Citation: 2009 TCC 394
Date: 20090806
Docket: 2005-4132(IT)G
BETWEEN:
JACK RICHER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Jorré J.
I. Introduction
[1]
This case involves the
debt forgiveness provisions of the Income Tax Act (the “ITA”).
[2]
This case arises from
the Appellant’s participation in four limited partnerships, litigation
regarding the Appellant’s liability for capital contributions to those
partnerships and the settlement of that litigation.
[3]
The two principal issues
that arise are: what was the amount of the Appellant’s debt, and when did the
settlement occur?
[4]
Under the terms of the
settlement the Appellant paid US$1 million and gave up certain rights. The
Appellant takes the position that the settlement entered into represented a
determination of the amount of the debt and that in consequence no debt was
forgiven. Alternatively, the Appellant takes the position that, if any amount
was forgiven, it was much less than computed by the Minister.
[5]
The Minister takes the
position that at the time of the settlement the Appellant’s debt was just over
US$2 million and that an amount of just over US$1 million was
forgiven.
[6]
Additional issues are
whether the Appellant could deduct certain partnership losses in 1996 and
whether the assessment of penalties was justified.
II. Facts
[7]
The Appellant is a
chartered accountant by training, although he has not been practising as such
since 1986. Presently he is occupied as a businessman involved in various
investments. His involvement in the limited partnerships central to this appeal
arose from his relationship with the Bronfman family. The Appellant explained
that he had participated in various investments with Charles Bronfman and other
individuals since the mid-1970s. These investments took various forms including
joint ventures, limited partnerships and corporations.
[8]
The financial affairs
of the Bronfman family were managed through Claridge Investments Ltd.
(“Claridge”). In 1985, the Bronfman family changed the manner in which its real
estate investment activities were conducted. A subsidiary of Claridge called
Claridge Properties Inc. (“Claridge Properties”) was created. It was agreed that
the Appellant would take part in future real estate investments through limited
partnerships operated by Claridge Properties.
[9]
In 1985 and 1986, the
Appellant became a limited partner in four such partnerships: Livonia
Associates and Company Ltd. (“Livonia”), Park Square Associates and Company
Ltd. (“Park Square”), Hickory Associates and Company Ltd. (“Hickory”) and The
Southland Building Partners and Company Ltd. (“Southland”). These limited
partnerships were formed for the purpose of acquiring and operating specific
real estate properties located in the United States.
[10]
Whereas prior to that
time when taking part in investments with Charles Bronfman he had invested his
own funds directly or money would be jointly borrowed from a bank, it was
agreed that the Appellant’s capital contribution to these four partnerships
would be funded by Claridge Properties. Under this new arrangement, Claridge
Properties provided capital to the limited partnerships in exchange for demand
interest-bearing promissory notes from each limited partner, including the
Appellant.
[11]
From time to time the
Appellant was asked to sign promissory notes in respect of amounts beyond those
initially agreed to. The Appellant testified that every six months, Claridge
Properties would issue a statement showing the amount of funds invested and
request a note from each of the partners in respect of any additional funds
contributed on their behalf.
[12]
Mr. Andrew Parsons, a
chartered accountant who was employed at Claridge up until 2004, testified for
the Minister. During his 23-year relationship with Claridge, he occupied
various positions including controller and senior vice‑president, finance,
and chief financial officer. Mr. Parsons explained that at the end of each
financial year, each partner would be asked to cover his proportionate share of
any deficit in the partnership accounts.
The reason for this was that once a partnership had acquired real estate, any
subsequent operating loss had to be funded in some way. According to Mr.
Parsons, this is how Claridge Properties ran all of its partnerships.
[13]
The effect of this
arrangement was that the Appellant would recognize his increased indebtedness
to Claridge Properties by signing promissory notes after the fact.
[14]
The terms of the
Appellant’s involvement in the four partnerships were not set down in formal
written partnership agreements, but instead agreed to verbally and by
handshake. The constitution of each limited partnership as well as the initial
capital contribution of each partner is outlined in four separate declarations
of limited partnership, however these documents do not reflect the arrangement
regarding subsequent contributions described above. The handshake
agreements also appear to have included certain other arrangements between the
parties.
[15]
The Appellant explained
that according to the agreed-upon arrangement, every six months he received
distributions of any income earned by the partnerships, along with statements
in respect of interest owing on the invested funds and any requests as to
further promissory notes. This continued until late 1989, by which time the
Appellant had signed promissory notes in favour of Claridge Properties
totalling US$1,209,266 as follows:
|
Limited partnership
|
Promissory notes
|
|
Southland
|
$194,500
|
|
Livonia
|
$273,000
|
|
Park Square
|
$213,188
|
|
Hickory
|
$528,578
|
|
Total of notes signed
|
US$1,209,266
|
[16]
With the exception of Livonia, the partnerships lost money due to declining real
estate values. Towards the end of 1989, an agreement was proposed that would
allow the Appellant to withdraw from the partnerships. The Appellant testified
that in early 1990, it had been verbally agreed that his liability to Claridge
Properties in respect of the funds advanced on his behalf would be discharged
in exchange for the transfer of his interest in the partnerships to Claridge
Properties plus the payment by him to Claridge Properties of the sum of US$187,000.
[17]
However, no final agreement
was reached to resolve the Appellant’s involvement in the partnerships or his
liability to Claridge Properties. No payment of US$187,000 was made by the
Appellant, and negotiations regarding the details of his withdrawal continued
through 1991; however, beginning in January 1990, the Appellant no longer
received requests regarding the payment of interest or requests that he
acknowledge further indebtedness in respect of subsequent contributions made by
Claridge Properties.
[18]
The matter remained
unresolved, and ultimately Claridge Properties instituted proceedings in the Québec
Superior Court against the Appellant in 1992.
[19]
In those proceedings,
Claridge Properties took the position that no agreement was ever reached with the
Appellant regarding his withdrawal from the partnerships, and claimed in
aggregate US$1,723,857.48. This figure represented what Claridge Properties had
determined at that time to be the Appellant’s total indebtedness in respect of
amounts advanced to fund his interest in the four partnerships. Claridge
Properties’ claim included amounts allegedly advanced to the partnerships on the
Appellant’s behalf, for which no promissory notes had been signed. These
amounts were included based on the understanding Claridge Properties had of the
verbal agreements described above regarding subsequent contributions of capital,
as it was admitted that no written agreement existed in respect of them.
[20]
The Appellant’s
position in defence of these claims is set out in a pretrial brief filed in the
Québec Superior Court in May 1996. His primary position was, as he testified in
this Court, that an agreement had been made to settle his liability in respect
of his involvement in the partnerships for the amount of US$187,000.
[21]
The Appellant took a
number of subsidiary positions as well. It is useful to reproduce the following
paragraphs from his pretrial brief:
Defendant contends that his liability towards Plaintiff was settled
and transacted and that in virtue of the agreement between the parties the only
amount owed by Defendant, and the only amount that Plaintiff is entitled to
claim from him, is the aforesaid sum of US $187,000.
Subsidiarily, it is Defendant’s position that he is not
liable for the full amounts claimed by the Plaintiff in its actions. In this
regard, Defendant states that his liability is limited either to the amounts
set out in the promissory notes or the amounts set out in the confirmations of
indebtedness produced by Plaintiff . . . .
If, however, it is determined that his liability was not
extinguished or transacted as aforesaid, Defendant is entitled to offset from
the total amount claimed by Plaintiff the value of his interest in the
properties as established in the reconciliation . . ., namely US $1,258,000.
Without prejudice to the foregoing, in the Livonia action . . . Defendant
claims compensation between any amount that he may be condemned to pay to
Plaintiff and the value of his interest in the said property, US $729,000, and
demands that Plaintiff be condemned to pay to him the sum of US $546,000.
[22]
Consistent with these
subsidiary positions, the Appellant filed four countersuits against Claridge
Properties, Charles Bronfman, Livonia, Hickory and other
related parties. The documents relating to these lawsuits were not put before
me. However, the Appellant testified that he sued for enforcement of the
agreement to settle his liability for the amount of US$187,000; for the amount
of US$456,000 he claimed he was owed on account of his involvement in Livonia and for the diminution in value of the properties
suffered by him due to the actions of Claridge Properties.
[23]
On December 19, 1996, the
Appellant and Claridge Properties entered into an agreement (the “Settlement
Agreement”) to settle their respective claims. The following paragraphs of the Settlement
Agreement are significant:
WHEREAS Claridge and Richer are parties to the
proceedings described on Schedule 2 to this Agreement and,
contemporaneously with the execution of this Agreement, have agreed to settle
their respective claims pursuant to such proceedings in consideration of the
payment by Richer to Claridge of the sum of $1,000,000 in United States
currency on the terms and conditions hereinafter set forth;
. . .
2. Claridge agrees that it shall cause Richer’s capital
accounts in respect of the Partnerships to be netted to $0.00 in the case of
each of the Partnerships. In consideration of such agreement, Richer agrees
that he is not entitled to any positive balances which are now or at any time
in the future may be in the capital accounts of any of the Partnerships,
which may be applied by Claridge to the netting of accounts as aforesaid, and Richer
transfers and assigns absolutely to Claridge all of his right and entitlement
to any distributions of cash or other assets to which he is now or at any time
in the future may be entitled as a partner of any of the Partnerships. . . .
Claridge acknowledges that Richer is not liable for any deficiency in the
capital accounts of any of the Partnerships.
. . .
4. Richer shall pay to Claridge, on or before January 8,
1997, the sum of $1,000,000 in United States currency, by certified cheque or bank draft. Richer acknowledges
that he has signed a confession of judgment for such amount, and further
acknowledges that should he fail to pay the amount of $1,000,000 in United States currency on or before January
8, 1997, Claridge may at any time thereafter obtain judgment upon such
confession of judgment, time being of the essence. Claridge acknowledges that
Richer’s payment pursuant to this paragraph is made without admission of
liability with regard to any amounts claims [sic] in the proceedings
described on Schedule 2.
. . .
6.
Claridge and Richer acknowledge that they
have signed a mutual release and discharge, a copy
of which is annexed hereto as Schedule 3.
[Emphasis added.]
[24]
I note that in addition
to agreeing to the US$1 million payment, the Appellant gave up his
interests in the partnership and his claims against Claridge and others.
[25]
This Settlement
Agreement was entered into contemporaneously with a Mutual Release and
Discharge (“Release”) that was signed by all the parties on December 19, 1996
and provided, inter alia:
For good and valuable consideration, the receipt and sufficiency
whereof is hereby acknowledged, Richer, for himself, his heirs, predecessors, successors
and assigns, hereby grants unto the Claridge Parties and each of them
release and discharge from any and all claims, actions, causes of action,
suits, debts, demands and damages whatsoever which Richer ever had, now has or
which he or his heirs, predecessors, successors and assigns hereafter can,
shall or may have against the Claridge Parties or any of them for or based
upon or by reason of any fact, matter, transaction or thing alleged in the
proceedings described in the Schedule attached hereto.
[Emphasis added.]
[26]
Pursuant to the terms
of the Settlement Agreement, the Appellant paid US$1 million to Claridge
Properties by cheque dated January 6, 1997. The confession of judgment referred
to was in consequence never registered.
[27]
The Appellant’s and
Claridge Properties’ legal representatives also executed a “Declaration of
Settlement Out of Court”. This document was signed by the Appellant’s lawyer on
December 20, 1996 and by Claridge Properties’ lawyer on January 7, 1997.
[28]
In his 1996 tax return,
the Appellant took the position that he was entitled to claim losses of C$215,740
in respect of his interests in Park
Square and Southland. He
explained that his position was based on his understanding that under the Settlement
Agreement his at-risk amount in those partnerships had increased. Prior to
1996, the Appellant had not deducted these losses because his understanding was
that his at-risk amount was nil for each of these two partnerships.
[29]
By notices of reassessment
issued on December 12, 2000, the Minister reassessed the Appellant for his
1993, 1995, 1996, 1997, 1998 and 1999 taxation years.
[30]
First, the Minister
disallowed the partnership losses claimed by the Appellant in 1996, on the
basis that no further capital contributions had been made by the Appellant or
on his behalf.
[31]
Second, the Minister
determined that the Appellant incurred a gain (the forgiven amount) in 1997 of C$1,368,528
on the settlement of his debt to Claridge Properties. This figure was based on
the following accounting prepared by Claridge Properties respecting the Appellant’s
liability in U.S. dollars:
|
|
Balance
Owing
Oct.
31/96
|
Capital
Contribution Dec. 96
|
Settlement
Jan. 97
|
Receipt
Distribution Dec. 96
|
Write-off
|
Balance
Owing
Oct.
31/97
|
|
Southland
|
275,632
|
238,632
|
(514,264)
|
0
|
0
|
0
|
|
Livonia
|
273,000
|
0
|
(155,369)
|
(117,631)
|
0
|
0
|
|
Park
Square
|
363,421
|
76,462
|
(330,366)
|
|
(109,517)
|
(1)
|
|
Hickory
|
609,216
|
88,725
|
|
|
(697,941)
|
0
|
|
Interest
receivable
|
193,220
|
|
|
|
(193,220)
|
0
|
|
Subtotal
US$
|
1,714,489
|
403,819
|
(1,000,000)
|
(117,631)
|
(1,000,679)
|
(1)
|
[32]
This chart had been
submitted to the Minister in the course of an audit it conducted of Claridge
Properties.
To arrive at C$1,368,528, the Minister converted the US$1,000,679 write-off
calculated by Claridge Properties into Canadian dollars at an exchange rate of
approximately 1.37 (being the rate accepted by the Minister as applicable in
January 1997).
[33]
The Minister applied
this gain first against the Appellant’s net capital losses carried forward and
second, against the capital cost of his depreciable property as follows:
|
Net capital losses
|
Amount
|
|
Reduction of net capital losses to be carried forward (from 1993-1995-1996)
|
C$89,469
|
|
Reduction of capital cost of the Appellant’s depreciable property
as of December 31, 1996
|
C$1,279,061
|
|
Total
|
C$1,368,529
|
[34]
The effect of these adjustments
is reflected in the remaining reassessments. In 1997 and 1998, the Minister
disallowed capital cost allowance deductions that had been claimed, and in 1999
the Minister refused to allow the carryforward of capital losses experienced
prior to the settlement.
[35]
In addition, the
Minister also levied penalties pursuant to subsection 163(2) of the ITA
on the additional taxable income resulting from the 1997, 1998 and 1999
reassessments.
[36]
There will be reference
to further facts in the analysis section below.
III. Issues
[37]
The issues are:
(a) Whether the Minister
correctly applied section 80, and more specifically:
(i) Timing — In what year does section 80 apply?
(ii) Was an amount
forgiven? If an amount was forgiven, what was the amount? In turn, this raises
the questions:
- What was the amount of the
debt?
- Apart from the US$1 million
payment, did the Appellant provide any other consideration as part of the
settlement?
(b) Whether the Appellant
is entitled to deduct losses of C$215,740 in respect of his interests in Park Square and Southland.
(c) Whether the Minister
was justified in assessing penalties against the Appellant pursuant to
subsection 163(2).
IV. Analysis
SECTION 80
[38]
Section 80 of the ITA
contains rules that apply where commercial obligations are forgiven or reduced.
The “forgiven amount” is applied to reduce the debtor’s losses carried forward
from preceding taxation years and various other amounts as provided in
subsections 80(3) to (12). If any portion of the forgiven amount remains unapplied,
the debtor is subject to an income inclusion in accordance with subsection
80(13). As provided by paragraph 80(2)(c), the provisions in subsections
80(3) to (13) must be applied in numerical order.
[39]
Subsection 80(3)
concerns the reduction of non-capital losses, and provides in part as follows:
(3) Reductions of non-capital losses – Where a commercial
obligation issued by a debtor is settled at any time, the forgiven amount at
that time in respect of the obligation shall be applied to reduce at that time,
in the following order,
(a) the debtor’s non-capital loss for each taxation year that
ended before that time . . .
(b) the debtor’s farm loss for each taxation year that ended
before that time . . .
(c) the debtor’s restricted farm loss for each taxation year
that ended before that time . . .
[40]
Similarly, subsection 80(4)
provides in relevant part:
(4) Reductions of capital losses – Where a commercial
obligation issued by a debtor is settled at any time, the applicable fraction
of the remaining unapplied portion of a forgiven amount at that time in respect
of the obligation shall be applied to reduce at that time, in the following
order,
(a) the debtor’s non-capital loss for each taxation year that
ended before that time . . .
(b) the debtor’s net capital loss for each taxation year that
ended before that time . . .
[41]
After subsection 80(4)
is applied, the taxpayer has the option of applying any remaining unapplied
portion of the forgiven amount against certain balances, such as the
undepreciated capital cost balances for depreciable property, in accordance
with certain provisions of subsections 80(5) to (12). If there remains a
portion of the forgiven amount unapplied and the taxpayer chooses not to make
the designations required by those provisions, the taxpayer will be subject to
an income inclusion in accordance with subsection 80(13).
[42]
The “forgiven amount”
is defined in subsection 80(1), to the extent relevant to the present appeal,
as follows:
“forgiven amount” at any time in respect of a commercial obligation
issued by a debtor is the amount determined by the formula
A – B
where
A is the lesser of the amount for which the obligation was issued
and the principal amount of the obligation, and
B is the total of
(a) the amount, if any, paid at that time in
satisfaction of the principal amount of the obligation,
. . .
[43]
Counsel for the
Appellant challenged the Minister’s application of section 80 on two grounds.
First, he argued that no forgiven amount arose on the settlement of the Appellant’s
debt to Claridge Properties or, alternatively, that the amount forgiven was
significantly less than the C$1,368,529 assumed by the Minister.
[43]
[44]
Secondly, he submitted
that, even if it is determined that an amount was forgiven, that event occurred
in December 1996 and not in January 1997 as assumed by the Minister. As a
result, counsel took the position that the reassessments made by the Minister
are incorrect and in contravention of the provisions of section 80. In oral
argument, counsel framed this argument in terms of the Minister having assessed
the wrong year.
Timing
[45]
It is clear that in
applying the debt forgiveness provisions in subsections 80(3) to (13), the
forgiven amount must be determined at the time the obligation is settled.
[46]
The Minister took the
position that the Appellant’s debt to Claridge Properties was settled in 1997,
focussing on the fact that it was not until January 1997 that the cheque for US$1 million,
dated January 6, was processed. The theory proposed by the Minister was that
there could not have been a reduction of the indebtedness of the Appellant in
this case until that amount was paid by the cheque, and that only then was the
debt settled for the purposes of section 80.
[47]
The Minister argued, as
I understand it, that the test was twofold. First, the debt must be settled or
extinguished.
[48]
Secondly, because of
the definition of “forgiven amount” in subsection 80(1) and, in particular, the
reference in “B” of the definition to the “amount, if any, paid” there can be
no forgiven amount until the amount is paid. The Minister argued:
. . . the forgiveness happens when the amount is paid. Because we
know that when an amount is paid and it’s for the full indebtedness there is no
forgiven amount obviously. There has to be a partial amount that is paid.
So in order for the Minister to set or to evaluate if there is a
forgiven amount, the amount had to be paid because when we look at the
definition of forgiven amount it says it’s A minus B, B being (a) the amount,
if any, paid at that time in satisfaction of the principal amount of the
obligation.
So if no amount is paid it can’t be taken into account in the
evaluation of the forgiven amount. And it’s only at that time it can be
realized or the Minister can realize if there is a forgiven amount or not.
. . . Our theory on this is . . . there could not have been a
reduction of the indebtedness of Mr. Richer in this case until the amount was
paid. And that’s when the debt is settled, pursuant to section 80 of the Act.
[49]
I do not agree.
[50]
Paragraph 80(2)(a)
provides that for the purposes of section 80:
an obligation issued by a debtor is settled at any time
where the obligation is settled or extinguished at that time . . .
[51]
In the context of
section 80, the word “settle” connotes a final and legally binding resolution
that terminates or reduces the debtor’s obligations: Carma Developers Ltd.
v. The Queen, 96 DTC 1798 (TCC), per Bowman J. (as he then was) at paragraph
23, affirmed 96 DTC 6569 (FCA). Similarly, in Arcade Construction Ltd. v.
M.N.R., 81 DTC 655 (TRB), M.J. Bonner (as he then was) held, at 656, that a
debt or obligation was settled when the “. . . creditor and debtor
deliberately agree to fix or vary their existing rights and obligations
. . .”.
[52]
In my view, the
combined effect of the Settlement Agreement and the Release, both signed on
December 19, 1996 had the effect of terminating the Appellant’s liability under
the promissory notes and all other amounts associated with his participation in
the four partnerships. The following paragraphs from the Release illustrate
this point:
For good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged, Claridge Properties Ltd. [and
other parties] (hereinafter the “CLARIDGE PARTIES”) hereby grant unto
Jack Richer (“RICHER”), for themselves, their heirs, predecessors,
successors and assigns, release and discharge from any and all claims, actions,
causes of action, suits, debts, demands and damages whatsoever which the
Claridge Parties or any of them ever had, now have or which any of them or
their respective heirs, predecessors, successors and assigns hereafter can,
shall or may have against Richer, for or based upon or by reason of any fact,
matter, transaction or thing alleged in the proceedings described in the
Schedule attached hereto.
For good and valuable consideration, the receipt and
sufficiency whereof is hereby acknowledged, Richer, for himself, his heirs,
predecessors, successors and assigns, hereby grants unto the Claridge Parties
and each of them release and discharge from any and all claims, actions, causes
of action, suits, debts, demands and damages whatsoever which Richer ever had,
now has or which he or his heirs, predecessors, successors and assigns
hereafter can, shall or may have against the Claridge Parties or any of them
for or based upon or by reason of any fact, matter, transaction or thing
alleged in the proceedings described in the Schedule attached hereto.
Richer further acknowledges that the release and
discharge herein granted in his favour shall not affect the right of Claridge
Properties Ltd. to obtain judgment upon the confession of judgment bearing even
date herewith executed by him in favour of Claridge Properties Ltd., in the
event that Claridge Properties Ltd. is entitled to obtain judgment thereon
under the terms and conditions of an agreement bearing even date herewith
between Richer and the said Claridge Properties Ltd.
. . .
[53]
Following the signing
of the Settlement Agreement and the Release, Claridge Properties retained only
the limited right to pursue the Appellant with regards to the US$1 million
payment he had agreed to make, the original obligation having been
extinguished. Therefore, the date of settlement for the purpose of applying the
provisions of section 80 is December 19, 1996.
[54]
Further, there can be
no question that the agreement to pay the US$1 million on or before
January 8, 1997 and to give up certain other rights constituted an amount paid
on December 19, 1996 given that “amount” is defined in subsection 248(1) of the ITA as:
. . . money, rights or things expressed in
terms of the amount of money or the value in terms of money of the right or
thing, except that, . . .
[The rest of the definition has no application.]
[55]
Two further points
warrant mention. First, the debt forgiveness scheme specifically contemplates
in paragraph 80(2)(h) the possibility that in settling a debt, part of
the consideration given by the debtor may consist of a new debt obligation:
(h) where any part of the consideration given by a debtor to
another person for the settlement at any time of a particular commercial debt
obligation issued by the debtor and payable to the other person consists of a
new commercial debt obligation issued by the debtor to the other person
(i) an amount equal to the principal amount of the new obligation
shall be deemed to be paid by the debtor at that time, because of the issue of
the new obligation, in satisfaction of the principal amount of the particular
obligation, . . .
[56]
Secondly, under the Civil
Code of Québec
whatever obligations existed between the Appellant and Claridge were
extinguished by a mixture of compensation,
mutual release and novation
in the Settlement Agreement of December 19, 1996. Again, there can be no
question that this results in an amount paid under the ITA.
[57]
The Appellant argued
that the Minister could not simply assess the settlement and debt forgiveness
in any year and then make consequential assessments in other years. I agree that
the assessment must be based on the correct year of the settlement.
[58]
However, insofar as the
Appellant is arguing that the result of concluding that the settlement occurred
in 1996 is that one should ignore any debt forgiveness entirely, I disagree.
[59]
An assessment is
usually of an amount of tax, interest and penalties and this is the case here.
The underlying facts are simply the reasons leading up to the tax assessment. Whether any
amount was forgiven and when is part of the underlying facts. Here there is no
question that the issue of debt forgiveness was part of the reasons for the
assessment.
As a result any debt forgiveness remains relevant to the disposition of the
appeal and will remain relevant to redetermining the Appellant’s liability.
[60]
The fact that the settlement
took place in 1996 will result in the appeal being allowed so that the
assessments in issue are changed to take account of that. However, the effect
of this change depends in part on the outcome of other issues. I shall return
to the effect of this change later although I would note that, as a practical
matter, given the way the debt forgiveness rules operate and given that a
judgment of this Court cannot increase a tax assessment, this finding will, on
its own, result in a very large reduction of the assessments.
Was an amount forgiven? If an amount was forgiven,
what was the amount?
[61]
In calculating the
forgiven amount according to the definition in subsection 80(1), a necessary
element of the formula is the principal amount of the obligation.
[62]
Where the amount paid
by the debtor is at least as great as the amount of the obligation, there can
of course be no forgiven amount. Counsel for the Appellant first argued the
Appellant’s liability towards Claridge Properties crystallized in 1990 at US$187,000.
[63]
In light of all the
evidence I am unable to conclude that the parties reached a binding agreement
fixing the Appellant’s liabilities in 1990. Negotiations regarding the details
of the Appellant’s withdrawal from the partnerships continued through 1991
without reaching a conclusion and no payment of US$187,000 was ever made by the
Appellant.
[64]
The main argument
pursued by counsel for the Appellant was that the US$1 million amount
agreed to in the Settlement Agreement in fact represented the amount of the
Appellant’s debt to Claridge Properties. In oral argument, however, counsel
acknowledged that the amount of US$1 million was not the result of a
careful calculation made by either the Appellant or Claridge Properties, that
no one knew the exact amount of the debt and that “. . . the parties
sawed it off at $1 million . . .” to avoid the risks and
inconvenience of litigation.
[65]
In his oral testimony,
Mr. Parsons confirmed the manner in which the amount of US$1 million was agreed
to:
It was basically a sum that, you know, I
would have discussed it with Mr. Ludwig. We would have agreed, because
there was some... you know, a lot of back and forth between Mr. Richer's
lawyers and mine. I recall my lawyer telling Mr. Richer's lawyer that any
settlement had to have seven figures. . . . and this is the one that
came and we accepted.
[66]
Under these circumstances, it cannot be
concluded that the amount of US$1 million agreed to by the parties
represented a determination of the Appellant’s debt to Claridge Properties.
Moreover, there is nothing in either the Settlement Agreement or the Release
that would indicate consensus between the parties regarding the amount of the
Appellant’s debt. All the evidence indicates that the settlement represented a
compromise between two disparate positions in order to avoid the expense and
uncertainty involved in determining the lawsuits at trial.
[67]
The Appellant raised a number of specific
reasons why the Appellant’s debt was lower than assumed by the Minister; I
shall return to those reasons. However, I would first note that while counsel
for the Appellant presented a rough schedule computing the Appellant’s
liability during oral argument,
no attempt was made to establish precisely the quantum of the Appellant’s debt.
Counsel explained that exact calculations had not been attempted because of the
difficulties of computation.
[68]
The difficulty of the computation
notwithstanding, determining the amount of the Appellant’s debt must be
undertaken to determine the consequences of section 80.
[69]
A substantial amount of time at trial was
devoted to challenging the Minister’s basis for concluding that the forgiven
amount was C$1,368,528. As explained, the Minister arrived at this amount
essentially by accepting as accurate the calculations performed by Claridge Properties
as summarized in the chart in paragraph 31 above. According to this chart, the
amount of the Appellant’s debt, which took into account US$117,631 owed to him
in respect of his interest in Livonia, was US$2,000,679 before the US$1 million payment.
[70]
The Appellant maintained
that the figures in this chart overstated his liability for a number of reasons
including the following:
(a) The balance owing October 31, 1996 includes amounts for which he did not
sign promissory notes.
(b) The “capital contributions” stated
as having been made in December 1996, totalling US$403,819, should not be included
as part of his liability.
(c) Distributions made by Livonia totalling C$536,011 (US$155,809 in 1995 and US$236,631 in 1996) were not received by him nor
applied against his debt to Claridge Properties.
(d) Management fees were wrongfully
charged to Livonia, thereby
decreasing his share in the proceeds from that partnership by US$137,097.
(e) Amounts were wrongfully transferred by Claridge Properties
from Livonia to Hickory,
thereby decreasing his share in the proceeds from Livonia by US$152,236.
[71]
In the first two arguments, counsel disputes the
amount the Appellant had agreed
to be liable for. The remaining arguments relate to the various claims made by the Appellant that would have offset part of
his liability.
Balance owing October 31,
1996
[72]
I will first consider the argument that the Appellant is not liable for principal
amounts in respect of which he did not sign promissory notes.
[73]
The Appellant signed promissory notes totalling
US$1,209,266. The signed notes are a clear acknowledgment of liability. The
chart prepared by Claridge Properties lists the Appellant’s total balance owing
as of October 31, 1996, including interest receivable of US$193,220, as US$1,714,489.
This total balance includes US$316,003 which is not evidenced by signed
promissory notes.
[74]
Despite considerable testimony on the matter,
the specific details of the arrangement made between the Appellant and Claridge
Properties regarding subsequent recognition of indebtedness remain unclear. The
Appellant acknowledged that the arrangement involved signing promissory notes
after the fact of a capital contribution made on his behalf by Claridge
Properties,
but appears to suggest that he could only be held liable for subsequent
contributions if he agreed to them by signing the promissory notes.
[75]
He also testified to breaches of the
understandings in the handshake agreements. These breaches will be discussed
later.
[76]
He also explained that he could not have been
subject to a cash call given that he was a limited partner in the ventures and
could therefore only be held liable for contributions that had been agreed upon. Given that the handshake agreements are
separate legal arrangements from the limited partnerships, the fact that the
Appellant, in his capacity as a limited partner, is not liable for further
contributions to the limited partnerships does not resolve the question.
[77]
The Appellant’s evidence is not entirely
consistent with that of Mr. Parsons, who explained that it was the usual
practice in all Claridge partnerships to require the partners to contribute
additional amounts in the event of a deficit. However, Mr. Parsons also
testified that he was not involved in the formation of the partnerships, and that he had virtually no role
respecting the loans to the partners beyond arranging for money to be
transferred from Claridge in accordance with instructions he received from
Claridge Properties.
For these reasons, I do not ascribe much weight to his evidence as it pertains
to the terms of the Appellant’s involvement in the partnerships.
[78]
It is clear that there was some kind of
obligation on partners to fund any cash needs of the partnership; indeed, the
course of conduct up to the point when the Appellant stopped signing promissory
notes is consistent with this. It is clear that there were other obligations;
on the evidence before me, Claridge breached at least one of those obligations
(see paragraphs 91 to 93). Finally, it is clear that after January 1, 1990 even Claridge implicitly recognized
that whatever funding obligation there had been had ended (see paragraph 83 below). The question then becomes whether the
funding obligation had ceased with respect to the debts claimed by Claridge in
the period beginning when the Appellant stopped signing promissory notes and
ending on January 1, 1990 (the 1989 period). The amount related to this period
is the US$316,003 already referred to.
[79]
Given that Mr. Parsons, the only witness from
Claridge, was not present when the handshake agreements were made, that, based
on the evidence before me, Claridge was breaching its obligations in 1989 by
charging management fees
(see below), that the only witness to testify who actually participated in
making the agreements was the Appellant and that I accept the Appellant’s
evidence on this, I conclude, in spite of the uncertainty of the terms of the
handshake agreements, that the Appellant was not liable for the amounts in
respect of which he did not sign promissory notes. For these reasons, the
amount of US$316,003 did not form part of the Appellant’s debt.
Capital contributions in December
1996
[80]
I now turn to the argument concerning the
capital contributions, totalling US$403,819, stated as having been made in
December 1996.
[81]
Mr. Parsons explained that the amounts in this
column represented the amount Claridge Properties had to contribute to the
partnerships to net the Appellant’s accounts to zero in accordance with the
Settlement Agreement.
The contributions were necessary because Claridge Properties had calculated there
to be deficiencies in his accounts due to unfunded liabilities that had accrued
in the partnerships. Mr. Parsons further explained that these deficiencies
were treated by Claridge Properties as loans to the Appellant.
[82]
I have already concluded there was no agreement
that the Appellant would be liable for amounts in respect of which he did not
sign a promissory note. For the same reasons as those outlined above, I find
that the amounts totalling US$403,819 included in the chart prepared by
Claridge Properties did not form part of the Appellant’s debt.
[83]
There is another reason for this conclusion.
When one examines the declarations in the four actions filed by Claridge
against the Appellant one
finds that in the case of the Hickory partnership the action was filed in November 1994 and in the other
three cases the actions were filed in October, November and December 1992.
Nowhere in these four actions is there a claim for the US$403,819. The actions
claim the following amounts plus interest (in US dollars):
|
Southland
|
275,632
|
|
Livonia
|
273,000
|
|
Park Square
|
286,959*
|
|
Hickory
|
609,216
|
* Note this amount is US$76,461 less than assumed by the Minister — see column entitled “Balance Owing Oct. 31/96” in paragraph 31 above.
Nowhere is there any suggestion of
any further or continuing liability. Further, Claridge Properties filed in the
Superior Court a pretrial brief dated April 29, 1996. The brief explicitly
claims the amounts set out above including interest but gives no suggestion of
any further liability.
[84]
I would also note that Claridge Properties only
made a claim for US$286,959 and not US$363,421
in the case of Park Square action. This is another reason to conclude that the
difference between the two amounts, US$76,461
(a portion of the US$316,003 for which there are no promissory
notes), was not a part of the Appellant’s debt.
Distribution by Livonia
[85]
The third argument made by counsel was that distributions
made by Livonia totalling C$536,011
(US$155,809
in 1995 and US$236,631
in 1996) were not received by the Appellant nor applied against his debt to
Claridge Properties. Based on the documents and the following evidence of Mr.
Parsons, I have concluded that this argument is unfounded.
[86]
Mr. Parsons explained that the distribution in
1995 of US$155,809 was applied against United States income taxes on the Appellant’s behalf.
[87]
The distribution in 1996 of US$236,631 was
accounted for in the chart prepared by Claridge Properties in two ways. First,
the amount of US$117,631 is credited to the Appellant in the column labelled
“Receipt Distribution Dec. 96”. Second, Mr. Parsons explained that
US$119,000 was applied to reduce the amount in respect of “interest receivable”
in the first column of the chart from US$312,220 down to US$193,220.
Management fees and transfer
from Livonia to Hickory
[88]
The last two arguments made by counsel,
concerning the charging of management fees to Livonia and the transfer of
amounts from that partnership to Hickory,
amount to the position that the Appellant was entitled to a greater
distribution in respect of his interest in Livonia, and that this entitlement
should be taken into consideration when determining the Appellant’s liability
to Claridge Properties.
[89]
These two claims with respect to Livonia are not elements in determining the
Appellant’s debt but, to the extent they are valid, the release from all claims
provided by the Appellant constitutes valuable consideration to be taken into
account in determining what consideration was provided by the Appellant and whether
any part of the debt was forgiven.
[90]
The difficulty I have with the position taken in
the reassessment is that it assigns the value of nil to the release provided by
the Appellant as part of the settlement. It appears from the evidence that in
reassessing the Minister took the rather one‑dimensional view that the
Appellant simply paid the amount of US$1 million in satisfaction of a debt
in excess of US$2 million. Even a cursory perusal of the Settlement Agreement
makes it clear that this was not the case. The consideration provided by the
Appellant to settle his debt to Claridge Properties included (i) his interests
in each of the four partnerships, (ii) a full release in respect of each of the
lawsuits he had initiated, and finally, (iii) the agreement to pay US$1 million
in cash. It is necessary to consider what value the non-cash consideration had.
Management fees
[91]
The Appellant testified that it had been agreed
that no management fees would be charged to the partnerships. I accept his testimony on this.
[92]
The Livonia partnership was successful and paid US$545,295 in management fees and since the Appellant had a 20%
interest this had the result of depriving him of US$109,059 that he
would otherwise have received.
[93]
Given this finding, it is reasonable in my view
to assign the value of US$109,059 to the release provided by the Appellant with
respect to this claim. This amount must be taken into account in
applying the debt forgiveness rules.
Transfer
from Livonia to Hickory
[94]
The Appellant argued that the Livonia partnership, which was profitable
and in which the Appellant had a 20% interest, improperly made a loan of
US$554,550 to the Hickory
partnership which was unprofitable and in which he had a 16% interest. The loan
was written off and as a result he was deprived of US$110,910 which would
otherwise have been paid out or credited to him on the windup of the
partnership.
[95]
The evidence regarding the loan to Livonia was very limited. For example we heard
nothing of the details or whether Livonia received anything in return. While the loan may well have reduced
what the Appellant may ultimately have received from the Livonia partnership I am not satisfied that
the Appellant has shown that the general partner was acting outside its
authority.
Accordingly I do not agree that the value of the release should reflect an
additional US$110,910 in respect of the transfer from Livonia to Hickory.
Conclusions respecting the
forgiven amount
[96]
As explained above, the Minister assessed the
Appellant on the basis that there was a forgiven amount of US$1,000,679. This
was based on the assumption that the Appellant’s debt was US$2,000,679 and that
a payment of US$1 million was made towards it.
[97]
Given the conclusions I have reached above, the
amount of the Appellant’s debt must be reduced as shown below:
|
US$2,000,679
|
Debt amount per
reassessment
|
|
(US$316,003)
|
Less: “1989 amount”
|
|
(US$403,819)
|
Less: December 1996
“capital contribution”
|
|
US$1,280,857
|
Appellant’s debt
|
[98]
In the result, the forgiven amount is calculated
as follows:
|
US$1,280,857
|
Amount of debt
|
|
(US$1,000,000)
|
Less: amount paid by
cheque
|
|
(US$109,059)
|
Less: value of release
— management fees
|
|
US$171,798
|
Forgiven amount
|
THE 1996 PARTNERSHIP LOSSES
[99]
In his 1996 tax return the Appellant claimed
partnership losses of C$215,740 consisting of a loss of C$89,208 in the Park Square partnership and C$126,532 in
the Southland partnership.
[100] Although there were a number of arguments raised about this, I find
that the Appellant is not entitled to deduct these partnership losses for the
following reason.
[101] In the Appellant’s 1990 tax returns one will find a calculation of
these two amounts (C$89,208 and C$126,532) as loss amounts that the Appellant
could not deduct under the at-risk rules.
This calculation is premised on the statements prepared for the partnerships
which took account of the contributions made by Claridge on behalf of the
Appellant. Those contributions took account not only of the signed promissory
notes but also of the US$316,003 for which there were no signed promissory
notes.
[102] For the Appellant to be able to claim any additional amount of
partnership loss he would have to make an additional contribution beyond the
amounts contributed for him (the amount equal to the promissory notes plus the
US$316,003 of the 1989 period)
so as to increase his at-risk amount.
[103] Was such a contribution made? Clearly he did not make any such
contribution directly. The only possible contribution would arise from the term
of the Settlement Agreement that says:
Claridge agrees that it
shall cause Richer’s capital accounts in respect of the Partnerships to be
netted to $0.00 in the case of each of the Partnerships.
It appears that this is the clause
that caused Claridge to show a December 1996 “capital contribution” of US$403,819 in the accounting set out in paragraph 31 above.
[104] If that were really a contribution made by Claridge on the
Appellant’s behalf and he were liable for it then it would indeed increase his
at-risk amount. However, I have already found that the Appellant was not liable
to make those contributions and, consequently, the US$403,819
cannot have been a contribution made on his behalf.
[105] Accordingly there was no increase in the at-risk amount and the C$215,740
partnership loss claimed is not deductible. It is not necessary for me to
consider the other arguments with respect to this loss.
THE CONSEQUENCES OF THESE FINDINGS
[106] With respect to the partnership losses claimed in 1996 I have found
in favour of the Respondent.
[107] With respect to the section 80 issues I have very largely found in
favour of the Appellant.
[108]
As a result, it will be
necessary to take account of the following in redetermining the Appellant’s tax
liability:
(a) First, the settlement
occurred in 1996 and not 1997.
(b) Second, the forgiven
amount is US$171,798 and not US$1,000,679.
(c) Third, there cannot be
an increase in the amount assessed in 1996 as a result of the judgment of this Court.
[109]
Given that I have found
in favour of the Minister on the partnership loss issue in 1996, the third
point is very significant as a practical matter because of the way in which
section 80 operates.
[110]
The effect of section
80 will have to be recomputed on the basis that the settlement occurred in
1996. According to subsections 80(3) and (4) any forgiven amount must first be
applied against non‑capital losses and then capital losses. After that
there are a number of provisions that apply but only if the taxpayer chooses
to use them, the first of these being subsection 80(5). If there
remains a portion of the forgiven amount unapplied and the taxpayer chooses not
to make the designations required by those subsections, the taxpayer will be
subject to an income inclusion in accordance with subsection 80(13).
[111]
In this case, there are
some capital losses but no non-capital losses in or before 1996. After the
forgiven amount is applied against non-capital losses to the extent possible, if
the Appellant chooses not to make the designations required by the optional
provisions under section 80, any remaining unapplied portion of the forgiven
amount would give rise to an income inclusion under subsection 80(13) in 1996.
In practice however such could not be the result in the present appeal since a
judgment of this Court cannot increase an assessment.
[112]
As a result the
Appellant will presumably not choose to make such designations, and the actual
impact of the US$171,798 forgiven amount will be limited to the reduction in
net capital losses to be carried forward, computed in accordance with
subsection 80(4) of the ITA.
One consequence will be that the Appellant will have to be reassessed on the
basis that the Minister should not have reduced the capital cost of the
Appellant’s depreciable property by C$1,279,061.
[113]
The Minister in
reassessing should also recompute the correct amount of debt forgiven converted
into Canadian dollars in accordance with paragraph 80(2)(k) of the ITA.
GROSS NEGLIGENCE PENALTY
[114]
I turn now to the penalties
the Minister levied under subsection 163(2).
[115]
There are two aspects
to this issue. First, given that as a result of this decision the additional
income, and tax thereon, will be reduced substantially any penalty must
necessarily also be reduced accordingly in respect of the tax that will no
longer be payable.
[116]
Secondly, to the extent
that any tax remains the issue under subsection 163(2) the question is whether
the Appellant:
. . . knowingly, or under circumstances amounting to gross
negligence, has made or has participated in, assented to or acquiesced in the
making of, a false statement or omission in a return . . .
[117] In Venne v. The Queen,
Strayer J. states:
. . . “Gross negligence” must be taken to
involve greater neglect than simply a failure to use reasonable care. It must
involve a high degree of negligence tantamount to intentional acting, an
indifference as to whether the law is complied with or
not. . . .
[118]
In Farm Business
Consultants Inc. v. The Queen,
Bowman J. (as he then was) made the following comments:
A court must be extremely cautious in sanctioning the imposition of
penalties under subsection 163(2). . . . In such a case a court must, even in
applying a civil standard of proof, scrutinize the evidence with great care and
look for a higher degree of probability than would be expected where
allegations of a less serious nature are sought to be established.
. . .
[119]
Such caution is
understandable when one considers that subsection 163(2) imposes a penalty
equal to 50% of the tax on the additional income added.
[120]
In examining this issue
I must also consider whether the conduct of the Appellant amounted to wilful
blindness. As stated by Nadon J.A. speaking for the court in Panini v.
Canada:
. . . Consequently, the law will impute knowledge to a taxpayer who,
in circumstances that dictate or strongly suggest that an inquiry should be
made with respect to his or her tax situation, refuses or fails to commence
such an inquiry without proper justification.
[121]
Here we have a
situation where the contested income in issue arises in the context of the
settlement of complicated litigation with Claridge Properties suing the
Appellant and the Appellant suing Claridge Properties in return. To further
muddy the waters the key arrangements in dispute involve handshake agreements. The
merits of the issues, as can be seen from the discussion above, are not self‑evident.
The settlement, while not a precise determination of the Appellant’s and
Claridge’s mutual liabilities, nonetheless was, as I have found, not that far
in relative terms from what the determination might have been had the parties
gone to trial. Further, there is no doubt in my mind that the Appellant was and
is convinced in his own mind that he did not owe Claridge Properties anything
beyond what he paid — including
what he gave up; indeed, I am satisfied that he believes that he paid more than
he owed.
[122]
In the circumstances I
find it impossible to see on what basis one could conclude that the Appellant
was grossly negligent with respect to any omitted income.
V. Disposition
[123]
Accordingly the appeal
will be allowed, with costs to the Appellant, and the matter sent back for
reconsideration and reassessment in accordance with these reasons for judgment,
on the basis that:
(a) the Appellant was not
entitled to claim the partnership losses of C$215,740 in issue in 1996;
(b) the settlement in
issue occurred on December 19, 1996 and not in 1997;
(c) the forgiven amount was
US$171,798 and not US$1,000,679; and
(d) the penalties under subsection 163(2) should be
deleted.
Signed at Ottawa, Canada, this 6th day of August 2009.
"Gaston Jorré"
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