Belair v. MNR, 89 DTC. 429, [1989] 2 CTC 2186 (TCC)

Mogan, T.C.J.: —The notice of appeal filed by the appellant himself with respect to his 1985 and 1986 taxation years did not adequately define the issues but, at the commencement of the hearing, the appellant acknowledged that the reply to notice of appeal filed on behalf of the respondent described the items in his notices of reassessment for 1985 and 1986 which he disputed. The first four issues are directly or indirectly connected with an amount which the appellant received in November 1985 when a corporation in which he was a minority shareholder purchased for cancellation some or all of his common shares. The fifth issue is the deductibility of a loss which the appellant claims with respect to his attempt to earn rental income from a residential property in Florida.

For a number of years prior to 1985, the appellant was an employee and minority shareholder of Tri-Way Machine Limited ("Tri-Way"). There was an agreement among the shareholders of Tri-Way which provided in part that Tri-Way would purchase the appellant's common shares in certain circumstances including the termination of the appellant’s employment. The appellant's employment by Tri-Way ended on June 1, 1985. When there was no immediate move on the part of Tri-Way after that date to purchase the appellant's shares, the appellant spoke to the firm of chartered accountants who were the auditors of Tri-Way but they told him that he should seek legal advice concerning the enforcement of the shareholders’ agreement. Apparently, the appellant had consulted with the auditors of Tri-Way because his shares were to be purchased by the corporation at "book value” and the appellant wanted to know the book value of his shares.

The appellant retained a lawyer to represent him in forcing his fellow shareholders and Tri-Way to honour the shareholders' agreement; and the lawyer retained a public accountant to advise on the book value of the shares in question. Subsequently, the appellant entered into an agreement with Tri-Way under which he agreed to sell all of his 1,500 common shares in Tri-Way for the aggregate sum of $119,342.50 payable in three equal annual instalments of $39,780.83 in November 1985, 1986 and 1987. Apparently the paid-up capital (stated capital) of the appellant's 1,500 common shares of Tri- Way was $11,250. The appellant reported the sale of his Tri-Way shares as resulting in a capital gain of $ 17,630.54 for 1985 computed as follows:

The respondent issued a notice of reassessment to the appellant for 1985 deleting the reported table capital gain of $17,630.54 but adding to the appellant's reported income a deemed dividend of $162,140 computed as follows:

The first four issues connected with the above transaction are as follows: (i) whether the amount received upon the sale of the Tri-Way shares resulted in a capital gain or a deemed dividend and how much of that amount was the appellant's income in 1985;

(ii) whether the amount of $2,300 paid for legal and accounting fees was deductible in computing income;

(iii) whether the appellant was entitled to forward averaging for 1985; and

(iv) whether the appellant was liable for the instalment interest of $698.31 for 1985 and arrears interest of $3,095.61.

Under subsection 84(3) of the Income Tax Act ("Act"), when a corporation acquires any shares of its capital stock, it is deemed to have paid a dividend on those shares equal to the amount by which the amount actually paid on the acquisition exceeds the paid-up capital in respect of those shares. And under paragraph 54(h), there is excluded from "proceeds of disposition” any amount that would otherwise be proceeds of disposition of a share to the extent that such amount is deemed to be a dividend by subsection 84(3). Therefore, when the appellant sold Tri-Way shares back to the corporation In November 1985, he did not realize a capital gain but received a deemed dividend under the terms of subsection 84(3).

The appellant reported in 1985 only one third of his purported capital gain because he received in 1985 only one third of the sale price of his Tri-Way shares. Upon reassessment, the respondent included a deemed dividend in the appellant's 1985 income as if the appellant had received in 1985 all of the sale price of his Tri-Way shares. In making such reassessment, the respondent assumed that in 1985 Tri-Way "redeemed 1,500 common shares .. . . owned by the appellant for a price of $119,342.50". There was uncontradicted evidence that the appellant received in 1985 only one third ($39,780.83) of the sale price. Ordinarily, the issued shares of a corporation are not purchased or acquired or redeemed by the corporation until they are paid for. In other words, if a corporation has not paid for certain of its issued shares, then the corporation has not purchased or acquired or redeemed such shares. The question therefore arises as to whether only one third of the appellant's Tri-Way shares were redeemed or otherwise acquired by Tri-Way in 1985. In my view, the appellant has rebutted the respondent's assumed fact with regard to Tri-Way having "redeemed 1,500 common shares” in 1985 for a price of $ 119,342.50; and there is no longer a burden of proof on the appellant concerning this question.

It is possible, however, that all of the appellant’s common shares were purchased by Tri-Way in November 1985 and that the appellant loaned back to Tri-Way two thirds of his sale price thereby changing his status from shareholder to creditor. The actual procedure followed by the appellant and Tri-Way can be determined only by looking at the resolutions of Tri-Way directors implementing the transaction and the relevant corporate balance sheets as approved by the Tri-Way directors.

Counsel for the respondent argued that subsection 84(7) supported the reassessment which included the full deemed dividend of $162,140 in the appellant's 1985 income. Subsection 84(7) reads as follows:

A dividend that is deemed by this section or by section 212.1 to have been paid at a particular time shall be deemed, for the purposes of this subdivision, to have become payable at that time.

With respect, I think that subsection 84(7) begs the question. It is only the “amount” of the dividend that is deemed by section 84 to have been paid at a particular time that is deemed, for the purpose of subdivision "h" to have become payable at that time. Subsection 84(7) does not assist in the determination of that amount and, in particular, it does not permit the respondent to increase the size of a deemed dividend under section 84 otherwise than in accordance with the particular facts of a corporate transaction. It seems that the purpose of subsection 84(7) is to permit other provisions in subdivision "h" (like subsection 83(2)) to apply to a dividend that is deemed to have been paid by section 84.

Counsel for the respondent also relied on the decision of this Court in Cabezuelo v. M.N.R., [1983] C.T.C. 2775; 83 D.T.C. 679 in which Mr. Cab- ezuelo sold his 25 shares in Triomphe Inc. back to the corporation for $300,000. In the same transaction, Triomphe Inc. was to repay Mr. Cab- ezuelo's advances of $50,000. The total amount of $350,000 was retired with two principal payments of $25,000 on December 29, 1978 and July 5,1979 and with the balance payable at 10 '/2 per cent per annum in blended monthly payments of $3,017.08 from February 5,1979 to December 5, 1981. The terms of the promissory note from Triomphe Inc. to Mr. Cabezuelo are set out at page 683 of the reported decision. In my view, the delivery of the promissory note from Triomphe Inc. to Mr. Cabezuelo characterized the transaction as one of sale and a change in his status from shareholder to creditor.

In this appeal, we have no such clear evidence. Specifically, we do not know whether the agreement between the appellant and Tri-Way provided for the sale of his 1,500 common shares in three annual parcels of 500 shares each or whether all 1,500 shares were sold in November 1985 with a liability from Tri-Way to the appellant for the balance of the purchase price. On this first issue, I reach the following conclusions:

(1) In November 1985, the appellant received a deemed dividend under subsection 84(3) upon the sale of certain Tri-Way shares and he did not realize any capital gain with respect to those shares.

(2) The amount of the deemed dividend received by the appellant in 1985 will be determined by the balance sheet of Tri-Way for its first fiscal period ending after the payment of $39,780.83 to the appellant in 1985. If such balance sheet shows all of the appellant's shares as having been cancelled and shows $108,092.50 as having been charged against retained earnings in respect of such cancellation and shows a liability to him with respect to the unpaid two thirds of his sale price, then he shall be regarded as having sold all of his Tri-Way shares in 1985 and as having received a deemed dividend of $108,092.50 to be grossed up by the appropriate fraction. But if such balance sheet shows only one third of the appellant's shares as having been cancelled and shows only $36,030.83 ($39,780.83 minus $3,750.00) as having been charged against retained earnings in respect of such cancellation, then he shall be regarded as having sold only one-third of his Tri-Way shares in 1985 and as having received a deemed dividend of only $36,030.83 which will, of course, be grossed up by the appropriate fraction.

Turning to the second issue, the appellant had two kinds of property relating to his investment in Tri-Way shares: he had his intangible rights under the shareholders' agreement and he had the shares themselves. Because the shareholders' agreement required a corporate acquisition of his shares, he would on the facts of this case receive a deemed dividend on the disposition of his shares. The provisions of subsection 84(3) prevented him from realizing a capital gain on shares which he had purchased from the treasury of Tri-Way.

The costs which the appellant incurred in legal and accounting fees ($2,300) to enforce his rights under the shareholders' agreement were, on the particular facts of this case, like expenses incurred to collect rents, royalties or other income from property. In my view, such costs are deductible and the appellant is entitled to deduct the said amount of $2,300 in computing his income for 1985.

The third issue concerns forward averaging. The short answer to the appellant's claim is that an individual taxpayer is permitted a forward averaging deduction under subsection 110.4(1) of the Act only if the taxpayer files with his return of income "an election in prescribed form . .. on or before the day on or before which he was required to file the return". The appellant did not file any such election with his 1985 income tax return or at any other time prior to May 1, 1986. Subsection 110.4(1) does not permit any discretion on the part of the Minister or the taxpayer; and the appellant's failure to file an election form within the prescribed time is fatal to his claim. The fact that the appellant was not aware in April 1986 (when he filed his 1985 income tax return) that he might have a large deemed dividend in 1985 is of no assistance to him if he did not file the prescribed form within the prescribed time.

The appellant fails on the fourth issue concerning his liability for instalment interest and arrears interest. The respondent's reply to notice of appeal included two schedules showing the actual calculation of the interest in dispute. The appellant produced no evidence whatsoever to show that the interest assessed was not correct; and he made no argument as to why the interest was not assessed under the relevant provisions of the Income Tax Act.

The fifth issue concerns a loss arising out of the appellant's attempt to rent his property in Florida. In March 1985, the appellant purchased a lot in Florida for $24,000 (U.S.) and borrowed the entire purchase price from the Toronto Dominion Bank. In March 1986, he purchased a used trailer (29 feet long) for $3,000 (U.S.) which would sleep four persons. He put the trailer on the lot and immediately joined a “condo rental group" which attempted to rent his trailer. When filing his 1986 income tax return, the appellant deducted a loss of $6,204.80 in connection with his Florida property computed as follows:

The tenants in Florida were tourists not known to the appellant who also stated in cross-examination that he purchased the lot not necessarily to secure a return on a yearly basis but because the property was going up in value. He stated that the property in 1989 was worth $45,000 (U.S.). He paid off his loan to purchase the Florida property with his second pay-out from Tri-Way in November 1986.

In argument, the appellant stated that if his annual expenses were prorated over the twelve months, he would show a profit for certain winter months when the trailer could be rented. That statement is doubtful because certain costs like the commissions should be charged directly against the rents. Also, it appears inconsistent to pro-rate all expenses over 12 months to attempt to show a profit for a few winter months if all expenses are going to be included as part of the loss claimed.

Counsel for the respondent relied on the decision of his Court in Perratt v. M.N.R., [1985] 1 C.T.C. 2089; 85 D.T.C. 101 and the decision of the Federal Court-Trial Division in Meech v. The Queen [1987] 1 C.T.C. 421; 87 D.T.C. 5251. I have no difficulty in concluding that the appellant had no reasonable expectation of profit when he attempted the rental of his trailer in Florida. With respect to the fifth issue, the appeal is dismissed.

The appellant’s reassessments for 1985 and 1986 are referred back to the respondent for reconsideration and reassessment in accordance with the first and second issues described above. With respect to the third, fourth and fifth issues, the appeals are dismissed. Having regard to the inadequate notice of appeal, the appellant is not entitled to any costs.

Appeal allowed in part.