Date: 20080407
Docket: A-19-07
Citation: 2008 FCA 128
CORAM: LINDEN J.A.
SEXTON J.A.
RYER
J.A.
BETWEEN:
BERT TOLHOEK
Appellant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
RYER J.A.
[1]
This is an
appeal from a decision of Justice Diane Campbell of the Tax Court of Canada
(2006 TCC 681), dated December 15, 2006, dismissing the appeal of Mr. Bert
Tolhoek (“Mr. Tolhoek” or “the appellant”) against a reassessment of his 1997
taxation year that was made by the Minister of National Revenue (the
“Minister”), pursuant to the Income Tax Act, R.S.C. 1985, c. 1 (5th
Supp.) (the “ITA”). Unless otherwise indicated, all statutory references in
these reasons are to the corresponding provisions of the ITA for the taxation
year under consideration.
[2]
In 1997,
the ICON Capital Limited Partnership (the “Limited Partnership”) issued limited
partnership units to Mr. Tolhoek for consideration that included the assumption
by Mr. Tolhoek of a portion of an indebtedness of the Limited Partnership (the “Assumed
Indebtedness”). On December 31, 1997, the Limited Partnership allocated a loss
in the amount of $47,646 to Mr. Tolhoek.
[3]
Subsection
96(2.1) essentially limits the amount of any loss of a limited partnership that
can be allocated to a limited partner to an amount equal to the at-risk amount,
as defined in subsection 96(2.2), of the limited partner in respect of the
limited partnership. The at-risk amount of a limited partner in respect of a
limited partnership is basically the adjusted cost base, within the meaning of section
54 (the “adjusted cost base”), of that limited partner’s interest in the
limited partnership, subject to a number of adjustments.
[4]
Pursuant
to subsection 143.2(6), the adjusted cost base of an interest in a limited
partnership can be reduced by an amount equal to any limited-recourse amount,
within the meaning of subsection 143.2(1) (a “limited-recourse amount”), of a
limited partner that relates to the limited partnership interest. A limited-recourse
amount is generally the amount of any indebtedness in respect of which the
recourse against the debtor is, or is deemed to be, limited.
[5]
The
Minister determined that the Assumed Indebtedness constitutes a limited-recourse
amount and that the adjusted cost base of Mr. Tolhoek’s interest in the Limited
Partnership was required to be reduced, pursuant to subsection 143.2(6), by the
amount of $32,646. The reassessment, in reliance upon subsection 96(2.1), denied
a corresponding amount of the loss of the Limited Partnership that was
allocated to Mr. Tolhoek.
[6]
The
reassessment was issued on November 24, 2003, after the end of Mr. Tolhoek’s
normal reassessment period, within the meaning of paragraph 152(3.1)(b),
(the “normal reassessment period”), in respect of his 1997 taxation year.
[7]
The issues
in this appeal are whether the Assumed Indebtedness constitutes a limited-recourse
amount and whether the reassessment was impermissible because it was issued outside
the normal reassessment period in respect of Mr. Tolhoek’s 1997 taxation year
or was otherwise issued too long after the end of that taxation year.
BACKGROUND
[8]
The actual
transactions that were undertaken are detailed and complex and the applicable
provisions of the ITA are at least comparable in detail and complexity. Accordingly,
a detailed consideration of the facts is warranted.
[9]
Mr. Edward
K. Furtak controls Trafalgar Research (Bermuda) Ltd. (“Trafalgar Research”), a
non-resident of Canada, which, in turn, controls Trafalgar Capital Ltd.
(“Trafalgar Capital”), another non-resident of Canada.
[10]
The
Limited Partnership was formed prior to 1997, with ICLP Management Inc. (the
“General Partner”) as its general partner, and Mr. Furtak as its initial
limited partner. The taxation year of the Limited Partnership ends on December
31st in each calendar year.
[11]
On
December 31, 1996, the Limited Partnership acquired certain computer software
(the “Software”) from Trafalgar Capital, pursuant to a “Software Agreement” that
was amended several times after its execution. Certain of the relevant
provisions of this agreement and of an “Amended Software Agreement” are as
follows:
(a) The
Software, which originally had been developed by Trafalgar Research, was
intended to instruct money managers when to buy and sell certain S&P
contracts.
(b) The
initial price of the Software was $20,000,000, which was paid by the issuance
of a $20,000,000 promissory note (the “Acquisition Note”) that bore interest at
the rate of 5% per annum and was due December 1, 2006.
(c) The
purchase price of the Software and the principal amount of the Acquisition Note
were reduced to $14,880,000, effective December 31, 1997, to reflect the lower number
of units in the Limited Partnership that had been sold to investors.
(d) Pursuant
to clause 4.01(k) of the “Amended Software Agreement”, Trafalgar Capital made
the following representation” (the “Clause 4.01(k) Warranty”):
4.01(k) The Computer Programs are capable
of generating at least 500 Trading Reports per year per $250,000 in Trading
Funds and, between the date hereof and December 1, 2006, will generate an
average annual return of no less than 12% on leveraged Trading Funds.
[12]
On July
22, 1997, Revenue Canada assigned a tax shelter
identification number to the Limited Partnership, and as such, units in the
Limited Partnership constituted tax shelter investments, within the meaning of
subsection 143.2(1).
[13]
The
Limited Partnership, Trafalgar Capital and Trafalgar Research, formed a Bermuda
limited partnership (the “Bermuda Limited Partnership”), as of October 31,
1997, for the purpose of licensing the Software from the Limited Partnership
and using it to buy and sell S&P contracts, effectively as a broker for,
and with funds (the “Trading Fund”) that were to be provided by, Trafalgar
Research.
[14]
Pursuant
to a “Software Licence Agreement” made as of October 31, 1997, the Limited
Partnership granted a non-exclusive right to use the Software (the “Licence”) to
the Bermuda Limited Partnership. As consideration for the Licence, the Bermuda
Limited Partnership agreed to pay US$20 to the Limited Partnership for each
futures contract trading instruction (a “Trading Report”) generated by the
Bermuda Limited Partnership from the use of the Software.
[15]
Trafalgar
Research and the Bermuda Limited Partnership entered into an Investment
Agreement, as of October 31, 1997, pursuant to which Trafalgar Research agreed
to provide the Trading Fund, in the amount of $4 million, to the Bermuda
Limited Partnership. Under this agreement, the Bermuda Limited Partnership
agreed to buy and sell S&P contracts on behalf of Trafalgar Research, in
accordance with the instructions contained in the Trading Reports generated by
the Software using the Trading Fund, which remained the property of Trafalgar
Research. For each futures contract purchased or sold using the Software and
the Trading Fund, Trafalgar Research agreed to pay a Trading Report Fee of
US$30 to the Bermuda Limited Partnership. Profits from such trading were to be
shared by the Bermuda Limited Partnership (in which the Limited Partnership was
a member) and Trafalgar Research.
[16]
On October
28, 1997, Mr. Tolhoek subscribed for and was issued 50 units in the Limited Partnership
at a price of $1,000 per unit, in accordance with an “Offering Memorandum”. In
so doing, he executed a Subscription and Power of Attorney and an Assumption Agreement,
which was dated as of June 30, 1997. (This date is curious given that Mr.
Tolhoek’s subscription for units was not accepted until December 31, 1997.)
Certain of the relevant provisions of the Assumption Agreement are as follows:
(a) Mr.
Tolhoek agreed to assume and
become liable to pay Trafalgar Capital his pro rata share of the
Acquisition Note, it being understood that such share was expected to be
$35,000, the difference between the total subscription price ($50,000) and the
portion thereof that was paid in cash ($15,000). The amount of the Acquisition
Note that Mr. Tolhoek agreed to assume has been hereinbefore referred to as the
Assumed Indebtedness.
(b) Mr. Tolhoek agreed
to a form of irrevocable direction (the "Direction") authorizing the
Limited Partnership to pay certain amounts to Trafalgar Capital. Specifically,
clause 3 of the Assumption Agreement reads as follows:
3. Each
Limited Partner hereby irrevocably directs the Partnership to pay to the Vendor
100% of his or her share of Gross Receipts, as defined in the offering
memorandum of the Partnership dated May 30, 1997 (the “Offering Memorandum”),
on a quarterly basis, until all of the interest owing under the Acquisition
Note is paid in full, and to pay to the Vendor 100% of the Class A Interest
distribution (as defined in the Offering Memorandum) until all principal owing
under the Acquisition Note is paid in full.
(c) In
the Offering Memorandum, “Gross Receipts” and “Business” are defined as
follows:
“Business” means the
acquisition and exploitation of the Computer Programs by the Partnership for
the purpose of earning income and all activities incidental thereto.
“Gross Receipts” means aggregate,
without duplication, of all revenues received from the operation of the
Partnership’s Business during the fiscal period in question, and all investment
income earned on the funds of the Partnership.
[17]
For the fiscal
period ending on December 31, 1997, the Limited Partnership claimed capital
cost allowance in respect of the Software in the amount of $14,880,000. During
that period, the Limited Partnership was entitled to receive US$20 for every
Trading Report that was generated by the Bermuda Limited Partnership using the
Software and a share of the trading profits generated by the Bermuda Limited
Partnership from its trading activities.
[18]
The
Bermuda Limited Partnership undertook its business operations in December of
1997 and provided a report to the Limited Partnership in respect of those
operations. Similar reports were provided on a monthly basis. In the initial
report, the Bermuda Limited Partnership stated that it had a trading loss of
$2,915.99 and that it had generated 377 Trading Reports. The Bermuda Limited
Partnership also stated that the Trading Fund amounted to $750,420.41.
[19]
As a
result of these 1997 activities of the Bermuda Limited Partnership, the Limited
Partnership generated revenues of US$7,540 (US$20 x 377) from Trading Reports
and no revenues from the trading activities of the Bermuda Limited Partnership.
During 1997, the Limited Partnership had no material amount of investment
income. Notwithstanding these results, the Limited Partnership reported
revenues of $704,900 in its financial statements for 1997.
[20]
The
promoters of the tax shelter arrangements testified before the Tax Court that
the difference between the revenues generated from the activities of the
Limited Partnership and those that were reported in the 1997 financial statements
were the result of the operation of the Clause 4.01(k) Warranty. In their view,
this provision was intended to be a mechanism that would ensure that the
Limited Partnership derived enough revenues to enable the limited partners to
pay the interest on the debt that they had assumed as partial consideration for
their partnership interests.
[21]
In respect
of the 1997 year, the promoters testified that the General Partner and
Trafalgar Capital agreed that the amount of the accrued interest on the
Acquisition Note in respect of that year was to be paid on behalf of the
limited partners by offsetting that amount against a corresponding amount that
was considered to be owing by Trafalgar Capital to the Limited Partnership,
namely, the total of the actual business revenues for that year plus an amount
that was considered to be payable to Trafalgar Capital to the Limited
Partnership under the Clause 4.01(k) Warranty.
[22]
The
Minister’s representatives requested information to verify the amount of the 1997
revenue that was reported in the 1997 financial statements of the Limited
Partnership and that the full amount of the interest on the Acquisition Note
that had accrued in 1997 had, in fact, been paid by Mr. Tolhoek and the other
limited partners within the first 60 days of 1998.
[23]
In the
course of its verification efforts, the Minister dealt mainly with the General
Partner. However, significant interaction also occurred with legal counsel
(“Legal Counsel”) to Mr. Tolhoek. In addition, correspondence was sent by the Minister
to the Trafalgar Group in Bermuda. The information garnering
efforts of the Minister ultimately lead to the issuance of a requirement, as
contemplated by paragraphs 231.2(1)(a) and (b) (the
“Requirement”), to the General Partner, formally requiring the production of
information that the Minister believed to be relevant to the verification of
the 1997 revenues of the Limited Partnership and the payment by Mr. Tolhoek and
the other limited partners of the 1997 accrued interest on the Acquisition Note
within the first 60 days of 1998. The Requirement requested documents and
information that the Minister believed to be situated in Bermuda. Such
documents and information included bank accounts and records with respect to
the "Trading Accounts" of the Bermuda Limited Partnership, as well as
banking and other records and information that were related to the indebtedness
of Mr. Tolhoek and the other limited partners to Trafalgar Capital and to the
computation of the business revenues of the Limited Partnership for its 1997
and subsequent periods.
[24]
The
General Partner responded to the Requirement, indicating that Trafalgar Capital
had provided certain information but that it would not provide any banking
records that pertained to the interest received by Trafalgar Capital on the
Acquisition Note or any banking records and other source documents that
pertained to the business revenues of the Limited Partnership for its 1997 and
subsequent periods (the "Unprovided Offshore Information").
[25]
The
Minister continued to press the General Partner for information verifying the
1997 revenues of the Limited Partnership and the payment of the 1997 accrued interest
on the Acquisition Note and was advised by the General Partner, in
correspondence dated November 19, 2002, that Trafalgar Capital had been given a
copy of the Requirement and that Trafalgar Capital continued to decline to
provide the Unprovided Offshore Information.
[26]
The
Minister had also received correspondence from Legal Counsel, who represented
Mr. Tolhoek and other limited partners. In correspondence dated March 21, 2001,
Legal Counsel stated:
Investors
generally understood that Trafalgar Capital Ltd. would be directly involved in
the marketing and distribution of the S&P Index trading method. Many
of the investors had met and/or spoken with Ed Furtak, the principal of
Trafalgar Capital, and were confident Trafalgar Capital Ltd. was capable of
marketing the S&P Index trading method to attract third party
capital.
In addition, in correspondence dated March
31, 2003, Legal Counsel advised the Minister as follows:
The 1997,
1999 and 2000 Taxation Years
For the 1997,
1999 and 2000 taxation years, you have suggested that the Partnership could not
have paid the interest amount because the Partnership did not have sufficient
sales in its financial years ended December 31, 1997, 1999 and 2000 to enable
it to make the interest payment.
We have been
advised by ICLP Management Inc. (general partner of the Partnership) that the
parties to the software acquisition transaction intended that the Partnership
would earn, from its business venture with Trafalgar Research, revenues from
the sale of trading reports at least sufficient to cover interest on the
Acquisition Note in each year. In this respect, Trafalgar Capital (an affiliate
of Trafalgar Research) represented and warranted to the Partnership that the
software was capable of generating, at a minimum, 500 trading reports per
$250,000 of trading capital (see section 4.01 of the Software Agreement, a copy
of which was previously provided to you). The Partnership earned US$20 for each
trading report generated by the Partnership. Assuming the software produced the
minimum number of trading reports warranted by Trafalgar Capital, the revenues
from trading report fees would enable the Partnership to pay the interest on
the Acquisition Note. It was the understanding between the parties that
Trafalgar was effectively guaranteeing minimum revenues equal to those it had
warranted in the Software Agreement.
ICLP
Management advised us that in 1997 and 1999, the software did not produce the
warranted number of trading reports. Nonetheless, Trafalgar Capital paid to the
Partnership (pursuant to its warranty under section 4.01 of the Software
Agreement) an amount that reflected the trading report fees the Partnership
would have earned had the software produced the warranted number of reports. Trafalgar
Capital and ICLP Management further advised that at the time these payments
were made, the parties contemplated that the software would generate greater
than the warranted number of trading report fees owed to the Partnership. In
effect, these payments were pre-payments for future trading report fees. Accordingly,
in our submission, the amounts paid from Trafalgar Capital and recorded in the
financial statements of the Partnership for 1997 and 1999 represent bona
fide revenues of the Partnership from which the Partnership paid interest
on the Acquisition Note on behalf of the limited partners.
It is our
submission that, in any case, the source of the funds used to pay the interest
is not relevant to this issue. Subsection 143.2(7) requires only that interest
be paid on the Acquisition Note within 60 days of the end of the year. It does
not require that interest be paid out of current revenues of the debtor (or
other payor). As indicated in your letters, for each of 1997 and 1999 the
Partnership made the payments to Trafalgar Research, by wire transfer, to
satisfy the interest on the Acquisition Note.
…
In the
present case, the Partnership paid interest on the Acquisition Note by way of
setoff of the amounts owed to it by Trafalgar Research in respect of trading
report fees pursuant to section 4.01 of the Software Agreement and pursuant to
their existing business arrangement. We submit that under these circumstances
it is clear that the Partnership paid the interest on the Acquisition Note as
required by subsection 143.2(7) of the Act.
[27]
The
concerns with respect to the 1998 “interest payment” transaction are
highlighted in correspondence from the Minister to Legal Counsel, dated July 4,
2003, as follows:
You also
indicate “the source of funds used to pay the interest is not relevant to the
issue.” However, Subsection 143.2(7) of the Income Tax Act (“ITA”) states the
interest must be “paid in respect of the indebtedness by the debtor.” In other
words, the ITA requires that the debtor be responsible for the indebtedness and
the source of funds must then be a source of funds of the limited partners (ie.
the “debtors”). As Icon is a Limited Partnership, the limited partners would
only get distributions from it based on the business of Icon. Therefore, the
revenues that are being attributed to the limited partners must be from Icon’s
business. As mentioned above, the General Partner has not supplied any calculations
that would allow the Agency to come to the conclusion that the limited
partners, in fact, were due any distributions from Icon’s business activities. It
is the debtors that owed the interest payments and the General Partner has not
provided any information that would establish a link between the debtors and
the revenues that Icon is reporting.
…
Interest
Payments to Trafalgar Capital
In addition
to the positions that were outlined in our proposal letter, it has come to our
attention that the interest payments made regarding the 1997 taxation year were
made to TRB [Trafalgar Research]. However, the interest payments were owed to
the “Holder” of the Acquisition Note. The “Holder,” as per the Acquisition Note,
is Trafalgar Capital Ltd. Therefore, it is the Agency’s contention that the
1997 payment was not made “in respect of the indebtedness” since the limited
partners did not owe the interest payments to TRB. Subsection 143.2(7) would
then treat the Acquisition Note as a limited recourse note in this situation. It
should be noted that the 1999 payment was handled similarly to the 1997
payment.
The 1998
interest payment was allegedly made via journal entries. Your March 31, 2003
letter states, on Page 3, “the Partnership paid interest on the Acquisition
Note by way of setoff of the amounts owed to it by Trafalgar Research in
respect of the trading report fees pursuant to section 4.01 of the Software
Agreement and pursuant to their existing business arrangement.” Therefore, the
“setoff” took place between Icon and Trafalgar Research (Bermuda). However,
the amounts owed were by the limited partners of Icon were to Trafalgar Capital
Ltd. Nowhere is Trafalgar Capital Ltd. mentioned in the payment of the 1998
interest. The Agency views the 1998 payment in this manner as falling under
subsection 143.2(7) and treating the Acquisition Note as a limited recourse
amount.
[28]
The record
disclosed that the actual business revenues of the Limited Partnership for each
year prior to 2001 were never equal to or greater than the accrued interest on
the Acquisition Note at the end of each such year. According to the promoters
of the tax shelter, the Clause 4.01(k) Warranty was invoked so as to “top up”
the business revenues of the Limited Partnership in respect of each of those
years to an amount that would be sufficient to enable the Limited Partnership
to stipulate that it had paid all of the accrued interest on the Acquisition
Note to Trafalgar Capital at the end of each of those years within the time
period contemplated by paragraph 143.2(7)(b).
[29]
It is
undisputed that the Minister did not receive information from Trafalgar Capital
and/or Trafalgar Research that was situated outside Canada and that related to the 1997 revenues of
the Limited Partnership and the 1998 interest payment transactions.
DECISION
OF THE TAX COURT
[30]
The Tax
Court determined that if either of subsections 143.2(7) or (13) applied to deem
the unpaid principal of the Assumed Indebtedness to be a limited-recourse
amount, the adjusted cost base of Mr. Tolhoek’s interest in the Limited
Partnership would be reduced by the amount of the deemed limited-recourse
amount, provided that the Minister was entitled to reassess outside the normal
limitation period pursuant to subsection 143.2(15).
[31]
The Tax
Court observed that the unpaid principal of the Assumed Indebtedness could be
deemed a limited-recourse amount pursuant to subsection 143.2(7) if there were
no bona fide arrangements for the repayment of the indebtedness and all
interest on the indebtedness as required by paragraph 143.2(7)(a), or if
interest was not actually paid on the indebtedness within the 60 day period
prescribed in paragraph 143.2(7)(b).
[32]
In
addressing the application of paragraph 143.2(7)(a), at paragraph 40 of
its reasons, the Tax Court rejected as too low a threshold, the contention of
Mr. Tolhoek that bona fide arrangements exist if there is a genuine
intention to repay:
Without being over
simplistic, the phrase "bona fide arrangement" in the context
of tax shelters cannot be resolved in favour of a taxpayer simply by having an
investor come to Court and asking the Court to accept that there was an honest
intention to repay the debt. A bona fide arrangement must encompass more
than this. Such an arrangement should readily be seen to be binding upon the
parties; it should be prima facie obvious.
[33]
At
paragraph 34, the Tax Court described the evidentiary burden under paragraph
143.2(7)(a) for establishing the bona fide nature of an
arrangement:
Examining
various indicia and evidentiary requirements is essential to establishing the
total relationship between the parties respecting their obligation to repay a
debt. This is the appropriate approach to interpretation of this provision.
Although there may be differences between "arrangements" and
"contracts", I believe that you either have a meaningful, binding
agreement between parties that means something to them or you do not. If the
evidence does not support the existence of a legally binding agreement, then
ultimately it is going to be on a collision course with the limited-recourse
debt rules.
[34]
The Tax
Court rejected the assertion of Mr. Tolhoek that the most compelling evidence
of the bona fide nature of the arrangements is found in the Acquisition
Note. According to the Tax Court, the terms of the Acquisition Note were
confusing leaving unanswered questions concerning the specific terms of the
transaction. Moreover, the terms of the Acquisition Note were not reinforced by
the surrounding circumstances of the transaction, including the lack of
security for the Acquisition Note, the presence of Mr. Furtak "on both
sides of the deal" and the prospect of circular cash flows in relation to
interest payments.
[35]
On
reviewing all of the facts, particularly the circular flow of money and the
inconsistencies in the evidence presented, the Tax Court concluded that the
arrangements were not bona fide within the meaning of paragraph
143.2(7)(a).
[36]
In
determining whether paragraph 143.2(7)(b) applied to deem the unpaid
principal of the Assumed Indebtedness to be a limited-recourse amount, the Tax
Court noted that the heart of the dispute was whether interest was paid within
the 60 day period following the end of each particular taxation year in which
the Acquisition Note was outstanding. The Tax Court went on to state that to
adequately resolve this issue it had to examine “whether interest was actually
paid at all and, if interest was paid, whether it was the correct amount”.
[37]
The
promoters testified that the tax shelter was structured such that business income
earned by the Limited Partnership from the Trading Reports was expected to be
treated as a distribution to the limited partners and such notional payments
would be redirected to pay interest owing by them to Trafalgar Capital. The
position of Mr. Tolhoek was that interest was paid in full each year or paid by
way of off-setting journal entries in 1998. The Tax Court found that in certain
years, funds did flow and "payment-like events occurred", within the
time limit prescribed in paragraph 143.2(7)(b). In particular, there was
evidence of a $700,000 payment in 1997.
[38]
The Tax
Court stated that “it is critical that interest was paid pursuant to a ‘bona
fide arrangement’”. While the Tax Court did not find the circular flow of
money described by Mr. Tolhoek in itself offensive, additional evidence was
required to establish that the payment-like events constituted payments of
interest, within the meaning of paragraph 143.2(7)(b).
[39]
According
to the Tax Court, Mr. Tolhoek provided inconsistent evidence documenting the
amount of the principal owing under the Acquisition Note, the amount of income
earned by the Limited Partnership from the Trading Reports, and the cash
amounts paid by the limited partners on the purchase of their units in the
Limited Partnership. Moreover, the Tax Court noted that witnesses were unable
to offer a precise calculation of the $700,000 payment in 1997 and Mr. Tolhoek
was unable to give any evidence respecting his payment obligations including
the interest rate, quantum of interest, or the dates that payments were made.
The Tax Court found that all of these factors made it impossible to determine
with any certainty the precise amount of interest owing in any year. The Tax
Court noted that relevant records of Trafalgar Capital and source documents relating
to the business revenues of the Limited Partnership may have resolved this
uncertainty, but such documentation was not put into evidence. Accordingly, the
Tax Court was “unable to conclude that interest was paid pursuant to a bona
fide arrangement”.
[40]
The Tax
Court went on to consider whether subsection 143.2(13) applied to deem the
Assumed Indebtedness to be a limited-recourse amount on the basis that
information relevant to that indebtedness was located outside Canada and was not provided to the
Minister. Documentation relating to the “Trading Accounts” of the Bermuda
Limited Partnership, in which Trafalgar Capital was the general partner, and the
banking records of Trafalgar Capital were requested from the Limited
Partnership and not provided to the Minister. For that reason, the Tax Court
determined that subsection 143.2(13) applied, notwithstanding that Mr. Tolhoek
may not have been in a position to force Trafalgar Capital to comply with the
Minister’s request for information and that the correspondence from the
Minister did not reference subsection 143.2(13).
[41]
In
determining whether the Minister was entitled to reassess outside the normal
limitation period, pursuant to subsection 143.2(15), the heart of the debate
was with respect to the meaning of the phrase “as are necessary”. Following a
textual, contextual and purposive analysis of subsection 143.2(15), the Tax
Court concluded that the Minister’s power to reassess under subsection
143.2(15) cannot be defined by considerations revolving around the timing and
availability of particular facts and information to the Minister. According to
the Tax Court, subsection 143.2(15) grants broad discretionary power to the
Minister to reassess beyond the normal limitation period in order to identify
and combat abuses using tax shelters. As such, the Tax Court found that the
reassessment by the Minister for the 1997 taxation year of Mr. Tolhoek was not
statute-barred.
ISSUES
[42]
The issues
in this appeal are whether the Assumed Indebtedness is a limited-recourse
amount and whether the Minister was permitted to reassess Mr. Tolhoek for his
1997 taxation year beyond the normal reassessment period for that year.
ANALYSIS
STANDARD OF REVIEW
[43]
The
standard of review that applies to appeals from decisions of the Tax Court
under the informal procedure contained in section 18 of the Tax Court of
Canada Act, R.S.C. 1985, c. T-2, has been determined by this Court in McGoldrick
v. Canada, 2004 FCA 189. At paragraph 7, Justice Malone described the
standard of review as follows:
The standard
of review set out in Housen v. Nikolaisen, [2002] 2 S.C.R. 235 applies
to appeals from the Tax Court conducted under its informal procedure (see Jastrebski
v. Canada, 94 DTC 6355 (F.C.A.); Polygon Southampton Development Ltd. v.
Canada [2003] F.C.J. No. 674, 2003 FCA 193). That is, for questions of law,
the standard is correctness while for findings of fact, inferences or
conclusions of fact, or conclusions of mixed law and fact, the standard is
palpable and overriding error.
IS THE ASSUMED INDEBTEDNESS A
LIMITED-RECOURSE AMOUNT?
[44]
The
Assumed Indebtedness could be a limited-recourse amount if, under its terms,
recourse against the debtor is limited. That has not been argued. Rather, the
argument is whether the Assumed Indebtedness is deemed to be a limited-recourse
amount, pursuant to either subsection 143.2(7) or (13).
Subsection 143.2(7)
[45]
Subsection
143.2(7) deems the unpaid principal of an indebtedness to be a limited-recourse
amount unless two conditions are met. Those conditions are contained in
paragraphs (a) and (b) of that subsection, which read as follows:
|
(7) For the purpose of this section, the unpaid principal
of an indebtedness is deemed to be a limited-recourse amount unless
(a)
bona fide arrangements, evidenced in
writing, were made, at the time the indebtedness arose, for repayment by the
debtor of the indebtedness and all interest on the indebtedness within a
reasonable period not exceeding 10 years; and
(b)
interest is payable at least annually, at a rate equal to or greater than the
lesser of
(i) the prescribed rate of interest in effect at the time
the indebtedness arose, and
(ii) the prescribed rate of interest applicable from time
to time during the term of the indebtedness,
and
is paid in respect of the indebtedness by the debtor no later than 60 days
after the end of each taxation year of the debtor that ends in the period.
|
7) Pour l’application du présent article, le principal
impayé d’une dette est réputé être un montant à recours limité sauf si :
a) des arrangements, constatés par écrit, ont été conclus
de bonne foi, au moment où la dette est survenue, pour que le débiteur
rembourse la dette et les intérêts y afférents dans une période raisonnable
ne dépassant pas dix ans;
b) les intérêts sont payables au moins annuellement, à un
taux égal ou supérieur au moins élevé des taux suivants, et sont payés sur la
dette par le débiteur au plus tard 60 jours suivant la fin de chacune de ses
années d’imposition qui se termine dans la période visée à l’alinéa a):
(i) le taux d’intérêt
prescrit en vigueur au moment où la dette est survenue,
(ii) le taux d’intérêt
prescrit applicable pendant la durée de la dette.
|
[46]
The Tax
Court concluded that the Assumed Indebtedness is a limited-recourse amount
under each of paragraphs 143.2(7)(a) and (b), as well as
subsection 143.2(13). Any one of those three bases will be sufficient to
support that conclusion. For my part, I prefer to start with paragraph
143.2(7)(b).
[47]
In the
circumstances, the issue is whether interest on the Assumed Indebtedness was
paid within the 60 day period referred to in paragraph 143.2(7)(b). It
is noteworthy that a failure to pay interest in respect of any year in which
the Assumed Indebtedness is outstanding will result in the principal amount of
that indebtedness being deemed to be a limited-recourse amount.
[48]
The Tax
Court correctly determined that it was necessary to establish whether interest
was paid at all and if any interest was paid, whether the correct amount was,
in fact, paid. In assessing the evidence, the Tax Court concluded that it was
impossible to determine, with certainty, the precise amount of interest that
was owing in any year, noting that the Unprovided Offshore Information of
Trafalgar Capital was not put into evidence. Accordingly, the Tax Court
determined, in paragraph 52 of its reasons, that it was “unable to conclude
that interest was paid pursuant to a bona fide arrangement”.
[49]
The
appellant attacks this conclusion on the basis that there is no obligation in
paragraph 143.2(7)(b) to pay interest pursuant to a “bona fide
arrangement”. In my view, the critical finding of the Tax Court was that the
appellant had not substantiated that the correct amount of interest had been
paid and that the reference to the “bona fide arrangement” was not
essential to that finding. It was open to the Tax Court to make a finding of
fact that interest had not been paid having regard to the evidence that was
before it and I have not been persuaded that the Tax Court made a palpable and
overriding error in this factual determination. Accordingly, this conclusion is
sufficient to decide the issue of whether the Assumed Indebtedness is a
limited-recourse amount.
[50]
While the
reference of the Tax Court to a “bona fide arrangement” in respect of
the finding of non-payment of interest was unnecessary, I am of the view that
such reference was not incorrect. In my view, the requirement of a “bona
fide arrangement” in paragraph 143.2(7)(a) extends to both the
principal and interest payments. It is incongruous to argue that even though
paragraph 143.2(7)(a) requires interest to be payable pursuant to a bona
fide arrangement, interest which is in fact paid in order to satisfy the
requirement in paragraph 143.2(7)(b) need not have been paid pursuant to
a bona fide arrangement.
[51]
While I am
of the view that the conclusion of the Tax Court with respect to the payment of
interest on the Assumed Indebtedness should not be interfered with, I am also
of the view that such a conclusion can also be supported by virtue of a
somewhat different analysis of the evidence that was before the Tax Court.
[52]
It is
clear that the tax shelter arrangement that was promoted by Mr. Furtak was
intended to provide investors with the benefit of “leveraged” tax deductions on
a basis that did not come within the anti-avoidance provisions of section
143.2. In particular, the intention was to avoid the Acquisition Note being
characterized as a limited-recourse amount. At the heart of this arrangement is
the warranty mechanism which was intended to provide a basis upon which the Limited
Partnership would receive sufficient business revenue to enable it to
notionally make distributions to the limited partners who would, in turn and
pursuant to written instructions, direct the Limited Partnership to make
interest payments on the notes on behalf of the limited partners on their
respective shares of the Acquisition Note.
[53]
This
intention, in and of itself, may not offend any of the specific provisions of
section 143.2 and it is noted that the Minister did not seek to challenge this
intended avoidance of the limited-recourse provisions in section 143.2 under
the general anti-avoidance rule. However, a mere intention to comply with the
provisions of section 143.2 will not, in and of itself, be sufficient to bring
about the desired result. The arrangements by which such compliance is to be
brought about must be legally effective and must withstand careful scrutiny to
determine whether they actually produce the intended compliance, having regard
to their specific terms and conditions.
[54]
Thus, the
question is whether or not the warranty arrangements properly interpreted and
construed, were sufficient to bring about the desired result of providing the
Limited Partnership with sufficient business revenues to enable it to make notional
distributions to the limited partners that would equal or exceed their interest
payment obligations on their respective shares of the Acquisition Note.
[55]
In my
view, the evidence falls short of establishing that interest was paid on the
Assumed Indebtedness in respect of the 1997 taxation year. There is no
suggestion that Mr. Tolhoek made a direct payment of interest on the Assumed
Indebtedness. Accordingly, any such payment of interest must have been made on
his behalf pursuant to the Direction.
[56]
A careful
review of the Direction indicates that it authorizes the Limited Partnership to
pay a particular type of amount to Trafalgar Capital on account of interest on
the Assumed Indebtedness. The Direction does not authorize the Limited
Partnership to pay Mr. Tolhoek's share out of "any cash-on-hand in the
Limited Partnership that is available for distribution" to Trafalgar
Capital. Rather, the Direction only authorizes the Limited Partnership to pay
his share of Gross Receipts, as defined in the Offering Memorandum, on account
of his obligation to pay interest to Trafalgar Capital. Accordingly, if Mr.
Tolhoek’s share of Gross Receipts for the 1997 fiscal period of the Limited
Partnership is less than the amount of the accrued interest on the Assumed
Indebtedness, as of December 31, 1997, it cannot be said that Mr. Tolhoek has
paid all of that accrued interest pursuant to the Direction. It would
necessarily follow, in those circumstances, that the requirement of paragraph
143.2(7)(b) could not have been satisfied and as a result, the Assumed
Indebtedness would be deemed to be a limited-recourse amount.
[57]
The
appellant argues that all of the accrued interest on the Acquisition Note on
December 31, 1997, and therefore, on the Assumed Indebtedness as of such date,
was paid by virtue of certain journal entries that were made in the accounts of
the Limited Partnership and Trafalgar Research within the first 60 days of 1998.
There are two problems with this assertion. First, the creditor in respect of
the Assumed Indebtedness was Trafalgar Capital, not Trafalgar Research. More
importantly, the amount credited to the Limited Partnership must be shown to
constitute a Gross Receipt, i.e. income from the business of the Limited
Partnership.
[58]
The
appellant argues that the amount credited to the Limited Partnership
constitutes a payment required to be made under the Clause 4.01(k) Warranty and
therefore, it has the character of a Gross Receipt. The record contains a
calculation by the Minister (see Appeal Book page 653) that shows that the
amount credited to the Limited Partnership significantly exceeded the amount
determinable by virtue of the application of that contractual provision (even
assuming that the issue of the journal entry being made by Trafalgar Research,
rather than Trafalgar Capital, could be overcome). In my view, the Minister’s
interpretation of the Clause 4.01(k) Warranty and his calculation of the
maximum amount payable thereunder for 1997 are correct. The Minister contends
that the excess amount credited by Trafalgar Research to the Limited
Partnership could not be “re-credited” to Trafalgar Capital as an interest
payment because the Direction does not contemplate a payment of any amount
other than Gross Receipts on account of interest on the Assumed Indebtedness. In
my view, this contention should be accepted. However, the appellant then argues
that even though the amount credited to the Limited Partnership may have been
incorrectly determined, the erroneously determined amount should nonetheless be
accepted as constituting a complete payment of all of the 1997 accrued interest
because the promoters intended the warranty to produce that result. In other
words, because the “heart of the transaction”, according to one of the
promoters, was that the warranty was expected to provide enough revenues to enable
the limited partners to pay interest on the Acquisition Note, the warranty
should be regarded as, in fact, bringing about that result even if it did not,
in fact, do so, on a proper interpretation of its provisions.
[59]
In my
view, this assertion cannot be accepted. As previously indicated, the intention
on the part of the promoters to structure the tax shelter in such a way as to
avoid the provisions of section 143.2 is irrelevant. If the specific and
technical aspects of the structure do not, in fact, bring about the intended
result, then the scheme must fail. That is what occurred in respect of the 1997
taxation year. The amount that the promoters hoped would be Gross Receipts of
the Limited Partnership by virtue of the interpretation and application of the
Clause 4.01(k) Warranty did not materialize. It follows that even assuming that
there was a notional flow of funds by virtue of the 1998 journal entries, the
amount in excess of the amount determined by virtue of the proper application
of that Clause 4.01(k) Warranty was not revenue from the business of the
Limited Partnership. Accordingly, whatever that excess amount may have been (in
all likelihood some kind of loan or advance), that excess amount could not be
said to have been paid by the Limited Partnership on behalf of Mr. Tolhoek as
interest on the Assumed Indebtedness because the Direction did not authorize
the payment of anything other than Mr. Tolhoek’s share of Gross Receipts in
that fashion. It follows, in my view, that Mr. Tolhoek has not demonstrated
that he paid the full amount of the accrued interest on the Assumed
Indebtedness as of December 31, 1997. Accordingly, Mr. Tolhoek has not
established that he met the condition in paragraph 143.2(7)(b) in
respect of the Assumed Indebtedness for his 1997 taxation year and as such, the
Assumed Indebtedness is deemed to be a limited-resource amount.
Subsection 143.2(13)
[60]
The Tax
Court found that the Minister had requested information relating to the Assumed
Indebtedness that was available outside Canada and that such information, the
Unprovided Offshore Information, had not been provided to the Minister. In
addition, the Tax Court concluded that the Minister was not satisfied that the
Assumed Indebtedness was not a limited-resource amount. Accordingly, the Tax
Court held that subsection 143.2(13) applied to deem the Assumed Indebtedness
to be a limited-resource amount. That provision reads as follows:
|
(13) For the purpose of this section, where it can reasonably
be considered that information relating to indebtedness that relates to a
taxpayer’s expenditure is available outside Canada and the Minister is not
satisfied that the unpaid principal of the indebtedness is not a
limited-recourse amount, the unpaid principal of the indebtedness relating to
the taxpayer’s expenditure is deemed to be a limited-recourse amount relating
to the expenditure unless
(a)
the information is provided to the Minister; or
(b)
the information is located in a country with which the Government of Canada
has entered into a tax convention or agreement that has the force of law in Canada
and includes a provision under which the Minister can obtain the information.
|
13) Pour l’application du présent article, lorsqu’il est
raisonnable de considérer que des renseignements concernant une dette se
rapportant à une dépense d’un contribuable se trouvent à l’étranger et que le
ministre n’est pas convaincu que le principal impayé de la dette n’est pas un
montant à recours limité, le principal impayé de la dette est réputé être un
montant à recours limité se rapportant à la dépense, sauf si, selon le cas :
a) les renseignements sont fournis au ministre;
b) les renseignements se trouvent dans un pays avec lequel
le gouvernement du Canada a conclu une convention ou un accord fiscal qui a
force de loi au Canada et qui comprend une disposition en vertu de laquelle
le ministre peut obtenir les renseignements.
|
[61]
The
appellant does not really challenge the finding that the Unprovided Offshore Information
had not been provided to the Minister. Instead, the appellant contends that such
information was not available to Mr. Tolhoek and that Parliament could not have
intended that a taxpayer’s indebtedness should be deemed to be a limited-resource
amount unless that taxpayer had access to the information and refused to supply
it.
[62]
In my
view, this contention cannot be accepted. The language of subsection 143.2(13)
is very broad and does not even require the Minister to request the information
in question from the taxpayer. While this provision might, in certain
circumstances, work a hardship on a taxpayer who is unable to obtain the
information that the Minister has requested, it must be remembered that section
143.2 is an anti-avoidance provision. A taxpayer who wishes to participate in a
tax shelter with an “offshore” flavour must assume the risk that persons
outside Canada who are in possession of
information that pertains to indebtedness that relates to the taxpayer’s expenditure
in respect of the tax shelter, may not cooperate in the provision of such
information to the Minister.
[63]
In the
present circumstances, the requested information was in the possession of
Trafalgar Capital, a corporation controlled by Mr. Furtak, the promoter of the
tax shelter. No reason was provided as to why Mr. Furtak refused to cooperate
in the provision of the Unprovided Offshore Information to the Minister.
Nonetheless, the failure of Trafalgar Capital to provide the Unprovided
Offshore Information is a sufficient basis for the application of subsection
143.2(13) to deem the Assumed Indebtedness to be a limited-recourse amount. In
so concluding, the Tax Court made no reviewable error of law or fact.
WAS THE REASSESSMENT TIME-BARRED?
[64]
Paragraph
143.2(15) reads as follows:
|
(15) Notwithstanding
subsections 152(4) to (5), such assessments, determinations and
redeterminations may be made as are necessary to give effect to this section.
|
(15) Malgré les
paragraphes 152(4) à (5), le ministre peut établir les cotisations voulues et
déterminer ou déterminer de nouveau les montants voulus pour l’application du
présent article.
|
The appropriate interpretation to be given to this
relatively short provision is not obvious.
[65]
In Markevich
v. Canada, [2003] 1 S.C.R. 94, 2003 SCC 9, the Supreme Court of Canada
considered whether the application of section 222, a tax-debt collection
provision, was subject to any temporal limitation. At paragraph 13, Justice
Major stated:
The
assessment provisions of the ITA are clearly stated on prescription. By
contrast, the collection provisions of the ITA are silent with respect
to prescription. There is no reference in s. 222 or its accompanying provisions
to either the absence or presence of a limitation period. Nonetheless the
appellant submits that the ITA has “otherwise provided” for
prescription. In the appellant’s submission, the ITA constitutes a
complete statutory scheme for the collection of taxes, and so silence in the
legislation indicates Parliament’s intent to avoid fettering the Crown’s
collection powers with limitation periods.
Justice Major rejected the Minister’s argument that there
was no temporal limitation with respect to the application of section 222 and
held that in the absence of any specific reference to prescription in that
provision, the prescription provisions in section 32 of the Crown Liability
and Proceedings Act, R.S.C. 1985, c. C-50 [rep. & sub. 1990, c. 8. s.
31] operated to limit the appellant’s collection rights.
[66]
Markevich provides limited guidance in
relation to this appeal. Unlike section 222, which contained no specific
reference to prescription, in my view, subsection 143.2(15) specifically
negates the application of the prescriptive provisions with respect to
reassessments by its opening words “Notwithstanding subsections 152(4) and
(5)…”. Thus, one is left to wonder whether Parliament intended to totally
eliminate prescription insofar as assessments or reassessments under section
143.2 are concerned or to search further in subsection 143.2(15) for guidance
with respect to whether there is any prescriptive limitation.
[67]
It is
clear that subsection 143.2(15) does not contain any express temporal
limitation with respect to the power of the Minister to levy assessments or
reassessments. At its core, the provision simply instructs that such
assessments or reassessments may be made if they are necessary to give effect
to section 143.2.
[68]
The Tax
Court, after a textual, contextual and purposive analysis of subsection
143.2(15), concluded that the reassessment of Mr. Tolhoek's 1997 taxation year
that was made on November 24, 2003 – a date that was after his normal
reassessment period in respect of that year – was not statute-barred. In so doing,
the Tax Court concluded that the words "as are necessary" provided a
discretionary power to reassess beyond the normal reassessment period in order
to fulfill the purpose of section 143.2, which was, according to the Tax Court,
to combat abusive tax shelters.
[69]
In my
view, the Tax Court was correct in finding that subsection 143.2(15) empowers
the Minister to levy assessments or reassessments against Mr. Tolhoek beyond
the normal reassessment period in respect of his 1997 taxation year. The Tax
Court did not go so far as to conclude that subsection 143.2(15) operates to
empower the Minister to levy assessments or reassessment without any
limitation. In my view, such a further conclusion would have been unnecessary.
[70]
In the
circumstances of this case, the terms of the Acquisition Note, a portion of
which became an obligation of Mr. Tolhoek, contemplate that interest payments
must be made on or before January 31 in each year that such indebtedness is
outstanding, up to and including the year of its maturity in 2006. A failure by
Mr. Tolhoek to pay such interest in respect of any taxation year, up to and including
the year of the maturity of the Acquisition Note, would permit the Minister to
reassess Mr. Tolhoek’s 1997 taxation year. Such a reassessment would clearly be
necessary in order to give effect to paragraph 143.2(7)(b) which is, of
course, a part of section 143.2. Accordingly, it follows that in the
circumstances of this case, an implied prescriptive limitation on the ability
of the Minister to reassess Mr. Tolhoek’s 1997 taxation year could not arise
before the maturity date of the Acquisition Note, at the earliest. Since the
reassessment occurred in 2003, it was well within the boundary of such a
prescriptive limitation. For that reason, I am of the view that the Minister’s
reassessment of Mr. Tolhoek’s 1997 taxation year was not time-barred.
DISPOSITION
[71]
For the
foregoing reasons, I would dismiss the appeal, with costs.
“C.
Michael Ryer”
“I
agree
A.M.
Linden J.A.”
“I
agree
J.
Edgar Sexton J.A.”
Email this Content