Citation: 2009 TCC 597
Date: 20091119
Docket: 2006-3858(IT)G
BETWEEN:
KATO KRAUSS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
McArthur J.
[1] These appeals are from reassessments by the
Minister of National Revenue of the Appellant’s 1992 and 1994 taxation years.
She withdrew her appeal for the 1993 taxation year.
[2]
Mrs. Krauss is an 82
year old survivor of the Holocaust and has been a Canadian citizen since the
1950s. She did not appear at the hearing. The only witness was her son Larry
Krauss (Larry) who has managed her affairs for many years. He is an able tax
lawyer, real property manager and developer
in the City of Toronto and other locations. He used his legal
taxation expertise to aggressively arrange his mother’s finances presenting
complex facts and issues.
[3]
These issues include
the following:
(i) Whether the appeals
should be dismissed because the Appellant was not personally present at trial.
(ii) Whether the loss of
$70,831 on the disposition of 5175
Yonge Street in 1992 was a
capital loss or a non-capital loss.
(iii) Whether the rebate
of commission of $24,906 by the Brewers Joint Venture is a deductible expense
for the Appellant in 1992 under paragraph 18(1)(a) of the Income
Tax Act.
(iv) The appropriate
allocation of income of $63,360 in 1994 from the Krauss Partnership to the
Appellant.
[4]
I permitted Larry to
testify on his mother’s behalf despite the objection of counsel for the
Respondent. She cited the recent decision in Luciano v. The Queen, which appeal was
dismissed for want of prosecution and delay. In contrast, the present case was
aggressively prosecuted through the Appellant’s son and counsel. To dismiss these
appeals because the Appellant did not and perhaps could not appear would be a
serious miscarriage of justice. No doubt her son and counsel were the most
qualified persons to present the appeals. While she is probably an excellent
property manager, from a reading part of her discovery transcript, the highly
technical tax and estate planning presented was beyond not only her reach, but
that of all who do not work in the area of taxation.
[5]
Briefly stated,
subsection 30(1) of the Tax Court of Canada Rules (General Procedure)
and subsection 17.1(1) of the Tax Court of Canada Act combined with
subsection 140(1) of the Rules clearly allow a taxpayer to “appear”
through counsel.
(ii) 5175 Yonge (1992 taxation year)
[6]
I will deal with one
fact situation and issue at a time, commencing with the 5175 Yonge Street property. Simply put, the Appellant purchased a part
interest in a property in 1987 for $163,921 and sold it in 1992 for $93,090.
The issue is whether the loss was on account of capital or income.
[7]
In greater detail, the
Appellant acquired a 20% interest in the property in June 1987, together with
Larry who acquired a 40% interest, and George Halasi who acquired the remaining
40% interest, indirectly through a corporation. The building on the property
consisted of a main-floor commercial space and two or more apartments above.
The vendor ran a hardware store in the commercial space and remained as a tenant
until 1989. Larry testified that the property was acquired with the intention
of assembling all of the properties on the same block to develop the entire
block. In January 1992, during the collapse of real estate values during the
real estate recession of the early 1990s, the Appellant sold her share in the
property to her corporation Kraussco Investments Limited (Kraussco) in consideration
of Kraussco assuming its 20% share of the mortgage which at the time of disposition
was $93,090.
[8]
From 1989 through the disposition
of 5175 Yonge Street, the commercial space was leased,
short-term, to various tenants. From the time of acquisition, the property lost
money. Larry explained that the original purchase price paid for the property
reflected its development value resulting in interest payments on the mortgage
greater than the rents on the undeveloped property could support. I have no
doubt that the property was acquired with a development intention, yet the
Appellant claimed capital deductions for the years up to disposition. Given the
overall tax planning aggressiveness, this is not surprising.
[9]
In light of her current
position, the Appellant now states that the capital cost deductions were taken
in error. At the time of the disposition, the Appellant had an undepreciated
capital cost in the property of $163,921 resulting in a loss of $70,831. The
Appellant’s share of the original cost of the property was $186,500 which would
have given rise to a loss of $93,410 had no depreciation been taken. The
Appellant continues to this day to indirectly own an interest in 5175 Yonge Street through Kraussco. Larry testified that the other
properties on the block have been recently acquired, or are soon to be
acquired, completing the assembly of the block for development purposes. She
disposed of the property to Kraussco solely for the purpose of triggering a tax
loss. Whether the loss is on account of income or capital is primarily a
question of fact. As stated, I accept Larry’s evidence to the effect that his
mother has a limited grasp of the facts and that he has made most of the
relevant decisions on her behalf, and is the best source to provide evidence.
[10]It is obvious that 5175 Yonge Street was acquired with the intent to develop it after
acquiring abutting property. This intent could be consistent with either
inventory or capital, and depends on what the intent was once the entire block
of land was ready to be developed or in fact developed. If the Appellant
intended to rent it on the long term, then it may be treated as capital
property, buy if she intended to flip it after development then it is inventory
property. For the reasons that follow I believe that, at the time of the disposition,
it was capital property in the hands of the Appellant.
[11]Predominately, the determination of whether a taxpayer
is dealing in inventory or capital takes place at the time of the disposition.
After the property is disposed of, all its dealings can be advanced to
determine whether the taxpayer was a trader or investor. The sale to the
corporation in fact terminated the Appellant’s dealings with 5175 Yonge Street, and the question whether she was dealing with it as
inventory or capital can be examined with the evidence between 1987 and 1992.
Her intentions over the long term are inconclusive because she still owns it
indirectly through Kraussco. From either perspective, the conclusion that the
sale was a disposition on capital account is the better view.
[12]The only evidence of her use of 5175 Yonge Street between June 1987 and January 1992 was to lease it.
This use is consistent with it being capital in nature. The disposition did not
constitute the “flipping” of inventory, but was retention of it in a
wholly-owned corporation. On balance, the objective evidence of the use of the
property during her direct ownership of 20% leans toward the conclusion that
the sale was on capital account.
[13] It was not sold as inventory, but to trigger
a tax loss. It has been the Appellant’s history to retain rental property, as
evidenced by her retention and management of townhouses originally purchased by
her husband (now deceased), many years ago. Since the intention of the
Appellant’s disposition was to keep 5175 Yonge Street until
it can ultimately be dealt with in the future, the intention was not one of
trading in inventory property. The loss incurred is on account of capital and
the loss (artificially created) is nil under subparagraph 40(2)(g)(i)
of the Income Tax Act (Act) which reads in part for the present
purpose as follows:
40(2) Notwithstanding subsection (1),
(a) subparagraph (1)(a)(iii)
does not apply to permit a taxpayer to claim any amount under that subparagraph
in computing a gain for a taxation year if
(b) …
(g) a taxpayer’s loss if any, from the
disposition of a property to the extent that it is
(i)
a superficial loss,
(ii)
…
I have no doubt that a superficial loss was created.
During the Appellant’s direct and indirect ownership, the only use of the
property was to lease it to tenants, albeit at a loss. The only use of it to
this day has been as a capital asset.
[14]Finally, this result is also supported by logic. The
Appellant has done nothing more than change the form of her ownership of the
property by disposing of it to Kraussco. The Appellant’s pre-5175 Yonge Street disposition
intention may be the same as Kraussco’s post-5175 Yonge Street disposition
intention (which intention would be derived by the Appellant’s guiding mind in
any event). It was not an adventure in the nature of trade. The Appellant’s
appeal claiming $70,831 as a business loss is dismissed.
(iii) Brewers Joint Venture
[15]The Brewers Joint Venture was one of the promoters and
developers of a condominium development at 2727 Yonge Street in the Lawrence Park
area of Toronto. The Yonge-Blythwood Limited Partnership
was established to carry out the condominium development. However, in order to
comply with Ontario securities law requirements relating to
the sale of the units in the condominium, the services of a limited market
dealer were required. Elkay Consultants Inc., a limited market dealer wholly
owned and managed by Larry, was retained for this purpose. Elkay was to market
the units in the Blythwood Limited Partnership to the public and provide
certain other services for a commission. Elkay subcontracted the provision of
the marketing services to two individuals, namely Messrs. Gilbert and Taub, for
a fee equal to the fee payable to Elkay for these services.
[16]The facts are intricate. Very simply put, in 1990 the
Appellant included $70,091 in her income as being her share of an account
receivable with respect to marketing services provided to Blythwood Limited Partnership.
In 1992 this account receivable was reduced by $24,906. The Minister disallowed
her claimed deduction of $24,906 in her 1992 income tax year on the basis that
it was not an expense incurred to gain or produce income.
[17]The Appellant states that the amount receivable by her
in the 1990 taxation year with respect to marketing services provided to the
Blythwood Limited Partnership was income from a business or property and that
the rebate in the 1992 taxation year of a portion of such receivable was
properly deductible by her in computing her income from a business or property
in such taxation year.
[18]The Respondent submits that neither the Joint Venture nor
the Appellant provided services to Blythwood Limited Partnership, nor were they
owed a payment from Blythwood Limited Partnership. Any payment, if any, was
owed to Elkay Consultants. Further, the Appellant admitted that all of her time
from 1988 to 1994 was occupied with renting out her rental property.
Analysis
[19]The facts are largely undisputed and neither party
cites any authority for their respective positions, although counsel for the
Appellant did assert that there is “ample authority” for the Appellant’s
position without directing this Court to any such authorities.
[20]In 1990, Elkay Consultants assigned an account
receivable in the amount of $198,617 to the Brewers Joint Venture, and in that
year, the account receivable was taken into income by members of the Brewers
Joint Venture. In 1992, upon settling the account receivable, some $70,571 was
rebated and the Brewers Joint Venture actually only received $128,046. Between
1990 and 1992, therefore, the members of the Brewers Joint Venture accrued
inclusions of $198,617 but only actually received $128,046.
[21]In the Brewers Joint Venture the Appellant owned a
35.29% interest and Larry owned a 46% interest.
[22]Unlike the case of 5175 Yonge Street, the issue with respect to the Brewers Joint Venture
does not obviously turn on the intention of the Appellant. In any event, I
believe the $70,571 was not appropriately deductible by the Brewers Joint
Venture or its members.
[23]The testimony of Larry was to the effect that Elkay
Consultants was structured to satisfy applicable securities laws and to have no
taxable income. This was carried out with respect to the commission income by
entering into back‑to‑back agreements with Yonge‑Blythwood
and Messrs. Gilbert and Taub, as I already mentioned. By entering into the
back-to-back agreements Elkay Consultants would have offsetting inclusions and
deductions and thus no taxable income.
[24]In the real estate market of the early 1990s, however,
Messrs. Gilbert and Taub were unable to sell all of the limited partnership
interests, and were disentitled to part of their commission. Upon the sale of
interests to the Brewers Joint Venture, Elkay Consultants nevertheless became
entitled to a fee from Yonge‑Blythwood. In order to reduce Elkay
Consultants’ taxable income to zero, it purported to assign the commission fee
receivable to the Brewers Joint Venture.
[25]There was no evidence or suggestion that the Brewers
Joint Venture performed any services for the payment from Elkay Consultants as
a subcontractor akin to Messrs. Gilbert and Taub, or otherwise. In fact, the
testimony of Larry and the documentary evidence indicates that the payment to
the Brewers Joint Venture was not made pursuant to any formal agreement but was
only reflected in the books of the Brewers Joint Venture.
[26]On
the evidence, it is inescapable that the $198,617 account receivable was income
to Elkay Consultants and not of the Brewers Joint Venture or the Appellant.
Although it is arguably logical to allow the $70,571 deduction to maintain the
symmetry of the Appellant’s treatment of the original $198,617, the Minister
must assess according to law. In other words, the Minister must not, and this
Court must not, perpetuate an error in a future year in order to arrive at a
result consistent with a prior year in which a taxpayer erred. See Coastal Construction and Excavating Ltd. v. R. where Bowman J. stated:
"The
Minister is obliged to assess in accordance with the law. If he assesses a
prior year incorrectly and that year becomes statute-barred this will prevent
his reassessing tax for that year, but it does not prevent his correcting the
error in a year that is not statute-barred..."
[27]The correct result would seem to be for the Appellant
to not have included her share of the $198,617 in income in 1990 and for Elkay
Consultants to have included it in its income. Since the Appellant should never
have had an inclusion in 1990, there is no basis for a deduction in 1992 in
respect of the rebate.
(iv) Amount to be included in income from the
Partnership
The
Partnership and Estate Freeze
[28]The
Partnership was formed on December 31, 1992 pursuant to a Partnership Agreement
between Kraussco, Larry, the Appellant and the Krauss Family Trust to effect an
estate freeze whereby future growth in the property transferred to the
Partnership would accrue to the beneficiaries of the Krauss Family Trust.
[29]The
Appellant and Larry each transferred and conveyed to the Partnership a 50%
undivided interest in the properties located at 1421-25 and 1429 Yonge Street
on a tax-deferred basis pursuant to subsection 97(2) of the Act. For the
purposes of subsection 97(2), the properties were treated as capital property.
The Partnership assumed all liabilities of the transferors in respect of the
properties.
[30]They
were each issued 1,252,000 redeemable Class A units and credited with a capital
contribution of $1,252,000, representing the fair market value of the Yonge Street
properties at the time less the assumed liabilities. The Partnership Agreement
contained a price adjustment clause in respect of the redemption value of the
Class A units issued for the Yonge Street properties in the event that the fair market value of
the properties was redetermined, inter alia, by any tax authority.
[31]Kraussco
and Larry also transferred to the Partnership an interest in Hudson Movers Co-Tenancy
for a respective capital contribution of $182,303 and $233,722 and were issued
182,303 and 233,722 redeemable Class B units. The Partnership Agreement
contained a similar price adjustment clause in respect of the redemption value
of the Class B units for the Hudson property. On January 1, 1993, Larry transferred
additional interest in the Hudson property and was issued additional 233,722 Class B
units.
[32]Effective
January 2, 1993, the Partnership issued 100 Class C units to the Krauss Family
Trust for cash consideration of $100 paid by the Trust. The funds came from
gifts to Larry’s eldest son by relatives on his birthday, and not from the
Appellant. The Preferred return reflected the expected commercial rate of
return on the properties. The income or loss on the property was allocated
proportionately to the unit holders.
[33]In
the 1994 taxation year, the Partnership made $343,431 on the Yonge Street
properties. In accordance to the Partnership Agreement, the Appellant and Larry
received $108,355 return on their Class A units. The balance of $126,721 was
allocated to the Trust. In the reassessment, the Minister added to the income
of the Appellant 50% of the amount allocated to the Trust, or $63,360.
Respondent’s
Position
[34]The
Partnership structure is basically income-splitting. The Respondent submits
that based on the capital contributions, the Appellant directly or indirectly
holds about 50% of the interest in the Partnership because she is the sole
owner of Kraussco as well.
[35]The Respondent submits that because the Appellant had invested 50% of the capital into the
Partnership and is responsible for 50% of the conduct of the Partnership in
accordance with the Partnership Agreement, the Minister appropriately allocated
50% of the Partnership income to her. Further, the only reason an estate freeze
conducted through a corporation receives a different tax treatment under the Act
is because the Act permits it. However, there is no provision in the Act
to allow an estate freeze through a partnership.
[36]The
Respondent adds that subsections 103(1) and 103(1.1) of the Act operate
to prohibit the use of partnerships to conduct estate freezes. The Respondent
relies on 103(1), 103(1.1) and 74.1(2) to support the Minister’s decision to
reallocate the Partnership income in the way it did. These provisions read as
follows:
103(1) Where the members of a
partnership have agreed to share income or loss of the partnership and the
principal reason for the agreement may reasonably be considered to be a
reduction or postponement of tax payable, the share of each member of the
partnership in the income or loss is the amount that is reasonable having regard to all the circumstances, including the proportions in which
members have agreed to share profits and losses.
103(1.1) Where two
or more members of a partnership who are not dealing at arm’s length agree to
share any income or loss of the partnership and such share is not reasonable in
the circumstances, having regard to the capital invested or work performed by
its members or such other facts that may be relevant, the share shall be deemed
to be the amount that is reasonable in the circumstances.
74.1(2) If any individual has transferred or lent property directly or
indirectly by means of a trust or any other means to or for the benefit of a
minor who does not deal with the individual at arm’s length, income or loss
from the property is deemed to be income or loss to the individual. Where that
provision applies, subsection 74.3(1) applies to determine the income of the
minors to be attributed to the related individual. Paragraph 74.5(1)(a)
provides, however that the provisions of subsection 74.1(2) do not apply to
income derived from property transferred where the fair market value of the
transferred property does not exceed the fair market value of the property
received by the transferor.
Appellant’s
Position
[37]The
amount included in her income was calculated in accordance with the Partnership
Agreement and is therefore properly included in her income pursuant to
paragraph 96(1)(a) of the Act. The interest of the Trust in the
Partnership was acquired in the course of an estate freeze and that such a
transaction, properly constituted, does not attract the operation of either
subsections 103(1) or (1.1) or the operation of the attribution rule in
subsection 74.1(2).
[38]The
issuance of Preferred Class A and B units to the Appellant, to Larry and to
Kraussco reflecting the fair market value of the properties transferred and the
issuance of “growth” Class C units to the Trust for nominal consideration
comply with the Act and in each case, met or exceeded the requirements
of the Respondent for a freeze share in an estate freeze using a corporation,
the only difference here being that the freeze was carried out through a
partnership and not through a corporation.
[39]According
to the Appellant, subsection 103(1) requires the allocation of income among
members of a partnership to be reasonable having regard to all the
circumstances. The Appellant submits that, and this is really the core of her
case, because the fair market value of the Class A units of the Partnership she
received in exchange for her interest in the Yonge properties was equal to the
fair market value of such interest, there was no transfer of value from her to
the Trust or to any other person, and that the allocation of the Partnership
income put in place on the establishment of the Partnership was reasonable in
the circumstances. The Appellant further submits that, by the same reasoning,
other anti-avoidance provisions like subsection 103(1.1) and 74.1(2) should
have no application.
[40]The
Appellant submits that the price adjustment clause in the Partnership Agreement
ensured that, if challenged, the value of the Class A units would reflect the
fair market value of the properties at the time of their transfer. The
Respondent has made no assumption about the valuation of the properties nor has
he assessed on the basis of the price adjustment mechanism in the Partnership
Agreement, she has met any onus that she bears with respect to such valuation.
[41]In
essence, the Appellant’s position is that the underlying estate freezing
transaction is not abusive under the Respondent’s assessing policy. The real
issue before the Court is not whether there has been an abuse of the Act
but whether the technical provisions of the Act have been complied.
[42]I believe that lot of rhetoric boils down to whether
the share of the Appellant, in 1994, was “reasonable in the circumstances” as
set out in subsection 103(1.1). If I find it is not reasonable, then the
Appellant’s “share shall be deemed to be the amount that is reasonable”
(subsection 103(1.1)).
[43]I begin from the premise that structured properly, a
partnership can replace a typical estate freeze through a corporation. I find
the Krauss Partnership departs from a typical estate freeze with respect to the
redemption of the preferred units and the allocation of losses. Setting that
aside, I turn to the appropriate amount of the Appellant’s income. A second
distinguishing factor is the treatment of partnership losses.
[44]Basically, paragraphs 64 and 65 of the Partnership
Agreement provided that all losses in respect of the 1421-29 Yonge Street properties are to be allocated to the Class A units,
regardless of when they are incurred and whether income had previously been
allocated to the Class C units. Further, the Class A units are required to fund
cash requirements in relation to the ongoing operation of the 1421‑29 Yonge Street properties. This requirement is particularly not in
accord with a typical estate freeze when coupled with the fact that the
Appellant could not unilaterally have her Class A units redeemed. If Larry did
not cooperate to effect a redemption, the Appellant could be required to
contribute additional capital to the Krauss Partnership without the ability to
opt out by forcing a redemption. Further, the Appellant’s allocation of income
and entitlement to distributions would appear to be unchanged following such a
capital contribution.
[45]The direct consequence of these deviations from a
typical estate freeze is to reduce the value of the limited partnership
interest held by the Appellant in the Krauss Partnership. This is not
inconsistent with the equality between the $1.00 redemption value per unit and
the fair market value of the 1421-29
Yonge Street properties at
the time of the contribution. A redemption would require a joint vote of the
Appellant and Larry
[46]The second distinguishing feature of the Krauss
Partnership from a typical estate freeze is with respect to its treatment of
partnership losses. Counsel for the Appellant placed emphasis on the adjustment
clause pursuant to which the Class A units would have their redemption value
adjusted retroactively to reflect any revision to the fair market value of the 1421-29 Yonge Street properties. The relevant part of that
clause of the Partnership Agreement provides as follows::
… in the event that at any time in the future the Minister of
National Revenue, any duly authorized official of Revenue Canada (Taxation),
any provincial taxing authority, any court of competent jurisdiction, or the
parties themselves makes(s) a determination to which the parties acquiesce or
from which there is no further right to object or appeal, that the fair market
value of the [1421-29 Yonge properties] … received by the Partnership as
consideration for the issuance of the Class A Units is greater than or less
than the sum obtained when the number of Class A Units issued in consideration
for the [1421-29 Yonge properties] is multiplied by the Class A Redemption
Amount, then the Class A Redemption Amount shall be adjusted nunc pro tunc
… so that the number of Class A Units issued in consideration for the [1421-29
Yonge properties] multiplied by the Adjusted Class A Redemption Amount is equal
to the fair market value of the [1421-29 Yonge properties] …
[47]This price adjustment clause provides a mechanism to
ensure through adjustments that the redemption amount of the Class A units will
be equal to the fair market value of the 1421-29 Yonge Street properties at the time of their contribution to the
Krauss Partnership. Even assuming that the redemption amount of the Class A units
is equal to the fair market value of the 1421-29 Yonge Street properties at the
time of the contribution, or that the price adjustment clause does what it is
supposed to do, the fair market value of the Class A units would not equal the
fair market value of the 1421-29 Yonge Street properties if the lack of
unilateral redemption and future capital requirements detract from the value of
the Class A units.
[48]The Partnership does not replicate the economics of a
typical estate freeze. There is a more fundamental flaw in the tax planning
purporting to divert $126,721 of income in a year to a partner whose only
contribution was $100.
[49]Subsection 74.1(2) provides, in summary, (i) that when
an individual transfers property directly or indirectly by means of a trust or
by any other means whatever; and (ii) that when the transferee or debtor be a
non-arm's length person under the age of 18, generally the transferor of the
property will be attributed the income or loss from the transferred property
(or property substituted for that property) until the person has attained the
age of 18.
[50]The beneficiaries of the Krauss Family Trust are Larry’s
wife and his two children born in 1992 and 1994. The Respondent could not plead
subsection 74.1(1) of the Act in order to attribute from Larry’s
wife to the Appellant. At best, subsection 74.1(2) is applicable to the Appellant's
share of two‑thirds of the income allocated to the Krauss Family Trust.
[51]In Romkey et al. v. The Queen, which involved a
factual scenario similar to the instant case, the Federal Court of Appeal
interpreted subsection 74.1(2) of the Act as follows.
It seems to me that by causing the Class "B" shares to be
issued to the trusts the appellants effectively forewent the right to receive
an increased measure of any future dividends declared and paid by the Company. As
Linden, J.A. put it …
By this transfer of property to his wife, he [the taxpayer] divested
himself of certain rights to receive dividends should they be declared. Hence,
when the dividends were paid to the wife in 1982, that was income from the
transferred property and was rightly attributable to the taxpayer.
This dictum directly applies to the instant appeals.
With respect to the 1421‑29 Yonge Street properties, the Appellant has foregone the right to receive an
increased measure of any future rental or other income beyond the preferred
return on the Class A units.
[52]The Krauss Family Trust paid approximately $100 to
receive the right to all income from the 1421-29 Yonge Street properties in excess of the preferred returns to the
Class A and Class B units. The theory purporting to support estate freezes
generally is that the common equity has no value at the time of its issue
because the preferred equity carries a fixed value equal to 100% of the
freezing vehicle's assets at such time. The Class C units did not have a
nominal value at the time of their issue because they carried valuable rights,
namely, the right to participate in income and no obligation to suffer losses.
Those rights were transferred before the admission of the Class C unit holders.
[53]The Appellant cites a family law decision of the
Ontario Court of Justice
for the proposition that there is no gift in an estate freeze. Our facts are
that the Family Trust received rights to income in 1994, which income was
ultimately in the amount of $126,721, in exchange for a $100 capital investment
made effective January 2, 1993. The fair market value of the Class C units was
not nominal.
[54]The fact that the income allocated to the Class C units
may have come from a lease termination payment rather than rents, does not
change this result. In exchange for $100, the Class C units were still granted
rights to all income in respect of the 1421-29 Yonge Street properties above
the preferred return payable on the Class A units. Lease termination payments
in respect of retail space on Yonge
Street in Toronto are not uncommon and are valuable.
[55]Unique to the Partnership attempt to establish an
estate freeze, subsection 103(1.1) of the Act will further allocate
the Appellant's share of the income allocated to the Krauss Family Trust in
respect of Larry ’s wife. This subsection would also allocate that income
allocated in respect of Larry’s children, overlapping the application of
subsection 74.1(2) of the Act in the partnership context.
[56]The elements of subsection 103(1.1) include: (i) that
members of a partnership not be dealing at arm's length; (ii) that such members
agree to a given allocation of income or loss; (iii) that the allocation to any
member is not reasonable in the circumstances having regard to the capital
invested in or work performed for the partnership. The consequence of failing
under subsection 103(1.1) of the Act is that the allocation of
income or loss to a member whose allocation is unreasonable will be deemed to
be the amount that is reasonable in the circumstances.
[57]The Appellant does not challenge the first two
elements. The Appellant relies on its assertion that the Class A units received
by the Appellant had a value equal to the fair market value of her share of the
1421-1429 Yonge Street properties, and the price adjustment clause, to argue
that the allocation to the Krauss Family Trust must be reasonable in the
circumstances.
As discussed above, the value of the Class A units would have been adversely
impacted by the lack of unilateral redemption option by the Appellant and the
future capital requirement of Class A Unit holders. But that is not obviously
the correct enquiry. Subsection 103(1.1) of the Act asks whether the
share of "any" member of the partnership is not reasonable. The Class
C units were issued in exchange for $100, or 0.000034% of the capital of the
Krauss Partnership. Further, there is no evidence that the Krauss Family Trust
performed any work for the Krauss Partnership. In 1994, the Class C units were
allocated $126,721. This represents 126,721% annual return on investment for
the 1994 taxation year. Additionally, as noted above, the Class C units had
complete downside protection. Quite simply, an investment in real estate with
no risk of loss that yields a 126,721% return is beyond unreasonable. It is
delusive to the point of absurdity, and betrays something more than aggressive
of tax planning. One wonders how such facts made it all the way to trial. To
the extent that authority is required for the proposition that an allocation
constituting a 126,721% risk-free return is unreasonable, one can point to Zalesky
v. The Queen
which held that a requirement to bear losses can support an increased
allocation. Here the Krauss Family Trust would never, even after years in which
it was allocated income, have to bear losses. Thus, the only factors that could
support an allocation to the Krauss Family Trust are its capital contributions
and services provided. In each case there was none. Additional authority is
found in Fillion v. The Queen
which held that "reasonableness" for purposes of subsection 103(1.1)
of the Act requires at a minimum that the allocations reflect reality. Here
there was simply no reality in allocating $126,721 to the Krauss Family Trust
some two years following a $100 investment.
[58]Counsel for the Appellant focused his argument on
scholarly articles musing about the ability to effect an estate freeze through
a partnership. Had the focus been on the facts of the instant case, and
possibly the unique provisions applicable to partnerships, one assumes that the
Appellant would have cut her losses at an earlier stage of the process. Whether
an estate freeze can be effected through a partnership in the abstract does not
need to be answered. I believe that to the extent an estate freeze can be
effected through a corporate vehicle, if the same economics can be replicated
through a partnership, that an estate freeze could be effected through a partnership.
[59]In conclusion, under subsection 74.1(2) of the Act
the rights of the Krauss Family Trust to income from the 1421-29 Yonge Street properties
is a transfer from the Appellant and Mr. Krauss (each a transferor of 50% of
such rights). Income generated by the portion of the transferred rights
benefiting the two children beneficiaries of the Krauss Family Trust is
attributed to the Appellant. The $100 capital contribution by the Krauss Family
Trust is too trivial to account for. This amounts to 50% of the income
allocated to the Krauss Family Trust multiplied by the two children
beneficiaries' interest in the trust.
[60]In addition, the allocation to the Krauss Family Trust
under the Krauss Partnership agreement was not reasonable in the circumstances.
Under subsection 103(1.1) of the Act in respect of the income
relating to the 1421‑29 Yonge Street properties, the Class A units
are to be allocated their pro rata share of such income purported to be
allocated to the Class C units under the Krauss Partnership agreement. The
deviations could reduce the Appellant’s equity and are contrary to a typical
estate freeze.
[61]For these reasons, the appeals are dismissed, with
costs.
Signed at Ottawa, Canada, this 19th day of November, 2009.
“C.H. McArthur”
Email this Content