REASONS
FOR JUDGMENT
Hogan J.
I. Overview
[1]
In 2004 and 2005, Edward Klemen (the
“Appellant”) transferred oilfield equipment (the “Equipment”) to Canadian
Hydrex Limited (“CHL”), a company with which he did not deal at arm’s length. As
consideration for the Equipment, CHL credited $135,000 and $38,500 to the
Appellant’s shareholder loan account in CHL’s taxation years ending September
30, 2004 and 2005 respectively. The Appellant did not report any income from
the transfer of the Equipment for his 2004 taxation year, claiming that the
proceeds of disposition equalled the Equipment’s adjusted cost base (“ACB”). For
his 2005 taxation year, the Appellant reported a capital gain of $43,500. The
Appellant did not collect or remit goods and services tax (“GST”) in respect of
the transfer of the Equipment in either taxation year. The Minister of National
Revenue (the “Minister”) issued in respect of the transfer a series of
assessments for unreported business income, unremitted GST, and shareholder
benefits conferred, including one assessment issued outside the normal
reassessment period. These assessments are the subject of these appeals.
[2]
Prior to trial, the parties settled the issue of
the assessment of shareholder benefits and made concessions on certain other issues,
some of which are detailed in a letter dated April 17, 2014 addressed to the
Court and some of which are described below (the “Concessions”). However,
four issues remain before the Court. The first issue is whether the Minister was
entitled to assess the Appellant outside the normal reassessment period. The
second issue is whether the proceeds of disposition from the transfer of the
Equipment were on capital or on income account. The third issue concerns the
determination of the ACB of the Equipment. The final issue is what amount of
GST, if any, the Appellant is liable for in respect of the transfer.
II. Factual Background
[3]
The parties filed an Agreed Statement of Facts
which, along with the facts adduced at trial, is summarized below.
[4]
Beginning in the 1980s, and throughout a lengthy
career in the oil patch, the Appellant acquired various pieces of oilfield
equipment, some of which is the Equipment involved in these appeals.
[5]
He acquired the Equipment in various ways. Some
of it he purchased second‑hand, and some he claims he received in lieu of
payment of various debts owed to him. However, the Appellant has no
documentation detailing the acquisition of the Equipment. The Appellant
testified that he destroyed his inventory records sometime in 1999. On
cross-examination, the Appellant admitted that he did not know how much he had paid
for the Equipment.
[6]
He testified that he acquired some of the
Equipment through Edge Energy Ltd. (“Edge Energy”), which he co-owned with his
brother, George Klemen. Edge Energy had been an oil production company. The
Appellant claims that he received some of the Equipment as payment for an
outstanding shareholder loan. He asserts that the financial statement of Edge
Energy details the transfer of that equipment.
[7]
The Appellant used the Equipment in various
business ventures. Typically, he would refurbish the Equipment and rent it to
junior oil companies at approximately one tenth of the Equipment’s cost. He
also used some of the Equipment in his own oil production companies, including
Edge Energy and Free West Energy.
[8]
One of the Appellant’s many business ventures
was CHL. During the relevant period, the Appellant was the sole
shareholder and director of 328859 Alberta Inc., which wholly owned CHL. The Appellant
was a director, officer and indirect shareholder of CHL.
[9]
CHL was in the business of purchasing,
refurbishing and selling oilfield equipment, cleaning up oil spills and tearing
down plants. The Appellant was the only person carrying on the business activities
of CHL. Prior to the relevant period, the Appellant allowed CHL to use the
Equipment in its business operations. The Appellant testified that he did not
collect rent from CHL for the use of the Equipment because he did not want any
liability associated with the Equipment.
[10]
In 2004 and 2005, the Appellant transferred the
Equipment to CHL. He testified that he transferred the Equipment to distance
himself from personal liability associated with its use.
[11]
In consideration for the transfer of the Equipment
in 2004, CHL credited $135,000 to the Appellant’s shareholder loan account. The
Appellant had estimated that amount as equalling his cost of the Equipment.
[12]
In 2005, the Appellant transferred the remaining
Equipment to CHL. For that year, he reported a capital gain as follows:
|
|
2005 ($)
|
|
Proceeds of Disposition
|
73,500
|
|
Cost of Goods Sold (GST incl.)
|
(30,000)
|
|
|
|
CHL credited
$38,500 to the Appellant’s shareholder loan account.
[13]
For 2004 and 2005, CHL reported capital gains
from the sale of the Equipment to third parties as follows:
|
|
2004 ($)
|
2005 ($)
|
|
Proceeds of Disposition
|
154,099.54
|
405,300.00
|
|
Cost of Goods Sold (GST incl.)
|
(100,000)
|
(153,500)
|
|
|
|
|
It is worthy of
note here that CHL reported the combined ACB of the Equipment transferred in the
two taxation years in question as being $253,000. That amount is $80,000 more
than the Appellant claims to have received in credits to his shareholder loan
account. In her oral submissions to the Court, the Respondent’s counsel argued
that the Appellant received $80,000 in cash from CHL, although no one testified
as to this.
[14]
As regards income tax, the Minister initially
assessed the Appellant for the 2004 and 2005 taxation years on May 5, 2005 and
May 11, 2006 respectively. On February 26, 2008, the Minister reassessed the
Appellant’s 2004 and 2005 taxation years (together, the “First Reassessment”)
to include unreported income and shareholder benefits as follows:
|
|
2004 ($)
|
2005 ($)
|
|
Unreported Net Income
|
126,154
|
110,734
|
|
Unidentified Bank Deposits
|
|
10,096
|
|
Office in Home Rental Income
|
3,000
|
3,000
|
|
Shareholder Benefits
|
68,873
|
32,533
|
|
Reversal of Taxable Capital Gain
|
|
(21,750)
|
|
|
|
|
[15]
The Minister assumed that the purchase and sale
of the Equipment was an adventure in the nature of trade such that the
Appellant earned business income from the transactions. Additionally, the
Minister assumed that the Appellant had purchased the Equipment for a nominal aggregate
price of $30.00.
[16]
The Appellant duly filed Notices of Objection in
respect of the First Reassessment. Subsequently, the Minister made further
adjustments for the Appellant’s 2004 and 2005 taxation years by Notices of
Reassessment dated October 8, 2009 (together, the “Second Reassessment”).
The Second Reassessment made the following adjustments:
|
|
2004 ($)
|
2005 ($)
|
|
Unreported Net Income
|
90,093
|
|
|
Shareholder Benefits
|
(3,210)
|
(3,210)
|
|
|
|
|
[17]
The Second Reassessment was issued on the basis
that the fair market value of the Equipment was the price at which CHL sold it
to third parties. The result was an upward assessment of $90,093 pursuant
to section 69 of the Income Tax Act (the “Act”), representing the
difference between (a) the value at which the Equipment was transferred to CHL,
and (b) the value at which it was resold to third parties. The Second
Reassessment was issued outside the normal 3-year reassessment period. As a
preliminary matter, the Appellant submits that the Second Reassessment is statute-barred.
Only the upward adjustment of $90,093 in respect of the Appellant’s 2004
taxation year is at issue with respect to the Second Reassessment.
[18]
With regard to the GST appeal, the Appellant did
not report any GST collected or collectible in respect of the transfer of the
Equipment. The Minister subsequently reassessed the Appellant for failing to
collect GST on the consideration he received from CHL for the Equipment.
Specifically, the Appellant was assessed for having failed to collect $22,889
for the reporting periods from January 1, 2004 to December 31, 2005 (the
“2004-2005 Reporting Period”) and $13,748.92 for January 1, 2006 to December
31, 2007 (the “2006‑2007 Reporting Period”).
[19]
The Minister originally assessed the Appellant
for unreported net tax in respect of the 2004-2005 Reporting Period by a Notice
of Assessment dated January 18, 2008. By a Notice of Reassessment dated August
19, 2009, the Minister subsequently varied that assessment through an upward
adjustment.
[20]
At the commencement of the trial, the Respondent
conceded that, in respect of the GST appeals, section 155 of the Excise Tax
Act (the “ETA”) would not apply to deem the disposition of the Equipment to
have taken place at fair market value. This nullifies the upward adjustment
made by the Reassessment dated August 19, 2009. The effect of this concession
is to reduce the alleged GST collectible by $6,307 in respect of the 2004-2005
Reporting Period, which now totals $16,582.
[21]
Also at trial, the Respondent’s counsel argued
that, in addition to the $38,500 credit to his shareholder loan in 2005, the
Appellant received $80,000 in cash from CHL. While this position was not
specifically pleaded nor was it addressed by the Respondent’s witness, the
Minister submits that it was implicit in the amount of net tax the Appellant
was assessed for in the 2004‑2005 Reporting Period.
III. Analysis
(1)
Preliminary Matter: Statute of Limitations
[22]
As a preliminary matter, the Appellant submits
that the Second Reassessment should be vacated because it was issued beyond the
normal reassessment period and the conditions set out in subsection 152(4) of the
Act have not been met. The Respondent argues that the limitations stated in
subsection 152(4) of the Act do not apply to the Second Reassessment because it
was issued following the Minister’s consideration of the Appellant’s Notice of
Objection filed in respect of the First Reassessment. The Respondent relies in
this regard on the wording of subsection 165(5) of the Act, which reads as
follows:
165(5) Validity
of reassessment − The limitations imposed
under subsections 152(4) and 152(4.01) do not apply to a reassessment made
under subsection (3).
[23]
I disagree with the Respondent’s interpretation
of subsection 165(5) of the Act. While I acknowledge that the provision, if
read literally, could support the Respondent’s argument, in The Queen v.
Anchor Pointe Energy Ltd.,
the Federal Court of Appeal (the “FCA”) stated that reassessments issued
beyond the normal reassessment period, following the consideration of a
taxpayer’s Notice of Objection, cannot increase the taxpayer’s tax payable
unless the limitations set out in subsection 152(4) of the Act are respected.
With regard to the scope of subsections 165(3) and 165(5) of the Act, Justice
Rothstein commented as follows:
I am unable to agree
with Rip J. that the expiry of the normal reassessment period is stayed or is
extended until the Minister takes action under subsection 165(5). The
implication of such an interpretation is that because a taxpayer files a Notice
of Objection, the Minister has an unlimited time to reassess the taxpayer to
increase tax payable after the normal reassessment period.
. . .
In my opinion, subsection
165(5) allows the Minister to reassess after expiry of the normal reassessment
period where a Notice of Objection has been filed but not to include in the
taxpayer's income amounts that were not included in an assessment or
reassessment made within the normal reassessment period.
[Emphasis
added.]
[24]
The Minister added an additional $90,093 of
unreported income by way of the Second Reassessment on the basis that the fair
market value of the equipment was greater than the consideration received by
the Appellant from CHL. Under the principles recognized in Anchor Pointe,
the Second Reassessment must be vacated unless it can be shown that the
conditions laid down in subsection 152(4) of the Act have been met.
[25]
There are two conditions for the application of
subsection 152(4) of the Act, and the Minister bears the onus of establishing, on
a balance of probabilities, that both have been satisfied. The first condition
is that the taxpayer have made a misrepresentation. The second condition
is that the misrepresentation be attributable to neglect, carelessness or wilful
default.
[26]
Although it is unclear, the Respondent’s
counsel, in her oral and written submissions, appears to suggest that the
Second Reassessment is valid because the evidence shows that the Appellant made
a misrepresentation by failing to report the income arising from the sale of
equipment to CHL and that this misrepresentation was attributable to negligence
on his part. I note that this position was not put forward in the Respondent’s
Reply to the Notice of Appeal (the “Reply”). In fact, paragraphs 26 and 27 of
the Reply state that the reassessments are not statute-barred for the following
reasons:
The Appellant’s 2004
income tax return was initially assessed by the Minister on May 5, 2005, and
the Appellant’s 2005 income tax return was initially assessed by the Minister
on May 11, 2006. The Minister reassessed the Appellant’s 2004 and 2005 taxation
years for the first time on February 26, 2008, and was well within the “normal
reassessment period” as defined by s.152(3.1) of the Act. Therefore, any
submission with respect to those reassessments being statute barred is without
merit.
The Appellant then
filed objections to the February 26th, 2008, reassessments on March 17, 2008. In
response to the objections filed, the Minister issued reassessments pursuant to
subsection 165(3) of the Act on May 5, 2008. Pursuant to subsection
165(5) of the Act, the limitations imposed by subsections 152(4) and
(4.01) do not apply to a reassessment made under subsection 165(3). Therefore,
any submission with respect to the reassessments dated May 5, 2008 being statute
barred is without merit.
[Emphasis
added.]
[27]
Counsel for the Appellant directed me to Bibby
v. The Queen
as authority for the proposition that parties cannot raise arguments that they
have failed to plead. There, the Minister had assessed the appellant solely on
the basis that there was a shareholder benefit, pursuant to section 15 of the
Act. In her reply, the Respondent did not plead the issue of unreported income
under either section 5 or 6 of the Act. At trial, the respondent made an
alternative argument that the appellant failed to report income in the form of
management fees pursuant to section 5 or 6 of the Act. Justice Bowie held that,
having failed to identify the issue of unreported income in the pleadings, it
was not open to the Minister to rely on that alternative basis of assessment.
At paragraph 23, Justice Bowie held:
Subsection 49(1) of
the General Procedure Rules requires that every Reply shall state:
(a)
the statutory provisions relied on; [and]
(b)
the reasons the respondent intends to rely on
The purpose of these
requirements is to ensure that the issues are properly defined for the purposes
of discovery and trial, and so that the appellant will know what arguments he
must meet, and so that he will be able to marshal and lead his evidence accordingly.
This is not a mere formality that may be overlooked when it has not been
complied with; it is a core component of the trial process, and to ignore
non-compliance would undermine the integrity of that process: see Glisic v.
The Queen.
[28]
It is clear that the Respondent failed to plead
in her Reply the argument that she invites me to consider. For procedural
fairness reasons alone, I cannot accept this argument at this late stage of the
proceedings.
[29]
In any event, the Respondent led no evidence to
show that the failure to report the income from the sale of the Equipment was
attributable to the Appellant’s negligence. It is not sufficient to show that
the Appellant misrepresented his income for 2004. The Respondent must show that
this misrepresentation is attributable, inter alia, to the Appellant’s
negligence. As the Respondent has failed to meet her onus in this regard, the
Second Reassessment, which increased the Appellant’s income by an additional
$90,093 of unreported income for the 2004 taxation year, must be vacated.
(2) Income Versus Capital
[30]
The Respondent contends that the gain realized
by the Appellant on the transfer of the Equipment to CHL was on account of
income because the Appellant intended to sell the Equipment at a later point
when the market for such equipment improved. The Respondent accepts that, in
the interim, the Appellant intended to either rent out the Equipment or use it
in one of his other business ventures.
[31]
Both parties cite a long list of cases in
support of their opposing positions on the income versus capital question.
These cases are, for the most part, fact‑specific. In Continental Bank
of Canada v. The Queen,
Judge Bowman (as he then was) adopts the criteria enunciated by Justice Rouleau
in Happy Valley Farms Ltd. v. The Queen
for the purpose of deciding whether a gain is on income or on capital account:
1. The nature of
the property sold. [Is the property customarily a capital asset, or is it a commodity
that is bought and sold?]
2. The length of
period of ownership. [Inventory is generally disposed of shortly after
acquisition, while capital assets are not.]
3. The frequency
or number of other similar transactions by the taxpayer. [Does the taxpayer
routinely sell such property?]
4. Work expended
on or in connection with the property realized. [If the taxpayer completes
steps to improve the property for resale, it is more likely inventory.]
5. The
circumstances that were responsible for the sale of the property. [Was this a
routine disposition, or were there overriding business considerations?]
6. Motive. [Why
did the particular disposition occur?]
[32]
Linden J.A. identified the following additional
factors in considering on appeal the Continental Bank decision:
(a) The intention
of the parties;
(b) Whether the
conduct of the vendor was similar to that of an ordinary trader;
(c) The nature and
quantity of the property in question;
(d) Whether the
transactions were isolated ones; and
(e) The uniqueness
of the transactions when compared to the taxpayer’s normal activities.
[33]
Weighing all of the above factors, I conclude
that the Appellant’s gain in each of the 2004 and 2005 taxation years was on
account of capital. First of all, the evidence shows that the Equipment was
used by the Appellant in his various business ventures over a very long period
of time. It was acquired at the beginning in the 1980s and then sold to CHL in
2004 and 2005. There is no evidence to show that the Appellant sold similar equipment
in earlier taxation periods. The Appellant did allow CHL and other corporations
that he held an interest in to use the Equipment in their business ventures.
There is no evidence to show that the Appellant modified or altered the
equipment for the purpose of realizing a higher price.
[34]
The evidence shows that there was a strong
upswing in the oil service industry beginning around 2001 and that the
Appellant sold the equipment to CHL in order to benefit from the resulting
unexpected significant rise in prices for used oil service equipment.
[35]
From all of the above I infer that the Appellant
acquired the Equipment for the purpose of using it in his various business
ventures. The circumstances surrounding the long holding period corroborate the
Appellant’s declaration that he purchased the Equipment to earn income either
directly or indirectly therefrom.
(3) Adjusted Cost Base of the Equipment
[36]
The Minister assumed that the ACB of the
Equipment was $15.00 per year. The Appellant’s argument is that the Minister’s
assumption is not reasonable. However, he was unable to offer any reliable
evidence to show what his cost of the Equipment was. He admits that he has no
documentation detailing the acquisition of the Equipment. He admits as well that
he cannot identify how much he paid for the Equipment.
[37]
With regard to the burden of proof, the
Appellant must rebut, on at least a prima facie basis, the Minister’s
assumption that his cost of goods sold was $15.00 per taxation year. The Appellant has failed to
provide any credible evidence that succeeds in demolishing that assumption.
[38]
At trial and in written submissions, counsel for
the Appellant invited the Court to make the inference that the ACB of the
Equipment was at least $76,243.86, that is the value of the shareholder loan on
the books of Edge Energy in 1999. The Appellant claims that he took some of the
Equipment in lieu of repayment of the shareholder loan. The Equipment was
consideration in satisfaction of the loan. Counsel for the Appellant submitted
that $76,243.86 is likely well below what the Appellant actually paid to acquire
the Equipment, but however the Appellant “would be happy
with receiving credit for the $76,000 in shareholder loan as ACB”.
[39]
The Appellant’s evidence in support of this amount
was a balance sheet of Edge Energy as at September 30, 1999. In 1998, the balance sheet
showed $76,244 as a shareholder loan due to the Appellant. In 1999, the shareholder
loan was written off with no loan shown as owing to the Appellant. However, as counsel for the Respondent points out,
there is no evidence, other than the Appellant’s vague testimony, to
corroborate the claim that he actually did take any equipment. There is nothing
that supports a finding that the Appellant had actually made that loan or that
he had contributed any capital assets to Edge Energy. In short, the Appellant’s
evidence as to the ACB of the Equipment is insufficient to rebut the Minister’s
assumption that it was $15.00 per taxation year.
(4) GST
[40]
The final issue concerns the quantum, if any, of
GST the Appellant was liable to collect in respect of the transfer of the
Equipment to CHL.
[41]
During the 2004-2005 Reporting Period,
subsection 165(1) of the ETA required that every recipient of a taxable supply
pay GST in respect of that supply calculated at 7% of the value of the consideration
received for the supply.
[42]
At trial and in written submissions, counsel for
the Appellant made two alternative arguments regarding the Appellant’s GST
appeal. The first was that the Appellant owed no GST. In counsel’s view, the transfer of the Equipment was not a “taxable
supply” because it was not made in the course of a “commercial activity”, each as defined in the ETA. The
Appellant relies on a carve-out in the ETA for individuals operating a business
without a reasonable expectation of profit. Section 123 of ETA defines a “commercial activity” as:
(a) a business
carried on by the person (other than a business carried on without a
reasonable expectation of profit by an individual, a personal trust or a
partnership, all of the members of which are individuals), except to the extent
to which the business involves the making of exempt supplies by the person,
(b) an adventure or
concern of the person in the nature of trade (other than an adventure or
concern engaged in without a reasonable expectation of profit by an individual,
a personal trust or a partnership, all of the members of which are
individuals), except to the extent to which the adventure or concern involves
the making of exempt supplies by the person, and
(c) the making of a
supply (other than an exempt supply) by the person of real property of the
person, including anything done by the person in the course of or in connection
with the making of the supply.
[Emphasis
added.]
[43]
The Appellant submits that, although he had a
rental business, he did not have a reasonable expectation of profit since the
Equipment was rented to related corporations, which did not have a legal
obligation to pay rent to the Appellant.
[44]
That argument is contradicted by the Appellant’s
testimony. On cross‑examination, the Appellant testified that “[m]y intention when I acquired the equipment was to make money
with it.” On the basis of his own testimony, it is clear the
Appellant carried on a business with a reasonable expectation of profit.
Therefore, the transfer of the Equipment was a “taxable supply”
made in the course of a “commercial activity”.
Given that conclusion, the Court must then determine how much GST was
collectible.
[45]
The Appellant’s alternative argument concerns
the amount of consideration actually received from CHL for the Equipment. The
Appellant submits that the consideration he received was the credit to his
shareholder loan account with CHL, and nothing more. In contrast, the
Minister’s position is that the Appellant’s shareholder loans formed only part
of the consideration for the supplies of the Equipment. The Appellant is
alleged to have received an additional consideration of $80,000 in cash.
[46]
The Minister’s position is based upon the fact
that CHL reduced its cash on hand by $80,000 in 2005. The general ledger of CHL
shows an entry whereby cash on hand was reduced by $80,000 to correct for the
purchase amount of assets sold for $195,000 in June 2005. In addition, when CHL
reported a capital gain on the sale of the Equipment to third parties, it
claimed an ACB equal to the amount of the shareholder loans credited to the
Appellant’s account plus an additional $80,000. The inference that counsel for
the Respondent invites the Court to make is that the Appellant received an
additional $80,000 as consideration for the supply of the Equipment. Thus, the
total consideration the Appellant received would have been $135,000 in his 2004
taxation year and $118,500 in his 2005 taxation year. Consequently, the
Appellant is alleged to have failed to account for a total of $16,582 of tax
collectible in respect of the 2004-2005 Reporting Period.
[47]
Counsel for the Appellant points out that the
Respondent’s own Reply clearly shows that the sale of the Equipment to CHL
occurred for credits to the Appellant’s shareholder loan account in the amounts
of $135,000 and $38,500 in 2004 and 2005 respectively. Furthermore, nowhere in
the Reply has the Minister assumed that the Appellant received the alleged
$80,000 in cash. Therefore, the onus is on the Minister to establish, on a
balance of probabilities, that the Appellant actually did receive that cash. I
believe the Minister has failed to establish that fact.
[48]
The only evidence at trial that corroborates the
theory that the Appellant received $80,000 in cash is the financial statements
of CHL. However, there is no annotation stating, or any indication, that the
Appellant received that amount. The evidence does not support the inference
that the Appellant actually received $80,000 in cash. The evidence only
illustrates what CHL calculated the ACB to be for the sale of the Equipment to
third parties. Hence, there is no credible evidence that contradicts the
Appellant’s assertion that he received nothing more than a credit to his
shareholder loan account in the 2004-2005 Reporting Period. The actual
consideration received by the Appellant for the Equipment was the amounts
credited to his shareholder loan account: $135,000 and $38,500 in 2004 and 2005
respectively.
IV. Conclusions
[49]
In conclusion, the appeals should be allowed on
the following basis. First, the Second Reassessment is vacated as the Minister
did not plead and was unable to demonstrate that the conditions in subsection
152(4) of the Act were met. Specifically, he was unable to show that the
Appellant’s misrepresentation was attributable to neglect, carelessness, or
wilful default.
[50]
Second, the transfer of the Equipment to CHL was
made on capital account. The length of time for which the Appellant held the
Equipment and his stated intent to earn income from it support the Appellant’s
position that it was a capital asset, and not inventory as the Minister has
assumed.
[51]
Third, the Appellant failed to demolish the
Minister’s assumption that the ACB of the Equipment was $15.00 for each of the
relevant taxation years. The evidence does not support the inference that the
Appellant received some of the Equipment in satisfaction of his shareholder loan
to Edge Energy. There is no reliable evidence to corroborate any amount other
than that assumed by the Minister.
[52]
Finally, the Appellant is liable to pay GST in
respect of the consideration he actually received for the transfer of the
Equipment, which was the amount credited to his shareholder loan account. The
Minister’s inference that the Appellant received $80,000 in cash is unsupported
by any evidence.
[53]
For these reasons, the appeals are allowed.
Signed at Magog, Quebec, this 29th day of July 2014.
“Robert J. Hogan”
Email this Content