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Citation: 2003TCC471
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Date: 20030707
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Docket: 1999-5090(IT)G
2000-271(IT)G, 2000-272(IT)G
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BETWEEN:
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DANIEL GEHRES JR.,
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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
Bowie J.
[1] These three appeals are brought
from reassessments of the Appellant's liability for income tax
for the 1995, 1996 and 1997 taxation years. By those
reassessments the Minister of National Revenue (the Minister)
added to the Appellant's income, as previously assessed, certain
amounts that he considered were deemed to be income of the
Appellant by reason of subsection 74.1(2) of the Income Tax
Act (the Act). That subsection reads:
74.1(2) Where an individual has transferred or lent property,
either directly or indirectly, by means of a trust or by any
other means whatever, to or for the benefit of a person who was
under 18 years of age (other than an amount received in respect
of that person as a consequence of the operation of subsection
122.61(1)) and who
(a) does not
deal with the individual at arm's length, or
(b) is the
niece or nephew of the individual,
any income or loss, as the case may be, of that person for a
taxation year from the property or from property substituted
therefor, that relates to the period in the year throughout which
the individual is resident in Canada, shall be deemed to be
income or a loss, as the case may be, of the individual and not
of that person unless that person has, before the end of the
year, attained the age of 18 years.
[2] The amounts in question are
$58,460 for 1995, $41,670 for 1996 and $41,006 for 1997. The
Appellant also appealed in respect of additional amounts of
$4,841, $5,118 and $4,963 that the Minister added to his income
in respect of his use of a company vehicle, but at the
commencement of the hearing his counsel abandoned that aspect of
the appeals.
[3] The Appellant has been very
successful in the business of selling and installing windows and
doors. A corporation called 528094 Ontario Limited, which was
referred to in the evidence as "Associates", carried on the
installation side of the business. The Appellant was the owner of
its only issued and outstanding share. At the end of October
1994, with the advice and assistance of his accountants and his
lawyers, the Appellant took steps to reorganize his corporate
business structure in the following way:
1. On October 28,
Associates declared a stock dividend of $100, which was paid by
issuing 625,000 Class A Special shares to the Appellant, and
adding $100 to Associates' stated capital account;
2. The Appellant
transferred these shares to 1102486 Ontario Ltd. (Holding) in
exchange for 100 common shares of Holding, pursuant to subsection
85(1) of the Act. By a joint election, Holding added $100
to its stated capital account, and the fair market value of the
100 shares was noted to be $625,000;
3. On October 31,
Associates redeemed the 625,000 Class A Special shares held by
Holding, paying the redemption amount of $625,000 by transferring
to Holding two term deposits issued by Canada Trust. One of these
had a face value of $500,000, bore interest at 9.75%, and matured
on November 1, 1996. The other had a face value of $125,000, bore
interest at 9.5% and matured on November 1, 1995. The holder of
these deposits was entitled to cash them on demand, but subject
to an adjustment of the rate of interest;
4. The Appellant
incorporated Lionsight Holdings Ltd. (Lionsight) on October 28.
On October 31, Holding subscribed for 625,000 Class A preference
shares in Lionsight at $1.00 per share and paid for them by
transferring the term deposits to Lionsight. These Class A
preference shares had the right to vote, and to receive
non-cumulative monthly dividends at the rate of 0.5% of the
redemption price. The redemption price was subject to a price
adjustment clause that permitted the directors to adjust the
price to conform to the fair market value of the consideration
for which they were issued, as determined by the Minister.
5. The Gehres Family Trust
(the Trust) had recently been settled by the Appellant's
mother-in-law, with capital of $100. The trustees were the
Appellant and his wife, and the beneficiaries as to the income of
the Trust were his minor children. On October 31, the Trust
subscribed for 100 common shares of Lionsight, which was all of
its issued and outstanding common shares.
[4] Thereafter, Lionsight used the
interest it earned on the term deposits to declare and pay
dividends of approximately $58,460 in 1995, $41,670 in 1996 and
$41,006 in 1997 on the 100 common shares held by the Trust. The
Trust distributed this income to the beneficiaries, who were
taxed on it under subsection 104(13). It is these amounts that
were added to the Appellant's income by the reassessments under
appeal.
[5] This reorganization was carried
out under the direction of Mr. Reginald Leftwick, C.A., a Toronto
accountant. He testified that there were four objects that he
sought to attain by the reorganization. These were to dissociate
the two operating companies, to take advantage of the available
capital gain exemption, to remove the investment income earned by
the term deposits from the operating company that held them, and
to split the income from the business and the term deposits
between Mr. Gehres and his children. The first three of these
objectives were accomplished by Mr. Leftwick's plan without
adverse tax consequences. However, the Minister took the view
that when Holding exchanged its two term deposits for the 625,000
Class A preference shares of Lionsight the Appellant became
subject to the application of the deeming provision found in
subsection 74.1(2). In reaching this conclusion, the
Minister was applying the decisions of the Federal Court of
Appeal in The Queen v. Kieboom[1] and Romkey et al. v. The
Queen[2]. Those cases stand for the proposition that an
individual who, through a series of transactions, causes the
value of his interest in a corporation to be reduced and the
value of a beneficial interest held by his children to increase
effects an indirect transfer of property to his children within
the meaning of subsection 74.1(2).
[6] There was a good deal of
discussion at the trial about the relative values of the term
deposits and the non-cumulative preference shares of Lionsight
that were exchanged for them. Two things are clear from the
evidence. One is that the total dividends actually declared on
the preference shares amounted to much less than the total
dividends declared on the 100 common shares. The other is that
the Minister at no time attempted to establish a value for either
the term deposits or the preference shares, and no witness was
called by either party to give evidence as to their values.
Nevertheless, I have reached the conclusion that subsection
74.1(2) has no application in the present case, by reason of
subsection 74.5(1), which, so far as it is relevant, reads:
74.5(1) Notwithstanding any other provision of this Act,
subsections 74.1(1) and (2) and section 74.2 do not apply to any
income, gain or loss derived in a particular taxation year from
transferred property or from property substituted therefor if
(a) at the
time of the transfer the fair market value of the transferred
property did not exceed the fair market value of the property
received by the transferor as consideration for the transferred
property;
[7] As I have said, there was no
evidence led at the trial as to the value of either the term
deposits or the preference shares that were issued for them by
Lionsight. However, counsel for the Respondent wrote on June 10,
2002, to counsel for the Appellant for the purpose of answering
certain undertakings given during the examination for discovery
of an officer of the Crown. That letter contains the following
sentence:
The "properties" transferred were either the term deposits or
the preferred shares, the values of which are equal.
Counsel sought to withdraw this admission during oral
argument. However she put no evidence before me to show that the
fact admitted was incorrect and that the admission resulted only
from inadvertence, and I therefore declined to permit the
admission to be withdrawn. The Appellant went to trial on the
basis of that admission, and he is entitled to the benefit of it.
The result is that paragraph 74.5(1)(a) precludes the
operation of subsection 74.1(2) in the circumstances of the
present case.
[8] That does not end the matter,
however, as the Crown sought to advance an alternative position
in support of the assessment, based upon subsection 74.4(2),
which reads:
74.4(2) Where an individual has transferred or lent property,
either directly or indirectly, by means of a trust or by any
other means whatever, to a corporation and one of the main
purposes of the transfer or loan may reasonably be considered to
be to reduce the income of the individual and to benefit, either
directly or indirectly, by means of a trust or by any other means
whatever, a person who is a designated person in respect of the
individual, in computing the income of the individual for any
taxation year that includes a period after the loan or transfer
throughout which
(a) the
person is a designated person in respect of the individual and
would have been a specified shareholder of the corporation if the
definition "specified shareholder" in subsection 248(1) were read
without reference to paragraphs (a) and (d) of that definition
and if the reference therein to "any other corporation that is
related to the corporation" were read as a reference to "any
other corporation (other than a small business corporation) that
is related to the corporation",
(b) the
individual was resident in Canada, and
(c) the
corporation was not a small business corporation,
the individual shall be deemed to have received as interest in
the year the amount, if any, by which
(d) the
amount that would be interest on the outstanding amount of the
loan or transfer of the property for such periods in the year if
the interest were computed thereon at the prescribed rate of
interest for such periods
exceeds the total of
(e) any
interest received in the year by the individual in respect of the
transfer or loan (other than amounts deemed by this subsection to
be interest),
(f) 5/4 of
all taxable dividends received (other than dividends deemed by
section 84 to have been received) by the individual in the year
on shares that were received from the corporation as
consideration for the transfer or as repayment for the loan that
were excluded consideration at the time the dividends were
received or on shares substituted therefore that were excluded
consideration at that time.
It was made quite clear at trial that this alternative
argument formed no part of the Minister's assessing position, but
is advanced as an afterthought. Indeed, the assessor, in giving
his evidence as to the amounts of tax that would be exigible
under this alternative position in each of the three years under
appeal, stated that he had made the computations only the night
before the trial began. The position taken by counsel for the
Appellant is that the Minister's alternative position was not
pleaded, or at least not adequately pleaded, and therefore cannot
be advanced at trial. For the reasons that follow, I agree with
that submission.
[9] The Reply to the Notice of Appeal
filed by the Respondent in each of the appeals, refers only
briefly and obliquely in Part A. Statement of facts,
paragraph 2 to the alternative argument:
2. Save that
he denies that the series of transactions which are the subject
of this appeal were part of a corporate reorganization, and
states that they were merely a scheme in the Appellant's effort
to transfer income to non-arm's length parties, he admits the
facts stated in paragraphs 4, 5, 6, 10 and 13 of the Notice of
Appeal.
Assumptions of fact are pleaded in some detail in paragraph 8,
but all of them are directed to the Minister's assessing position
based upon subsection 74.1(2), and to the facts relating to the
automobile standby charge issue. No additional facts relating to
the application of section 74.4(2) are pleaded, as assumptions or
otherwise. In particular, there is no allegation that one of the
main purposes of the transfer of property may reasonably be
considered to be to reduce the income of the Appellant and to
benefit a designated person. Nor is there any allegation as to
the computation of the income that the Minister alleges to be the
deemed income of the Appellant under the subsection. The issues
are stated under Part B. issues to be decided as
follows:
9. The main
issue is whether the Appellant has transferred property, either
directly or indirectly, by means of a trust or by any other means
whatsoever, to or for the benefit of a person who was under 18
years of age who did not deal with the Appellant at arm's length,
such that the income from the property is attributable to the
Appellant pursuant to subsection 74.1(2) of the Act.
10. The second issue is
whether the Appellant has properly been assessed a standby charge
and operating benefit pursuant to paragraphs 6(1)(e) and
6(1)(k) of the Act.
There is no reference at all to the proposed alternative
argument. In Part C. Statutory Provisions, Grounds Relied On, and
Relief Sought, subsection 74.4(2) is mentioned in a list of
nine different provisions of the Act that the Deputy
Attorney General of Canada says he relies on. There is no other
reference at all to the alternative argument that the
Respondent's counsel sought to advance at the trial. In my view,
it cannot be said that the Appellant was given fair notice by
this pleading of the issues, both factual and legal, that were
involved in the proposed alternative argument.
[10] During the course of her argument,
after the evidence and argument for the Appellant had been
completed, the Appellant sought to deal with this deficiency in
the pleading by requesting leave to amend the Replies by adding
the allegations of fact and the proposed alternative argument
that were missing. It would be wrong in the circumstances of this
case to permit such an amendment.
[11] I should make it clear that Mr. Morris
put his objection to the alternative position of the Respondent
entirely upon the principles of pleading, and not upon the
obiter of the Supreme Court of Canada in Continental
Bank v. Canada[3] and the recently much-argued issue of the reach of
subsection 152(9) of the Act, which was enacted in
response to it. In its simplest form, the argument is that the
pleading did not give adequate notice of the case to be met, and
it is much too late at the end of the trial to seek to amend it.
This is a subject on which authority abounds, but I need only
refer to two. In The Queen v. Hollinger Inc.,[4] the Federal Court of
Appeal dealt with a preliminary issue as to an amendment to the
Crown's Reply to the Notice of Appeal advancing a new basis to
support the assessment that had been permitted in the Tax Court
proceeding. In delivering the unanimous reasons of the Court,
Létourneau J.A. held that the Crown was entitled to raise
the new argument in support of its assessment, and went on to
say:[5]
... The respondent was fully and timely informed of [the new
basis] and had ample time to prepare as the hearing of the appeal
took place more than three and a half years later. All the
relevant evidence was before the Tax Court judge.
In Transcanada Pipelines Limited v. The Queen,[6] the
Federal Court of Appeal had to deal with the question whether
more than one appeal could be brought by a taxpayer from one
assessment. After concluding that only one appeal would lie,
Rothstein J.A. said for the unanimous Court:[7]
... I do not rule out an amendment to a notice of appeal to
raise additional issues, provided the amendment is timely and
is sought in accordance with the Rules of the Tax Court.
(emphasis added)
It certainly cannot be said that the proposed amendment to the
Replies in the present case is timely, nor has it been sought in
accordance with the Rules of the Court. If the Respondent
had brought a motion prior to the opening of the trial for leave
to amend the Replies, then Orders permitting the amendments could
perhaps have been made, on appropriate terms. However, I am not
prepared to give such leave in response to an extemporaneous
request made in the course of final argument. It is simply too
late to permit the new argument to be properly raised for the
first time.
[12] The appeals will be allowed and the
assessments referred back to the Minister for reconsideration and
reassessment on the basis that the Appellant is not subject to
the additions to his income made under subsection 74.1(2) of the
Act, but he is subject to the additions made under
paragraphs 6(1)(e) and 6(1)(k). The Appellant is
entitled to one set of costs only.
Signed at Ottawa, Canada, this 7th day of July, 2003.
E.A. Bowie J.
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