Date: 19990305
Dockets: 96-1738-IT-G; 96-2154-IT-G
BETWEEN:
MIDANCO CANADA INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
Lamarre Proulx, J.T.C.C.
[1] These two appeals in respect of the appellant’s fiscal year ending December 31, 1989, were heard together.
[2] The issue in appeal 96-1738(IT)G is whether a gain made on the disposition of real property owned by the appellant was a capital gain or business income. Appeal 96-2154(IT)G concerns a capital dividend surplus, so its outcome depends on the outcome of appeal 96-1738(IT)G. These reasons for judgment will therefore deal with appeal 96-1738(IT)G.
[3] The facts on which the Minister of National Revenue (“the Minister”) relied in assessing the appellant are set out in paragraphs 6 to 18 of the Reply to the Notice of Appeal (“the Reply”):
[TRANSLATION]
6. The appellant is part of a group of related companies in which the common denominator is the Zaidan family.
7. The companies work in real estate, and the appellant and a number of the companies acquired and disposed of real property during the years before and after the taxation year at issue.
8. The Zaidan family includes Michael [sic] Zaidan, the father, and Joseph Zaidan, his son.
9. Until 1987, the appellant’s shareholders were companies controlled by Michael Zaidan.
10. In 1987, Joseph Zaidan became the appellant’s principal shareholder with almost 87 percent of the appellant’s common shares.
11. In August 1984, a group of companies purchased some rental property with a total of 368 units in London, Ontario. The property was known as “Thames Valley Property” (hereinafter “the Property”).
12. According to the purchase contract, the purchasers of the Property were the following taxpayers:
PURCHASER PERCENTAGE SIGNER OF THE
ACQUIRED DEED FOR THE
PURCHASER
Midanco Inc. 26.5% Joseph Zaidan
Zaidan Properties Ltd. 50.0% Michael Zaidan
97794 Canada Inc. 15.0% Michael Zaidan
Zaidan Entreprises Inc. 5.0% Michael Zaidan
Les immeubles A.M.E.
Inc. 3.5% Joseph Zaidan
13. The acquisition cost of the Property was $3,725,000. It was financed through mortgages.
14. In May 1988, Zaidan Properties Ltd., 97794 Canada Inc. and Zaidan Entreprises Inc. — the companies represented by Michael Zaidan at the time of the purchase — sold their interests in the Property to the appellant for a total of $4,340,000;
15. The appellant’s interest in the Property thus rose from 26.5 percent in 1984 to 96.5 percent in 1988; the other 3.5% was still owned by Immeubles A.M.E. Inc.
16. Shortly thereafter, in November 1988, an offer to purchase was made to the appellant, which agreed to sell its interest in the Property for $11,180,000.
17. The transaction occurred in January 1989, and the appellant reported a capital gain as follows when it filed its tax return for that year:
Proceeds of disposition: $11,180,000
Adjusted cost base: $3,803,279
Expenses: $371,267
Capital gain: $7,005,462
Taxable capital gain: 2/3 $4,670,302
18. At the time the Property was acquired, the appellant was thinking of reselling it at a profit, and that possibility was a motivating factor in the acquisition of the Property.
[4] The grounds for appeal are set out as follows in paragraph 7 of the Notice of Appeal:
[TRANSLATION]
(a) THAT the capital gain reported by the Appellant is really a capital gain and not business income;
(b) THAT the Respondent should not have disallowed the capital losses;
(c) THAT the Respondent should not have revised the quantum of the capital losses;
(d) THAT the Respondent has not explained the changes she made, with the result that she has the burden of proof in this case;
(e) THAT the Respondent assessed the Appellant on the basis of an audit report by Revenu Québec, that the Respondent made the assessment without doing an audit and that the assessment is therefore void ab initio;
(f) THAT at the objection stage, the Appellant submitted its minute book, a letter by Joseph Zaidan explaining what the Appellant intended and a series of documents; the Respondent did not consider them . . . .
[5] Youssef Zaidan, the appellant’s principal shareholder and president, Vicky Martin, a former manager of the property in question, and Frank Falbo, an officer from Revenue Canada’s Objections Directorate, were called to testify by counsel for the appellant. Mr. Falbo was also called by counsel for the respondent.
[6] The appellant was incorporated as Zaidan & Kfoury Constructions Ltd. under Part I of the Quebec Companies Act on August 27, 1969. It is part of a group of corporations with related shareholders, which can be called the Zaidan group. Exhibit A-2 is a chart showing the corporations that made up the group in 1987.
[7] Exhibit A-3, the appellant’s minute book, shows that in 1969, Michel Zaidan, Youssef’s father, was the president, Philippe R. Kfoury was the treasurer and Joseph Zaidan was the vice-president. This Joseph Zaidan is not the same person as Youssef Zaidan, the appellant’s current president, who also occasionally uses the given name Joseph.
[8] A variety of real estate transactionscan be found in the minute book. For instance, on September 10, 1969, the appellant purchased some vacant land in Dollard-des-Ormeaux from Selected Realties Limited. The price was payable through the issue of common and preferred shares in the appellant. On August 22, 1972, the appellant purchased 1,000,000 square feet of land from Zaidan Corporation Ltd. On November 10, 1977, a resolution of the appellant authorized Joseph Zaidan to negotiate and sign a new hypothec on the land and buildings it owned at 170-180 Dorchester Street.
[9] A resolution of the appellant dated March 17, 1975, states the following, inter alia:
[TRANSLATION]
The president submitted a statement of the properties sold by the company since 1971. He said that the sales were closed and signed on the company’s behalf by Youssef Zaidan, Henry Zaidan or Charles Zabbal pursuant to the general resolution of March 27, 1973, or special resolutions prepared by the officiating notaries.
The president added that it would be expensive for the company to have all the deeds checked to determine whether those who signed them had the authority to do so and, in the case of special resolutions, to trace the resolutions.
He therefore moved that the sales in question be ratified all at once.
The list of properties built by the corporation that is appended to the resolution shows that there were about 65 homes, with prices ranging from $15,000 to $20,000.
[10] According to the minute book (Exhibit A-3), Joseph Zaidan resigned from the board of directors on May 3, 1971. Youssef Zaidan became a member of the appellant’s board of directors and was appointed secretary of the corporation. On March 27, 1973, both he and his father, Michel Zaidan, the appellant’s president, had authority to bind the corporation. On July 1, 1973, Philippe Kfoury resigned as a director of the corporation.
[11] On March 17, 1975, the corporation adopted a resolution to change its name to Corporation immobilière et d’investissements Midanco Ltée - Midanco Investment and Realty Corp. Ltd. The name change was officially approved on July 18, 1975. On February 15, 1989, the corporation changed its name again to the one it currently has.
[12] According to Exhibit A-1 (also reproduced at Tab 27 of Exhibit R-1), which is the deed of purchase, the property in question was acquired on August 31, 1984, for $3,725,000 by the purchasers referred to in paragraph 12 of the Reply, which is reproduced in paragraph 3 of these reasons. The property consisted of apartment buildings in the city of London, Ontario, with the civic addresses 621-645 Kipps Lane and 1166-1182 Adelaide. It was known as Thames Valley Property or Thames Park Apartments and had an area of 13.3 acres. It consisted of 12 apartment buildings with a total of 368 units. The property was sold by Seaway Trust Company as liquidator of the property in receivership. When it was acquired, it was in a serious state of disrepair. The following appears in a letter by Youssef Zaidan filed as Exhibit A-11 (or Tab 76 of Exhibit R-5):
. . . When we acquired the property, it was a complete disaster, with many if not two thirds of the apartments in completely non habitable states, floods and other damage having occurred years before we acquired the asset. Our development work was phenomenal.
[13] Appendix A to the financial statements (Tab 1 of Exhibit R-1) shows that the expenses incurred in 1985 and 1986 to repair and maintain the property were relatively minimal at $235,229 and $178,240, respectively. For the other years, the financial statements contain no specific calculations for the property in question.
[14] According to page 4 of a report in a letter dated October 12, 1984, that was sent to the purchasers of the property by their lawyers (the letter is part of Exhibit A-1), the price was paid by means of two mortgages: one for $3,150,000 made to General Trust and another for $850,000 made by Zaidan Group Ltd. and secured against property it owned north of Kipps Lane.
[15] Exhibit A-2 is an organization chart showing the corporations in the Zaidan group. It was prepared in 1987 for the purpose of reorganizing the group and transferring property in accordance with section 85 of the Income Tax Act (“the Act”). Joseph Zaidan explained that this butterfly transaction took place at his request because he wanted to stop having to share the management of the Zaidan group with his father, Michel Zaidan. On April 4, 1988, as a result of the reorganization of the Zaidan group, Youssef Zaidan became the appellant’s only director.
[16] Exhibit A-2 also includes the deed dated May 1, 1988, transferring the interests of the purchasers of the property to Midanco. The transfer was registered on May 16, 1988, and a copy of the registration appears in Exhibit A-2. From then on, the appellant had a 96.5 percent interest and Les immeubles A.M.E. Inc. had a 3.5 percent interest. The consideration was $4,340,000 (letter of January 18, 1996, filed as Exhibit A-1).
[17] At the time of the reorganization, the appellant gave up its entire ownership interest in a building at 1000 St-Antoine and acquired 50 percent of a building called West Lodge and 97.5 percent of Thames Valley Property.
[18] Exhibit A-4 is an appraisal of Thames Valley Property dated October 14, 1986. The appraiser found that the market value of the property was $6,800,000. According to Youssef Zaidan, the appraisal was prepared for the purpose of transferring properties between the members of the Zaidan family and not for the purposes of the substantial mortgages later placed on the property. When the property was acquired, General Trust held a mortgage in the amount of $3,150,000. At the time of the sale, it held a mortgage in the amount of $6,400,000.
[19] Thames Valley Property was sold for $11,200,000 on November 15, 1988. The deed of sale was filed as Exhibit A-5. The purchaser agreed to assume the $540,000 first mortgage and the $6,400,000 second mortgage. The vendor agreed to take a $1,560,000 mortgage on the balance of the sale price.
[20] The introductory portion of clause 1 and the vendor’s undertaking at the end of the contract with regard to the real estate agents for the vendor and the purchaser read as follows:
1. The Vendor shall sell the Real Property to the Purchaser through DISTRICT REALTY CORPORATION and JOHN THIEL REAL ESTATE, Agents for the Vendor, and the Purchaser, subject to the terms and conditions herein contained, shall purchase the Real Property from the Vendor at the price or sum of ELEVEN MILLION TWO HUNDRED THOUSAND ($11,200,000) DOLLARS in lawful money of Canada payable as follows:
. . .
[Vendor’s undertaking]
IN WITNESS WHEREOF THE VENDOR hereby accepts and executes this agreement and in consideration of having procured this Agreement, the Vendor agrees with DISTRICT REALTY CORPORATION AND JOHN THIEL REAL ESTATE as Agents for the Vendor to pay a commission of Three (3%) Percent of the sale price herein on the Closing Date, said commission to be split equally by District Realty Corporation and John Thiel Real Estate. Should the deposit paid by the Purchaser not be sufficient to pay the amount of fee then I do hereby irrevocably instruct and authorize my solicitor to pay any unpaid balance of said fee out of the proceeds of said sale.
[21] According to Youssef Zaidan, the sale was unsolicited. He explained that he retained the services of a real estate agent even for unsolicited sales.
[22] Youssef Zaidan explained that the appellant intended to keep the property because it wanted it to be its base of operations in Ontario; the property was to serve as an administrative and maintenance office for all the properties the appellant acquired in Ontario. It had already acquired another rental property not very far away. It had, inter alia, begun some work and hired rental agents on a bonus basis. Vicky Martin managed the rental activities and was very efficient.
[23] According to Youssef Zaidan, the appellant had problems with Ontario's rent review board. It was also under pressure from one of its bankers. It had also received a number of offers, which it declined, but then it was made an exceptional offer it could not refuse.
[24] The written answers (filed as Exhibit A-11) he gave his lawyer on November 6, 1995, to explain why Thames Valley Property was sold did not change when he testified. He explained that the appellant had acquired Thames Valley Property to strengthen its footing in Ontario. It already owned another property in London, Country Lane Apartments, which it purchased in 1980 and sold in 1989. It sold Thames Valley Property because the real estate market had gone "insane". He also said that the restoration of the property, which was in an appalling state when it was acquired, had required a phenomenal amount of work. He further stated that they always, except in a few special cases, intended to hold on to assets in order to "derive revenues" from them and that they never bought with the intention of reselling.
[25] Exhibit A-8 is a letter dated October 25, 1995, from F. Falbo of Revenue Canada’s Appeals Division to counsel for the appellant. A Revenu Québec report is stapled to the letter. During his examination, Mr. Falbo said that this report is not the document that was or should have been attached to the letter, because what was supposed to be attached to it was a report by John Wood. Counsel for the appellant told the Court categorically that the Revenu Québec report had indeed been attached to Mr. Falbo’s letter, not the report by John Wood. This would explain what was stated in the Notice of Appeal. It seems strange that this mistake was not discovered until the hearing.
[26] The report states the following: [TRANSLATION] ". . . All the transactions are carried out in similar stages from one company to another. The mortgages are always from General Trust of Canada. All the purchases, without exception, are at very modest prices. A new appraisal is performed by an expert one year after the purchase. . . . The company obtains a second mortgage from General Trust equal to the increase in value determined by the appraisal. . . ."
[27] Counsel for the respondent prepared tables on the purchase and sale of various properties by 12 corporations, including the appellant. She used those tables to question Mr. Zaidan. Each of the corporations is related in some way to the appellant or, in other words, is part of the Zaidan group. The many pieces of property are acquired through forced sales, as a result of a change in a government assistance program or for another such reason. The table shows that they are always sold at a substantial gain.
[28] Counsel for the respondent filed extracts from Joseph Zaidan’s examination for discovery at Tab 28 of Exhibit R-1:
Q. Right now, what do you do?
A. Right now, I am scrambling to stay alive.
Q. And what does it mean, exactly?
A. It means I am trying to get back into real estate with a name that has been very dirtied by many people, among which this assessment, and I am trying to find a way to get on with my life.
Q. And in 1989, what were you doing for a living?
A. My business was the acquisition of real estate properties which we would basically buy and hold, or buy and improve, or buy and develop.
Q. And what do you mean by “buy and develop”?
A. Meaning we would buy a property, it would be in a very bad state, we would fix it and hold on to it. The program is a very simple one; we would buy buildings that need work, we would buy them at a good price to compensate for the risk that we took, and we would hold on to them until such time as we felt it was unwise to hold on to them any longer.
[29] Counsel for the appellant began his oral argument with two statements that appear to be inaccurate. First, he said that Joseph Zaidan was the directing mind of the appellant from 1984 to 1989. However, the evidence showed that Michel Zaidan was the appellant’s president from 1984 to 1988. Counsel for the appellant also said that the appellant had paid 25 percent in cash, when in fact the amount by which the purchase price exceeded the mortgage was also borrowed through an intercorporate loan. With regard to the first point, the appellant’s president at the time of the acquisition did not testify. In any event, regardless of who the company’s directing mind was at the time of the acquisition, what matters is the corporate intention at that time, which depends much more on the historical context in which the acquisition occurred than on the testimony of those who ran the company.
[30] Counsel for the appellant referred, inter alia, to the Federal Court of Appeal’s decision in Hiwako Investments Limited v. The Queen, 78 DTC 6281. According to the summary of that decision, Hiwako’s principal shareholder, a German, had a long history of trading in real estate in various countries. He purchased a property in 1967 and resold it nine months later at a very large profit. The Tax Review Board and the Federal Court - Trial Division dismissed his appeal. The Federal Court of Appeal allowed it. Counsel for the appellant referred to two passages from the decision:
. . . I do not read the evidence in this case as being open to an inference that a prospect of re-sale at a profit was a motivating reason for the purchase and I do not read the learned Trial Judge’s finding of fact in the last paragraph of his judgment as amounting to more than a finding that the investment was in a profit producing property that would increase in value and that circumstances in the future might dictate a change in investments.
. . .
. . . Had the alleged assumption been that there was an expectation on the part of the purchaser, at the time of purchase, that, in the event that the investment did not prove to be profitable, it could be sold at a profit, and that such expectation was one of the factors that induced him to make the purchase, such assumption, if not disproved, might (I do not say that it would) support the assessments based on “trading” if not disproved.
[31] Counsel for the appellant argued that, as in Hiwako, the appellant simply wanted to acquire property that would yield a good return and that resale at a profit was not the reason or one of the reasons for the purchase. He also argued that the offer to purchase had not been solicited. He further submitted that the respondent was trying to prove the correctness of the assessment by using facts that differed from those on which the Minister relied in making the assessment and that the burden of proof was therefore on the respondent.
[32] On this last point, counsel for the appellant attacked the Revenu Québec report that had been mistakenly attached to Mr. Falbo’s letter instead of John Wood’s report. The part of the report that angered counsel for the appellant is the statement that the company sells to a related company before selling to a third party, since in the case at bar there was no prior sale to a related company. There was a disposition to the appellant as part of a butterfly transaction. It is my view that these are not grounds for reversing the burden of proof. The assessment was clearly based on the fact that the property in question was acquired for the purpose of resale and not as a long-term investment.
[33] Counsel for the respondent referred to the decision by Associate Chief Judge Christie of this Court in Leonard Reeves Incorporated v. The Queen, 85 DTC 419, and more specifically to the following comments at page 422:
3. The direct evidence of a person who has an interest in the outcome of an appeal regarding the intention behind a transaction or series of transactions is not determinative of the existence of the stated intention. Generally speaking the intention is to be ascertained from the entire course of conduct and relevant circumstances and the inferences flowing therefrom: Gairdner Securities Limited v. M.N.R., 52 DTC 1171 per Cameron, J. at 1175 and Racine et al. v. M.N.R., 65 DTC 5098 per Noël, J. at 5103.
4. A consideration of statements in Articles of Incorporation regarding the objects of the corporation or restrictions on the businesses it may carry on is not helpful. What the company did in fact is paramount: Regal Heights Ltd. v. M.N.R., 60 DTC 1270 per Judson, J. at 1272-3: Glacier Realties Limited v. The Queen, 80 DTC 6243 per Addy, J. at 6245. The same is true with respect to what may be said in a partnership agreement regarding the nature of the partnership’s business.
5. Evidence of transactions of the sale and purchase of real estate by an appellant after the years under review in an appeal is admissible: Osler Hammond & Nanton Ltd. v. M.N.R., 63 DTC 1119 per Judson, J. at 1120: G. W. Golden Construction Ltd. v. M.N.R., 67 DTC 5080 per Ritchie, J. at 5082 and Fyke v. M.N.R., 64 DTC 5032 per Cameron, J. at 5033. The weight to be assigned to evidence of this kind will depend on the circumstances of particular cases. Evidence of an intended sale and purchase that for some reason was not consummated is also admissible. The comment respecting assignability of weight also applies to evidence of this type.
6. The fact that real estate is not advertised for sale and that an offer which results in a sale and purchase is unsolicited is not preclusive of there having been a primary intention on the part of the appellant at the time of purchasing the property to sell it at any time he regarded it as financially favourable to do so. Lack of advertising and the fact of an unsolicited offer are simply matters to be weighed together with the other relevant evidence: Slater et al. v. M.N.R., 66 DTC 5047 at 5050.
7. If an individual who is an appellant has a history of trading in real estate or if the appellant is a corporation that is controlled by such a person, this is a relevant consideration which points away from the purchase in issue being made with the primary intention of securing an income-producing asset: Vaughan Construction Company Ltd. v. M.N.R., 70 DTC 6268 per Laskin, J. (as he then was) at 6270 and Slater at page 5051.
[34] In my opinion, the evidence showed that the appellant’s real estate activities involve either acquiring land and building homes on it to sell or acquiring properties that are generally in poor condition and renovating and reselling them. The evidence revealed no interest in rental income. The entire purchase price is borrowed. Moreover, immediately after acquiring property, the appellant has it appraised at a higher value and takes out mortgages on it for the maximum amount. That is what it did with regard to the property in question. The steps it took did not differ from the modus operandi described by the Revenu Québec investigator. In the Hiwako case referred to by counsel for the appellant, the property in question was purchased following a long search, and what was sought was rental property in good condition that would yield a good return. Those circumstances are very different from the ones in this case, where the property was acquired from a trustee and was in a seriously deteriorated condition, the repairs carried out were minor and a mortgage was taken out on the property at almost twice the amount of the mortgage taken out at the time it was acquired.
[35] As for the argument that the offer to purchase was not solicited, it should be noted that this fact was not raised in the appellant’s Notice of Appeal. As stated in Leonard Reeves Incorporated, this fact is not determinative but of course, it is an important consideration; if it is true, it should be referred to in the notice of appeal. When Hiwako was heard by the Federal Court - Trial Division (74 DTC 6360, at page 6367), the evidence as to the circumstances in which the purchaser made its offer to Hiwako was complete. In the case at bar, we have only the testimony of Youssef Zaidan on this point. Nothing prevented the appellant from calling the real estate agents involved in the sale as witnesses.
[36] I conclude that the acquisition and sale of the property in question were the acts of a trader in this market and that the gain resulting from the sale was business income, not a capital gain. The assessment was therefore properly made and the appeal is accordingly dismissed with costs.
Signed at Ottawa, Canada, this 5th day of March 1999.
“Louise Lamarre Proulx”
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]