Harvey v. R., 98 DTC 1089, [1997] 3 C.T.C. 3022 (TCC)

Bell T.C.J.:

Issue:

• 1. Did the Appellant transfer money to his infant children within the meaning of subsection 75(1) of the Income Tax Act (“Act”) in prior years with the result that interest earned on that money would be attributed to the Appellant?

• 2. Was the sum of $10,000 paid by the Appellant to a management company[FN1: <p>The management company was owned by the Appellant's wife. It performed services for the Appellant.</p>] for accounting services and claimed by him as a deduction from his income allowed as a deduction by the Respondent?

• 3. Was the Appellant entitled to deduct 15 percent of the amount of costs of the management company in providing services to the Appellant?

• 4. Is the sum of $5,680, or any part thereof, paid to J.K. Maguire & Associates (“Maguire”) described on a receipt dated December 21, 1982 as follows:

  Financial Planning - $180.00

  Money Management - $5,500.00

  deductible under paragraph 20(1)(bb) of the Act?

2 Respecting the first issue, the Appellant appealed his 1983 taxation year to this Court. The identical issue in respect of the same monies has already been considered by Judge Bowman [ Harvey v. R. (1994), [1995] 1 C.T.C. 2507 (T.C.C.)]. I quote from his Reasons for Judgment,

Documents described as promissory notes were signed by Shelly Harvey, Dr. Harvey's wife and the children's mother. I will read one as representative:

• Promissory note $40,000.00 (forty thousand dollars), Wheatly, Ontario, due on demand. May 31, 1978. On demand, I Andrew Harvey covenant, agree and promise to pay to Greg Harvey the sum of $40,00.00 without interest. In the event I default interest shall be paid from the date of default at the rate of 20% per annum.

This note is deemed for all purposes to be a specialty instrument. To be used as an education trust fund with Shelly Harvey as trustee.

It is signed by Shelly Harvey and the witness appears to be R.D. Clarkson. The note, all of the notes, are in Dr. Harvey's handwriting.

Dr. Harvey admitted that he had no idea what “specialty instrument” meant. The note contains quite a remarkable provision in the event of default. Interest is to be paid at 20% per annum. This by a child aged two or three years old.

No formal trust agreement was ever signed and no trust was created other than whatever legal fiduciary relationship might have arisen out of Shelly Harvey's signing the notes.

A schedule of repayment was prepared as the notes were paid off. The Minister attributed the interest on the monies so advanced by Dr. Harvey to him on the basis that there was no genuine loan of money to the children.

The Appellant relies upon the decision of Thurlow, J. in Dunkelman v. Minister of National Revenue[1959], 59 DTC 1242 which held that for the purposes of the attribution a bona fide loan was not a transfer. Subsection 75(1) as it applied to 1983 read in part, as follows:

Where a taxpayer has, since 1930, transferred property to a person who was under 18 years of age, either directly or indirectly, by means of a trust or by any other means whatever, any income or loss, as the case may be, for a taxation year from the property or from property substituted therefor shall, during the lifetime of the transferor while he is a resident in Canada, be deemed to be income or a loss, as the case may be, of the transferor and not of the transferee, unless the transferee has, before the end of the year, attained the age of 18 years.

The Dunkelman case is good law in Canada and has been followed on numerous occasions. The appellant relies also on Interpretation Bulletin IT 260-R, paragraphs 3 and 4:

For the purposes of subsection 75(1), a transfer does not include a genuine loan made by a taxpayer to a trust for the benefit of a minor. No all-inclusive statement can be made as to when a loan can be considered to be “genuine”, but a written and signed acknowledgment of the loan by the borrower and the agreement to repay it within a reasonable time ordinarily is acceptable evidence that it was so. If, in addition, there is evidence that the borrower has given security for the loan, that interest on the loan has been paid, or that actual repayments have been made, it is accepted that the loan was genuine. The fact that no interest is required to be paid does not mean, in itself, that a genuine loan has not been made.

Where a loan has characteristics of a genuine loan (see 3 above) and there is no evidence that the terms of that loan are not being honoured by the minor, the Department considers that such a loan made directly to a minor is not a transfer of property for the purposes of subsection 75(1).

I do not think that we can push the principle in Dunkelman too far. A bona fide loan to a properly constituted trust may well meet the criteria in Dunkelman to avoid the provisions of subsection 75(1). A somewhat loose arrangement between husband and wife where the wife, without any form of documentation, calls herself a guardian of the infant children does not. It must be recognized that subsection 75(1) is designed to prevent income splitting and if one wishes to avoid the section on the basis of Dunkelman the formalities of a real trust must be set up. While a real trust could presumably borrow funds, an infant cannot do so directly. Such a contract is void.

In Upper Lake vs. Lightening Fastener Employees Credit Union (St. Catherines Limited), I think it is 9 Bankruptcy Reports. It is a decision of the County Court of Ontario of His Honour Judge Leach. He says:

In English law, apart from statute, an infant does not possess full legal competence. Since he is regarded as of immature intellect and immature discretion, English law, while treating all the acts of an infant which are for his benefit on the same footing as those of an adult, will carefully protect his interests and not permit him to be prejudiced by anything to his disadvantage.

He goes on to say:

Infant's [sic] contracts are at common law generally voidable. However, there are certain exceptions to this rule where the contracts are void ab initio.

And, he quotes from Halsbury where he says:

Contracts which are obviously prejudicial to an infant are wholly void; thus an infant cannot contract a loan or give a penal bond.

Judge Brule of this Court in what appears to be an unreported decision Kallaur dealt with the situation that was virtually identical to this one. He stated:

Prior to the period under appeal and during this period the Appellant transferred funds to his wife purportedly as “loans” to his two infant children. These “loans” were non-interest bearing and payable on demand. The investments made with the transferred funds earned ... (substantial sums of money) in 1984.

He goes on to say on page 2:

The Minister has relied on subsection 75(1) of the Income Tax Act as it then existed for the years under appeal. That provision contemplated the transfer of property to minors [sic] did not include a genuine loan. However minors cannot contract and be parties to a proper loan. The accepted method of achieving a desired result in similar circumstances was by way of a bona fide trust.

In the present case a form of trust was eventually obtained but this was not completed in such a manner to satisfy the requirements of a valid trust.

And to distinguish the Dunkelman case he goes on to cite Lakeview Gardens Corporation which states the frequently cited observation that just because you might have been able to achieve a particular result in one way doesn't mean that if you go about it another way you are going to achieve that result. I am in complete and respectful agreement with the decision of Judge Brule and I am following his decision.

3 Respecting the second issue, Mr. Jajal, an audit accountant with the Department of National Revenue, testified that the sum of $10,000 described above was allowed as a deduction to the Appellant in the 1982 taxation year as forming part of the sum of $19,535 described as “Wages; Other”. The Respondent had allowed that sum in each of the three prior taxation years. Some corroboration of Mr. Jajal's testimony lies in the fact that the amount of “Wages; Other” for the previous years were $10,659.93, $7,325.81 and $8,279 respectively. It is noted that each of these is less than the aforesaid sum of $19,535 by approximately $10,000 or more. An exhibit introduced in this regard was prepared by Mr. Jajal and entitled STATEMENT OF INCOME FOR THE YEAR ENDED MARCH 31.

4 In addition to showing the said sum of $19,535, the following note was set forth:

Please note that $20,337.00 wages to Mrs. S. Harvey for 1982 is considered unreasonable for services performed and your wage expense is reduced accordingly. We are allowing service fee mark-up on $10,000.00. This amount is now included in total other wages.

5 Respecting the third issue, what, if any, expenses incurred or paid by the management company in 1982 qualify for a deduction by the Appellant and in what percentage? The exhibit above referred to showed the following items described as

I am pleased to inform you that, following a long period of discussions, Revenue Canada - Taxation has now agreed that, as a general rule, a 15 per cent “mark-up” on all services (and PMC[FN2: <p>Professional Management Company.</p>] direct costs) provided by the management company to the professional practice is a reasonable expense of the professional practice.

More specifically, the general rule will be that “mark-ups” on services provided to professional practices by PMCs will be accepted to the extent that “net income” from services provided to the professional practice does not exceed 15 per cent of total costs in providing the services (i.e. all service and direct costs related to the provision of these services).

Examples of the PMC expense items that the department will recognize as eligible for “mark-up” are:

• all salaries/benefits (including auxiliaries and para-professionals)

• all practice/company supplies (dental and office supplies)

• laboratory services

• equipment/furniture depreciation (and/or rental costs)

• rent, utilities, telephone, maintenance/repairs

• postage, laundry, subscriptions, etc.

• bank charges/interest, taxes, business licences, business insurance

• advertising and promotion etc.

This list is not intended to be exhaustive. Additional items would be considered for “mark-up” if the circumstances warrant such an approach. For example, a percentage of automobile expenses will be considered if the automobile use is identified as being necessary.

Directly personal professional services will not be accepted for mark-up. For example, professional licence fees and dues, convention expenses, continuing education expenses, professional malpractice insurance, etc., paid for by the PMC will not be eligible for “mark-up”.

6 The Appellant seeks, under paragraph 20(1)(bb), to deduct the sum of $5,680 made up, as set out above, of $180 for Financial Planning and $5,500 for Money Management paid to Maguire. That provision reads in part, as follows:

20(1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(bb) an amount other than a commission paid by the taxpayer in the year to a person

(ii) for services in respect of the administration or management of shares or securities of the taxpayer,

if that person's principal business

(iv) includes the provision of services in respect of the administration or management of shares or securities;

7 The Appellant presented no evidence whatever in connection with this claim. He stated simply that he had paid Maguire for management fees. He then stated that Maguire did not use the funds “in that respect” but that he had paid for that purpose. He stated further that the purpose was to buy bonds and the Appellant stated that he assumed Maguire had done so.

8 Because of the Appellant's tacit admission or agreement that his activities in relation to Maguire were the same as those in Schultz v. R. (1993), 93 D.T.C. 953 (T.C.C.), I refer briefly, as did counsel for the Respondent, to certain aspects of that case. Judge Beaubier of this Court said that the assessments relate to securities transactions in dispute respecting investment clubs in which Dr. and Mrs. Schultz were allegedly involved in 1983 and to hedging transactions they conducted in subsequent years. He said that Maguire described some of these as “investment clubs” and that the Appellants allegedly participated in two of those clubs. Maguire stated that the activities of the investment clubs were essentially an income splitting hedge where Dr. Schultz took a short position in a Government of Canada bond and his wife took a long position in a similar Government of Canada bond. Maguire also said,

...quite simply, the investment club was more designed for income splitting and there was a much larger, obviously, tax emphasis on income splitting than investment whereas with other hedges we...

Because he was merely dealing with himself, there was no prospect of gaining income and thus the brokerage fees and charges were not incurred for the purpose of gaining income and were not deductible. Furthermore, in these circumstances, the Schultzes had no legal interest or entitlement in or to the alleged transactions which were entirely Mr. Maguire's.

Nor does the Court believe that such clubs ever in fact existed in any form.

It is the Court's view that both form and substance are missing. Dr. and Mrs. Schultz were not in business in any so-called “investment clubs” in 1983. Furthermore, on the evidence before the Court, there were no investment clubs in 1983. There was just Mr. Maguire trading with himself and making up lists in 1984.

9 No evidence having been given by the Appellant with respect to any services provided by Maguire “in respect of the administration or management of shares or securities of the taxpayer” and no evidence having been given about the acquisition or ownership of any shares or securities, the claim for deduction of this amount fails.

10 No costs are awarded.