Bowman
J.T.C.C.:—This
appeal
is
from
an
assessment
for
the
appellant's
1983
taxation
year.
By
that
assessment
the
Minister
of
National
Revenue
included
in
the
appellant's
income
$69,238
under
subsection
245(2)
of
the
Income
Tax
Act,
R.S.C.
1952,
c.
148
(am.
S.C.
1970-71-72,
c.
63)
(the
"Act")
as
it
read
in
that
year.
At
trial
the
respondent
relied
upon
subsection
7(1)
and,
alternatively,
section
6.
The
problem,
briefly
put,
is
this:
the
appellant
was
an
employee,
director,
chief
financial
officer
and
a
shareholder
of
an
oil
and
gas
company,
DEB
Petroleum
(1980)
Limited
("DEB").
He
had
received
options
to
purchase
47,000
shares
of
DEB
at
$5.20
per
share
over
five
years
subject
to
the
provision
that
if
over
50
per
cent
of
the
shares
were
acquired
by
another
person
he
could
exercise
all
of
his
options
immediately.
An
offer
was
made
by
Trilogy
Resource
Corp.
("Trilogy")
to
acquire
all
of
the
shares
of
DEB,
including
any
outstanding
stock
options.
The
appellant
believed
that
to
sell
the
stock
options
directly
to
Trilogy
could
give
rise
to
tax
immediately
under
paragraph
7(1)(b)
and
so,
on
the
advice
of
solicitors,
he
incorporated
a
numbered
company,
287495
Alberta
Inc.,
transferred
the
options
to
it
and
sold
the
shares
of
the
numbered
company
to
Trilogy
for
shares
of
Trilogy,
and
filed
jointly
with
Trilogy
an
election
under
section
85.
He
took
the
position
that
this
was
not
a
transfer
or
disposition
of
the
stock
option
as
contemplated
by
paragraph
7(1)(b)
of
the
Act
and
that
he
was
therefore
not
taxable
on
the
transaction.
The
Tax
Avoidance
Section
of
the
Department
of
National
Revenue
saw
this
stratagem,
whichadmittedly
had
no
commercial
purpose
other
than
the
avoidance
of
tax,
as
unacceptable
and
levied
tax
on
a
deemed
benefit
under
subsection
245(2)
equal
to
what
it
assumed
was
the
value
of
the
Trilogy
shares
received,
$69,238.
On
objection
the
assessment
was
confirmed
under
paragraph
7(1)(b)
and
it
was
that
provision,
rather
than
subsection
245(2),
upon
which
the
respondent
relied
principally
at
trial.
The
question,
of
course,
is
whether
the
appellant's
tax
avoidance
strategy
was
effective.
In
the
course
of
the
trial
a
matter
arose
in
respect
of
which
I
was
required
to
rule.
Since
the
correctness
of
my
ruling
may
become
an
issue
in
the
event
of
an
appeal
I
should
briefly
set
out
the
ruling
and
the
basis
for
it.
The
assessment
as
originally
made
was,
as
stated
above,
premised
on
the
assumption
that
Trilogy
had
conferred
a
benefit
on
the
appellant
under
subsection
245(2)
as
it
read
in
1983
and
that
this
benefit
was
taxable.
In
light
of
the
exception
in
subsection
245(3),
subsection
245(2)
could
only
be
applied
if
the
appellant
and
Trilogy
were
not
dealing
at
arm's
length
and
in
maxing
the
assessment
the
assessor
proceeded
on
the
assumption
that
they
were
not
at
arm's
length.
Subsection
7(1)
was
not
considered
applicable
and,
indeed,
if
the
appellant
and
Trilogy
were
not
at
arm's
length
paragraph
7(1)(b),
the
section
relied
on
at
trial,
could
not
have
supported
the
assessment
as
the
application
of
that
section
requires
that
the
transferor
and
the
transferee
of
the
options
be
at
arm's
length.
An
objection
was
filed
and
the
appeals
assessor
considered
that
the
provision
that
should
be
applied
was
paragraph
7(1
)(b).
The
notification
of
confirmation
read
as
follows:
.
.
.a
benefit
equal
to
the
amount
of
$69,238
conferred
by
Trilogy
Resource
Corp.
in
respect
of
an
agreement
to
sell
shares
of
DEB
Petroleum
(1980)
Ltd.
to
you
has
been
determined
and
deemed
to
have
been
received
by
you
by
virtue
of
your
employment
in
the
taxation
year
in
accordance
with
the
provisions
of
paragraph
7(1)(b)
of
the
Act.
Obviously,
if
paragraph
7(1
)(b)
is
to
apply,
the
appellant
and
Trilogy
would
have
needed
to
deal
at
arm's
length,
contrary
to
the
assumption
made
on
assessing
when
subsection
245(2)
was
applied.
The
reply
to
the
notice
of
appeal
sets
out
a
number
of
factual
assumptions
which
appear
on
the
evidence
to
be
substantially
correct
or
which
are
at
all
events
not
challenged.
The
reply
does
not
mention
subsection
245(2)
nor
does
it
deal
with
the
question
whether
the
appellant
was
dealing
at
arm's
length
with
Trilogy.
Nor
was
an
answer
filed
by
the
appellant
tothe
reply.
On
discovery
the
appellant
obtained
copies
of
memoranda
prepared
by
the
departmental
official
who
made
the
assessment.
One
memorandum,
Exhibit
A-15,
sets
out
detailed
reasons
for
concluding
that
the
appellant
and
Trilogy
were
not
dealing
at
arm's
length.
It
was
clearly
one
of
the
essential
"assumptions"
upon
which
the
assessment
under
subsection
245(2)
was
based.
At
the
opening
of
trial
counsel
for
the
appellant
advised
the
court
that
he
would
be
adducing
evidence
of
this
unpleaded
assumption,
and
that
he
would
rely
upon
it
in
support
of
the
position
that
even
if
the
Crown's
position
that
the
transfer
of
the
shares
to
the
numbered
company
followed
by
the
sale
of
the
numbered
company's
shares
to
Trilogy
was
indeed
a
"transfer
or
disposition”
of
the
options
to
Trilogy
within
the
meaning
of
paragraph
7(1
)(b),
it
was
not
a
transfer
or
disposition
to
a
person
with
whom
the
appellant
was
dealing
at
arm's
length.
Therefore,
counsel
contended,
if
section
7
was
relevant
it
was
paragraph
7(1
)(c)
or
(d)
that
applied
because
in
the
case
of
a
non-arm's
length
transfer
of
share
options
tax
is
not
triggered
until
the
non-arm's
length
transferee
exercises
the
options
or
disposes
of
them
in
an
arm's
length
transaction,
neither
of
which
events
has
ever
occurred.
Both
counsel
contended
strenuously
that
they
had
been
taken
by
surprise.
Counsel
for
the
respondent
contended
that
if
the
appellant
was
going
to
rely
on
the
unpleaded
assumption
that
the
appellant
and
Trilogy
were
not
at
arm's
length
he
should
have
said
so
in
his
pleadings.
Counsel
for
the
appellant
contended
that
if
the
respondent
was
going
to
take
a
position
that
was
contrary
to
an
assumption
made
on
assessing
the
respondent
should
have
so
pleaded
and
assumed
the
onus
of
rebutting
the
assumption.
The
ruling
I
made
pleased
no
one.
I
ruled
that
it
was
not
necessary
for
either
party
to
amend
the
pleadings
and
that
counsel
for
the
respondent
could
cross-
examine
the
appellant
in
an
attempt
to
establish
that
he
was
in
fact
dealing
at
arm's
length
with
Trilogy.
To
permit
or
require
an
amendment
to
the
pleadings
at
this
late
stage
would
nave
delayed
the
trial
and
would
not
have
been
in
the
interests
of
justice.
Section
7
is
not
a
complex
section
and
in
determining
the
manner
of
its
application
the
question
whether
a
transferor
and
transferee
are
or
are
not
dealing
at
arm's
length
is
an
essential
ingredient
that
could
not
have
escaped
the
notice
of
the
senior
and
experienced
counsel
who
appeared
in
the
case.
Procedural
and
evidentiary
skirmishes
should
not
be
allowed
to
impede
the
business
of
hearing
and
disposing
of
an
appeal.
This
interesting
and
somewhat
unusual
procedural
wrangle
does
however
put
a
novel
twist
on
the
role
of
assumptions
in
income
tax
litigation.
We
have
an
assessment
under
subsection
245(2)
based
upon
a
factual
and
essential
assumption
that
the
parties
to
the
transaction,
the
appellant
and
Trilogy,
were
not
dealing
at
arm's
length.
On
objection
and
at
trial
the
Crowndevelopeda
new
theory
of
the
case
that
was
based
on
a
fundamentally
different
premise,
that
there
was,
in
substance,
and
notwithstanding
the
interposition
of
the
numbered
company,
an
arm's
length
transfer
of
the
options
by
the
appellant
to
Trilogy,
giving
rise
to
an
immediate
inclusion
under
paragraph
7(1)(L>)
in
the
appellant's
income
of
an
amount
equal
to
the
value
of
the
Trilogy
shares
received.
The
pleading
of
assumptions
in
income
tax
appeals
can
be
traced
to
the
statement
of
Rand
J.
in
Johnston
v.
M.N.R.,
[1948]
S.C.R.
486,
[1948]
C.T.C.
195,
3
D.T.C.
1182,
at
pages
489-90
(C.T.C.
202-03,
D.T.C.
1183):
Notwithstanding
that
it
is
spoken
of
in
section
63(2)
as
an
action
ready
for
trial
or
hearing,
the
proceeding
is
an
appeal
from
the
taxation;
and
since
the
taxation
is
on
the
basis
of
certain
facts
and
certain
provisions
of
law
either
those
facts
or
the
application
of
the
law
is
challenged.
Every
such
fact
found
or
assumed
by
the
assessor
or
the
Minister
must
then
be
accepted
as
it
was
dealt
with
by
these
persons
unless
questioned
by
the
appellant.
If
the
taxpayer
here
intended
to
contest
the
fact
that
he
supported
his
wife
within
the
meaning
of
the
Rules
mentioned
he
should
have
raised
that
issue
in
his
pleading,
and
the
burden
would
have
rested
on
him
as
on
any
appellant
to
show
that
the
conclusion
below
was
not
warranted.
For
that
purpose
he
might
bring
evidence
before
the
Court
notwithstanding
that
it
had
not
been
placed
before
the
assessor
or
the
Minister,
but
the
onus
was
his
to
demolish
the
basic
fact
on
which
the
taxation
rested.
The
allegations
necessary
to
the
appeal
depend
upon
the
construction
of
the
statute
and
its
application
to
the
facts
and
the
pleadings
are
to
facilitate
the
determination
of
the
issues.
It
must,
of
course,
be
assumed
that
the
Crown,
as
is
its
duty,
has
fully
disclosed
to
the
taxpayer
the
precise
findings
of
facts
and
rulings
of
law
which
have
given
rise
to
the
controversy.
[Emphasis
added.]
The
practice
in
the
courts
as
it
relates
to
the
Minister’s
assumptions
has
developed
over
the
years.
In
M.N.R.
v.
Pillsbury
Holdings
Ltd.,
[1964]
C.T.C.
294,
64
D.T.C.
5184
(Ex.
Ct.),
Cattanach
J.
at
page
302
(D.T.C.
5188),
after
quoting
from
the
reasons
of
Rand
J.
in
Johnston
stated:
The
respondent
could
have
met
the
Minister’s
pleading
that,
in
assessing
the
respondent,
he
assumed
the
facts
set
out
in
paragraph
6
of
the
notice
of
appeal
by:
(a)
challenging
the
Minister's
allegation
that
he
did
assume
those
facts,
(b)
assuming
the
onus
of
showing
that
one
or
more
of
the
assumptions
was
wrong,
or
(c)
contending
that,
even
if
the
assumptions
were
justified,
they
do
not
of
themselves
support
the
assessment.
(The
Minister
could,
of
course,
as
an
alternative
to
relying
on
the
facts
he
found
or
assumed
in
assessing
the
respondent,
have
alleged
by
his
notice
of
appeal
further
or
other
facts
that
would
support
or
help
in
supporting
the
assessment.
If
he
had
alleged
such
further
or
other
facts,
the
onus
would
presumably
have
been
on
him
to
establish
them.
In
any
event,
the
Minister
did
not
choose
such
alternative
in
this
case
and
relied
on
the
facts
that
he
had
assumed
at
the
time
of
the
assessment.)
A
further
refinement
in
the
extensive
body
of
jurisprudence
relating
to
assumptions
and
onus
in
income
tax
appeals
is
found
in
the
Federal
Court
of
Appeal
decision
in
Pollock
v.
Canada,
[1994]
1
C.T.C.
3,
[1993]
94
D.T.C.
6050
(F.C.T.D.).
There
the
taxpayer
contended
that
it
was
sufficient
for
him
to
demolish
some
of
the
assumptions
made
by
the
Minister
(including
some
that
were
not
even
pleaded).
The
Court
of
Appeal
said
at
pages
7-8
(D.T.C.
6053):
As
I
understand
him,
appellant's
counsel
takes
the
position
that
where
some
of
the
Minister’s
assumptions
are
successfully
demolished
by
a
taxpayer,
the
Minister’s
position
must
necessarily
fail
unless
he
can
show
that
the
assumption
or
assumptions
that
remain
are
in
and
of
themselves
enough
to
support
the
assessment.
In
my
view,
this
contention
is
wrong
and
is
founded
upon
a
misapprehension
as
to
the
respective
roles
of
pleadings
in
general
and
the
assumptions
made
by
the
Minister
in
taxation
cases
in
particular.
It
is,
of
course,
the
general
rule
that
every
party
to
litigation
in
this
Court
must
plead
the
facts
upon
which
he
relies
in
such
a
way
as
to
put
his
opponent
fairly
on
notice
of
the
case
he
has
to
meet.
Where
a
party's
pleadings
are
so
inadequate
as
to
disclose
no
case
at
all
he
runs
the
risk
of
having
them
struck
out
and
of
losing
for
that
reason.
That
rule
is
quite
irrelevant
here.
There
is
no
question
in
the
present
case
of
the
Minister’s
pleadings
being
inadequate
or
of
the
appellant
not
knowing
clearly
and
beyond
any
possibility
of
doubt
the
basis
upon
which
he
was
reassessed.
That
basis
was
and
is
that
the
appellant's
dealings
in
shares
of
the
companies
in
question
constituted
for
him
an
adventure
in
the
nature
of
trade
so
as
to
make
the
profits
therefrom
taxable
as
income.
The
special
position
of
the
assumptions
made
by
the
Minister
in
taxation
litigation
is
another
matter
altogether.
It
is
founded
on
the
very
nature
of
a
self-reporting
and
selfassessing
system
in
which
the
authorities
are
obliged
to
rely,
as
a
rule,on
the
disclosures
made
to
them
by
the
taxpayer
himself
as
to
facts
and
matters
which
are
peculiarly
within
his
own
knowledge.
When
assessing,
the
Minister
may
have
to
assume
certain
matters
to
be
different
from
or
additions
to
what
the
taxpayer
has
disclosed.
While
the
Minister’s
assumptions,
if
any,
are
generally
made
in
the
pleadings,
that
is
not
always
the
case
and
we
have
seen,
in
this
very
record,
an
example
of
the
taxpayer
taking
pains
to
demolish
assumptions
which
the
Minister
had
not
pleaded.
Where
pleaded,
however,
assumptions
have
the
effect
of
reversing
the
burden
of
proof
and
of
casting
on
the
taxpayer
the
onus
of
disproving
that
which
the
Minister
has
assumed.
Unpleaded
assumptions,
of
course,
cannot
have
that
effect
and
are
therefore,
in
my
view,
of
no
consequence
to
us
here.
The
burden
cast
on
the
taxpayer
by
assumptions
made
in
the
pleadings
is
by
no
means
an
unfair
one:
the
taxpayer,
as
plaintiff,
is
contesting
an
assessment
made
in
relation
to
his
own
affairs
and
he
is
the
person
in
the
best
position
to
produce
relevant
evidence
to
show
what
the
facts
really
were.
Where,
however,
the
Minister
has
pleaded
no
assumptions,
or
where
some
or
all
of
the
pleaded
assumptions
have
been
successfully
rebutted,
it
remains
open
to
the
Minister,
as
defendant,
to
establish
the
correctness
of
his
assessment
if
he
can.
In
undertaking
this
task,
the
Minister
bears
the
ordinary
burden
of
any
party
to
a
lawsuit,
namely
to
prove
the
facts
which
support
his
position
unless
those
facts
have
already
been
put
in
evidence
by
his
opponent.
This
is
settled
law.
In
no
case
of
which
I
am
aware,
including
the
numerous
cases
to
which
the
Federal
Court
of
Appeal
referred
in
a
footnote
to
the
passage
which
I
have
cited,
has
this
specific
issue
arisen,
which
I
shall
endeavour
to
enunciate
as
follows:
Where
the
Minister
bases
an
assessment
on
a
particular
assumption
of
fact
(in
this
case,
the
non-arm's
length
relationship
between
the
appellant
and
Trilogy
as
a
necessary
ingredient
to
the
application
of
subsection
245(2))
and,
in
confirming
the
assessment
and
at
trial
abandons
the
original
basis
of
assessment
and
advances
a
new
reason
for
supporting
the
assessment
(i.e.,
paragraph
7(1)(b))
in
which
an
essential
fact
(i.e.
that
the
appellant
and
Trilogy
were
at
arm's
length)
is
contrary
to
the
original
assumption:
(a)
may
the
appellant
rely
upon
the
unpleaded
assumption
in
his
defence
against
the
new
basis;
and
(b)
must
the
Crown
plead
the
new
fact
and
does
it
have
the
onus
of
establishing
The
answer
to
these
questions,
based
on
the
principles
established
in
Johnston
and
Pillsbury,
is
that
the
appellant
may
rely
upon
an
unpleaded
assumption
in
support
of
his
case
and
unless
the
respondent
establishes
that
the
assumption
is
wrongand
that
there
are
new
facts
that
support
the
assessment
on
a
different
basis,
the
appellant
must
succeed.
The
non-arm’s
length
relationship
between
the
appellant
and
Trilogy
(Johnston,
supra):
found
or
assumed
by
the
assessor
or
the
Minister
must
then
be
accepted
as
it
was
dealt
with
by
these
persons
unless
questioned
by
the
appellant.
Here
the
appellant,
far
from
questioning
the
original
unpleaded
assumption,
relies
on
it
to
destroy
the
very
factual
underpinning
of
the
new
basis
advanced.
The
only
difference
between
assumptions
that
the
Crown
chooses
to
disclose
in
the
reply
and
those
that
it
does
not
is,
as
stated
in
Pollock,
supra,
that
unpleaded
assumptions
cast
no
onus
on
the
appellant.
The
pleading
of
assumptions
is
no
more
than
the
fulfilment
of
the
Crown's
obligation
to
disclose
fully
the
basis
of
the
assessment.
Since
pleaded
assumptions
are
in
the
nature
of
particulars
it
is
incumbent
upon
the
Crown
to
plead
honestly
and
fully
all
of
the
assumptions
relevant
to
the
assessment.
If
a
new
basis
of
upholding
the
assessment
is
conceived
after
the
assessment
is
made
and
is
advanced
at
trial
and
the
original
assumptions
are
inconsistent
with
that
new
basis
they
must
nonetheless
be
disclosed
in
the
reply
and
the
Crown
must
undertake
the
task
of
establishing
that
the
original
assumptions
were
wrong.
It
would
be
inappropriate
if
the
Crown
were
to
obtain
a
tactical
advantage
by
failing
to
disclose
in
its
reply
assumptions
that
are
embarrassing
or
irrelevant
to
its
new
theory
of
the
case
or,
as
is
the
case
here,
inconsistent
with
that
new
theory.
Where
the
Minister
bases
an
assessment
on
a
particular
assumption
of
fact
and
in
the
confirmation
of
that
assessment
after
objection
and
at
trial
advances
a
new
factual
basis
for
the
assessment
that
is
the
reverse
of
that
assumption,
although
the
respondent
must
plead
and
prove
the
new
basis,
counsel
for
the
respondent
need
not
necessarily
call
witnesses
for
that
purpose.
He
or
she
can
endeavour
to
establish
the
new
fact
in
the
cross-examination
of
the
appellant’s
witnesses.
In
the
particular
circumstances
of
this
case
and
in
light
of
the
novelty
of
the
point
I
did
not
require
counsel
for
the
respondent
to
amend
his
reply.
In
the
normal
course,
however,
a
new
factual
basis
for
assessing
should
be
pleaded.
Even
if
I
am
wrong
in
believing
that
the
original
assumptions
survive
their
abandonment
by
the
Crown
and
may
be
relied
upon
by
the
appellant
to
attack
the
assessment
on
the
basis
set
forward
in
paragraph
(c)
in
the
passage
from
Pillsbury,
supra,
quoted
above,
the
fact
nonetheless
remains
that
the
Crown
has
the
onus
of
establishing
any
new
ground
advanced
to
uphold
the
assessment.
I
do
not
think
that
it
has
met
that
onus.
The
evidence
is
more
consistent
with
the
position
taken
on
assessing
that
Mr.
Bowens
was
not
dealing
at
arm's
length
with
Trilogy.
He
was
a
partner
in
the
Delta
partnership
which,
with
othercorporations,
raised
capital
and
promoted
the
acquisition
by
Trilogy
of
the
shares
of
DEB
and
of
other
oil
and
gas
interests.
Mr.
Bowens
was,
since
1982,
an
executive
vice-president
of
Trilogy
and
was
active,
indeed
instrumental,
in
formulating
the
exchange
offer
made
by
Trilogy
for
the
shares
and
options.
I
need
not
repeat
the
detailed
reasons
set
forth
in
Exhibit
A-15.
They
were
not
rebutted
by
the
respondent
and
they
were
supported
by
Mr.
Bowens’
viva
voce
testimony.
It
follows
therefore
that
even
if,
as
the
respondent
contends,
Mr.
Bowens,
in
transferring
the
options
to
the
numbered
company
for
shares
and
subsequently
selling
the
shares
to
Trilogy,
can
be
said
to
have
"transferred
or
otherwise
disposed
of"
the
options
to
Trilogy,
he
did
not
do
so
to
a
person
with
whom
he
was
dealing
at
arm's
length
and
accordingly
paragraph
7(1)(b)
has
no
application.
The
appellant
also
contended
that,
even
if
he
were
dealing
at
arm's
length
with
Trilogy,
in
transferring
the
options
to
the
numbered
company
and
in
subsequently
selling
its
shares
to
Trilogy,
he
did
not
"transfer
or
otherwise
dispose
of"
the
options
to
Trilogy.
If
one
looks
solely
at
the
form
of
the
transaction
the
appellant's
position
is
obviously
correct.
On
the
other
hand
the
broad,
"substance
versus
form"
approach
advocated
by
the
Crown
would
involve
essentially
the
erasure
of
the
numbered
company.
The
company,
it
is
true,
served
no
purpose
other
than
that
of
a
vehicle
or
repository
for
the
options.
Nonetheless
it
was
not
suggested
that
the
transaction
with
287495
Alberta
Inc.
was
either
a
sham
or
legally
ineffective.
The
company
dealt
with
the
options
as
its
own
and,
in
fact,
subsequently
agreed
to
their
cancellation.
While
it
might
be
tempting
to
excise
what
may
be
seen
as
an
unnecessary
proliferation
of
corporate
entities,
the
principle
that
substance
must
prevail
over
form
does
not
extend
to
the
ignoring
of
legally
effective
relationships
or
properly
constituted
legal
entities.
Absent
sham,
the
legally
effective
form
of
a
transaction
must,
for
income
tax
purposes,
be
respected.
In
Canada
v.
Irving
Oil
Ltd.,
[1991]
1
C.T.C.
350,
91
D.T.C.
5106
(F.C.A.),
the
Federal
Court
of
Appeal
recognized
the
legal
validity
of
relations
with
an
offshore
subsidiary
whose
sole
raison
d'être
was
to
avoid
tax.
If
anything,
Irvcal’s
ownership
of
the
oil
was
far
more
tenuous
and
ephemeral
than
the
numbered
company's
ownership
of
the
options.
Leave
to
appeal
to
the
Supreme
Court
of
Canada
was
denied.
The
principle
to
be
deduced
from
the
authorities
relating
to
substance
versus
form
is
simply
this:
the
essential
nature
of
a
transaction
cannot
be
altered
for
income
tax
purposes
by
calling
it
by
a
different
name.
It
is
the
true
legal
relationship,
not
the
nomenclature
that
governs.
The
Minister,
conversely,
may
not
say
to
the
taxpayer
"You
used
one
legal
structure
but
you
achieved
the
same
economic
result
as
that
which
you
would
have
had
if
you
used
a
different
one.
Therefore
I
shall
ignore
thestructure
you
used
and
treat
you
as
if
you
had
used
the
other
one”.
In
light
of
these
observations
I
cannot
accept
the
respondent's
position
that
the
existence
of
and
the
legal
relations
with
the
numbered
company
can
be
ignored
and
the
transaction
treated
as
a
direct
sale
of
the
options
by
the
appellant
to
Trilogy.
The
alternative
position
under
section
6
was
not
pressed
with
vigour,
and
rightly
so,
in
my
view,
in
light
of
paragraph
7(3)(a).
The
grant
by
DEB
of
the
options
to
the
appellant
was
the
type
of
agreement
contemplated
by
subsection
7(3)
and
this
fact
alone
displaces
section
6.
As
it
happens,
however,
paragraph
7(1)(b)
was
inapplicable.
This
in
itself
does
not
of
course
propel
the
taxpayer
into
section
6.
For
all
of
the
above
reasons
the
appeal
is
allowed
with
costs
and
the
assessment
referred
back
to
the
Minister
or
National
Revenue
for
reconsideration
and
reassessment
to
delete
from
the
appellant's
income
for
1983
the
sum
of
$69,238.
Appeal
allowed.
Harvey
A.
McLachlin
and
Pearl-Anne
Dick-McLachlin
v.
Her
Majesty
[Indexed
as:
McLachlin
(H.A.)
v.
Canada]
Tax
Court
of
Canada
(O'Connor
J.T.C.C.),
August
5,
1993
(Court
File
Nos.
93-437,
93-505)
Income
tax—Federal—Income
Tax
Act,
R.S.C.
1952,
c.
148
(am.
S.C.
1970-71-72,
The
appellants
were
husband
and
wife.
During
the
1987,
1988
and
1989
taxation
years,
the
female
appellant
("the
wife")
(a)
in
partnership
with
her
husband
owned
until
July
1989
a
triplex
("the
triplex"),
two
units
being
rented
out
and
the
third
being
occupied
since
sometime
in
1984
until
July
1987
as
a
principal
residence;
(b)
also
in
partnership
with
her
husband
acquired
land
at
Hurd's
Lake,
Ontario
("Hurd's
Lake"),
built
a
home
thereon,
apparently
as
a
principal
residence,
then
converted
it
to
a
duplex
and
rented
out
one
storey,
occupying
since
July
1987
the
other
storey
as
a
principal
residence;
(c)
operated
a
tax
preparation
business;
and
(d)
was
a
real
estate
sales
representative
on
a
commission
basis.
In
computing
their
income,
the
appellants
claimed
numerous
deductions
which
were
disallowed
by
the
Minister.
The
items
in
dispute
related
to
the
disallowance
of
expenses
generally,
the
calculation
of
a
capital
gain
realized
on
the
sale
of
one
property,
the
capital
cost
of
building
a
second
property
and
whether
interest
on
a
loan
was
deductible.
HELD:
Although
the
decision
related
to
numerous
different
items,
many
issues
were
resolved
by
agreement
and
others
were
of
no
particular
interest.
Those
items
of
interest
were
as
follows:
(1)
the
appellants'
expenditure
of
$4,670
in
the
1987
taxation
year
for
the
replacement
of
carpeting
and
vinyl
flooring
with
respect
to
the
triplex
was
fully
deductible
in
1987
from
the
triplex
rentals
because
the
expenditure
was
in
the
nature
of
maintenance
expense;
(2)
the
appellants’
mileage
expense
of
$1,062.92
with
respect
to
Hurd's
Lake
was
disallowed
because
of
the
lack
receipts
and
the
likelihood
that
the
expenses
were
personal
in
nature;
(3)
the
advertising
and
promotion
expenses,
the
wage
expense,
and
the
office
expenses
claimed
with
respect
to
the
wife's
tax
preparation
business
were
not
allowed
because
they
were
not
supported
by
receipts;
(4)
the
wife's
claim
with
respect
to
the
tax
preparation
business
for
capital
cost
allowance
on
the
husband's
car
which
the
husband
allegedly
used
to
pick
up
tax
returns
was
not
allowed
because
the
wife
could
not
claim
capital
cost
allowance
on
a
vehicle
owned
by
her
husband;
(5)
the
wife
was
entitled
to
deduct
$718.75
in
1987,
$1,477.17
in
1988
and
$945.13
in
1989
with
respect
to
advertising
and
promotion
expenses
with
respect
to
her
real
estate
business
because
a
deduction
of
five
per
cent
of
gross
commissions
was
reasonable;
(6)
the
wife
was
entitled
to
deduct
80
per
cent
of
her
automobile
expenses
for
each
of
1987,
1988
and
1989
with
respect
to
her
real
estate
business;
and
(7)
the
interest
on
the
additional
$26,905.56
by
which
the
appellants
increased
their
mortgage
loan
on
the
triplex
was
not
deductible
against
the
triplex
because
there
was
no
evidence
that
it
had
been
used
for
the
purpose
of
earning
income
from
a
business
or
property;
the
interest
was,
however,
deductible
from
the
rentals
at
Hurd’s
Lake.
Appeal
allowed
in
part.
Pearl-Anne
Dick-McLachlin,
agent
for
the
appellants.
Heather
Hemphill
for
the
respondent.
O'Connor
J.T.C.C.:—These
matters
were
heard
together
and
on
common
evidence
by
consent
of
the
parties
in
Ottawa,
Ontario,
on
July
12,
1993.
They
are
appeals
pursuant
to
the
informal
procedure
of
this
Court
and
concern
the
appellants'
1987,
1988
and
1989
taxation
years.
The
appellants
are
husband
and
wife.
During
the
whole
or
part
of
the
years
under
review
the
appellant
Pearl-Anne
Dick-McLachlin
("Pearl"),
(a)
in
partnership
with
her
husband
Harvey
A.
McLachlin
("Harvey")
owned
until
July,
1989
a
triplex
at
98,
98A
and
100
Graham
Avenue,
Renfrew,
Ontario
(“Graham
Avenue"),
two
units
being
rented
out
and
the
third
being
occupied
since
sometime
in
1984
until
July
1987
as
a
principal
residence;
(b)
also
in
partnership
with
Harvey
acquired
land
at
Hurd's
Lake,
Ontario
("Hurd's
Lake’’),
built
a
home
thereon,
apparently
as
a
principal
residence,
then
converted
it
to
a
duplex
and
rented
out
one
storey,
occupying
since
July
1987
the
other
storey
as
a
principal
residence;
(c)
operated
a
tax
preparation
business
("tax
preparation
business”);
and
(d)
was
a
real
estate
broker
on
a
commission
basis
("real
estate
operation").
In
filing
income
tax
returns
consider-
able
expenses
have
been
claimed
relating
to
the
foregoing
operations
and
many
of
those
expenses
have
been
challenged
by
the
respondent.
There
were
also
disputes
as
to
the
calculation
of
the
capital
gain
realized
on
the
sale
of
Graham
Avenue,
the
capital
cost
of
the
building
at
Hurd's
Lake
and
whether
interest
on
a
certain
loan
was
deductible
from
the
rentals
at
Graham
Avenue.
The
sections
of
the
Income
Tax
Act,
R.S.C.
1952,
c.
148
(am.
S.C.
1970-71-72,
c.
63)
(the
"Act")
most
relevant
to
the
determination
of
the
issues
in
this
appeal
are
18(1)(a),
18(1)(b),
18(1)(h),
20(1
)(a),
20(1)(c)(i)
and
40(2)(b)
which
provide
as
follows:
18(1)
In
computing
the
income
of
a
taxpayer
from
a
business
or
property
no
deduction
shall
be
made
in
respect
of
(a)
an
outlay
or
expense
except
to
the
extent
that
it
was
made
or
incurred
by
the
taxpayer
for
the
purpose
of
gaining
or
producing
income
from
the
business
or
property;
(b)
an
outlay,
loss
or
replacement
of
capital,
a
payment
on
account
of
capital
or
an
allowance
in
respect
of
depreciation,
obsolescence
or
depletion
except
as
expressly
permitted
by
this
Part;
(h)
personal
or
living
expenses
of
the
taxpayer,
other
than
travelling
expenses
incurred
by
the
taxpayer
while
away
from
home
in
the
course
of
carrying
on
his
business;
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:
(a)
such
part
of
the
capital
cost
to
the
taxpayer
of
property,
or
such
amount
in
respect
of
the
capital
cost
to
the
taxpayer
of
property,
if
any,
as
is
allowed
by
regulation;
(c)
an
amount
paid
in
the
year
or
payable
in
respect
of
the
year
(depending
upon
the
method
regularly
followed
by
the
taxpayer
in
computing
his
income),
pursuant
to
a
legal
obligation
to
pay
interest
on
(i)
borrowed
money
used
for
the
purpose
of
earning
income
from
a
business
or
property
(other
than
borrowed
money
used
to
acquire
property
the
income
from
which
would
be
exempt
or
to
acquire
a
life
insurance
policy),
40(2)
Notwithstanding
subsection
(1),
(b)
where
the
taxpayer
is
an
individual,
his
gain
for
a
taxation
year
from
the
disposition
of
a
property
that
was
his
principal
residence
at
any
time
after
the
date,
(in
this
section
referred
to
as
the
“acquisition
date")
that
is
the
later
of
December
31,
1971
and
the
day
on
which
he
last
acquired
or
reacquired
it,
as
the
case
may
be,
is
his
gain
therefore
for
the
year
otherwise
determined
minus
that
proportion
thereof
that
(i)
one
plus
the
number
of
taxation
years
ending
after
the
acquisition
date
for
which
the
property
was
his
principal
residence
and
during
which
he
was
resident
in
Canada,
is
of
(ii)
the
number
of
taxation
years
ending
after
the
acquisition
date
during
which
he
owned
the
property
whether
jointly
with
another
person
or
otherwise;.
.
.
The
issues
are
as
follows.
Some
were
resolved
prior
to
and
during
the
trial
but
all
are
mentioned
so
as
to
enable
the
Minister
to
make
a
complete
reassessment.
1.
With
respect
to
Graham
Avenue
(a)
The
parties
disagree
on
the
treatment
of
an
expenditure
by
the
appellants
in
the
1987
taxation
year
of
$4,670
for
the
replacement
of
carpeting
and
vinyl
flooring.
The
appellants
desire
to
treat
this
as
an
expense
deductible
in
1987
and
the
respondent
submits
that
it
is
a
capital
outlay
principally
because,
in
the
respondent's
submission,
it
was
made
to
improve
the
property
to
make
it
more
saleable.
The
property
actually
was
sold
in
July
1989.
The
appellants
have
testified
that
the
installation
of
the
new
carpeting
and
flooring
was
simply
to
replace
the
former
items
which
had
become
worn
and
that
the
quality
of
the
materials
was
equal
rather
than
superior
to
that
of
the
former
items.
They
have
also
submitted
as
Exhibit
A-1
a
document
signed
by
the
installer,
Mid-Town
Flooring
and
Furnishings,
supporting
their
testimony.
The
Court
accepts
the
position
of
the
appellants
and,
having
reviewed
the
applicable
authorities
and
jurisprudence,
concludes
that
the
expenditure
of
$4,670
was
in
the
nature
of
a
maintenance
expense
fully
deductible
in
1987
from
Graham
Avenue
rentals.
(b)
An
earlier
disagreement
between
the
parties
as
to
the
fair
market
value
of
the
lot
remaining
at
Graham
Avenue
after
the
sale
in
1989
has
been
resolved
by
both
parties
agreeing
to
an
amount
of
$5,000.
(c)
As
to
the
calculation
of
the
principal
residence
exemption
in
relation
to
the
capital
gain
realized
in
1989
on
the
sale
of
Graham
Avenue
the
appellants
submitted
that
they
resided
there
for
six
months
in
1987
and
the
respondent
submits
that
it
was
only
five
months.
The
Court
accepts
the
sworn
testimony
of
Pearl
that
the
period
of
residence
was
six
months
in
1987.
(d)
A
further
disagreement
as
to
the
treatment
of
interest
deductibility
is
dealt
with
in
paragraph
5
below.
2.
With
respect
to
Hurd's
Lake
(a)
The
respondent
has
allowed
a
previously
disputed
$400
expense
for
wood
in
1987.
(b)
The
appellants
and
the
respondent
have
agreed
that
the
capital
cost
of
the
building
at
Hurd's
Lake
totals
$62,642.86,
one
half,
i.e.,
$31,321.43
for
each
of
the
two
appellants.
(c)
An
additional
maintenance
expense
of
$93
raised
at
the
hearing
of
this
appeal
has
been
allowed
by
the
respondent.
(d)
With
respect
to
certain
1988
repair
expenses
at
Hurd's
Lake
the
difference
between
what
the
respondent
would
allow
and
what
the
appellants
claimed
was
$296.34.
The
respondent
was
prepared
to
accept
a
figure
of
$148.17
and
owing
to
the
lack
of
receipts
or
indications
of
what
the
receipts
represented
the
Court
agrees
that
the
correct
figure
be
$148.17.
(e)
Although
not
claimed
on
the
appellants’
financial
statements
they
have
on
the
appeals
claimed
a
mileage
expense
relative
to
Hurd's
Lake
of
$1,062.92.
This
the
respondent
has
refused
and
the
Court,
owing
to
lack
of
receipts
and
the
likelihood
that
the
expenses
were
personal
in
nature,
agrees
with
the
respondent.ip3.
With
respect
to
the
taxation
business
carried
on
by
Pearl:
(a)
The
respondent
disallowed
portions
of
"Advertising
and
Promotion"
expenses
claimed
in
the
1987,
1988
and
1989
years.
The
amounts
disallowed
were
$269.35
in
1987;
$1,169,
$339.27
and
$307.80
in
1988
and
$931.09
in
1989.
According
to
the
evidence
given
by
Ms.
Christine
Buck,
auditor
for
the
respondent
who
examined
all
available
receipts
and
questioned
Pearl
on
nonreceipted
items,
the
amounts
disallowed
appeared
to
be
of
a
personal
as
opposed
to
a
business
nature.
The
Court
is
prepared
to
accept
the
position
of
the
respondent
on
all
these
expenses;
(b)
The
respondent
disallowed
a
wage
expense
of
$510
claimed
in
the
1987
year
as
no
receipt
or
other
evidence
was
submitted
by
Pearl;
the
latter
main-
tained
that
this
item
represented
cash
wages
paid
to
a
person
who
later
moved
abroad
and
could
not
be
reached.
It
is
the
burden
on
the
appellant
to
prove
an
expenditure
and
in
the
present
instance
this
burden
has
not
been
discharged
and
consequently
the
disallowance
of
$510
is
found
to
be
correct;
(c)
The
respondent
disallowed
an
amount
of
$1,000
claimed
in
each
of
the
1988
and
1989
years
as
capital
cost
allowance
on
Harvey's
car
which
he
allegedly
used
to
pick
up
tax
returns
and
other
documents
from
clients
of
Pearl.
This
amount
has
been
properly
disallowed
by
the
respondent
because
Pearl
cannot
claim
capital
cost
allowance
on
a
vehicle
owned
by
her
husband
nor
is
she
entitled
to
consider
it
a
"freight"
expense,
as
she
suggested
at
trial,
because
no
payment
to
the
husband
was
made.
Nor
is
Pearl
entitled
tothe
additional
mileage
expense
claims
presented
immediately
prior
to
the
trial
of
$1,152
for
1988
and
$1,000
for
1989
because,
in
the
Court's
opinion,
the
respondent
has
properly
allowed
all
claimable
car
expenses
such
as
gas
and
oil
bills
and
consequently
the
additional
mileage
expenses
are
not
admissible;
(d)
The
respondent
originally
disallowed
certain
maintenance
expenses
claimed
for
1988
but
at
trial
reduced
the
total
disallowed
amount
to
$140.
Owing
to
the
fact
that
the
receipts
produced
relative
to
this
amount
of
$140
indicate
they
did
not
relate
to
the
business,
the
disallowance
of
this
amount
of
$140
is
maintained;
(e)
The
respondent
disallowed
as
office
expenses
an
amount
of
$792.07
and
a
further
claim
of
$386.13.
The
Court
agrees
with
these
disallowances
owing
to
absence
of
receipts,
or
lack
of
indication
on
the
receipts
of
details
proving
a
business
relationship
or
because
it
seems
many
items
appear
to
be
of
a
personal
nature.
(f)
A
1988
expense
of
$329
for
a
phone
has
been
allowed
by
the
respondent.
(g)
A
claim
by
Pearl
for
the
capitalization
of
that
portion
of
the
Graham
Ave.
used
as
an
office
for
the
tax
preparation
business
(i.e.,
'/3
of
the
unit
occupied
by
the
appellants
as
a
principal
residence)
has
been
allowed
by
the
respondent.
It
must
be
noted
that
in
agreeing
with
most
of
the
respondent's
disallowances,
the
Court
has
taken
into
consideration
the
relatively
small
gross
revenues
realized
by
Pearl's
tax
preparation
business
($4,350
in
1987,
$6,110
in
1988
and
$7,185
in
1989)
and
the
fact
that
the
respondent
has
allowed
numerous
other
deductions
which
were
claimed.
4.
With
respect
to
the
real
estate
operations
carried
on
by
Pearl
(a)
The
respondent
has
disallowed
the
following
amounts
claimed
as
"Advertising
and
Promotion",
namely
$1,041
in
1987
(of
an
amount
claimed
of
$1,320.92),
$2,516.16
in
1988
(of
an
amount
claimed
of
$3,190.16)
and
$2,877
in
1989
(of
an
amount
claimed
of
$2,877).
The
reasons
for
the
disallowances
are
similar
to
those
expressed
above,
namely
the
absence
of
receipts
in
some
cases,
lack
of
detail
in
others
and
a
conclusion
that
the
expenses
were
more
of
a
personal
than
business
nature
in
some
cases.
In
reviewing
these
items
the
Court
recognizes
that
Pearl
was
essentially
an
independent
real
estate
agent
working
strictly
on
a
commission
basis.
She
was
responsible
for
her
own
advertising
and
promotion
and
she
submits
this
involved
entertaining
clients,
prospective
clients
and
other
contacts
in
the
real
estate
field.
In
the
circumstances
the
Court
believes
that
some
higher
amount
of
the
expenses
claimed
should
be
allowed
in
the
circumstances.
The
Court
observes
that
the
gross
commissions
earned
were
$14,374.90
in
1987,
$29,543.50
in
1988
and
$18,902.70
in
1989.
If
a
factor
of
five
per
cent
of
gross
commissions,
which
the
Court
considers
appropriate,
were
to
be
used
the
advertising
and
promotion
expenses
allowable
would
be
$718.75
in
1987,
$1,477.17
in
1988
and
$945.13
in
1989.
The
Court
considers
this
reasonable
and
so
rules.
(b)
The
respondent
has
allowed
50
per
cent
of
automobile
expenses
for
each
of
1987,
1988
and
1989
and
Pearl
claims
90
per
cent.
She
points
out
that
her
car
is
indispensable
to
carry
out
her
real
estate
duties
and
testified
that
she
may
have
used
it
as
much
as
99
per
cent
for
business
purposes.
The
respondent
points
out
that
much
of
the
travel
relates
to
trips
from
Renfrew,
where
Pearl
lived,
to
Ottawa
and
back
and
that
a
largeportion
of
those
trips
should
be
considered
as
personal
driving
to
and
from
work
as
opposed
to
driving
while
working.
Ottawa
is
not
a
major
location
for
Pearl’s
sales
of
real
estate
but
she
testified
that
she
had
to
go
there
frequently
to
meet
clients
and
contacts
and
arrange
mortgage
financing.
The
Court
recognizes
some
validity
in
both
positions
and
concludes
that
the
proper
percentage
to
be
used
is
80
per
cent.
The
Court
also
finds
that
the
only
individual
items
of
car
expense
not
allowed
by
the
respondent
of
$750,
$205.60
and
$300
are
to
be
allowed;
5.
Deductibility
of
Interest
(a)
In
1987
the
appellants
increased
their
mortgage
loan
on
Graham
Avenue
from
$43,094.44
to
$70,000,
an
increase
of
$26,905.56
and
they
seek
to
deduct
the
interest
on
the
said
$26,905.56
from
the
rentals
of
Graham
Avenue
with
respect
to
parts
of
1987
and
1989
and
all
of
1988.
The
respondent
has
disallowed
the
deductions
because
they
were
not
interest
on
money
borrowed
for
the
purpose
of
earning
income
from
a
business
or
property.
What
were
the
funds
used
for?
Pearl
testified
that
when
the
property
was
acquired
in
1984
she
alone
out
of
her
own
available
funds
made
the
down
payment
of
$15,375
and
to
that
extent
the
additional
funds
borrowed
were
paid
to
her,
i.e.,
not
one
half
to
her
and
one
half
to
Harvey.
In
the
Court's
view
this
payment
does
not
result
in
a
conclusion
that
the
interest
on
said
amount
constitutes
interest
on
money
borrowed
to
produce
income.
It
would
be
different
if
she
had
originally
borrowed
the
$15,375
with
interest.
In
that
event
the
$15,375
would
be
considered
as
replacement
financing
and
the
interest
thereon
would
normally
be
deductible.
The
balance
of
the
$26,905.56,
namely
$11,530.56,
the
appellants
submit
was
used
to
pay
for
repairs
and
maintenance,
the
acquisition
of
equipment
and
appliances
and
other
miscellaneous
items,
all
with
regard
to
Graham
Avenue.
The
respondent
submits
that
most
of
the
$26,905.56,
and
therefore,
at
the
very
least,
the
said
$11,530.56
was
used
to
construct
the
property
at
Hurd's
Lake.
This
appears
to
be
the
case
from
an
examination
of
withdrawals
from
the
bank
account
into
which
the
$26,905.56
was
deposited.
The
respondent
further
argues
that
the
rentals
from
Graham
Avenue
could
easily
have
supported
these
expenses
of
$11,530.56
and
that
therefore
there
was
no
need
to
borrow.
After
considering
the
testimony
and
reviewing
certain
exhibits
the
Court
concludes
that
the
respondent
is
correct
and
that
the
interest
on
the
$26,905.56
is
not
deductible
from
the
Graham
Avenue
rents.
The
respondent
agreed
that
such
interest
could
be
deducted
from
the
rentals
at
Hurd's
Lake.
(b)
The
respondent
has
attempted
to
allocate
interest
charged
on
two
visa
accounts
and
a
checking
account
in
each
of
the
1987,
1988
and
1989
years
in
varying
percentages
to
the
four
operations
discussed
above.
The
amounts
of
interest
(which
are
not
great)
have
been
agreed
on
but
the
respondent
has
assessed
the
said
amounts
as
25
per
cent
business
and
75
per
cent
personal
and
based
on
the
evidence
submitted
the
Court
finds
the
respondent's
assessments
correct.
Appeal
allowed
in
part.