Whitehead v. R., [1996] 1 CTC 2637, 96 DTC 3229

Sobier J.T.C.C.: — The appellant elected to have his appeals, from the assessments of the Minister of National Revenue (the “Minister”) for his 1987 and 1989 taxation years, heard under the Informal Procedure.

The issue arose whether the Minister was entitled to assess the 1987 taxation year beyond the normal period because of misrepresentations of the kind described in subparagraph 152(4)(a)(i) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the “Act”). [1] The misrepresentations are alleged to be the failure of the appellant to report a benefit conferred upon him by 687420 Ontario Limited (“687”), in connection with the sale of shares of 568792 Ontario Limited (“568”) by him to 687.

The appellant is a Certified Management Accountant, tax advisor and promoter. He was the owner of 10,000 common shares in the capital of 568, and in 1986 transferred 5,000 of these shares to his spouse, leaving him the owner of the remaining 5,000 shares (the “Shares”). The appellant determined that the fair market value of the 10,000 shares was $70,000. This value was not disputed. On October 15, 1987, the appellant transferred 2,000 of the Shares to 687 for a purchase price of $35,000. Mr. Whitehead was a shareholder of 687 at that time. Based upon the valuation of $70,000 for 10,000 shares, the consideration for 2,000 shares should have been $14,000 not $35,000.

It was the appellant’s contention that he intended to transfer all of the Shares to 687 and did not. The error was made, according to the appellant, because he did not have in his possession, the appropriate records, they having been seized by the authorities.

The stock transfer register of 568 and the agreement to take up shares signed by Mr. Whitehead on behalf of 687, show 2,000 shares being transferred. In addition, the T2 Return of 687 for its year ending October 31, 1988, disclosed that it was the owner of 25 per cent (sic) of the common shares of 568. The 1987 T1 General Return of Mr. Whitehead also shows that he disposed of 2,000 shares of 568 for $35,000. All of these documents were either prepared and signed by Mr. Whitehead or were signed by him. It was clear that he prepared all of the tax returns showing that only 2,000 shares were involved.

Under the circumstances, I ruled that the assessments were properly made under subparagraph 152(4)(a)(i) of the Act, based upon the reasons for judgment of Judge Bowman of this Court, in Farm Business Consultants Inc. v. R. (sub nom. Farm Business Consultants Inc. v. Canada), [1994] 2 C.T.C. 2450, 95 D.T.C. 200. Dealing with subparagraph 152(4)(a) of the Act, Judge Bowman said, at page 2455 (D.T.C. 204):

The types of misrepresentation by a taxpayer that will permit the Minister to reopen a statute-barred year run the entire gamut from innocent carelessness to fraud.

That Mr. Whitehead knew or ought to have known that 2,000 shares were being transferred is beyond doubt. What Mr. Whitehead did was a great deal more than innocent carelessness. For these reasons, the appellant’s argument on the statute-barred issue fails.

Having disposed of this interim matter, I proceeded to hear the appeal with respect to the 1987 taxation year. The issue with respect to that year was whether 687 conferred a benefit of $21,000 on the appellant, in his capacity as a shareholder of 687 in the 1987 taxation year. (See subsection 15(1) of the Act. [2] ) Penalties under subsection 163(2) were also assessed.

The issue with respect to the 1989 taxation year is whether the appellant was a 50/50 partner with 687, in respect of a partnership unit of Seawinds Limited Partnership (“Seawinds Unit”). Mr. Whitehead states that he was such a partner and claimed a partnership loss in the 1989 taxation year. The Minister also assessed penalties under subsection 163(2) of the Act.

Dealing with the 1987 taxation year

The appellant had determined that $70,000 represented the value of 100 per cent of the Shares. He made a decision to sell the Shares of 568 to 687 for the stated purpose of putting his financial affairs in such order that would permit him to obtain a visa to carry on business in the United States of America by reason of the Canada/U.S. Free Trade Agreement. He claims to have intended to transfer all the Shares. However, there are too many pieces of evidence which show that what was transferred was not 5,000 but only 2,000 shares. However, the purchase price was $35,000. He reported this disposition as a capital gain, i.e. 2,000 shares disposed of at $35,000 rather than 2,000 shares at $14,000. The Minister disallowed the capital gain deductions resulting from it and added $21,000 to his income as an appropriation under subsection 15(1) of the Act.

The appellant admitted that the $21,000 was used to repay approximately $10,000 of his indebtedness to 687 and the balance was used to create indebtedness owing by 687 to him in a like amount. Therefore, after the event, not only did he not owe 687, he was owed by 687.

That no amounts were withdrawn from the loan account owed by 687 to him matters not. Subsection 15(1) of the Act deals with the conferring of a benefit and not the receipt of income.

Reference was made to R. v. Leslie, [1975] C.T.C. 155, 75 D.T.C. 5086 (F.C.T.D.). The defendant Leslie incorporated a company and sold his business to it. The purchase price for the assets purchased aggregated $25,000. Ten thousand dollars was satisfied by the issuance of 10,000 common shares of the purchaser and $15,000 was evidenced by a promissory note in that amount. Five thousand dollars represented the value of the business, exclusive of good will. The balance of $20,000 was allocated to good will, which was admitted to be non-existent.

The issue there was: Was the benefit conferred at the time of the issuance of the promissory note (1959) or at the time of the payment of part of the promissory note (1969)? The taxpayer argued that it was at the time the note was issued since its taxability would be statute-barred and the Crown of course maintained that it was at the time of payment.

Counsel for the Respondent cited the following as authority for the proposition that it is the time of creation of the obligation which is the time the benefit is conferred: [3]

Generally speaking, when a legally enforceable obligation to pay has been entered into, in one taxation year, and this obligation creates a taxable benefit in the hands of the obligee or of the payee and the legal obligation is met and paid in a subsequent taxation year, it is when the legally enforceable benefit is created and not when the taxpayer actually receives payment that the amount should be taken into account.

However, counsel left the matter there, in support of this argument. Unfortunately, he neglected to put the exception to this rule.

Again on page 159 (D.T.C. 5089), following the above quoted passage, Addy, J. continued with the following:

This principle was approved by my brother Cattanach, J. in Kennedy v. Minister of National Revenue, [1972] C.T.C. 429, 72 D.T.C. 6357, and his decision was confirmed on this point by the Court of appeal in Kennedy v. Minister of National Revenue, [1973] C.T.C. 437, 73 D.T.C. 5359.

In the above-mentioned case, Jackett C.J. also clearly re-states the distinction made in other cases between “income” and a “benefit” as contemplated in section 8(1) as follows (refer pages 842 and 843 of the above-mentioned report of the case before the Court of Appeal):

In the case of “income”, it is assumed, in the absence of special provision, that Parliament intends the tax to attach when the amount is paid and not when the liability is created. (The courts naturally react against taxation before the income amount is in the taxpayer’s possession). Here, the question is when a “benefit” has been “conferred” within the meaning of those words in section 8(1). In my view, when a debt is created from a company to a shareholder for no consideration or inadequate consideration, a benefit is conferred. (The amount of the benefit may be a question for valuation depending on the nature of the company.). [73 D.T.C. at 5361.]

Immediately following that, however, in the same paragraph he goes on to state:

On the other hand, when a debt is paid, assuming it was well secured, no benefit is conferred because the creditor has merely received that to which he is entitled. I am, therefore, of the opinion that the $53,000 promissory note must be taken into account for the purposes of section 8(1) in the year in which it created an indebtedness from the company to the appellant, namely, 1965. (The italics are mine.)

He then goes on to state in the following paragraph:

The question of benefit or no benefit in the 1965 taxation year is, in my view, primarily a question of fact in connection with which the onus of proof was on the appellant (taxpayer). (The word in parenthesis is mine.)

The italicized words “assuming it (the debt) was well secured” obviously do not refer to the type of instrument under which the debt is secured, that is, whether it is secured by a simple promise, a promissory note, a charge or a mortgage, since in the Kennedy case, supra, the debt was only secured in that sense by a promissory note and it is evident that a promissory note of itself does not constitute security: the security, in so far as a promissory note is concerned, depends entirely on the maker’s ability to pay. The type of security contemplated in the above-quoted passage must be taken to refer to the existence of sufficient assets to create a good or a sound expectation of the debt actually being paid. In such a case, a benefit is in fact being conferred at the time the legal debt is created. Conversely, if there are no assets, then, although a legal debt might be created, there is no benefit conferred at the time, although a benefit might well accrue if and when assets are accumulated sufficiently to allow the obligation to mature into a real benefit.

Mr. Justice Addy then went on to find that there was no “security” for the amount in excess of the value of the assets transferred and allowed the Crown’s appeal from the Tax Review Board.

Therefore, in the case at bar, one must examine the financial condition of 687 at the time the obligation was created in order to determine whether 687 was capable of honouring his obligation to Mr. Whitehead and therefore conferring a benefit at that time. The unaudited balance sheet of 687 for its year ending October 31, 1988 shows the comparative balance sheet as of October 31, 1987. An excess of assets over its liabilities of $166,699 was shown on the 1987 balance sheet of 687, more than sufficient to satisfy its obligation to Mr. Whitehead.

Based upon the foregoing, I conclude that a benefit of $21,000 was conferred upon Mr. Whitehead by 687 and that the benefit was conferred in 1987. The appeal with respect to this issue is dismissed.

Dealing with the 1989 taxation year

The assessments related to this year are based upon the Minister’s as- sumption that the appellant was not a 50/50 partner with 687 with respect to the Seawinds Unit and therefore not entitled to share in the losses.

The appellant maintains that at the outset, it was intended that he and 687 were to be partners in the Seawinds Unit. Outside of his viva voce evidence to that effect, the only other evidence in support of this position is the T5013 Supplementary Statement of Partnership Income slip, in the name of “687420 Ontario Limited & T.E. Whitehead” issued by Seawinds Limited Partnership for the period ending December 1990.

Other evidence consisted of:

1. a unit certificate for the Seawinds Unit, dated December 29, 1989, for one unit in the name of “T.E. Whitehead”;

2. a subscription form and power of attorney dated and accepted on October 13, 1989, whereby 687 subscribed for the Seawinds Unit and;

3. a promissory note dated October 13, 1989 in the principal amount of $20,000 made by 687 in favour of Seawinds Limited Partnership as part payment for the Seawinds Unit.

In addition, Mr. Whitehead claims that he provided one-half of the $10,000 cash portion of the subscription price for the Seawinds Unit, although no backup documents were produced.

Between the time of the original subscription, in 1989 and 1990, changes were wrought in the status of various parties with respect to the Seawinds Unit. In the unit certificate, (December 29, 1989), Mr. Whitehead is shown as the Unit holder, notwithstanding that 687 executed the subscription and promissory note (October 13, 1989). The T5013 for December 31, 1990, shows 687 and Mr. Whitehead jointly as unit holders.

It is the 1989 taxation year which is in issue. In that year, there are the unit certificate, the subscription and promissory note to be examined. The unit certificate indicates to me that Mr. Whitehead either was attempting to appropriate the Seawinds Unit for his own account or he became an owner or a part-owner of it after October 13, 1989. Although the T5013 is for the 1990 taxation year, it is evidence that at some time prior to the end of 1990, Mr. Whitehead became part-owner of the Seawinds Unit. Based on the viva voce evidence of Mr. Whitehead, I find that he acquired an interest in the Seawinds Unit and was a 50/50 partner with 687 in the Seawinds Unit in 1989 and entitled to treatment accordingly.

However, at the hearing, Mr. Whitehead conceded that he had only $5,000 at risk and would therefore only be entitled to a $5,000 deduction in respect of the partnership loss in the 1989 taxation year.

The remaining issue for the 1989 taxation year deals with the treatment of the disposition by the appellant of a Coventry Park Limited Partnership Unit (the “CP Partnership Unit”).

In 1989, the appellant reported a capital gain of $35,000 on the disposition of the CP Partnership Unit and claimed a capital gain deduction in the amount of $6,666.67.

Eventually, the Minister reassessed Mr. Whitehead on the basis that a capital gain of $15,000 be allowed but that the remaining $20,000 was received by him as professional income. In addition, penalties under subsection 163(2) of the Act were reduced from $5,779.64 to $3,721.68.

The position of the appellant and the Minister changed over the years, from one whereby the Minister allowed all as claimed by the appellant as a capital gain, to another where all was denied by the Minister as a capital gain, to another whereby the Minister allowed part of as a capital gain and assessed the remainder as income. In addition, the Minister disallowed the deduction by the Coventry Park Limited Partnership (“CP Limited Partnership”) of the amount claimed by the Minister to be income to the appellant.

The appellant performed services for CP Limited Partnership. Although an agreement was entered into between the appellant and CP Limited Partnership whereby it would pay the appellant 1 per cent of sales as a fee for providing administrative services, the agreement was never acted upon according to the appellant.

Mr. Whitehead admitted that he received the CP Partnership Unit in consideration for other services rendered by him to CP Limited Partnership. As such, it was income in his hands and should have been reported as such. The appellant’s argument that he received the CP Partnership Unit for no consideration and therefore had a zero cost base, does not jibe with this admission that he received the CP Partnership Unit as consideration for services rendered. Accordingly, the appeal is dismissed on that issue.

Penalties

I will now deal with the issue of the penalties assessed under subsection 162(3) of the Act, which reads as follows:

Every person who, knowingly, or under circumstances amounting to gross negligence in the carrying out of any duty or obligation imposed by or under this Act, 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 as required by or under this Act or a regulation, is liable to a penalty of the greater of $100 and 50 per cent of the total of....

It can be seen that in order to assess penalties, the Minister must establish that the taxpayer “knowingly or under circumstances amounting to gross negligence” made a false statement in filing his return.

Previously in these reasons, I dealt with the degree of neglect required in order to permit the Minister to assess after the normal assessment period under subparagraph 152(4)(a)(i) of the Act. If the misrepresentation is attributable to neglect or carelessness, not amounting to gross negligence, the penalties under subsection 163(2) of the Act cannot be assessed. Much more is required in order to assess the penalties under subsection 163(2) than to reassess under subparagraph 152(4)(a)(i). Subsection 163(2) is tantamount to a penal sanction and care must be taken before assessing a penalty. If there was doubt as to the degree of misrepresentation, one must give the benefit of this doubt to the appellant. One must start by looking subjectively at the appellant. Whatever may be expected of him may not be what is expected of others. It is his experience, knowledge and intelligence which must be factored into the equation. The appellant is a Certified Management Accountant, practicing since 1975, so that in the years in question, he possessed 12 to 14 years experience. In addition, he was a tax advisor and business promoter. One would expect a higher degree of skill and knowledge from him than from someone not schooled in accounting and tax law.

1987 Penalties

Dealing with the penalties assessed for the 1987 taxation year, in respect to the sale of the shares to 687, all of the evidence points to the fact the appellant knowingly reported the sale of the 2,000 shares for $35,000. He was the architect of the scheme, prepared the financial statements and returns on the basis that there were 2,000 shares not 5,000 shares transferred. Yes, he did report the receipt of $35,000, but he reported it as a capital gain based on the value for all of the shares being $70,000. It must have been clear to him that the gain was $14,000 and that the balance had to be treated in another fashion. As a shareholder of 687, he caused that corporation to credit him with an additional $21,000, which is a benefit conferred upon him pursuant to subsection 15(1) of the Act. This benefit was conferred in 1987. The appeal against the assessment of the penalties on this issue is dismissed.

1989 Penalties

As to the penalties assessed for the 1989 taxation year, on the claim for partnership losses with respect to the Seawinds Unit, although the appellant was successful in establishing he was a 50/50 partner in that unit, he claimed 100 per cent of the losses in that year. It was the appellant’s position that he was always intended to be a 50 per cent partner, never more, never less. Having insisted on that position, he cannot be heard to claim 100 per cent of the losses for his 50 per cent interest. However, he did establish that he was a partner and that he would be entitled to $5,000 of losses, since his investment was only $5,000. Accordingly, the appeal as to penalties is allowed based on the appellant being a 50/50 partner and entitled to $5,000 of partnership losses.

Lastly, dealing with the penalties assessed with respect to the CP Partnership Unit. The appellant’s own admission that he received $20,000 by way of remuneration for services, squarely puts him in the position of knowingly reporting the receipt of this $20,000 as a capital gain rather than income as admitted. The appeal with respect to this issue is also dismissed.

The appeal is allowed with respect to the 1989 taxation year, without costs, and the matter referred back to the Minister on the basis that the appellant is allowed partnership losses in 1989 of $5,000 with respect to the CP Limited Partnership and that the penalties for that year be recalculated on that basis. In all other respects, the appeals are dismissed.

The appellant is entitled to no further relief.

Appeal allowed in part.