Denelzen v. The Queen, 97 DTC 456, [1996] 2 CTC 2464 (TCC)

Mogan J.T.C.C.: — The Appellant and Julia Denelzen (“Julia”) were married in 1960. They separated in 1984 and Julia commenced divorce proceedings in 1985. They each obtained independent legal advice. The Appellant retained John G. Walsh and Julia retained Frank I. Liebeck. Messrs. Walsh and Liebeck were experienced in family law matters and practised law in downtown Toronto, each within one block of the other. In April 1986, the parties signed a Separation Agreement, a document which divided all of their property in a manner consistent with the Family Law Act of Ontario, 1986 S.O. Chapter 4 (referred to herein as the “FLA”). The original Family Law Reform Act of Ontario was enacted in 1978 but it was replaced by the FLA which was proclaimed in force on March 1, 1986.

The Appellant and Julia had operated a successful retail store in Toronto under the name “The Lager Salon”. The retail business was in fact owned and operated by 490340 Ontario Limited (the “Company”), an Ontario corporation with only two issued shares and having a paid-up capital of only $2.00. The Appellant held one share and Julia held the other share. The Separation Agreement provided for the transfer or redemption of the share held by Julia. That share was in fact redeemed for $300,000 in July 1986 as a direct result of the Separation Agreement. Upon the redemption of that share, the Company was deemed to have paid a dividend in the amount of $299,999 ($300,000 less $1.00) under subsection 84(3) of the Income Tax Act, and a taxable dividend of $449,999 under section 82 of the Act. In these reasons for judgment, the “Ac” will refer to the Income Tax Act as distinct from the “FLA” which will refer to the Family Law Act of Ontario.

The Minister of National Revenue assumed that the share which had been held by Julia was transferred to the Appellant first and then redeemed. Accordingly, the Minister claims to have issued a notice of reassessment to the Appellant for 1986 increasing his reported income by the amount of the taxable dividend. One of the principal issues in this appeal is whether the share in question was redeemed out of the hands of Julia or the Appellant. In other words, is the taxable dividend of $449,999 part of Julia’s 1986 income or part of the Appellant’s 1986 income. The other principal issue is whether the Minister did in fact issue a notice of reassessment for 1986 within the three year period referred to in paragraph 152(4)(c) of the Act.

The procedural issue concerning whether the Appellant’s reassessment was made within the three year period is fundamental to the whole appeal because, if it was made after the three year period, then the parties are in agreement that the reassessment is to be vacated; the appeal will be allowed; and there will be no need to consider the other principal issue. But if that reassessment is not vacated, then it will be necessary to determine the other principal issue concerning out of whose hands the share was redeemed. Therefore, I will consider first the procedural issue.

The Appellant filed an income tax return for the 1986 taxation year. An original assessment for 1986 was mailed to him on November 2, 1987. Under subsection 152(3.1) of the Act, the normal reassessment period for the Appellant’s 1986 taxation year was the period that ended three years after November 2, 1987. Therefore, the Minister could reassess the Appellant for 1986 any time up to November 2, 1990 without a waiver and without alleging misrepresentation. The Minister claims to have reassessed the Appellant on October 30, 1990. The Appellant testified that he did not receive the alleged notice of reassessment dated October 30, 1990 and, at trial, the Respondent admitted that such notice was not received by the Appellant. There is a letter from Revenue Canada which indicates that the reassessment for 1986 was issued after November 28, 1990. On this procedural issue, the Appellant makes three basic arguments: (i) no notice of reassessment for 1986 was mailed; (ii) if it was mailed, it was late because it was mailed after November 2, 1990; and (iii) if it was mailed, it was never received. The Respondent argues that a notice of reassessment was dated and mailed on October 30, 1990.

The reassessment came to the Appellant’s attention when Revenue Canada mailed to the Appellant on November 28, 1990 a form T7W- C explaining the adjustments to his 1986 income. The Appellant served a Notice of Objection in January 1991 without prejudice to his right to claim that he had not been reassessed within the three year period. The problem concerning delivery of the notice of reassessment is based on an error in the Appellant’s address. The correct address at all relevant times was:

73 Homewood Avenue

Toronto, Ontario

MAY 2K1

The Appellant’s 1986 income tax return was prepared by his accountant and showed his address as:

73 Homewood Drive

Toronto, Ontario

There was no postal code on the return as filed but someone (probably an employee of Revenue Canada) wrote in hand “M4Y 2K1” on the face of the return immediately under the address. Homewood Avenue where the Appellant lives is in central Toronto. There is a Homewood Drive in North York, a suburb north of Toronto. The notice of reassessment (Exhibit R-2) which the Minister claims was mailed on October 30, 1990 was sent to the Appellant at the following address:

73 Homewood Dr.

Toronto, Ontario

M4K 2K1

There are two errors in this address. First, the street is shown as “Homewood Dr.” when the Appellant lived on Homewood Avenue. And second, the postal code is shown as “M4K 2K1” when it should be M4Y 2K1.

The Appellant through his professional advisors had asked Revenue Canada to provide a true copy of the notice which the Minister claimed was mailed on October 30. Revenue maintained that they could not find or reproduce such a copy until a week before trial when a copy was suddenly found in Ottawa. The Respondent called two officers of Revenue Canada to explain the reassessment process for the Appellant’s 1986 taxation year. Their evidence is summarized below.

The audit of the Appellant commenced on September 19, 1990 when the auditor (Winnie Wong) made contact with the Appellant’s accountant, Leo Kurz, C.A. (Exhibit R-6). On October 22, Mr. Kurz told Ms. Wong that the Appellant would not sign a waiver for purposes of subparagraph 152(4)(a)(ii) of the Act. On that same day (October 22), Ms. Wong wrote her auditor’s report by hand (Exhibit R-7) recommending that a deemed dividend of $299,999 be added to the Appellant’s reported income for 1986. Page 8 of Exhibit R-7 contains the following comment:

Because the 1986 personal return was going statute barred on November 2, 1990, three days were allowed to the t/p in order for him to decide on whether or not to sign a waiver in respect of the normal reassessment period. The taxpayer and his representative refused to sign a waiver, so the file is being processed with no representation (See T2020 memo file dated Oct. 16 and Oct. 19/90)

Ms. Wong was aware on October 22 that the Appellant’s 1986 year would be statute barred on November 2. Because of the urgency in issuing a reassessment, Ms. Wong had her report approved on October 22 by her Group Head, Mr. Anton Volz who testified at the hearing of this appeal. He was involved in processing the reassessment.

Exhibit R-8 is an internal Revenue Canada form T20ST used to summarize the result of an audit and to record the date when the audit was completed. Mr. Volz inserted October 22 on Exhibit R-8 as the date when the audit was completed. The statute barred date (November 2) was also shown in Zone A of Exhibit R-8. Because of the short time to reassess before 1986 became statute barred, Mr. Volz decided that this would be what he called a “walk-through reassessment”. Accordingly, the file was taken to Audit Review for processing on the same date (October 22). Exhibit R-9 is another internal Revenue Canada form T-99 prepared by Ms. Wong on October 22 showing the actual adjustments which would be made to the Appellant’s reported income for 1986. In the upper right corner of Exhibit R-9, someone had written in red “Statute Barred on November 02-90”. Mr. Volz said that such notation in red was standard procedure when a file was going statute barred. The form T-99 is used as the basis for the information which is transcribed on the form T7W-C and then sent to the taxpayer.

Exhibit R-13 is a handwritten memo dated October 22 from Mr. Volz to Audit Review which states in part “After review please date and send letter to taxpayer and his rep”. Attached to Exhibit R-13 was a 2-page letter to the Appellant on Revenue Canada letterhead and signed by Winnie Wong but not dated. That letter is Exhibit A-1 Tab 10. It explains the proposed changes to the Appellant’s 1986 income and ends with the following paragraph:

Since we have not received a waiver in respect of the normal reassessment period, for the 1986 return as discussed in a telephone conversation with your representative, Mr. Leo Kurz, C.A. on October 16, 1990, the return will be processed forthwith.

Mr. Volz stated that this kind of letter explaining proposed changes would ordinarily be sent by his Group before the audit was completed so that the taxpayer could make representation to the auditor. Because of the few days before 1986 became statute barred, Mr. Volz decided only to inform the taxpayer of what was happening by having the letter sent out by Audit Review when they had completed their work. He acknowledged that he was departing from the normal procedure because of the urgency in getting the reassessment out by November 2. He did assume, however, that Audit Review would send the letter out after their review and before the reassessment was issued. For whatever reason, the letter was not sent until late November.

Audit review was aware of the time constraint because the file would have been in a red folder with a “Priority Reassessment Control” form attached to it indicating the statute barred date. Exhibit R-16 is an Audit Review Control form showing that the Appellant’s file was sent for typing of the form T7W-C on October 24. Exhibit R-16 also shows that the file was received back from typing on October 25 and on that same date sent for faxing to the Data Centre in Ottawa. Apparently, at that time, all of the assessments and reassessment for taxpayer files in the Toronto district office of Revenue Canada were issued out of the Data Centre in Ottawa.

Exhibit R-17 is a Facsimile Transmission dated October 25 to the T1 Expediter in Ottawa from Audit Review in Toronto. This document was explained by Mr. Terrence Alderson, the Senior Designated Appeals Officer in Toronto responsible for the Appellant’s file at the appeal stage. Mr. Alderson stated:

The reason it would have gone to the expediter was because of the impending statute-barred date, just for them to be aware that it’s coming up, making them aware so that they could manually walk the reassessment through the reassessment process. In other words, because of the impending statute- barred date coming up within a week, they would have taken the documents to one of the reassessment clerks, the computer operators, to have this put into the system out of the normal sequence. (Transcript page 125)

There is no doubt from the evidence reviewed above that Revenue Canada was aware of the short period in which to reassess. The notice of reassessment dated October 30, 1990 was entered as Exhibit R- 2. Mr. Alderson explained that 18 months before the hearing of this appeal, he had tried to obtain a copy of the October 30 reassessment but was told that there was no copy and that it could not be recreated because the original had been hand typed and was not done by computer. Later (about one week before the hearing) he found that a “numerical control copy” of the reassessment was in the vault at the Ottawa Taxation Centre and he asked an expediter to search through the archives. The expediter found the document which is Exhibit R-2 and has printed across the bottom “numerical control copy”. This exhibit may be contrasted with Exhibit R-3 which is a reassessment to the Appellant for 1987 also dated October 30 but not under appeal. Because there was no short deadline to reassess 1987, Exhibit R-3 was processed in the normal way and the Appellant’s 1987 file was in Ottawa for the reassessment. A copy of the 1987 reassessment identified as the “file copy” was placed in the Appellant’s 1987 file in Ottawa and returned to Toronto. Apparently, the “file copy” for the Appellant’s 1986 reassessment went astray because his 1986 file was not in Ottawa on October 30. What makes this issue exasperating for the Appellant and his professional advisors is that they were told a number of times that Revenue Canada could not locate or reproduce a copy of the notice of reassessment dated October 30, 1990.

The letter (Exhibit A-l Tab 10) and T7W-C (Exhibit A-l Tab 6) were both dated-stamped November 28, 1990 and mailed to the Appellant at:

73 Homewood Drive

Toronto, Ontario

MAY 2K1

The Appellant received both documents and they indicated that a reassessment would follow. Exhibit R-15 is a computer printout of the Appellant’s files with Revenue Canada showing that a reassessment for 1986 was processed on October 30, 1990.

Counsel for the Appellant argued that the onus was on the Respondent to prove that a reassessment for 1986 was mailed prior to November 3, 1990 and that the Respondent had failed to discharge such onus. I would not necessarily conclude that such onus was on the Respondent but even if the onus was on the Respondent, I am satisfied that a notice of reassessment for 1986 was sent to the Appellant on October 30, 1990.1 accept the explanation of Mr. Alderson as to why the Appellant was told over a long period of time that Revenue Canada could not locate or reproduce a copy of that reassessment when the “numerical control copy” was later found in the vault of the Data Centre in Ottawa. I accept the evidence of Mr. Volz that Revenue Canada was very conscious of the November 2 deadline throughout the last 10 days of October. I find that Exhibit R-2 is a true copy of a reassessment for 1986 issued to the Appellant on October 30, 1990. The letter (Exhibit A-l Tab 10) and T7W-C (Exhibit A-1 Tab 6) should have been mailed by Audit Review when they finished their work on or about October 23 but the failure to forward those documents until they were discovered in the file on November 28 does not affect the validity of the reassessment issued on October 30 (Exhibit R-2).

The Appellant’s failure to receive the notice of reassessment is no defense to its effectiveness. The address on the Appellant’s own return was wrong because it named his street as “Homewood Drive”. Exhibit R-2 simply continued that mistake. The Appellant’s return did not show a postal code. The Minister wrote in the correct postal code on the return and the notice of reassessment dated October 30 had only one mistaken letter - a “K” for a “Y”. The Appellant has not been prejudiced by such minor errors in his address. He received the letter and T7W-C dated November 28; he knew that he faced a significant increase in his income tax for 1986; and he filed a protective Notice of Objection which led to this appeal. A notice of reassessment does not have to be received by the taxpayer in order to be effective. In Flanagan v. R. (sub nom. Flanagan v. The Queen), [1987] 2 C.T.C. 167, 87 D.T.C. 5390, the Federal Court of Appeal stated at page 168 (D.T.C. 5391):

We are all in agreement with the Trial Judge’s view that the sending contemplated by subsection 152(2) is to be understood as a dispatching which does not necessarily include receipt; it is certainly not obligatory that the sending be by mail, as is made quite clear by subsection 244(10).

I would decide the procedural issue against the Appellant.

Having decided that the reassessment under appeal was issued on October 30, 1990 and is a valid assessment, I am required to consider the other principal issue concerning out of whose hands the share was redeemed. The formal Separation Agreement (Exhibit A-l Tab 1) is a 10-page document dated April 18, 1986 and signed on the last page by the Appellant and Julia. The Appellant’s signature is witnessed by Mr. Walsh and Julia’s is witnessed by Mr. Liebeck. Mr. Walsh and Mr. Liebeck both testified at the hearing of the appeal. The Appellant and Julia initialled each of the first nine pages. The Agreement contains in paragraphs 3, 4, 5 and 6 the usual provisions concerning (3) living separate and apart; (4) freedom from the other; (5) custody; and (6) support for children. Paragraph 7 is entitled “Division of Property and Financial Provisions” and covers two and one- half pages of the Agreement. The relevant parts of paragraph 7 are set out below.

7. DIVISION OF PROPERTY AND FINANCIAL PROVISIONS

(1) Matrimonial Home

The parties agree that the matrimonial home has been sold and the parties shall divide the net proceeds from the sale of the matrimonial home equally and will equally share in the arrears of taxes at the time of the sale of the matrimonial home, but that the husband is at liberty to pay his share from the matrimonial home to the wife in partial satisfaction of other monetary payments payable to the wife by the husband as prescribed in this Agreement. The parties agree that upon the sale of the matrimonial home each is entitled to Three Hundred and Seventeen Thousand ($317,000.00) Dollars, more or less, subject to adjustments.

(3) Cottage, Contents, Boats and Trailer

The wife agrees to transfer her interest in the cottage, the cottage contents, boats and trailer located in the Township of Georgian Bay, described as Lot 1, Plan M-513.

(4) Kitchener Condominiums

The wife agrees to transfer all her interest in nine condominium units located in the City of Kitchener and being units 8, 10, 19, 21, 85 and 91 at 165 Green Valley Drive and 1 and 3 at 410 Pioneer Drive, Kitchener.

(5) C.H. Lager Limited

The wife agrees to transfer all her interest in the corporation, C.H. Lager Limited.

(6) 4903401 Ontario Limited

The Lager Salon

The wife agrees to transfer all her interest in the corporation, 4903401 Ontario Limited.

(7) Automobiles

Each party will retain their present automobiles and the company that holds title to the automobile in the wife’s possession shall transfer title to the wife of the said automobile in her possession.

(8) The husband shall pay to the wife in consideration of the transfers of her interests in properties as contained in this Agreement for the sum of $600,000.00, and the said purchase price shall be paid to the wife by certified cheque, by the husband, from whatever source he may have including arranging a mortgage on the properties and business assets of the corporation referred to herein within 30 days after the closing of the sale of the matrimonial home.

There had been protracted negotiations settling the terms of the Separation Agreement. Exhibit A-2 is a binder of 11 letters, ten of which were exchanged between Messrs. Walsh and Liebeck between February 11, 1986 and June 10, 1986. In the third letter (March 27), Liebeck sent a draft agreement to Walsh and in the fourth letter (April 8), Walsh indicated general acceptance of the draft agreement subject to specific amendments. It appears that Liebeck was the principal draftsman of the agreement and that he amended his draft in accordance with the changes suggested in Walsh’s letter of April 8. Liebeck testified that the date number “18” on page one was written in by him when Julia and he signed page 10 on April

18. For some reason, the document as signed by Julia was not sent to Walsh for execution by the Appellant until April 24 when it was enclosed in a letter from Liebeck (Exhibit A-2 Tab 7).

On April 22, 1986, Walsh wrote to Liebeck (Exhibit A-2 Tab 5) suggesting further changes to the agreement. It appears that, when Walsh wrote this letter, he did not know that Julia had already attended at Liebeck’s office on April 18 and signed the Separation Agreement (Exhibit A-l Tab 1) which had incorporated Walsh’s suggested changes of April 8. This letter of April 22 from Walsh to Liebeck is so important that I shall set out below the entire letter.

Re: Denelzen and Denelzen

Further to our letter of April 8, 1986 and our recent telephone discussions regarding the separation agreement we wish to advise as follows:

1. Our client is prepared to pay one-half the arrears of taxes outstanding on the matrimonial home to finally resolve all the matters.

2. With reference to paragraph 7 we believe that you omitted stating that

the husband is to pay the total consideration of $917,000.00 to the wife.

3. Paragraph 7 (6) should be deleted as the wife has no interest in this company.

4. With reference to the total monies being paid by the husband in return for the properties being transferred to him we require that the monies be allocated as follows:

The Lager Salon: $ 300,000

4903401 Ontario Limited: balance of assets: $ 617,000

The husband agrees to cause the company to redeem the share held by the wife to make payment in accordance with the agreement.

Our client is prepared to permit his wife to purchase merchandise at the store based on wholesale rates.

With respect to the valuation of The Lager Salon we used a value of $600,000.00 which is less than the average between the high and the low value established by the valuator. Please contact us to advise whether the amendments are acceptable. Yours very truly

Although the offices of Walsh and Liebeck were only a block apart, Walsh’s letter of April 22 was sent by ordinary mail but Liebeck’s letter of April 24 (Exhibit A-2 Tab 7) was hand delivered. It is therefore possible that Walsh had in his hands the agreement as signed by Julia and Liebeck before Liebeck had in his hands the letter of April 22 suggesting further amendments. Apparently, Walsh did not think of withholding from his client the agreement as signed by Julia until that agreement had been amended to incorporate the changes suggested in his letter of April 22. Whatever Walsh’s thoughts may have been, the Appellant signed (and Walsh witnessed) the Agreement as signed by Julia, and Walsh sent back to Liebeck on May 5 two copies of the Separation Agreement as fully executed and two copies of his earlier letter of April 22 with a fresh “acknowledgement” typed on page two in the following words:

ACKNOWLEDGMENT

The undersigned hereby acknowledges that the Separation Agreement is to be amended in accordance with paragraph 4 hereof.

DATED at Toronto, this 5th day of May, 1986.

BEATTY & WOOD

PER: [Solicitor for Julia Denelzen]

Walsh’s letter of May 5, (Exhibit A-2 Tab 8) is also on important document; it was hand delivered; and the first part of it reads as follows:

Re: Denelzen vs Denelzen

Please find enclosed herewith the following:

1. Two copies of Separation Agreement, executed by our client.

2. A copy of our letter dated April 22nd, 1986, amending the Separation Agreement covering the means of payment with respect to the Lager Salon (4903401 Ontario Limited) as discussed in our recent telephone conversation. This letter is enclosed in duplicate and we would ask you to kindly sign the Acknowledgement on the duplicate copy thereof and return same to the bearer of this letter.

3. We believe the following matters are outstanding and are to be dealt with as part of the Separation Agreement:

(a) Consent or Order dismissing the Petition;

(b) Resignation of Julie Denelzen as officer and director of the Lager Salon and C.H. Lager Limited;

(c) Share Certificate for the Lager Salon, endorsed in blank;

(d) ...

Liebeck signed the “acknowledgment” and, on May 8, returned the relevant documents in a short letter (Exhibit A-2 Tab 10) which stated:

Re: Denelzen & Denelzen

Please find enclosed Mrs. Denelzen’s Resignation of the numbered company and C.H. Lager Limited, our Consent to Dismissal of the divorce petition, the documentation from Sun Life Assurance Company and the Share Certificate. I would ask that you keep the Share Certificate and Resignation documents in escrow until such time as payment has been made in full.

The Appellant claims that the Separation Agreement dated April 18 was amended by the letter dated April 22; that the share of the Company which had been owned by Julia was redeemed out of her hands; and that any deemed dividend is part of Julia’s 1986 income. The Respondent claims that the Separation Agreement dated April 18 was not amended by the letter dated April 22; that the share of the Company which had been owned by Julia was transferred to the Appellant under subparagraph 7(6) of the Separation Agreement; and that any deemed dividend is part of the Appellant’s 1986 income. In my opinion, the basic cause of this appeal is the joint carelessness of Walsh and Liebeck with respect to the letter of April 22. Walsh purported to amend the Separation Agreement with his imprecise and ambiguous letter of April 22. Liebeck purported to accept the amendment without giving adequate attention to what the amendment was and what its consequences might be. I will comment further on this joint carelessness later in these reasons. At the end of 1986, the Company issued a T5 Revenue Canada form to Julia showing that she had received a taxable dividend of $449,999. This is not surprising because, after the share which had been owned by Julia was redeemed, the only issued share of the Company was owned by the Appellant and he was in complete control. It appears that Revenue Canada first intended to reassess Julia but issued a reassessment to the Appellant only after protests from Julia.

In the Separation Agreement, there is parallel drafting in subparagraphs 7(3), (4), (5) and (6) because each commences with the words “the wife agrees to transfer”. The subject of paragraph 7 is the division of property and subparagraph 7(8) refers to a payment by the husband “in consideration of the transfers of her interests in properties as contained in this Agreement”. There is no doubt that subparagraphs 7(3), (4), (5) and (6) refer to transfers from Julia to the Appellant. Standing alone, subparagraph 7(6) provides for a transfer of Julia’s one share in the Company to the Appellant. As an aside, I point out that subparagraph 7(4) refers to her transfer of nine condominium units in Kitchener when only eight are listed! Also, subparagraph 7(6) refers to an Ontario corporation with the number 4903401 when the Company’s personalized cheque (Exhibit A-1 Tab 3) and the pleadings indicate that the number should be 490340.

The letter of April 22 (Exhibit A-2 Tab 5) is either inaccurate or ambiguous in a number of ways. The question is whether the ambiguities are sufficient to deprive the letter of its intended effect to amend the Separation Agreement. The items which I regard as inaccurate or ambiguous are as follows:

1. Paragraph no. 1 of the letter does not appear to change subparagraph 7(1) of the Separation Agreement already quoted above. I do not understand why the letter of April 22 makes this reference to arrears of taxes on the matrimonial home if it does not change subparagraph 7(1).

2. Paragraph no. 2 of the letter is correct in the sense that paragraph 7 of the Separation Agreement does not specifically state the aggregate amount of $917,000. It is crystal clear to me, however, from subparagraph 7(1) that the Appellant and Julia are each to receive $317,000 from the sale of the matrimonial home, and from subparagraph 7(8) that the Appellant was to pay an additional $600,000 to Julia in consideration of the transfers (plural) of her interests in other properties. In fact, I think the Separation Agreement has more clarity on this item than Walsh’s letter because Walsh states that the Appellant is to pay a “total consideration of $917,000 to the wife” whereas, according to the Separation Agreement, they are to divide equally the net proceeds from the sale of the house and then the Appellant is to pay $600,000 to Julia for her interests in other properties. In other words, I should have thought that the $317,000 which each was to receive from the sale of the matrimonial home was not part of any “consideration” from one spouse to the other.

3. Paragraph no. 3 of the letter is inaccurate. Walsh acknowledged in evidence that the reference in paragraph no. 3 of the letter should have been to “paragraph 7(5)” and not to “paragraph 7(6)” because Julia did not have any interest in C.H. Lager Limited. Mr. Walsh appeared as a witness for the Appellant. When he was examined in chief by Mr. Scace, he twice passed over this mistake (Transcript pages 7 and 23) stating at page 7:

And, also, a very important point, in paragraph 3, was that the wife had no interest, and it was not part of this agreement, with respect to the ownership or transfer of any sort relating to C.H. Lager Limited, the holding company.

Mr. Walsh apparently did not know of this mistaken reference to subparagraph 7(6) in his own letter until it was pointed out by Mr. Gluch in cross-examination (Transcript pages 49-50) when he then acknowledged it. See subparagraphs 7(5) and 7(6) quoted above.

4, Paragraph no. 4 of the letter is the important one which the Appellant relies on to amend the Separation Agreement. Walsh acknowledged in evidence that the small schedule allocating amounts to assets “could have been better set out”. Specifically, the schedule in the letter looks like this:

The Lager Salon: $ 300,000

4903401 Ontario Limited: balance of assets: $617,000

Mr. Walsh agreed with Mr. Scace in chief and with Mr. Gluch in cross- examination that the schedule should look like this (Transcript pages 8-9 and 51-52):

The Lager Salon: $300,000

4903401 Ontario Limited

Balance of Assets: $617,000

Mr. Walsh also said of the schedule: “It isn’t as tidy as I would like but it is clear”. I do not regard the schedule or the rest of paragraph 4 as being clear by any standard.

Firstly, the original schedule as it appears in paragraph 4 is not easily understood. Secondly, and more important, the opening sentence of paragraph 4 together with the revised (and better aligned) schedule is not accurate and is in conflict with the meaning and intent of the Separation Agreement. Subparagraph 7(1) of the Separation Agreement states explicitly that upon the sale of the matrimonial home, the parties “shall divide the net proceeds” and “each is entitled to $317,000”. The amount of $317,000 which the wife was entitled to under subparagraph 7(1) of the Separation Agreement was not part of any “monies being paid by the husband in return for the properties being transferred to him” as stated in paragraph 4 of Walsh’s letter. Consolidating that $317,000 in subparagraph 7(1) with the $600,000 in subparagraph 7(8) to make an aggregate amount of $917,000 is confusing and misleading. To use an old cliché, it is mixing apples with oranges.

And thirdly, the last sentence in paragraph 4 is almost meaningless when read with the rest of the paragraph. According to the first sentence, the “monies” are being paid for properties “transferred to” the husband, and Walsh concludes the first sentence by saying “... we require that the monies be allocated as follows:”. He then allocates the aggregate amount of $917,000 between The Lager Salon and the Balance of Assets. According to the last sentence, the husband agrees “to cause the company to redeem the share held by the wife to make payment in accordance with the agreement”. If payment is to be made “in accordance with the agreement”, the husband will be paying an amount to the wife under subparagraph 7(8) “in consideration of the transfers of her interests in properties” and the Company will have redeemed the share in his hands after the transfer from the wife. This is contrary to Walsh’s objective in sending the letter of April 22. The last sentence in paragraph 4 contains the only reference to a “redemption” of the share “held by the wife”. If the $300,000 allocated to The Lager Salon in the schedule was to be paid by the Company directly to the wife as part of the $600,000 referred to in subparagraph 7(8) of the Separation Agreement, it seems to me that the schedule and the last sentence of the letter should have been revised along the following lines:

The Lager Salon: $300,000

490340 Ontario Limited

Balance of Assets: $300,000

The husband agrees to cause the company to redeem the share held by the wife and the amount of $300,000 to be paid by the company to the wife shall be regarded as part of the aggregate amount of $600,000 set out in subparagraph 7(8) of the agreement.

5. If Mr. Walsh intended that his letter of April 22 amend what he regarded as a draft separation agreement, he did not say so in the opening paragraph of his letter. He simply stated “ . we wish to advise as follows”. The word “amendment” does not appear until the last sentence of the letter. Although the actual word in the last sentence is “amendments” (plural), the Acknowledgement as typed on May 5 stated that the Separation Agreement “is to be amended in accordance with paragraph 4 hereof’. The Acknowledgement indicated a more restricted amendment than the body of the letter itself.

Are the above ambiguities sufficient to deprive the letter of its intended effect? Mr. Liebeck had retained a tax lawyer (Robert Stikeman) to advise him with respect to the Separation Agreement. Mr. Stikeman’s letter of April 11 to Mr. Liebeck was entered as Exhibit R- 5. According to Mr. Stikeman, the funds payable by the husband to the wife for the transfer of properties would be tax-free in the hands of the wife, and the husband would inherit the wife’s low adjusted cost base of those respective properties. That tax advice to Mr. Liebeck was not challenged by either party to this appeal. The parties agree, however, that if the letter of April 22 amends the Separation Agreement, then the single share in the Company which was held by Julia would not be transferred by her to the Appellant in accordance with subparagraph 7(6) of the Separation Agreement but would be redeemed out of her hands by the Company; and the amount ($300,000) payable to her by the Company upon such redemption would be a deemed dividend (except for one dollar).

If the Separation Agreement is amended by the letter of April 22, the income tax consequences are truly significant. A capital amount of $300,000 received by Julia tax-free under subparagraph 7(8) of the Separation Agreement as consideration for the transfer of her share in the Company to the Appellant under subparagraph 7(6) would, under the amendment, become a deemed dividend received from the Company and therefore taxable as income in her hands. This result would be detrimental to Julia and beneficial to the Appellant because he would avoid acquiring her share in the Company at an adjusted cost base of one dollar. The letter of April 22 would require clear language to achieve such a reversal of fortunes.

In my opinion, the letter of April 22 did not amend the Separation Agreement dated April 18 as signed by Julia and the Appellant. Even though the letter was accepted and signed by Liebeck, it is too inaccurate and too ambiguous to be regarded as an amendment to the relative clarity of the Separation Agreement. The basic problems in the letter were (i) the failure of Walsh and Liebeck to distinguish the character of the $317,000 which each spouse was to receive under subparagraph 7(1) of the Separation Agreement from the character of the $600,000 which the husband was to pay to the wife under subparagraph 7(8); and (ii) the failure to specify from whose hands the share would be redeemed. In these circumstances, the Separation Agreement signed by the parties prevails over the purported amendment in the letter of April 22. If I should be wrong in concluding that the letter is too inaccurate and too ambiguous to operate as an amendment to the Separation Agreement, there are two other very different grounds for holding that the Separation Agreement was not amended by the letter.

After the exchange of documents described in the letters of May 5, 6 and 8 between Walsh and Liebeck (Exhibit A-2 Tabs 8, 9 and 10 respectively), neither the Appellant nor the Company (then under his 100% control) acted in an unequivocal manner as if the share were being redeemed out of Julia’s hands. On June 7, 1986, the Company issued a cheque for $300,000 payable to Walsh’s law firm and the notation “share redemption” appears on the face of the cheque (Exhibit A-l Tab 3). That cheque was held by Walsh until July 14, 1986 when it was deposited in his firm trust account (Exhibit A-4). On that same day (July 14), Walsh’s law firm issued a cheque to “Beatty & Wood in Trust” (Liebeck’s law firm) for $300,000 (Exhibit A-5). Apparently, the $300,000 was later paid to Julia as part of the $600,000 she expected to receive under subparagraph 7(8) of the Separation Agreement.

Even as late as June 7 when the Company issued its cheque for $300,000 (Exhibit A-l Tab 3), the purported amendment in the letter of April 22 may possibly have been salvaged if the cheque had been payable only to Julia; if the cheque as issued had been forwarded by Walsh to Liebeck with an adequate explanation that the amount payable by the Company to Julia for the redemption of her one share was to be regarded as part of the $600,00 otherwise payable to her by the Appellant under subparagraph 7(8) of the Separation Agreement; and if Julia had accepted and cashed the cheque. None of that was done. Instead, the Company’s cheque was payable to Walsh’s law firm and deposited in the firm trust account. At that moment, Walsh received the funds from the Company as agent for the Appellant. From the Appellant’s position, these actions by the Appellant and the Company and Walsh were at best equivocal as to whether the share was being redeemed out of the hands of the Appellant or Julia. From the Respondent’s position, it is easier to infer that the share was being redeemed out of the Appellant’s hands because the Company issued its cheque to Mr. Walsh, the Appellant’s agent, and not to Julia.

The receipt of the $300,000 by Walsh (as agent for the Appellant) had the same effect as if the funds had been paid by the Company to the Appellant himself. I find that the share in the Company which had been held by Julia was in fact transferred to the Appellant under subparagraph 7(6) of the Separation Agreement and redeemed out of his hands by the Company. Any deemed dividend resulting from such redemption was income to the Appellant and not to Julia. This conduct of the Appellant and the Company after May 8 is a second ground for holding that the letter of April 22 did not amend the Separation Agreement.

Before considering the third ground for holding that the letter of April 22 did not amend the Separation Agreement, I have a further comment on what I regard as the joint carelessness of Walsh and Liebeck with respect to that letter. Having heard them testify, it is my impression that neither one fully understood the significant income tax consequences of having a share (with high value but low paid-up capital) redeemed by a corporation as opposed to having that share transferred from one spouse to the other (a rollover). If Mr. Walsh did understand those income tax consequences, I think that he did not have the ability to express them clearly in writing. Both Walsh and Liebeck were receiving outside tax advice from third parties. I am satisfied that Mr. Kurz (Exhibit A-2 Tab 6) knew precisely what he was doing when he recommended to the Appellant and Mr. Walsh that Julia’s share of the Company be redeemed and not transferred to the Appellant. If Walsh’s letter of April 22 had been more explicit in describing the change he wanted in the Separation Agreement (i.e. the share was not to be transferred from Julia to the Appellant but was to be redeemed out of her hands by the Company ; and any money paid by the Company for such redemption was to be subtracted from the $600,000 payable by the Appellant to Julia under subparagraph 7(8) of the Separation Agreement), it is possible that Liebeck would have been alerted to seek further tax advice, and would then have rejected the proposed change. As events unfolded, both Walsh and Liebeck were flying in a fog of ambiguity and confusion with the letter of April 22 and the manner in which the share was later redeemed.

After the Appellant and Julia, through their respective lawyers, had accepted the basic terms and the form of the Separation Agreement which was later dated April 18 and signed by both parties, the Appellant was in a “Catch 22” position in his desire to make the change recommended by Mr. Kurz. If the proposed amendment was ambiguous and confusing, it would not be effective. If the proposed amendment was clear and explicit, it would likely be rejected by Liebeck and Julia.

There is a third ground for holding that the letter of April 22 did not amend the Separation Agreement. Subsection 55(1) of the Family Law Act, 1986 states:

55(1) A domestic contract and an agreement to amend or rescind a domestic contract are unenforceable unless made in writing, signed by the parties and witnessed.

A “domestic contract” is defined in section 51 to include a separation agreement. Taken at face value, subsection 55(1) would prevent the letter of April 22 from amending the Separation Agreement dated April 18 because the letter was not signed by the Appellant and Julia. There is, however, a significant decision of the Ontario Court of Appeal which qualifies the application of subsection 55(1). In Geropoulos v. Geropoulos (1982) 35 O.R. (2d) 763, 26 R.F.L. (2d) 225 (C.A.) a husband and wife separated and, in 1979, the wife commenced a lawsuit claiming support and a division of assets under the provisions of the Family Law Reform Act which, in section 54(1), contained a provision similar to subsection 55(1) set out above. The husband’s lawyer wrote a letter to the wife’s lawyer offering certain terms on which the dispute could be settled. The wife’s lawyer replied accepting the offer. Subsequently, the wife refused to adhere to the settlement. The husband then applied in Family Law Motions Court for judgment in accordance with the settlement reached between the two lawyers in their exchange of letters. The Motions Judge granted judgment to the husband and the wife appealed to the Ontario Court of Appeal. When dismissing the wife’s appeal, Robins J.A. speaking for the Court stated at pages 767-68:

it is conceded that the agreement in question was complete, definite and intended to be binding; there is no suggestion of any lack of authority on the part of the solicitor or of any mistake, misrepresentation, duress or other circumstances which might impair the settlement or render it unenforceable....

... The case was argued in this Court, as it was in the court below, on the basis that a final agreement of settlement had been concluded but, by virtue of s. 54(1), and that section alone, it was not binding on the wife or enforceable in law against her....

I share the view that settlement agreements concluded by solicitors or counsel resolving outstanding claims in pending litigation under the Act are beyond the reason and purview of subsection 54(1)....

And further at page 769:

In my opinion, the section plainly is not aimed at or intended to apply to authorized settlement agreements like the present, made with legal advice during the pendency of court proceedings which, to be effective, require the intervention of the court. Such agreements derive their effect from an act of the court; their authenticity is assured by the court’s supervision and control over them; and ample protection is afforded the parties to these agreements, wholly independent of the section. The court’s jurisdiction to enforce settlements or refuse to do so, notwithstanding any agreement between solicitors or counsel, is well established; whether they should be enforced or not, in the final analysis, is a matter for the discretion of the court and, in litigation under the Family Law Reform Act, a matter that would be subject to the court’s overriding jurisdiction with respect to domestic contracts.

Mr. Scace relied on the decision in Geropoulos to argue strongly that the letter of April 22 was an effective amendment under Ontario law because the Separation Agreement was entered into after Julia had commenced an action for divorce. Therefore, the letter of April 22, signed by only the lawyers, was under Geropoulos and beyond the purview of subsection 55(1). I have serious doubts about the application of Geropoulos to the situation concerning the Appellant and Julia.

I will digress briefly to speculate. Suppose the Minister had relied on the TS from the Company and had issued to Julia a quick assessment in 1987 adding the taxable dividend to her reported income for 1986; that she had served a Notice of Objection on the Minister and then applied to the appropriate Ontario Court for an interpretation of the Separation Agreement. That is probably the appropriate forum to determine this issue concerning Geropoulos. By similar reasoning, it seems to me that the Appellant could have applied to an Ontario Court for the same interpretation after serving a Notice of Objection to the reassessment which is under appeal herein. For whatever reason, that avenue was not pursued and I am left to decide whether the letter of April 22 comes under the umbrella of Geropoulos.

It seems clear that one of the purposes of the Separation Agreement was to terminate and not settle the divorce action commenced by Julia. Paragraph 19 of the Separation Agreement states:

19. DIVORCE ACTION NUMBER DI28241/85

The wife agrees to file a Notice of Discontinuance in Action Number DI28241/85 and the husband agrees not to claim costs therein.

Mr. Walsh’s letter of May 5 (Exhibit A-2 Tab 8) contains the following words:

3. We believe the following matters are outstanding and are to be dealt with as part of the Separation Agreement;

(a) Consent or Order dismissing the Petition;

(b) ...

And Mr. Liebeck’s reply of May 8 (Exhibit A-2 Tab 10) encloses a number of executed documents including: “... our Consent to Dismissal of the divorce petition.” The Ontario Rules of Civil Procedure include Rule 23.01 which states:

23.01(1) A plaintiff may discontinue all or part of an action against any defendant,

(a) before the close of pleadings, by serving on all parties who have been served with the statement of claim a notice of discontinuance (Form 23A) and filing the notice with proof of service;

(b) after the close of pleadings, with leave of the court; or

(c) at any time, by filing the consent in writing of all parties.

Under paragraph (c) of Rule 23.01(1), Julia’s action for divorce would be discontinued when Walsh filed the Consent enclosed with Liebeck’s letter of May 8. As I understand the procedure, the Ontario Court would have no opportunity to supervise or control the purported amendment or to afford any protection to the Appellant or Julia. I repeat the following sentence from the decision in Geropoulos:

Such agreements derive their effect from an act of the court; their authenticity is assured by the court’s supervision and control over them; and ample protection is afforded the parties to these agreements, wholly independent of the section.

Those words are particularly true when a husband and wife do not have a formal separation agreement, and litigation is commenced to obtain a division of property and a judgment on other questions like custody and maintenance. In the circumstances of this appeal, it seems likely that Julia’s petition for divorce in 1985 brought about the Separation Agreement dated April 18. That Agreement, however, not only provided for the division of property in paragraph 7 but also provided for custody (paragraph 5), support of the children (paragraph 6) and discontinuance of the divorce action (paragraph 19). In my view, when the properties had been transferred and the monies described in subparagraphs 7(1) and 7(8) had been paid, and when the other relevant documents had been executed and exchanged (including Julia’s consent to the dismissal of her divorce petition), there was nothing left for the Court’s “supervision and control”. The protection which the Ontario Court could provide in the Geropoulos situation would not be available to the Appellant and Julia. With some hesitation, I find that the letter of April 22 does not come under the principle established in Geropoulos\ it is not excluded from the operation of subsection 55(1) of the Family Law Act; and that letter required the signatures of the Appellant and Julia in order to be effective.

In argument, counsel for the Respondent acknowledged that the penalty assessed under subsection 163(2) of the Income Tax Act should be cancelled. The appeal is allowed and the assessment is referred back to the Minister of National Revenue only for the purpose of deleting the penalty assessed under subsection 163(2) of the Income Tax Act. There will be no order as to costs.

Appeal allowed in part.