Bestpipe Limited v. Press-Seal Corporation of Canada, Limited, Appellants,, [1970] CTC 310, 70 DTC 6226

CATTANACH, J.:—These are appeals by the appellants named in the above styles of cause from assessments to income tax. For the purposes of convenience the first named appellant will be hereinafter referred to as Bestpipe and the second named appellant as Press-Seal.

The appeals of Bestpipe relate to assessments for its 1963 and 1964 taxation years in which the respective amounts of $29,551.74 and $73,922.87 were included in the appellant’s income by the Minister and the tax computed accordingly.

The appeal of Press-Seal relates to its assessment to income tax for its 1964 taxation year wherein an amount of $71,995.30 was included in this appellant’s income by the Minister and the tax was computed accordingly.

Bestpipe is a joint stock company incorporated pursuant to the laws of the Province of Ontario and since its incorporation in 1955 has been engaged in the manufacture of concrete pipe. Press-Seal is also a joint stock company incorporated under the laws of the Province of Ontario and since its incorporation in 1958 has been engaged in the manufacture of sealing rings used to ensure a water tight fitting between various lengths of concrete pipe, the product being sold exclusively to Bestpipe.

The two appellant corporations are admittedly ‘‘associated corporations’’ within the meaning of the Income Tax Act. Their business operations have been conducted from premises jointly occupied. Their shareholders and directors are the same persons, although there are various differences in the proportions of shareholdings and in the offices held by the directors in either of the corporations. There is no question that the profitable operation of Press-Seal was related directly to the successful business operations of Bestpipe from which it follows that the directors and shareholders of Press-Seal were guided in their business decisions by whatever course best served the interests of Bestpipe. Despite the fact that they were separate legal entities, because the shareholders and directors were the same persons in each corporation and because their business interests were so inextricably the same, the two appellants invariably acted jointly and in concert.

The matter in issue is the liability of the appellants for income tax on the three amounts (the accuracy of which are not in dispute) which the Minister included in the appellants’ incomes in the years in question as profit realized from the sale of land which had been acquired by the appellants in the Township of Scarborough in Metropolitan Toronto under the circumstances to be immediately described.

Bestpipe came into being as the result of the desire of a conerete pipe salesman and a concrete pipe installation contractor to form their own corporation to manufacture concrete pipe.

The city of Kitchener was deliberately selected by them as the site of the factory, the paramount consideration being that the raw materials were plentiful in that area with little regard being paid to other considerations other than that land costs were less there.

From the inception of Bestpipe in 1955 until 1959 its business operations were very profitable. In 1959 Bestpipe realized a profit of approximately $177,000 from its operations. In 1960 the profit dropped to approximately $50,000, in 1961 to $92,000 and in 1962 and 1963 there were losses of $27,000 and $52,000 respectively. From the nature of Bestpipe’s operations the drop in sales could be foreseen because manufacture was predicated upon advance orders. More than 75% of Bestpipe’s sales were made to consumers in the area of Metropolitan Toronto.

The reason for this drastic drop in Bestpipe’s sales after its successful 1959 year was that many more producers entered into this lucrative field many of whom were in Metropolitan Toronto. In short the business had become more competitive. To meet this competition Bestpipe reduced its prices as much as possible but a constant factor affecting the price of Bestpipe’s product was the high cost of transportation.

Therefore to retain its share of the market in the Metropolitan Toronto area the directors of Bestpipe decided in 1959 that it was imperative to erect a plant in that area. The directors of Press-Seal reached the same conclusion.

At the same time the directors of both appellants decided it would be expedient to embark upon a program of expansion and diversification. Particularly Bestpipe considered that it would be advantageous to enter into the precast concrete business and the development and production of a sand-lime brick. Press-Seal contemplated the construction of an extrusion plant to manufacture the raw material used in the manufacture of the sealing rings it produced which had been theretofore purchased from outside sources.

With these ends in mind the appellants in late 1958 and early 1959 began the search for a suitable site in Metropolitan Toronto.

At a meeting of the board of directors, on January 19, 1959, and duly recorded in the minutes thereof, Mr. Sorbora and Mr. Cosentino reported that they had received an offer of approximately 97 acres of land located in the Township of Scarborough in Metropolitan Toronto, two and one-half miles north of Highway 401 (the Trans-Canada Highway) and three- quarters of a mile west of Highway 48 (another major high- way) at a cost of $1,300 an acre. Mr. Cosentino was the concrete pipe installation contractor, who was one of the original founders of Bestpipe and Mr. Sobora was engaged in real estate development as well as the owner of a real estate company which bought and sold land on behalf of clients.

This land (hereinafter referred to as the Scarborough land) was then used for agricultural purposes and was unserviced. However it was table land within ready access of major sandpits and there was hydro service and an adequate supply of water for the appellants’ purposes.

It was considered by the respective boards that this property as ideally suited for appellants’ future expansion plans.

It was therefore unanimously resolved, by the directors of Bestpipe, that the purchase of this land be recommended to the shareholders.

At a meeting of the shareholders held on the same day, it was resolved, with one dissent, that the directors be authorized to purchase the land.

On the same day the identical resolutions were passed at meetings of the directors and shareholders of Press-Seal.

On October 22, 1959 Bestpipe and Press-Seal, pursuant to a single purchase each acquired approximately 4814 acres of Scarborough land at a total cost of $128,222.02 or $64,111.01 to each appellant.

The: appellants paid an amount of $40,000 in cash on closing, assumed an existing first mortgage in the approximate amount of $35,200 and the vendor took a second mortgage for the balance repayable over a six-year period in semi-annual payments of $1,500 with interest at 6%.

There were two schedules attached to and forming part of the offer to purchase, the first of which contained a provision that the vendor would co-operate with the purchaser in the registration of any plan of subdivision. However this provision was part of the provisions of the then existing first mortgage and was accordingly perpetuated and was not instigated by the appellants herein. In the second schedule there was a provision for partial discharge of the mortgage for any number of whole acres upon appropriate payment. This provision in the second schedule was negotiated by the appellants.

As previously intimated and was anticipated by the directors of Bestpipe, the profits declined during the latter part of 1959 and throughout 1960. To remedy this the directors intensified their efforts to diversify the operations of Bestpipe.

To this end the directors and shareholders made an offer in December 1960 to purchase 50% of the shares of DeSpirt Mosaic & Marble Co., Limited (hereinafter referred to as DeSpirt) and its subsidiary Hydro-Silica Cleaning Company Limited. The offer was accepted February 21, 1961. This decision to purchase shares of DeSpirt followed the purchase of the Searborough lands by about one month. As indicated by its corporate name DeSpirt engaged in the business of dealing in marble, tile and the manufacture of precast building components, the latter activity comprising 55% of DeSpirt’s business.

After the purchase of the shares in DeSpirt the directors of Bestpipe and Press-Seal became directors and officers of DeSpirt.

At this point I should mention that the decision of the directors of Bestpipe to diversify, in addition to their own business acumen, was predicated upon the advice of a firm of consulting engineers who also recommended that negotiations be entered with several European firms. Two directors made trips to Europe to investigate other possible products. The most promising appears to have been a sand-lime brick which enjoyed success in Germany and which might have been suitable to Canadian conditions. However this did not materialize because the German firm would not license its process until the device for making the bricks had been perfected by further research. The precast concrete building components manufactured by DeSpirt were within the range of products suitable and feasible for the diversification contemplated by Bestpipe.

Between February 21, 1961, when 50% of the shares of DeSpirt and its subsidiary were purchased, and April 17, 1962, all of the issued and outstanding shares of DeSpirt and its subsidiary were purchased by Bestpipe at a cost of $374,506.11. Press-Seal did not participate in the purchase of these shares. The entire purchase price of the shares was not paid. The unpaid purchase price was payable by instalments secured by fourth and fifth mortgages in the amounts of $17,466.98 and $82,860.62 dated February 11 and February 6, 1962 respectively on the whole of the Scarborough land, that is, the land owned by Bestpipe and the land owned by Press-Seal.

Upon the initial acquisitions of shares in DeSpirt, Bestpipe guaranteed the indebtedness and liabilities of DeSpirt to the Toronto-Dominion Bank.

After control of DeSpirt was acquired by Bestpipe the directors (all of whom were common to both companies) decided that the rented premises occupied by DeSpirt were completely inadequate which factor coupled with prior poor management in the opinion of the directors caused the financial difficulties with which DeSpirt was faced and the rapidly increasing financial difficulties were accentuated by the inadequate premises.

Accordingly Bestpipe purchased 20 acres of real property in the Township of North York at a cost of $225,000 to be used as a site for the construction of new and improved premises for DeSpirt. On July 25, 1961 this property was transferred from Bestpipe to DeSpirt at its cost price.

It was explained in evidence that directors accepted advice that it was not practical to locate the premises of DeSpirt on the Scarborough site because the Italian labour force required for the DeSpirt operations was available to the North York site, but not to the Scarborough site. Added to the availability of the requisite skilled labour was the advantage of being more centrally located to be accessible to architects. It was also explained that the activities of DeSpirt were not incorporated into those of Bestpipe but were conducted under the separate entity to retain the goodwill which had been built up by DeSpirt in the trade.

Bestpipe engaged architects to prepare architectural plans and drawings for the construction of offices, plant and storage facilities for DeSpirt to be located on the North York site at a cost of approximately $40,000. These plans were completed in June 19653.

In the meantime the Canadian Imperial Bank of Commerce, the appellants’ banker, also became the banker of DeSpirt. Bestpipe and Press-Seal executed a guarantee of the indebtedness of DeSpirt to that bank, this being the second guarantee SO given.

Beeause of the substantial commitment to the affairs of DeSpirt the appellants found it necessary to concentrate on DeSpirt and therefore, as said by a witness, Bestpipe, “deferred” plans to construct a plant at Scarborough.

The estimated cost of the DeSpirt plant at North York was about $1,000,000 and the estimated cost of the plant at Scarborough was about $1,100,000.

Accordingly in November 1961 the Scarborough land was listed for sale for a period of one year with a real estate com- pany of which Sam Sobora was the president. The real estate agent, presumably to facilitate the sale either in whole or in part, placed a plan of subdivision on the land, apparently without the immediate knowledge and concurrence of the other directors of Bestpipe and Press-Seal at a cost of approximately $150 which was subsequently paid by Bestpipe.

In the meantime the financial position of DeSpirt steadily worsened. This factor, together with the problem of liquidating the obligations incurred by Bestpipe in connection with DeSpirt and the very substantial cost of erecting the proposed DeSpirt plant on the North York site, led to the plan of erecting a more modest plant on the Scarborough land.

The listing of the Scarborough land for sale expired in November 1963 and was not. renewed. The directors of Bestpipe and Press-Seal concluded that the advice they had received previously as to impracticality of constructing the DeSpirt plant on the Scarborough land was not as sound as they had thought.

The decision to construct the less ambitious DeSpirt plant on the Scarborough land was reached in January 1963. Architects were engaged who prepared drawings at a cost of $1,507 which at the insistence of the architects was contracted and paid for by Bestpipe rather than DeSpirt and the understanding that upon the completion of the building the architects should have the right to acquire preference shares in Bestpipe.

On February 11, 1963 DeSpirt sold the real property in North York, which was unencumbered, to former shareholders of that company.

Bestpipe and Press- Seal were unable to undertake the construction of the proposed building for DeSpirt on the Scarborough land. It was, therefore, arranged that the building should be erected and financed by Columbus Investments Limited, a company owned by relatives of Mr. Sobora, the building to be leased to DeSpirt and eventually bought by DeSpirt or Best pipe.

Before construction was undertaken the affairs of DeSpirt sank to such a low ebb that DeSpirt made an assignment in bankruptcy in August 1963.

At the time of the bankruptcy of DeSpirt Bestpipe was obliged to assume the unsatisfied obligations of DeSpirt to its bankers by reason of their guarantees. The final amount so assumed was $204,000. In addition Bestpipe suffered a loss of $407,749 in connection with its purchase of DeSpirt shares made up by the purchase price thereof and interest thereon. This amount was written off as a complete loss, the shares of DeSpirt having become worthless.

Prior to these events the Canadian Pacific Railway began expropriation proceedings, about May 1962, to acquire a small portion of the Scarborough land owned by Bestpipe. In anticipation of negotiations with the railway or eventual litigation, Bestpipe engaged an appraiser who in his report expressed the opinion that the land was ripe for speculative development. It must be borne in mind that this opinion was expressed to the directors of Bestpipe and Press-Seal in 1962 subsequent to the purchase of the land in 1959.

In November 1963 Bestpipe transferred 0.9 acres to the railway. The gain realized upon this sale is the amount that the Minister included in the income of Bestpipe in its 1963 taxation year.

In April 1964 Bestpipe attempted to sell 10 acres of the Scarborough land to the vendors of the shares of DeSpirt to it in an effort to clear this indebtedness.

In June 1963 Bestpipe sold its fleet of transport trucks for $56,000 in an effort to obtain needed working capital.

It became necessary to modernize the Kitchener plant and equipment of Bestpipe at a considerable outlay. Accordingly in July 1963 Bestpipe obtained a loan of $495,000 from its bank secured by a mortgage on the Kitchener property.

At the conclusion of its 1963 financial year ending September 30, Bestpipe suffered a loss of approximately $52,000 in its business operations after a loss of $21,000 in 1962.

At this time there is no question that Bestpipe and Press-Seal were in dire financial straits. The appellants were heavily indebted to their bank for loans obtained and by reason of the guarantees extended on behalf of DeSpirt. The bank pressed for payment to the accomplished by the realization of some assets particularly the Scarborough property. The bank also indicated that as part of the capital loans were used in the purchase of the Scarborough land, that the bank should be given a fifth mortgage on that property as collateral, and because it was expected that a portion of the proceeds of the sale would be used to absorb losses with respect to DeSpirt.

At meetings of the directors of Bestpipe and Press-Seal held on July 16, 1964 the sale of the Searborough property was authorized and listed with the real estate company controlled by Mr. Sobora.

The land was sold on September 15, 1964 at an appreciation over cost to Bestpipe in the amount of $73,922.37 and to Press-Seal in the amount of $71,995.30. These amounts were included in the income of the appellants for their 1964 taxation years by the Minister and it is the propriety of the inclusion of these amounts as taxable income which is now in dispute, together with the gain realized by Bestpipe upon transfer of a portion of the Scarborough land to the C.P.R. in its 1963 taxation year.

After disposition of the Scarborough land Bestpipe arranged a line of credit with its bank subject to stringent terms. With this working capital now available Bestpipe enjoyed a succession of three progressively successful years. In 1965 it earned a profit of $114,000, in 1966 a profit of $234,000 and in 1967 a profit of $428,000, all before taxes. Bestpipe was now in a position to expand its conerete pipe business in the Toronto area. In 1969, ten years after the purchase of the Scarborough land, Bestpipe purchased an existing conerete pipe manufacturing business in Ajax, Ontario, about twenty-five miles east of Toronto located on a site of 17 acres. The Scarborough land was not repurchased because the price had then increased very greatly.

Bestpipe required a large area of a vacant land to store its pipe when manufactured. I believe the area in Kitchener to have been about 50 acres. To make up that area Bestpipe acquired an additional 10 acres to compensate for a small portion of land that was expropriated for a highway and in anticipation of future requirements. Press-Seal did not require land for storage of its product. While 97 acres, the area of the Scarborough land, were in excess of Bestpipe’s immediate requirements, it was explained that the directors envisioned the establishment of a large industrial complex over a period of years and there was no suggestion in the evidence that a lesser area would be satisfactory or that the vendor insisted upon the sale of the whole of the land and might not have been amenable to the sale of a lesser area. On the contrary the evidence given was that eventually the entire 97 acres would be utilized at some future time if the plans for an industrial complex materialized over a number of years.

During the period between the acquisition of the Scarborough land in 1959. and its sale in 1964 it was rented to a farmer for $1,200 a year and was used by the tenant for farming purposes.

The issue with respect to the gain realized upon the sale of the Scarborough land is whether that gain realized by both appellants in their 1964 taxation year was profit from a business—including therein, by virtue of Section 139(1) (e)* [1] of the Income Tax Act, an adventure or concern in the nature of trade—and therefore subject to tax as income under Sections dt [2] and 4: [3] of the Act as contended by the Minister. If this contention is correct it follows that the gain realized by Bestpipe upon the negotiated compensation for the 0.9 acres in its 1963 taxation year which was subject to contemplated expropriation proceedings by the Canadian Pacifie Railway would be properly included on the income of Bestpipe for that taxation year. (See Kennedy v. M.N.R., [1952] Ex.C.R. 258; [1952] C.T.C. 59. An appeal from this decision to the Supreme Court of Canada was dismissed without reasons, [1953] 2 8.C.R. viii.)

Counsel for the appellants readily conceded that if the gain realized by Bestpipe and Press-Seal was income from a business, then the compensation received by Bestpipe in 1963 upon the transfer to the railroad of 0.9 acres is also income from a business.

However he vigorously opposed the contention of counsel for the Minister that the gains realized by the appellants were income from a business. On the contrary he contended that the sale of the land was a mere realization of a capital asset and the amounts in question are not subject to tax as income under the Act.

I have no hesitation whatsoever in finding that the appellants, particularly Bestpipe, had valid reasons for diversifying their business and establishing the manufacture of concrete pipe in the Metropolitan area, that the interests of Press-Seal were synonymous with those of Bestpipe and that the Scarborough land was acquired in 1959 in furtherance of those purposes.

However such findings do not resolve the matter.

If it were the exclusive intention of the appellants to use the Scarborough land at the time of its acquisition as the site for the construction of a plant for the manufacture of concrete pipe and such other products as plans for diversification might dictate, then the profit from the sale of part of the Bestpipe land in 1963 and the sale of the balance of the land owned by Bestpipe and the whole of the land owned by Press-Seal in 1964 would not be taxable.

However if that were not the appellants’ exclusive intention at the time of the acquisition of the land but the appellants also had in mind at that time the possibility of turning the land to account for profit in any practical way that might arise including the sale of it, should it not be feasible to proceed with the construction of a manufacturing plant, then the profits from the subsequent disposition of the land are properly taxable.

Counsel for the appellants contended that the first proposition was the case. He contended that the sole purpose of the appellants in acquiring the land was to expand their manufacturing operations and the establishment of a concrete pipe manufacturing plant to successfully compete in the Metropolitan Toronto area, that the implementation of the latter mentioned part of that plan was deferred by reason of the heavy commitment in DeSpirt but never abandoned. He further contended that the acquisition of the Scarborough land and the shares in DeSpirt were part and parcel of the same capital program of expansion and diversification. He said that the construction of a plant on the Scarborough land was frustrated because of the heavy financial commitments in DeSpirt, the appellants ’ own declining profit position and its loss of adequate working capital with the resultant pressure from the appellants’ bank to reduce Bestpipe’s obligation to the bank through the sale of the Scarborough land which was done because the combined pressure of the foregoing circumstances was irresistible but totally unforeseen by the appellants when the land was first acquired.

On the other hand counsel for the Minister readily conceded that it might well have been the intention of the appellants to acquire the land as a site for the erection of their plants, but he contended that was not their sole intention.

In support of that contention he pointed out that what were called plans by the directors were no more than hopes and contemplations, that no detailed cost estimates were obtained, no enquiries were made of the municipal authority as to the possibility of the agricultural land being zoned as industrial, nor was a building permit obtained or applied for. He also pointed to the small equity in the land, an amount of $40,000 being laid out in cash in a total purchase price of approximately $126,000 and that when the land was listed for sale in 1961 a plan of subdivision was filed on the land the cost of which was paid by Bestpipe. Furthermore, he submitted that financing was not available and no arrangements were made therefor. He argued that since the land was in Metropolitan Toronto with a rapidly expanding development the principals must have been aware of that development and that the land was highly speculative for that purpose at the time of its purchase as they were certainly aware of the opinion to that effect. expressed by the appraiser engaged by Bestpipe at the time of the expropriation proceedings some two years later. He characterized the purchase of the land as precipitous and the plans so tentative as to amount to mere hopes and expectations. The plant was not built but rather the plans for diversification were implemented through the medium of the purchase of shares of DeSpirt almost simultaneously with the purchase of the Scarborough land from which circumstance he submitted that what happened in reality was that any plans for construction on the Scarborough site were then abandoned rather than deferred. The appellants indicated a willingness to sell the land in 1961, two years after its purchase and that nothing was done in the interval in furtherance of the erection of a plant.

From the foregoing he argued that the inference was irrebuttable that the appellants did not have for their exclusive purpose at the time of the purchase of the land the erection of a manufacturing plant, but also had in mind the possibility of the sale of the land if the construction of the plant should not prove feasible.

With respect to the appellant Press-Seal, he pointed out that the evidence indicated nothing of investment plans on its behalf but rather that the directors were willing to subjugate the interests of Press-Seal to those of Bestpipe.

Two witnesses were called by the appellant. The first was Mr. S. R. Bernardo who had been the vice-president of Bestpipe and Press-Seal from their inceptions and managing director, as well as vice-president of both appellants from 1964. In addi tion he was also the general manager of DeSpirt following the purchase of shares in that company by Bestpipe. In answer to questions put to him he stated that the Scarborough land was acquired as a site for plants for Bestpipe and Press-Seal and that a large industrial complex was in contemplation to be developed over a period of years. He was adamant in his evidence that such was the sole purpose and that such plans w ere frustrated by the precarious financial position in which Bestpipe found itself as a consequence of its injudicious investment in the shares of DeSpirt. He also stated that at the time of its acquisition the possibility of the sale of the land was never discussed, or that it could be readily disposed of if the plans for manufacturing plants did not materialize.

The second witness, Mr. Longo, who was employed as the comptroller, of the appellants, expressed the view that the plans for an industrial complex on the site was a ‘‘brilliant idea’’ and deplored the fact that it was not implemented.

The onus of disproving that the Minister’s assumption when assessing the appellants as he did falls on the appellants.

The question in each case is what is the proper deduction to be drawn from the taxpayers’ whole course of conduct viewed in the light of all the circumstances. The conclusion must be one of fact.

The appellants’ evidence at trial that their purpose was to use the Scarborough lands as the site for manufacturing plants is only part of the evidence, While such evidence may be given in all sincerity it may not reflect the true purpose at the time of acquisition. Statements now made as to intention at the time of acquisition must be considered along with the objective facts.

The appellants never did begin the construction of a plant on the land, nor was there any evidence of taking preparatory steps towards that construction in a serious way. The plans of the appellants were twofold, (1) to diversify, and (2) to establish a concrete pipe manufacturing plant in the Metropolitan Toronto area, the first of which was implemented by the purchase of shares in DeSpirt within two months of the acquisition of the Scarborough land. It seems to me that in view of the declining profits of the appellants which prompted these plans that the appellants must be taken at this point to have abandoned its plan for beginning the concrete pipe plant at Scarborough, or at least relegated this portion of their overall plans to some future date. In short they opted in favour of diversification to the detriment of expansion of the concrete pipe business in the Toronto area.

In 1961 the Searborough land was listed for sale. While that listing was for a period of one year I fail to follow how it could be considered as ‘‘temporary’’ as suggested by Mr. Bernardo. The land was not sold out but if it had been during the year that would have ended the matter and since the land was listed the appellants must be taken to have intended to sell it. During the interval the acquisition of the land and the listing of it for sale in 1961 nothing concrete was done towards implementation of the construction of a plant on that land. While the plans for an industrial complex on the land may have been a “brilliant idea’’, as described by Mr. Longo, nevertheless they remained just that. There was no blueprint or timetable laid down for the future development contemplated.

it is inconceivable to me that business men of the experience possessed by the officers and directors of the appellants would not have contemplated the sale of the land if their more ambitious plans for the use of that land could not be realized in whole or in part, nor do I think that they were oblivious of the fact that the land was situate in a developing area with the likelihood of an increase in price.

After having given careful consideration to all the evidence, I am not convinced that there is a balance of probability that appellants acquired the property for the purpose of constructing a manufacturing plant on it to the exclusion of any purpose of disposition at a profit.

Accordingly it cannot be said that the assumptions of the Minister in assessing the gain so realized by the appellants on the sale of the land as income in the years in question were not warranted.

In an amended Notice of Appeal, the appellant, Bestpipe, raised the alternative plea that if the gain resulting from acquisition and sale of the Scarborough land is income from a business (as I have found it to be for the foregoing reasons), then the acquisition of the shares in DeSpirt is equally a business and the loss sustained by Bestpipe resulting therefrom is properly deductible as business losses in the computation of its income in its 1963 and 1964 taxation years.

I do not accept this contention. It is conclusively established by the evidence that the acquisition of the shares of DeSpirt was in furtherance of the Bestpipe’s plan for diversification and as such was a capital expenditure. Accordingly the loss

sustained is a loss of capital, the deduction of which is prohibited by Section 12(1)(b)* [4] of the Income Tax Act.

It follows therefore that the appeals are dismissed with costs.