REASONS
FOR JUDGMENT
V.A. Miller J.
I. Overview
[1]
Mr. Bernd Struck (“Mr. Struck”) appealed from
income tax reassessments dated April 20, 2012 in respect of his 2008, 2009 and
2010 taxation years. 468543 B.C. Ltd. (the “Corporation”) appealed from income
tax reassessments dated May 7, 2012 in respect of its taxation years ending
November 30, 2008 and November 30, 2009. Mr. Struck was the only shareholder in
the Corporation during the years in issue. The appeals were heard on common
evidence.
[2]
Prior to the hearing, the parties agreed on a
number of issues that had been raised in the reassessments. The only issues
that remained in dispute in respect of Mr. Struck’s appeal were as follows:
a)
Whether the Corporation conferred shareholder
benefits on Mr. Struck in accordance with subsection 15(1) of the Income Tax
Act (“Act”) in the amounts of $32,803, $33,493, and $33,493 in the
2008, 2009 and 2010 taxation years respectively?
b) Whether Mr. Struck was liable for a gross negligence penalty under
subsection 163(2) of the Act in respect of his omission to include the
subsection 15(1) shareholder benefits in his income?
c)
Whether Mr. Struck was properly assessed a
shareholder loan benefit in the amount of $81,425 in accordance with subsection
15(2) of the Act in his 2009 taxation year?
[3]
With respect to the Corporation’s appeal, the
following issues were in dispute:
a)
Whether the Corporation was allowed to claim
interest expenses in the amounts of $27,402 and $14,039 in the 2008 and 2009
taxation years respectively?
b) Whether the Corporation was allowed to deduct direct wage expenses
in the amounts of $8,000 and $10,000 in the 2008 and 2009 taxation years
respectively?
c)
Whether the Corporation was liable for gross
negligence penalties under subsection 163(2) of the Act?
[4]
For the reasons that follow, I have allowed Mr.
Struck’s appeal in part and I have dismissed the Corporation’s appeal.
II. Bernd
Struck
[5]
The witnesses at the hearing were Mr. Struck,
Ms. Leah Norminton, an auditor with the Canada Revenue Agency (“CRA”) and Mr.
Jason Chow, a Business Valuator with the CRA. As I will describe in my
decision, I found that Mr. Struck was not credible. Many of his statements were
self-serving and were not supported by the documents filed at the hearing.
A. 15(1)
Shareholder Benefits
(1) Facts
[6]
In the 1980s, Mr. Struck started his career as a
tree planter with a company in British Columbia. He later purchased this
company and renamed it Cardinal Forestry Consulting Co. Limited (“Cardinal”).
For months at a time, he worked in logging camps as a log harvester and quality
control consultant. In the early 2000s, Mr. Struck caused Cardinal to change
its business to become a certified home warranty building company. Mr. Struck
continued to earn employment income from Cardinal during the years at issue.
[7]
In 1994, Mr. Struck together with his father,
Horst Struck (“Horst”), incorporated the Corporation under the laws of British
Columbia.
[8]
The Corporation was in the business of
residential property rentals. At all materials times, the Corporation had no
employees. Mr. Struck and his father performed the small repairs, maintenance
work, and day-to-day operations that the Corporation required for its
properties. The Corporation hired Cardinal to perform any larger renovations
and repairs that it may have required.
[9]
From 1994 until 2005, Mr. Struck and Horst were
equal shareholders of the Corporation.
[10]
On February 1, 2005, Horst gifted his shares in
the Corporation to Mr. Struck. Horst did not report the transaction on his
income tax return and, in 2008, the CRA audited Horst with respect to the gift
of his shares. Jason Chow, a CRA Business Valuator, determined the fair market
value of the Corporation’s shares at the time of disposition. Mr. Chow
testified at the hearing of these appeals regarding his role in the 2008 audit.
[11]
During the years at issue, Mr. Struck was the
Corporation’s sole shareholder. He was also a director, an officer and the
directing mind of the Corporation. While Horst maintained his cheque-signing
authority for the Corporation, he was no longer involved in the running of the
Corporation due to age.
[12]
Mr. Struck testified that the Corporation
started with no assets. By 2009, the Corporation owned six rental properties.
He testified that the rental income alone was not sufficient to generate this
level of growth. According to the unaudited Financial Statements filed at the
hearing, the Corporation only had a net income in 2002, 2005 and 2006 when it
sold some of its properties. In all other years since 2001, it showed net
losses. I note that these Financial Statements were prepared by Mr. Struck.
[13]
Mr. Struck stated that the Corporation was only
able to purchase its properties because the shareholders personally invested
large amounts of capital in the Corporation. The capital invested included
advances of mortgage proceeds that were secured on the shareholders’ personal
residences. To that end, Mr. Struck further testified that there was an
agreement between the shareholders and the Corporation that since the mortgage
proceeds were advanced to the Corporation for its benefit, the Corporation
would take on the mortgage liabilities and make the corresponding mortgage
payments.
[14]
As detailed below, I found that Mr. Struck’s
testimony was contradicted by the documentary evidence provided at the hearing.
The evidence presented in respect of the mortgages that were taken out on the
two properties at issue: (a) 1601 Keating Cross Road, Saanichton, BC (the
“Keating Property”); and (b) 2326 Weiler Avenue, Sidney, BC (the “Weiler
Property”) do not support Mr. Struck’s testimony that the mortgage
proceeds were advanced to the Corporation for its benefit.
(a) Mortgages on the Keating
Property
[15]
In 2001, Mr. Struck purchased the Keating
Property from Robert George Martin, Robert William Martin and Elizabeth Martin
(the “Martins”) for $160,000. He used his personal savings for a down payment
of $20,000 and the Martins provided him with a mortgage of $140,000 (the
“Martin Mortgage”).
[16]
Mr. Struck purchased the Keating Property so
that he could build his personal residence on it.
[17]
In March 2003, Mr. Struck and Horst agreed to
take a first mortgage on Horst’s personal residence, the Weiler Property, in
the total amount of $220,000. This mortgage was registered with a BC Land
Titles registration number EV024789 (the “Weiler Mortgage”). The proceeds of
the Weiler Mortgage, net of legal fees, were disbursed as follows:
a)
$140,797.68 was used to discharge the Martin
Mortgage on the Keating Property for the benefit of Mr. Struck;
b) $19,456.21 was used to pay the tax deferment on the property taxes
owed by Horst personally; and
c)
The remaining balance of $58,028.46 was paid to
Horst.
[18]
In 2003, Mr. Struck and his spouse had
matrimonial difficulties which led to a divorce. On the advice of his lawyer,
Mr. Struck transferred ownership of the Keating Property to Horst. As a result
of the transfer, Mr. Struck was assessed a taxable capital gain of $10,000 in
his 2003 taxation year.
[19]
In July 2003, Horst obtained a construction
mortgage with number 6216628 (“Construction Mortgage”) from CIBC in respect of
the Keating Property in the amount of $250,000. The BC Land Titles registration
number was EV84590. Mr. Struck was the guarantor on the Construction Mortgage.
[20]
Horst received three advances under the
Construction Mortgage. On August 8, 2003, there was a first advance of
$150,000. In May 2004, the Construction Mortgage was modified to increase the
available loan principal to $350,000.00. The BC Land Titles registration number
for the modified Construction Mortgage was EW73790. On or about June 15, 2004,
$110,546.00 was advanced on the Construction Mortgage. On February 4, 2005, a
third mortgage advance was made in the amount of $38,650.85. The advances on
the Construction Mortgage totalled $299,196.85.
[21]
For the Corporation’s taxation year ending on
November 30, 2005, the Construction Mortgage was recorded in the Corporation’s
unaudited Financial Statement as a long-term debt. It is otherwise unclear
based on the evidence whether the remaining loan balance (i.e. 350,000 –
299,196.85) was ever drawn and disbursed or if it was, whether the Corporation
or Horst or Mr. Struck received it.
[22]
Mr. Struck testified that there were draws on
the Construction Mortgage that were used for the Corporation’s business.
However, he could not provide any documentary evidence during the audit or at
Court to support his assertion.
[23]
At the hearing, Mr. Struck claimed that the
amount of the Construction Mortgage was not $299,196.85 but was only $195,000.
The evidence has shown otherwise.
[24]
The notes to the Financial Statements for the Corporation
for 2005 showed that the Construction Mortgage was $299,196.85
[25]
Mr. Struck completed the construction of his
personal residence on the Keating Property in January 2006.
[26]
Mr. Struck testified that Horst probably
transferred the property back to him in 2006.
[27]
Notwithstanding this testimony, I find that the
Keating Property remained in Horst’s name throughout the years at issue. My
conclusion is based on the following evidence. On January 14, 2006, the
Construction Mortgage of $299,196.85 was converted into a conventional mortgage
on the Keating Property (the “Keating Mortgage”). The Keating Mortgage was in
the amount of $199,190.85 and was a CIBC Mortgage with number 6216629. Despite
the conversion from a Construction Mortgage to a conventional mortgage, Horst
continued to be the mortgagor on the Keating Mortgage, as shown on the annual
mortgage statements for 2008 and 2009.
[28]
However, the Keating Mortgage continued to be
recorded as the Corporation’s long-term debt on its unaudited Financial
Statements for the taxation years ending November 30, 2006, November 30, 2007,
November 30, 2008 and November 30, 2009.
[29]
The earliest documentary evidence which showed
the Keating Property in Mr. Struck’s name was a BC Land Titles registration
document (CA153192). It registered a mortgage dated April 21, 2010 that Mr.
Struck had given on the Keating Property to First National Financial
Corporation. The mortgage was in the amount of $585,000 and the proceeds were
used as follows:
a)
To discharge the Keating Mortgage by paying the
balance in the amount of $179,985.37;
b) To discharge Mr. Struck’s personal line of credit in the amount of
$298,958.99; and,
c)
To pay himself the balance of $104,950.29.
[30]
A letter dated April 27, 2010 from First
National Financial Corporation to Mr. Struck congratulated him on the purchase
of his new home.
[31]
Mr. Struck testified that the Corporation did
not pay the mortgage payments after April 2010.
[32]
The Keating Property has been Mr. Struck’s
personal residence from 2006 to the present.
[33]
The Minister assessed Mr. Struck pursuant to
subsection 15(1) of the Act on the basis that the Corporation conferred
a benefit on him by paying the mortgage payments for the Keating Property in
the amount of $14,525, $14,521 and $14,521 in 2008, 2009 and 2010 respectively.
[34]
However, the Minister audited the Corporation
for its 2008 and 2009 taxation years only. For the 2010 taxation year, she
assumed that the amount of mortgage payments for the Keating Property was the
same ($14,521) as that paid in 2009.
[35]
As a result of the evidence provided at the
hearing, the Respondent has conceded that the amount included in Mr. Struck’s
income, with respect to the Keating Property for 2010, should be reduced to
$4,840.02 to take into account that the Keating Property was registered in Mr.
Struck’s name in April 2010 and he stated that he paid the mortgage payment
from that time.
(b) Mortgages on the Weiler
Property
[36]
At all material times, the Weiler Property was
Horst’s personal residence.
[37]
As stated above, in 2003, while Horst was still
a 50% shareholder of the Corporation, he agreed to mortgage the Weiler
Property. The mortgage proceeds of $220,000 were paid out as I have described
in paragraph 17 above.
[38]
The Weiler Mortgage, which had a BC Land Titles
registration number EV024789 and a CIBC mortgage number 6130483, was recorded
as a liability on the Corporation’s books from 2004 to 2009.
[39]
At all material times, Horst was the mortgagor
on the Weiler Mortgage. However, the Corporation’s unaudited financial
statements showed the Weiler Mortgage as one of the Corporation’s liabilities.
[40]
Mr. Struck testified that he and Horst had
agreed that the Corporation would assume the liability on the Weiler Mortgage
because Horst had loaned the Corporation his personal savings of $160,000.
[41]
I do not believe Mr. Struck for several reasons.
He did not submit any documentary evidence to corroborate this testimony. He failed
to call Horst as a witness to testify to this matter and I have drawn a
negative inference from this failure. The CRA auditor, Ms. Norminton, testified
that Mr. Struck did not mention this alleged loan during the audit.
[42]
During the 2008 and 2009 taxation years, the
Corporation made mortgage payments on the Weiler Mortgage in the amount of
$18,278 and $18,972 respectively.
[43]
In March 2010, Horst remortgaged the Weiler
Property by granting a mortgage to MCAP Service Corporation in the amount of
$400,000. The mortgage proceeds were disbursed as follows: (i) pay out of the
Weiler Mortgage in the amount of $157,266.39; (ii) payment of the lawyers’ fees
in the amount of $811.63; and, (iii) payment of the balance of $241,906.38 to
Horst. This amount was deposited into Horst’s personal bank account.
[44]
On March 25, 2010, Horst withdrew $235,000 from
his bank account and deposited it into the Corporation’s bank account.
[45]
The Corporation issued cheques on March 30,
2010, April 5, 2010 and April 7, 2010. Each cheque was in the amount of
$50,000. The April 5, 2010 cheque was made payable to Mr. Struck. Mr. Struck
did not submit copies of the cheques dated March 30 and April 7, 2010. There
was no evidence whether the March 30 and April 7 cheques were used for business
purposes. There was also no evidence whether the balance of $85,000 was used
for business purposes.
[46]
The Minister assessed Mr. Struck pursuant to
subsection 15(1) of the Act on the basis that the Corporation conferred
a benefit on him by paying the mortgage payments for the Weiler Property in the
amount of $18,278, $18,972 and $18,972 in 2008, 2009 and 2010 respectively.
(2) Analysis
(a) Shareholder Benefits
[47]
Subsection 15(1) of the Act provides:
15.(1) Where at
any time in a taxation year a benefit is conferred on a shareholder, or on a
person in contemplation of the person becoming a shareholder, by a
corporation otherwise than by
…
the amount or
value thereof shall, except to the extent that it is deemed by section 84 to be
a dividend, be included in computing the income of the shareholder for the
year. [emphasis added]
[48]
While the wording of the provision is quite
broad, it clearly only captures benefits conferred by a corporation on (i) a
shareholder; or (ii) on a person in contemplation of his or her becoming a
shareholder. A shareholder is defined in subsection 248(1) of the Act to
include “a member or other person entitled to receive
payment of a dividend.”
[49]
It is my view that subsection 15(1) is not broad
enough to capture the mortgage payments made by the Corporation on the Weiler
Property. In this regard, the Corporation conferred a benefit on Horst who was
not a shareholder at the relevant time. It is settled law that subsection 15(1)
of the Act only applies when the benefit is conferred on a person qua
shareholder: MNR v Pillisbury Holdings Ltd, 64 DTC 5184 (EX Ct).
[50]
The Corporation did not confer a benefit on Mr.
Struck for the mortgage payments made on the Weiler Property.
[51]
However, the Corporation did confer a benefit on
Mr. Struck when it made the mortgage payments on the Keating Property during
the years in issue. The Corporation paid the mortgage on Mr. Struck’s personal
residence. This was definitely a benefit to Mr. Struck.
[52]
In her written submissions, counsel for the
Respondent took the position that paragraph 15(1.4)(c) of the Act allows
the Minister to assess a benefit on Mr. Struck for all mortgage payments. I
disagree. Paragraph 15(1.4)(c) is an interpretative provision and it reads as
follows:
15(1.4) For the
purposes of this subsection and subsection (1),
…
(c) a benefit
conferred by a corporation on an individual is a benefit conferred on a
shareholder of the corporation, a member of a partnership that is a
shareholder of the corporation or a contemplated shareholder of the
corporation—except to the extent that the amount or value of the benefit is
included in computing the income of the individual or any other person—if
the individual is an individual, other than an excluded trust in respect of
the corporation, who does not deal at arm's length with, or is affiliated
with, the shareholder, member of the partnership or contemplated
shareholder, as the case may be; [emphasis added]
[53]
Paragraph 15(1.4)(c) was not in force during the
years at issue. Specifically, it was added by S.C. 2013, c. 34, subsection
177(3) and is applicable in respect of benefits that are conferred on or after
October 31, 2011.
[54]
The shareholder benefit included in Mr. Struck’s
income is reduced to $14,525, $14,521, and $4,840.02 in 2008, 2009 and 2010
respectively.
(b) Gross negligence penalties
[55]
It is my view that the gross negligence
penalties levied in respect to the mortgage payments made by the Corporation
for the Keating Property must be maintained.
[56]
During the relevant period, Mr. Struck was the
only shareholder and the directing mind of the Corporation. He intended and
directed the Corporation to make the mortgage payments on both the Weiler
Mortgage and the Keating Mortgage. He commingled his personal expenses and the
Corporation’s expenses. He prepared the Corporation’s books and records.
[57]
The proceeds from the various mortgages were
used toward the payment or construction of Mr. Struck’s personal residence.
[58]
Mr. Struck has not provided any credible
evidence that the proceeds from the Weiler Mortgage or the Keating Mortgage
were ever used for the Corporation’s business. I find that the gross negligence
penalties with respect to the Keating property only were properly imposed.
(c) Shareholder Loan Inclusion
(i) Facts
[59]
Mr. Struck admitted that he has never maintained
the shareholder loan account in accordance with the generally accepted
accounting principles (GAAP). He did not keep a “running
tally” of the amounts in and out of the account. Instead, he relied on a
methodology he concocted to track the account balance.
[60]
In its 2009 taxation year, the Corporation
reported a balance of zero in the shareholder loan account. The Corporation’s
balance sheet showed a balance of $423,230.88 in the Due to Shareholder account
in 2009. The audit of the taxpayers in 2011 was commenced as a result of this
inconsistency. This led to the reassessments at issue.
[61]
During the audit, Mr. Struck represented to Ms.
Norminton, the auditor, that neither amount was accurate. He subsequently made
numerous submissions to her providing a different number for the account
balance each time. Eventually, Mr. Struck arrived at a shareholder loan account
balance of negative $81,425 at the end of the Corporation’s 2009 taxation year.
He revised the Corporation’s 2009 Financial Statement on or about January 30,
2012 to reflect that amount.
[62]
The auditor testified that there were no source
documents or transactional records provided that would allow her to verify any
of the numbers claimed by Mr. Struck. The auditor eventually accepted Mr.
Struck’s own representation that he owed the Corporation $81,425 and the
Minister assessed him accordingly pursuant to subsection 15(2) of the Act.
[63]
The Corporation’s 2010 taxation year was not
audited because the 2010 tax return had not been filed by the time the audit
was conducted. The auditor could not verify if the negative balance in the
shareholder’s loan account had been repaid in 2010 because the Corporation did
not keep a transactional record of the shareholder loan account.
[64]
Mr. Struck reconstructed the shareholder loan
account for the Corporation’s 2008, 2009 and 2010 taxation years for the
hearing of his appeal. He stated that he reconstructed the shareholder loan
account pursuant to his lawyer’s instructions.
[65]
According to this reconstruction, the
shareholder loan account had a credit balance of $223,367 at the beginning of
the Corporation’s 2009 taxation year. Mr. Struck alleged that, during the year,
he made various shareholder contributions for a total of $248,122 in the form
of advances from his personal line of credit or cash purchases and utilities payments
made on behalf of the Corporation. In this reconstruction, Mr. Struck also
received benefits which were recorded as loans from the Corporation, such as
payments for Mr. Struck’s personal VISA in the year for a total amount of
$552,914. This reduced the shareholder loan account from a credit balance of
$223,367 to a debit balance of $81,425 at the end of the 2009 taxation year,
i.e. the amount that was assessed.
[66]
For the 2010 taxation year, Mr. Struck
maintained at trial that the outstanding shareholder loan at the end of the
2009 taxation year was repaid by him in 2010. He argued that the shareholder
loan account reconstruction prepared by him at Exhibit A-2, Tab 23 supported
his position. The Chart showed that Mr. Struck made contributions and payments
on behalf of the Corporation for a total of $124,717 in the 2010 taxation year.
He also received similar types of payments which were recorded as loans made by
the Corporation for a total amount of $84,829. However, in computing the net
shareholder contribution for 2010, Mr. Struck did not include a payment of
$50,000 that he received from the Corporation on April 7, 2010. He made the
following notation beside this amount: “paydown 1601
Keating Mortgage - not to be included in shareholder loans.” As a result,
the total amount of shareholder loan allegedly taken in 2010 was determined to
be $34,829. Therefore, the net shareholder contribution or repayment was
$89,888, thereby allegedly bringing the shareholder loan account back to a
credit balance of $8,463 by the end of the Corporation’s 2010 taxation year.
[67]
The Respondent took the position that Mr. Struck
did not make a net repayment of $89,888 in respect of the shareholder loan
account in 2010. The Respondent argued that Mr. Struck’s testimony was suspect
and the shareholder loan account reconstructions at Exhibit A-2, Tabs 23 to 25
were made up for the purposes of the trial and should not be given any weight
as Mr. Struck did not provide any source documents from which one could verify
the entries.
[68]
The Respondent argued in the alternative that,
even accepting all of the other shareholder contributions and repayments as
reconstructed by Mr. Struck, the $50,000 payment by the Corporation to Mr.
Struck in respect of the Keating Mortgage should be included as a shareholder
loan to Mr. Struck in 2010. Therefore, the shareholder loan account should
remain in the debit balance of $41,537 (i.e. $39,888-$81,425), which amount
ought to be included in Mr. Struck’s income for his 2009 taxation year.
(ii) Analysis
[69]
Subsection 15(2) of the Act provides as
follows:
(2) Where a
person … is
(a) a shareholder of a particular corporation,
…
and the person …
has in a taxation year received a loan from or has become indebted to the
particular corporation ... the amount of the loan or indebtedness is included
in computing the income for the year of the person or partnership.
[70]
Subsection 15(2.6) of the Act provides an
exemption to the application of subsection (2) where the indebtedness is repaid
within one year after the end of the corporation’s taxation year in which the
indebtedness arose. The provision read as follows during the years at issue:
15(2.6)
Subsection 15(2) does not apply to a loan or an indebtedness repaid within one
year after the end of the taxation year of the lender or creditor in which the
loan was made or the indebtedness arose, where it is established, by subsequent
events or otherwise, that the repayment was not part of a series of loans or
other transactions and repayments.
[71]
The Minister accepted Mr. Struck’s own representation
that the shareholder loan account had a negative balance of $81,425 at the end
of the 2009 taxation year and assessed him accordingly since the Corporation’s
tax return for the 2010 taxation year had not been filed at the time of the
audit. There was no way to verify if the outstanding amount was repaid. Mr.
Struck alleged that the shareholder loan in 2009 was repaid by the end of the
Corporation’s 2010 taxation year. Consequently, pursuant to subsection 15(2.6)
of the Act, the negative balance should not be included in his income in
2009. Mr. Struck produced a transactional listing of entries in and out of the
shareholder loan account, Exhibit A-2, Tab 23, which he prepared for the
purpose of the trial. In support of his reconciliation, Mr. Struck only
produced deposit slips, bank account statements, and like documents.
[72]
I find that Mr. Struck has not shown that he
repaid the amount of $81,425 that he owed to the Corporation at the end of the
2009 taxation year.
[73]
There were no documents submitted from which I
could verify the entries on Exhibit A-2, Tab 23 and from which I could glean
whether the amounts were personal or business.
[74]
The reliability of Mr. Struck’s evidence
regarding the shareholder loan repayment in 2010 is suspect, to say the least.
He testified that he did not follow the GAAP and instead used his own
methodology to compute the shareholder loan account. He admitted that he did
not maintain a transactional record of the shareholder loan account
contemporaneously ever since the Corporation was incorporated in 1994. He
reported wildly inaccurate numbers in respect of the “Due
to Shareholder” account on the Corporation’s Financial Statements that
were incompatible with the Corporation’s tax returns for the relevant years.
Both of these documents had been prepared by him personally. During the audit
and objection stage, he made various different submissions to the auditor who
eventually had no better option but to accept his own estimate for the 2009
taxation year.
[75]
Second, as the Respondent correctly pointed out,
Tab 23 also showed a $50,000 payment by the Corporation to Mr. Struck dated
April 7, 2010, with a note stating “paydown 1601
Keating Mortgage – not to be included in the shareholder loans”. Mr.
Struck’s explanation for this entry was that the Keating Mortgage was the
liability of the Corporation. The evidence has shown that his explanation was
simply not correct.
[76]
I have not been persuaded that Mr. Struck paid
the outstanding balance in the shareholder’s account by the end of the Corporation’s
2010 taxation year. Mr. Struck’s evidence was self-serving. He has not provided
any convincing evidence to support his statements.
[77]
Therefore, I conclude that the shareholder loan
balance of $81,425 was correctly included in Mr. Struck’s income in 2009.
III. 468543 BC Ltd (the “Corporation”)
A. Disallowed
Interest Expenses
(1) Interest payments on the Weiler Mortgage and
the Keating Mortgage
[78]
In addition to the shareholder benefits assessed
to Mr. Struck as the shareholder of the Corporation, the Minister also assessed
the Corporation for its 2008 and 2009 taxation years by disallowing the
deduction of (i) $8,713 and $3,923 in mortgage interest payments made by the
Corporation in respect of the Weiler Mortgage, and (ii) $9,100 and $8,823 in
mortgage interest payments made in respect of the Keating Mortgage.
[79]
Paragraph 20(1)(c) of the Act provides
that interest payments made on “borrowed money used for
the purpose of earning income from a business or property” may be
deducted.
[80]
Mr. Struck claimed that the mortgage proceeds on
the Weiler Mortgage and Keating Mortgage were advanced to the Corporation for
its business use including the acquisition of rental properties by the
Corporation. Specifically, Mr. Struck alleged that the proceeds from the
mortgages were used to acquire the property located at 9609 Fifth Street,
Sidney, BC (the “9609 Property”) “free and clear”
of any encumbrances.
[81]
Based on the evidence, I am not convinced that
the mortgage proceeds were used for a business purpose.
[82]
With regard to the Weiler Mortgage, the
documentary evidence showed that in March 2003 none of the Weiler Mortgage was
used for the Corporation’s business. See my paragraph 17 above where I list how
the proceeds of the mortgage were disbursed. After paying off the Martin
Mortgage, the amount of $58,000 was given to Horst.
[83]
Mr. Struck claimed that Horst advanced the
amount of $58,000 to the Corporation so that it could purchase the 9609
Property. In support of his testimony, Mr. Struck produced a copy of the
Corporation’s bank statement for the month of June 2004 which showed a deposit
of $60,000 on June 18, 2004. I place no weight on this evidence. There were no
documents to link the $60,000 to Horst. The amounts do not match and the
$60,000 deposit occurred more than a year after the Weiler Mortgage proceeds
were disbursed to Horst. There was also no evidence that any of the proceeds
from the Construction Mortgage on the Keating Property were advanced to the
Corporation for its business.
[84]
The Appellants also rely on Mr. Chow’s testimony
as evidence that the Keating Property and the Weiler Property, as well as their
respective mortgages, were the Corporation’s assets and liabilities. I
disagree. Mr. Chow clearly testified that he simply relied on Mr. Struck’s
representations in his valuation and he did not conduct an audit of the
mortgages himself. During the 2008 valuation audit, Mr. Struck represented to
Mr. Chow that the Weiler and Keating Mortgages were liabilities of the
Corporation. The Minister is certainly not bound by Mr. Chow’s earlier
valuation opinions or any misrepresentations that Mr. Struck made to Mr. Chow.
Mr. Chow’s evidence is not relevant for the purposes of these appeals.
[85]
In conclusion, I find that there was simply no
credible evidence that would demonstrate that any part of the Weiler Mortgage
or Keating Mortgage proceeds actually went to finance the Corporation’s
business. Rather, the documentary evidence showed that most, if not all, of the
proceeds from the mortgages were used for Mr. Struck’s or Horst’s personal expenses.
Therefore, the mortgage interest expenses that the Corporation attempted to
deduct during the relevant years were properly denied by the Minister as the
mortgages on the Weiler Property and the Keating Property cannot be considered
as “borrowed money used for the purpose of earning
income from a business or property” under paragraph 20(1)(c) of the Act.
(2) Interest
Discrepancies
[86]
For the Corporation’s taxation years ending on
November 30, 2008 and November 30, 2009, the Minister disallowed the deduction
of $9,589 and $2,968 respectively, due to a lack of supporting documentation.
These amounts were labelled interest discrepancies.
[87]
Mr. Struck testified that most of the amount of
$9,589 claimed in the 2008 taxation year represented a missed invoice from the
Corporation’s lawyer. The actual invoice was for the amount of $9,355. The
expense was incurred in 2007. Rather than re-filing the Corporation’s 2007 tax
return, Mr. Struck claimed the amount in the Corporation’s 2008 return. Mr.
Struck requested the Court to allow this amount in 2008. He stated that the net
effect to the Corporation would be the same because, in both 2007 and 2008, the
Corporation was in a loss position.
[88]
The Respondent submitted that the Corporation
was entitled to claim the $9,589 expense in the 2007 taxation year and it could
submit a T2 adjustment for that year with the supporting documents. Counsel
stated that if the Court allowed the Corporation to claim the amount that was
incurred in the 2007 taxation year in the 2008 taxation year, there is no
mechanism in the Act that would prevent the Corporation from amending
its T2 return for 2007. In other words, the Respondent was concerned about the
problem of “double-dipping”. I agree.
[89]
It is a fundamental principle of Canadian tax
law that a current expense should only be deducted in the year that it was
incurred. This amount, which was incurred in the Corporation’s 2007 taxation
year, cannot be deducted in the 2008 taxation year. The Corporation should
amend its T2 return for the 2007 taxation year to claim this amount.
[90]
During the audit, the Corporation made
representations to the auditor that there was an additional interest expense of
$4,133 that should have been claimed and allowed in the 2009 taxation year. The
Corporation’s submissions were accepted by the auditor and the adjustments were
reflected in the reassessment dated May 7, 2012. Mr. Struck appeared to take
the view in his written submissions that the adjustments were not made and he
has asked for the deduction of an interest expense in 2009 of $2,968.
[91]
I have checked the relevant documents. The
relief sought by the Corporation in respect of the 2009 discrepancy had already
been adjusted in accordance with the Corporations’ request. The auditor made an
adjustment for $7,100 that included both the underreported amount and the
discrepancy. No further action is necessary.
(3) Duplicative Interest Deduction by Shareholder
on T1
[92]
The Minister disallowed an additional $1,924 in
interest expense which was claimed by both the Corporation on its 2009 tax
return as well as by Mr. Struck on his income tax return.
[93]
Mr. Struck acknowledged at trial that this item
was not in dispute.
(4) Interest
expenses on U.S. property
[94]
In September 2009, the Corporation also gave
mortgages on three of its properties. A portion of the mortgage proceeds was
used by a U.S. corporation named Kool Holdings Inc. (“Kool Holdings”), a real
estate company incorporated in 2009 and co-owned by Mr. Struck and his wife, to
purchase properties in the U.S. The Minister pro-rated the portion of the
interest payments corresponding to the proceeds that went into the
Corporation’s Canadian business operations and disallowed $3,501 in interest
expenses that were claimed by the Corporation in respect of Kool Holdings’ U.S.
operations.
[95]
In a letter dated June 13, 2013, Mr. Struck on
behalf of the Corporation indicated that this item remained in dispute.
[96]
However, the Corporation did not raise this
issue at trial. The Corporation also did not produce any evidence to contradict
the assumption of fact made by the Minister in her pleadings that the interest
at issue related to money borrowed for Kool Holdings’ business in the U.S.
[97]
As such, the Minister’s assessment on this
amount stands.
B. Direct Wage Expenses
[98]
The Corporation filed T5 slips and summaries in
its 2008 and 2009 taxation years with respect to dividends it issued in the
amount of $8,000 and $10,000 respectively.
[99]
In his 2008 personal tax return, Mr. Struck
reported a total of $11,600 in dividend income. This amount included the
dividend of $8,000 he received from the Corporation as well as dividends he
received from shares held in his trading account.
[100]
On his 2009 personal tax return, however, Mr.
Struck did not report any dividend income but reported the amount of $12,104.74
as a taxable capital gain. Mr. Struck testified that he made a mistake in his
filings and that this amount should have been dividend income.
[101]
The Respondent submitted that Mr. Struck lacked
credibility on this issue. In particular, Mr. Struck admitted on
cross-examination that he was an active trader during the years at issue.
Documentary evidence showed that in the 2009 taxation year, Mr. Struck reported
share dispositions for a total of $411,365 and a capital gain from these share
dispositions in the amount of $24,209.
[102]
Notwithstanding the above, the Corporation
reported the dividends on its financial statements in the respective years as
operating expenses and reported the amounts as wage expenses in the
Corporation’s tax returns in the relevant years.
[103]
The Minister disallowed the wage expenses
pursuant to paragraph 18(1)(a) of the Act on the basis that the amounts
constituted dividends which were paid out of the Corporation’s profit and hence
cannot be characterized as an outlay or expense incurred for the purpose of
gaining or producing income.
[104]
Mr. Struck did not dispute that the amounts were
dividends. In a letter dated June 13, 2013 to the auditor, Mr. Struck indicated
that he agreed with the reduction in wage expenses. In his written submissions,
Mr. Struck addressed this issue again and sought the following relief:
I ask that the
court allow the numbered company to report the dividends it paid out to Bernd
Struck on its 2008 and 2009 T5 statement, to be recorded in the numbered
companies Financial Statement for the respective years.
[105]
It is unclear what relief Mr. Struck is seeking
on this issue based on his submission. But to the extent that he is requesting
that the amounts be allowed as an expense for the Corporation’s 2008 and 2009
taxation years, the relief is denied.
[106]
Mr. Struck was clearly conflating the concepts
of a dividend versus a wage. A dividend is paid out from the after-tax profits
of a corporation whereas a wage expense is deducted in computing a
corporation’s profit for the purpose of determining a corporation’s taxable
income and tax payable.
[107]
The Minister properly denied the deduction of
dividend payments as wage expenses of the Corporation.
C. Gross negligence penalties
[108]
Subsection 163(2) of the Act provides as
follows:
(2) Every person
who, knowingly, or under circumstances amounting to gross negligence,
has made or has participated in, assented to or acquiesced in the making of, a
false statement or omission in a return, form, certificate, statement or answer
(in this section referred to as a “return”) filed or made in respect of a
taxation year for the purposes of this Act, is liable to a penalty … [emphasis
added]
[109]
In Venne v Canada, [1984] CTC 223,
Justice Strayer stated the test for gross negligence as follows:
"Gross
negligence" must be taken to involve greater neglect than simply a failure
to use reasonable care. It must involve a high degree of negligence tantamount
to intentional acting, an indifference as to whether the law is complied with
or not.
[110]
The Minister has discharged the onus of proving
that the Corporation is liable for gross negligence penalties under subsection
163(2) in respect of the disallowed expenses. Mr. Struck was the directing mind
of the Corporation during the years at issue. Mr. Struck prepared the
Corporation’s books and records. Although Mr. Struck had many years of business
experience, he commingled his personal expenses and the Corporation’s business
expenses. I find that Mr. Struck either knowingly or in circumstances amounting
to gross negligence, or “tantamount to intentional
acting” and “indifference”, directed the
Corporation to deduct expenses that clearly should not have been claimed. This
includes, among others, (i) mortgage interest expenses that were clearly
personal in nature; (ii) interest expenses that were incurred in respect to
another corporation’s business; and (iii) dividend payments.
IV. Conclusion
[111]
Mr. Struck’s appeal is allowed to reduce the
shareholder benefit to $14,525, $14,521, and $4,840.02 in 2008, 2009 and 2010
respectively. The gross negligence penalties are to be reduced accordingly. In
all other respects, his appeal is dismissed.
[112]
The Corporation’s appeal is dismissed.
Signed at Ottawa, Canada, this 29th day of May 2017.
“V.A. Miller”
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