Citation: 2008TCC84
Date: 20080206
Docket: 2006-1125(IT)G
BETWEEN:
MICHAEL R. KAISER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Miller J.
[1] This case
highlights the difficulties that can arise in applying provisions of the Income
Tax Act (the “Act”) to transactions intended to be effective
retroactively. Mr. Kaiser directed some after-the-fact accounting due to the
breakdown of a common-law relationship with Christina Seymour. This involved
deciding in 2003 to make certain journal entries in two companies of which he
and Christina were shareholders, Innovage Technologies Inc, (“ITI”) and
Innovage Microsystems Inc., (“IMI”). The journal entries were to effect a shift
of certain debts in 1999 and 2000 owed by the companies to Mr. Kaiser to Ms. Seymour.
The Respondent assessed Mr. Kaiser on the basis that such amounts were to be viewed
as a transfer of capital property (the debt owed to Mr. Kaiser) from Mr. Kaiser
to Ms. Seymour effective in 1999 and 2000, and the combination of section 73 of
the Act and the attribution rules in section 74.2 of the Act
would therefore operate to bring the capital gains arising on the disposition
of the debt by Ms. Seymour into Mr. Kaiser’s hands.
[2] At trial the
Respondent also argued that such amounts represented shareholder loans to Mr.
Kaiser alone, and any reduction of such loans was a disposition of capital
property in his hands, resulting in a taxable capital gain to him only.
[3] Mr. Kaiser’s
position was that no such amounts were actually withdrawn in 1999 and 2000, or
alternatively, that there was a transfer of capital property from Mr. Kaiser to
Ms. Seymour, but it was not effective in 1999 and 2000, but only in 2003, at a
time when Mr. Kaiser and Ms. Seymour were separated, so attribution rules could
not apply.
[4] The parties
provided an Agreed Statement of Facts which I have attached as Schedule “A” to
these Reasons. I will however summarize the significant facts as follows:
I. Mr.
Kaiser and Ms. Seymour were common-law spouses in 1999 and 2000, but ceased
that relationship in 2001.
II. Mr. Kaiser and Ms.
Seymour were both shareholders of ITI and IMI (the “Companies”).
III. Mr. Kaiser acquired
shareholder’s loans of other shareholders in the Companies in 1996,
representing $1,974,675 of loans in ITI for $4 and representing $1,677,951 of
loans in IMI for $4 (the “Loans”).
IV. Both Mr. Kaiser and
Ms. Seymour withdrew amounts from the Companies in 1999 and 2000, which were
allocated and debited to their respective shareholder loan accounts in draft
financial statements prepared in the fall of 2002.
V. In January 2003, Ms.
Seymour’s counsel claimed Ms. Seymour was entitled to 50% of the Loans by
virtue of certain matrimonial property rights.
VI. As a result, Mr.
Kaiser, as a director of the Companies, directed the Companies to make journal
entries which debited Mr. Kaiser’s shareholder loan account and credited Ms.
Seymour’s shareholder loan
account in the following amounts:
|
1999
|
2000
|
|
ITI - $74,149
|
$240,660
|
|
IMI - $87,800
|
$23,419
|
|
|
|
VII. The Companies and
Mr. Kaiser filed their 1999 and 2000 tax returns in February 2003, after the journal
entry adjustments. Mr. Kaiser’s returns were nil returns.
Issues
[5] The parties framed
the issues differently. The Respondent premises its issue on the understanding
that Mr. Kaiser withdrew the shareholder loans at issue (i.e, the amounts subject
to the journal entry decreases) from both Companies in 1999 and 2000. The
Respondent therefore states that the issue is whether the Minister was correct
to reassess Mr. Kaiser:
(a) to
include in his income tax for capital gains the amounts of $90,089.24 and
$128,678.34 as a result of the disposition of capital property, being the
withdrawals from the shareholder loan accounts of ITI and IMI, respectively in
the 1999 taxation year; and
(b) to include in his
income tax for capital gains the amounts of $257,363.44 and $80,813.59 as a
result of the disposition of capital property, being the withdrawals from the
shareholder loan accounts of ITI and IMI, respectively in the 2000 taxation
year.
[6] I note that this does not reflect the
Canada Revenue Agency’s (“CRA”) assessing position as set forth in its letter
of November 3, 2005 where CRA accepted there was a transfer of property, being
the loans, from Mr. Kaiser to Ms. Seymour, but effective in each of 1999,
2000 and 2001. CRA applied subsection 73(1) and section 74.2 of the Act such
that any gain arising from Ms. Seymour’s adjustment to the shareholder
loan account would be attributed back to Mr. Kaiser in 1999 and 2000, as he and
Ms. Seymour were still together. There would be no attribution in 2001 as they
had separated by that point.
[7] The Appellant’s
position is that the journal entry decreases did not involve any amounts
actually being withdrawn and therefore did not trigger any disposition of
capital property as contemplated by the Respondent. The Appellant goes on to
frame the issues as follows:
Whether the decreases in the balances owing by ITI and Innovage
Microsystems Inc. (“IMI”) (collectively the “Corporations”) to the Appellant
under the Appellant’s shareholder loan accounts with the Corporations
(collectively the “Loans”) resulting from:
1. the following journal entries made to the
Corporations’ accounts on or after January 31, 2003, but purporting to be
effective as of October 31, 1999, ought to be included in calculating the
amount of capital gains realized by the Appellant in 1999:
(a) a debt of $74,149 against the Appellant’s
shareholders loan account with ITI and a corresponding credit to Ms. Seymour’s
shareholders loan account with ITI (the “1999 ITI Journal Entry”); and
(b) a debt of $87,800 against the Appellant’s
shareholders loan account with IMI and a corresponding credit to Ms. Seymour’s
shareholders loan account with IMI (the “1999 IMI Journal Entry”),
(collectively the “1999 Journal Entries”); and
2. the following journal entries made to the
Corporation’s accounts on or after January 31, 2003, but purporting to be
effective as of October 31, 2000, ought to be included in calculating the
amount of the capital gains realized by the Appellant in 2000:
(c) a debt of $240,660 against the Appellant’s
shareholders loan account and a corresponding credit to Ms. Seymour’s
shareholders loan account (the “2000 ITI Journal Entry”); and
(d) a debit of $23,419 against the Appellant’s
shareholders loan account and a corresponding credit to Ms. Seymour’s
shareholders loan account (the “2000 IMI Journal Entry”),
(collectively the “2000 Journal Entries”).
[8] The question that
begs to be answered is whether the journal entries made in 2003 are effective
for tax purposes in 1999 and 2000. If they are, then one of two interpretations
follow, both of which lead to the journal entry amounts constituting a capital
gain in Mr. Kaiser’s hands. The first interpretation, suggested by the Crown,
is that because only Mr. Kaiser could withdraw funds from the shareholder loan
accounts, only he can be found to have withdrawn funds in 1999 and 2000. The
second interpretation is that the journal entries constituted a transfer of
part of the loans from Mr. Kaiser to Ms. Seymour, which she immediately
redeemed. Section 73 of the Act would operate such that the transfer
would be at Mr. Kaiser’s cost, a nominal amount, and when Ms. Seymour
coincidentally redeemed the loans as a result of the journal entries, she
triggered a capital gain, attributable back to Mr. Kaiser as a common-law
spouse pursuant to section 74.2 of the Act. This latter interpretation
would be my preferred interpretation if I were to find the journal entries were
effective for tax purposes in 1999 and 2000.
[9] In determining the
timing of the effectiveness of the journal entries, I must first address the
question of whether Mr. Kaiser is estopped from arguing the journal entries
were not effective in 1999 and 2000. Both parties relied on Chief Justice
Bowman’s comments in King v. R.,
to address this matter of estoppel. In King, accounting entries were
made in 1988 to effect a credit to Mrs. King’s shareholders loan account in
1987. Mrs. King filed as though the credit was made in 1987 and the assessor
assumed as much. At the time of trial the 1988 taxation year was
statute-barred. Chief Justice Bowman stated:
… Even if I had held that a capital gain had been realized, but that
it was attributable to Mr. King under section 74.2, it would mean putting the
taxable capital gain into a statute-barred year of Mr. King. To do so would not
disturb me particularly in a case where the Minister had a choice between two
years and deliberately and knowingly chose one that turned out to be the wrong
one. Here however the Minister acted on the basis of a representation of fact
by the appellant in her 1987 tax return that the relevant transactions,
whatever their ultimate legal effect, occurred in 1987. While it is trite law
that there is no estoppel against the terms of a statue, we have here a classic
case of estoppel with respect to a matter of fact. The Crown sometimes argues -
- erroneously in my view - - that whenever a taxpayer changes his or her
position from that taken in a return of income or in some other document he or
she somehow “estopped”. Estoppel by conduct is a much narrower concept. It is a
rule that prohibits a person who has made a statement of fact upon which
another party had relied and has acted to his or her detriment from denying the
truth of that statement as against that other party. That is precisely what
happened here. The time at which an event takes place is purely a matter of
fact and the Minister, in assessing 1987 on the basis of the statement that the
events took place in 1987 and in not assessing 1988, acted in reliance on that
statement to his detriment. Accordingly the appellant is estopped from now
taking the position that the taxable event took place in 1988.2
2 I should not wish to be taken as condoning the
practice of some accountants of recording, by making “year-end adjustments”, as
transactions in a prior year events that were not even thought of in that prior
year. This case is somewhat unusual in that it gives rise to a pure example of
estoppel by conduct. There is a difference between reflecting, after a year-end,
a quantification of taxable benefits for a prior year of manager/shareholder of
a corporation - - a practice albeit somewhat artificial has at least the virtue
of long-standing entrenchment and apparent acceptance by the tax department - -
and creating out of airy nothing transactions in a prior year that in that year
were not even a gleam in anybody’s eye. It never ceases to amaze me how some
accountants think they can retroactively create reality by a subsequent moving
of figures around on a piece of paper.
[10] At the time Mr.
Kaiser directed the journal entries in January 2003, he did not believe, as
evident from filing a nil tax return, that he was subject to tax on amounts he
actually withdrew in 1999 and 2000 as against his shareholder’s loan, let alone
any amounts that were the subject of the journal entries. It appears neither
did Ms. Seymour’s counsel. In a letter dated January 10, 2003, Mr. Dunphy,
acting for Ms. Seymour, wrote to the chartered accounting firm of Czechowsky
and Graham:
Further, it is our position that the shareholder’s loans of Michael
Kaiser that are in a credit balance are matrimonial property and belong 50% to
Christina Seymour and accordingly, we are of the view that you may file the tax
return of Christina Seymour without having regard to any debit balance in her
shareholder’s loan account because we are of the view that it is set-off by
the credit balance in the other loan.
[11] So it is not Mr.
Kaiser’s filing of a return that can be the conduct, or statement of fact, upon
which CRA relied, as a nil return is not indicative that the journal entries
were intended to be effective in 1999 and 2000. The conduct, for estoppel
purposes, can only be the Companies’ financial statements that reflect the
journal entries, that CRA received in 2003. Mr. Kaiser’s counsel argues that
these are not Mr. Kaiser’s statements, and therefore estoppel is not
applicable. Yet clearly, from a review of the minutes authorizing the journal
entries, it was Mr. Kaiser’s conduct that directed such entries. CRA did rely
on those entries to assess Mr. Kaiser, knowing that the journal entries were
not recorded until 2003. But what statement is Mr. Kaiser allegedly now denying
the truth of? He is certainly not denying the journal entries were made. He is
arguing that, for tax purposes, the journal entries were not effective in 1999
and 2000 for purposes of triggering attribution rules. This is a conclusion of
law, not a denial of a statement of fact. CRA took a different view and
maintained, knowing all the circumstances, that attribution applied in 1999 and
2000, but not in 2001. They have suffered no detriment due to any misstatement
of fact by Mr. Kaiser. I find the principle of estoppel does not operate in
these circumstances to preclude my consideration of the retroactive effect for
tax purposes of the journal entries.
[12] The question then is
whether the retroactive transfer of property of common-law spouses, due to a
breakdown of the relationship, triggers attribution rules for the period
between the purported effective date of the transfers and the actual date of
the decision to transfer (long after the couple had separated). Or, in the
words of Chief Justice Bowman, was the Appellant “creating out of airy nothing
transactions in a prior year that in that year were not even a gleam in
anybody’s eye?” Transferring the Loans in 1999 and 2000 was not in anyone’s
contemplation in 1999 and 2000 – airy nothing, as it were.
[13] I find this
conclusion consistent with comments made by Justice Bonner in the case of Wood
v. Minister of National Revenue:
13 The portion of Article 79 which
requires that a resolution “…be held to relate back to any date therein stated
to be the date thereof …” does not operate to require persons other than the
company and its shareholders to treat an event as having taken place before it
in fact took place. Subsection 29(1) of the Companies Act of Alberta provided:
29(1) The
memorandum and articles, when registered, bind the company and the members
thereof to the same extent as if they respectively had been signed and sealed
by each member, and contained covenants on the part of each member, his heirs,
executors, and administrators, and in the case of a corporation, its successors
to observe all the provisions of the memorandum and of the articles, subject to
the provisions of this Act.
Nothing in the wording of the statute
makes the Articles binding on persons other than the company and its members.
They do not bind the respondent who is a stranger to them.5 I find
unacceptable the notion that a company and its shareholder are entitled, for
purposes affecting the rights of third parties to rewrite history, that is to
say, treat imaginary events as having happened. A legislature has the power to
enact deeming provisions. Others do not.
[14] This is exactly what
these journal entries were – a re-writing of history, that are not binding on
third parties, in this case CRA. CRA cannot pick and choose which imaginary
events are taxable and which are not. For purposes of the determination of Mr.
Kaiser’s tax liability, the loans could not have been transferred until he
decided to do so, and that was in 2003: a stroke of the accountant’s pen cannot
alter that fact.
[15] If the journal entries
were not effective for tax purposes in 1999 and 2000, what was Mr. Kaiser’s tax
position in those years. He is certainly responsible for tax on the gains
arising from his actual withdrawals against his shareholders loans in
those years. He is not responsible for tax arising on any monies Ms. Seymour
took out of the Companies in those years, however they might have subsequently
agreed to treat them due to the breakdown of their relationship.
[16] I am reinforced in
my conclusion by the application of logic and common sense. The evidence is clear
that the journal entries were made to effect a splitting of the capital
property (Loans) as a result of rights Ms. Seymour had to property arising from
the common-law relationship with Mr. Kaiser. Section 74.2 of the Act is
clear that attribution only arises during the period the parties are common-law
partners. It is illogical that a decision to transfer property due to the
breakdown of a relationship could create any attribution. Otherwise, what a
great deal for the recipient: not only does she get her rightful entitlement to
50% of the property, but her ex remains on the hook for the tax arising on the
capital gains on the disposition of such property. Barring any estoppel
argument, this is not sensibly how the attribution rules are to operate. Couples
who are at the stage of splitting property are no longer in the attribution
period, being the period when they remained common-law partners.
[17] I allow the appeal
and refer the matter back to the Minister for reconsideration and reassessment
on the basis that Mr. Kaiser is not taxable on any amounts arising as a result
of the journal entries made in January 2003. Further, the parties have agreed
that the Appellant’s 2000 taxable income is to be reduced by a further $2,116
to take into account the impact of the $44,196 advance made by the Appellant to
ITI.
[18] Costs are awarded to
the Appellant.
Signed at Ottawa, Canada, this 6th day of February, 2008.
“Campbell J. Miller”
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