Date: 19990707
Dockets: 98-2445-IT-G; 98-2449-IT-G
BETWEEN:
DAVID GUTHRIE, KAREN GUTHRIE,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent,
Reasons for Judgment
Hamlyn, J.T.C.C.
[1] In each of the Appellants’ returns of income for the 1991, 1993 and 1994 taxation years, the Appellants reported gains from the disposition of two properties as capital gains.
[2] A Partial Agreement of Facts was filed. It reads:
1. The Appellants are Canadian residents, whose address is R.R.#3, Woodstock, Ontario, N4S 7V7.
2. The Appellants were at all material times engaged in, among other things, the business of poultry farming.
3. In their returns of income for the 1992, 1993 and 1994 taxation years the Appellants reported gains realized from the disposition of certain real property (the “Gains”) as capital gains by a partnership (the “Partnership”) of which the Appellants were the members (the “Partners”).
4. The fiscal year of the Partnership at all material times ended at the end of the month of February.
5. By the 1991 Reassessments the Minister disallowed the deduction of the non-capital loss for the 1992 taxation year claimed by the Appellants in computing their taxable income for the 1991 taxation year.
6. The Appellants objected to the 1991 Reassessments by Notices of Objection dated July 28, 1997.
7. The Minister confirmed the 1991 Reassessments by Notices of Confirmation dated July 24, 1998.
8. In their returns of income for the 1992 taxation year the Appellants each reported a capital gain in the amount of $359,521 from the disposition of the Kitchener Property.
9. In their returns of income for the 1993 taxation year the Appellants each reported a capital gain in the amount of $278,147 from the disposition of the Parksville Property.
10. In their returns of income for the 1994 taxation year the Appellants each reported a capital gain from the disposition of the Parksville Property in the amount of $596,026, which was the amount claimed as a reserve under paragraph 40(1)(a) in their 1993 return of income.
11. By reassessments made by Notices of Reassessment Nos. 1678843, 1678844, 1678853, and 1678854, all dated June 12, 1997, for the 1993 and 1994 taxation years, respectively, (the "First Reassessments") the Minister treated the aforementioned amounts of $278,147 and $596,026 as business income, and also assessed penalties against the Appellants in reliance upon subsection 163(2) of the Act.
12. The Appellants objected to the First Reassessments by Notices of Objection dated July 28, 1997.
13. By the 1993 Reassessments and the 1994 Reassessments, the Minister vacated the aforementioned penalties but otherwise confirmed the First Reassessments.
14. In all matters relating to property located at 3289 King Street East, Kitchener, Ontario (the "Kitchener Property") and property located at 550 Hirst Avenue, Parksville, British Columbia (the "Parksville Property") David Guthrie acted with the complete authority of the Karen Guthrie to the extent that David Guthrie executed documents relating to these two properties.
The Parksville Property
15. In or about August of 1987, the Partners purchased the property municipally known as 550 Hirst Avenue, Parksville, British Columbia at a price of $300,000 (the "Parksville Property") (Joint Book of Documents, Tab 17).
16. In August of 1987 the Parksville Property was zoned R-1 for single family dwellings.
17. The Parksville Property consisted of 90.55 acres in total of undeveloped land.
18. The Appellants listed the Parksville Property for sale on January 12, 1990 for $2,350,000.00 (Joint Book of Documents, Tab 34).
19. In March of 1992 the Partners sold the Parksville Property for proceeds of disposition in the amount of $2,200,000, including a first mortgage in the principal amount of $1,500,000. (Joint Book of Documents, Tab 39).
20. While the Appellants owned the Parksville Property, they made no enhancements or improvements to the property to increase its value.
The Kitchener Property
21. On or about October 7, 1988, the Partners purchased the property municipally known as 3289 King Street East, Kitchener, Ontario (the "Kitchener Property") at a price of $600,000. (Joint Book of Documents, Tab 22, 26).
22. On September 30, 1988, the Kitchener Property consisted of approximately 2.75 acres and was zoned for agricultural use.
23. The Appellants listed the Kitchener Property for sale on September 19, 1989. (Joint Book of Documents, Tab 31).
24. Neither of the Appellants applied to have the zoning of the Kitchener Property changed.
25. On or about April 4, 1991, the Partners sold the Kitchener Property for proceeds of disposition in the amount of $1,385.000. (Joint Book of Documents, Tab 38).
SIGNIFICANT EVIDENCE ADDUCED AT TRIAL
[3] The Appellants have been and continue to be successful poultry farmers. They also operate successful retirement home businesses. The Appellants are also farm landholders in the operation of their poultry business; this is necessitated by the size of their business, the need to guard against disease and the necessity to dispose of poultry waste.
[4] In the early eighties, the poultry industry was governed by marketing boards, supply management rules and border controls. During this period of time, with the impending passage of the North American Free Trade Agreement ("NAFTA"), the Appellants were concerned about the survival of their poultry business in that the Appellants believed NAFTA would materially affect their supply management poultry business. To meet this perceived threat, the Appellants sought to diversify their investments to another form of business. Towards this end, they looked to the retirement home industry. Their view was with an ageing baby boomer demographic, the retirement home industry was growing and presented them a potentially attractive business opportunity. Moreover, within their own community, they had an example of neighbours also in the poultry business who had diversified their business enterprises to include the operation of successful retirement homes. This diversification decision shift took shape within the Appellants' own thinking in the mid-eighties. Thereafter, they looked for land for retirement home development and looked at existing retirement home businesses. The initial exploration and search stage was part of the Appellants' learning curve in their pursuit of a new business.
[5] While on holiday in British Columbia, the Appellants purchased (August 15, 1987) the Parksville Property. The Appellants described the Parksville community on Vancouver Island as a retirement area. The property was zoned R-1, however, the Appellants were of the view the property could be developed and operated as a retirement community of leased homes and leased four-plexes. The site was also to have developed recreation areas including a golf course.
[6] On September 30, 1988 the Appellants purchased the Kitchener Property. The Kitchener Property was 2.75 acre property zoned agricultural in the City of Kitchener. The site was close to a mall and close to the type of services that is required by seniors. The plan of the Appellants was to seek a zoning change and construct a low-density senior citizen apartment building.
[7] Throughout this period, the Appellants continued to look at other retirement homes and sought information about the retirement home industry. On March 26, 1990, the Appellants bought a retirement home (Delrose Manor) in Delhi, Ontario that was financially troubled and was in receivership. The home had 54 available spaces but only seven residents. The property purchase was initially financed through the Appellants’ poultry farm operating loan. The bank with whom the poultry farm operating loan was placed insisted that upon the retirement home acquisition the Appellants hire a manager and hire a marketing company. The Parksville Property was also part of the bank’s security.
[8] From the beginning, the Appellants have operated their businesses on the basis they do not like debt. The Appellant, Karen Guthrie, on cross-examination stated, in essence, from her point of view to operate three retirement homes before the retirement home business had been fully experienced and understood, could have led to disaster. Therefore, the Appellants in an effort to reduce their debt and consolidate their retirement home business proposals sold the Kitchener Property on April 4, 1991, and sold the Parksville Property in March 1992. The price realized on the sale of both properties substantially exceeded the cost of acquisition.
THE RESPONDENT’S POSITION
[9] The Respondent’s position is that the dispositions of the Kitchener Property and the Parksville Property were adventures in the nature of trade such that the gains realized on these dispositions constituted income from a business for the purposes of the Income Tax Act (the "Act").
THE APPELLANTS’ POSITION
[10] The Appellants plead the Kitchener Property and the Parksville Property were business investments and the gains realized on the disposition should be recognized as capital gains.
ANALYSIS
[11] This analysis must determine whether or not the Parksville Property and/or the Kitchener Property were acquired by the Appellants as investments and as a consequence to determine if the sales were realization of investments of a capital nature or were the property sales dispositions on income account. Several analytical factors have been set forth in Happy Valley Farms Ltd. v. The Queen, 86 DTC 6421 (F.C.T.D.). To assist in the determination of the characterization of the gains, what follows is an analysis of the evidence of this case in relation to those factors.
The nature of the properties sold
[12] The Parksville Property was a large tract of land. The Kitchener Property was a 2.75 acre lot. The Appellants’ retirement home proposals for each property were tailored to the land size. Nothing was done in relation to either property to take them beyond the intention to establish retirement homes. The selling of the properties was not especially unique other than it was relative to the acquisition of Delrose Manor.
Length of period of ownership
[13] The length of ownership was not long for either property but neither period of ownership falls into the parameters of a pure speculative land turnover (land flip) in an active real estate market.
Frequency or number of other or similar transactions
[14] The Appellants had several land dealings in relation to their poultry business and retirement home sites. The Respondent has sought to have the Court conclude the Appellants' real estate experience gave them a subjective appreciation of the profits that could be made in the real estate market. The Appellants in their evidence clearly explained their real estate transactions related to their business or proposed business endeavours. The Appellants acquired knowledge about the real estate market in the course of the their business and personal activities, I conclude, is part of their acquired expertise to operate successful businesses including the poultry business and the retirement home businesses. I cannot conclude from this acquired knowledge the Appellants had formed the intention to sell the properties for a profit on income account at the time of acquisition.
Work expended on or in connection with property realized
[15] From acquisition, no work was expended in connection with either property.
The circumstances that were responsible for the sales
[16] The circumstances responsible for the sale of the two properties are related to the proposal to operate retirement home businesses. The Appellants were successful businesspersons. The Appellants operate their businesses on a hands-on tight control basis. They operate their businesses in an organized manner based on budgets, marketing and management. The Appellants do not like debt. To operate three retirement home sites without full knowledge of the business was to the Appellants a scenario for disaster. As a consequence, in order to meet the acquisition of the Delrose Manor and to reduce their debt, the Appellants sold Parksville and Kitchener.
Motive or intention
[17] The exclusive operating motive in the acquisition of both properties (Kitchener and Parksville) from both the surrounding factual circumstances and the stated intention was to acquire business assets to operate retirement homes. In the end, they decided for their clearly stated reasons to operate only one retirement home and that being from the third site (Delrose Manor). The conduct of the Appellants, including their business history and how they run their businesses, their decision making motivation (NAFTA), and their aversion to debt all lend credence to the stated intention at acquisition they wished to operate retirement home businesses at both Parksville and Kitchener sites. The Appellants did not have the intention to trade-in properties at the time of acquisition. This conclusion is drawn from the Appellants uncontroverted evidence. There was no reason to doubt the credibility of the Appellants' evidence.
THE ALTERNATIVE ARGUMENT IN RELATION
TO THE PARKSVILLE PROPERTY
[18] Counsel for the Appellants in his submissions in relation to the Parksville Property posed an additional issue arising from the Respondent’s pleadings.
[19] Specifically, in the summary of the Appellants’ argument[1] he stated:
When a party seeks to support its cause of action on the basis of a statutory provision, the facts necessary to make the provision applicable must be pleaded so that the opposing party may decide what position to take and may have discovery and prepare for trial with regard to those facts.
...
In the Amended Replies the Respondent pleaded that in reassessing the Appellants the Minister assumed, inter alia, that at the time of their acquisition of the Kitchener property the Appellants had in mind the possibility of reselling the property at a profit and that possibility was an opening motivation for the purchase of the Kitchener Property.
However, such an assumption was not pleaded as having been made in respect of the B.C. property. The Respondent pleaded only the Minister’s assumption that "at all times it was the intention of the Appellant to resell the Parksville Property for a profit."
It is a misstatement of the test of secondary intention for the Court to ask merely, "Did the taxpayer have in his mind the thought that he might sell the asset in question at a profit".
...
There is no onus on the Appellant to demolish an assumption that is not pleaded. The assumptions pleaded in the Amended Reply do not include the crucial one that operating motivation of the Appellants at the time of purchase of the B.C. property was the resale of it at profit. The 1993 and 1994 Reassessments therefore, cannot be supported on the assumptions pleaded.
[20] The Minister's response to this submission was the Court must look at all the assumptions. Contrary to what was submitted by the Appellants' counsel, the other pleaded assumptions are not neutral and the pleadings of the Minister are sufficient to put the Appellants on notice and are sufficient to support the assessment on the Minister’s conclusion.
[21] In view of my finding that the gains reported by the Appellants constituted capital gains rather than business income, it is not necessary for the Court to rule on this additional argument.
[22] Suffice it to say in any event, once the evidence is in, the Court is required to determine the validity of the assessment in accordance with the Act.
DECISION
[23] The appeals are allowed and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the gains reported by the Appellants on the sales for the properties in question are capital gains.
[24] The Appellants are entitled to one set of costs.
Signed at Ottawa, Canada, this 7th day of July 2000.
"D. Hamlyn"
J.T.C.C.