Robbie Holdings Limited v. Minister of National Revenue, [1978] CTC 3096, [1978] DTC 1819

M J Bonner:—The sole issue in this appeal is whether the profit realized by the appellant on the sale of two farms located approximately twenty-five miles south of the City of Winnipeg is a profit on revenue or on Capital account.

The sole beneficial shareholder and directing mind and will of the appellant company is Morton Nemy, a Winnipeg lawyer. Mr Nemy’s practice is concentrated mainly in the fields of real estate, wills and trusts. Before 1973 Mr Nemy had acted for lenders to farmers and he had become familiar with the business of farming. The appellant company was incorporated by Mr Nemy to hold his personal investment assets, including mortgages and farmland. In 1974, before the acquisition of the farms in question in this appeal, the appellant owned two other farms and it has since acquired still another. farm. The appellant’s farms are rented out on a cash-rental basis. Apparently the appellant has experimented with rentals on a crop-sharing basis and found them unsuited to its needs.

In 1973 Mr Nemy commenced to act for a number of European investors in connection with the purchases by them of Manitoba farmland. He was introduced to the investors by Roland Richter, a German real estate agent. Typically the investors distrusted debt instruments because of concern with the incursions which inflation might be expected to make in their capital. They therefore sought to buy land. They were content to accept lower rates of return on land in return for security of capital. They purchased for the long-term and seldom sold. Mr Richter was successful in finding ever-increasing numbers of such investors and in interesting them in the purchase of Manitoba farmland. Mr Nemy’s practice in connection with these purchases grew quickly and substantially. Before long Mr Richter was permitted to use space in Mr Nemy’s suite of offices.

The influx of foreign buyers was observed with interest and some reservations by the Manitoba farming community. At least initially farmers were concerned with the question of whether foreigners who had entered into agreements of purchase and sale would fulfill their obligations under the agreements and complete the transactions. Over a period, however, it became fairly well known that a farmer interested in selling his land might well find a purchaser if he contacted either Mr Nemy or Mr Richter.

Early in 1974 Mr Richter decided to commence farming on his own account. By agreement made February 27, 1974, Mr Richter agreed to purchsae a farm from George Boaler. The total price was $162,400. A deposit of $1,000 was paid upon the signing of the agreement. A further cash payment of $80,200 was due April 20, 1974, the date set for closing. The balance of the purchase price, $81,200, was to be secured by mortgage and was payable in three annual instalments of $27,066.67 each with interest at eight %. The first payment of principal and interest was due on May 1, 1975.

On March 8, 1974, Mr Richter entered into an agreement to buy from Alex Christiuk a farm located adjacent to the Boaler farm. The purchase price was $115,000. A deposit of $2,000 was paid on signing the agreement. A further cash payment of $63,000 was due on closing, May 1, 1974, and the remainder, $50,000, was to be secured by mortgage back to the vendor. That mortgage was repayable in five equal annual instalments of $10,000 plus interest, such instalments to commence May 1, 1975.

Mr Nemy understood that Mr Richter had arranged lines of credit with his bank, not only for the money which he required to purchase machinery and seed, but also to pay the balances due on the closing of the Christiuk and Boaler purchases. However, shortly before closing it was discovered that Mr Richter’s bank manager, who approved the loans, was unable to secure the requisite further approval from his superiors for loans of that size. Mr Richter was told that the funds required to complete the land purchases would be unavailable.

Mr Nemy regarded the prospect of default on the land purchases with some dismay. He felt that word of default would spread within the farming community and adversely affect his growing land-purchase legal practice. Mr Richter had already bought seed and machinery. He asked Mr Nemy whether the latter would take over the purchases and lease the farms to him. Mr Nemy testified that he was persuaded that the views of his European clients as to the wisdom of investing in land were correct and thus that the land would be a valuable asset. Accordingly, he explored the possibility of purchasing.

Mr Nemy discussed the possibility with his wife and his bank manager. He then took steps to take over the purchases of the farms. Following advice from the bank manager, savings bonds belonging to Mrs Nemy and some held in trust by Mr Nemy for his children were cashed, thus raising a total of $50,000. Mrs Nemy’s savings account was the source of the further $10,000. That $60,000 represented all the liquil resources of the Nemy family. It was used together with a bank loan to pay the balances due on the closing of the two purchases. Mr Nemy stated he anticipated that, initially at least, annual payments would exceed revenues by approximately $23,000 per annum, but he expected that the appellant would be able to meet the deficiency out of revenues from other sources.

The purchases were closed early in May of 1974. On May 14, 1974, the appellant leased the farms to Mr Richter for a term of one year at an annual rental of approximately $27,000 payable half on June 1, 1974, and half on December 1, 1974. The June 1st instalment of rent was not paid on time. Mr Nemy was not prepared to evict Mr Richter for non-payment or to “get tough” with him because that would destroy a lucrative business relationship.

Another German real estate agent named Poll was aware of Mr Richter’s default and he approached Mr Nemy to determine whether the appellant would sell the two farms to a group of German investors represented by a Dr Wilhelm Schuler. Apparently Mr Nemy knew Dr Schuler, having acted for him in the past. Mr Nemy stated in evidence that despite a potential for large profit he had never bought from farmers and sold to Europeans because he felt that a conflict of interest might arise. In this case Mr Nemy wanted to ensure that Dr Schuler, as a former client, was fully informed as to his interest in the appellant, past and present circumstances (including default under the lease) and particulars of the purchases by the appellant including, price paid. Apparently Mr Nemy directed Mr Poll to fully inform Dr Schuler.

An oral agreement to sell to Dr Schuler was reached sometime before June 28, 1974. On that day the appellant executed a written offer to sell the two farms to Dr Schuler at a price of $383,157.60. Acceptance of that offer was dated July 12, 1974. On July 19, 1974, Mr Richter was killed in an accident on the farm. The rent was not paid until February of 1975. Mr Nemy testified that the appellant purchased on the basis of three factors: annual return, potential appreciation and avoidance of adverse publicity. The appellant sold, he said, because the failure of Mr Richter to pay the June 1st rent led Mr Nemy to conclude that he had “bitten off too much”..

I have no doubt when the farms were bought Mr Nemy contemplated as a possibility the retention of the farms as investments. The farms, if rented to a tenant capable of fulfilling his covenants under the lease, were well able to generate a flow of investment income, and thus, they were not property incapable of being the subject of an investment.

The default in meeting the June 1st rent payments was portrayed as an event which clearly brought home to Mr Nemy the fact that the appellant’s ability to meet its obligations under the mortgages and to keep the farms was dependent on an uninterrupted flow of rental revenue. However, both the likelihood of such default and its consequence, resale, were apparent from the outset. It was apparent that Mr Richter could not have looked to the farms as a source of revenue to meet the first rental payment. By that time the crop had just been planted. Mr Richter’s financial position was, from the time the appellant first considered the purchase of the farms, patently shaky. Mr Nemy was not prepared to take any of the steps open to him as a result of the default in the payment of rent. The appellant was, on Mr Nemy’s admission, able to meet an annual revenue shortfall of only $23,000. It therefore did not seem logical to me that Mr Richter’s failure to pay the June 1st rent was an event which revealed to Mr Nemy for the first time the fact that the appellant might be hard-pressed to keep the farms.

In a case such as this a rapid turnover of property at a profit is a circumstance which, unless explained, can lead to an inference that trading in the property was intended from the outset. Factors other than those set out above lead me to doubt the explanation that the default in the payment of rent led to the early sale.

Evidence was given by Michael Cudjoe, a Revenue Canada assessor, of interviews with Mr Nemy which took place at a time before the making of the assessment in issue. Initially, according to Mr Cudjoe, Mr Nemy stated that the decision to sell the farms was made because the tenant, Mr Richter, had died. A further interview took place following discovery by Mr Cudjoe of the fact that the agreement of purchase and sale between the appellant and Dr Schuler preceded the death. In a subsequent interview, according to Mr Cudjoe, Mr Nemy stated that the property was sold because Mr Richter had difficulty paying the rent and also because there were problems getting the land drained properly.

Mr Nemy was cross-examined by counsel for the respondent on statements made to Mr Cudjoe. His recollection of statements made by him at the meeting did not appear to be particularly clear. He recalled discussing drainage, but not drainage problems particular to the land in question. When asked whether he had indicated to Mr Cudjoe that the death of Mr Richter was a factor leading to the sale he responded that the death took place on July 19 and the sale took place before then. I am satisfied that Mr Nemy offered Mr Cudjoe, as reasons for the sale, explanations which were not advanced at the hearing. The appellant, in its notice of objection dated March 22, 1977, and signed by Mr Nemy, stated:

Capital gain on disposal of farm property which was not suitable for company operations was reported for the fiscal year ended December 31, 1974.

When this statement was put to Mr Nemy on cross-examination he simply commented that the notice of objection was prepared by his accountant. The statement in the notice of objection could conceivably be regarded as enigmatic, but no attempt was made by Mr Nemy to explain it. Having considered, as carefully as I can, the evidence of both Mr Nemy and Mr Cudjoe and their demeanor when giving evidence I have concluded that Mr Nemy was not entirely forthright, at least in his explanation of the circumstances leading to the decision to sell.

It appears to me that the appellant bought the farms in circumstances in which it is impossible to find any clear dedication of them to investment account. This conclusion flows not only from the bare fact of a subsequent sale not explained by acceptable evidence, but also from the fact that the sale of the farms was negotiated without hesitation well before the first payments on the mortgage were due and well before the over-extended Mr Richter could have been expected to derive any revenue from the operation of the farms.

Mr Nemy disavowed any intention to speculate by buying farms and selling them to foreign investors. He stated that although he might have made a fortune doing so it would have created a conflict of interest. There was no evidence that all foreign investors were clients of Mr Nemy, and certainly foreign investors did not form all of the potential purchasers of Manitoba farmland. In any case, Mr Nemy did in fact sell to a former cilent (after quite properly making full disclosure). Between September of 1973 and May of 1974 Mr Nemy closed forty-five “foreign transactions” involving 75,000 acres of land. The market was clearly visible.

In Paul Racine, Amédée Demers and François Nolin v MNR, [1965] CTC 150; 65 DTC 5098, Noël, J described the doctrine of secondary intent at 159 [5103] as follows:

In examining this question whether the appellants had, at the time of the purchase, what has sometimes been called a “secondary intention” of reselling the commercial enterprise if circumstances made that desirable, it is important to consider what this idea involves. It is not, in fact, sufficient to find merely that if a purchaser had stopped to think at the moment of the purchase, he would be obliged to admit that if at the conclusion of the purchase an attractive offer were made to him he would resell it, for every person buying a house for his family, a painting for his house, machinery for his business or a building for his factory would be obliged to admit, f this person were honest and if the transaction were not based exclusively on a sentimental attachment, that if he were offered a sufficiently high price a moment after the purchase, he would resell. Thus, it appears that the fact alone that a person buying a property with the aim of using it as capital could be induced to resell it if a sufficiently high price were offered to him, is not sufficient to change an acquisition of capital into an adventure in the nature of trade. In fact, this is not what must be understood by a “secondary intention’’ if one wants to utilize this term.

To give to a transactions which involves the acquisition of capital the double character of also being at the same time an adventure in the nature of trade, the purchaser must have in his mind, at the moment of the purchase, the possibility of reselling as an operating motivation for the acquisition; that is to say that he must have had in mind that upon a certain type of circumstances arising he had hopes of being able to resell it at a profit instead of using the thing purchased for purposes of capital. Generally speaking, a decision that such a motivation exists will have to be based on inferences flowing from circumstances surrounding the transaction rather than on direct evidence of what the purchaser had in mind.

The appellant has not established that its sole intention at the time of the purchase of the farms was to hold them as investments. On the contrary the evidence leads irresistibly to the conclusion that the appellant, in buying the farms, did so with the secondary intention of reselling them at a profit. The appeal will therefore be dismissed.

Appeal dismissed.