Citation: 2013 TCC 73
Date: 20130228
Docket: 2007-3940(IT)G
BETWEEN:
ELIAHU SWIRSKY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Paris J.
[1]
In three transactions, in 1991,
1993 and 1995, the appellant, Mr. Swirsky, transferred shares in a family-owned
corporation to his spouse, Joanne Swirsky. On each occasion, Ms. Swirsky
borrowed the money to purchase the shares. The interest and certain carrying
costs incurred in relation to the loans resulted in losses from the shares. Mr.
Swirsky claimed those losses pursuant to subsection 74.1(1) of the Income
Tax Act, (the “Act”) which attributes income and losses on property
transferred from one spouse to the other back to the transferor spouse.
[2]
The Minister of National Revenue
(the “Minister”) reassessed Mr. Swirsky for his 1996 to 2003 taxation years to
disallow his claim for those losses. The Minister determined that the interest
and carrying costs on the loans were not deductible to Ms. Swirsky because she
did not borrow the money for the purpose of earning income and therefore that there
were no losses on the shares that could be attributed back to Mr. Swirsky.
[3]
In confirming the reassessments,
the Minister also relied on the General Anti‑Avoidance Rule (the “GAAR”)
in section 245 of the Act to disallow the losses.
[4]
Mr. Swirsky is appealing those
reassessments in these proceedings.
[5]
In the Reply to Notice of Appeal,
the respondent has raised the further argument that the losses should be denied
pursuant to subsection 74.5(11) of the Act. That provision applies where
one of the main reasons for the transfer of the property (in this case the
shares) is to reduce taxes payable on the income from the property.
Facts
[6]
Mr. Swirsky’s father immigrated to
Canada in 1970 and began carrying on business as a real estate developer. Mr.
Swirsky himself came to Canada in 1974 and attended university for a few years
before dropping out to work with his father. In 1978 he incorporated a company with
capital advanced by his father. The company later became Torgan Construction
Limited (“Torgan”). Mr. Swirsky was the sole shareholder of the company and
both he and his father were directors.
[7]
In 1981 Mr. Swirsky married Joanne
Rumack. In about 1985, she became an equal shareholder in Torgan with Mr.
Swirsky. Mr. Swirsky also held approximately 12% of the shares in Torgan in
trust for his sister who lived in Israel. When Ms. Swirsky acquired her
interest in Torgan, she and Mr. Swirsky entered into an agreement whereby they
pledged their Torgan shares as security for certain management fees that Torgan
was obligated to pay Mr. Swirsky’s father each year.
[8]
Despite certain early setbacks,
Torgan was successful in the real estate development business and from the mid 1980’s
it supported Mr. and Ms. Swirsky and their children, Mr. Swirsky’s parents and
his disabled brother.
[9]
In the mid 1980s, Mr. Swirsky’s
mother became ill and his father spent a large part of his time caring for her.
Mr. Swirsky then entered into a partnership with Sam “Shlomo” Cohen to
carry out various development projects. Mr. Swirsky testified that he and Mr.
Cohen each set up a separate corporation for each project. Mr. Swirsky’s
corporations held their interests in the properties that were developed in
trust for Torgan.
[10]
By the late 1980’s Torgan held a
half interest in approximately 20 properties, mostly medical office buildings
that it, along with Mr. Cohen’s corporations, leased and managed. The average
cost of these developments was between $5 million and $10 million.
[11]
In 1989, Mr. Swirsky and Mr. Cohen
undertook the development of a two acre parcel of land on Yonge Street near Eglinton Street
in Toronto. The scope of this project far exceeded anything they had done
before. The cost of the land was $20 million and the anticipated cost of
construction of the luxury condominium and retail project they planned was and
additional $30 million. In order to secure the financing from the Royal Bank to
purchase the land and construct the project, Mr. Swirsky and Mr. Cohen provided
joint and several personal guarantees.
[12]
Pre-sales were started in the fall
of 1989, just as the real estate market in Toronto slowed sharply. Mr. Swirsky
and Mr. Cohen were not able to pre-sell enough units to proceed and they had to
cancel the project. As a result of the financial difficulties created by the
project, Mr. Cohen sought to have Mr. Swirsky buy him out. Mr. Swirsky
testified that Mr. Cohen told him that if the Royal Bank sought to enforce
their personal guarantees, it would not be able to collect anything from him because
of the way in which he had arranged his holdings, and therefore that Mr.
Swirsky would be required to pay back the entire amount of the guarantees.
[13]
Faced with this possibility, Mr.
Swirsky asked his accountants to devise a plan that would allow him to buy out
Mr. Cohen and pay off the Royal Bank by selling off properties. Mr. Swirsky
testified that he also became concerned about losing his shares in Torgan to
creditors if he were required to declare bankruptcy. Since Torgan was the
primary source of financial support for his family, the loss of his shares
would have serious consequences not just for him but for all of his family.
[14]
By January 1991 it became apparent
that Mr. Swirsky could not come to an arrangement with Mr. Cohen. Mr. Swirsky’s
accountant, David Steinberg, then proposed a plan under which Mr. Swirsky would
sell his shares in Torgan to Ms. Swirsky, thereby protecting them from seizure
by creditors. Mr. Swirsky would use the proceeds to repay his outstanding shareholder
loans from Torgan so that the proceeds from the sale of the shares would not be
available to creditors. By repaying those loans before Torgan’s June 30, 1991 year
end, he would avoid having to include them in his income in that year, pursuant
to subsection 15(2) of the Act.
[15]
Mr. Swirsky and Mr. Steinberg
testified that since the main goal of the plan was to creditor-proof Mr.
Swirsky, it was preferable that he sell only enough of his shares at one time
to enable him to repay his outstanding shareholder loans. They explained that
if he sold all of his shares and ended up holding cash after repaying the
shareholder loans, the cash could be easily seized by creditors in the event of
bankruptcy.
[16]
Pursuant to this plan, the
following transactions were carried out:
(i) in March 1991, a loan from Mutual Trust Company (Mutual
Trust) to Ms. Swirsky for $2.5 million was arranged. The loan was to be for a
term of five years at 11% interest. It was to be guaranteed by Torgan, and
supported by the purchase and assignment by Torgan of a Mutual Trust guaranteed
investment certificate (GIC) for $2.5 million. Torgan was to receive 10%
interest on the GIC. In return for the loan guarantee, Ms. Swirsky would pay
Torgan an annual fee of 0.5% of the loan balance.
(ii) on
or about April 19, 1991, Ms. Swirsky accepted the offer of financing from
Mutual Trust and paid a commitment fee of $18,750 to Mutual Trust from her
personal account. Mr. Swirsky testified that he later reimbursed her for the
commitment fee.
(iii) on
June 25, 1991:
- Mutual
Trust advanced $2.5 million to Ms. Swirsky, who used it to purchase 122 Class C
shares of Torgan and 441 shares of another corporation (689799 Ontario Limited) from Mr. Swirsky at their
fair market value. The purchase agreement provided that the number of Torgan shares
purchased would be subject to adjustment based on a valuation report to be
prepared after the transfer so that the total value of the shares of both
Torgan and 689799 Ontario Limited that were transferred would match the amount
of the outstanding shareholder loans.
- Mr.
Swirsky used the proceeds of the sale to repay his shareholder loans from
Torgan.
- Torgan
used the repayment proceeds to purchase a GIC for $2.5 million from Mutual
Trust and assigned it to Mutual Trust.
[17]
The interest payable to Torgan on
the GIC was applied by Mutual Trust to the interest owing by Ms. Swirsky on the
loan. The balance of the interest owing was paid by Torgan and charged to Mr.
Swirsky’s Torgon shareholder loan account each month. The guarantee fee payable
by Ms. Swirsky to Torgan for the loan was also charged to Mr. Swirsky’s Torgan shareholder
loan account each year.
[18]
In accordance with a valuation
report dated January 18, 1993, the number of Torgan shares purchased by Ms.
Swirsky was adjusted to 202.71.
[19]
Simultaneously with the June 30,
1991 share sale, Torgan issued Mr. Swirsky additional Class A voting
shares to maintain his voting control over the company.
[20]
The second sale of Torgan shares
by Mr. Swirsky to Ms. Swirsky took place on June 30, 1993. The value of the
Torgan shares sold in this transaction was $1.7 million dollars, which was
equal to the outstanding balance of Mr. Swirsky’s shareholder loans from Torgan
on that date. Ms. Swirsky financed the purchase with a loan from Mutual Trust
on similar terms to the 1991 loan and Torgan guaranteed the loan on the same
terms as in 1991.
[21]
The third sale of Torgan shares by
Mr. Swirsky to Ms. Swirsky took place on January 31, 1995 (Torgan’s new fiscal
year end, due to an amalgamation.) Mr. Swirsky sold $700,000 worth of Torgan
shares to Ms. Swirsky, which was again equal to his shareholder loan account
balance. Ms. Swirsky obtained a loan from Mutual Trust for the full purchase
price and Torgan guaranteed the loan. The terms of the loan and guarantee were
similar to the previous transactions.
[22]
The number of shares sold to Ms.
Swirsky in the second and third transactions was adjusted upon the completion
of valuation reports, as with the first transaction.
[23]
From 1991 to 2002 Mr. Swirsky claimed
the losses arising from the Torgan shares that he transferred to Ms. Swirsky in
1991, 1993 and 1995. The amount of the losses was equal to the interest and
carrying charges paid on the loans. In 2003, Torgan paid a dividend of $1,572,748.22 on Ms. Swirsky’s shares and
the grossed-up amount of the dividend ($1,965,935.28) less the interest on the
Mutual Trust loans still outstanding was included by Mr. Swirsky in his income
for that year.
Torgan also paid a capital dividend of $2,500,000 in 1999. Because it was a
capital dividend it was non-taxable and was not included in the computation of
the income arising from the transferred shares that was included by Mr. Swirsky
in his income for that year. Mr. Swirsky testified that he has continued to
claim the interest and carrying charges on the loans that are still outstanding
up to the present, but the amounts claimed were not put into evidence.
[24]
The amounts of interest and
carrying costs deducted by Mr. Swirsky in computing his income in the years in
issue were as follows:
[25]
The Minister reassessed Mr.
Swirsky for his 1996 to 2003 taxation years to disallow the deduction of the
interest expenses and carrying costs paid on the Mutual Trust loans. As
indicated at the outset of these reasons, the Minister assumed that the loans
were not used for the purpose of earning income from a business or property and
therefore that the interest and carrying costs claimed were not deductible.
[26]
The issues before the Court are:
1. Whether Ms. Swirsky used the funds borrowed
from Mutual Trust in 1991, 1993 and 1995 for the purpose of earning income from
the shares? If not, the interest and carrying charges on those loans would not
be deductible to her under subparagraph 20(1)(c)(i) and paragraph 20(1)(e.1)
of the Act and there would be no losses that would be attributed back to
Mr. Swirsky.
2. If Ms. Swirsky did use the borrowed funds to
earn income, whether the attribution of her losses on the Torgan shares she
acquired from Mr. Swirsky is prohibited by subsection 74.5(11) of the Act?
3. If subsection 74.5(11) does not prohibit the
attribution of the losses to Mr. Swirsky, does the General Anti-Avoidance Rule
in section 245 of the Act apply to deny the losses?
Legislation
[27]
The relevant provisions
of the Act read as follows:
Subparagraph 20(1)(c)(i)
(c) interest
—an amount paid in the year or payable in respect of the year (depending upon
the method regularly followed by the taxpayer in computing the taxpayer’s
income), pursuant to a legal obligation to pay interest on
(i) borrowed money
used for the purpose of earning income from a business or property (other than
borrowed money used to acquire property the income from which would be exempt
or to acquire a life insurance policy),
Subparagraph 20(1)(e.1)
(e.1) annual fees,
etc. [re borrowings] – an amount payable by the taxpayer
(other than a payment that is contingent or dependent on the use of, or
production from, property or is computed by reference to
revenue, profit, cash flow, commodity price or any other similar criterion or
by reference to dividends paid or payable to shareholders of any class
of shares of the capital stock of a corporation) as a standby
charge, guarantee fee, registrar fee, transfer agent fee, filing fee, service
fee or any similar fee, that can reasonably be considered to relate solely to
the year and that is incurred by the taxpayer
(i) for the purpose of borrowing money to
be used by the taxpayer for the purpose of earning from a business
or property (other than borrowed money used by the taxpayer for
the purpose of acquiring property the income from which would be exempt income)…
Subsection 74.1(1)
Transfers and loans
to spouse [or common-law partner]—Where an individual has transferred or lent
property (otherwise than by an assignment of any portion of a retirement
pension pursuant to section 65.1 of the Canada Pension Plan or a comparable
provision of a provincial pension plan as defined in section 3 of that Act or
of a prescribed provincial pension plan), either directly or indirectly by
means of a trust or by any other means whatever, to or for the benefit of a
person who is the individual as spouse or common-law partner or who has since
become the individual’s spouse or common-law partner, any income or loss, as
the case may be, of that person for a taxation year from the property or from
property substituted therefore, that relates to the period in the year
throughout which the individual is resident in Canada and that person is the
individual’s spouse or common-law partner, shall be deemed to be income or a
loss, as the case may be, of the individual for the year and not of that person.
Subsection 74.5(11)
Artificial
transactions —Notwithstanding any other provision of this act, section 74.1 to
74.4 do not apply to a transfer or loan of property where it may reasonably be
concluded that one of the main reasons for the transfer or loan was to reduce
the amount of tax that would, but for this subsection, be payable under this
Part on the income and gains derived from the property or from property
substituted therefore.
Section 245
(1)“tax benefit” means a reduction, avoidance or
deferral of tax or other amount payable under this Act or an increase in a
refund of tax or other amount under this Act, and includes a reduction,
avoidance or deferral of tax or other amount that would be payable under this
Act but for a tax treaty or an increase in a refund of tax or other amount
under this Act as a result of a tax treaty;
“tax consequences” to a person means the amount of
income, taxable income, or taxable income earned in Canada of, tax or other
amount payable by or refundable to the person under this Act, or any other
amount that is relevant for the purposes of computing that amount;
“transaction” includes an arrangement or
event.
(2) Where a transaction is
an avoidance transaction, the tax consequences to a person shall be determined
as is reasonable in the circumstances in order to deny a tax benefit that, but
for this section, would result, directly or indirectly, from that transaction
or from a series of transactions that includes that transaction.
(3) An avoidance
transaction means any transaction
(a) that,
but for this section, would result, directly or indirectly, in a tax benefit,
unless the transaction may reasonably be considered to have been undertaken or
arranged primarily for bona fide purposes other than to obtain the tax
benefit; or
(b) that
is part of a series of transactions, which series, but for this section, would
result, directly or indirectly, in a tax benefit, unless the transaction may
reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain
the tax benefit.
(4) Subsection (2) applies
to a transaction only if it may reasonably be considered that the transaction
(a) would,
if this Act were read without reference to this section, result directly or
indirectly in a misuse of the provisions of any one or more of
(i) this
Act,
(ii) the
Income Tax Regulations,
(iii) the
Income Tax Application Rules,
(iv) a
tax treaty, or
(v) any other enactment that is relevant in computing
tax or any other amount payable by or refundable to a person under this Act or
in determining any amount that is relevant for the purposes of that
computation; or
(b) would
result directly or indirectly in an abuse having regard to those provisions,
other than this section, read as a whole.
…
Did Ms. Swirsky use the
proceeds of the Mutual Trust loans for the purpose of earning income?
[28]
The matter of deductibility of
interest under subparagraph 20(1)(c)(i) of the Act was considered
by the Supreme Court in Shell Canada Ltd. v. Canada, and Ludco
Enterprises Ltd. v. Canada.
In Shell, the Court stated that there are four requirements that must be
met in order to obtain a deduction:
28 …(1) the amount
must be paid in the year or be payable in the year in which it is sought to be
deducted; (2) the amount must be paid pursuant to a legal obligation to pay
interest on borrowed money; (3) the borrowed money must be used for the purpose
of earning non-exempt income from a business or property; and (4) the amount
must be reasonable, as assessed by reference to the first three requirements.
[29]
In this case, we are only
concerned with whether the third requirement has been met: whether the borrowed
money was used for the purpose of earning non‑exempt income from the
Torgan shares. This is a question of fact.
[30]
In Ludco, the Supreme Court
held that the test for determining the purpose for interest deductibility was
“whether, considering all of the circumstances, the taxpayer had a reasonable
expectation of income at the time the investment was made.” The Court noted that a
taxpayer’s subjective intention, while relevant, is not conclusive of the
question of purpose.
[31]
The appellant’s position is that
Ms. Swirsky had a reasonable expectation of income from the Torgan shares at
the time she purchased them in 1991, 1993 and 1995, and that this expectation
was borne out by the payment of dividends on the shares in 1999, 2003, 2004 and
2005. Counsel also referred to the evidence of Mr. and Ms. Swirsky that Torgan
constituted the primary source of income for the entire Swirsky family. Finally
counsel submitted that the creditor proofing purpose of the transactions was,
in itself, evidence of the Swirskys’ belief in the future income earning
potential of the shares.
[32]
The first difficulty with the
appellant’s position, however, is that there is no evidence that Torgan, prior
to 1999, had any history of paying dividends. Instead, it appears that Mr.
Swirsky took money out of the company in the form of bonuses or as loans that
were subsequently included in income. These were the funds used to support the
family.
[33]
Mr. Swirsky testified that Torgan
paid family expenses and treated those payments as shareholder advances. Those
shareholder advances would then either be cleared out by the payment of
bonuses, or the advances would be included in income pursuant to subsection
15(2) of the Act. Prior to the first sale of shares to Ms. Swirsky, Mr.
Swirsky said that all of the advances to family members or for family expenses
were treated as “a global sum” and that, generally speaking, the advances would
be recorded in his shareholder loan account, and would be cleared off by Torgan
declaring a bonus to him, or by his including all of the advances in income at
the end of the year following the year they were received. Later, he said that
the usual practice of Torgan was to declare a bonus or management fee to him
sufficient to pay down the loan balance to zero. He also said that Torgan would
pay him bonuses rather than dividends because bonuses were deductible to Torgan
whereas dividends were not.
[34]
It appears to me that, prior to
the first transaction, the family was supported by shareholder loans from Torgan
and that those loans were transformed into bonuses to Mr. Swirsky. Those
bonuses were not income derived from the Torgan shares. This is confirmed by
Mr. Swirsky’s own admission in cross‑examination in the following
exchange:
|
Q.
|
That was your only income producing
asset, wasn’t it?
|
|
A.
|
What was?
|
|
Q.
|
Your shares in Torgan.
|
|
A.
|
I had shares in Torgan, but the income
didn’t come from the shares. It came from the company.
|
[35]
I therefore find that the income
that the Swirskys claim the share transfer was intended to protect was not
income from the Torgan shares.
[36]
This conclusion is supported by
what took place in the years immediately after the transactions as well, when
the family expenses continued to be paid by Torgan and treated as advances.
There is some evidence that after July 1, 1993 separate loan accounts were
maintained for each family member, but it was not established whether the loans
were repaid, included in income or dealt with in some other way. More
importantly, all withdrawals from Torgan continued to be treated as loans which
were advanced to family members regardless of whether they held shares in the
company. For example, amounts paid to or on behalf of Mr. Swirsky’s father and
brother were recorded as loans to them.
[37]
Between the first and the third share
sale transactions it was not necessary for Torgan to declare any bonuses to Mr.
Swirsky because he repaid his shareholder loans with proceeds from the sale of
his shares to Ms. Swirsky.
[38]
In addition, there is no evidence
that the income producing potential of the Torgan shares was ever considered
before the transactions took place. The plan to sell the shares to Ms. Swirsky
and all of the steps in the transaction were devised by the accountant, Mr.
Steinberg. Those steps were set out in a letter dated February 18, 1991
addressed to Mr. Swirsky. Nowhere in the letter is there any discussion or
consideration of an income earning purpose to the proposed acquisition of the
shares by Ms. Swirsky.
[39]
In cross-examination, Mr. Swirsky
testified that he made no representations or promises to Ms. Swirsky that
dividends would be paid on the Torgan shares he was selling her. In fact, there
was no evidence that dividends were discussed at all. He also confirmed that
Ms. Swirsky was not expecting to realize any gains by selling the shares to a third
party.
[40]
Ms. Swirsky stated that her
purpose in entering into the transactions was to assist her husband whom she
believed was about to go bankrupt and to “salvage some income for the family.”
However, it is clear that Ms. Swirsky was unaware how the income to support her
family was derived from Torgan and that she had little knowledge of Torgan’s
finances. The following passage from her cross‑examination illustrates
these points:
|
Q.
|
For instance, when I mean by negotiate,
you didn’t come up with the 2.5 million figure?
|
|
A.
|
No. The only thing I was happy about was that they looked to see
where there was a gap, like a debt in the company. I was happy that it would
be more money. They wouldn't give me more money than that, because I didn't
want floating extra money around. That's all.
|
|
Q.
|
What debt are you talking about?
|
|
A.
|
I guess in order to see what would bring everything to zero in the
company, they looked up and saw what -- I don't know what the debt was
for, but I know that missing money was about that amount. Then if I got a
loan and paid it to my company, it would bring things to a zero. That's how
I understood it.
|
|
Q.
|
Was it the debt into the shareholder loan account?
|
|
A.
|
Is the question like -- at that time, I just knew of it as
owing money. The company owed money. I didn't know where it was placed
exactly.
|
|
Q.
|
You really didn’t know any of the financial situation of the
company first hand?
|
|
A.
|
Not from the stand point of book keeping details. I would go to
the office and constantly keep apprised of how many properties I had and what
the names were. But in terms of the intricacies, financial book keeping, no,
I was not. I entrusted that to him.
|
|
Q.
|
Him being?
|
|
A.
|
Eli.
|
[41]
In any event, there was no
evidence that Ms. Swirsky believed or expected at the time she entered into the
three transactions that there would be dividends paid on the shares. Nor was
there any evidence that she intended to sell the shares at a profit.
[42]
The evidence also shows that Ms.
Swirsky expected to return the shares to Mr. Swirsky at some point after the
financial problems relating to the Yonge Street project passed. The following
passage from Ms. Swirsky’s testimony illustrates this point:
|
Q.
|
Who suggested to you to buy the shares?
|
|
A.
|
Eli.
|
|
Q.
|
Why did he make that suggestion to you?
|
|
A.
|
Because our family used to live off the
company, the existing properties. I understood that if he held his 43
percent, if he kept his shares, the bank would take it all away. On top of
even that, I used to think they would have to take all the properties away.
There would be nothing for my family to live on. We were accustomed to a
comfortable lifestyle. He thought he could try to solution with the bank, buy
some time a little bit. In the meantime, I would hold his interest, his
shares.
|
[43]
In fact, Ms. Swirsky did transfer
the shares back to Mr. Swirsky in 2008 as part of their divorce settlement. Mr.
Swirsky assumed the remaining outstanding Mutual Trust debt of about $2.4
million but did not pay any other consideration for them. Ms. Swirsky said she
transferred them back out of a moral obligation.
[44]
I am also satisfied that it was
arranged at the outset of the transactions that Ms. Swirsky would not have to
pay the interest and carrying costs on the Mutual Trust loans out of her own
pocket and therefore it is more likely than not that she was not concerned with
the income earning potential of the shares. Mr. Swirsky testified that it was
arranged that the interest would be paid by Torgan and charged to his
shareholder loan account. Although counsel for Mr. Swirsky submitted that it
was only through a bookkeeping error that these payments were charged to
Mr. Swirsky’s shareholder loan account rather than Ms. Swirsky’s, the
evidence of Mr. Swirsky satisfies me that he intended to pay these amounts. In
this regard, Mr. Swirsky testified as follows:
|
Q.
|
That was understood from the start, that
your wife would not be paying interest out of her own pocket. Correct?
|
|
A.
|
Yes -- not from her own salary.
|
|
Q.
|
When you told your wife that you would
take care of the interest, describe how you intended to take care of the
interest on the $4.9 million loan.
|
|
A.
|
The way it works, like everything else in
the company, all the money required to pay the expenses came out of the
company as a shareholder's advance. That was to me, and then I paid all the
expenses relating to whatever was required. She knew that I would make sure
that there was sufficient money to pay for the loan from the way our company
was operated.
|
|
Q.
|
Let's take it one at a time. The actual
interest payments and other costs related to the loan were, in fact, paid
each year by Torgan. Is that correct?
|
|
A.
|
Yes.
|
|
Q.
|
When Torgan
made the payment each year, it had to charge that amount to a shareholder
loan account. Right?
|
|
A.
|
Yes.
|
|
Q.
|
In fact, Torgan charged the interest that
it paid to your shareholder loan account. Correct?
|
|
A.
|
Yes.
|
|
Q.
|
As opposed to your wife’s shareholder
loan account.
|
|
A.
|
Yes.
|
|
Q.
|
So that was charged to you.
|
|
A.
|
Yes.
|
[45]
Counsel’s submission
that there was a bookkeeping error was based on evidence from Torgan’s bookkeeper from 1993 to 2000. She testified that
she posted the Mutual Trust loan payments to Mr. Swirsky’s shareholder loan
account during those years because there was no instruction on the debit memos
for those payments to charge them to Ms. Swirsky’s shareholder loan account.
She also explained that where there was a specific direction on an invoice or
bill or debit memo to charge the amount to a specific person’s loan account, it
would be charged to that account. If there was no specific instruction, the
practice was to post the amount to Mr. Swirsky’s shareholder loan account.
However, this evidence alone does not prove that the payments were misposted. I
note that Mr. Swirsky was not asked about this alleged error, and his evidence
indicates that he intended these amounts to be charged to his account.
Furthermore, it seems implausible that those payments, which totaled almost
$1.6 million for the period in issue, could have been posted to the wrong
account without anyone noticing.
[46]
On the basis of the evidence
before me, I am unable to conclude that the appellant has met the onus on him
to show that Ms. Swirsky had a reasonable expectation of income from the Torgan
shares at the time she acquired them in each of the three transactions. The
appellant has not shown that there was any history of dividend payments on the
Torgan shares or that there was any policy or plan in place to pay dividends on
those shares after the acquisitions.
[47]
While dividends were eventually
paid on the shares, this was after a substantial amount of time had passed
since Ms. Swirsky’s purchased the shares. Furthermore, the first dividend, paid
in 1999, was a capital dividend which was paid out of the non-taxable portion
of capital gains realized by Torgan. No evidence was led to show what the
balance in Torgan’s capital dividend account was at the time of the three
transactions in issue such that Ms. Swirsky could be said to have a reasonable
expectation of receiving a capital dividend from Torgan. The next dividend was
not paid until 2003.
[48]
According to the test laid down by
the Supreme Court in Ludco, there must be a reasonable expectation of
income at the time the investment was made. The appellant has not shown that
this test was met in this case. After considering all of the circumstances
surrounding the transactions, including Ms. Swirsky’s subjective intention in
acquiring the shares, I find that she did not have a reasonable expectation of
income when she acquired them. Therefore, she was not entitled to deduct the
interest and carrying charges in computing her income from the shares, and the
losses and income reported by Mr. Swirsky in respect of those shares were
properly determined by the Minister.
[49]
My conclusion that the interest
and carrying charges are not deductible to Ms. Swirsky is sufficient to dispose
of Mr. Swirsky’s appeal. The entire amount of the losses claimed by Mr. Swirsky
for the 1996 to 2002 taxation years consisted of the interest and carrying
charges and therefore there are no losses remaining to be attributed to him for
those years. In 2003, however, Ms. Swirsky received a dividend on the Torgan
shares, and Mr. Swirsky included that dividend, minus the interest paid on the
Mutual Trust loans, in his income. The Minister reassessed the 2003 taxation
year to increase the amount of income attributed to Mr. Swirsky by denying the
deduction of the interest. Since Mr. Swirsky agrees that subsection 74.1(1)
applies to attribute the losses and gains on the shares to him, the full amount
the dividend has been properly included in Mr. Swirsky’s income for his 2003
taxation year.
[50]
Although it is not necessary for
me to consider the alternative arguments presented by the parties, it may be of
assistance to the parties for me to do so.
First
alternative argument: Does subsection 74.5(11) preclude the attribution of
income and losses on the shares to Mr. Swirsky?
[51]
The respondent’s first alternative
argument is that subsection 74.5(11) precludes the attribution of the net
income or loss on the shares to Mr. Swirsky because one of the main reasons for
the transfer of the Torgan shares was to reduce the amount of tax that would be
payable, but for that section, on the income and gains derived from the shares.
[52]
For the purposes of subsection
74.5(11), the inquiry into the main reasons for the transfer is a factual one,
and in this respect would be similar to the one that is undertaken under
subsection 245(3) of the Act in a GAAR analysis concerning the existence
of an avoidance transaction. In relation to the latter section, the Supreme
Court stated in Canada Trustco v. Canada, that :
28 While the inquiry proceeds on the
premise that both tax and non-tax purposes can be identified, these can be
intertwined in the particular circumstances of the transaction at issue.
It is not helpful to speak of the threshold imposed by s. 245(3) as high or
low. The words of the section simply contemplate an objective assessment
of the relative importance of the driving forces of the transaction.
29 Again, this is a factual
inquiry. The taxpayer cannot avoid the application of the GAAR by merely
stating that the transaction was undertaken or arranged primarily for a non-tax
purpose. The Tax Court judge must weigh the evidence to determine whether it is
reasonable to conclude that the transaction was not undertaken or arranged
primarily for a non-tax purpose. The determination invokes
reasonableness, suggesting that the possibility of different interpretations of
the events must be objectively considered.
While subsection 74.5(11)
does not require that the primary purpose of the transfer be the
reduction of tax payable on the income or gains derived from the property, only
that it be one of the main reasons, it would nonetheless require “an objective
assessment of the relative importance of the driving forces of the
transaction.”
[53]
The respondent did not rely on
subsection 74.5(11) in reassessing Mr. Swirsky or in confirming the
reassessments. This argument was raised for the first time in the Reply to
Notice of Appeal. While it is possible to raise a new argument at that stage of
the proceedings, the onus of proving any of the facts required to support that
argument will be on the respondent: Canada v. Anchor Pointe Energy Ltd. Therefore the respondent is required to show on the
balance of probabilities that one of the main reasons for the transfer of the
Torgan shares was to reduce tax. For the following reasons, I find that the
respondent has not met that onus.
[54]
Mr. Swirsky testified that he had
two reasons for transferring the shares: to protect them from seizure by
creditors and to enable him to pay off his shareholder loans that he would
otherwise have been required to include in his income. I accept his testimony,
firstly because it is consistent with the circumstances in which he found
himself at the time the transactions were entered into, and secondly because
Mr. Swirsky struck me as a credible witness.
[55]
It was not disputed that the Yonge Street project which Mr. Swirsky and Mr. Cohen began in late 1989 was a financial
disaster for them. The value of the property dropped from $20 million to $8
million within a year of purchase and the luxury condo collapsed just as they
were beginning presales. Both Mr. Swirsky and Mr. Cohen had given personal
guarantees to the Royal Bank for the loans advanced for the purchase of the
property and I find it was reasonable for Mr. Swirsky to assume that their was
a substantial risk that the bank would try to collect from him. He said that
the Royal Bank loan was being handled by the “Special Loans” division
throughout the period from 1990 to 1995 and was subject to being called at any
time. Mr. Swirsky also testified that two of their other projects were in
financial difficulties and letters from the CIBC backed those statements up. It
is well known that the Toronto real estate market went through a severe
downturn in the early 1990’s and that property values were slow to recover. All
of these factors lead me to conclude that Mr. Swirsky had ample grounds to want
to protect his major asset.
[56]
The respondent argued that there
was no evidence that the transactions were effective to creditor-proof the
Torgan shares or that there was even a need to do so. However, the respondent
presented no evidence to show that the transactions were not effective for that
purpose or any evidence to show that Mr. Swirsky was not at risk of going
bankrupt. In the absence of such evidence, I am satisfied that to the extent
that Mr. Swirsky was able to transfer shares to his spouse for fair market
value, he removed them from the reach of creditors. Both Mr. and Ms. Swirsky’s
evidence was that Mr. Swirsky was extremely concerned at the time about going
bankrupt, and this was confirmed by Mr. Steinberg.
[57]
The respondent also submitted that
the transfers to Ms. Swirsky did not protect the shares because they were still
subject to seizure by her creditor, Mutual Trust, after the transfer. I am
satisfied, though, that the shares were not seriously at risk after they were
transferred. In light of the fact that Mutual Trust held GICs for the full
amount of the loans, the possibility that Mutual Trust would have tried to
collect first from Ms. Swirsky seems remote at best.
[58]
In addition, it was submitted that,
if Mr. Swirsky truly intended to protect his shares in Torgan, he would have
sold all of his shares immediately to Ms. Swirsky. However, this ignores the
evidence that if he had done so, he would have been left with a substantial
amount of cash that would have been more easily accessible to creditors. It
would have made little sense to proceed in the manner suggested by the
respondent. On the other hand, I believe that the staggering of the share sales
supports the appellant’s position that it did not undertake the transactions in
order to reduce tax payable on the income from the shares. If it had so
intended, it would have achieved even greater tax savings by transferring all
the shares as soon as possible, rather than over a four year period.
[59]
The respondent also suggested that
Mr. Swirsky could have increased his shareholder loan in Torgan up to an amount
that would have equaled the fair market value of all of his Torgan shares and
then sold all of the shares at once to Ms. Swirsky. He also suggested that the
extra funds withdrawn as shareholder loans from Torgan could have been given to
Ms. Swirsky. However, it seems that the obvious flaw in this plan would be that
there would be no consideration given by Ms. Swirsky for the funds withdrawn
from Torgan, and therefore the transfer would be subject to attack as a
preferential transaction.
[60]
The respondent contended that the
fact that Mr. Steinberg did not consult with a bankruptcy lawyer about the plan
showed that creditor-proofing was not the goal of the transactions. I do not
believe, though, that it would be necessary to get such advice on a transaction
that involved a transfer of property at fair market value.
[61]
Another argument was that the
Royal Bank was unlikely to try to seize the shares because it would get more by
working with Mr. Swirsky or because the shares were a minority interest in a
private company or because the shares were subject to a lien in favour of
Torgan for the unpaid shareholder loans. The respondent did not present any
evidence from the Royal Bank to support the contention that it would not have
tried to seize the shares in the event of a bankruptcy and it is, at best, only
speculation.
[62]
The respondent also queried
whether the transfers constituted a material adverse change in Mr. Swirsky’s
financial condition that would have triggered a default under the financing
agreement for the Yonge Street project (as provided for in the agreement) and
exposed his Torgan shares to immediate collection action. It is not obvious to
me, though, that the sale of an asset to repay a debt would constitute a
material change in Mr. Swirsky’s financial condition. Again, no evidence was
led to show that it would have been treated that way by the Royal Bank.
[63]
Finally, the respondent submitted
that there was no documentation contemporaneous with the transactions that
referred to a creditor-proofing purpose. It would not seem unusual to me that
references to creditor-proofing would be omitted from planning documents, given
the potential problems that could arise should they come to the attention of
creditors.
[64]
Having regard to the evidence that
was presented at the hearing, and considering the relationships between the
parties and the actual transactions that took place, I am not satisfied that
one of the main reasons for those transactions was to reduce the tax payable on
the income derived from the Torgan shares. For this reason, section 74.5(11)
would not preclude the attribution of the losses on the shares to Mr. Swirsky.
Second alternative
argument: Does
the GAAR apply?
[65]
Mr. Swirsky’s counsel argued that
it was not open to the respondent to argue that the GAAR applied, in light of the
respondent’s reliance on the anti-avoidance rule in subsection 74.5(11). He
referred to the following passage from the dissenting reasons of Rothstein J.
in Lipson v. Canada
in support of his position that subsection 74.5(11) pre-empted the application
of the GAAR:
[102] With respect
to the views of my colleague, LeBel J., I do not believe it was appropriate for
the Minister to rely on the general anti-avoidance rule (“GAAR”) in this
case. In my opinion, the GAAR does not apply here because there is a
specific anti-avoidance rule that pre-empted its application. Had the
Minister reassessed Mr. Earl Lipson using the
relevant specific anti-avoidance provision, s. 74.5(11), the tax benefit that
resulted from Mr. Lipson’s use of the attribution
rules would have been precluded.
[66]
This view, however, was rejected
by the majority in Lipson. Lebel J. wrote at that the court should not
refuse to apply the GAAR “on the ground that a more specific provision …might
also apply to the transaction.”
I am, of course, bound by the majority decision of the Supreme Court.
[67]
In Canada Trustco, the
Supreme Court summarized the approach to be taken to the application of the
GAAR. It stated that the following three requirements must be established in
order to apply the GAAR:
(1) A tax
benefit resulting from a transaction or part of a series of transactions
(s. 245(1) and (2));
(2) that the
transaction is an avoidance transaction in the sense that it cannot be
said to have been reasonably undertaken or arranged primarily for a bona
fide purpose other than to obtain a tax benefit; and
(3) that
there was abusive tax avoidance in the sense that it cannot be
reasonably concluded that a tax benefit would be consistent with the object,
spirit or purpose of the provisions relied upon by the taxpayer.
[68]
Mr. Swirsky’s counsel conceded the
existence of a tax benefit from the transactions in issue.
[69]
The next step is to determine
whether any of the impugned transactions was an avoidance transaction, which is
defined in subsection 245(3) of the Act as:
(a) any
transaction that , but for this section, would result, directly or indirectly,
in a tax benefit, unless the transaction may reasonably be considered to have
been undertaken or arranged primarily for bona fide purposes other than to
obtain the tax benefit, or
(b) is part of a series of
transactions, which series, but for this section, would result, directly or
indirectly, in a tax benefit, unless the transaction may reasonably be
considered to have been undertaken or arranged primarily for bona fide purposes
other than to obtain the tax benefit.
[70]
The purpose test in subsection
245(3) is broader than the test in subsection 74.5(11) in that it looks to
whether the primary purpose of the transaction was to obtain any of the
tax benefits arising from the transaction whereas the latter is concerned
specifically with the purpose of reducing tax payable on the income and gains
from the transferred property.
[71]
The purpose of a transaction is a
question of fact and the ordinary rules of onus apply. Since the GAAR was first
used by the Minister at the confirmation stage in this case, the respondent is
required to show that the primary purpose of the three share dispositions was
to obtain a tax benefit.
[72]
I have already concluded that the
respondent has not shown that the reduction of tax on the income or gains from
the shares was one of the main purposes of the transactions. However, it is
also necessary to evaluate the transactions in light of the two additional tax
benefits identified by the respondent that accrued to Mr. Swirsky from the
transactions: the deferral of the capital gains on the disposition of the
shares as a result of the rollover provided by subsection 73(1) of the Act,
and the avoidance of tax on the income inclusion that would have arisen under
subsection 15(2) of the Act if Mr. Swirsky had not repaid his
shareholder loans. Both of these results appear to fall within the broad
definition of “tax benefit” in subsection 245(1) of the Act:
“tax benefit” means a reduction, avoidance or
deferral of tax or other amount payable under this Act or an increase in a
refund of tax or other amount under this Act, and includes a reduction,
avoidance or deferral of tax or other amount that would be payable under this
Act but for a tax treaty or an increase in a refund of tax or other amount
under this Act as a result of a tax treaty;
[73]
In my view, the respondent has not
shown that the primary purpose of the transactions in issue was to obtain
either of these two additional tax benefits. I find that the deferral of the
capital gains was incidental in this case, because there was no evidence to
show that Mr. Swirsky was contemplating the disposition of his shares prior to
being presented with the plan by his accountant. Since Mr. Swirsky was not
already planning to dispose of his shares, it cannot be said that the plan was
devised and executed in order to defer the gain on the dispositions.
[74]
I also find that while the
repayment of the shareholder loans was one of the main purposes of the
transactions, it has not been shown to be the primary purpose. There was no
evidence to show that Mr. Swirsky was concerned about the repayment of the
loans before the plan to sell them was devised. In prior years, it had been his
practice to be paid a bonus by Torgan to enable him to repay the loans and to
pay the tax associated with the loans. In the absence of any evidence to show
that it would not have been possible to follow this practice with respect to
the loans outstanding at the end of Torgan’s 1991, 1993 and 1995 taxation
years, I infer that the loans would have been treated in the same manner as in
earlier years. Mr. Swirsky admitted that he was aware of the tax advantage to
repaying the loans from the proceeds of the sales of his shares and that this
was one of the reasons he undertook the transactions, but I accept his evidence
that this was not his main reason for entering into the transactions.
[75]
Since I have found that the
respondent has not demonstrated that the transactions in issue were avoidance
transactions, it is not necessary for me to consider the question of whether there
was abusive tax avoidance. If I were to decide that question, I would have
great difficulty in distinguishing the transactions in this case from those in Lipson.
Counsel for Mr. Swirsky suggested that I should follow the decision of this
Court in Overs v. The Queen,
given that the facts in that case were almost identical to those in the case at
bar. In Overs, Little J. accepted that the disposition of the shares by
Mr. Overs to his spouse did not constitute abusive tax avoidance and that the
GAAR did not apply. However, in my view, that case has been implicitly
overruled by the Lipson decision.
[76]
For all of these reasons, the
appeals are dismissed, with costs to the respondent on a party and party basis.
Signed at Toronto, Ontario, this 28th day of February 2013.
“B.Paris”
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