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Citation: 2004TCC118
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Date: 20040205
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Docket: 2002-1265(IT)I
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BETWEEN:
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BALVINDER KHAIRA,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Mogan J.
[1] On November 30, 1994, the
Appellant subscribed for five units in the Shyloh 1994-1 Limited
Partnership (the "Partnership") at a price of $5,000
per unit for a total subscription price of $25,000. On the same
day, the Appellant subscribed for 25 common shares in Shyloh
1994-1 Investments Ltd. (the "Corporation") at a price
of one dollar per share for a total subscription price of $25.00.
The Partnership and the Corporation held themselves out as having
been formed "to carry on the business of acquiring,
breeding, raising, showing, exhibiting and selling Straight
Egyptian Arabian horses for the purpose of earning farming
revenue". See Exhibit R-1, Tab 13. As a result of his
investment in the Partnership and the Corporation, the Appellant
deducted in computing income farm losses of $8,750 in 1994 and
$6,250 in 1995. He also carried forward to 1996 a farm loss of
$7,116.
[2] By Notices of Reassessment, the
Minister of National Revenue disallowed the deduction of farm
losses in 1994 and 1995, and also disallowed the loss
carry-forward in 1996. The Appellant filed a Notice of Appeal
dated March 12, 2002 claiming to appeal for the years 1994 to
1998. In the Reply, the Respondent alleged that the appeals with
respect to 1997 and 1998 were invalid because no Notice of
Objection had been served for either year; and the Respondent
stated that an application would be made to the Court for an
order quashing the appeals for 1997 and 1998. At the commencement
of the hearing, the Respondent moved to quash. After hearing
brief viva voce evidence, I granted the Respondent's
motion and quashed the purported appeals for 1997 and 1998. The
hearing then proceeded to determine the appeals for 1994, 1995
and 1996. The Appellant has elected the informal procedure.
[3] The Appellant states in his Notice
of Appeal that he was told by Canada Customs and Revenue Agency
("CCRA") that the primary reason for his reassessment
was that he did not have a reasonable expectation of profit with
respect to the Partnership or the Corporation. The Appellant
claims that his only reason for investing in the Partnership and
the Corporation was to earn a profit. In the Reply to the Notice
of Appeal, the Respondent does not rely on "reasonable
expectation of profit" but raises other issues
including:
(a) whether the Partnership was
validly formed;
(b) whether the Partnership carried on
a business;
(c) whether certain expenses deducted
by the Partnership in computing income were incurred;
(d) whether certain shares transferred
by the Appellant to his Registered Retirement Savings Plan
("RRSP") were "qualified investments" for
purposes of the Income Tax Act (the
"Act"); and
(e) whether the fair market
value of such shares at the time of transfer to the RRSP exceeded
$1,600.
The Facts
[4] The Appellant was born in India in
1959, and came to Canada when he was about 12 years old entering
Grade 8 in a Canadian elementary school. He completed Grade 12
high school and has been employed ever since. In the years under
appeal, he held a responsible position earning a salary in the
range of $50,000 to $80,000. He also operated a small enterprise
on the side placing pop (i.e. soft drink) machines in offices and
office buildings. The Appellant is intelligent, hardworking and
enterprising but not sophisticated in matters relating to
investments or income tax.
[5] The Appellant was shown an
Offering Memorandum (Exhibit R-1, Tab 13) inviting prospective
investors to subscribe for 250 "combined interests" on
the basis that each combined interest consisted of one unit
($5,000) in the Partnership and five common shares ($5.00) in the
Corporation. The Offering Memorandum is an intimidating document
of about 75 pages drafted like a prospectus but containing the
following two cautions on the first page:
No securities commission or similar authority in
Canada has in any way passed upon the merits of the securities
offered in the present offering memorandum or reviewed this
offering memorandum and any representation to the contrary is an
offence.
THE SECURITIES OFFERED HEREBY ARE SPECULATIVE.
There is no market for these securities so that it may be
difficult or even impossible for the holders to sell them. The
resale or transfer of the Units and Common Shares is subject to
the restrictions imposed by the Securities Act (British
Columbia) ... and, in the case of the Units, by the Limited
Partnership Agreement. Holders of Combined Interests may not be
able to liquidate their investment; their purchase should be
considered only by investors who are able to make long-term
investments and who are able to accept the risks inherent in the
breeding of horses. ...
These are standard cautions in a private offering of
securities which are not described in a prospectus filed with a
provincial securities commission for review.
[6] The Offering Memorandum specified
that the minimum subscription for a resident of British Columbia
was $25,025 representing five Partnership units ($25,000) plus 25
common shares ($25.00) of the Corporation. Because the Appellant
resided in British Columbia, he made the minimum investment of
$25,025. Exhibit R-4 comprises six documents which may be
described briefly as follows:
(a) a subscription for 5
Partnership units for a total subscription price of $25,000
tendering a cheque for $18,750.
(b) a subscription for 25 common
shares of the Corporation for a total subscription price of
$25.00 tendering a cheque for $25.00.
(c) a loan application in which the
Appellant applies to Shyloh Ranches Ltd. to borrow $6,250 being
the unpaid balance of the subscription price for the units.
Shyloh Ranches Ltd. is a wholly owned subsidiary of Shyloh
Management Ltd. which is the general partner of the
Partnership.
(d) a promissory note for $6,250
signed by the Appellant in favour of Shyloh Ranches Ltd.
(e) an acknowledgement in Form
20A under the B.C. Securities Act with respect to 25
(sic) units in the Partnership.
(f) an acknowledgement in Form
20A under the B.C. Securities Act with respect to 25
common shares in the Corporation.
All of the above six documents are dated November 30, 1994
indicating that they were signed by the Appellant at Surrey, B.C.
on that date.
[7] The two acknowledgements described
as items (e) and (f) in paragraph 6 above each contain a
statement along the following lines:
The Purchaser by virtue of his net worth and investment
experience, or his consultation with a person who is not an
insider of the issuer, but who is a registered advisor or dealer,
is able to evaluate the prospective investment on the basis of
information provided by the issuer.
I have already stated that the Offering Memorandum is an
intimidating document of 75 pages. My appraisal of the Appellant
from his oral testimony is that he is not sophisticated in
matters relating to investments. He does not appear to have
significant capital because (i) he borrowed $6,250 from Shyloh
Ranches Ltd.; and (ii) he stated that the down payment of $18,750
was obtained partly from personal savings and partly from a loan.
The Appellant further stated that he recalled seeing the Offering
Memorandum but did not examine the details and could not recall
how the Partnership was going to earn a profit. Although the
Appellant signed both acknowledgments (e) and (f), I think he is
not the kind of person who was able to evaluate the investment in
the Partnership and Corporation on the basis of information
provided in the Offering Memorandum.
[8] During his examination-in-chief,
the Appellant said that he was shown the plan (I think he meant
the Offering Memorandum); he was not under any pressure to
subscribe; the document showed that it was about horses; he was
willing to take the risk; and he thought that the expected profit
outweighed the risk. He stated that the was not an accountant and
so he trusted the documents. In cross-examination, he was shown
Exhibit R-2, Tab 35 with the title "Reconciliation of
Limited Partnership Losses of Prior Years". It is a table
which was provided to the Appellant by the Partnership. The table
lists the years 1990 to 1996 but amounts are entered for only
1994, 1995 and 1996. I therefore conclude that it was provided to
the Appellant sometime after December 31, 1996. The amounts shown
in Exhibit R-2, Tab 35 (on a per partner basis) may be summarized
as follows:
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1994
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1995
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1996
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A Cumulative losses beginning of
year
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$ -0-
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$6,250
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$10,000
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B Current year losses
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15,000
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10,000
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-0-
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C Subtotal
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15,000
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16,250
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10,000
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D Deducted in the year
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8,750
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6,250
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7,116
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E Cumulative losses end of
year
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6,250
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10,000
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2,883
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[9] Because the Partnership showed
actual losses in 1994 and 1995 (line B in above table), and
because the losses were regarded as derived from farming, the
Appellant deducted only the restricted farm loss under section 31
of the Act. That explains the amounts deducted in 1994 and
1995 in line D of the above table. For 1996, the Appellant
reported farming income of $7,116 (see Exhibit R-1, Tab 3); and
so he carried forward and deducted prior year losses of only
$7,116 (line D in above table) to offset the farming income
reported for 1996. It is not clear from the amounts shown in the
Appellant's 1996 income tax return (Exhibit R-1, Tab 3) that
he actually carried forward a prior year loss of $7,116. Line 150
shows total income of $62,808. Lines 208 to 232 show total
deductions of only $20,852 leaving a balance of $41,956. But in
line 260, the Appellant shows taxable income of $34,840; and he
can get down to that amount only by deducting an additional
$7,116 which is not in fact shown on line 251 or 252 of the
return.
[10] According to paragraph 8 of the
Respondent's Reply to the Notice of Appeal, the Minister
reassessed the Appellant in respect of the 1996 taxation year to
disallow a restricted farm loss carry-forward of $3,750. I cannot
find any evidence to explain the discrepancy between the amount
$3,750 in the Respondent's pleading and the amount $7,116
which I conclude the Appellant deducted in 1996 as a loss
carry-forward. In my view, the relevant amount is $7,116.
[11] Having regard to the evidence of the
Appellant's income and financial circumstances, his
investment of $18,750 cash and his obligation to pay a promissory
note of $6,250 (Exhibit R-4) were significant transactions. The
substance of the promissory note states:
FOR VALUE RECEIVED BALVINDER S. KHAIRA (the
"Borrower") hereby promises to pay to or to the order
of Shyloh Ranches Ltd. (the "Lender") at 200-1465 Ellis
Street, Kelowna, British Columbia V1Y 2A3 or at such other
address as the Lender may designate in writing, the principal
amount of (1) SIX THOUSAND TWO HUNDRED & TWENTY-FIVE DOLLARS
(sic) ($6,250.00) on that date which is forty-five (45)
days after the date of the issuance of preferred shares by Shyloh
1994-1 Investments Ltd. upon the transfer of assets from Shyloh
1994-1 Limited Partnership or, in the event that the said
preferred shares are not issued by February 15, 1996, on February
15, 1996. The principal amount shall bear interest as and from
the due date at the rate of 12% per annum.
In the Appellant's loan application (also part of Exhibit
R-4), there is a provision that the loan amount shall not bear
interest prior to maturity. I conclude from the terms of the
promissory note that its due date or maturity was February 15,
1996 or 45 days after the issuance of certain shares by the
Corporation if those shares were issued by February 15, 1996. In
other words, the due date of the promissory note could be earlier
than but not later than March 31, 1996 (February 15 plus 45
days). After the due date, the loan amount would bear interest at
12% per annum.
[12] The promissory note refers to a
transfer of assets from the Partnership to the Corporation in
exchange for shares. The Offering Memorandum describes that
transfer in greater detail. At page 1:
It is proposed that the Limited Partnership will carry on
business until approximately January 15, 1996. Subject to
approval by the Limited Partners, the assets of the Limited
Partnership will then be transferred to the Corporation (the
"Asset Transfer"). In consideration of the Asset
Transfer, the Corporation will assume all of the liabilities of,
and will issue preferred shares (the "Preferred
Shares") to, the Limited Partnership. Within 45 days of the
Asset Transfer, the Limited Partnership will be dissolved. Upon
dissolution, the Limited Partners will receive all of the
Preferred Shares on a pro rata basis. The Corporation will
continue operations until December 31, 1999, at which time it
will be dissolved. Prior to dissolution, the Corporation's
assets will be liquidated in order to permit a final cash
distribution on or before the dissolution date.
and at pages 3 and 4:
Subscribers will have the option of repaying the loan from Shyloh
Ranches by remitting Class B Preferred Shares of the Corporation
to Shyloh Ranches. Upon the proposed transfer of the business of
the Limited Partnership to the Corporation on January 15, 1996,
Class A and Class B Preferred Shares will be issued to the
Limited Partnership. The Loan Application Form provides that each
Limited Partner will remit to Shyloh Ranches, upon the
dissolution of the Limited Partnership, Class B Preferred Shares
having an aggregate redemption price equal to $1,250 per Unit
subscribed, in full repayment of the loan. The Class A and Class
B Preferred Shares of the Corporation are identical in all
material respects.
If the Limited Partner does not wish to repay the loan by
remitting Class B Preferred Shares to Shyloh Ranches as described
above, he will be required to: (i) send a notice to that
effect in prescribed form to Shyloh Ranches by January 15, 1996:
and (ii) repay the loan on February 15, 1996. The Limited Partner
will then receive Class A Preferred Shares of the Corporation.
If the foregoing notice is not received by the Limited
Partnership and Shyloh Ranches by January 15, 1996, Class B
Preferred Shares will be automatically remitted to Shyloh Ranches
in repayment of the loan.
[13] The Offering Memorandum is long but
there is a summary of its provisions at pages 6 to 10. From that
summary, I consider the following passages relevant:
Income Tax Considerations:
The Limited Partnership will use the cash method of computing
income for income tax purposes and anticipates that there will be
losses available to the holders of Units in 1994 and 1995. In
certain circumstances, the Income Tax Act (Canada)
restricts the deductibility from other sources of income of a
taxpayer's share of losses from a farming business.
...
Income Tax Deductions:
The table below sets forth, based on a maximum offering
hereunder the estimated 1994 and 1995 income tax deductions,
income tax savings, and income tax savings as a percentage of
total investment for individuals who are British Columbia
resident taxpayers who subscribe for five Units for an investment
of $25,000 ... and who are Limited Partners on the last day
of the Limited Partnership's 1994 and 1995 fiscal periods.
...
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1994
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1995
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Investment
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$25,000
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-
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Loss Allocated to Limited Partner
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15,000
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10,000
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Income Tax Deductions
- 100% of first $2,500
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2,500
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2,500
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- 50% of balance (up to $6,250)
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6,250
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3,750
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$8,750
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$6,250
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Cumulative Income Tax Savings*
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$4,739
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$8,124
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Cumulative Income Tax Savings
as a % of Total Investment
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19.0%
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32.5%
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*
Income tax savings assume that the income tax deductions are
claimed at the highest marginal rate. The combined highest
marginal rate in 1994 is 54.16% in British Columbia. ...
Although the Offering Memorandum was printed and circulated in
October 1994, it accurately "estimated" the amount of
loss which would be allocated to each limited partner in 1994 and
1995. The amounts in the table in paragraph 8 above showing for
1994 and 1995 actual losses in line B and losses actually
deducted in line D match precisely the amounts estimated (loss to
be allocated and loss available to be deducted) in the Offering
Memorandum as quoted in this paragraph.
[14] It is apparent from the Offering
Memorandum that the Partnership would have a limited life span.
The Memorandum was dated October 1994 inviting subscriptions for
combined interests. The Appellant signed his subscriptions and
promissory note; and delivered his cheque for $18,750 on November
30, 1994. See Exhibit R-4. The Memorandum stated on page one:
It is proposed that the Limited Partnership will carry on
business until approximately January 15, 1996. ... the
assets of the Limited Partnership will then be transferred to the
Corporation (the "Asset Transfer"). ... Within 45
days of the Asset Transfer, the Limited Partnership will be
dissolved. ...
According to the terms of the Offering Memorandum, the
Appellant could not expect to be a member of the Partnership for
more than 15 months because he became a limited partner only on
November 30, 1994 and the Partnership was, at that time, intended
to be dissolved not later than February 29, 1996 (45 days after
January 15, 1996). The Offering Memorandum not only projected (in
October 1994) losses allocated to each limited partner of $15,000
in 1994 and $10,000 in 1995 (see Exhibit R-1, Tab 13, page 9) but
the Partnership lived up to that projection and actually
allocated losses to each limited partner of $15,000 in 1994 and
$10,000 in 1995 (see Exhibit R-2, Tab 35).
[15] Exhibit R-2, Tab 42 is an agreement
dated December 30, 1994 between Montebello Farms Inc. as vendor
and Shyloh Ranches Ltd. as purchaser relating to the sale and
purchase of six Straight Egyptian Arabian mares and fillies
described in Schedule "A" to the Agreement. The
purchase price was $400,000 and the transaction was to close on
or before December 31, 1994. Exhibit R-2, Tab 43 is the Bill of
Sale (also dated December 30, 1994) with respect to the purchase
by Shyloh Ranches Ltd. of the six mares and fillies. Exhibit R-2,
Tab 36 is another agreement of purchase and sale dated December
30, 1994 between Shyloh Ranches Ltd. as vendor and the
Partnership as purchaser relating to the same six mares and
fillies. The purchase price was $400,000 and the transaction was
to close on or before December 31, 1994. Exhibit R-2, Tab 37 is
the Bill of Sale (also dated December 30, 1994) with respect
to the purchase by the Partnership of the same six mares and
fillies.
[16] Exhibit R-2, Tab 23 is an Amended and
Restated Board and Care Agreement dated October 13, 1994 between
Montebello Farms Inc. and the Partnership. Under this agreement,
Montebello agrees to provide board and care for all horses owned
by the Partnership for a fee of $525 per month "payable in
advance at such time or times as may be determined by the
parties" (paragraph 2). Exhibit R-2, Tab 45 is the
financial statements of the Partnership as at December 31, 1994
showing livestock of $400,000 on the balance sheet. Note 3 to the
balance sheet states that the livestock consists of three mares,
two fillies and one en utero foal. The financial
statements show nil sales, expenses of only $1,256 and a net loss
of $1,256.
[17] Exhibit R-2, Tab 30 is the Revenue
Canada Information Return of the Partnership for its fiscal
period ending December 31, 1994. Attached to the Information
Return is a "Reconciliation of Net Loss per Financial
Statements to Net Farming Loss for Income Tax Purposes". The
reconciliation shows how a modest loss of $1,256 in the financial
statements is transformed into a net farming loss of $270,000 for
18 partners, or $15,000 per limited partner. This is the amount
of loss for 1994 which caused the Appellant to deduct $8,750. See
paragraph 8 above. In the reconciliation, two significant
deductions are (i) the accounting value of the inventory at
December 31, 1994 stated as $400,000; and (ii) prepaid expenses
at December 31, 1994 stated as $135,000.
[18] There was no explanation for the
prepaid expenses of $135,000 at December 31, 1994. It seems like
a high amount for a purported farming operation which acquired
its only livestock on December 30 just one day before the end of
the fiscal period. Under the board and care agreement (Exhibit
R-2, Tab 23), six horses at $525 per month would cost the
Partnership as owner of the horses $3,150 per month. Prepaid
board and care for a full 12 months would be $37,800. The prepaid
expenses of $135,000 are puzzling and in need of explanation. The
Appellant was not able to explain that amount. No witness
appeared from the Partnership to explain that amount.
[19] Exhibit R-2, Tab 47 is the financial
statements of the Partnership as at December 31, 1995 showing nil
sales and a net loss of $82,913. Exhibit R-2, Tab 31 is the
Revenue Canada Information Return of the Partnership for its
fiscal period ending December 31, 1995. Attached to the
Information Return is what purports to be a "Reconciliation
of Net Loss per Financial Statements to Net Farming Loss for
Income Tax Purposes". I say "purports to be"
because it is simply not an reconciliation. The document in
question commences with the word "loss" but no amount
is entered where the financial statement loss of $82,913 ought to
have been entered. The arithmetic on the remainder of the page is
accurate but it blithely ignores the amount of the loss which it
was intended to reconcile.
[20] It appears to me that the amount of
$180,000 shown as a farming loss in the purported reconciliation
statement is a flawed amount because of the total failure to
reconcile it with the loss ($82,913) shown in the Partnership
financial statements for 1995. There are, however, so many
arbitrary adjustments in the so-called reconciliation statements
that the general partner may have been able to achieve a net
farming loss of $180,000 even if the financial statement loss of
$82,913 had been included in the reconciliation statement. The
omission of the amount $82,913 in the reconciliation statement is
an indication of the casual, and perhaps careless, bookkeeping of
the Partnership. I will comment on this later in these
reasons.
[21] Exhibit R-2, Tab 32 is the Revenue
Canada Information Return of the Partnership for its fiscal
period January 1, 1996 to January 15, 1996. The period is only 15
days because the Partnership transferred its assets to the
Corporation on January 15, 1996. This is confirmed in Note 2 to
the financial statements of the Corporation for the fiscal period
ending December 31, 1996:
2. ASSET
TRANSFER
On January 15, 1996, the net assets of the Limited Partnership
consisting primarily of livestock, were acquired by the Company
as contemplated in the Offering Memorandum. As consideration for
the net assets, the company issued 5,138 preferred shares at $1
each for each $5000 unit held in the Limited Partnership,
representing a total of 462,438 preferred shares. The preferred
shares are redeemable by the Company at the issue price, together
with unpaid cumulative dividends.
See Exhibit R-2, Tab 50
Returning to the Partnership Information Return (Exhibit R-2,
Tab 32), the Partnership showed nil revenue for the first 15 days
of 1996 but income of $128,102 identified as "Farming Income
for period ending on dissolution". This amount of $128,102
was allocated among the 18 limited partners on the basis of
$7,116 per partner. As stated above, the Appellant reported farm
income of $7,116 on his 1996 income tax return and then carried
forward a loss of $7,116 from prior years to offset the reported
farm income.
[22] It is necessary to consider in more
detail what happened when the assets of the Partnership were
transferred to the Corporation. Exhibit R-2, Tab 41 is a copy of
Revenue Canada form T2058 "Election on Disposition of
Property by a Partnership to a Taxable Canadian Corporation"
signed by Jim Ramsay on behalf of the Partnership and
Corporation. This form showing the Partnership as transferor and
the Corporation as transferee states that the assets were
transferred on January 15, 1996. The particulars of the property
transferred and the consideration received are recorded in form
T2058 as follows:
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Property Transferred
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Fair Market Value
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Cost Amount
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Livestock
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$575,000
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$193,584
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Consideration Received
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Loan payable
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$193,500
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-
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381,500 preferred shares
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381,500
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-
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Total Consideration
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$575,000
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[23] The financial statements of the
Corporation at December 31, 1996 (Exhibit R-2, Tab 50) state
in Note 2 that, upon the transfer of assets from the Partnership
to the Corporation, the Corporation issued 462,438 preferred
shares on the basis of 5,138 preferred shares for each $5,000
unit in the Partnership. There had been 90 outstanding
Partnership units at $5,000 each, of which the Appellant had held
five such units. Accordingly, the Appellant received 25,690
preferred shares of the Corporation upon the dissolution of the
Partnership. When the Appellant subscribed for five units in the
Partnership for a total subscription price of $25,000, he
borrowed $6,250 from Shyloh Ranches Ltd. and undertook to repay
that loan with 6,250 preferred shares of the Corporation
following the dissolution of the Partnership. After repaying the
loan of $6,250 from Shyloh Ranches Ltd. with preferred shares,
the Appellant was left with 19,440 preferred shares determined as
follows:
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Preferred shares received on dissolution of
Partnership
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25,690
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Preferred shares delivered to Shyloh Ranches Ltd. to
repay loan
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6,250
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Remainder
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19,440
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[24] I note in passing a discrepancy between
the 381,500 preferred shares shown as part consideration in the
Rollover Election form T2058 (Exhibit R-2, Tab 41) and the
462,438 preferred shares issued by the Corporation according to
its 1996 financial statements (Exhibit R-2, Tab 50). The
difference is 80,938 preferred shares. I do not see any apparent
explanation for the difference.
[25] According to subparagraphs 12(tt) and
(uu) of the Reply to the Notice of Appeal, the Minister assumed
that the Appellant transferred (during 1996) his remaining 19,440
preferred shares to his self-directed RRSP and withdrew from his
RRSP cash in the amount of $19,440. The Appellant did not deny
that he executed with his RRSP this exchange of preferred shares
for cash. Indeed, his Notice of Appeal states:
Shares of Shyloh were eligible for RRSP portfolio and were
transferred to my RRSP. These were later disallowed by CCRA which
resulted in my having lost the tax savings I deferred in 1996 and
1997 tax years. ...
Such a transaction was contemplated in the Offering Memorandum
(Exhibit R-1, Tab 13) at page 8 where the following statement
appears:
... The Limited Partnership's transfer of its
business operations to the Corporation in exchange for Preferred
Shares of the Corporation, and its subsequent distribution of
those Preferred Shares to the Limited Partners on the dissolution
of the Limited Partnership, can be done on a tax-deferred basis.
Provided certain conditions are met, a Common Share or a
Preferred Share of the Corporation will be a qualified investment
for a registered retirement savings plan or registered retirement
income fund of a shareholder. ...
The boldface words appear that way in the Offering
Memorandum.
[26] To summarize, the following amounts are
in dispute in these appeals:
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1994
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Deducted farm loss
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$8,750
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1995
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Deducted farm loss
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6,250
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1996
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Farm loss carry-forward
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7,116*
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1996
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RRSP withdrawal
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19,440
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*
There is a collateral question, not stated in the pleadings, as
to whether the Partnership had, in 1996, any farming income of
which $7,116 could be allocated to the Appellant.
Valuation
[27] The farm losses in 1994 and 1995 and
the farm profit in 1996 reported by the Partnership were based in
substantial part on the cost of the horses purchased by the
Partnership on December 30, 1994 and transferred to the
Corporation on January 15, 1996. The Partnership showed no
revenue in any of the periods ending December 31, 1994, December
31, 1995 or January 15, 1996. See Exhibits R-2, Tabs 45, 47 and
32. I therefore assume that the six horses purchased by the
Partnership on December 30, 1994 were still on hand when the
assets of the Partnership were transferred to the Corporation on
January 15, 1996. The following statement appears on page four of
the Offering Memorandum:
It will be a condition of any purchase that the purchase price
paid by the Limited Partnership not be greater than the Fair
Market Value of the horse in question, as determined by an
independent valuation.
[28] The agreement dated December 30, 1994
under which the Partnership purchased six mares from Shyloh
Ranches Ltd. (Exhibit R-2, Tab 36) stated the price at $400,000
(paragraph 2.1) but the price was not allocated among the six
horses listed in Schedule "A" to the agreement as
follows with their respective dates of birth
("DOB"):
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Name
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DOB
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Ak Su Sharafa
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04/10/86
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VES Jamaara
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04/17/91
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|
*
CH Princess Pasha (1995 in utero)
|
00/00/95
|
|
Imperial Mahreena
|
06/09/92
|
|
G. Elizamara
|
05/24/93
|
|
Prince's Last Love
|
05/02/94
|
*
Only the in utero foal is purchased (not the mare)
[29] Exhibit R-9 is a list of horse sales
provided to a Revenue Canada auditor when she visited the offices
of Shyloh Ranches Ltd. in 1998. The first page of Exhibit R-9
shows that the purchase price of $400,000 was allocated among the
six horses as follows:
|
Ak Su Sharafa
|
$95,000
|
|
VES Jamaara
|
95,000
|
|
EAI Pasha's Jewel (foal of Princess
Pasha)
|
15,000
|
|
*
Imperial Mahreena
|
85,000
|
|
G. Elizamara
|
55,000
|
|
Prince's Last Love
|
55,000
|
|
|
$400,000
|
*
The price allocated to Imperial Mahreena is different from the
price
($95,000) shown for the same horse in the Offering
Memorandum.
According to Exhibit R-8, a letter dated October 9, 1996 from
Cabreah International Inc. to James Ramsay (Shyloh Ranches Ltd.),
the Corporation did an exchange with Montebello Farms Inc.
trading VES Jamaara for Moneeka.
[30] There is no evidence that the purchase
price of $400,000 paid by the Partnership on December 30, 1994
for six horses was determined by an independent valuation as
required by the Offering Memorandum. See paragraph 27 above.
Quite the contrary! The Respondent called an expert witness who
stated her opinion that the fair market value of the six horses
on December 30, 1994 was substantially less than $400,000.
Exhibit R-10 contains the written report of Janet Henderson
expressing her opinion with respect to the five mares actually
purchased by the Partnership on December 30, 1994, the foal which
was born March 8, 1995 to C.H. Princess Pasha, and the mare
Moneeka which was later received in exchange for VES Jamaara.
[31] The resumé of Janet Henderson is
also part of Exhibit R-10. She has been in the Arabian horse
industry for 27 years. She and her husband own a breeding and
training facility in Ontario. She belongs to a number of
equestrian associations and is recognized as a
Nationals/Regionals judge with the International Arabian Horse
Association. Her qualifications were not challenged in Court. I
have no hesitation in accepting Janet Henderson as an expert
witness qualified to express her opinion with respect to the fair
market value of Arabian horses. She introduced her report with
the following overview of market conditions for Straight Egyptian
Arabian Horses in December 1994:
The Arabian horse marketplace saw steadily rising prices
through the late 1970's and the early 1980's, and peaked
in 1984. The second half of 1985 saw a trend of decline and after
the U.S. tax reform in 1986, the average price for Arabians
dropped by 30% to 50% per year. The decline bottomed out in the
1990 - 1991 period.
In 1992, overall prices were buoyed by the Gleannloch Final
Legacy Sale. In 1994, prices for Egyptian Arabians averaged
$6,191.00 USD, while the First Annual Scottsdale Egyptian Sale
averaged $6,843.00 USD per head. This sale showed a high selling
price of $19,000.00 USD. One stallion and one mare sold at
this price, while the balance of mares were sold for an average
of $5770.00 USD.
[32] Ms. Henderson provided a detailed
description for each of the seven horses she appraised. Because
she was engaged to do her appraisal around 2001 or 2002, it was
difficult to view the horses themselves but she was able to
examine their ancestry, their progeny, and how frequently they
had been sold (and the prices) before and after December 1994.
For each horse, she expressed her value as between two amounts.
In the table below, I have summarized her seven valuations
including her range of value for each horse and, in the extreme
right column, I have stated the midpoint value within her
range.
|
Name
|
Valuation Range
|
Midpoint
|
|
Ak Su Sharafa
|
$20,000 - $22,000
|
$21,000
|
|
VES Jamaara
|
$10,000 - $12,000
|
11,000
|
|
Pasha's Jewel (foal of Princess Pasha)
|
$ 8,000 - $10,000
|
9,000
|
|
Imperial Mahreena
|
$30,000 - $32,000
|
31,000
|
|
G. Elizamara
|
$10,000 - $12,000
|
11,000
|
|
Prince's Last Love
|
$ 9,000 - $11,000
|
10,000
|
|
Moneeka
|
$35,000 - $37,000
|
36,000
|
[33] In the preceding table, I included
Moneeka only because it was appraised by Ms. Henderson. Moneeka
was acquired by the Partnership in October 1996 in exchange for
VES Jamaara. I will therefore exclude Moneeka from the value of
horses purchased by the Partnership in December 1994. Excluding
Moneeka, the total of the midpoint amounts for the first six
horses listed in the table above is $93,000. This aggregate
appraised value of $93,000 for the six horses purchased by the
Partnership on December 30, 1994 is in sharp contrast with the
purchase price of $400,000 paid by the Partnership. The
difference of $307,000 is truly significant.
[34] Ms. Henderson's valuation report is
dated December 8, 2002 and is part of Exhibit R-10. Also included
as part of Exhibit R-10 is a letter dated December 10, 2002
from Ms. Henderson to CCRA in which she states:
I have operated a board and care facility for Arabian horses
for twenty-four years. I am familiar with industry practices
throughout North America, specifically with respect to the board
and care of Arabian horses. As such, I feel that I am qualified
to opine of the issue of the reasonable cost of board and
care.
I charge $360.00 per month per horse for board and care. The
reasonable range for the cost of board and care would be from
$360.00 to $450.00 per month per horse. This amount could be
increased to $1200.00 per month per horse with training for
showing included.
It is not reasonable nor it is the normal business practice
for the owner of a horse to prepay board and care for a period of
two years.
Analysis
[35] The opinion evidence given by Janet
Henderson was not contradicted by any expert witness called by
the Appellant. I accepted Ms. Henderson as a well-qualified
expert witness. In her appraisal of each horse, she took into
account its sire and its dam; the performance of both the sire
and dam as show or race horses; and the recorded performance of
the progeny of the sire and the dam including sale prices where
possible. She also had reference to the first Egyptian Arabian
Sale in Scottsdale in February 1994, just 10 months prior to the
valuation date. I find that Ms. Henderson's conclusions as to
value are objective, balanced and fair. This is important when
the opinion relates to fair market value.
[36] The unchallenged opinion evidence of
Ms. Henderson is very damaging to the Appellant's case and to
the whole Arabian horse farming proposal put forward by the
Partnership and the Corporation in the Offering Memorandum
(Exhibit R-1, Tab 13). According to the financial statements of
the Partnership at December 31, 1994 (Exhibit R-2, Tab 45), 90
limited partnership units of $5,000 each were issued for a total
cash consideration of $450,000. The Appellant purchased five of
such units. The Offering Memorandum was dated October 1994.
Therefore, it may be concluded that the 90 limited partnership
units were issued or sold from October to December 1994. The
Appellant purchased his five units on November 30, 1994. See
Exhibit R-4.
[37] As soon as the limited partnership
units were sold and most of the money was in hand, the general
partner (Shyloh Management Ltd.) caused the Partnership to
purchase six horses at an aggregate price of $400,000 when the
fair market value of those six horses was only $93,000. If the
person making the decisions for the general partner had little
knowledge of Arabian horses, then that person made an imprudent
and foolish purchase on behalf of the limited partners. The
Partnership lost $307,000 by December 31, 1994 because it paid
$400,000 for horses which were worth only $93,000.
[38] If the person making the decisions for
the general partner had substantial knowledge of Arabian horses
including knowledge of what they were worth on the open market,
then that person cheated the limited partners (like the
Appellant) by causing them to lose most of their capital through
a deceitful purchase of horses. No one testified for or on behalf
of the Partnership. There is not enough evidence in this case for
me to conclude that the Appellant was the victim of a fraudulent
scheme but there is plenty of evidence to conclude that the
Appellant's appeals for 1994, 1995 and 1996 must be
dismissed.
[39] The summary of the Offering Memorandum
covers pages 6 to 10 and concludes with the following note on
page 10 (Exhibit R-1, Tab 13):
Conflicts of Interest:
Mr. James Ramsay, the sole officer and director of the General
Partner and of the Corporation, is also the sole officer,
director and shareholder of Shyloh Ranches. Shyloh Ranches has
entered into the Consulting Agreement with the General Partner
whereby Shyloh Ranches will provide the services of Mr. Ramsay to
assist the General partner in fulfilling its obligations to
render management services to the Limited Partnership and to the
Corporation. Potential conflicts of interest exist due to other
business endeavours in the Straight Egyptian Arabian horse
industry in which Shyloh Ranches may be involved. See
"Management Interests and potential Conflicts of
Interest".
The Appellant had no personal knowledge of what operation or
activity (if any) the Partnership performed. He relied on what he
was told when he invested his $18,750 and on what he might have
read from the Offering Memorandum. I regret that Mr. James Ramsay
did not come forward to testify as a witness in support of the
Appellant's case. He might have been able to answer some of
the following questions which I consider relevant:
1. What did Mr. Ramsay
know about Arabian horses in December 1994 when the
Partnership purchased six horses for $400,000?
2. Having regard to Ms.
Henderson's overview of the market at the beginning of her
report, did Mr. Ramsay know that prices of Egyptian Arabians
averaged $6,191 (USD) in 1994? Did he know that the first Annual
Scottsdale Egyptian Sale in February 1994 averaged $6,843
(USD)?
3. If Mr. Ramsay knew
about the average prices of Arabian horses in 1994 as recited in
the Henderson Report, why did he agree on behalf of the
Partnership to purchase six horses for $400,000 (Can)?
4. If Mr. Ramsay did not
have first-hand knowledge of the Arabian horse market in 1994,
how could he hold himself out in the Offering Memorandum as a
person on whom innocent investors like the Appellant could
rely?
5. The Offering Memorandum
stated at page 5 ("Purchase of Horses") that the
Partnership will purchase from Montebello Farms Inc. the Straight
Egyptian mare in Appendix "A" for $95,000. The horse in
Appendix "A" is Imperial Mahreena. What does Mr. Ramsay
say about Ms. Henderson's opinion that the fair market value
of Imperial Mahreena in December 1994 was $31,000?
6. If Mr. Ramsay were to
disagree with Ms. Henderson's valuation of Imperial Mahreena
in December 1994, on what facts would he rely? Does he know if
Imperial Mahreena was sold at arm's length at any time before
or after December 1994?
7. Was Shyloh Ranches Ltd.
at arm's length with Montebello Farms Inc. in December 1994
when the six mares were purchased for $400,000?
8. The Offering Memorandum
at page 4 under the heading "Purchase of Horses" states
that the purchase price paid by the Partnership for a horse will
not exceed fair market value "as determined by an
independent valuation". Did the Partnership ever obtain an
independent valuation for any horse it purchased? If so, was the
valuation expressed in writing? If it was in writing, why was the
written report not produced in this case to support the
Appellant's appeal? If the Partnership did not obtain an
independent valuation for each horse that it purchased, why did
Mr. Ramsay or the general partner fail to honour the undertaking
given at page 4 of the Offering Memorandum?
9. Why was Shyloh Ranches
Ltd. used first to purchase the six mares from Montebello Farms
Inc. on December 30, 1994 (Exhibit R-2, Tab 42) and then to sell
the same six mares on the same day at the same price to the
Partnership (Exhibit R-2, Tab 36)? What does Mr. Ramsay say about
signing Exhibit R-2, Tab 36, on behalf of both vendor and
purchaser?
10. Where were the six horses kept in
the period from December 30, 1994 to January 15, 1996? Where they
boarded at Montebello Farms Inc.? Were the boarding fees prepaid?
If so, why? Were the boarding fees prepaid so that the
Partnership (on a cash basis for a farming operation) could show
a significant loss in its first short fiscal period ending on
December 31, 1994?
11. Was the Partnership ever intended
to make a profit? If so, why was the profit element not
emphasized or promoted in the Offering Memorandum? Why did the
Offering Memorandum emphasize (as on page 9) only the loss to be
allocated to each limited partner; the tax savings resulting from
the deduction of such loss; and the tax savings as a percentage
of the limited partner's investment?
12. If the Partnership lost $307,000
on the purchase of its first six horses, how could it possibly
make a profit in its projected short life span from October 1994
to February 1996?
13. Did the Partnership operate a
business? If so, what was the business? Did it keep any books or
records? If so, where are they?
[40] With reference to question 13 above, a
Revenue Canada auditor (Ms. Esther Dirksen) testified in
this case. She stated that she attended at Shyloh Ranches Ltd. at
Kelowna, B.C. in May 1998. She asked for the full accounting
records of the Partnership but all she was given were closing
general ledger entries as at December 31, 1994 and 1995. These
entries appear as photocopies in Exhibit R-2, Tabs 46 and 48. In
paragraphs 19 and 20 above, I described a purported
reconciliation of the Partnership's net loss in its financial
statements to its farming loss for tax purposes for the fiscal
period ending December 31, 1995. Similarly, in paragraph 24, I
noted a discrepancy of 80,938 preferred shares between the
consideration in the rollover agreement and the issued shares
according to the Corporation's financial statements. On the
evidence before me, I conclude that the Partnership did not
maintain books and records up to the standard one would expect
from an organization which raised $450,000 from public
subscriptions.
[41] I rely on the evidence of the
Respondent's expert witness, Janet Henderson, because I
found her to be intelligent, knowledgeable and objective. I am
satisfied from her evidence that the fair market value of the six
horses purchased by the Partnership on December 30, 1994 was
$93,000 at the time of purchase. Because the Partnership paid
$400,000 for six horses which had a fair market value of only
$93,000, I find in the absence of contrary evidence that it was
not possible for the Partnership to earn a profit at any time
and, in particular, within the projected short life span of the
Partnership from October 1994 to February 1996.
[42] I am also satisfied from Ms.
Henderson's letter of December 10, 2002 (part of Exhibit
R-10) that a reasonable range for the cost of board and care
would be $360 to $450 per month per horse; and that it is not
reasonable or normal for a horse owner to prepay board and care
for a period of two years. Under the terms of a board and care
agreement (Exhibit R-2, Tab 23) the Partnership agreed to pay to
Montebello Farms Inc. $525 per horse per month for the board and
care of the Partnership's horses, payable in advance. And
according to the Partnership's financial statements at
December 31, 1994 (Exhibit R-2, Tab 45), there were prepaid
expenses of $135,000 which I conclude were at least in part for
the board and care of horses. In the purchase agreement (Exhibit
R-2, Tab 42), the purchase price of $400,000 was payable by
Shyloh Ranches Ltd. to Montebello Farms Inc. by a promissory
note. There is no evidence that the promissory note was
secured.
[43] Having regard to the evidence and
conclusions summarized in paragraphs 41 and 42, I draw the
inference that the Partnership, Shyloh Ranches Ltd. and
Montebello Farms Inc. did not deal with each other at arm's
length at any time relevant to this case. Accordingly, I question
the good faith of any transaction between or among those
parties.
[44] I have already found in paragraph 41
that it was not possible for the Partnership to earn a profit at
any time. Considering the terms of the Offering Memorandum, and
the fact that all Partnership transactions were with either
Shyloh Ranches Ltd. or Montebello Farms Inc., I find that the
Partnership was never expected or intended to earn a profit. The
Partnership was simply a custodian of certain documents which
gave it the façade of "acquiring, breeding, raising,
showing, exhibiting and selling" Arabian horses. On the
evidence before me, the Partnership never took custody of a
single horse. I find that the Partnership did not carry on any
business in the period from October 1994 to that date in January
1996 when it purported to (and perhaps did in fact) transfer its
assets to the Corporation.
[45] Because the Partnership did not carry
on any business, it did not have any loss or profit to allocate
to the limited partners in the years 1994, 1995 or 1996.
Therefore, there was no farm loss for the Appellant (as a limited
partner) to deduct in 1994 or 1995. And there was no farm income
of $7,116 for the Appellant to report in 1996.
[46] The decision of the Federal Court of
Appeal in Witkin v. The Queen, 2002 DTC 7044, is
helpful because Mr. Witkin was claiming to deduct a certain loss
allocated to him by a limited partnership. In dismissing Mr.
Witkin's appeal, Rothstein J.A. writing for the Court stated
in paragraph 15:
While a primary motivation of a taxpayer, in entering a
purported partnership, may be to secure a tax loss, there must at
least be an ancillary intention to carry on business in common
with a view to profit for the test for partnership to be met.
(See Continental Bank, supra, at paragraph 43.) In this
case, the only evidence accepted by the Tax Court Judge was that
the appellant was intending to, and did, purchase a tax loss.
Applying the correct, low threshold, test for partnership to the
facts as found by the Trial Judge, it is apparent that the
appellant was not carrying on business in common with a view to
profit in respect of his participation in Claridge Holdings No.
1. ...
[47] In my opinion, the above passage from
Witkin applies to this case because the primary purpose of
the Offering Memorandum was to promote the use of farm losses for
tax purposes, and the possible sale of newly issued shares to an
RRSP. See pages 8 and 9 of the Memorandum. The Appellant does not
meet the "low threshold" test for partnership because
he had no interest in using Arabian horses to operate a farming
business for profit. Neither did the general partner and Mr.
James Ramsay or they would not have permitted the Partnership to
pay $400,000 for six horses having a fair market value of only
$93,000.
[48] Considering the 19,440 preferred shares
of the Corporation which the Appellant transferred to his RRSP in
1996, I find that those shares had no value. According to the
financial statements of the Corporation as at December 31, 1996
(Exhibit R-2, Tab 50), the balance sheet showed a deficit of
$152,032. This is not surprising when, according to the rollover
election (Exhibit R-2, Tab 41), the Corporation paid
$575,000 for livestock which probably had a fair market value of
about $100,000. Because the Appellant transferred 19,440
worthless preferred shares into his RRSP and took out $19,440 in
cash, he is required to include that $19,440 in his 1996
income.
[49] I have already observed that the
Offering Memorandum is an intimidating document. It promotes the
opportunity to deduct farm losses for income tax purposes, and
the further opportunity to transfer newly issued shares to an
RRSP in exchange for cash. The Appellant was attracted to these
opportunities like a moth to a flame and paid out $18,750 of his
own money. Using the cliché of a century ago, he bought
the Brooklyn Bridge!
[50] On the one hand, a person might have
some sympathy for an individual like the Appellant who is duped
by a highly promotional document. On the other hand, the Offering
Memorandum does not have a true ring, and common sense must be
given some play in the open market. The appeals for 1994 and 1995
are dismissed. The appeal for 1996 is allowed (i) to exclude the
amount $7,116 from the Appellant's income (and excluding any
loss carry-forward) because the Partnership did not have any farm
business from which to allocate farm income; and (ii) to permit
the Appellant to claim a possible loss (capital or non-capital,
depending on the circumstances) with respect to the disposition
of his 19,440 preferred shares to his RRSP. I am not attempting
to decide whether the Appellant realized such a loss, or whether
he is entitled to deduct a capital or non-capital loss if the
cost of such shares exceeded their value at the time of transfer
to his RRSP. He is, however, at least entitled to claim such a
loss if circumstances permit.
Signed at Ottawa, Canada, this 5th day of February, 2004.
Mogan J.
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