Citation: 2009 TCC 420
Date: 20091027
Docket: 2007-68(IT)G
BETWEEN:
JEANETTE WACHSMANN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
AMENDED REASONS FOR JUDGMENT
Archambault J.
[1]
This is the sad story
of a taxpayer who put too much faith in her brother and who did not give enough
attention to her own affairs, especially her tax returns. Mr. Issac
Zahler, the father of the taxpayer, Mrs. Jeanette Wachsmann, purchased a rental
property (rental property) situated in Mississauga, Ontario, on or about
December 4, 1980, at a price of $2,5 million. Although the situation
is not clear, it appears that the property was paid for in full by Issac Zahler
out of his own funds (see Exhibit R‑1, Tab 12, par. 7). The rental
property was to be held in equal shares for the benefit of Mrs. Wachsmann and
her brother, Maurice Zahler. The title to the property was held in trust by a
corporation, Carjeane Investments Inc. The father was a diamond dealer living
in Belgium, while Mrs. Wachsmann was living at the time in London, England, with her husband. Her brother was based
in Toronto. It seems the brother was put in charge of
managing the rental property. Mrs. Wachsmann left England in 1989 and moved to Toronto, where she lived for 10 years. Thereafter, she moved
to Montreal.
[2]
Mrs. Wachsmann claims
that she never saw the rental property even when she lived in Toronto and relied completely on her brother for its
management. The financial statements for the property and her tax returns were
prepared by her brother’s accountant, a Mr. Edward M. Kalkstein of the
firm Zeifman & Company.
[3]
A series of mortgages
were taken out from 1983 to 1990 which aggregated roughly $2 million. In 1995,
a $3.5 million mortgage was taken out by Mr. Maurice Zahler. Mrs. Wachsmann
claims that she was never told about the existence of these mortgages. The $3.5
million mortgage appears on the rental property’s financial statements for the
1996 to 1998 fiscal periods and the most substantial expense in the statement of
operations is interest of $324,291 in 1997. This interest expense was deducted in
full in computing, for tax purposes, the income from the rental property.
[4]
This property was sold
in September 2000 for $6,080,000. Mrs. Wachsmann also claims that she was not
told of the disposition of the property before March 2002, when informed of it by
her brother. Mrs. Wachsmann claims as well that she never received her share
of the proceeds of the disposition of the rental property and, in a legal
action taken against her brother in April of 2002, she alleged that her brother
had appropriated the proceeds of the sale of the property and that the $3.5 million
mortgage taken out in 1995 had been used for the acquisition of personal assets
by her brother. Surprisingly, that legal action was abandoned by
Mrs. Wachsmann in 2006, apparently for lack of funds to pursue it (see
Exhibit R‑1, Tab 16).
[5]
On the basis of these
facts, the Minister of National Revenue (Minister) reassessed both Mrs.
Wachsmann and Mr. Maurice Zahler and disallowed all the mortgage interest
claimed from 1997 to 1999 and included in Mrs. Wachsmann’s income for 2000 her
share of the taxable capital gain, that is, $1,193,333, and of the amount of
the recapture of the capital cost allowance (recapture) claimed with
respect to the rental property, that is, $685,540. The Minister did not
disallow the interest on the $3.5 million mortgage claimed in computing
the net rental income for the 2000 taxation year.
[6]
At the outset of the
hearing, the respondent filed an admission whereby she acknowledged that the
interest expense amount that should have been disallowed for 1997 and 1998 was
as follows:
1997 $162,145.50
1998 $160,892.50
It was further acknowledged that for 2000 the amount
of the recapture should be $685,540 and that the amount of the taxable capital
gain should be reduced to $1,154,021. The amount of the interest disallowed for
1999 remains at $164,680.
[7]
Mrs. Wachsmann filed a notice
of objection and, later on, instituted before this Court an appeal contesting
the disallowance of the interest deduction on the basis that she had never
benefited personally from the money obtained by means of the mortgage and that her
brother should be taxed on the interest expense amount. Alternatively, she
argued that she should be entitled, in computing her rental income, to a
deduction equal to the amount of the income stolen by her brother. She based
her argument on Interpretation Bulletin IT-460. A similar argument was made
with respect to the taxable capital gain and the recapture for the 2000
taxation year.
[8]
It should be pointed
out that the Minister reassessed Mrs. Wachsmann outside the normal reassessment
period and therefore the respondent has the burden of establishing that Mrs.
Wachsmann made in her tax returns a misrepresentation that was attributable to
her neglect, carelessness or wilful default, as contemplated by subsection 152(4)
of the Income Tax Act (Act).
Analysis
[9]
First, on the issue of
the statute-barred taxation years, the evidence disclosed that Mrs. Wachsmann -
who had a high school education and who had at one point been a kindergarten
teacher in Toronto and later on a sales person in the textile
industry - relied completely on her brother to deal with the filing of her tax
returns. Her brother used the services of his accountant, who prepared these
returns and the financial statements. Mrs. Wachsmann never signed the tax
returns for the relevant taxation years and she never reviewed them before they
were filed. Nor did she ever review the financial statements that were prepared
for the rental property. When she moved to Montreal in 1999, she hired her own chartered accountant, Mr. Ronnie
Jakobovits, who prepared her tax returns on the basis of the financial
statements prepared by Mr. Kalkstein. Even then, Mrs. Wachsmann never signed
the tax returns and never reviewed them. She relied completely on her new
accountant, who got his information from the previous accountant. With respect
to the 2000 taxation year, Mr. Jakobovits testified that he never received the
financial statements for the 2000 taxation year. He said that he got the
information directly from Mr. Kalkstein, and prepared a statement of income and
expenses using the Minister’s form.
[10]
In my view, a
distinction can be drawn between the 1997 to 1999 taxation years and the 2000 taxation
year. The fact that Mrs. Wachsmann never reviewed the tax returns that were
prepared on her behalf clearly, in my view, disclosed a lack of diligence on
her part with respect to the preparation of those returns. This kind of
behaviour is a recipe for disaster. Had Mrs. Wachsmann been diligent in the
filing of her tax returns, for example, by doing at least a cursory review of
the information, she would have realized that there had been a $3.5 million
mortgage on the rental property since 1995 and she would have been in a
position, as she acknowledged in her cross-examination, to ask questions concerning
the purpose of such a substantial loan that not only encumbered the rental property
but also affected its profitability. She would have seen also that a
significantly greater share of the funds generated by the rental property had
been distributed to her brother (or her brother’s wife) than to her (see
Exhibit R-1, Tabs 8, 9 and 10, Statement of Participant’s Deficiency). For
example, in 1999, drawings in favour of her brother’s wife amounted to $522,827
while those in Mrs. Wachsmann’s favour were $19 714. It should be noted that
her brother did not contest the Minister’s disallowance of the interest
deduction in computing his income or the addition of the taxable capital gain
and the recapture. Given that the money was used for personal purposes and not
for the purpose of earning income from property, the interest expenses were not
deductible.
[11]
Since the misrepresentation
made in her tax returns for the 1997 to 1999 taxation years can be attributed
to Mrs. Wachsmann’s neglect, the Minister is allowed to reassess those taxation
years outside the normal reassessment period. That being so, the burden was on
Mrs. Wachsmann to establish that the interest expense could be deductible
in computing her income from the rental property. One of the arguments put
forward by her counsel was that Mrs. Wachsmann earned substantial investment
income in 1998, mainly from the Toronto Dominion Bank, and that the capital
used to generate this income may have come from the proceeds of the 1995
mortgage.
[12]
However, when Mrs. Wachsmann
testified, she consistently claimed that she had not received any of the proceeds
from the mortgage taken out by her brother in 1995. Her four children also
testified to confirm that they had not received any money from their mother or
their uncle, Maurice Zahler, to finance the acquisition of a home or to help
them start their own business. In addition, Mrs. Wachsmann was unable to
identify the source of the funds that were used to produce her significant investment
income of $17,178 in 1999, $18,082 in 2000 and $27,944 in 2001. Therefore, the
Court is not satisfied that Mrs. Wachsmann’s share of the interest which she claimed
in the computation of her income from the rental property, could be deductible.
The evidence is far from clear that she ever received such income, and, even if
she did, the Court has no basis for determining what percentage of the mortgage
proceeds were used for investment purposes and which portion was used to meet
her domestic needs.
[13]
With respect to the
2000 taxation year, I am not convinced that the respondent succeeded in establishing
that the misrepresentation made with respect to the taxable capital gain and
the recapture constituted a misrepresentation attributable to Mrs. Wachsmann’s
neglect. Although it is clear that in not reviewing her tax return, she was
negligent, I am not satisfied that the misrepresentation with respect to the
computation of her taxable capital gain and the amount of her recapture is
attributable to this neglect. Indeed, I accept her counsel’s argument that Mrs. Wachsmann
was never told in 2000 or 2001 of the disposition of the rental property that
took place in September 2000 and that she could not have known about it.
[14]
In addition, there is
no evidence that financial statements were prepared for that year. Her
accountant was provided with the financial data that were used by him to
compute the rental income for the 2000 taxation year. What is peculiar is that the
gross rental income amount of $964,317 exceeds the gross rental income amount of
$935,881 for the previous year.
In my view, the respondent has failed to establish that for the 2000 taxation
year the Minister could have reassessed Mrs. Wachsmann with respect to the
taxable capital gain and the recapture.
[15]
However, the respondent
made an alternative argument in support of assessing a lower amount of taxes
for 2000. This argument was advanced in an Amended Reply to the Notice of
Appeal and a request was made to the Court on the day of the hearing to allow
the Minister to file that amended reply. It should be stated that counsel for
Mrs. Wachsmann was informed several months before the hearing, by letter dated
October 24, 2008, of the Minister’s intention to put forward this new argument
and to request leave from the Court to file an amended reply. The interest
expense deduction of $164,680, representing Mrs. Wachsmann’s share of the total
expense, claimed in computing her net rental income should, according to the
respondent, be disallowed for the same reasons as for the 1997 to 1999 taxation
years. The Minister had omitted to refuse that expense in reassessing for the
2000 taxation year. Although the 2000 taxation year is also statute‑barred,
the respondent argues that she has established that Mrs. Wachsmann in preparing
and filing her tax returns made a misrepresentation attributable to neglect with
respect to the net rental income.
[16]
Counsel for Mrs.
Wachsmann argued that the respondent cannot be seen to raise an alternative
ground in defence of the Minister’s assessment given that it constitutes a completely
new assessment made by the Minister many years after the 2000 taxation year
became statute‑barred.
[17]
The key statutory
provision applicable here is subsection 152(9) of the Act, which reads as
follows:
152(9) The Minister may advance an alternative argument in
support of an assessment at any time after the normal reassessment period
unless, on an appeal under this Act
(a)
there is relevant evidence that the
taxpayer is no longer able to adduce without the leave of the court; and
(b)
it is not appropriate in the
circumstances for the court to order that the evidence be adduced.
[My
emphasis].
[18]
It is well known that this
subsection was added to the Act after the decision rendered by the Supreme
Court of Canada in Continental Bank of Canada v. Canada, [l998] 2 S.C.R.
358. Although the purpose of this provision was to adopt a less restrictive
interpretation than the one adopted in Continental Bank, counsel for Mrs. Wachsmann
still propose a restrictive interpretation of the words used in subsection 152(9).
He argues that a distinction should be made between an alternative “argument”
and an alternative “ground”. For instance, if a benefit had been conferred on a
taxpayer and the Minister had taxed that benefit pursuant to section 6 of the
Act, the Minister could be seen to advance a new argument to justify the
taxation of the benefit by relying on another section of the Act, for example, subsection
15(1) dealing with a benefit conferred on a shareholder or section 246 dealing
with a benefit conferred on a person. However, when the tax to be assessed
results from a different set of facts, such as a different transaction, then it
is not an alternative argument and the principles in Continental Bank of
Canada should apply. In Mrs. Wachsmann’s counsel’s view, such is the
situation here. The inclusion of the taxable capital gain and the recapture
resulting from the disposition of the rental property in September 2000 constitutes
a different ground for taxation than that relied on with respect to the rental
income earned prior to the disposition of the rental property.
[19]
In reply to this
argument, counsel for the respondent cited the reasons for judgment of
Rothstein J.A., then of the Federal Court of Appeal, in The Queen v. Anchor
Pointe Energy Ltd., 2003 DTC 5512, 2003 FCA 294, at paragraph 38, where
he states that he does “not find that semantical argument productive”.
[20]
Accepting this as the
law of land, I do not believe that the respondent is estopped from advancing
the new argument based on the refusal of the interest expense in computing the
rental income earned from the rental property in the 2000 taxation year. The
restrictions are those enunciated in paragraphs 152(9)(a) and (b)
of the Act. Those restrictions are not applicable here. Mrs. Wachsmann
does not suffer any prejudice resulting from this alternative argument. The
issue raised with respect to 2000 is exactly the same as that raised for the 1997
to 1999 taxation years. The defence advanced by Mrs. Wachsmann for those
taxation years, although not successful, was equally applicable for the 2000
taxation year. Moreover, the respondent is not doing indirectly was she could not
have done directly. The alternative argument could only be considered by this
Court if the respondent had successfully established that Mrs. Wachsmann had
made in her tax return a misrepresentation attributable to her neglect. Here I
have concluded that the respondent has been successful in so establishing. The respondent
is not circumventing subsection 152(4) of the Act. Therefore, leave to file the
Amended Reply to the Notice of Appeal is granted. My reasons respecting the
refusal of the interest deduction for the 1997 to 1999 taxation years apply equally
to the 2000 taxation year and, accordingly, the interest is not deductible from
Mrs. Wachsmann’s share of the income from the rental property.
[21]
For all these reasons, the
appeals for the 1997, 1998 and 2000 taxation years are allowed and the
assessments should be referred back to the Minister for reconsideration and
reassessment on the basis that the interest amounts that should be disallowed
for the first two years are those indicated in the admission filed as Exhibit
R-2, and with respect to the appeal for the 2000 taxation year, on the basis
that Mrs. Wachsmann was not entitled to the interest expense of $164,680
and that the taxable capital gain and the recaptured depreciation resulting
from the disposition of the rental property should be excluded from her income.
The Respondent shall be entitled to all of its
disbursements and 50% of its other costs with respect to procedures which
occurred after April 8, 2009.
Signed at Ottawa, Canada, this 27th day of October 2009.
"Pierre Archambault"
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