Donald G Wilson Et Al v. Minister of National Revenue, [1974] CTC 2219

Judge Flanigan (orally: May 28, 1974):—This is an appeal by some thirteen appellants* [1] against reassessments by the Minister of National Revenue for the 1969 taxation year. I propose to use as the lead case for the purpose of this judgment the appeal of Donald G Wilson, Tax Review Board File No 73-316, mainly because the evidence of this appellant is the basic evidence upon which all these appeals turn, and which each of the other appellants agreed to adopt.

Two appellants are not before me today. W Wallace Muir, File No 73-331, I am informed by counsel, is prepared to abide the outcome of this appeal. I have elicited some information about him, from Mr McKendry, one of the other appellants. In respect of the Estate of Anthony C Butler, File No 73-308, it is agreed that at the time of Mr Butler’s death he was engaged in the general practice of law in the City of Ottawa, and that he had a one-third interest in a property at 74 Somerset Street and owned 110 Gloucester Street. The evidence is that he also at one time, with others, owned another property that was revenue-producing and which was subsequently sold.

This is a very difficult case, not only to decide but also to put down, in some semblance of order, my reasons for judgment, so that, should the matter go further, they will be of some assistance to anyone hearing it. There are, however, certain factors that are common to all the appellants.

One of the factors that makes it a difficult case to decide, and out of the realm of the normal trading case, is that not all of the members of the group entered the picture at the same time. I think some eleven of the nineteen entered in 1963 when the property was originally purchased, and the balance over the years, mainly from 1964 to 1966. They were all members, I think, at the time of the sale of the property in 1969, at which time the profit was made. In addition, the company that originally purchased the property subsequently, in 1966, transferred it to the individual members at book value—and that was a non-arm’s length transaction—so that the members of the company would hold title as tenants in common through a trust agreement, and each would thereby be able to take advantage of any tax concessions that would come to them by way of capital cost allowance.

The original group, although several in number, were closely associated through either business connections or friendship, save and except one party with whom I shall deal in a moment. My recollection is that, of those appearing before me, Mr Kenny, Mr Lamothe, Mr Pittaway, Mr McKendry, Mr Butler, Mr Wilson, Mr Adams and Mr Rothwell were the originals of this company. Some were active; some were not. I think it is fair to say that those active were Mr Wilson, Mr McKendry and Mr Sheen, and perhaps Mr Adams, who certainly ended up in a less than enviable position in the final result just prior to the sale in 1969.

Although the evidence of Mr Wilson is the evidence upon which a great deal of the case rests, I think I must really start with the evidence of another of the appellants. Let me say first of ail that in each instance the appellants have taken the witness box, and have sworn under oath that their intention at the time they entered the transaction was to make a long-term investment to supplement their earnings in their later years when their productive years of high income were past, and as a hedge against inflation and that they had no intention to resell. These pronouncements under oath are the typical pronouncements of people in trading cases, who must, at the very least, give this testimony under oath, because, in trying to determine what was the intention of the parties, one must look, or try to look, into their heads and assess what they really had in mind. I say this, fully aware that each and every one of them, at the time of giving evidence, believed firmly that that was his intention at the time he entered the project. What makes it difficult for anyone trying such a case is having to find something in the overall evidence to support or contradict this subjective evidence of the appellants. For that purpose I must leave the general and direct my attention to the specifics.

I shall refer first to the evidence of Mr Gerald McKendry, who is now a real estate agent, a fact that has no bearing whatsoever on this case because in 1963 he was vice-president and general manager of Morrison Lamothe Bakery in this city. He has, since that date, worked on a contract basis with Dustbane Enterprises Limited, an international company with its head office for Canada in this city, and on a contract basis with the federal government, but at the material time he was inexperienced, as were all of them, in this type of rental endeavour. He was contacted by a man named Sheen who was an agent for a well known real estate firm in this city, Percy Kerwin Realties Limited, which subsequently, for what it is worth, was the agent for the sale in 1969. No evidence was adduced as to whether or not a commission was paid on that sale, and I was not able to ascertain that by a brief glance at the agreement of purchase and sale, although the information may be there. In any event, I do not place any great weight on the fact that it is or is not there, because I am satisfied that, in 1969, when the sale to NDM Leaseholds was consummated, the property was sold as a result of a majority vote pursuant to paragraph 4(k) of the trust or management agreement, which gave the majority the right to sell and do many other things. This is the type of clause that one would expect to find in such an agreement, because wherever so many people are involved there must be some rules laid down to bind the whole.

In any event, Mr McKendry’s evidence is that he did not know Mel Sheen before, and he did not know how he had come to approach him with this proposition. He said that Sheen may have known about him, but he certainly did not know Sheen. He said he remembers his own motivation because he was seeking something at that time to secure him in later life. Mr McKendry approached those who worked around him. He approached Mr Wilson, who was a chartered accountant and, I think, secretary-treasurer of Morrison Lamothe at that time; Mr Thomas P Lamothe, who was director of personnel of the company at that time; Mr Butler, who was the solicitor for them in other matters; and Mr Kenny, who was a farmer, not retired, and who I think had done business with them but who was certainly known to them all.

So much for how the project got under way, and here I should say a few words about the project. It was a 4-unit apartment complex, apparently containing 50 units in each building, situated on the north side of Baseline Road, just east of what is now Woodroffe Avenue. My knowledge of the geography of the area in 1963 is not great, but today it is a built-up area. The project was a forerunner of the many low-rental highrise apartment buildings we are familiar with today. It was designated for those on lower incomes, and was purchased for the group by two of them as trustees for a company to be incorporated. but for all intents and purposes by Kenwin Realty Company Limited. Mr Wilson, being a chartered accountant and secretarytreasurer of the company, was interested in an investment for the future because he had been employed, as I recall it, for some ten years and had received a lump sum payment for whatever pension contributions he had made with his former employer, and had been only some three years with Morrison Lamothe at the time that this offer was brought to his attention. He referred to a prospectus being handed to him (Exhibit A-1), which is really a pro-forma projection of the income and expenses and the possibilities of return on this project. He was given it the day before the meeting which was held to decide whether or not this group would purchase the Four Winds, as it was known and is still known, and he went out to the site. He made an eyeball assessment, and took the figures home with him. My recollection of his evidence is that, although the figures were based on 100% occupancy, he, applying his general accountancy conservatism, I suppose, because he was not experienced in the rental field, allowed for a 5% vacancy factor, and to him it still looked like a good proposition for a long term investment. He said that, because it was a low- rental type of accommodation, he felt that they could look forward to 100% occupancy. The next day he met with the rest of the group, and they came to an oral understanding that they would purchase the property, and they did purchase it.

I should also say, in my comments that are general to all the appellants, that none of them had ever been involved in this sort of real estate transaction before. None of them were real estate agents or brokers, save and except Sheen. The evidence indicates that none of them had ever disposed of raw land prior to this time, although one of them, to whom I shall refer, did at some later date. Some of them, prior to 1963, had small real estate holdings, all of which I find, on the facts before me, to have been purchased as revenue- producing investments by them at the material times. I shall deal with the individuals who did have such holdings as I proceed.

I return to the evidence of Mr McKendry, who said that after they took over the property they discovered several things, and this is borne out by the evidence of Mr Wilson. First of all, the building was not as well constructed as they had anticipated. They experienced difficulties with this low income class of tenant that they had not foreseen. Shortly after the purchase—about eight months after, I believe—they were forced into a serious financial position, mainly as a result of having to evict 40 or 50 undesirable tenants, and a gas explosion in the City of Montreal that resulted in injury and/or death to several people caused a mass exodus of some fifty tenants from the Four Winds, which was heated by gas, who removed not only themselves but some of the property of the appellants.

The appellants generally ran into difficulty so far as the law is concerned by virtue of the contents of the minutes of a meeting of the board of directors in May of 1964, which clearly show a desire to sell by authorizing the sale by Sheen because of these two difficulties I have just mentioned. A third difficulty, that was not yet evident to them but which became evident shortly thereafter, was that Sheen, who was the only man among them experienced in real estate and a man who had a substantial interest at the outset of some $20,000, and who had been made manager or superintendent of the apartments, turned out to be less capable than they had expected, and the loss of market that they experienced was subsequently found not to be the result of general trends but the result of his operations, and he was subsequently discharged. But this was not an easy matter to accomplish, because they had to raise $20,000 with which to purchase his equity before they could get rid of him.

In 1964 they were faced with what they had done, and the answer given by Mr Wilson—and perhaps by Mr McKendry, but certainly adopted by them all—was that, faced with obvious losses that were occurring and that were going to continue to occur, they panicked and agreed to sell the property. They agreed to pay a substantial bonus, as I recall, to Sheen if he could achieve sale. I do not have the evidence of Sheen before me to see what efforts he made, but I note that not many months passed before they managed to bring in some outside money by enticing additional people—! think primarily Dr Hamel in 1964 or 1965—which helped provide the money to dispose of Sheen’s services.

In 1965 Mr Pittaway as well as Dr Hamel, put in additional funds, and also Mr Elvins, and Mr Muir came in in 1966. There was a substantial infusion of capital into the business, and this allowed them to discharge a third mortgage, or sufficient encumbrances, in any event, to make the operation viable and to make it attractive to the people who were putting in money as an investment, as alleged by them.

One other aspect of the documentary evidence that I have not yet mentioned, and that counsel for the respondent would have me look at, is the letters patent, which contain an object that is obviously sufficient to cover trading in real estate.

They also had an appraisal value made of the property to determine what their position was with respect to the capital they had invested, and what their prospects were of retrieving their capital if the complex was not going to succeed as an investment project. They did get an offer of $1,650,000, which was $50,000 less than the valuation of $1,700,000 made by a man by the name of Lafontaine. It was discussed among themselves and turned down because of the low down payment. They were on the covenant for the first mortgage, and this was not a prudent sale. They decided that if they had to sell they would not sell for less than sufficient to recover their original investment. At the same time, however, they were considering the possibility of turning this over to the trust, as they referred to it, to gain the advantage of capital cost allowance against their own income tax, and this would make it possible to generate more new capital for the business.

As has been pointed out by more than one of them, if they had intended to sell the property, there would have been no benefit in changing it into a trust, as they would have lost the advantage of the loss of $70,000 that they then had in the company. It is suggested that, when they did turn it over to the trust, they retained the chattels of the company for the purpose of utilizing this loss, but nothing much was made of it. If it was in their minds—and it is only speculation on my part—it would not have been bad consideration, in any event.

The trustees were given the task of managing the Four Winds, and they began, after the infusion of capital in 1965 and 1966, to reduce their losses from $30,000-odd down to $500 and subsequently, as I have said, they sold, as a result of a majority vote.

I come back now to deal with the reasoning of the individuals. Dr Hamel was called. He was a practising physician. He did not have a pension plan. Mr Butler, who was his solicitor, contacted him and told him that this, in his opinion, was a safe long term investment. The point that appealed to Dr Hamel most, I think, was the fact that his money would be managed for him. He looked at it as a saving, and he would not have to be bothered wiht it; it would be looked after by Mr Butler and the others. He attended meetings of shareholders and agreed or disagreed with various decisions, but he is quite firm that he was against the sale at the time it was being discussed in 1969, as were some of the others. Perhaps he was in a better position financially to take such a strong stand, but he had the most in it and he still believed it to be a good investment.

Dr Lidington, who is also a practising physician, joined in 1966. He had a connection with Mr McKendry through his daughter and Mr McKendry’s son, I gather, who were going together, and Mr McKendry convinced him it was a good investment, and that if they could get enough people into the group to pay off the third mortgage a good revenue would result. This to me is indicative of the type of man I have assessed Mr McKendry of being, in that he made no attempt at the time of speaking to Dr Lidington to gloss over the problems that the group were facing. He told him that it was only by people like Dr Lidington putting in more money that the investment would right itself and produce revenues sufficient to satisfy their original avowed intention.

According to Dr Lidington, what happened after this infusion of money in 1966 and the transfer to the individuals was that the rents went up, and he said, “We started to realise a good income from it, and since we were going to keep it for a long time it made sense to transfer it to the individuals”. He said, “We would not even have considered this if we had planned to sell it because of the recapture situation”.

He had never been in such a syndicate before. He had owned a duplex which was revenue-producing, and which he owned for some twenty years. He built an apartment building in 1953 on Holmwood Avenue in this city in which his office was located. He found that the disadvantages of being so close to his tenants far outweighed the advantages, and he finally disposed of it for this reason. During the time he held it he earned income on which he paid tax. He also held six or more mortgages and never discounted them. He paid tax on the recapture when he sold some of his other properties, but the apartment building he had sold for what it had cost him. Here is a history of this man’s putting his money into what would be a very practical thing for a man in his position without a pension, and a history of doing it over the years.

Mr Rothwell was one of the original group. He was a bank manager in 1963, and he indicated that he was then expecting to retire in 1972. I infer from his evidence that in order to continue to live in the manner to which he had become accustomed it was necessary to supplement any pension income he had from the bank, and he was interested in a long-term investment. In fact, he said he was looking for one.

It is interesting to note, in answer to the allegations of the Minister that the operation was undercapitalized from the beginning, that Mr Wilson and Mr Rothwell, a chartered accountant and a banker, respectively, both professions being noted for conservatism in their approach to this sort of investment, felt there was sufficient capital to substantiate the program of rental, if it produced on the basis of the Original so-called prospectus, which is filed as Exhibit A-1. Mr Rothwell gave, as the reasons for the damning minutes of May 1964, the mass exodus, the market deterioration, and panic decision.

Some evidence was adduced through the various witnesses (but it was not too clear in some of their minds) that some three months, or some short while, after they had purchased it they became aware that the owner, Gladstone Realty Limited, had had an opportunity to sell it for $100,000 more. They investigated this and discussed it at a meeting and, whether they believed it to be a fact or not, none of them was interested in the prospect of a quick profit of $100,000. This is interesting because later, after many trials and tribulations, they sold the property for only twice as much money in profit but with twice as many people in the group to share it.

Mr Alarie, who was a plumber, gave a pretty honest reason for joining the operation. He had had no previous real estate transactions except that he had sold a duplex four years before. Things were picking up in 1966, and he had lots of work. His bank manager, Mr Rothwell, said it would take a long time to get the money out, but it would be a good pension for him. He said he agreed, based mainly on the advice of his bank manager, which is probably the most persuasive advice that one can get. He also voted against the sale but, as he said, the majority ruled. He had a duplex at 260 Donald Street, which he had rented for over 20 years. He also had a duplex on Clementine Boulevard which he had to take over in order to get his account for plumbing services paid. He kept it for three or four years, and then disposed of it. When someone holds a duplex for 20 years before selling it, he is hardly an example of someone in the trading business.

Mr Alfred E Adams, again one of the originals, was a general insurance agent with a small business. He felt he needed supplementary income for later years. He had had no real estate experience, no sales experience and no rental experience. Although he admitted to writing policies of insurance on real estate, that would hardly qualify him as an expert in the problem that faces me today. I made a comment earlier that he ended up in the least enviable position of all, because apparently, towards the end, he had to move in to try to keep the tenants satisfied, and he bore the brunt of the complaints at the Four Winds. He took over the insurance coverage on the buildings in 1965 and received his normal commission, so he had an alternate means of generating income by belonging to this group.

I refer again to Mr McKendry’s evidence. The first mortgagee required 80% occupancy in the way of leases before the final mortgage advance would be made. The required number of leases were obviously produced, but among them were those of the undesirable tenants who had to be evicted. This left the group with an almost 25% loss in occupancy in one fell swoop shortly after taking over.

Mr McKendry said that he was reluctant to sell, but the offer was sufficient to free him from his personal covenant and, since he had changed jobs, he voted for it.

I think it is safe to say that by 1969 they had all had enough. Without meaning any disrespect, and before going on to describe the other members of the group, I think this is a perfect example of where the admonition “Shoemaker, stick to your last” is apt. The whole venture smacks of amateur night in a great many of things that were done. I have seen some pretty spectacular sophisticated plans to deprive the treasury of some money by way of capital gains, but never have I seen one like this, where so much was done by so many for so little.

Another of the appellants, Mr Aldous E Pittaway, who is retired by reason of medical necessity, was one of the originals. He had $10,000 in life savings, of which he invested $5,000, and then he had to put in the other $5,000, as he said, to try to salvage the first $5,000. He said that originally the investment was for a long term. Here I find one of the most truthful answers I could expect. He said he became frightened when he nearly lost his life’s savings and he could not see any reason for not selling in 1969, which showed, I think, some honesty as well as good sense on his part.

Mr Thomas Lamothe gave the usual reasons. He said: “! considered it a 15- to 20-year proposition before it would be good.” He told Mr McKendry this, and said: “There was no intention to make a quick sale.”

Mr Percy Kenny, who is a farmer and was a farmer in 1963, was one of the original shareholders whom Mr Lamothe asked to join the group. It was obvious from his evidence and his attitude that he plans to work until somebody prevents him from doing so, but he did have one of the most cogent reasons for wanting something secure in his future, and that was the fact that he is the parent of a deaf child, and he was thinking of this as security for her. He also said there was a great concern in his own mind that at some time during his association he might lose the money he had put in. He said, “That was enough for me in 1969”, and ! think it would have been enough for most people.

Mr Charles E Elvins, another of the appellants, was retired at the time he gave his evidence. He is a former vending machine operator who naturally would have had some connection with Morrison Lamothe. He was friendly with Mr McKendry. He had no pension, and he talked to Mr Lamothe and Mr Butler. He says he was a silent partner, but I find that hard to believe. That he did not take any active part in the operation of the buildings, I think would be a better way to put it. He said he did not want to sell, and he felt they should keep it. He was cross-examined at some length about his other real estate holdings. It is clear that he owns seven town houses which he built in 1970, and which are all rented. He has a plant on Boyd Avenue from which he collects rent. I suppose that is the plant from which he carried on his business, but when he sold the business he retained the plant. He had another piece of land in the east end that he had planned to build a plant on if he stayed in the vending machine business, but when the purchasers of his business did not wish to take on that responsibility he disposed of the site after holding it for 10 or 11 years. These are hardly the actions of a trader. He sold a piece of land on Richmond Road when he ran into problems with City Hall. He had a cottage chalet that he lived in, and then sold. He has now bought a house for himself in Florida.

in respect of the activities of Mr Butler, it is agreed that he had an interest in the Winston Apartments as one of the tenants in common, and with some others he sold a piece of property to Dominion Chalmers United Church. When the two churches united, they needed more space for parking, and Mr Tilley, Mr McKendry, Mr Butler and Mr Muir, who owned a piece of property on Lisgar Street for three or four years, sold it to the church at a profit of about $3,000 each, upon which I place no significance in this transaction.

I elicited from Mr McKendry, I think it was, that he had known Mr W Wallace Muir for a number of years. They were close friends; they lived relatively close to each other. He knew him to have no interest in real estate other than what I have mentioned; that he had never engaged in the buying and selling of land. Mr McKendry said that when this project did not turn out as they had expected Mr Muir also was glad to get out.

I have now given, I think, all of the reasons advanced by all of the people who have appeared. If I have missed any, then to state it would be repetitious, because all of the evidence was basically the same. The question is: is there support for the allegation of the original group in 1963 that they intended to enter into a long-term investment? I have come to the conclusion that, notwithstanding the time at which the others joined, I am certain that those others who joined in 1965 and 1966 were also motivated only by long-term investment possibilities. I am convinced that they merely joined the original group, who were really the controlling group and whose intention I should consider as being binding on ail.

There has been filed as Exhibit R-2 an abstract of title, which begins with the sale by Gladstone Realty Limited to Kenwin Realty Company Limited. From that time on, there is a mortgage back to the vendor, and there is a series of mortgages, notices of leases, releases, discharges of mortgage, agreements, postponing agreements, evidence of borrowing money from Mr Kenny on one or two occasions, his postponement of his mortgage, and a final discharge of mortgages. Until 1969, other than the grant to themselves, there is a series of transactions, as borne out by the minutes of the company, that indicate to me that these people, had they not intended to keep this property and to turn it into a revenue-producing future for them all, would not have endured the difficulties that they did. They made arrangements for moratoriums. They made arrangements for the purchase of furniture on time; they furnished 50 units in the hope of enticing the Ministry of Transport to rent them for people taking courses at Uplands, which is not all that far away. They spent a considerable sum of money, when they first started to make some, on priming the outside of the buildings and then painting them. They spent money on fixing the roof on a long-term basis. Finally, after all those years of desperation, when they began to see a few dollars coming in, they turned around and pumped the money back into the buildings. It seems to me that these are hardly the activities of people bound on turning their property to a profit at the first opportunity.

I accept without question the test set out by Associate Chief Justice Noël of the Federal Court of Canada in Racine, Demers and Nolin v MNR, [1965] CTC 150; 65 DTC 5098, which followed Regal Heights Limited v MNR, [1960] CTC 384; 60 DTC 1270, which originally brought out the secondary intention principle. I also accept the line of cases which say that no one would enter into the purchase of a property of this magnitude, or of any magnitude, if there was certainty in his mind that he was going to lose money. No one, in my view, and not this group in any event, would have gone through all the gyrations they did to keep the thing going for six years if they had always intended to turn it to a profit at the first opportunity, because they could have done so shortly after purchasing it.

But this is an unusual case, and there are difficult problems for the appellants to overcome. I was surprised that the only other case that I am aware of that even comes close to this case was not cited. I refer to the decision of Mr Justice Cattanach in MNR v Glen-Rouge Parks Limited, [1973] CTC 443; 73 DTC 5364. This was a case of a large group of individuals from varying callings in life who purchased a piece of property in Toronto, and were subsequently frustrated in their efforts, and sold it at a profit of $450,000 after not being able to do anything with it for some months or years. What makes that case so vivid in my mind in relation to this one is that there was among that group a very active real estate personage who wrote letters exhorting people to put money into the business on the basis that they could never lose their money; that they could sell at any time at a profit because Toronto was moving quickly in that direction, and it was a sure thing. He even went further, in some of the minutes of that company, as I recall, than is the case here. There was no question of panic in that instance. It was simply a case of sitting tight until the conservation authority came along and, as I said, gave them $450,000 more than they paid for it.

In that case it was decided that, write what he may, say what he may, or infer what he may the real estate personage could not dominate the transaction, because it took a majority of the members of that corporation to vote for the sale. I find that case very close to this one. Mr Justice Cattanach had no hesitation in finding that they had the primary intention of investing on a long-term basis. Secondly, there was evidence in that case, from at least one of the dominant figures in the group, that there may well have been a time when in 10 or 15 years the revenue was not keeping pace with the value of the land, and when they might well have decided to sell it. It was found that this did not meet the test of a secondary intention, motivated by profit, to turn the property to account at the first opportunity, but was an honest straightforward answer as to what any sound group of businessmen would be expected to do should that circumstance arise.

I find this case very much along the principle of that case. If the evidence of the realtor and the evidence of the decision to sell could be overcome in that case, then I have no hesitation whatsoever in saying that this is a far weaker case on behalf of the respondent. I am satisfied, on all the evidence, that there was a primary intention of the parties involved in this transaction to hold this property as a long-term investment for the supplementing of their individual incomes at a time when their earning power would be less, and the question of selling it never entered the minds of the original group in 1963, and certainly was never in the minds of people like Dr Liding- ton and those who came in later in 1965 and 1966.

Therefore, the appeal will be allowed and the matter referred back to the Minister for reassessment.

Appeals allowed.

MR PYNE: Mr Chairman, before proceeding with the appeal scheduled for this morning, may I address a few remarks to the Board concerning yesterday’s proceedings? THE CHAIRMAN: Yes.

MR PYNE: I spoke to Mr Shaw, who represents Mr Muir, again on the telephone, and I agreed with him that we could adjourn Mr Muir’s appeal until such time as the department decides how it wishes to proceed. THE CHAIRMAN: I thought the understanding we had was that Muir’s appeal would follow the event. That is what I think I said in my judgment. I allowed his appeal based on the evidence, because the same evidence applies.

MR PYNE: When you said his appeal would abide the result, I was a little confused. However, that is fine. It is just that the department does not want to be in the position of having to consent to judgment, because we might be in trouble if . .. . THE CHAIRMAN: No, I have found on the evidence that he should succeed, so you are not prejudiced. In that way we can dispose of all of them, and if you appeal then they will all go together. That is agreeable to you?

MR PYNE: Yes, perfectly. THE CHAIRMAN: That is my understanding of what I said in my reasons. I referred to McKendry’s evidence as being support for the fact that Muir was not a trader. I referred to him in connection with the church property on Lisgar Street. On that evidence I found that he should succeed also, as I did with Butler on the basis of what had been admitted, because I felt that if any of them won, they all would.

MR PYNE: Yes, I think I submitted that either they all win, or they all lose. THE CHAIRMAN: Yes. So judgment will go for them all, but it will not be a consent judgment so you will not be prejudiced.