Lionel Houle v. Minister of National Revenue, [1982] CTC 2218, 82 DTC 1208

D E Taylor:—This is an appeal heard in Vancouver, British Columbia, on October 22, 1981, against income tax assessments for the years 1975 and 1976 in which the Minister of National Revenue increased the taxable income of the appellant by adding thereto amounts of $4,405 and $5,533 respectively as “Taxable Benefit re use of company yacht”. The respondent relied, inter alia, upon sections 3, 4 subsection 15(1) and paragraph 18(1 )(l) of the Income Tax Act, SC 1970-71-72, c 63 as amended.

The appellant is a majority shareholder and officer of Joyce Management Ltd (“Joyce”). Houle Electric Ltd (“Houle Electric”) is a wholly-owned subsidiary of Joyce. In each of the relevant years Joyce owned a 36-foot motor vessel (yacht) known as the SANS SOUCI II, the capital cost of which was $51,924. In 1975 and 1976, Joyce incurred expenses in the amount of $3,039 and $4,680 respectively in the operation of the said yacht, for Houle Electric which used it for entertainment and promotion for about 15 days in 1975 (or 64.7 hours) and 5 days in 1976 (or 33.6 hours); and the appellant who used it personally for about 31 days in 1975 (or 160.2 hours) and 25 days in 1976 (or 150.6 hours). In his income tax returns for the 1975 and 1976 taxation years, the appellant reported as a taxable benefit the amount of $1,800 pertaining to his personal use of the said yacht. In assessing, the respondent calculated the total benefits as $6,205 and $7,333 respectively.

As a matter of record, this appeal was originally scheduled to be heard with a separate appeal from Houle Electric in which the issue was to be the deductibility of the payment made by Houle Electric to Joyce for the “business” use of the vessel in question in 1975 and 1976 in the amounts of $2,650 and $2,500 respectively. At the start of the hearing a request from counsel was made to the Board that the Houle Electric appeal be adjourned, to await the outcome of the appeal of Jaddco Anderson Limited v The Queen, [1981] CTC 11; 81 DTC 5002, from the Federal Court, Trial Division, to the Federal Court of Appeal. It was the expressed view of counsel that the determination of Jaddco (supra) regarding the deductibility of a rental charge for a recreational lodge would probably determine the similar issue in the Houle Electric appeal. It was not explained to the Board the basis upon which one could arrive at the conclusion that the payment from Houle Electric to Joyce for the use of the vessel in this appeal could be classified as rental in the same way as the payment in Jaddco (supra). It should be noted that no reconciliation of the actual expenses paid by Joyce for operating and maintaining the vessel in the instant appeal with the amounts received from both Houle Electric and the appellant, was provided to the Board. However, as I understand the testimony of Mr Houle and Mr Lahti (later witnesses), the payments by the appellant and Houle Electric were designed to reimburse Joyce. The request for an adjournment of the Houle Electric appeal was granted by the Board.

Contentions

For the appellant:

— The taxpayer disputes the computation of the “additional benefit”.

For the respondent:

— Joyce conferred a benefit or advantage on the appellant in his capacity qua shareholder, which benefit was the personal use by him of the company yacht.

Evidence

The appellant testified regarding the acquisition of the vessel in question (actually there was an earlier version Sans Souci I in about the year 1970), its purpose and use, where required by Houle Electric or desired by himself. The vessel had been available to him for his own use, at his discretion — certainly no one else had control of, or hindered his access to it. He kept a meticulous log book of all the operating dates and times, purpose of the trips, and the persons aboard the vessel. Joyce had no particular use for the vessel, but nevertheless its capital cost had been paid for out of that company. The appellant had calculated the personal “benefit” portion at $1,800 each year, which sum he had reported according to the ratio which his own use bore to the total operating costs. He had made no allowance in that calculation for such things as interest on money invested, or capital cost allowance on the vessel. In the years 1975 and 1976, Houle Electric did not claim as an expense in its corporation records, any capital cost allowance on the vessel. Joyce initially paid for the operating and maintenance expenses of the vessel, and then Joyce was effectively reimbursed by Houle Electric and the appellant. The $1,800 per year, originally included as a “benefit” and reported by the appellant, arose out of this process of apportioning the “running expenses” of the vessel between Houle Electric and the appellant in relation to the respective days used by each. It was the view of Mr Houle that the vessel now was probably worth more as an asset than when it was acquired by Joyce.

Mr Lahti, an officer with Revenue Canada, testified regarding the formula used by the Minister to assess the benefit. Basically, it reflected an interest rate charge as a return on capital invested. The net effect of the Minister’s calculations and assessment was to consider the charge for return on investment (at 8% per annum) in the nature of a “stand-by charge” benefiting the appellant for all of the 365 days per year, minus only the proportion of that total which could be allocated to the days the vessel was used by Houle Electric. There was some slight difference of opinion about the breakdown of the days of utilization between Houle Electric and the appellant, which was expressed by Mr Lahti.

Argument

Counsel for the appellant argued that the Income Tax Act did not provide for the approach used by the Minister in assessing — to add to the acknowledged and generally agreed upon direct operating costs of the vessel, an indirect interest rate charge for return on the use of the capital invested in the vessel. While certain case law pointed out that a portion of capital cost allowance might well be a benefit to a shareholder in similar circumstances, that did not apply here because the company owning the vessel (Joyce) had not charged any depreciation as part of its operating expenses for the vessel. The Minister’s assessment was simply unsupportable — there was no additional cost to allocate proportionately to Mr Houle. In the jurisprudence cited by counsel for the appellant were:

Canim Lake Sawmills Limited v MNR, [1961] CTC 25; 61 DTC 1035; John B Starky v MNR, 27 Tax ABC 6; 61 DTC 360.

Counsel summarized his position by commenting:

I would submit with respect that all of the jurisprudence from years gone by until now have never imposed a taxable benefit on the basis sought by the Crown in this case which, I would submit, works a very unreasonable hardship on an individual because the result is that he bears the entire load of this benefit based upon this formula, whether he uses the board or not and whether or not there is a substantial advantage to the company in using the boat.

Counsel was not aware of jurisprudence which would permit an “interest” charge, even if a “depreciation” charge could be made against the appellant. Certainly the “imputed” interest charge was unsupportable in his view.

Counsel for the respondent emphasized the fact that Joyce could not claim the vessel was required or used in the business of that company. At best, the acquisition might be characterized as one in which Joyce owned and provided it to Houle Electric for business use, and to the appellant for personal use. Joyce had “tied up” some $50,000 in the vessel and, for all practical purposes, put it at the disposal and discretion of the appellant. Potential revenue to Joyce on that investment had been foregone, and the benefit to the appellant should be representative of that foregone revenue, to the extent of an annual charge for the lost return on the investment, according

to the Minister. In the case law referenced by counsel for the Minister was MNR v Pillsbury Holdings Limited, [1964] CTC 294; 64 DTC 5184.

Findings

After considering the evidence relevant to the number of days of total running time of the vessel which should be allocated to the appellant or to Houle Electric respectively, I have concluded that the testimony of the appellant should be accepted regarding this breakdown. Therefore, to that degree at least, the fundamental support for the $1,800 benefit he allocated to himself is on solid ground. In any event, the total running days for each year is so small that that issue does not appear critical to me.

The first issue to address is the effect of the ownership of the vessel in Joyce, in which company it had no evident business purpose. That it was not even intended as a business asset of any kind in Joyce is the only logical conclusion to reach from the unfolding of events. There is no indication of use by anyone other than Houle Electric and Mr Houle, and there is no indication that efforts were made by Joyce to more widely expand the use of the vessel in an attempt to profit from its availability. There was no recognizable advantage to Joyce in owning the vessel, let alone the “substantial advantage” asserted by counsel; and any advantage which could accrue to Houle Electric ty its use had nothing to do with its ownership by Joyce — Houle Electric could have used any available vessel for the same purpose. There was no business reason as an asset in a management company for Joyce to purchase the vessel; it was not alleged by the appellant that Joyce, as a valid reason for the acquisition of the vessel, intended to rent it out to the appellant and to Houle Electric — “for the purpose of gaining or producing income”, simply as another business venture in which Joyce decided to engage. Indeed, such a contention (rental as a business) would be difficult for the appellant to support in view of the practice and policy of Joyce not to take into account the capital invested or the capital cost allowance when setting the charges for its use by the appellant, but particularly to Houle Electric; finally, it was not an investment by Joyce (in the sense of earning interest on surplus funds) or there would be no appeal before the Board on the assessments in question. In this appeal, the circumstances under which a legitimate deduction of either one (depreciation or interest) for income tax purposes could be made by the company were not explained to the Board, and any such deduction has earlier been rejected. The fact that it was never charged by Joyce is irrelevant.

As I see it, the appellant cannot claim to be merely reimbursing Joyce for costs incurred on his behalf in the use of a company business asset as the asset had nothing to do with Joyce. Its limited and unprofitable use by Houle Electric does not moderate that situation in my view. Certainly it is open to Joyce to expend any of its available excess capital in any way it should see fit, and in any manner legally permitted to it. However, that does not endow the expenditure with characteristics which automatically permit positive or favourable tax results either to the company or to this appellant.

The appellant has not contended in this matter that Joyce could acquire the vessel, record it as a company asset on its books without any valid business purpose, put it completely at the appellant’s disposal, and absorb that capital cost unchallenged by the Minister. Such a contention would be tantamount to acceptance of a principle that funds of a corporation could be diverted, at the sole discretion of a taxpayer for his own personal benefit, and that he would not be called to account for the diversion of those funds, but merely assessed for an alleged calculated annual operational disbenefit suffered by the company. I am not aware of jurisprudence which would countenance such a diversion of funds with income tax impunity.

Counsel has contended that there was no basis in law for the annual “imputed” interest on capital rationale for the assessments in question, based upon the appellant’s use of a company asset, even if an argument could be made that a “depreciation charge” was deductible according to Canim Lake (supra) and Starky (supra). According to counsel, any such charge (for interest) would belong solely to the company since the asset belonged to the company, if indeed any charge was warranted. For purposes of this appeal, I am unable to see a distinction in principle between depreciation and interest. The first is a calculated amount related to the wear and tear on an asset resulting from use, the other is an amount paid related to the use of funds expended to acquire an asset. Both are deductible for income tax purposes under given and not totally dissimilar sets of circumstances. If anything, the fact that interest was paid, as opposed to calculated, could give it a more positive foundation for such apportionment. Therefore, where the issue is “interest” rather than “depreciation”, whatever principles may be found in Canim Lake (supra) and Starky (supra) should be equally applicable. The problem, as noted above, is that both Canim (supra) and Starky (supra) are of only academic interest in the instant matter since there was no business purpose in Joyce for the vessel at all. Any cost to Joyce resulting from the vessel would be improperly treated as tax deductible. The question then becomes one of deciding whether there is any cost buried in Joyce by virtue of its capital invested in the vessel.

There is no evidence that in either of Canim Lake (supra) or Starky (supra) the Minister would have assessed a proportion of a depreciation charge not already deducted as an expense by the corporation against the individual taxpayer appellants. What is clear from the above two mentioned cases is that, in addition to apportioning the depeciation charge, the Minister did not calculate and impute a charge related to any return on capital invested in the assets — in those cases, airplanes. Any interest paid (in the event borrowed funds were used to acquire the airplanes) would have been deductible and, presumably, subject to apportionment treatment similar to that accorded depreciation on the assets. However, irrespective of what might have happened with regard to interest actually paid, it is the further position of the appellant in this matter that the Minister has no authority in the absence of such actual payment to calculate and impute an interest charge which would only be related to the use of the company’s own funds. In a recent decision of the Board (Thompson v MNR — not yet published), the Minister did not impute and tax an interest charge on funds allegedly available from company resources, and this appeal might be considered on those grounds alone. The availability to a shareholder of a corporation’s own funds at no interest rate may appear illogical in light of the fact that an Obligation of the company to pay interest on borrowed funds should be passed on to that shareholder if the funds are loaned to a shareholder or are used to acquire an asset for the shareholder’s use (see Thompson (supra)). I fail to find anything in the jurisprudence cited by the respondent in Pillsbury (supra) which would endow the Minister with the authority to impute such a charge when none has been incurred directly. In fact, quite the opposite could be argued if one followed the subsequent and consequential decision in Wale v MNR, 6 Tax ABC 255; 64 DTC 632, also noted for reference purposes in Thompson (supra).

The Minister’s contention, as stated in the Reply to Notice of Appeal, is — “the appellant in his capacity as majority shareholder and officer caused Joyce Management Ltd to confer a benefit or advantage on him qua shareholder by allowing him the personal use of the yacht owned by Joyce Management Ltd. Certainly Mr Houle paid for the direct costs associated with his use of the yacht owned by Joyce. The Minister’s comment, therefore, is designed to attribute to Mr Houle the indirect costs absorbed by the company by the investment of its funds in the yacht. The Minister is not merely shifting the burden of a cost from the company to the appellant, but rather inventing a new one, not considered to be a cost by the company, for annual return on capital, and stating that it should be borne by the appellant.

In my mind there was nothing advanced by the Minister which would support any action by the corporation of conferring anything upon the appellant when the definition in Pillsbury Holdings (supra) is recognized: “The word ‘confer’ means ‘grant’ or ‘bestow’”. Indeed, it would appear that in the transactions for which the appellant is assessed, the corporation Joyce was totally passive — its last active participation with the yacht having occurred at the time of acquisition. While recognizing that a corporation can only act through its officers, there is no indication that the appellant acting for the corporation did anything whch could be construed as equivalent to the corporation conferring the use of the vessel on the appellant.

I can only assume that the term used in the Minister’s allegation quoted above — “caused Joyce . . . to confer a benefit . . . by allowing him the use of the yacht ...” is supposed to be synonymous with the requirement of paragraph 15(1 )(c) of the Act which reads:

a benefit . .. has been conferred on a shareholder by a corporation,

As I see it, the appellant at the time of acquisition simply took possession of the vessel personally, which was his obvious purpose. That would be more in line with the term “appropriated” as found in paragraph 15(1 )(b) of the Act but the appropriation there would be of the “funds or property . . . for the ‘benefit’ of the appellant”. That leaves the view that any benefit which might have been at issue in this appeal would be the cost to Joyce of the vessel itself — not any imputed (and allegedly lost) return on the capital invested. In this connection, reference should be made to the case of J Mercer Reid v MNR, 26 Tax ABC 321; 61 DTC 263, where, on dismissing the appeal, the Board noted at 326 and 266 respectively:

As to paragraph (b) it includes in the income of a shareholder funds or property of a corporation which have been appropriated in any manner whatsoever to or for his benefit otherwise than on the reduction of capital, redemption of shares, or on the winding-up, discontinuance or re-organization of the company’s business. “Appropriated in any manner whatsoever to or for the benefit of a shareholder” is wide enough to include payment for a quid pro quo, gift, voluntary or gratuitous division of capital or surplus or any other act by which a company confers a benefit on a shareholder in respect of any of its property. In fact the property need not pass to the ownership of the shareholder nor need he receive it. All that is required is that it be appropriated in any manner for his benefit. “Appropriated” is defined in the Century Dictionary of the English Language as follows:

“(a) in general, to take for any use; put to use” and

“(b) to set apart for or assign to a particular purpose or use in exclusion of all other purposes or uses.”

From this analysis the Board reaches the conclusion that the basic thrust of the appellant’s argument is correct . . . there was no legislative or judicial authority provided to support the action of the Minister in imputing a charge against the appellant for his use of the corporation’s own capital. In the peculiar circumstances of this case, the corporation had no business purpose for the acquisition of the asset and could not have sustained any such operating charge. The net result is that if any “benefit” is to be charged against the appellant, it would require foundation in the acquisition and capital cost of the asset itself under paragraph 15(1 )(b) of the Act, not in some annually calculated “benefit” arising from the provisions of paragraph 15(1 )(c) of the Act. The Minister’s assessment is therefore ill-founded and the appeal will be allowed.

In my view the assessments for the years 1975 and 1976, as they have been struck, are not in accordance with the Income Tax Act or the relevant jurisprudence. In arriving at this conclusion, I am mindful of the recent decisions of the Board in William E Fellner v MNR, and Robert F Fellner v MNR, (not published) which appeals bear substantial similarity to this matter and were also allowed. While the reasons advanced for allowing the appeals in William E Fellner and Robert F Fellner differed markedly from the reasons I have advanced herein, I see no requirement for the Board in this matter to examine and reconcile the areas of difference in view of the fact that the same end result was attained .. . the allowing of the appeals.

The Board is not called upon in this matter to decide what would be the result if there were some legitimate business purpose by the company making the acquisition (no matter how limited), but concurrently or coincidentally there was partial utilization by the appellant — for example, if the yacht had been acquired by Houle Electric Ltd, used sparingly for that company’s benefit, but left exclusively at the disposition of the appellant in circumstances similar to those reviewed in this appeal. In that situation counsel for the appellant might look for support from Canim Lake (supra) and Starky (supra) on the “apportionment” procedure, but it is a moot question if the standard indicated on 34 and 1040 of Canim Lake (supra):

. . . that . .. the property had been regularly used for the purpose of gaining or producing income, and in part for some other purposes . .. (Italics mine).

would be applicable. There are no “stand-by” provisions such as subsection 15(5) of the Act dealing specifically with an automobile which might intervene, and the general principle to be followed seems rooted in paragraph 18(1 )(I) of the Act which, although it deals with certain particular assets, nevertheless notes clearly:

. . . unless the taxpayer made or incurred the outlay or expense in the ordinary course of his business of providing the property for hire or reward,

As I see it, when a corporate expenditure is of value only to a shareholder, it is the capital cost, not an annual charge related to that capital cost which is at issue under section 15 of the Act. In a similar situation where the asset was of value primarily to the shareholder as contrasted with the corporation, the same result might well obtain. I find no merit in an argument that where there is little utilization of the asset by either party (and the proportionate numbers in this case would be an example), the tax impact of the capital cost, the return on investment, or the depreciation charges, as the case may be, for the idle time, should automatically be borne by the corporation rather than by the shareholder. Section 15 of the Act is designed to prevent benefits to shareholders, not to provide them, as I read the words.

In the assessments at issue in this appeal, the Minister leaves the basic capital transaction itself unchallenged (and I recognize that now it may be beyond normal challenge since it occurred in or about the year 1970), while proposing that the appellant would be exonerated from any beneficial results flowing therefrom, by contributing a tax bearing a relationship to an imputed “return on investment”. I find no substance in that skein of logic, nor any basis for it in the Income Tax Act, in the circumstances of this case.

Decision

The appeal is allowed and the matter referred back to the respondent for reconsideration and reassessment in a manner not inconsistent with the above Reasons for Decision.

Appeal allowed.