Hazlewood v. The Queen, 89 DTC 5537, [1990] 1 CTC 5 (FCTD)

Joyal, J.:—This is an action instituted by the plaintiff in 1977 and which finally came on for trial in Vancouver on October 3, 1989. It is an income tax matter relating to the taxation years 1970 and 1971. In each of those years, the Minister of National Revenue had disallowed certain capital cost allowances claimed by the plaintiff and had added other amounts to income which the plaintiff had not disclosed. Furthermore, as regards the plaintiff's tax return for the year 1971, the Minister had levied a penalty on the taxpayer of $1,385.73 pursuant to subsection 163(2) of the Income Tax Act, S.C. 1970-71-72, c. 63 and a penalty of $538.90 under section 19 of the British Columbia Income Tax Act.

For the year 1970, the spread between the plaintiff's tax return and the Minister’s reassessment was as follows:

Both reassessments were dated May 23, 1975. Notices of objection were filed concurrently and the actions before this Court were instituted on January 13, 1977. At trial, both proceedings were heard on common evidence.

The main points at issue between the parties is on the item of business losses for the year 1970 and 1971 and on the item of professional income for the year 1971. With respect to business losses in both years, the defendant argues that these arise from a capital cost allowance on an asset in which the plaintiff's cost is but a small proportion of the total value of the asset. With respect to professional income for 1971, the defendant argues that the increase of $17,032 is effectively taxable income which the plaintiff failed to disclose.

As set out in the statements of claim for each of the two years, the plaintiff not only disputes the grounds on which the reassessments were made but raises several other issues as well.

These issues may be summarized as follows:

1. The reassessments themselves are invalid and null on the grounds that they were purportedly made under the authority of a Deputy Minister of National Revenue for Taxation who had ceased at the time to hold office.

2. A counsel for the Crown in respect of another trial in which the plaintiff had been involved as instructing counsel had threatened the plaintiff with charges of fraud or misrepresentation;

3. A departmental assessor, in the course of that other trial, had vowed to get even with the plaintiff.

4. The reassessments were not made in good faith.

At the beginning of the trial before me, plaintiff raised each of the foregoing issues and added even more serious ones. He stated that the departmental assessor, in the course of the earlier trial, had solicited a $10,000 bribe and that Crown counsel had acted throughout in a most unprofessional or fraudulent manner in regard to it. The plaintiff further added that the defendant's actions throughout the years 1975 to 1989 had been vexatious, scandalous and of a nature to subvert his rights to a proper and expeditious trial.

The parties agreed that the Court should first of all proceed with those preliminary matters, hear evidence on the most unusual allegations raised by the plaintiff and proceed later on with the merits of the case.

The only evidence adduced by the plaintiff was by way of his own bold statements, all of which were denied by the two individuals the plaintiff had charged. I found that not only were the plaintiff's accusations bereft of any corroboration but where there was objective documentary evidence in the record relating to the whole history of the proceedings to date, such evidence was inconsistent with the alleged derelictions of duty having taken place. I found the accusations all the more grievous as they were directed by a former practising member of the bar who was presumably trained to appreciate and understand the full impact of his words on the reputation and well-being of others.

After observing the plaintiff's conduct and behaviour during that part of the trial, I could only suspect that the plaintiff, who had long harboured a grudge towards tax officials, had slowly become convinced that he was being persecuted. This created a predisposition to interpret certain comments made to him or certain facts he might have observed as containing elements of malfeasance or misfeasance which, through the passage of time, he came to view as objectively true. The events to which the plaintiff had referred had after all taken place in 1974, some 15 years earlier. I felt, at the time I made my ruling, that this suspected condition was the most I could express to attenuate somewhat the plaintiff's disturbing behaviour.

On the claim by the plaintiff that his rights had been breached, he adduced neither evidence nor argument. With particular reference to the lengthy delays in having the tax issue come to trial, I could only conclude on the evidence before me that such delays were of the plaintiff's own choosing. After all, throughout that long period of time, he had the carriage of the action and the initiative remained his to take more expeditious steps in the proceedings leading to trial.

As regards the claim that the reassessments themselves were null and void, I could only subscribe to the argument of defendant's counsel when he referred to the provisions of the Income Tax Act, specifically subsection 152(8), section 166, subsection 244(13) and subsection 244(16). Subsection 152(8) makes it clear that an assessment is ”. . .. deemed to be valid and binding notwithstanding any error, defect or omission therein . . .”. Subsection 244(13) is to the same effect and declares that any departmental document, including an assessment, shall be deemed to have been properly executed unless it has been called into question by the Minister or by some person acting for him or Her Majesty.

Counsel for the defendant had also referred to the case of M.N.R. v. United Auto Parts Limited, [1961] C.T.C. 439; 61 D.T.C. 1259 and to the more recent case of Walter P. Swyryda v. The Queen, 81 D.T.C. 5109. On the basis of these authorities, I declared that the reassessments were valid and of full force and effect.

I now come to the merits of the plaintiff’s case on these reassessments for the years 1970 and 1971. As I have observed earlier, the plaintiff's challenges centre on the capital cost allowance for the years 1970 and 1971 and on the additional professional income attributed to him for the year 1971.

On this last issue, the evidence found in Exhibit P-1, Tabs 61, 62 and 66, as well as in the documents filed pursuant to what is now subsection 170(2) of the Act, relates to the financial records of the law partnership into which the plaintiff was admitted in 1964 and from which he retired in 1971. These statements clearly indicate the plaintiff's revenue account and capital account during the term of the partnership. At the termination of the partnership, the capital account of the plaintiff stood at $13,313 and this amount was paid to him on May 10, 1971. According to the evidence of the local assessor who inspected the partnership books, this cheque bore a notation to the effect that one-quarter share of accounts and work-in-progress as at March 31, 1971, was to follow. In due course, a further $17,032 was paid by the firm to the plaintiff.

The plaintiff argues that these statements are not correct or do not disclose other provisions of the verbal partnership agreement in which he had entered. As I understand the thrust of the plaintiff's evidence in that respect, it was to establish that, in the course of his practising years, there were verbal arrangements whereby his share of partnership earnings would be discounted with the balance being credited to capital. This balance would represent accruals on capital account to pay for the value of work-in- progress and, I presume, accounts receivable outstanding on the date when he first entered the partnership. This capital account accumulated over the years 1964-1971. On leaving the partnership, this capital was repaid to him. As a consequence, only the amount he declared in his tax return for the year 1971 constituted earned income for tax purposes, the balance representing a return of capital.

The partnership accounts for 1965 show $1,110.46 of undistributed income to the plaintiff’s account with that amount being applied on the note payable to the partnership in the amount of $12,000. For the year 1966, the same item amounted to $2,257.37. For 1967, the figure was $4,067.67, and for 1968, it amounted to $4,553.24. By that time, I calculate that the original $ 12,000 note to buy into the partnership had been discharged and thereafter, any taxable but undistributed earnings accrued to the plaintiff's capital account.

Accordingly, the share of earnings accruing to the plaintiff for the year 1969, after provision for his periodic drawings, represented a current capital account of $3,740.58.

In 1970, the plaintiff's current capital account stood at $3,261 and in 1971, it had increased to $4,968. If this amount is added to the fixed capital amount of $7,000, and I will concede the evidence on this is not clear, it might account for the capital pay-out of $13,313 made to the plaintiff in May of 1971.

There is admittedly some plausibility to the plaintiff's own interpretation of his arrangements with the firm. As the financial statements disclose, the firm operated throughout on a cash basis as was permitted during the years in question. When the plaintiff entered the partnership, he began to enjoy his share of work-in-progress and accounts receivable. One might assume that he would have to pay for this one way or another, especially if, as records disclose, he should have become entitled to the same kind of share upon leaving the partnership.

It is equally plausible of course that when the plaintiff entered the partnership, he brought with him his own clientele, files, work-in-progress and accounts receivable which had accumulated over his previous years of practice and these were fed into the partnership hopper. In this fashion, one would cancel the other out.

The plaintiff provided the Court with no corroborative evidence as to the scheme which allegedly was in place in that respect. No support evidence was given by his former partners. This should not surprise anyone as it was in the interest of these remaining partners to pay off the plaintiff out of revenue and not out of capital.

The plaintiff, as a result, stands alone in his assertions. He has offered no objective evidence that he had paid his way into the partnership and could therefore consider that the pay-out on his leaving constituted a capital receipt. There is one element, however, in his evidence which appears to be confirmed by the firm's financial statements. His admission to partnership, called for a capital contribution of some $12,000. This was no more, no less than the amount of capital standing in the name of each of his partners indicating, prima facie, an equal participation of 25 per cent in the earnings of the firm. The firm records, however, indicate that the plaintiff did not share profit in this manner. His share was incremental beginning with a 15 per cent in 1965 and thereafter increasing by 1.5 per cent from year to year until it was expected to reach the target area of 25 per cent in 1971 or 1972. Such an arrangement could conceivably lead the plaintiff to believe that over those years, he had effectively “paid” the work-in-progress and receivables which the firm disbursed to him when he left the partnership. This view of the evidence is consistent with the notation found by the defendant's assessor in reviewing the firm’s books. It is not a view which is material to the defendant's findings that such pay-out was of an income nature, but that is another matter.

What it does raise, in my respectful opinion, is serious doubt as to whether a penalty is justified. Subsection 163(3) of the federal statute and section 19 of the provincial statute, impose on the defendant the burden of proving that a false return was made "knowingly" or under circumstances amounting to gross "negligence". This is obviously not a matter of gross negligence and the facts do not bear it out.

On the issue of whether the plaintiff made the false return "knowingly", the explanations he has offered, buttressed by some hard evidence before me, leads me to conclude that the case for a penalty is not made out.

The standard of proof required under this, as well as many other similar provisions in statutes where penalties are involved, might still be a matter of debate. It has been said that the standard of proof is one beyond a reasonable doubt with the burden resting on the complainant throughout. It has also been said that the fact of a statement being false shifts the burden, as it were, on a defendant to provide some explanation. Even if one should side with this interpretation leaving aside for the moment the more stringent rule, I should find that the explanation offered by the plaintiff is sufficiently of an exculpatory nature that I should rescind the penalty imposed. There is some consistency between his belief and the more objective evidence before me to give weight to what might otherwise be regarded as mere selfserving assertions.

On the legitimacy of the defendant's assessment, however, I can find nothing wrong. To find otherwise I would have to rule that the plaintiff's purchase of work-in-progress and receivables came out of after-tax income. In effect, I find that if there was indeed such a purchase, it would necessarily have come from pre-tax earnings otherwise distributable to him by the firm. The hard evidence is that it did not.

The other issue before the Court concerns the application of those provisions of the Income Tax Act, 1952, relating to capital cost allowance. On June 1, 1970, the plaintiff, together with five other individuals and one business corporation, entered into a partnership to carry on the business of operating an apartment property in Burnaby, B.C. Concurrently, the partnership and the business corporation, namely Elgara Enterprises Ltd., entered into a Declaration of Trust whereby that company thereafter held the property in trust for the partnership. Furthermore, the Declaration contemplated that a limited partnership would be formed consisting of the existing partners as limited partners and Elgara Enterprises Ltd. as general partner.

This limited partnership was declared on December 9, 1970 and was to terminate on January 1, 1973. The plaintiff contributed capital in the amount of $500 to the partnership. The business corporation, Elgara Enterprises Ltd. reserved the right to purchase the plaintiff's share on January 1, 1973 for the sum of $100.

For the year 1970, the limited partnership, now called Elgara Enterprises, prepared a financial statement showing revenue of $51,700 and expenses of $102,570.93 of which $53,761 was made up of depreciation or capital cost allowance. The plaintiff, in his tax return for that year, claimed a business loss of $7,267.22 representing his share of the loss suffered by the limited partnership. The same procedure was followed in 1971 and again the plaintiff claimed his proportionate share of the partnership's business loss, this time in the amount of $6,397.92.

In a notice of reassessment for each of the years 1970 and 1971, the defendant disallowed the claim for capital cost allowance on the grounds that such a claim was limited to an allowance based on the capital contribution by the plaintiff to the partnership of $500, i.e., reducing the allowance claimed to $39.67 for 1970 and $35.70 for 1971.

In assessing as it did, the defendant applied paragraph 11(1)(a) which provides that there may be deducted from the income of a taxpayer for a taxation year "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".

The defendant made a finding that the capital cost to the taxpayer, as that expression is found in paragraph 11(1)(a), was limited to his exposure or risk. The realistic situation, according to defendant's counsel, could only lead one to conclude that at the most, the plaintiff at that time faced perhaps contingent liabilities but nothing more.

The plaintiff asserted that he had signed a short-term bank note for $10,000 on behalf of the partnership. He also noted that legal fees in the amount of $12,000 owing to him or his firm had been at risk. He further argued that at least for the period ending December 9, 1970, his risk was total. There was no limitation of liability during that period of time.

I am unable to give great weight to the plaintiff's evidence in that regard. His evidence as to the note is in conflict with the evidence he gave on discovery. Professional fees owing to him or his firm have no relevancy to the issue. The risk of not being paid had nothing to do with his $500 capital contribution. As to any other kind of risk, I cannot subscribe to any proposition whereby the plaintiff would assume liabilities and at the same time grant the business corporation the right to purchase his share two years later for $100. As to the unlimited risk to which he became exposed over the period June to December, 1970, the Partnership Declaration, by itself, is of no weight. The December document is the material one.

It was stated by Addy, J. In Lipper v. The Queen, [1979] C.T.C. 316; 79 D.T.C. 5246 at pages 319-20 (D.T.C. 5248):

Although it is clear that there is an absolute liability of the partnership under both agreements to Potterton to pay the balance due on both films in 1982, it is equally clear that, at law, the liability rests entirely and exclusively on the general partner and not on the taxpayer, a limited partner. The only remaining liability of the limited partner is the contingent one to which I have already referred which is not to be taken into account unless and until the contingency arises. A taxpayer cannot at law, in the absence of any specific statutory provision to the contrary, claim any part of a capital cost allowance which is based exclusively on another taxpayer's liability to pay. It matters not what the taxpayer's proportion of interest in the asset might be. The question is to be decided on the basis of its cost to him. As my brother Cattanach, J. stated in the case of Morris Besney v. Her Majesty The Queen [1974] CTC 54; 73 DTC 5592 at p 62 (5599):

In my view both the plaintiff and Milton had an interest in the land at all relevant times, but that the capital cost allowance which the plaintiff is entitled to claim as a deduction does not turn upon the proportionate interest in the land but upon the respective contributions to the capital cost made by the plaintiff and Sorokin.

The same principle is also found in an earlier case, Paquin v. M.N.R. decided by the Tax Review Board and reported at [1974] C.T.C. 2181; 74 D.T.C. 1142.

In Raessler v. M.N.R., [1984] C.T.C. 2575; 84 D.T.C. 1516, Christie, C.J.T.C., endorsed the principle that a taxpayer cannot escape the limitations on the "capital cost to him" under the statute when the taxpayer in a partnership arrangement assumes merely a contingent liability. This was the view which had been adopted by the Federal Court of Appeal in the case of Mandel v. The Queen, [1978] C.T.C. 780; 78 D.T.C. 6518 and which was later confirmed by the Supreme Court of Canada at [1980] C.T.C. 130; 80 D.T.C. 6148.

It is true that most of the cases dealing with capital cost allowance schemes raise issues of fact and that the conclusions reached on the basis of these facts do not necessarily give rise to general doctrine or principles applicable to others. I should observe, however, that in investigating these facts, courts have not hesitated in discarding appearances and endorsing realities. Courts have dissected the purported characteristics of an arrangement to arrive at its objective nature and purpose.

On the facts before me, limited and somewhat confused as they are, I can only conclude that there was no exposure to the plaintiff beyond the $500 capital contribution he made to the partnership. I do not see where any risk was involved beyond that amount.

I would go further. I fail to see in the scheme the necessary ingredients to establish a proper business purpose. Such a finding may not be material to the case before me but I should doubt that a total of $3,500 of capital contributed to an investment, which was as tottering on the brink of disaster as was alleged by the plaintiff, could have provided the investment with a second life.

I should therefore conclude that the plaintiff has failed to make out a case against the defendant's reassessment in respect of the allowable capital costs to the plaintiff for the taxation years 1970 and 1971.

The plaintiff, in the course of the trial, alleged that certain expense and revenue items in the Elgara Enterprises limited partnership which the de- fendant applied in determining taxable income in the hands of the plaintiff were wrongly allocated. The plaintiff's evidence in that respect is lacking in either credibility or clarity. I should therefore not disturb the defendant's findings except to observe that, as a general principle, partnership income allocation formula, as applied to the plaintiff, should be based on the same formula as that which might have been made to apply to the other partners.

When dealing with preliminary issues which were raised at the trial, I referred to an earlier case in which the plaintiff had participated as instructing counsel. This is the case of E/gara Enterprises Ltd. v. The Queen which is reported at [1974] C.T.C. 642; 74 D.T.C. 6500. This was a tax matter involving the determination as to whether the profit realized on the sale of an apart ment building by Elgara Enterprises Ltd. in 1966 constituted income or a capital gain. There is reference in the judgment of Mahoney, J., as he then was, to the partnership "Elgara Enterprises", and the plaintiff, in his own case, seemed to take a great deal of comfort from it.

Mahoney, J. does refer to the transaction involving this partnership. Nevertheless, at page 647 (D.T.C. 6504), he says the following:

The tax implications of these transactions for the plaintiff and its partners are not presently in issue and I do not have to consider them except as evidence material to the acquisition and disposition of the Lugano by the plaintiff.

I should therefore conclude that this Court is dealing with a completely different issue and whatever material findings Mahoney, J. might have made in the earlier case do not touch upon my disposition of this one.

I should therefore conclude as follows:

1. The plaintiff's appeal against his reassessment for the year 1970 is dismissed.

2. The plaintiff's appeal against his 1971 reassessment is allowed in part and the penalty imposed by the defendant under both federal and provincial statutes is rescinded.

3. As the parties’ success is divided as between the years 1970 and 1971, I should make no order as to costs.

Appeal allowed in part.