an option to take it back within two months on fulfilling the terms of the loan and paying the premium of $5,200 for same. In the event of default, 12% interest on $70,200 would be due in addition to this capital sum. Although substantial corporations such as the Standard Life Assurance Company and the Metropolitan Trust Company had made commitments to finance the borrowers’ project it had not reached the stage when drawings could be made against these financial commitments, and in fact the borrowers did not even own the property yet but merely had an option to buy same. The fact that there was some speculation and risk involved is apparent, as subsequent events proved when the borrowers were unable to go through with the project and abandoned the property, and this element of risk justified the lenders charging $5,200 for what was to have been, in effect, a loan of the sum of $65,000 for two months, and in demanding various forms of security. It was a business transaction made in the ordinary course of the business of appellant companies of lending money, and Mr Elman evidently considered that, with the security offered, the profit to be anticipated justified the risk. The possibility of having to keep the property, therefore, in order to recover the sum loaned, premium for making the loan and interest, always existed, and in this event if the property had to be sold this resale might have resulted in either a profit or a loss and it was unforeseeable at the time of the loan or of the quit claim deed confirming the decision to retain the property that a large profit in excess of the premium anticipated and interest would be realized. My view as to the nature of the transaction is fully borne out by the judgment of Grant, J of The High Court of Justice of Ontario in the case of Sidmay Ltd et al v Wehttam Investments Ltd, [1966] 1 OR 457, in which it is interesting to note the same parties were involved in an identical transaction, although the issue was not one of taxation but rather of the validity of mortgages taken by the defendant corporation which was not registered under The Loan and Trust Corporations Act, RSO 1960, c 222. In this case Matthew Elman and his three daughters owned all the preferred shares of the defendant company and Mrs Elman owned all the common shares. The Messrs Gordon and Benjamin, who were the owners of the shares in the plaintiff companies, caused Natham Leifer to. purchase as a nominee for a company to be formed by them (which company became the Sidmay Company) certain land in the Town of Burlington for $55,000 on which they proposed to construct 64 two-storey maisonettes. They approached Elman for a loan and after he had ascertained that the Canada Trust Company had agreed to advance funds by mortgage loan on the buildings he offered to purchase the land in the name of the Bardot, Joleen and Terry companies instead of having same purchased by Sidmay, and Sidmay would then have the option to repurchase the land from these companies for the price paid plus $50 for each apartment to be constructed thereon, which in this case amounted to a bonus of $3,200 so that on taking title back they would be paying $58,200 for the $55,000 loan. The loan was made on April 17, 1964 and they had until July 1, 1964 to exercise the option to repurchase. It will be seen that the method adopted to carry out the transaction and the parties involved was identical with the present case. In rendering judgment Mr Justice Grant stated at page 460:

Although such arrangements took the form of such agreement with an option to Sidmay to repurchase, the true intent of the parties was that it was in fact a loan on the security of the lands to be so acquired. The amount advanced was to be $55,000 and the interest was to be $3,200.

I agree entirely with these conclusions which are applicable in the present case.

The fact that appellants acquired the property as part and parcel of a lending transaction, however, and not with the intent of reselling same at a profit, and that the profit was in the nature of a windfall does not lead to the conclusion sought by appellants that it should therefore be considered as in the nature of capital gain. In support oi this contention, appellants’ attorney cited several cases, none of which appear to me to be directly in point or to lead to the conclusion he wishes to draw from them. In the Tax Appeal Board case of Douglas Casey v MNR, 25 Tax ABC 49, appellant had accepted a piece of vacant land which he considered at the time to be worth about $300 in satisfaction of a debt of $600 which he was having difficulty collecting. Subsequently he was able to sell this property for $850 making a profit of $250 which the judgment treated as capital gain. Mention was made in the judgment, however, of the fact that the debtor also owed appellant another three or four hundred dollars in respect of other transactions which was uncollectable so the total owed was more than the sale of the land realized. More important, appellant was not in the money lending business but this was merely an incidental transaction of a capital nature. In another Tax Appeal Board case, Baker Estates, Limited v MNR, 11 Tax ABC 391, a company which had acquired property on which to build dwellings as an investment was forced to sell the property due to the ever-increasing cost of labour and materials and lack of funds to carry out the building project. Although the sale resulted in a profit, the basis of the decision was that the lands had been bought as an investment and were sold only when what was thought to be a good investment turned out to be a dangerous risk and this was simply the realization of an investment rather than a real estate transaction. This was also the basis of the finding of Kerr, J in Shields-Snow Limited v MNR, [1971] CTC 848, where a gain realized on the sale of a shopping centre was held to be a capital gain from the sale of an investment and not income from an adventure in the nature of trade. The project, although financed almost wholly by borrowed funds, was a viable operation which was sold after three years under pressure from the bank as the result of an unexpectedly tight money situation which left the company short of cash. Similarly, in the case of Bead Realties Limited v MNR, [1971] CTC 774, the basis of the decision was that the appellant had a sincere intention of developing property which it had acquired as an investment by building warehouses or similar industrial buildings on same to the specifications of tenants to whom it would lease them. When the member of the firm who was managing this enterprise was moved out of town and the appellant received soon after an unsolicited but generous offer, the property was sold. The profit was held to constitute capital gain. The case of MNR v Valclair Investment Company Limited, [1964] Ex CR 466; [1964] CTC 22, held that for a purchase to qualify as an investment the object purchased must at least be susceptible of yielding an annual return such as rental, dividends or interest, although the amount of the return is not important. In this case the respondent had made an incidental purchase of real estate which it rented for a very nominal sum. It made no effort to sell the property but eventually accepted an unsolicited offer which yielded a substantial profit and this was held to be the realization of an investment.

In all of these last four cases the property in question had been purchased as an investment, according to the finding of the Court. In the present case, the fact that the purchase and sale of real estate is not part of the normal business operations of appellants does not mean that they acquired the property in question as an investment. They did not acquire ownership of it because they wanted to with the intention of deriving income from the use or development of it. On the contrary, they acquired it as part of their normal business operations and as the security which they took for guaranteeing repayment of the loan. The subsequent realization of this security, since it yielded a profit to appellants, must be considered as a profit resulting from this business transaction even although this profit at least to the extent of the amount realized in excess of $70,200 plus interest, was not foreseeable and did not result from any active steps taken by appellants to obtain such profit, just as any loss which appellants might have suffered had they been forced to sell the property for less than the $65,000 advanced by way of loan and had been unable to recover the difference from the guarantors of the note, would no doubt have been claimed by appellants as a business loss, chargeable against their business income derived from other loans. There was even some evidence that they themselves had on previous occasions charged uncollectable advances up against income.

The case of Jack Blustein et al v MNR, [1964] Ex CR 200; [1963] CTC 326, cited by respondent, is directly in point. In that case the appellants who were in the furniture business made a practice of investing extensively in mortgages, mostly second mortgages. Some were purchased at a discount and some were obtained as security for money advanced in which case a bonus or an exceptionally high rate of interest was demanded. Most of them were for a short term. Some of the mortgages matured, some were sold at a profit, and one was foreclosed and the property sold at a profit. The judgment of Cattanach, J included in the taxable income of the appellants not only the profits made by reselling the mortgages and realizing the bonuses but also the profit made on the resale of the foreclosed upon property. In commenting on this Cattanach, J states at page 212 [336]:

Counsel for the appellants particularly emphasized that the profit realized upon the sale of the property which the appellants were forced to foreclose upon was a Capital profit and not assessable to income tax since the appellants had no history of trading in real estate and, therefore, the profit did not arise from the conduct of a business.

Since I have found that the present appellants were engaged in a scheme of profit-making, it follows that the sale of a property under the covenant in a mortgage thereon or the instigation of foreclosure proceedings are incidental remedies of that business and any profit arising therefrom is as much a profit in the business as holding the mortgage to maturity and realizing the discount thereon where no foreclosure proceedings were necessary. In highly speculative ventures such as the appellants engaged in, they must be taken to have contemplated that the monies might have to be realized by foreclosure and sale rather than by being collected at maturity.

In two Supreme Court Cases, namely James Frederick Scott v MNR, [1963] SCR 223; [1963] CTC 176, and MNR v William Hedley Mac- Innes, [1963] SCR 299; [1963] CTC 311, the facts were almost identical. In the Scott case the appellant was a barrister and solicitor who purchased agreements for sale of land, lease-option agreements on land and mortgages at a discount and then held the securities to maturity, and in the Maclnnes case the respondent was an elderly soap manufacturer who had, over a period of ten years, purchased 309 mortgages at a discount. They were usually for small amounts and for relatively short terms. In both cases Judson, J, rendering the unanimous judgment of the Court, held that the profits realized resulting from these discounts were taxable income. The headnote to the SCR report of the Scott case reads, in part, as follows:

It was true that the appellant purchased the agreements by himself and never in association with anyone else, and that he did not set up any organization for their acquisition. He was not in the business of lending money nor in the business of buying and selling agreements. That there was an element of risk in the transactions was obvious. Nevertheless, the facts established that the appellant was in the highly speculative business of purchasing these agreements at a discount and holding them to. maturity in order to realize the maximum amount of profit out of the transactions. The profits were taxable income and not a Capital gain.

The Maclnnes case was held to be indistinguishable from this. While neither case dealt with the realization of an unexpected profit as the result of the resale of a property acquired as a result of these money lending transactions, and in this respect differed from the Blustein case (supra) which also included as taxable income the profit realized from the sale of a property acquired as the result of a foreclosure of a mortgage, I feel that no distinction should be made. The appellants did not buy this property as an investment but rather acquired it as an incident to the money lending transaction on which they anticipated earning a bonus of $5,200 in a two-month period. To say that only this bonus together with the interest earned on the loan should be taxable and the excess considered as capital gain is equivalent to finding that the property was acquired as an investment, which it was not. The money loaned was not loaned as an investment but as a business transaction in the normal course of appellants’ business and the acquisition of the property was an incidental result of this loan.

The appeals of both appellants are therefore dismissed, with costs.