Youngman v. The Queen, 90 DTC 6322, [1990] 2 CTC 10 (FCA)

Pratte J.A.:—This is an appeal from a judgment of the Trial Division (McNair, J.) dismissing the appellant's appeal from a reassessment of his income tax for the 1979 taxation year. That reassessment had been made on the basis that, during that year, the appellant had received from a company of which he was a shareholder a benefit having a value of $6,526 which, pursuant to paragraph 15(1)(c) of the Income Tax Act, [1] was to be included in his income.

The appellant is a chartered accountant and a licensed trustee in bankruptcy. He is one of the main shareholders of Andrich Developments Limited, an Ontario company incorporated for a variety of purposes including the development of land. The appellant and his wife owned 35 per cent each of the shares of that company; the rest belonged to their three children. In 1966, the company acquired a 16-acre parcel of land in the township of Guelph, near the city boundary, with the purpose of subdividing it into residential building lots. The municipal authorities, however, did not approve of that subdivision project which, by the summer of 1978, appeared doomed to failure.

In 1977, the appellant who resided with his family in a comfortable house on Forest Hill Drive, in the city of Guelph, was thinking of moving into a larger and more luxurious house. He conceived of the idea of having his company build a house for him on its land. He and his wife designed the new house and hired a draftsman to prepare the blueprints under their direction. In the fall of 1977, the company entered into a cost-plus building contract for the construction of the house, the cost of which, at that time, was estimated at approximately $250,000. On August 31, 1978, the appellant sold his Forest Hill home for $86,500 which he immediately loaned, interest free, to his company in order to assist in financing the construction of the new home; the company had also obtained, for the same purpose, a mortgage loan in the amount of $80,000 from Canada Trust.

The house was finished in December 1978. Its final cost amounted to $395,549. The appellant and his family, who had temporarily moved into an apartment after the sale of their Forest Hill home, then moved into their new home and, starting on February 1, 1979, the appellant paid his company a monthly rent of $1,100 (including $300 for utilities).

In the Minister's view, the rent that the appellant paid his company during 1979 was too low and did not represent the real value of the benefit or advantage that the company had conferred on the appellant and his wife. The Minister estimated that the value of that benefit for the year was $37,251 and, as a consequence, that the appellant and his wife had each received a benefit equal to one half of that amount (i.e., $18,625.50). As the Minister acknowledged that the appellant had, during the year, paid $12,100 for rent and expenses, he valued at $6,526 the amount that was to be added to the appellant's income under paragraph 15(1)(c) of the Act.

After having unsuccessfully challenged that reassessment before the Tax Review Board, the appellant appealed to the Trial Division and alleged that the fair market value of the rental of the house he had occupied in 1979 did not exceed the rent that he had paid and that, as a consequence, he had received no benefit from his company during the year.

In her statement of defence, the respondent stated that in reassessing the appellant, the Minister of National Revenue had made the following assumptions:

(a) the plaintiff, his wife Beatrice, and their three children at all relevant times owned all of the issued voting shares of Andrich Developments Limited ("the corporation"), the appellant and his wife holding 1400 shares each, and the children 400 shares each;

(b) in 1978, the corporation, at the direction of and for the benefit of the plaintiff and his wife, constructed a luxury single-family residence ("the residence") on a 16-acre lot owned by the corporation, at a cost of $395,549.34;

(c) the plaintiff, his wife and his three children, occupied the house in or about January of 1979, and in February of 1979 and throughout the rest of the year, the plaintiff paid rent to the corporation of $800.00 per month, and paid other expenses related to the operation of the house, including utilities, of $300.00 per month, a total of $12,100.00 in the 1979 taxation year;

(d) the residence was charged with a first mortgage of $79,413.55;

(e) the corporation's equity in the residence was $316,135.79;

(f) during the 1979 taxation year, the corporation paid mortgage interest of $7,566.00, municipal taxes of $420.00 and insurance premiums of $813.00, a total of $8,799.00, in respect of the said residence;

(g) a reasonable estimate of the value of the benefit conferred upon the plaintiff by the corporation in the 1979 taxation year was $6,526.00;

(h) in 1977, an investor could expect a 9% return on capital from an effectively risk-free investment;

(i) the corporation did not build the residence for the purpose of producing or gaining income from a business or property.

Moreover, in a schedule to the statement of defence, the respondent indicated that the amount of the benefit allegedly conferred on the appellant had been calculated in the following manner:

At trial, the appellant and his wife testified as to the circumstances in which the house had been built. The appellant said that the decision to have his company build that house had been made not only for the purpose of providing him and his family with a bigger and better home but also in the hope that the building of such a nice home in that area would serve to eliminate opposition to the proposed subdivision development. The appellant also introduced expert evidence as to the rental value of the house. According to one expert, the free market rental value of the house was approximately $800 per month plus utilities; the other expert fixed it at approximately $950. Both agreed that there was no comparable house on the market in the area. One said that, in that area, the free market rental value of houses bore no relation to their real value.

The appellant's basic argument at trial was that the assessment was wrong because, instead of being based on the value of the benefit that the appellant had received from his company—which value was established by the uncontradicted evidence of the two experts—it was based on the costs that the company had incurred to provide him with that benefit. The trial judge rejected that argument. He first found that the appellant's company had not built the house for a business purpose since, in his view, it had been, from the outset, built for the personal use of the appellant. He also found that, in the circumstances, the fair market rental value was totally inappropriate for measuring the value of the benefit conferred on the appellant because that fair market rental value bore no relation to the actual costs of that benefit.

Counsel for the appellant renewed, at the hearing of the appeal, the submissions he had made at trial. His main argument was that the trial judge had confused, as had the Minister, the value of the benefit conferred on the appellant with its cost to the corporation. In 1979, said he, the appellant rented the house that his company had built for him; his only interest in that house was that of a tenant and it follows that the value of the benefit conferred on the appellant must be measured by comparing the free market rental value of that house with the rent that the appellant paid.

The appellant's counsel also attacked the trial judge's finding that the company had not built the house for any business purpose and argued that, in any event, this finding was completely irrelevant since the activities of a corporation cannot be said to have benefited a shareholder for the sole reason that the company did not engage in these activities for a business purpose.

The appellant also submitted that, assuming that the real value of the benefit conferred on the appellant was not to be measured by reference to the fair market rental value of the house, the Minister had the onus of establishing what that real value was since it appeared that the assumptions on which the reassessment was based were themselves based on an arbitrary mathematical formula.

Another submission made by the appellant, and one, I must confess, that I do not understand, was that the Minister's reassessment was bad because it was a form of "imputed taxation" on a "notional income” since the reassessment was based on the assumption that the company “should have made at least a nine per cent yield on its investment”.

Finally, counsel for the appellant argued that in the event that the Minister's approach to valuation was to be retained by the Court, the appellant should be given credit for the fact that the construction of the house he occupies was financed in part by interest-free loans he made to his company.

I will deal first with the question of onus of proof. The rule is well known. When the Minister has, in his pleadings, disclosed the assumptions of facts on which the assessment was made, and when, as is the case here, it is not contested that the assessment was in fact based on those assumptions, the taxpayer has the onus of disproving the Minister's assumptions. Here, the Minister's basic assumption was that “a reasonable estimate of the value of the benefit conferred upon the plaintiff by the corporation in the 1979 taxation year was $6,526.00”. The argument of the appellant on this point, as I understand it, is that this assumption has been rebutted since the evidence shows that it was made for the reason that the Minister considered arbitrarily, according to the appellant, that the company that had built the house was entitled to a nine per cent return on its investment. It follows, says the appellant, that the only evidence as to the value of the benefit conferred on the appellant is that of his experts. I do not see merit in that argument. In order to rebut the Minister's assumption, the appellant had to prove that the value of the benefit in question was less than $6,526. The assumption of the Minister could be correct even if it was made for a wrong reason. It follows, therefore, that the question to be resolved in this case is whether the appellant adduced evidence showing that, in 1979, the appellant did not receive a benefit or advantage of $6,526 from Andrich Developments Limited.

As to the attack made by the appellant on the trial judge's finding that Andrich Developments Limited had not built the house for a business purpose, I shall simply say that I cannot say that the judge was plainly wrong in reaching that conclusion. Moreover, as will now become apparent, this finding was not without importance.

The appellant's main proposition is that, under paragraph 15(1)(c), what is to be added to the income of the shareholder is the value of the benefit that he received rather than the cost of that benefit to the corporation. That proposition is certainly well founded. However, it does not support the appellant's conclusion. In determining the value of benefit, one may take its cost into consideration. Free market value is not, in all circumstances, the sole indication of real value.

It is now well settled that paragraph 15(1)(c) applies only when a shareholder has received, qua shareholder, a benefit or advantage from a corporation. [2] In valuing a benefit allegedly received by a shareholder, it is therefore necessary to find what the shareholder would have had to pay for the same benefit in the same circumstances if he had not been a shareholder of the company. A shareholder receives no benefit for the purposes of paragraph 15(1)(c) if, in the same circumstances, he would have received the same benefit from a company of which he is not a shareholder. For instance, if a company builds an expensive house with the intention of selling it at a profit and later, after realizing that it cannot be sold for more than half its cost, sells it at that low price to one of its shareholders, that shareholder in all likelihood certainly gets a benefit out of that transaction but paragraph 15(1)(c) does not apply to it.

In order to assess the value of a benefit, for the purposes of paragraph 15(1)(c), it is first necessary to determine what that benefit is or, in other words, what the company did for its shareholder; second, it is necessary to find what price the shareholder would have had to pay, in similar circumstances, to get the same benefit from a company of which he was not a shareholder. In the present case, the benefit or advantage conferred on the appellant was not merely the right to use or occupy a house for as long as he wished; it was the right to use or occupy for as long as he wished a house that the company, at his request, had built specially for him in accordance with his specifications. How much would the appellant have had to pay for the same advantage if he had not been a shareholder of the company? Certainly more than what the two experts referred to as the free market rental value since, in my view, the company would have then charged a rent sufficient to produce a decent return on its investment. It is impossible to determine with accuracy the amount of that rent. However, subject to one important reservation, I cannot say that it would have been less than what the Minister assumed it to be. That reservation is that if the appellant had been dealing with a company of which he was not a shareholder, consideration would certainly have been given, in determining the rent payable, to the fact that he had himself lent more than $100,000 without interest to the company in order to help to finance the construction of the house. As long as that loan remained outstanding, the rent otherwise payable would, in my view, have been reduced by an amount equal to the interest that should normally have been paid on the balance of the loan.

I would, therefore, allow the appeal and refer the reassessment back to the Minister for reconsideration and reassessment in accordance with these reasons. I would grant the appellant his costs in this Court and in the Trial Division.

Appeal allowed.