Leonard v. The Queen

Leonard v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2021-04-30
Neutral citation
2021 TCC 33
File numbers
2017-219(IT)G, 2017-221(IT)G
Judges and Taxing Officers
Don R. Sommerfeldt
Subjects
Income Tax Act
Decision Content
Docket: 2017-221(IT)G
BETWEEN:
JEREMY LEONARD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
BETWEEN:
Docket: 2017-219(IT)G
CAROL TENNEY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on June 28, 2019, at Winnipeg, Manitoba
and on October 3, 2019 at Ottawa, Ontario; and Written Submissions received on July 15, 2020
Before: The Honourable Justice Don R. Sommerfeldt
Appearances:
Counsel for the Appellants:
Jeff D. Pniowsky, Matthew Dalloo
Counsel for the Respondent:
David Silver, David Grohmueller
JUDGMENT
The Appeals of both Appellants are (subject to paragraph 119 of the accompanying Reasons) allowed, with costs, and the reassessments issued by the Minister of National Revenue (the “Minister”) to both Appellants are referred back to the Minister for reconsideration and reassessment on the basis that, in 2011, Jeremy Leonard sustained a non-capital loss in the amount of $826,426.
If the Parties are unable to reach an agreement in respect of costs within 30 days of the date of this Judgment, the Appellants may, within the ensuing 30 days thereafter, file a written submission on costs, and the Respondent shall thereafter have yet a further 30 days to file a written response. Any such submissions shall be limited to five pages in length. If, within the applicable time limits, the Parties do not advise the Court that they have reached an agreement and no submissions are received from the Parties, one set of costs (adjusted to recognize the need for a separate Notice of Appeal for each Appellant), in accordance with the Tariff, shall be awarded to the Appellants (to be apportioned between them as they so determine).
Signed at Edmonton, Alberta, this 30th day of April 2021.
“Don R. Sommerfeldt”
Sommerfeldt J.
Citation: 2021 TCC 33
Date: 20210430
Docket: 2017-221(IT)G
BETWEEN:
JEREMY LEONARD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
Docket: 2017-219(IT)G
BETWEEN:
CAROL TENNEY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Sommerfeldt J.
I. INTRODUCTION
[1] These Reasons pertain primarily to the Appeals instituted by Jeremy Leonard in respect of reassessments (the “Reassessments”) issued to him by the Canada Revenue Agency (the “CRA”) on behalf of the Minister of National Revenue (the “Minister”) in respect of the 2011, 2012, 2013 and 2014 taxation years. The 2011 Reassessment disallowed a claimed non-capital loss (the “Loss”) in the amount of $1,472,006, [1] which Mr. Leonard had reported on his income tax return for 2011. The Reassessments for 2012, 2013 and 2014 disallowed the carry-forward of portions of the Loss.
[2] Ms. Tenney is the spouse of Mr. Leonard. On her 2011 income tax return she had claimed a spousal amount in respect of Mr. Leonard as well as a transfer of unused personal credits from Mr. Leonard to her. In addition, in that income tax return, she indicated that the amount of the family income, for the purposes of the Canada Child Tax Benefit (the “CCTB”) was $45,942. By reason of the disallowance of the Loss, which Mr. Leonard had reported for 2011, the CRA recalculated the family income as $496,733, which meant that Ms. Tenney no longer qualified for the CCTB. At the outset of the hearing, and again when making oral submissions, counsel for the Parties acknowledged that the determination of the outcome of Mr. Leonard’s Appeals will automatically determine the outcome of Ms. Tenney’s Appeal.
II. ISSUES
[3] In his Notice of Appeal, Mr. Leonard alleged that, during the relevant taxation years, he carried on the business of acquiring mortgages and lending money, and that the Loss was realized in the course of that business. Alternatively, Mr. Leonard alleged that any transaction giving rise to the Loss was an adventure in the nature of trade. [2]
[4] In his opening statement at the hearing, counsel for Mr. Leonard advised the Court that Mr. Leonard was, for the purposes of these Appeals, abandoning the argument that the Loss arose in the course of a business of lending money. Counsel also advised that the only position being advanced by Mr. Leonard at the hearing was that the transaction in question (the “Transaction”) was an adventure in the nature of trade. [3]
[5] Accordingly, as listed in the order in which they will be considered, the fundamental issues in respect of these Appeals are:
(a) If there was a loss, was it a capital loss or a loss incurred in respect of an adventure in the nature of trade (i.e., a non-capital loss)?
(b) Was there a loss, and, if so, did Mr. Leonard realize the Loss in 2011, and what was the amount of the Loss?
III. FACTS
[6] Mr. Leonard is an entrepreneur. He is a resident of Canada for the purposes of the Income Tax Act (the “ITA”). [4] He has homes in both Alberta and Hawaii. Through corporate entities, he carries on business in Alberta, Hawaii and Brazil.
[7] In approximately 2004 or 2005, Mr. Leonard became acquainted with Brian Anderson, who was a real estate developer carrying on business in Hawaii (and perhaps elsewhere). From time to time, over the course of the next five or so years, Mr. Leonard loaned money to Mr. Anderson and may have made equity investments in some of Mr. Anderson’s developments. Sometime before 2009, Mr. Anderson acquired two adjoining lots (the “Lots”) in the Kukio community in Hawaii. One of the Lots, designated as “Lot B-3,” had a house constructed on it. The other Lot, which was designated as “Lot B-2,” was undeveloped. Mr. Leonard described Lot B-2 as bare lava rock. Both Lots were subject to mortgages to secure debts owed by Mr. Anderson to the Central Pacific Bank. The mortgage (the “Mortgage”) in respect of Lot B-2 secured a debt (the “Debt”) that was evidenced by a promissory note (the “Note”) [5] and that related to a loan in the amount $1,500,000, which Mr. Anderson had borrowed from City Bank on December 20, 2004. Sometime thereafter, City Bank merged into Central Pacific Bank (the “Bank”). [6]
[8] The economic downturn of 2008 had a serious impact on Mr. Anderson, who apparently was heavily leveraged. Mr. Leonard stated that he understood that Mr. Anderson had judgments against him aggregating approximately $40,000,000. It was Mr. Leonard’s understanding that Mr. Anderson was unable to repay all of his debts.
[9] As Mr. Anderson was in default in respect of the Debt secured by the Mortgage on Lot B-2, the Bank commenced foreclosure proceedings on April 6, 2009 in respect of the Mortgage. The Bank did not commence foreclosure proceedings in respect of the mortgage on Lot B-3. [7]
[10] After defaulting in April 2007 in the repayment of a $1,500,000 loan that Mr. Leonard had made to Mr. Anderson in December 2006, [8] Mr. Anderson approached Mr. Leonard with a deal whereby Mr. Leonard could obtain the Lots at a discount, as a means of making amends for Mr. Anderson’s failure to repay the 2006 loan. [9] Mr. Leonard subsequently contacted the Bank to express an interest in acquiring the Lots. He then negotiated an arrangement with the Bank, pursuant to which it was arranged that he would, as he thought, acquire both Lots at a price of $5,700,000, using funds to be loaned to him by the Bank. It appears that, for its purposes, the Bank allocated $4,400,000 of the total price to Lot B-3 (i.e., the Lot with a house constructed on it) and $1,300,000 to the Mortgage, the Note and the Debt (which pertained to Lot B-2). [10] Mr. Leonard understood that the amount of the Debt was originally $1,500,000, but the price payable by Mr. Leonard to the Bank in respect of the Mortgage, the Note and the Debt was, apparently during negotiations with Mr. Leonard, reduced by the Bank to $1,300,000. [11]
[11] Subsequently, after the Bank and Mr. Leonard had settled on the terms of their arrangement, a meeting was scheduled among Mr. Leonard, Mr. Anderson and the Bank’s representative. At that meeting, Mr. Anderson expressed displeasure with the price put on the two Lots. He was of the view that the price should have been greater. [12]
[12] The transaction among Mr. Leonard, Mr. Anderson and the Bank was documented in such a manner that Mr. Leonard acquired Lot B-3 from Mr. Anderson, and he acquired the Mortgage, the Note and the Debt from the Bank. The key transactional document relating to the transaction between Mr. Leonard and the Bank was an Assignment of Mortgage, Security Agreement and Financing Statement (the “Assignment”), dated effective as of June 24, 2009. [13] The significant operative portions of the Assignment read as follows:
KNOW ALL MEN BY THESE PRESENTS:
That the CENTRAL PACIFIC BANK … hereinafter called the “Assignor”, in consideration of the sum of TEN DOLLARS ($10.00) and other good and valuable consideration to it paid by JEREMY PAUL LEONARD, … hereinafter called the “Assignee”, the receipt whereof is hereby acknowledged, does hereby sell, assign, transfer, set over and deliver unto the Assignee, its successors and assigns, the mortgage hereinafter described, together with the promissory note and the debts thereby secured, and together also with all the right, title and interest of the Assignor in and to the property more particularly described in said mortgage, to-wit:
That certain Mortgage, Security Agreement and Financing Statement dated December 20, 2004, made by BRIAN A. ANDERSON, as Trustee of the Brian A. Anderson Revocable Living Trust dated September 18, 2001, and JOAN G. ANDERSON, as Trustee of the Joan G. Anderson Revocable Living Trust dated September 18, 2001, as Mortgagor, in favor of City Bank, whose successor in merger is CENTRAL PACIFIC BANK, as Mortgagee, securing the principal amount of $1,500,000.00, and recorded in the Bureau of Conveyances of the State of Hawaii as Document No. 2004-264058.
TO HAVE AND TO HOLD the same unto the Assignee, its successors and assigns, forever.
This assignment is without recourse, except as to the warranties hereinafter provided. The Assignor does hereby covenant to and with the Assignee, its successors and assigns, that the Assignor is the lawful owner and holder of the above-mentioned promissory note and mortgage; and that the Assignor has good right to sell, transfer and assign the same as aforesaid. [14]
It is interesting that, in the warranties set out in the last paragraph quoted above, reference is made only to the Note and the Mortgage, but not to the Debt.
[13] To finance the purchase of Lot B-3 from Mr. Anderson and the purchase of the Mortgage, the Note and the Debt from the Bank, Mr. Leonard borrowed $5,700,000 from the Bank, pursuant to a Term Loan Agreement dated June 24, 2009. [15] That agreement did not allocate the $5,700,000 among Lot B-3, the Mortgage, the Note and the Debt. [16] The Final Buyer Statement issued by the escrow agent, Title Guaranty Escrow Services, Inc., on June 28, 2009 in respect of the sale of Lot B-3 to Mr. Leonard (which closed on June 26, 2009), shows that the price was $4,400,000. [17] As it is my understanding that Mr. Leonard used only borrowed money to purchase Lot B-3, the Mortgage, the Note and the Debt, it follows that the amount that he paid to the Bank for the Mortgage, the Note and the Debt was $1,300,000 (i.e., $5,700,000 − $4,400,000). This is consistent with subsection 4.15 of the Term Loan Agreement between the Bank and Mr. Leonard, which provided that, if Lot B-2 were to be sold to a third party as a result of the foreclosure auction, Mr. Leonard was required to make a principal payment to the Bank in an amount equal to the proceeds of the foreclosure auction up to a maximum amount of $1,300,000. [18] The price allocation of $1,300,000 for the Mortgage, the Note and the Debt is also consistent with the handwritten note at the bottom of the second page of the Assignment granted by the Bank to Mr. Leonard on June 24, 2009, [19] with the handwritten note at the bottom of a Loan Statement issued by the Bank to Mr. Leonard showing a payment due date of July 25, 2009, [20] and with an undated table showing the original amounts of two loans, described as Loan #1 and Loan #2, as being $1,300,000 and $4,400,000 respectively (for a total of $5,700,000). [21]
[14] Mr. Leonard stated that he acquired the Debt at a discount from the Bank. [22] However, the amount of the discount is not readily ascertainable in a straightforward manner. In a letter dated July 31, 2015, which was attached to Mr. Leonard’s Notice of Objection, [23] and in a letter dated August 24, 2016, [24] both of which were written by Mr. Leonard’s accountants to the CRA, those accountants stated that, on June 24, 2009, Mr. Leonard purchased the Note and the Mortgage for a price of $1,487,551. In their letter of August 24, 2016, the accountants also stated that the amount owing under the Note on June 24, 2009 was US$1,606,528.65. To substantiate the amount paid for the Mortgage and the Note, the accountants referred to a particular document that accompanied the letter of July 31, 2015. That document was a Loan Modification Agreement, dated June 29, 2010, among the Bank, Mr. Leonard and Pacific Pump & Power, Inc. (which was one of Mr. Leonard’s corporations). [25] In actuality, that document stated that, as of June 29, 2010, Mr. Leonard was indebted to the Bank in the principal amount $1,487,551.03, but the document said nothing about the amount paid by Mr. Leonard to acquire the Mortgage and the Note.
[15] As indicated, in the above-mentioned letter of August 24, 2016, from Mr. Leonard’s accountants to the CRA, the accountants stated that the amount owing under the terms of the Note when Mr. Leonard acquired the Mortgage and the Note (i.e., June 24, 2009) was US$1,606,528.65. [26] I think that this amount is derived from a table on the fourth page of a Memorandum in Support of Motion, dated October 15, 2009 and filed by Mr. Leonard’s attorneys with the Circuit Court of the First Circuit of the State of Hawaii (the “Circuit Court”), in respect of the foreclosure proceedings against Mr. Anderson. [27] That table shows that the unpaid principal amount of the Debt was $1,497,657.53, [28] with interest from an unspecified date to June 24, 2009 in the amount of $108,871.12, resulting in a total of $1,606,528.65. [29]
[16] To summarize, the above-mentioned documents indicate that, on June 24, 2009, Mr. Leonard acquired the Mortgage, the Note and the Debt from the Bank at a discount of $306,528.65 (i.e., $1,606,528.65 − $1,300,000.00).
[17] After acquiring the Mortgage, the Note and the Debt from the Bank, Mr. Leonard did not attempt to sell or assign the Mortgage, the Note or the Debt to anyone else. [30]
[18] Given that he had acquired the Mortgage, the Note and the Debt at a discount, it seems that, notwithstanding that he thought that ultimately he would likely acquire Lot B-2 through the foreclosure process, Mr. Leonard was also aware of the possibility that, in the ensuing judicial sale, someone might bid enough for Lot B-2 to result in the Debt being repaid in full, resulting in a profit for him. [31]
[19] Mr. Leonard said that, in entering into the foregoing arrangement to acquire Lot B-3 from Mr. Anderson and the Mortgage, the Note and the Debt from the Bank, he understood that the actual fair market value of the Lots was greater than the amount that he had paid to acquire Lot B-3, the Mortgage, the Note and the Debt. Therefore, as another possibility, he anticipated that he would be able to realize a profit by acquiring Lot B-3 by purchase and Lot B-2 by foreclosure, and then reselling the Lots. [32]
[20] After completing the transactions to acquire Lot B-3, the Mortgage, the Note and the Debt, Mr. Leonard was surprised to realize that his ability to sell Lot B-2 would be delayed until such time as the foreclosure proceedings came to a formal conclusion. In Hawaii, this required the holding of a judicial sale, which was to be conducted by public auction.
[21] On October 7, 2009, Mr. Leonard was substituted as the real party in interest in the foreclosure. [33] On October 15, 2009, a decree of foreclosure was filed in the Circuit Court. [34] However, it was not until mid-2011 that the judicial sale was completed.
[22] The judicial sale occurred by means of a public auction near the flagpole in front of the local courthouse. The date of the auction was not put into evidence; however, it seems that it would have been sometime after October 15, 2009 (which was the date when the Decree of Foreclosure was filed) and January 3, 2011 (which was the date of filing an Order granting Mr. Leonard’s Motion for Confirmation of Sale, Allowance of Costs, Commissions and Fees and Directing Conveyance, Writ of Possession and Deficiency Judgment). [35] Mr. Leonard attended the auction. He stated that approximately 12 other people were also there. When the bidding opened, Mr. Leonard was surprised that no one bid in respect of Lot B-2. He decided to start the bidding. In determining how much to bid, he testified that he was aware at the time of the auction that no property in Kukio had previously sold for anything less than $1,000,000. [36] However, he did not have that much liquidity; therefore, he made an opening bid of $500,000. To his surprise, no one else bid at the auction, with the result that Lot B-2 was sold to him for $500,000. [37] The judicial sale closed, and title to Lot B-2 was transferred to Mr. Leonard, effective as of June 20, 2011. [38]
[23] While Mr. Leonard was testifying, it became apparent that he did not have a proper understanding of the judicial sale process. In his testimony, he stated that, if someone else at the auction had bid $500,001, he would not have made an additional bid, because he did not have sufficient funds to pay anything more than $500,000 for the property. It appears that he was not aware that, if he were the successful bidder, whatever amount he might pay for Lot B-2 (less expenses, and limited by the outstanding amount of the Debt) would come back to him as the holder of the Mortgage, the Note and the Debt.
[24] A second misunderstanding that Mr. Leonard had was that he expected and hoped that someone would bid approximately $2,200,000 for Lot B-2, as he testified that he understood that the entire amount paid by a third party for Lot B‑2 would go to him. He was not aware that, if anyone had paid more than $1,972,252.63 (i.e., the amount payable in respect of the Debt on June 20, 2011), [39] the excess would have been paid to Mr. Anderson.
[25] After the judicial sale, Mr. Leonard was in shock. [40] He testified that he was aware that he owed $5,700,000 to the Bank and he had expected to net approximately $2,200,000 from the judicial sale.
[26] Mr. Leonard realized that, in order to repay the Bank, it would be necessary for him to sell Lot B-2 as soon as possible. Accordingly, he met with Carrie Nicholson, a prominent and successful real estate agent in Hawaii, and arranged to have Lot B-2 listed for sale. [41]
[27] Lot B-2 did not sell. Eventually the listing expired, whereupon Mr. Leonard relisted the property. [42] In 2015, in order to reduce the monthly association fees that he was paying for property maintenance, Mr. Leonard arranged to have Lots B-2 and B-3 combined. [43] As of the commencement of the hearing, Lot B-2 (now combined with Lot B-3) had still not been sold.
[28] As part of the foreclosure proceedings, a deficiency judgment (the “Deficiency Judgment”), in the amount of $1,472,006.44, was filed in the Circuit Court, apparently on or after May 16, 2011, in favour of Mr. Leonard against Mr. Anderson. [44] Mr. Leonard testified that he has not recovered anything in respect of the Deficiency Judgment, although he never expected to, given the extent of the numerous debts owed by Mr. Anderson to a multitude of creditors. During cross-examination, Mr. Leonard stated that he has not forgiven the Debt, at least in writing. He did not explain what he meant by that qualification. In other words, I was left wondering whether he had orally forgiven the Debt, but there was no evidence in this regard.
IV. POSITIONS OF THE PARTIES
A. Mr. Leonard
[29] It is the position of Mr. Leonard that, in his dealings with the Mortgage, the Note, the Debt and Lot B-2, he was participating in an adventure in the nature of trade. [45] His counsel asserted that Mr. Leonard bought the Mortgage, the Note and the Debt for $1,487,551, [46] thinking that “lots of people were going to bid on” Lot B-2 at the auction and that he would make a profit, given that the outstanding amount of the Debt (i.e., principal and accrued interest) was greater than the amount that he had paid for the Mortgage, the Note and the Debt. [47] As it turned out, no one (other than himself) bid for Lot B-2, with the result that, in his view, in 2011 he sustained the Loss in the amount (as calculated by his accountants) of $1,472,006. [48]
[30] It seems that counsel for Mr. Leonard takes the position that the amount paid by Mr. Leonard to acquire the Mortgage, the Note and the Debt was an outlay or expense that was deductible in computing Mr. Leonard’s income for 2011. In the written submissions of counsel for Mr. Leonard, that position was stated as follows:
The nature of the outlay is the only remaining issue as defined in the pleadings.
If the outlay in issue was for the purpose of earning income from a business (an adventure in the nature of trade) it is deductible from income pursuant to s. 18(1)(a) of the Act. As the sum total of such expenses exceeds income for the year there will be a loss carried pursuant to s. 111 of the Act…. If the outlay, which indisputably occurred, was made for securing a profit rather than as a long term investment, it is deductible from income in the year. This is trite, immutable law of taxation in Canada. Only a finding of additional income earned in the year can offset or reduce a loss in that year. The Crown is not saying other income in that year has offset this loss….
… the only issue before this court: whether the (admitted) outlay was made to earn a profit. [49] [Footnote omitted.]
B. The Crown
[31] The Crown submits that Mr. Leonard did not participate in an adventure in the nature of trade and that, when he acquired the Mortgage, the Note and the Debt from the Bank, his objective was, by means of the judicial sale, to acquire Lot B-2 and hold it as a long-term investment. For instance, during oral argument, counsel for the Crown made the following statements:
… the Appellant purchased the note and mortgage with the intention of obtaining title to the underlying real property. [50]
… the intention wasn’t to get rid of this property by way of foreclosure. It was -- the intention was to buy that property out of foreclosure and to control that process and -- in an effort to gain title to the underlying property. [51]
… the transaction was about the real property. The mortgage was a part, a feature, a tool, a method of acquiring this. [52]
This wasn’t an investment in a mortgage. This was an acquisition of real property. [53]
[32] The Crown takes the position that Mr. Leonard did not incur the Loss in 2009 or 2011, given that he continues to own Lot B-2 (which is now consolidated with Lot B-3) and he still holds the Deficiency Judgment relating to the principal and interest owed in respect of the Debt (less the proceeds of the judicial sale).
[33] The Crown’s position is, in part, represented by several of the assumptions made by the Minister when reassessing Mr. Leonard, as set out in paragraph 12 of the Reply:
In determining the appellant’s [i.e., Mr. Leonard’s] tax liability for the 2011, 2012, 2013 and 2014 taxation years, the Minister made the following assumptions of fact: …
z) it was not the appellant’s intention to trade, resell or re-assign the promissory note and mortgage at the time when he acquired it through assignment;
aa) the appellant’s intention at the time of acquiring the promissory note was to purchase and hold it, and proceed with the foreclosure of the Kukio 15B-2 Property to realize a profit on the Kukio 15B-2 Property;
bb) the appellant’s intention was to hold the Kukio 15B-2 Property for long-term investment purposes, awaiting an appreciation of its value;
cc) the appellant’s intention was not to make a profit on the promissory note itself by collecting interest generated from it or by trading it; …
gg) the appellant’s intention in purchasing the promissory note was investment-related; …
mm) the appellant was not engaged in an adventure in the nature of trade…. [54]
[34] Notwithstanding the position taken by the Crown (as summarized above), in paragraph 1 of the Reply, the Crown admitted paragraph 8 of Mr. Leonard’s Notice of Appeal, which reads as follows:
8. As a result of the Transaction [defined in paragraph 5 of the Notice of Appeal as Mr. Leonard’s purchase of the Note for $1,487,551], the Appellant incurred a total loss of $1,472,006 (the “Loss”). [55]
During his opening statement at the hearing, counsel for the Crown qualified that admission by indicating that the Crown was merely acknowledging that the amount of the reported Loss, as calculated by Mr. Leonard, was $1,472,006, but the Crown was not admitting that Mr. Leonard was entitled to deduct the Loss. [56]
C. Applicable Law
[35] The resolution of these Appeals may require an analysis of the nature of a mortgage, the legal procedures pertaining to a foreclosure and a judicial sale, and the effect of obtaining a deficiency judgment. The transactions which are the subject of these Appeals took place in Hawaii; however, neither party adduced any expert evidence concerning the laws of Hawaii.
[36] If a party fails to adduce expert evidence to describe the operation of a foreign law, the concept of lex fori (i.e., the law of the forum, or the law of the jurisdiction where the case is pending) [57] will apply, with the result that the Canadian court hearing the matter should “act as if the foreign law is the same as its own law, unless the law is of a local or regulatory nature.” [58] Thus, if the applicable foreign law is not satisfactorily proven, the law is assumed to be the same as the law of the province where the trial is held. [59] This principle extends to a statute of general application that is part of the law of the forum. [60]
[37] Counsel for the Crown took the position that, in the absence of expert evidence of Hawaiian law, the principle of lex fori should apply. As the evidentiary portion of the hearing took place in Winnipeg, counsel for the Crown submitted that Manitoba law should be applied by the Court. Counsel for Mr. Leonard made no submissions concerning the choice of law or the principle of lex fori.
D. Inapplicable Statutory Provisions
[38] Counsel for both parties have acknowledged that neither section 79.1 of the ITA [61] nor section 16 of The Mortgage Act (Manitoba) [62] was applicable to the transactions that are the subject of these Appeals.
V. ANALYSIS
A. Adventure in the Nature of Trade or Investment
[39] The first issue in these Appeals raises the question of whether, in acquiring the Mortgage, the Note and the Debt and in his subsequent dealings therewith (including the foreclosure, the judicial sale, the acquisition of Lot B-2 and the Deficiency Judgment), Mr. Leonard was making an investment or engaging in an adventure in the nature of trade. In other words, were his transactions on capital account or on income account? As recently stated by Justice Hogan in Paletta, the determination of whether a gain or a loss is on capital account or income account is a question of fact. [63] Like Justice Hogan, I will use the approach and the summary of the factors, as set out in Friesen, [64] that are typically used to determine whether a transaction involving real estate is an adventure in the nature of trade or a capital transaction.
[40] In Friesen, Justice Major stated, “The concept of an adventure in the nature of trade is a judicial creation designed to determine which purchase and sale transactions are of a business nature and which are of a capital nature.” [65] He then noted the importance of there being a “scheme for profit-making” in these terms:
The first requirement for an adventure in the nature of trade is that it involve a “scheme for profit-making”. The taxpayer must have a legitimate intention of gaining a profit from the transaction. [66]
Borrowing from an Interpretation Bulletin issued by the predecessor of the CRA, Justice Major then listed four factors to be considered “to determine whether a transaction involving real estate is an adventure in the nature of trade creating business income or a capital transaction involving the sale of an investment[,]” [67] as follows:
Particular attention is paid to:
(i) The taxpayer’s intention with respect to the real estate at the time of purchase and the feasibility of that intention and the extent to which it was carried out. An intention to sell the property for a profit will make it more likely to be characterized as an adventure in the nature of trade.
(ii) The nature of the business, profession, calling or trade of the taxpayer and associates. The more closely a taxpayer’s business or occupation is related to real estate transactions, the more likely it is that the income will be considered business income rather than capital gain.
(iii) The nature of the property and the use made of it by the taxpayer.
(iv) The extent to which borrowed money was used to finance the transaction and the length of time that the real estate was held by the taxpayer. Transactions involving borrowed money and rapid resale are more likely to be adventures in the nature of trade. [68]
[41] A precursor to the above list was set out in the Happy Valley Farms case. In that case, after considering previous cases that had determined whether a particular transaction was an adventure in the nature of trade, Justice Rouleau enumerated several tests that had been used by the courts, as follows:
Several tests, many of them similar to those pronounced by the Court in the Taylor case, have been used by the courts in determining whether a gain [or a loss] is of an income or capital nature. These include:
1. The nature of the property sold. Although virtually any form of property may be acquired to be dealt in, those forms of property, such as manufactured articles, which are generally the subject of trading only are rarely the subject of investment. Property which does not yield to its owner an income or personal enjoyment simply by virtue of its ownership is more likely to have been acquired for the purpose of sale than property that does.
2. The length of period of ownership. Generally, property meant to be dealt in is realized within a short time after acquisition. Nevertheless, there are many exceptions to this general rule.
3. The frequency or number of other similar transactions by the taxpayer. If the same sort of property has been sold in succession over a period of years or there are several sales at about the same date, a presumption arises that there has been dealing in respect of the property.
4. Work expended on or in connection with the property realized. If effort is put into bringing the property into a more marketable condition during the ownership of the taxpayer or if special efforts are made to find or attract purchasers (such as the opening of an office or advertising) there is some evidence of dealing in the property.
5. The circumstances that were responsible for the sale of the property. There may exist some explanation, such as a sudden emergency or an opportunity calling for ready money, that will preclude a finding that the plan of dealing in the property was what caused the original purchase.
6. Motive. The motive of the taxpayer is never irrelevant in any of these cases. The intention at the time of acquiring an asset as inferred from surrounding circumstances and direct evidence is one of the most important elements in determining whether a gain is of a capital or income nature. [69]
[42] In reviewing the various factors that the courts have identified, I will follow the organizational structure set out in Friesen, and will then comment briefly in respect of the additional factors identified in Happy Valley Farms.
(1) Intention [70]
[43] At the hearing, there was some uncertainty as to whether Mr. Leonard, in his transaction with the Bank, intended to acquire the Mortgage encumbering Lot B-2 and then, by means of the judicial sale, hopefully obtain, from a third-party bidder, repayment in full of the Note and the Debt, [71] or intended to bid himself at the judicial sale and ultimately acquire title to Lot B-2, after which he would sell Lot B-2 for a profit. Examples of his description of his intention are set out and discussed in the ensuing paragraphs.
[44] During his direct examination, Mr. Leonard explained how he came to acquire the Mortgage and how he hoped to make a profit, as follows:
Q. Now, what brought you to this -- this particular transaction in issue?
A. … And so that’s how I knew about this gentleman [i.e., Mr. Anderson] and his property and it came available to buy it for less than the cost of the -- the bank debt on the property and I thought that was very attractive.
Q. … So you -- you bought a mortgage?
A. Okay. Yeah, this -- this mortgage specifically was being held by a bank called the Central Pacific Bank and at that time they were under duress and had a great deal of trouble and they needed to clean up their books. So I met with the Central Pacific Bank and they offered to sell me this mortgage for below -- below the cost and it was secured by a property and, as we discussed here already, it was already in foreclosure.
This -- this property was not a property that was useful to be on. It was just bare lava rock. It wasn’t possibly gainful or something that anyone would have without developing it fully. It was just bare lava rock. So the -- the only reason I wanted to buy this property was to resell it and -- or this mortgage was to resell it and to have -- have this -- make a profit because I was buying it for less -- well -- well below the property cost, which was actually tax appraised by the tax assessment people in -- in Kona for $4.4 million. And I was able to buy this property for less than $2 million, fully expecting to sell it for at least half of what the tax-assessed value was of 4.4 [million]. So I fully expected that I would be able to sell the mortgage, which in Hawaii can’t be done, I found out after the fact, until you actually have an auction on the property. And I fully expected that property would sell for somewhere in the neighbourhood of 50 percent of the tax-assessed value, which would have been 2.2 million, which would have been -- I -- I understood would -- would give me that profit…. [72]
I happened to know at the time that there had never been a property sold at Kukio, this place where this property was, for less than a million dollars, never in the history so far, and so I felt very comfortable putting in a bid for $500,000, with actually zero expectation that there wouldn’t be more bids, and then I was excited to have the property bid up in the auction environment and I was expecting it would be bid up to 2.2 million or somewhere near half the tax-assessed value of the property. [73]
While Mr. Leonard stated that he hoped to make a profit by reselling the Mortgage, [74] the above testimony also suggests that, as an alternative, he thought that the profit might come from the acquisition and subsequent sale of Lot B-2. [75]
[45] At one point in his cross-examination, Mr. Leonard indicated that he purchased the Mortgage and the Debt as a means to acquire Lot B-2:
Q. But he [i.e., Mr. Anderson] was in financial distress and not paying his debts by 2009, correct?
A. I understand that was the case.
Q. And my understanding is essentially Mr. Anderson came to you with a deal to obtain these two -- we’ll call them the Kukio properties; is that -- you know what I'm referring to, the two parcels?
A. Yes.
Q. He felt -- or he suggested to you that you could have them at a discount to essentially, well, make a profit, partially to make amends for the failure to pay that loan back; correct?
A. I -- I don't think -- I mean that was his suggestion that it would be useful for him. From -- from his perspective, he had a debt with the Central Pacific Bank that he wanted to get paid off and was happy to not have those properties and also not have that debt.
Q. And owe that debt to you instead?
A. No, that -- he wouldn’t owe that debt to me. I would purchase the debt from the Central Pacific Bank and purchase the mortgage, which I did, and they -- they just freed Brian Anderson from that debt because I purchased the debt from the Central Pacific Bank.
Q. You purchased the debt?
A. Purchased the mortgage and I purchased the property.
Q. And when you purchase a debt, someone owes you the money under that debt; correct? I mean that’s what debt is, it’s a right to collect money from someone else. It’s something someone owes you, correct?
A. I -- I purchased a mortgage that was in foreclosure and the reason the Central Pacific Bank sold it to me is because it was an uncollectible debt. They had already determined that. So it wasn’t -- it wasn’t collectible from anyone except by going through the foreclosure process and selling the property, which is -- I didn’t realize when I purchased it, it was going to be such a difficult process in Hawaii because I think it’s much easier in Canada, but that was the -- that was the intention, to get the money from the property.
Q. And you knew at the time you entered this transaction the assessed value of the subject property -- we often call it the property. There’s two Kukios, but the one related to the mortgage, you knew that was assessed by property taxes at over $4 million; correct?
A. That -- that’s correct.
Q. So you expected by entering this transaction you could sell the property, both of them, but specifically the one under the mortgage, at a profit?
A. That’s correct and everybody that was party to this also thought that would be the case.
Q. And although you made some comments about it being bare land, you’d also made some comments about the value of these properties always being quite high. So you knew that this, even though it was bare lava rock, was quite valuable property; correct?
A. Right…. [76]
It is curious that the Minister seemed to question Mr. Leonard’s profit-seeking intention, yet several of the questions asked by counsel for the Crown in the above exchange seemed to suggest, if not actually acknowledge, that the Crown thought that Mr. Leonard intended to make a profit by acquiring, and then selling, the two Lots. [77]
[46] Further testimony showing that Mr. Leonard intended ultimately to acquire both Lots and then, in selling them, to make a profit, is set out in the following exchange during cross-examination:
Q. And so you entered this transaction, and I think it’s conceded, with no intention of ever –– I shouldn’t say that. You didn’t expect that the Andersons would be paying monthly interest payments or anything like that on this loan?
A. No. No, absolutely not. I –– I expected I’d sell these properties promptly at a very significant discount to the market because I bought well below what I thought the market price was. That was the intention.
Q. And at the time when you’re making this transaction and signing the documents, you essentially believed you were buying two properties. You did not believe you were buying debt at the time?
A. I knew –– I knew I was buying a mortgage that would turn into that, sure. It would end up with me owning two properties. That’s –– that’s what this would lead to.
Q. I’m going to again sug