Cartwright v. The Queen, 94 DTC 6677, [1995] 1 CTC 15 (FCTD)

Rouleau J.:-This is an appeal from a decision of the Tax Court of Canada dated April 10, 1991 (unreported). At issue is whether the plaintiff had benefits conferred on him qua shareholder for the 1985, 1986, and 1987 taxation years, and if so, the value of those benefits to be included in the computation of his income pursuant to paragraph 15(l)(c) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970- 71-72, c. 63) (the ’’Act”).

The plaintiff is a member of the Bars of Alberta, British Columbia and Ontario. During the period in question, he was a resident of Toronto, married and the father of three children; Meredith, born in December, 1964; Brian, born in July 1966; and Heather, born in May, 1969. In November of 1976, he created a family trust for the express purpose of accumulating capital for the benefit of his children. The only trustees were the plaintiff and Mr. Judson. A small sum of money was settled on the trust which the trustees used to acquire 99 common shares in Merbriheath, a company incorporated by the plaintiff at or about the same time as the creation of the trust. The plaintiff then settled on the trust shares in Aurland and Jobborn, companies related to his main business venture, Canada Law Books. All of the shares of these companies had been acquired by him some years before. In consideration for transferring these shares to the trust, Mr. Cartwright received 40,000 non-voting junior preference shares from Merbriheath. The shares of Aurland and Jobborn provided dividend income for Merbriheath, tax free, thereby providing cash flow for the trust.

The issued shares of Merbriheath consisted of 99 common shares, the "equity shares", held by the trust and 100 voting preference shares held by Mr. Cartwright in order to retain control of the company in the event misunderstandings should develop amongst his children before the trust assets could eventually be distributed.

In 1980, Mr. Cartwright and his fellow trustee, Mr. Judson, discussed investments in real estate and finally settled on the idea of purchasing a recreational property as a long term investment. Both felt that properly timed purchases and resales of a recreational property would yield a profit.

Accordingly, in October of 1980, Merbriheath acquired a property in the Muskoka resort area, the "Milford Bay" property, for $117,016. The purchase was financed by a loan from the Canadian Imperial Bank of Commerce which the company obtained at prime rate because the plaintiff provided a personal guarantee.

In subsequent years, several improvements were generated to the property, especially to the waterfront areas and the septic system. All costs incurred for capital improvements and significant repairs on the cottage were borne by Merbriheath on the basis these capital improvements would add to the value of the property thereby increasing the equity of the trust fund. The company also paid the mortgage interest and property taxes. All annual operating and maintenance costs for the cottage were paid by Mr. Cartwright personally.

In 1985, the "Milford Bay" property was sold. A capital gain of $34,000 was realized and reported on Merbriheath’s tax returns, in its capital account. In June of that year, the company purchased the "Gibraltar Island" property at a cost of $350,000. The proceeds of the "Milford Bay” sale together with an additional loan secured by Mr. Cartwright, provided the financing for this second purchase.

Once again, several capital improvements, paid for by Merbriheath, were made to the property in the ensuing years. The cottage was not winterized however, and was only suitable for use during the summer season. The company continued to pay the mortgage interest and property taxes and the plaintiff paid the annual operating and maintenance costs. In September of 1986, Mr. Cartwright and his wife separated. He removed his personal effects from the cottage and never returned. At the time of trial the property was being offered for sale at a price of $975,000.

On October 6, 1989, the plaintiff was reassessed with respect to his 1985, 1986, and 1987 taxation years. The Minister determined the "Gibraltar Island" cottage property was made available for use by Mr. Cartwright and his family throughout the period from January, 1985 to December 31, 1987, and that Merbriheath had accordingly conferred a benefit on the plaintiff qua shareholder, the value of which was to be included as income pursuant to paragraph 15( 1 )(c) of the Income Tax Act.

In quantifying the value of the benefit, the Minister proceeded on the same cost base analysis method endorsed by the Federal Court of Appeal in Youngman v. Canada, [1990] 2 C.T.C. 10, 90 D.T.C. 6322. Added to the acquisition cost of the property was the amount of any capital improvements, when and as they were made. This sum was then multiplied by a rate of return based on the then-current yield of Government of Canada Treasury Bills as per section 4301 of the Income Tax Regulations. This is often referred to as the "equity rate of return" valuation method. Had the company invested the moneys, it would have received a rate of return as fixed by the Regulations. The Minister therefore determined the value of the benefit conferred on the plaintiff as $24,751 for 1985; $39,779 for 1986; and, $36,804 for 1987.

It should be noted that although subsection 15(1) does not specifically provide that Regulation 4301 applies for the purpose of determining the value of this type of benefit, the regulation is referred to in other sections of the Act dealing with benefits. There being no other provision for the calculation of the value of the benefit under subsection 15(1), the Minister chose to rely on Regulation 4301.

The plaintiff appealed to the Tax Court of Canada on the grounds no benefit had been conferred on him since his actual use of the property was de minimus and in fact, he had not set foot on it after separating from his wife in September of 1986. In the alternative, he argued if he did receive a benefit, the amounts assessed by the Minister were excessive, unreasonable and failed to have regard to the fact the cottage is an appreciating asset. In addition, it was submitted Mr. Cartwright paid all maintenance and operating costs, seldom used the cottage, and the value of his personal guarantee which resulted in Merbriheath obtaining a loan at prime rate, was not taken into account in determining the value of the benefit.

Bonner J.T.C.C. upheld the Minster’s determination a benefit had been conferred on the plaintiff from the corporation, stating at pages 4-5 of his decision as follows:

The appellant contended that no benefit was conferred. He stressed that the cottages were acquired with a view to earning a gain on resale. The use of the cottages during the holding period was not what was sought by the company and was not regarded by the appellant as a benefit. The appellant emphasized as well in argument that the voting preferred shares were held by him only for use in the event of strife among the children.

Despite these considerations, I find that the evidence supports a conclusion that the corporation, by making the cottages available for use by the appellant and his family, conferred benefits on the appellant. Those benefits were conferred on him qua shareholder. Although the voting preference shares were no doubt acquired to bestow control upon the appellant for the purposes previously mentioned, it is clear that it was a consequence of the appellant’s position in the company, that use of the cottage was available to him and his family and not to anybody else. The fact that the availability for use was a by-product of the scheme for earning gains on resale is not a circumstance which points to a conclusion that such availability was not a benefit.

The learned tax judge held the availability for use of the cottage was a thing of value. That value was not dependent on the extent to which the plaintiff and his family actually made use of the property.

However, his Honour accepted the plaintiff’s submission the amounts assessed with respect to the value of the benefits were excessive. The reassessments were referred back to the Minister for reconsideration on the basis the rates employed in calculating the value of the benefit, should be reduced to reflect rates of return appropriate to investments and appreciating assets, as well as the efforts made by the plaintiff to improve the properties and to secure low cost financing.

Notices of reassessment were issued on September 27, 1991, in accordance with the Tax Court’s decision, wherein the amounts previously assessed were reduced by ten per cent. The new assessments are $22,275.90 for 1985; $35,801.10 for 1986; and, $33,123.60 for 1987.

The plaintiff now appeals from the decision of the Tax Court on the grounds the cottage was purchased for a legitimate business purpose and any personal use by him, which was minimal in 1985 and 1986 and non-existent in 1987, was incidental to this ultimate purpose. It is further submitted if a benefit was received, it was offset by the fact the plaintiff personally paid all the maintenance and operating expenses of the property.

The defendant submits Merbriheath acquired the "Gibraltar Island" property for personal use by the plaintiff and his family and there was no legitimate business purpose underlying the corporation’s decision to purchase. It is further argued that since the property was available to the plaintiff on a year round basis, his actual use is irrelevant and his efforts at improving the property and securing financing should not form a basis for reducing the interest rate otherwise applicable. It therefore seeks by way of Counterclaim to have the original reassessments restored.

The first issue is whether a benefit was conferred on the plaintiff qua shareholder. To begin with, I reject the defendant’s contention there was no business purpose behind the acquisition of the "Gibraltar Island” property. The indications are all to the contrary. The facts demonstrate the cottage properties were purchased by Merbriheath for the purpose of gaining income. The "Milford Bay" property was purchased by the company, which then paid for the cost of significant improvements and sold it for a profit. That profit was used to purchase another, more expensive property, "Gibraltar Island", and once again considerable expenses were incurred by the company for improvements. At the time of trial, it was being offered for sale at a price which would bring Merbriheath a substantial gain upon disposition. It is clear therefore, any use of the cottages by the plaintiff was incidental to the company’s ultimate business purpose in acquiring them, which was to purchase and sell recreational property for a profit.

At the same time however, the cottages were made available to the plaintiff for personal use. I am satisfied Mr. Cartwright did receive a benefit during the 1985 and 1986 taxation years when he and his family made use of them during the summer season. However, it is not reasonable on the basis of the evidence, to suggest a benefit was conferred on him during the 1987 taxation year, as he never returned to the "Gibraltar Island" cottage nor made personal use of it after September of 1986. Neither is there any evidence his spouse or his three adult children, who by 1987 were twenty-three, twenty-one and eighteen years old respectively, made use of the property during that taxation year. Accordingly, I find a taxable benefit was conferred on the plaintiff qua shareholder during the 1985 and 1986 taxation years only.

Having so determined, the next issue is the value to be placed on the benefit. As previously stated, the Act does not provide a formula to be applied in this calculation. The Minister chose to rely on Regulation 4301, but there is no statutory direction or requirement to do so.

The Federal Court of Appeal has provided some guidance as to how the value of a benefit is to be calculated in cases of this nature. In Youngman, supra, Pratte J.A. stated at page 14 (D.T.C. 6325):

In order to assess the value of a benefit, for the purposes of paragraph 15(l)(c), it is first necessary to determine what that benefit is or, in other words, what the company did for its shareholder; second, it is necessary to find what price the shareholder would have to pay, in similar circumstances, to get the same benefit from a company of which he was not a shareholder.

In addition, the calculation of a benefit received by a shareholder using a corporation’s assets depends on the corporation’s purpose in acquiring it. That principle has been endorsed in this Court as well as the Court of Appeal. As stated by McNair J. in Youngman v. Canada, [1986], 2 C.T.C. 475, 86 D.T.C. 6584 (F.C.T.D.), at page 480 (D.T.C. 6588-89):

Counsel for the defendant concedes, on the strength of the Houle case, that if it is found that the house on Shadow Drive was built for a business purpose and for use as a business asset so that any use of the house by the shareholders was only incidental thereto then the Minister’s assessment was incorrect.

Applying those principles to the facts before me, I conclude the benefit conferred on Mr. Cartwright during the 1985 and 1986 taxation years was the use of an exceptional cottage during the summer season. Ideally, the value of that benefit would be calculated according to the amount of rent the plaintiff would have been required to pay had he not been a shareholder. However, due to the unique character of these cottages and the fact cottages of this sort are not, as a general rule, rented out for the summer season, neither party was able to provide the Court with an appropriate rental amount.

I am satisfied the proper course to follow here is to consider how much the plaintiff would have paid during the 1985 and 1986 taxation years had he and his family vacationed in an exclusive resort for a summer season of twelve weeks. That is, in fact, what Mr. Cartwright received from the company and that is the amount properly included in his income in accordance with paragraph 15(l)(c) of the Income Tax Act. In my view, a reasonable amount is $1,000 per week. Accordingly, the value of the benefit conferred on the plaintiff is $12,000 for each of the 1985 and 1986 taxation years.

For these reasons, the plaintiffs appeal is dismissed, with the exception of the reassessment for the 1987 taxation year, during which time I find he did not receive a benefit as a shareholder. The defendant’s counterclaim is dismissed and the original reassessments will not be restored. In addition, the value of the benefit received by the plaintiff in his 1985 and 1986 taxation years is to be assessed at $12,000 per year.

I make no order as to costs.

Appeal dismissed.