Station Heights Subdivision Limited v. Minister of National Revenue, [1973] CTC 2004, [1973] DTC 13

Roland St-Onge:—This appeal is from an assessment dated July 8, 1970 and concerns the appellant’s 1967 taxation year.

On February 17, 1956 the appellant purchased 371/2 ‘acres of vacant farm land at the intersection of Highway No 5 and Erindale Station Road now known as Cooksville, Ontario for $100,000, paid $20,000 cash and gave a mortgage for $80,000.

On July 28, 1965 the appellant sold the said vacant land to Liman Construction Ltd for $277,000 and obtained $65,000 in cash and assumed the existing first mortgage which had, by that time, been reduced to $76,500. The appellant took back a second mortgage for $135,500 in respect of which the reserve has been claimed. The said second mortgage was granted by De Carlo Brothers Ltd and by California Investment Company and guaranteed by Liman Construction Ltd because, prior to the closing off of the transaction between Liman Construction Ltd and the appellant, Liman had transferred its rights to De Carlo and California so that these companies in fact acquired the property transferred under the deed of July 28, 1965.

The second mortgage provided for a principal payment of $3,500 together with interest at 6% per annum which fell due on May 1 and November 1 in each of the years 1967, 1968, 1969 and 1970, with the balance payable on November 1, 1970. This five-year mortgage provided for a further term of two years.

In the appellant’s 1966 fiscal year ending June 1966, the actual balance remained outstanding but in the following taxation years it was reduced as follows: in 1967 to $132,000; in 1968 to $125,000; in 1969 to $118,000; in 1970 to $111,000; and in 1971 to $39,128. The balance of $39,128 was paid in September of 1971.

An abstract from the Registry Office records was introduced as Exhibit A-9 to indicate the transfers in connection with this vacant land from November 1965 to September 1970. On November 1, 1965 the land was transferred from the appellant company to De Carlo and California. Liman being the original purchaser had assigned its interest to De Carlo and California and took a mortgage of $58,000.

On November 15, 1967 the land was transferred from De Carlo and California to Corpus Holdings Limited and Tompkin Investments Limited and Hogar Estates Limited for a total purchase price of $651,682 of which $154,682 was paid in cash, and the assumption of three existing mortgages and a fourth mortgage in the amount of $250,000. Between November 1, 1965 and November 15, 1967 there were two increases, one of $58,000 and another of $400,000.

On January 18, 1967 the land was sold to Erin Glen Gardens Ltd for $875,116.50 paid by the assumption of all the mortgages and a cash amount of $153,429.59. On September 4, 1970 another sale took place which increased the value of the land by approximately $23,500.

Counsel for the respondent argued that the transactions subsequent to 1965 are irrelevant, whereas counsel for the appellant contended that they are to show what is a reasonable amount to be deducted as a reserve in computing the income that can reasonably be regarded as a portion of the profit from the sale (subparagraph 85B(1)(d)(ii)).

As already mentioned, the sale took place in the appellant’s 1966 taxation year. In that year the Minister included the profit from the sale in the appellant’s income and took the gross profit ($128,518.56) over the selling price ($277,000) and multiplied that by the amount of the mortgage outstanding at the end of the 1966 and 1967 fiscal years to arrive at a reserve of $86,854.18 and $84,610.07 respectively:

The appellant did not appeal the 1966 assessment but, in computing its income for the taxation year 1967, it brought back into income the amount of the previous year’s reserve.

In reassessing the appellant for its 1967 taxation year the respondent made the following adjustments:

In so re-assessing the appellant, the Minister has allowed as a reserve the sum of $84,610.07. The appellant claims that a reasonable amount to be deducted as a reserve is $61,854.18 and not $84,610.07 as allowed and that accordingly if the said profit is taxable income, the amount of the net income to be assessed for its 1967 taxation year is $29,803.27 computed as follows:

Net Income previously assessed	$29,803.27
Deduct: Prior adjustment re Section 85B Reserve	$25,000.00
	$ 4,803.27
Add: Section 85B Reserve adjustment to be allowed
Balance June 30, 1966	$86,854.18
Balance June 30, 1967	$61,854,18
Amount of reserve realized in 1967	$25,000.00
Revised Net Income to be assessed	$29,803.27

Counsel for the appellant argued that because of paragraph 85B(1)(e) of the Income Tax Act, the amount of the previous year’s reserve is required to be brought back into income so that the scheme of the section is that at the end of the 1967 taxation year the taxpayer can claim a reserve at that time in respect of the mortgage in accordance with subparagraph 85B(1)(d)(ii) which reads as follows:

85B. (1) In computing the income of a taxpayer for a taxation year,

(d) where an amount has been included in computing the taxpayer’s income from the business for the year or for a previous year in respect of property sold in the course of the business and that amount or a part thereof is not receivable,

(ii) where the property sold is land, until a day that is after the end of the taxation year,

there may be deducted a reasonable amount as a reserve in respect of that part of the amount so included in computing the income that can reasonably be regarded as a portion of the profit from the sale;

The Income Tax Act and the Income Tax Regulations nowhere set out any formula or any procedure for determining what is a reasonable amount. However, there are cases which deal with the issue and in which the formula, gross profit over gross selling price, less the amount of the mortgage assumed, times the amount receivable, can produce a reasonable amount.

This formula allows the claiming of the maximum amount and in all the cases cited, the taxpayer has tried to claim more than the maximum amount. In the case at bar, counsel for appellant contended that any amount less than the maximum amount is also reasonable, ie section 85B uses the permissive word “may” to indicate that the taxpayer can take less than the maximum amount. He also gave many dictionary definitions of the word “reasonable” to show that the amount claimed as a reserve was also reasonable.

Counsel for the respondent agreed that because of the words “may be deducted” in subparagraph 85B(1)(d)(ii) the taking of a reserve is optional but, if the taxpayer elects to take such reserve, the only amount derived from a reasonable formula can be reasonable and such formula would have to be consistently applied from year to year.

He also contended that on reserves for such items as capital cost allowance, the lending of money on the security of mortgages (paragraph 85G(a)), or amounts payable for goods to be delivered or services to be rendered after the end of the year (paragraph 85B(1)(c)) the taxpayer is allowed to claim only the maximum amounts allowable. In his opinion it would not be reasonable for a taxpayer to claim any percentage he saw fit of the cost of such items because it would enable him to arbitrarily select any amount as his income for the year.

In the present appeal, counsel for the respondent stated that the appellant sought to average its income by reporting approximately equal amounts of income each year over the five-year period of the second mortgage and thus gain the average of the low rate on the first $35,000 income on the entire profit instead of having to report larger amounts in 1971. Paragraph 12(1)(e) of the Income Tax Act prohibits the deduction of a reserve except as expressly permitted. It was further submitted that the reserve is not unlike an exempting provision, and that the appellant must bring itself strictly within the expressed provisions to qualify.

He referred the Board to the following jurisprudence: Sun Insurance Office v Clark, [1912] AC 443; Publishers Guild of Canada Ltd v MNR, [1957] CTC 1; 57 DTC 1017; No 703 v MNR, 24 Tax ABC 129; 60 DTC 237; Aden Building Enterprises Inc v MNR, 23 Tax ABC 222; 60 DTC 31: Gardner v MNR, 39 Tax ABC 162; 65 DTC 591; [1967] Tax ABC 293: 67 DTC 247: Weinstein v MNR, [1968] CTC 357; 68 DTC 5232; MNR v Burns, [1958] Ex CR 93; [1958] CTC 51; 58 DTC 1028.

Subparagraph 85B(1)(d)(ii) is included under Division H of Part I of the Income Tax Act which deals with special reserves, and where the property sold is land, the provision allows the taxpayer to set a reserve in those words: “there may be deducted a reasonable amount as a reserve in respect of that part of the amount so included in computing the income that can reasonably be regarded as a portion of the profit from the sale”. [Italics mine.] But the said provision does not provide the taxpayer with any formula for the calculation of what is called a reasonable amount” and does not stipulate any maximum or minimum. In this type of reserve, we are dealing with an actual deferment of income rather than the establishment of an actual reserve to provide for eventual doubtful debts or contingencies. The deferred amount, in the present case, is well secured by a mortgage and according to the evidence adduced, does not represent a sizeable risk inasmuch as the land has been originally purchased at a cost of $100,000 and sold, ten years later, for $875,116.50. Consequently, under the circumstances, the amount of $61,854.18 fixed by the taxpayer might be as reasonable as the $84,610.07 set by the Minister. The matter of reasonableness could be subjective as well as objective. In the present case, because the option belongs to the taxpayer, due to the use of the verb “may” the subjective value would be the one fixed by the taxpayer rather than that set by the Minister. Furthermore, because the taxpayer is in a better position to know the nature of the deferred income as well as the amount likely to be received by him as part of the profit in future years, it is reasonable to expect that the taxpayer is the person who should determine what is reasonable under the circumstances. It is well established in the jurisprudence that a taxpayer can arrange his affairs to pay the least amount of income tax as long as he complies with the Act and therefore the Board cannot understand why the Minister would object to a taxpayer increasing his taxable income in any one year by claiming a smaller reserve. The jurisprudence cited by counsel for the respondent is applicable to cases where it was obviously necessary to set a maximum reserve so that the taxpayer could not unduly reduce his income. In the present appeal, the appellant is not trying to reduce unduly his income but rather to average, by deferment, his profits in accordance with the section enacted for that very purpose. The mathematical formula used by the Minister in the cited cases is purely arbitrary and the amount set by the appellant could be as reasonable, if not more so, than that set by the Minister, when taking into account all of the evidence adduced: the well-secured loan, the substantial increase in land value, the possibility of prepayment of mortgages, and the appellant’s business and experience in real estate.

The Minister cannot intervene in the present appeal because there is no evidence of any abuse on the part of the taxpayer, and should the latter not receive the amount to which it is entitled, it would be because it had not availed itself fully of the provisions of the Act. The Board, for the above reasons, is of the opinion that the amount claimed by the appellant is reasonable.

At the beginning of the hearing it was agreed between the parties that no evidence would be adduced with respect to the taxability of the gain and that in case of an appeal to the Federal Court of Canada, the taxpayer would be allowed to raise that issue. Consequently, on the question of the calculation of the amount of the reserve, the appeal is allowed.

Appeal allowed in part.