Citation: 2008TCC310
Date: 20080516
Docket: 2007-914(IT)I
BETWEEN:
BRENDA EVANS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
AND BETWEEN:
2007-915(IT)I
DENNIS EVANS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Sheridan, J.
[1] The Appellants,
Brenda and Dennis Evans, are appealing the reassessments of the Minister of
National Revenue of their 2003 taxation years in which recaptured capital cost allowance
amounts were added to their income.
[2] Brenda Evans testified on their behalf. I found her
entirely credible. Some 35 years ago, the
Appellants founded a business known as Evans Electric which they ran as a partnership;
Mr. Evans did the electrical work and Mrs. Evans handled the administrative and
bookkeeping duties. Their two sons grew up helping in the family business and
with their parents’ help, ultimately became qualified electricians and then, employees
of Evans Electric. It was always their parents’ intention that when they were
ready to retire, their sons would take over the business. And so it was that in
2003, the Appellants turned over the operation of Evans Electric to their sons.
They ended their partnership and became employees of the business now run by
their sons. As often happens in small family-run businesses, all of this was
accomplished harmoniously around the kitchen table without the benefit of
legal, accounting or tax advice.
[3] These appeals
have at their centre a garage the Appellants built on their property during
1996-1998. It served as a workshop and equipment storage facility for Evans
Electric. They did not claim capital cost allowance deductions for the garage
until 2001 when their accountant advised them to do so. When they ceased
operating as Evans Electric in 2003, they retained ownership of the garage but
permitted its use in the business now operated by their sons. The sons reimbursed
the Appellants for their cost of utilities and property tax for the garage by each
paying $25 per week to the Appellants, with an adjustment at year end to cover
any shortfall in the actual cost. From a practical point of view, both the
Appellants and their sons used the garage in the same way in their respective
businesses.
[4] It was against
this background that the Minister concluded that the handing over of Evans
Electric to their sons in 2003 resulted in a “change of use” of the garage thereby
triggering its deemed disposition under paragraph 13(7)(a) of the Income
Tax Act:
Rules
applicable. Subject to subsection 70(13), for the purposes of paragraphs 8(l)(j)
and (p), this section, section 20 and any regulations made for the
purpose of paragraph 20(1)(a),
(a) where
a taxpayer, having acquired property for the purpose of gaining or producing
income, has begun at a later time to use it for some other purpose, the
taxpayer shall be deemed to have disposed of it at that later time for proceeds
of disposition equal to its fair market value at that time and to have
reacquired it immediately thereafter at a cost equal to that fair market value;
[5] Applying this
provision, the Minister determined that having ceased to carry on their
partnership in 2003, the Appellants were no longer using the garage for the
purpose of gaining or producing income; accordingly, they had begun to use it
for some “other” purpose within the meaning of paragraph 13(7)(a). They
were therefore deemed to have disposed of the garage at a price equal to its
fair market value in 2003. As the fair market value of the garage exceeded its
undepreciated capital cost at the time of the deemed disposition, the resulting
recaptured capital cost allowance for the garage was added to their income[1].
[6] The Appellants’
position is that there was no change in use since their sons continued to use
the garage in exactly the same way they had before turning Evans Electric
over to them. The flaw in the Appellants’ reasoning is that it fails to distinguish
between “Evans Electric”, the business they had operated as a partnership until
2003 and “Evans Electric”, the business subsequently taken over by their sons
and of which they then became employees. I can certainly understand how, after
35 years of operating Evans Electric as a family enterprise, the Appellants
might have trouble distinguishing one legal entity from another, especially
since its name remained the same and they and their sons continued to work in
the business after the changes made in 2003.
[7] The problem is
that for tax purposes, such legal distinctions matter. For example, as Mrs.
Evans herself testified, whether she and her husband earned income as partners
of the business known as Evans Electric or as its employees made a difference
to how they reported their income. They, not their sons, were the legal owners
of the garage. When their employee sons became the proprietors of the business
known as Evans Electric in 2003, the source of their income changed from
employment to business. Because they used the Appellants’ garage in their
business and incurred an expense for that use by reimbursing the Appellants for
their costs for the garage, the sons were entitled to deduct that operating
expense from their business income; the Appellants no longer could. Had the
sons paid the Appellants rent, it too would have been a deductible expense. By
the same token, the Appellants would have had to include the rent paid by their
sons in their income as income from property but could have deducted their
costs in respect of that property.
[8] Unfortunately,
the Appellants did not turn their minds to such details and things became
hopelessly muddled. They wanted to help their sons get started in the business
and accordingly, limited what they charged for the use of the garage to their
actual expenses. They did not bother to report rent or claim expenses for the
garage in their 2003 income tax return because these amounts would have
cancelled each other out.
[9] Had they charged
their sons a fair market value rent for the garage when they took over in 2003,
the Appellants could have prevented the triggering of the deemed disposition
under paragraph 13(7)(a). Although the Appellants would no longer
have been using the garage to earn income from business, they would still have
been using it to gain income from property. In this scenario, there would have
been no “change of use” as contemplated by that provision.
[10] The fact is,
however, no rent was charged in 2003, the only time relevant to these appeals. At
that time, the Appellants decided to recover only the utility costs from their
sons. Although at the objection stage there seems to have been some discussion
between the Appellants and Canada Revenue Agency officials about revising the
arrangements for the sons’ use of the garage, nothing ultimately came of it. At
the hearing, there was no evidence presented as to what the fair market value
of rent for the garage might have been in 2003. In any event, it seems
reasonable to assume that the Appellants would have charged rent of more than
their bare actual costs had they rented it to an arm’s-length third party. In
all of these circumstances, I am unable to find that the reimbursement of the
Appellants’ utility costs constituted rent for the garage.
[11] As for the
Appellants’ argument that there was, practically speaking, no change in the
actual use of the garage, the focus of paragraph 13(7)(a) is not the
asset itself but rather, how it is used by the taxpayer who acquired it and
claimed a capital cost allowance for it. His entitlement to do so hinges on his
use of that asset in each taxation year to earn income from his business[2]. Pursuant to paragraph 13(7)(a), if ever
that particular taxpayer begins to use that asset for a purpose “other” than
generating income from business (in other words, if he stops using it to earn
his own business income), he is deemed by paragraph 13(7)(a) to have
disposed of it at its fair market value at that time. The fact that another
taxpayer continues to use his asset in the same way as he had been doing does
not prevent the operation of paragraph 13(7)(a).
[12] In the present
case, when in 2003 the Appellants ceased to operate Evans Electric as a
partnership, they were no longer earning business income from Evans Electric. From
this it follows that they were not using the garage for the purpose of “gaining
or producing income from business”. While there was still in existence a
business known as “Evans Electric” that used their garage in the same way as
the Appellants had, it was no longer their business and accordingly,
they had begun to use the garage other than for earning income from business.
That their sons continued to use the Appellants’ garage in the same way did not
in any way block the application of paragraph 13(7)(a) to the
Appellants’ circumstances. The moment the Appellants ceased their business
activities as Evans Electric, their situation met all the criteria under
paragraph 13(7)(a) and they were deemed to have disposed of the garage
at its fair market value. The number used for the fair market value of the
garage was provided by the Appellants themselves;
there was insufficient evidence before me to conclude that some other figure
ought to have been used. Also, when the garage was added to inventory in 2001,
the wrong amount seems to have been used for its capital cost; it is too late
to attempt to rectify that error.
[13] Finally, as I
understood their argument, the Appellants took the position that because their
employment with Evans Electric would not have been possible had they not
permitted their sons, as the new proprietors of Evans Electric, to use their
garage, the source of their [the Appellants’] income was “the business” and therefore, there had
been no change in use as contemplated by paragraph 13(7)(a). While there
is a certain practical basis for that argument, it does not square with the need,
for the purposes of the Income Tax Act, to trace income earned back to
its source. Regardless of the Appellants’ role in enabling the business
to continue, the fact remains that in 2003, they were employees, not
proprietors, of Evans Electric. From this it follows that the source of their
income was employment, not business. For that reason, there was a change in use
as contemplated by paragraph 13(7)(a).
[14] Good intentions
notwithstanding, the changes made in the operation of Evans Electric in 2003
had significant repercussions for all concerned. Unfortunately, the Appellants
did not realize the consequences of their actions until well after the fact
when remedial action was no longer a possibility. Based on the evidence of the
situation as it existed in 2003 when the change in business operations of Evans
Electric occurred, I am unable to conclude that the Minister was wrong in
reassessing as he did. Accordingly, the appeals must be dismissed.
Signed at Ottawa, Canada, this 16th day of May, 2008.
"G. A. Sheridan"
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