Date: 20000315
Dockets: 97-1789-IT-I; 97-1790-IT-I; 97-1833-IT-I; 97-2450-IT-I
BETWEEN:
PATRICIA ANN GRANT, GEORGE GRANT, BRIAN S. MARKELL,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.T.C.C.
[1] These appeals are from assessments for the 1991 and 1992 taxation years of Patricia Ann Grant and her spouse George Grant and the 1991, 1992, 1993 and 1994 taxation years of Brian S. Markell. They were heard together.
[2] In the case of Mr. and Mrs. Grant, the appeals are concerned with losses claimed by them in relation to interests in the Queen Street Limited Partnership, which owned an apartment building in Kingston, Ontario.
[3] Mr. Markell also was a limited partner in the Queen Street Partnership and his claim is essentially the same as that of Mr. and Mrs. Grant. He also had units in a limited partnership known as Gallery 2000, which owned a small shopping mall in Pembroke. The figures are not in issue. The losses result from a write-down of the value of property held by the Queen Street Limited Partnership or the co-tenancy Studio 2000. The nature of his interest in the Wellington Retirement Centre Inc. is somewhat less clear, but he is claiming an allowable business investment loss ("ABIL") in respect of that project.
[4] By way of background, both the Grants and Mr. Markell became involved in the real estate projects with which we are concerned here through Gary Simpson, a financial advisor. Simpson had worked for many years with Investors Group. In 1984, he left that company and joined Glenn Lucas who was experienced in real estate. In quick succession they bought three residential properties in Vanier and sold them within months at a profit. Simpson treated the profit as income. The purchases were heavily leveraged. During the short periods in which they held the properties they were rented.
[5] The next project was a 24-unit apartment building in Kingston, the Conacher. It was bought for $600,000 in 1984 by 24 investors and was sold for $1,000,000 at a profit in 1987. The purchase was syndicated through a limited partnership. Simpson treated his share of the profit as a capital gain. Throughout these various real estate ventures there appears to be a remarkable fluidity in the way in which partners treated profits realized by the partnership. I should have thought that a trading profit realized by a partnership would be allocated to the partners as their share of the income and a similar allocation to the partners would be made of capital gains and losses. The purchasers defaulted on the mortgages and so the partnership foreclosed and took back the building. In 1991, the partnership wrote the building down to $825,000 and claimed a non-capital loss.
[6] These real estate syndications were done through a company owned by Lucas and Simpson, Real Property Investments and Management Ltd. ("RPIM"). The modus operandi was that RPIM would buy the building "in trust" and then sell it to a limited partnership at a profit. The expression "in trust" is somewhat meaningless since it was never clear just who it was "in trust" for. A share of the profit on the sale would be paid to Simpson and treated by him as a commission. I need not explore the somewhat interesting and unorthodox way of accounting for these profits and the manner in which they found their way into the shareholders' hands. What is significant is that in the remaining 19 real estate syndications that followed the Conacher, whether or not the investors made any money, Simpson and Lucas usually saw to it that they, or RPIM, did. In virtually all of the projects the property would be bought by RPIM and sold to a partnership or co-ownership at a profit.
[7] I shall list briefly these transactions:
Regent Street — This was an apartment building in Kingston. It was sold at a profit by RPIM to a partnership. It was sold within two years at a profit by the partnership. Mr. Simpson thinks the other partners treated the profit as capital, but RPIM, one of the owners of a partnership unit, treated its share as income. I have difficulty in seeing how this could be appropriate. The characterization of a profit or gain as income or capital takes place at the partnership level, not at the level of the partners.
The Winchester — The pattern here was the same as in the case of Regent Street — a sale at a profit by RPIM, a sale by the partnership at a profit within three years and the partners treated their share of the profit as capital, except for RPIM.
The Academy— This was an apartment building in Bath. As in the other cases it was sold to the partnership by RPIM at a profit. This project did not work out and the mortgage, National Trust, took it over and sold it. The investors sustained a loss.
Neepawa Townhouse Project — These were rental units. They were sold under power of sale and the investors lost money.
Queen Street — This is one of the projects in issue in this case. Both the Grants and Mr. Markell invested in this limited partnership. The property was an apartment building in Kingston. RPIM (or possibly the general partner, 652706 Ontario Ltd.) bought it "in trust" and sold it to the limited partnership. Simpson's share of the profit was to be paid to him after the partnership sold it at a profit. This never happened.
The project did not succeed. It was rented to university students. In 1991, the partnership wrote it down on its books and treated this as an inventory write-down. The loss resulting from this write-down was treated as an income loss and allocated to the partners.
In 1992, the first mortgagee foreclosed and sold the property. The Grants claimed a business loss in 1992 which the Minister of National Revenue disallowed and treated as a capital loss.
I shall revert to this transaction later.
Gallery 2000— This is another project in which Mr. Markell was involved. It was a co-tenancy rather than a partnership. The property was a shopping mall in Pembroke. Like many of the Simpson/Lucas/RPIM ventures it failed and in 1992 a write-down was taken and treated as an inventory write-down. Mr. Markell and possibly the other investors deducted their share in computing income.
Harbour Place — This was a commercial building in Kingston. It was acquired by a limited partnership of which RPIM owned one or more units. An offer was made to buy it but the sale was opposed by some of the partners and the offer was therefore rejected, although the Lucas/Simpson/RPIM group wanted to accept it. Ultimately it was sold under power of sale at a loss.
Rosemont Seniors Residence — This was a retirement home that was built by the RPIM group as well as a developer, who held interests in a limited partnership formed for that purpose.
As usual the project went sour. It ended up in bankruptcy and the investors lost money.
The Kingston Daycare — This was a commercial building in Kingston. It was bought by RPIM "in trust" and sold to a limited partnership. Unlike most of the other projects it was sold at a profit after two years.
RPIM, one of the unit holders, treated its share of the profit as income but the other investors treated the gain as capital. As noted in the Regent Street project, the discrepancy in treatment between the partners is inappropriate, but it is not relevant to these appeals.
Wellington Retirement Centre — A parcel of land was assembled at the intersection of Somerset and Wellington Streets.
As usual the land was bought by RPIM "in trust" and sold to the co-tenancy at a profit. One of the investors was Mr. Markell, who claimed a loss as an ABIL. I shall revert to this project later, because it is one that is in issue in these appeals.
Cooper Street — This was a small commercial real estate project which Simpson and Lucas and some others kept for a year or so and then sold at a profit.
Loughborough Shores — This was a subdivision near Kinsgton which Lucas and Simpson and others tried to develop and sell, but without success and they lost money.
Petawawa Beach Estates — This was a 28-acre subdivision which Lucas and Simpson and some others developed and sold, for a change, at a profit.
Hincks Plaza — This was a commercial plaza in Pembroke. RPIM bought it "in trust" and sold it at a profit to a co-tenancy of which RPIM held about 1/3 of the units. It was sold at a small loss.
Shangri-La Campground, Lodge & Marina — The usual pattern: RPIM bought it and sold it to some investors at a profit. It still has not been developed or sold.
Cobourg Plaza — Lucas and Simpson bought the property, a two-acre parcel of land and sought to develop it as a plaza. They made some money when they attracted some investors, but it was lost to the first mortgagee.
Elmsmere Seniors Residence — The usual story: RPIM bought it and sold it at a substantial profit to a limited partnership. Simpson sold his interest in 1993.
Wellington Business Centre — This project was lost to the first mortgagee.
Collins Court Plaza — This was a plaza in Napanee. The only money made on this was when RPIM sold it to a limited partnership. Then it was lost to a mortgagee.
[8] I have recited this litany of projects, most of which were disasters for the investors, because it establishes beyond peradventure of a doubt that Lucas, Simpson and their company were traders in real estate. Their method of operation was the quick flip. Whatever may have happened to the unfortunate investors to whom they sold a project, they usually ensured that they got their profit up front.
[9] From this fairly obvious conclusion, I move to what is the real issue: was the property in the projects in which they were involved inventory held in the course of a business or an adventure in the nature of trade?
[10] If the property held by the Queen Street Partnership and the Studio 2000 co-tenancy is inventory in the hands of the owners, the write-down is appropriate. The amount of the write-down is not challenged. In fact, the property had declined significantly in value and it was sold later for even less than the written down value.
[11] The write-down of the properties occurred in 1992, prior to the amendment to section 10 which was intended to counteract the decision of the Supreme Court of Canada in J. Friesen v. The Queen, [1995] 2 C.T.C. 369. The majority of the Supreme Court of Canada held in that case that land held in the course of an adventure in the nature of trade was inventory within the meaning of section 10 and could be valued at the lower of cost or market. If it declined in value from its original cost it could be written down and a business loss taken in the year, notwithstanding that it was not sold in the year. Subsection 10(1.01) of the Income Tax Act was introduced later to prevent this result but in the years in question, if the property was inventory, the principle stated in Friesen applied.
[12] Was it inventory? Here the viva voce evidence and the documentary evidence seem to be in conflict. I shall deal with the viva voce evidence first. Whether property owned by a partnership is capital or inventory must be determined at the level of this partnership. A partnership is not a legal entity, although section 96 requires that its income or loss be computed "as if" it were a separate person. Whether property is held on revenue or capital account requires the application of the usual tests to the partnership. I need not burden these reasons by yet another laborious recitation of the usual tests. We all know what they are. They are well summarized in Happy Valley Farms Ltd. v. The Queen, 86 DTC 6421 and in M.N.R. v. Taylor, 56 DTC 1125. The tests set out in Taylor were approved in Irrigation Industries Ltd. v. M.N.R., 62 DTC 1131. The concept of "secondary intent" was discussed in Racine, Demers and Nolin v. M.N.R., 65 DTC 5098. The Supreme Court of Canada in Regal Heights Limited v. M.N.R., [1960] C.T.C. 384 anticipated the concept.
[13] How then does one apply the well-known principles embodied in these cases to a partnership, or a co-tenancy where the individual investors may well have widely disparate expectations and intentions? One co-owner or partner may hope for a quick profit, another may be looking to a long-term investment.
[14] We must start by looking at the nature and structure of the partnership itself. In a limited partnership the general partner has control of the operations. The limited partner's role is a passive one, but if the partnership carries on a business so does the limited partner: The Queen v. Robinson et al., 98 DTC 6065; Grocott v. The Queen, 96 DTC 1025.
[15] In determining whether the partnership, considered as a notional separate person, is engaged in an adventure in the nature of trade, one must look at what the partnership actually does and at what the motives and intentions of the persons who in fact run the partnership are. I do not mean necessarily the persons with the largest number of votes or largest share of the partnership interest. Rather I am referring to the dominant partners who are the driving force and motivation behind the partnership. In some cases this may be a difficult question to answer, but in this case I have no difficulty. Clearly it was Lucas and Simpson, and their company RPIM. It was they who effectively made the decisions in these partnerships. Lucas and RPIM, in which Simpson had an interest were the promoters. The situation is not dissimilar to that which existed in M.N.R. v. Lane, 64 DTC 5049 where Noël J. said at pages 5054 to 5055:
It would appear from this that the Syndicate's non-active members were quite content to leave the handling of the Syndicate's activities to the executive committee who had carte blanche to handle the business of the Syndicate as they thought best and because of this situation, the passive members here would be in no different position than that of the active members. Indeed, if the transactions are business transactions, any profit derived therefrom from any of the members would be taxable.
[16] In the case of Mr. Markell and Mr. and Mrs. Grant, they were quite content to leave the decisions to Lucas and Simpson, who, as noted above, were clearly real estate traders and they imposed their intentions and pattern of operations on all of the projects in which they were involved.
[17] As to what was in fact done, Lucas, Simpson and RPIM bought the real estate and sold it to a partnership such as the Queen Street Limited Partnership, or a co-tenancy such as Gallery 2000 with the intention of flipping it at a profit. As it happened in many of the projects the downturn in the real estate market in the late 1980s and the early 1990s prevented their selling the property at a profit. The facts are quite clear that, whatever may have been in the promotional material or the prospectus, the intention of Simpson and Lucas was to have the partnerships or co-tenancies sell the properties at a profit as soon as possible.
[18] There are a number of indicia of a trading intent throughout:
(a) There was no management structure that was equipped to manage real estate projects of the type the Simpson/Lucas/RPIM group were syndicating.
(b) The properties were heavily mortgaged by the partnerships, and also the investors often borrowed money as well to finance their acquisition of units.
(c) Lucas, Simpson or RPIM, who were clearly traders, usually had an interest, either as co-tenants or limited partners, in the projects. It is improbable, to say the least, that they were interested in retaining the projects as long-term investments.
[19] Statements of intent are seldom particularly reliable, and all the more so where they are made by minority participants whose role in a project is passive. Moreover such statements are not necessarily indicative of the intent of the partnership as a whole. Nonetheless, they cannot be ignored entirely and the statements of Mrs. Grant and Mr. Markell are consistent with a trading intent. Mrs. Grant is a nurse and Mr. Markell is a retired police officer. From my observation of them, it is clear that they are unsophisticated investors, not knowing the difference between capital gains and trading profits, or the difference between a partnership interest and a direct ownership of real estate. Mrs. Grant invested in four of the projects — Wellington, Queen Street, Harbour Place and Elmsmere. She testified that she expected all of these projects to be sold at a profit.
[20] Mr. Markell invested in Neepawa, Queen Street, Gallery 2000 and Wellington. He was expecting to recover the money he had lost on the stock market.
[21] It is clear that at least these two investors were involved for a quick profit, not a long-term investment. What is however more important is that the dominant animus behind all of these projects was a quick profit by resale.
[22] I mentioned above that the viva voce evidence was at variance with the documentary evidence. In particular the prospectus for the Queen Street partnership contains a number of statements such as:
The investment should be considered only by investors who are able to make a long-term investment.
...
The Partnership was formed on August 15, 1986 for the purpose of acquiring, owning and operating a building... located in Kingston, Ontario.
[23] On page 10, the following appears:
Objectives and Concept of the Partnership
The objective of this offering is to afford investors in Units of the Partnership the opportunity to earn cash income from the Building owned and operated by the Partnership. In addition, in the first year of the operation of the Building, investors are expected to be able to deduct from personal income from any source losses of the Partnership, attributable for income tax purposes to certain initial services costs associated with the financing of the Building. See "Canadian Income Tax Consequences".
[24] On page 21, there is projected the "capital gain" if the building is sold in 1990. A great deal of the prospectus is devoted to income tax consequences, which are premised upon a capital gain being realized when the building is sold.
[25] I shall not reproduce any more of the boilerplate found in the prospectus. It is the sort of thing that we have all seen scores of times in these real estate syndication prospectuses: language designed to protect the promoters, (and, presumably, their lawyers), keep the securities regulators quiet, confound the tax department, tell the investors nothing comprehensible on which they could sue and ensure that the big capital gains and tax write-offs that they were undoubtedly promised orally by the promoters are buried under several layers of verbiage and unsupported assumptions. I have little doubt that if the projects had been sold at a profit these very same investors would have used the language in the prospectus as a basis for claiming a capital gain. Nonetheless I have to deal with the facts as I find them, not with hypotheses that might have been advanced to support a different conclusion in different circumstances.
[26] It is very clear that the appellants in these cases did not read the prospectus. I doubt that they would have understood it if they had. Prospectuses of this sort are said to be for the benefit, protection and edification of the investors. That purpose, if it exists at all, is secondary. The primary purpose is the protection of the promoters.
[27] I find the prospectus of no assistance in determining whether the Queen Street property was held as inventory or on capital account. The same is true of the financial statements, which show the building as "fixed assets". These documents simply do not reflect reality.
[28] I find as a fact that the properties involved in the Queen Street and Studio 2000 projects involved here were held in the course of an adventure in the nature of trade and that in accordance with Friesen the partnership or the co-tenants as the case may be were entitled to write them down to their market value, thereby giving rise to an inventory loss.
[29] So far as the Wellington Retirement Centre Inc. is concerned, the facts are more complicated, if not to say confusing. This project started out, apparently, as a land assembly in Ottawa to construct a seniors' home and the initial intention was to sell the land to co-tenants. It had to be converted, apparently as the result of a change in policy by the Ontario Securities Commission, to a limited partnership. However not enough units were sold and so the limited partnership never came into existence and never acquired the land.
[30] Mr. Markell claimed his loss incurred on the advances to the project as an ABIL. An ABIL arises on the loss on a loan to a Canadian controlled private corporation ("CCPC") or on shares of a small business corporation (i.e. a CCPC that carries on an active business).
[31] In the notice of appeal an ABIL was claimed.
[32] I do not see where there was a loan to any company of the type described in the definition of business loss in paragraph 39(1)(c). Mr. Markell clearly put some money into the project but it is unclear how. Certainly it was not by way of a loan to or subscription for shares of any of the corporate entities that seemed to be floating around. One of the corporations mentioned was Wellington Retirement Centre (1990) Inc. There is nothing to indicate a loan by Mr. Markell to this corporation and in any event the evidence seems clear that Wellington Retirement Centre (1990) Inc. was inactive and did not carry on an active business — a necessary condition to its being a small business corporation.
[33] Counsel for the appellants invited me to recharacterize Mr. Markell's basis for deduction and treat it as an inventory write-down or simply a loss on the disposition of inventory.
[34] It is rather late, after all the evidence is in, to alter fundamentally the basis on which the claim for deduction is made. Even if I were prepared to do so, I do not think this would change the result. It is not clear whether Mr. Markell ever acquired an interest in the land. Certainly the limited partnership did not do so; indeed the limited partnership did not come into existence. I can see no reason to interfere with the Minister's treatment of the loss on the Wellington project as a loss on capital account.
[35] In the result, the appeals of George and Patricia Grant for 1991 and 1992 are allowed and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that:
(a) George Grant is entitled to deduct in computing income business losses of $8,067 in 1991 and $9,067 in 1992, being his portion of the loss sustained by the Queen Street partnership on the inventory write-down in 1991 and his portion of the loss sustained on the disposition of the Queen Street property in 1992.
(b) Patricia Grant is entitled to deduct in computing income business losses of $8,067 in 1991 and $19,532 in 1992 on the same basis as George Grant, and also in respect of the further amount of $8,670.68 which she was ordered to pay to 358426 Ontario Ltd.
[36] The appeals of Brian Markell for the 1991, 1992, 1993 and 1994 taxation years are allowed and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that Mr. Markell was entitled to deduct a loss of $18,571 as his portion of the loss sustained by the Queen Street partnership upon the write-down of the Queen Street property and $12,814 as his portion of the loss upon the write-down of the Gallery 2000 property and to adjust the loss carry forwards accordingly.
[37] The appellants are entitled to their costs on the basis of one set of counsel fees.
Signed at Ottawa, Canada, this 15th day of March 2000.
"D.G.H. Bowman"
A.C.J.