Tax Court of Canada Judgments

Date: 20011122

Docket: 2000-1410-IT-G

BETWEEN:

318806 B.C. LTD.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasonsfor Judgment

Rip, J.

[1]            The appellant 318806 B.C. Ltd. appeals an income tax assessment for its taxation year ending December 14, 1995, in which it claimed an "inventory write-down" pursuant to subsection 10(1) of the Income Tax Act ("Act") in respect of certain property the appellant reacquired in that year on default of a debt due to it. The issue before me is whether the property in question was capital, as claimed by the respondent, or inventory, as claimed by the appellant.

[2]            Mr. Michael Smith is the sole director and officer of the appellant. Mr. Smith is also the sole shareholder, director and officer of M.R. Smith Ltd. ("Smithco"), the only shareholder of the appellant.

[3]            At all relevant times Smithco carried on the business of a wholesale sales agent of Imperial Oil Canada Limited ("Imperial") selling oil and gas north of the Fraser River in British Columbia. Sometime in about 1989 Mr. Smith decided that he would like to increase his business activity by owning an Esso service station and incorporated the appellant for this purpose. ("Esso" is a trade name under which Imperial sells gasoline.) The appellant purchased a gasoline station consisting of gas pumps and a convenience store ("Property") east of the Pitt River and along the Lougheed highway. The facility purchased was rundown and had to be converted to an Esso station. The purchase price was $345,000.

[4]            The Property's location was ideal for a retail gas outlet. A sales tax of four cents per litre of gasoline was exigible on gas sold within the Greater Vancouver Regional District ("District"). In 1990 Pitt Meadows was outside the District and gasoline retailers could sell gasoline for four cents less per litre than the dealers within the District. The Property was located only metres east of the District and the gasoline station on the site could sell gas at the lower price. Potential customers could cross the Pitt River and then return to the District at minimum convenience. Mr. Smith also believed he had an opportunity to develop a "card lock" operation on the Property. Commercial users, that is large trucks, would be granted access to the gasoline station 24 hours a day using special access cards to purchase their gasoline.

[5]            After the appellant purchased the Property, it incurred expenses of approximately $350,000 to refurbish the Property, installing new gasoline storage tanks and improving the convenience store. During the renovations Mr. Smith discovered contaminated soil on the Property, which had to be cleaned and replaced with clean soil.

[6]            The appellant operated the Property as a gasoline station and convenience store for a period of approximately 46 months. The appellant was very successful. The volume of business increased from 400 litres a day at the time of purchase to 20,000 litres per day when the station was reopened after renovations, an increase of 500 per cent.

[7]            On several occasions Mr. Smith was approached by principals of Soni & Sai Holdings Ltd. ("Soni") to purchase the Property. Offers to purchase ranged from $1.2 million to $1.6 million and each time Mr. Smith rejected the offer. However, in the spring of 1990 Soni offered the appellant $1,950,000. The offer was accepted since, amongst other things, it was three times the cost of the Property to the appellant. Another reason for accepting the offer, Mr. Smith said, was because Smithco's wholesale business was increasing and he did not have enough time to devote to the retail outlet. Mr. Smith recalled that the appellant could not build a card lock operation because there were too many cars on the lot buying gas and it would have been difficult for large trucks to enter and exit the Property. Once the appellant sold the Property, Mr. Smith devoted all his time and effort to the business of Smithco.

[8]            The purchase price of $1,950,000 was payable as follows: cash of $700,000 on closing (April 30, 1990) plus an additional $100,000 plus interest to be paid on December 31, 1990. The balance, $1,150,000, plus interest, was payable over five years with a final balloon payment on May 31, 1995. The blended monthly payment of interest and principal was $11,866.85. The balance of purchase price was secured by an Agreement for Sale to the vendor.

[9]            After the transaction neither Mr. Smith nor the appellant had anything to do with the Property. Smithco delivered gas to the site for the first couple of years. Soni met all monthly payments.

[10]          Upon completing the transaction in 1990 the appellant recorded the debt as a receivable from Soni in its books of account. The Property was no longer reported as an asset of the appellant. The appellant reported the transaction as a capital gain in its 1990 tax return, claimed a reserve under subparagraph 40(1)(a)(iii) and continued to claim a reserve in its 1991 to 1994 tax returns accordingly.

[11]          Soni did not make the final payment on May 31, 1995. Soni advised Mr. Smith that it had arranged to sell the Property to a third party ("third party") and undertook to make the final payment once the Property was sold. Mr. Smith agreed to defer the making of the final payment so long as Soni continued to make monthly payments in the amount of $11,866.85 until the sale was completed.

[12]          In the course of carrying out its due diligence, the third party discovered soil contamination on the Property and, as a result, the transaction did not take place.

[13]          The contamination was "news" to Mr. Smith. He thought the contamination had been cleaned up when he acquired the site but he was not surprised. In 1995 contamination on oil sites was a "big issue". However, the extent of the contamination was a surprise to him and he had to notify the Provincial government of the dangerous waste. Because the transaction with the third party did not take place, Soni could not get financing and did not make the balloon payment. Soni was told that it would cost "six digits" to clean up the site. According to the assumptions made by the Minister of National Revenue ("Minister") in assessing the appellant, the third party indicated the clean up cost would be approximately $500,000. Soni also advised the appellant that it was in arrears of approximately $115,000 for Goods and Service Tax ("GST") it failed to remit to the Receiver General for Canada and that Revenue Canada, as it was then called, was prepared to garnish its bank account. Soni told the appellant that it was in no position to continue making the monthly payments.

[14]          Mr. Smith sought legal advice. He was told that regardless of when the contamination occurred the appellant and he could be personally liable for the cost of the remediation of the property as well as fines and penalties under the Waste Management Act of British Columbia. The appellant could be liable to Soni and even the third party in both contract and tort.

[15]          Mr. Smith decided to buy back the Property with the intent of cleaning it up and then selling it. He wanted to "go back to square one", the state of affairs in 1990. He feared any potential liability he or the appellant may have incurred with Soni. As far as Mr. Smith was concerned he wanted to "clean up the property and flip it" to a purchaser for a profit.

[16]          Mr. Smith got in touch with Mr. Bob King of Imperial's Environmental Department. Mr. King informed him that there was a firm in the Vancouver area that could clean up the contaminated soil using a new process for less cost than Soni indicated. Mr. Smith got in touch with this firm and was informed that the site could be cleaned up for between $65,000 and $75,000. Also, the business could continue to operate during the cleaning or remediation of the soil.

[17]          That the gasoline station could continue to operate during the clean up was very important to Mr. Smith. If the station were closed, he stated, any good will related to the Property would be lost. In Mr. Smith's view, the Property had problems and the last thing he wanted to do was to close the station for any period of time. He wanted to maintain the value of the station so that he would be able to obtain a price of over $1 million for the Property.

[18]          Apparently the Property became part of the District in 1992 or 1993 and the advantage of selling cheaper gasoline was lost. Also, by 1995 the intersection allowing entry and egress from the Property was relocated. In 1995 the business of Smithco was expanding and demanding all of Mr. Smith's working hours, as in 1990, he had no time available to operate another business. This also influenced Mr. Smith's decision to sell the Property as soon as possible.

[19]          On or about December 12, 1995, the appellant reacquired the property from Soni for $150,000 plus the cost of some equipment Soni had purchased which the appellant wished to acquire. The Property was not conveyed to the appellant pursuant to its rights under the Agreement for Sale but under an agreement dated October 20, 1995. The purchase price was satisfied by the appellant paying directly to the Receiver General for Canada the amount of GST owing by Soni and the balance was paid to Soni. The appellant also released Soni of its obligation to pay $1,097,000 then owing under the original sale to Soni. Soni and the appellant entered into a mutual release of all claims one may have had against the other.

[20]          Once the Property was reacquired by the appellant, the appellant engaged the firm recommended by Imperial to remediate the soil. The work was completed within budget and the business continued to operate.

[21]          While negotiating for the repurchase of the Property Mr. Smith arranged to cause the appellant to enter into a lease with Mr. Barj Dhahan, an experienced and successful gas station operator in the Lower Mainland to operate the gas station for one dollar a month. Mr. Smith arranged with Imperial for the appellant to receive 1.5 cents per litre on all gasoline Smithco sold to Mr. Dhahan. The lease included an option to Mr. Dhahan to purchase the Property for $1.25 million; the option was to be exercised on or before July 1, 1997.

[22]          Mr. Smith testified that he charged only a nominal rent to Mr. Dhahan because he did not want to take the Property back. As an experienced operator Mr. Dhahan could continue the station's operation without Mr. Smith's involvement. Once the Property was remediated, Mr. Smith hoped, Mr. Dhahan would purchase the station.

[23]          Unfortunately Mr. Dhahan did not exercise the option. In 1997 Mr. Dhahan and Mr. Smith reviewed the operation of the gasoline station and both realized the Property was no longer worth $1.25 million. The business changed from earlier: margins were lower and there were greater environmental problems and concerns. Mr. Dhahan continued to operate the Property for $1 a month until he found someone to purchase the Property from the appellant in 1999 for $725,000.

[24]          The appellant's accountant prepared the appellant's financial statements and income tax return for 1995. He treated the reacquisition of the Property as an adventure in the nature of trade. The appellant considered the Property to be inventory. It computed the cost of the Property on reacquisition to be $1,244,296, relying on subsection 79.1(6) of the Act and claimed an "inventory write-down" of $885,296 to $359,000 in respect of the Property pursuant to subsection 10(1) of the Act.

[25]          By notice of reassessment the Minister disallowed the deduction on the basis that the Property was a capital property when reacquired by the appellant in 1995.

[26]          The parties concede that if the Property was inventory or if the reacquisition and eventual sale in 1999 was a venture in the nature of trade, the appeal should succeed but if the property continued to have the character of capital when so acquired, the appeal should fail.

[27]          The appellant's argument proceeded on the basis that there is no rule of law that requires a taxpayer's former capital property to continue to be treated as capital property when subsequently reacquired by the taxpayer in consequence of a default under a loan.

[28]          Section 79.1 of the Act, sets out the rules applicable to a creditor who reacquires property in consequence of non-payment of a debt, whether the creditor had held the property as capital or inventory. Subsection 79.1(6) contains a formula that is deemed to be the creditor's cost of the reacquired property, depending on whether the debt itself is capital or non-capital property to the creditor. Subsection 79.1(7) provides for the treatment of the debt. There is no rule in section 79.1 respecting the character of the reacquired property.

[29]          Counsel for the appellant argued that if Parliament had intended to provide a specific deeming rule that the taxpayer's former capital property continues to be capital property when reacquired by the taxpayer in circumstances to which section 79.1 applies, it could easily have done so. In the absence of such express statutory language I should be cautious before finding in the clear provisions of section 79.1 an unexpressed legislative intention.[1] The normal tests for distinguishing capital from investing should be applied, counsel submitted. These tests include whether the taxpayer dealt with the asset as a trader would, the length of time between acquisition and sale, whether the taxpayer took steps to improve the marketability of the asset, the nature of the asset and, among other factors, the intention to resell the asset at a profit.[2]

[30]          In appellant counsel's view, this approach is consistent with the scheme of the Act. The Act treats the original disposition of capital property (from the appellant to Soni) subject to "vendor back" debt as a "complete, discrete disposition" and taxes it accordingly. Then, the disposition of the vendor back debt on reacquisition of the property is treated as another complete, discrete transaction, taxable in accordance with subsection 79.1(7) of the Act. On reacquisition of the asset, at a cost determined in accordance with subsection 79.1(6), the Act does not determine the tax character of the asset.

[31]          Appellant's counsel considered it important to the facts at bar that once the appellant disposed of the Property in 1990 and acquired a secured debt evidenced by the Agreement for Sale, that from April 30, 1990 to December 12, 1995, the appellant had no beneficial interest to the Property, except as security for Soni's debt and, on December 12, 1995, the appellant disposed of the debt for the consideration of reacquiring the Property.[3] A taxpayer who acquires or reacquires property on the default of a loan, counsel declared, may do so with the intention of holding the asset as an investment on capital account or as a speculative venture in the nature of trade and, in any event, with the intention completely different from the taxpayer's interest when the property was originally acquired.

[32]          Counsel argued that if the appellant was not a trader, it dealt with the Property in the same way a trader would and, therefore, reacquired the Property and disposed of the Property as part of a venture in the nature of trade. Appellant's counsel described Mr. Smith's actions as those of "a classic 'flipper' of real estate". He simultaneously arranged to reacquire the Property from Soni and to resell it to Mr. Dhahan after repairing the soil contamination. There was no time interval between the appellant's reacquisition of the Property and granting an option to purchase the property to Mr. Dhahan or to a corporation he owned. When the appellant reacquired the Property, its sole intention was to sell it at a profit.

[33]          Further, appellant's counsel argued, the appellant took steps to maintain the Property's value and improve its marketability: it paid off Soni's GST liability, it repaired the soil contamination and it arranged for the gasoline station to continue operating during the soil remediation process.

[34]          Lastly, the nature of the Property was that it could be held as capital or as a trading asset in an adventure in the nature of trade.

[35]          Thus, counsel asked me to conclude, the appellant reacquired the Property in December 12, 1995 as adventure in the nature of trade and is entitled to claim an "inventory write-down" for its 1995 taxation year in accordance with the decision of the Supreme Court of Canada in Friesen.[4]

[36]          I cannot agree with appellant's counsel. One cannot, on the facts at bar, sever the original sale to Soni from the appellant's reacquisition of the Property from Soni. The appellant reacquired the Property to protect its investment. When Soni was not able to consumate a sale to a third party due to the soil contamination, it failed to make the final "balloon" payment to the appellant. Because of the soil condition, the appellant and Mr. Smith feared legal action and a distinct possibility of a decrease in the value of the Property. The appellant decided to reacquire the Property, repair the soil and sell the Property. The appellant's motives for reacquiring the Property were to mitigate against any potential legal action against it and to protect its investment in the Property by disposing of it as quickly as possible for the best possible price. Its actions confirm this: remediating the soil, ensuring that the business continued during the remediation process, having a competent person operating the business until the Property could be sold. It is true, as appellant's counsel stated, that these actions improved the marketability of the Property, but it does not necessarily follow that these actions are always those of a trader or that the appellant reacquired and held the Property as inventory.

[37]          Counsel stated that the facts on page 1327 of Bailey v. M.N.R.,[5] leading to my conclusion that in the property in that appeal did not change its character, are distinguishable from the appeal at bar. The facts in Bailey are different, but it does not follow that the difference in facts requires a different conclusion. In Bailey, I referred to President Thorson's comments in Taylor:[6]

. . . The intention to sell the purchased property at a profit is not of itself a test of whether the profit is subject to tax for the intention to make a profit may be just as much the purpose of an investment transaction as of a trading one. . . .

[38]          In 1995 the appellant reacquired the Property with the intention of doing with it what it intended to do in 1990, to complete the sale of the Property. The appellant's actions to sell the Property were not part of a venture in the nature of trade and the Property was not inventory of the appellant.

[39]          The appeal is dismissed, with costs.

Signed at Ottawa, Canada, this 22nd day of November 2001.

"Gerald J. Rip"

J.T.C.C.

COURT FILE NO.:                                                 2000-1410(IT)G

STYLE OF CAUSE:                                               318806 B.C. Ltd. v. The Queen

PLACE OF HEARING:                                         Vancouver, B.C.

DATE OF HEARING:                                           November 5, 2001

REASONS FOR JUDGMENT BY:                      The Honourable Judge Gerald J. Rip

DATE OF JUDGMENT:                                       November 22, 2001

APPEARANCES:

Counsel for the Appellant:                  Richard J. Bennett

Counsel for the Respondent:              Patricia A. Babcock

COUNSEL OF RECORD:

For the Appellant:                

Name:                Richard J. Bennett

Firm:                  Lang Michener

For the Respondent:                             Morris Rosenberg

                                                                Deputy Attorney General of Canada

                                                                                Ottawa, Canada

2000-1410(IT)G

BETWEEN:

318806 B.C. LTD.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeal heard on November 5, 2001, at Vancouver, British Columbia, by

the Honourable Judge Gerald J. Rip

Appearances

Counsel for the Appellant:          Richard J. Bennett

Counsel for the Respondent:      Patricia A. Babcock

JUDGMENT

          The appeal from the assessment made under the Income Tax Act for the 1995 taxation year is dismissed, with costs.

Signed at Ottawa, Canada, this 22nd day of November 2001.

"Gerald J. Rip"

J.T.C.C.

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