Bowens v. R., [1996] 2 CTC 120, 96 DTC 6128

Hugessen J.T.C.C.: — This is an appeal by the Crown from a judgment of the Tax Court of Canada allowing the respondent taxpayer’s appeal against a reassessment to income tax.

In its original reassessment Revenue Canada assumed that the taxpayer was not at arm’s length with Trilogy Resources, a corporation which had required certain options rights which had initially been granted to the taxpayer; the reassessment was said to be based on the provisions of sections 245(2) and 245(3) as they then read:

245(2) Indirect payments or transfers - Where the result of one or more sales, exchanges, declarations of trust, or other transactions of any kind whatever is that a person confers a benefit on a taxpayer, that person shall be deemed to have made a payment to the taxpayer equal to the amount of the benefit conferred notwithstanding the form or legal effect of the transactions or that one or more other persons were also parties thereto; and, whether or not there was an intention to avoid or evade taxes under this Act, the payment shall, depending upon the circumstances, be

(a) included in computing the taxpayer’s income for the purpose of Part I

(b) deemed to be a payment to a non-resident person to which Part XIII applies, or

(c) deemed to be a disposition by way of gift.

245(3) Arm’s length — Where it is established that a sale, exchange or other transaction was entered into by persons dealing at arms length, bona fide and not pursuant to, or as part of, any other transaction and not to affect payment, in whole or in part, of an existing or future obligation, no party thereto shall be regarded, for the purpose of this section, as having conferred a benefit on a party with whom he was so dealing.

Following a notice of opposition from the taxpayer, the Minister confirmed the reassessment but on an entirely different basis: he assumed that the taxpayer and Trilogy Resources were at arm’s length and that tax was due by reason of the provisions of section 7(1 )(b):

7(1) Agreement to issue shares to employees — Subject to subsection (1.1) where a corporation has agreed to sell or issue shares of the capital stock of the corporation or of a corporation with which it does not deal at arm’s length to an employee of the corporation or of a corporation with which it does not deal at arm’s length,

(b) if the employee has transferred or otherwise disposed of rights under the agreement in respect of some or all of the shares to a person with whom he was dealing at arm’s length, a benefit equal to the value of the consideration for the disposition shall be deemed to have been received by the employee by virtue of his employment in the taxation year in which he made the disposition;

On the taxpayer’s appeal to the Tax Court the Crown, surprisingly, did not plead or invoke an assumption to the effect that the taxpayer and Trilogy were at arm’s length. This was quite improper and the Crown was at risk of having its Reply struck out as not pleading a fact which was at the basis of the reassessment; however, no objection was taken prior to trial and the judge was obviously of the view, with which we agree, that it was then too late in the day to raise a purely technical point of pleading.

The judge also took the view that the Crown had the burden of showing that the taxpayer and Trilogy were at arm’s length. If we understand him correctly, this was because of the mutually contradictory but unpleaded assumptions which had been made in the reassessment process and in particular the initial assumption that the relationship was non-arm’s length. While we agree with the result, the reasoning is, with respect, wrong: as we made clear in Pollock v. R. (sub nom. Pollock v. Canada), [1994], 1 C.T.C. 3, [1994] 2 C.T.C. 385, 94 D.T.C. 6050 (F.C.A.), unpleaded assumptions can have no effect on the burden of proof one way or the other. The reason the Crown bore the burden in this case of proving that Trilogy and the taxpayer were at arm’s length is that that was a fact on which the validity of the reassessment depended, and since no assumption to that effect had been pleaded the Crown did not have the benefit of any reversal of onus.

As matters turned out, the question of burden of proof became of only theoretical interest since there was ample material before the judge showing the relations between the taxpayer and Trilogy and the result did not turn on either party having failed to meet its burden. The judge’s finding that they were not at arm’s length was clearly one which was open to him on the evidence and we have not been persuaded that he committed any manifact or palpable error.

In the circumstances it is not necessary for us to reach the question of whether the taxpayer did in fact dispose of his option rights to Trilogy and we make no comment on it.

The appeal will be dismissed with costs.

Appeal dismissed.