Citation: 2011 TCC 435
Date: 20110920
Dockets: 2006-3802(IT)G, 2006-3801(GST)I
2006-3600(IT)G
2006-3599(IT)I
BETWEEN:
DELSO RESTORATION LTD.,
DOMENIC ERAMO,
NATALIE ERAMO,
appellants,
and
HER MAJESTY THE QUEEN,
respondent.
REASONS FOR ORDER
Jorré J.
Introduction
[1]
The appellants have
applied for a determination of questions before trial pursuant to Rule 58 of
the Tax Court of Canada Rules (General Procedure), specifically:
(a) Were the assessments
of Domenic Eramo and Natalie Eramo in issue in these appeals permitted by subsection
15(1) of the Income Tax Act (Act), as amended, as alleged by the
respondent?
(b) Were the assessments
of Mr. and Mrs. Eramo in issue in these appeals permitted by
subsection 56(2) of the Act, as alleged by the respondent?
[2]
Neither of these
questions affects the two appeals relating to Delso Restoration Ltd. (Delso),
one of which is an income tax appeal and the other a GST appeal.
[3]
Throughout the
remainder of these reasons, the discussion, unless otherwise noted, relates to
the appeals of Mr. and Mrs. Eramo.
Background
[4]
Based on the pleadings,
the Minister reassessed the appellants’ 1995 taxation year, inter alia,
on the following basis:
(a) Mr. and Mrs. Eramo
owned, respectively, 80% and 20% of Nadome Investments Ltd., a company which in
turn is the parent corporation of Delso.
(b) Delso paid for various
renovations on the home of Mr. and Mrs. Eramo, as well as for landscaping
at the home of Mr. Eramo’s parents and deducted these costs in computing
its expenses.
(c) These expenditures of
some $90,000 plus GST were not made for the purpose of producing income.
(d) At the direction of
Mr. and Mrs. Eramo, the invoices for the renovation work were issued to Delso
and were falsified in an effort to disguise the renovation costs as legitimate
business expenses.
(e) The renovation costs
were personal and living expenses of Mr. and Mrs. Eramo.
(f) Delso made no
adjustments to the shareholder loan accounts.
(g) Neither Mr. nor Mrs.
Eramo included any amount in their income in relation to benefits received in respect
to the renovations and the landscaping.
[5]
The Minister also
alleges in the replies that Mr. and Mrs. Eramo failed to include benefits
with respect to the renovations and other personal expenditures that were
appropriated from, or conferred by, Delso.
[6]
The Minister included
in the income of Mr. Eramo a benefit equal to 80% of the expenditures and, in
the case of Mrs. Eramo a benefit equal to 20% of the expenditures.
[7]
In the submissions
portions of the replies, the respondent submits that Mr. and Mrs. Eramo
received “. . . benefits appropriated from, or conferred by, Delso, but which
he [she] failed to include in his [her] income for that year. The Minister
correctly reassessed the Appellant’s 1995 taxation year to include the . . .
unreported benefits in his [her] income, pursuant to subsections 15(1) and
56(2) of the Act.”
[8]
The Minister disallowed
the deduction of the renovation and landscaping expenditures by Delso.
[9]
The four notices of
appeal raise a variety of other issues including alleged charter violations and
whether the 1995 taxation year was statute barred.
Analysis
Rule 58
[10]
Rule 58 says:
58(1) A party may apply to the Court,
(a) for the determination, before hearing, of a question of
law, a question of fact or a question of mixed law and fact raised by a
pleading in a proceeding where the determination of the question may dispose of
all or part of the proceeding, substantially shorten the hearing or result in a
substantial saving of costs, or
(b) to strike out a pleading because it discloses no
reasonable grounds for appeal or for opposing the appeal,
and the Court may grant judgment accordingly.
(2) No evidence is admissible on an application,
(a) under paragraph (1)(a), except with leave of the
Court or on consent of the parties, or
(b) under paragraph (1)(b).
(3) The respondent may apply to the Court to have an appeal
dismissed on the ground that,
(a) the Court has no jurisdiction over the subject matter of
an appeal,
(b) a condition precedent to instituting a valid appeal has
not been met, or
(c) the appellant is without legal capacity to commence or
continue the proceeding,
and the Court may grant judgment accordingly.
[11]
The law is well settled
that Rule 58 is not intended to provide an easily available right to have the
determination of complex and contentious issues and that the rule is
discretionary.
[12]
There is a great deal
of authority for the proposition that there must be no dispute as to facts although much of
this authority precedes the amendments made in 2004 which added to Rule 58(1)(a)
the following words: “a question of fact or a question of mixed law and fact”.
[13]
Given those amendments
the existence of a factual dispute cannot be an absolute bar to there being a
determination under the rule.
[14]
However, the existence
of one or more factual disputes will always be relevant to the question whether
the determination will substantially shorten the hearing or result in a
substantial saving of costs.
[15]
Here, I am satisfied that
there are significant factual disputes between the parties even if one excludes
all the other issues raised by Mr. and Mrs. Eramo apart from those
relating to subsections 15(1) and 56(2) of the Act. On the pleadings,
there are no admissions by Mr. and Mrs. Eramo of the facts assumed or
alleged by the Minister in relation to subsections 15(1) and 56(2).
[16]
However, in Canada
v. Webster,
Rothstein J.A., speaking for the majority, states at paragraph 5 :
5 In Berneche, supra, at paragraph 7, Mahoney
J.A. noted that the requirement that there be no dispute as to any material
fact is often stated in terms of an agreement or admission of facts. However,
agreement is not a requirement. The Motions Judge may draw a conclusion that
there are no material facts in dispute, and such conclusion might be drawn from
the entire pleadings of the respondent on the motion, on the assumption that
what has been pleaded is true, much as in the case of a motion to strike a
statement of claim as disclosing no reasonable cause of action. . . .
[17]
Although the motion
does not say so explicitly, it is clearly implicit in the grounds set out in
the motion
as well as the basis on which Mr. and Mrs. Eramo argued the motion that, for the
purposes of the motion, the appellants are prepared to accept that the facts
alleged in the replies are to be taken as true.
[18]
I will proceed on the
basis that Mr. and Mrs. Eramo have, for the purposes of the motion,
admitted the allegations and assumptions set out in the replies.
[19]
Given the comments
quoted from Webster, above, I cannot see any reason why the absence of
agreement between the parties on the relevant facts would, in itself, preclude
a determination of law where one party is prepared to accept, for the purposes
of the motion, the allegations made by the other party as is the case here.
[20]
However, for reasons
that will become apparent below, it is not, in fact, necessary for me to decide
this point and I choose not to do so.
[21]
If, assuming the
allegations of the respondent to be true, the answer to the two proposed
questions is “no”, then the replies would not disclose any valid basis for the
assessments in issue and the disputes might well come to an end.
[22]
A key requirement of
the rule is that the determination “may dispose of all or part of the
proceeding, substantially shorten the hearing or result in a substantial saving
of costs”. (I shall refer collectively to the words just quoted as “shorten the
hearing”.)
[23]
Consequently for this
purpose, it is relevant to ask if it is likely that the determination will
shorten the hearing.
[24]
In this case, if the
answer to either question is “yes”, then the litigation will not be materially shorter
since it will be necessary to deal with all the evidence relating to the
conferring of benefits as well as all the other issues raised in the notices of
appeal apart from subsections 15(1) and 56(2) of the Act.
[25]
Accordingly, to answer
the question “Will the determination shorten the hearing?”, it is necessary to
consider the law on the two proposed questions taking, for the purposes of the
motion, the allegations and assumptions in the replies to be true.
[26]
I will begin with subsection
56(2).
[27]
The essence of Mr. and Mrs. Eramo’s
argument with respect to the subsection 56(2) issue is that, in addition to the
four generally accepted requirements for subsection 56(2) to apply, there is a
fifth condition.
[28]
The four generally
accepted conditions are:
(1) the payment must be to a person other than
the reassessed taxpayer;
(2) the allocation must be at the direction or
with the concurrence of the reassessed taxpayer;
(3) the payment must be for the benefit of the
reassessed taxpayer or for the benefit of another person whom the reassessed
taxpayer wished to benefit; and
(4) the payment would have been included in the
reassessed taxpayer's income if it had been received by him or her.
[29]
Mr. and Mrs. Eramo
argue that the fifth condition is that subsection 56(2) can only apply if the
benefit conferred is not taxable in the hands of the transferee. Specifically,
they submit that subsection 56(2) cannot apply because the contractors are
taxable on the payments.
[30]
This additional
condition is discussed in Smith v. M.N.R. where Mahoney
J.A. speaking for the Federal Court of Appeal said, at pages 262-263:
. . . That, however, is not an end to the matter. This
Court’s decision in Outerbridge Estate was rendered after the trial
judgment herein. It has added another precondition to the application of
subsection 56(2), which seems to me to be relevant in the circumstances.
It was held in Outerbridge, supra, at
pages 117–18 (D.T.C. 6684),
that the validity of an assessment under subsection
56(2) of the Act when the taxpayer had himself no entitlement to the payment
made or the property transferred is subject to an implied condition, namely
that the payee not be subject to tax on the benefit received.
That conclusion, obiter in the result, was based on the
analysis by Marceau, J.A. that preceded it (C.T.C. 117, D.T.C. 6684).
It is generally accepted that the provision of subsection 56(2) is
rooted in the doctrine of “constructive receipt” and was meant to cover
principally cases where a taxpayer seeks to avoid receipt of what in his hands
would be income by arranging to have the amount paid to some other person
either for his own benefit (for example the extinction of a liability) or for
the benefit of that other person [citations omitted]. There is no doubt,
however that the wording of the provision does not allow to its being confined
to such clear cases of tax-avoidance. The Bronfman judgment, which
upheld the assessment, under the predecessor of subsection 56(2), of a
shareholder of a closely held private company, for corporate gifts made over a
number of years to family members, is usually cited as authority for the
proposition that it is not a pre-condition to the application of the rule that
the individual being taxed have some right or interest in the payment made or
the property transferred. The precedent does not appear to me quite compelling,
since gifts by a corporation come out of profits to which the shareholders have
a prospective right. But the fact is that the language of the provision does
not require, for its application, that the taxpayer be initially entitled to
the payment or transfer of property made to the third party, only that he would
be subject to tax had the payment or transfer been made to him. It seems to
me however, that when the doctrine of constructive receipt is not clearly
involved, because the taxpayer had no entitlement to the payment being made or
the property being transferred, it is fair to infer that subsection 56(2) may
receive application only if the benefit conferred is not directly taxable in
the hands of the transferee. Indeed, as I see it, a tax-avoidance provision is
subsidiary in nature; it exists to prevent the avoidance of a tax payable on a
particular transaction, not simply to double the tax normally due nor to give
the taxing authorities an administrative discretion to choose between possible
taxpayers.
[Emphasis
added.]
While I might have distinguished Bronfman on further or other
grounds, since the benefit to the shareholders of having personal gifts paid
for by the company with pre-tax dollars over the shareholders themselves paying
for them with after-tax dollars seems transparently clear, I agree with that
analysis. Being “subject to tax on the benefit received” means that it is
required to be included in the calculation of the recipient’s taxable income.
[31]
In considering the
application of subsection 56(2) it is important to emphasize the third
condition: “for the benefit of the reassessed taxpayer or for the benefit
of another person whom the reassessed taxpayer wished to benefit” (emphasis
added). The subsection is concerned with the conferring of a benefit on
someone.
[32]
It is also useful to
bear in mind the purpose of subsection 56(2), as explained by the Supreme Court
of Canada in Canada v. McClurg:
Subsection 56(2) of the Income Tax Act
In attempting to discern the purpose of s. 56(2), it is helpful to
refer to the body of jurisprudence dealing with the subsection. A useful
starting point is an early case dealing with the predecessor section to
s. 56(2): Miller v. M.N.R., 62 D.T.C. 1139 (Ex. Ct.). In that case, Thurlow J., as he
then was, in examining s. 16(1) of the Act, made some general comments, at p. 1147,
as to the anti-avoidance purpose of the provision which remain relevant today:
In my opinion, s. 16(1) is intended to cover cases where a taxpayer
seeks to avoid receipt of what in his hands would be income by arranging to
have the amount received by some other person whom he wishes to benefit or by
some other person for his own benefit. The scope of the subsection is not
obscure for one does not speak of benefitting a person in the sense of the
subsection by making a business contract with him for adequate consideration.
Strayer J. noted, at p. 4, in respect of the Miller case:
Two important qualifications are noted here: the first is that the
taxpayer seek “to avoid receipt” of funds, presumably funds that would otherwise
be payable to him; and the second is that the concept of payment of a “benefit”
is contrasted to payments for adequate consideration.
In my opinion, the views of Thurlow J. and Strayer J. provide a
sound foundation for the interpretation of s. 56(2). The subsection obviously
is designed to prevent avoidance by the taxpayer, through the direction to a
third party, of receipts which he or she otherwise would have obtained. I agree
with both Thurlow J. and Strayer J. in their characterization of the purpose of
the section and, specifically, I concur with their view that the section
reasonably cannot have been intended to cover benefits conferred for adequate
consideration in the context of a legitimate business relationship.
[33]
In M.N.R. v. Neuman, the Federal
Court of Appeal stated that there was no general requirement of a fifth
condition being met.
[34]
The circumstances of Outerbridge
Estate v. Canada
and Smith are important.
[35]
In Outerbridge,
Sir Leonard Outerbridge caused a company he controlled to sell shares to his
son-in-law for less than their fair market value. The appellant had argued that
the son-in-law was taxable on the benefit under subsection 15(1) and that the
law was not intended to tax the benefit twice.
[36]
While the Court of
Appeal found the son-in-law was not taxable under subsection 15(1) because the
benefit was conferred on the son-in-law in his capacity as a son-in-law, it
accepted the principle that if the son-in-law had received this in his capacity
as shareholder then subsection 15(1) would have applied to him and subsection
56(2) would not have applied to Sir Leonard. The Court of Appeal was
satisfied that what had been conferred was a benefit.
[37]
In Smith the
facts are somewhat complicated. However, when one goes back to the judgment of Addy
J. at trial
it is very clear that, with respect to the amounts which the Court of Appeal
held to be taxable, there was a finding that these amounts had been received as
benefits by the transferee “Holiday 77”.
That finding was upheld on appeal.
[38]
The Court of Appeal
also found in Smith, at page 263,
that the amounts received by the transferee, “Holiday 77”, as benefits were
taxable. The amounts received by the transferee were not earned by the
transferee as consideration for services rendered or goods supplied.
[39]
In Outerbridge
and Smith, the payments to the transferees were taxable benefits because
the payments were not made in return “for adequate consideration in the context
of a legitimate business relationship”.
[40]
In both Outerbridge and
Smith, the recipient of the payment or the property happened to also be the
person on whom a benefit was conferred.
[41]
Where the recipient of
the payment or the transferred property is simply receiving payment in return
for adequate consideration (the supply of goods or services), there is no
benefit being conferred on the recipient of the payment.
[42]
Those factual
circumstances assist in understanding Smith, at page 263:
. . . subsection 56(2) may receive application only if
the benefit conferred is not directly taxable in the hands of the transferee.
Indeed, as I see it, a tax-avoidance provision is subsidiary in nature; it
exists to prevent the avoidance of a tax payable on a particular transaction,
not simply to double the tax normally due nor to give the taxing authorities an
administrative discretion to choose between possible taxpayers.
. . . Being “subject to tax
on the benefit received” means that it is required to be included in the
calculation of the recipient's taxable income.
[Original italicized. Underlining added.]
The “it” in the second to last line of the preceding
quotation is clearly a reference to the word “benefit”.
[43]
As stated in McClurg:
“The subsection obviously is designed to prevent avoidance by the taxpayer,
through the direction to a third party, of receipts which he or she otherwise would
have obtained.”
If the “fifth condition” in Outerbridge and Smith were that
subsection 56(2) is inapplicable when the recipient of the payment is
obliged to include the payment in his income, then the subsection would be
largely ineffective.
[44]
This is easily
illustrated by the following example. “A”
causes company “X” to pay company “Y”, an electronics store, for the purchase
of the television to be delivered to “A”. Since “Y” sells the television in the
course of its normal business, the receipt would enter into its computation of
taxable income and subsection 56(2) would be inapplicable if the correct
approach is that subsection 56(2) can have no application where the recipient
is taxable. That would largely defeat the purpose of the subsection as stated
by the Supreme Court of Canada in McClurg.
[45]
Nothing in subsection
56(2) supports such an interpretation. In Outerbridge and Smith
it was unnecessary to distinguish between (i) the recipient of the payment (or
transferee of the property) and (ii) the person intended to receive the
benefit; in Outerbridge and Smith they were one and the same
person. As a result it was not necessary in those decisions to make a
distinction between the recipient and the beneficiary.
[46]
However, where the
recipient and the beneficiary are different persons when one considers the
wording of the subsection and the comments cited above in McClurg as to
the purpose of the provision, it becomes apparent that the additional condition,
the fifth condition, should be restated in circumstances such as this case in
the following manner:
1. Where the first four conditions
are met,
2. where the taxpayer has
no pre-existing entitlement to the payment or property,
3. where a benefit
is conferred on a person other than the taxpayer and
4. that benefit is
taxable as a benefit in the hands of that other person under some other
provision of the Act,
then the benefit conferred will only be
taxable once, in the hands of the actual recipient of the benefit (that other
person). It cannot be taxed a second time under subsection 56(2).
[47]
This is entirely
consistent with the purpose of subsection 56(2) as set out in McClurg
above. If a taxpayer buys a gift for his child and pays for the gift with money
he appropriated from a corporation he owns, the taxpayer will be taxable on the
appropriated funds notwithstanding the fact that the supplier of the gift will
be taxable on the sale of the gift to the taxpayer as part of his normal
business income.
[48]
Similarly, under
subsection 56(2) the taxpayer who directs a corporation to buy a gift for his
child and send the gift to his child is taxable on the amount spent by the corporation;
this liability of the taxpayer is not affected by the fact that the supplier of
the gift is taxable on the sale of the gift.
[49]
This is a very
different situation from the situation in Outerbridge where, if
the son-in-law had been taxable in his capacity as a shareholder, then there might have been
taxation of the same benefit twice.
[50]
In this case, no benefit
was conferred on the contractors doing renovations or making improvements to Mr.
and Mrs. Eramo’s residence, nor was any benefit being conferred on the
contractors doing landscaping on the house of Mr. Eramo’s parents. The
recipients of the benefit were Mr. and Mrs. Eramo as well as
Mr. Eramo’s parents.
[51]
The contractors were
simply receiving payments for services supplied in the normal course of
business.
[52]
Accordingly, to the
extent that there is a fifth condition, it does not have application here,
given the facts I must assume.
[53]
With respect to
subsection 56(2), the appellants made a further argument that, on the face of
the respondent’s pleadings, the fourth condition was not met insofar as the respondent
did not plead that the amounts in question would have been included in the
income of Mr. and Mrs. Eramo if the amounts had been received by them.
[54]
The difficulty with
this submission is the following.
[55]
For these purposes I
must assume that it is not a shareholder benefit nor an employee
benefit,
both of which would be taxable if that were the nature of what happened. Taking
the respondent’s allegations as a given, they amount to Mr. and Mrs. Eramo
having indirectly appropriated over $90,000 from Delso to their benefit by causing
Delso to pay for the renovations and landscaping.
[56]
For the purposes of the
fourth condition one has to analyze the situation as if Mr. and Mrs. Eramo
had received the $90,000 themselves instead of the funds being paid to
contractors.
[57]
Had Mr. and
Mrs. Eramo received the $90,000 it could not have been the reimbursement
of a loan or a return of share capital, nor could it have been a gain from the
disposition of something to the company.
[58]
It would purely and
simply have been an appropriation to themselves directly of corporate assets to
which they had no legal right.
[59]
Delso, like any
companies, is a separate legal entity; the fact that Mr. and Mrs. Eramo
may own Delso directly or indirectly does not mean that they have any right to
simply take any asset of the corporation. For them to validly acquire any
corporate assets there must be a valid corporate decision which results in a
transfer of the assets.
[60]
For example there must
be a corporate decision to effect a return of capital, the payment of
dividends, a loan to someone or the payment of bonuses to employees, etc. Such
decisions are normally recorded in some way and show up in the corporate
records. For example, a loan to a shareholder will be recorded in a shareholder
loan account.
[61]
Here, based on the
allegations which I must assume for these purposes, there is nothing like that.
There are allegedly false invoices to disguise the purpose of the payments.
Even if the appellants are officers of the corporation, given the obligations
that they have to the corporation in corporate law, they could not be validly
acting on behalf of the corporation in making payments justified with false
invoices that hide the fact of their benefiting from the payments.
[62]
As a result, if the
appellants appropriated the $90,000 directly to themselves in such
circumstances they could not be doing so in any capacity as officers, employees
or shareholders; they would be doing so in their capacity as individuals
without the company having validly authorized such a payment from a corporate
law perspective.
[63]
Such an appropriation
of property to which a person has no legal right is income and is taxable. The
fact that they may be under legal obligation to account for the income to the
corporation does not change the fact that the appropriation has the quality of
income in the hands of Mr. and Mrs. Eramo.
[64]
As a result the
allegations in the replies provide sufficient facts to support the fourth
condition.
[65]
Thus, the answer to the
second question is: Yes, subsection 56(2) does form a basis for the
assessments, on the assumption that the allegations in the replies are true.
[66]
Consequently, the
proposed determinations are unlikely to significantly shorten the hearing.
[67]
In the circumstances,
given this conclusion it is unnecessary for me to consider the first question.
Conclusion
[68]
Accordingly, it is not
appropriate to order a determination and the motion will be dismissed.
[69]
Costs will be in the
cause.
Signed at Ottawa, Ontario, this 20th day of September 2011.
“Gaston Jorré”
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