Dean v. R., [1998] 1 CTC 3326, 98 DTC 1179

Bonner T.C.J.:

The Appellant appeals from assessments of income tax for the 1987, 1988 and 1989 taxation years. On assessment the Minister of National Revenue treated as benefits to be included in the income of the Appellant under subsection 15(1) of the Income Tax Act a total of $129,083.00 in outlays made on behalf of the Appellant by 710107 Ontario Limited, the Appellant’s wholly-owned corporation.

The Appellant contended that, although she became indebted to 710107 as a consequence of the outlays, the debts should have been set off against amounts owing by the corporation to her. Her position is that there was a regular pattern of deposits to and withdrawals from her shareholder account with 710107 and from that pattern can be inferred the existence of a common intention to set off the debts owing by her to the corporation against amounts owed by the corporation to her in respect of cash advanced to it. The Appellant accepts that the financial statements of 710107 wrongly overstated the amount owing to her (by failing to record the set-off) but she blames the firm of accountants who prepared the statements and says that the “errors” should be corrected and not be permitted to form the basis of taxation.

The Assessor took the somewhat rigid position that, to the extent that set-off was not recorded in the financial statements of the corporation at year end, it cannot be recognized at all. In any event, according to the Respondent, there was no evidence of any intention to set off the debt arising from the outlays.

The corporate outlays giving rise to the problem were made in the course of the renovation of three attached dwellings, 126, 128 and 130 Earl Street, Kingston, Ontario. The three properties were initially purchased by the Appellant with a view to earning income by renting accommodation to university students. Although the Appellant recognized at the outset that renovations would be required for that purpose she anticipated that the work would be limited in scope. After completing the purchase she discovered structural problems requiring more extensive work than had been foreseen. She concluded that the cost of the necessary work would be so great that it could be recovered only by resale of the property as three single family dwelling units. Sale of the three units on a unit by unit basis required a severance under the Planning Act.! [1] It was obtained in May of 1987. In June of 1987 the Appellant incorporated 710107 Ontario Limited and conveyed 128 Earl Street to it thereby separating ownership of contiguous properties and eliminating the Planning Act problem.

The renovation work then commenced. The work on all three units was carried out as a single project. The Appellant did not engage a general contractor. Rather she dealt directly with laborers, suppliers and tradesmen.

The Appellant held a number of other properties used for rental purposes. She testified that she wanted to keep the cost of the renovations to the Earl Street properties separate from her rental operation. The latter was carried on by her personally and for that purpose she maintained a bank account in her own name. To effect and maintain the financial separation between the rental operation and the Earl Street renovations the Appellant decided to pay all costs of the renovation project out of a single bank account. For that purpose she chose to use the account of 710107. To permit allocation of amounts expended among the three units, the Appellant, when issuing a cheque, adopted a practice of making a notation on the face of the cheque of the address of the unit on which the money was expended.

At the outset 710107 had no funds of its own. The initial purchase of the Earl Street properties was funded by mortgages. When 710107 required money for renovation work the Appellant transferred funds from her personal account. Later she arranged funding for 710107 by way of a line of credit from a bank.

Following the completion of the renovations the properties were put up for sale. Number 126 Earl Street was sold on March 31, 1989, number 128 on June 2, 1989 and number 130 on August 31, 1989. In each case a substantial profit was in fact realized.

The tax returns filed by 710107 and by the Appellant left much to be desired. The Appellant did not report the disposition of either 126 or 130 Earl Street in her individual returns. The costs of renovating those two units were treated by 710107 in its tax returns as costs of renovating its property at 128 Earl Street with the result that its 1989 return reported a loss on the disposition.

Both the Appellant’s individual income tax returns and the financial statements and tax returns of 710107 were prepared by a firm of chartered accountants. The material furnished by the Appellant to the accountants in relation to the renovation project consisted of canceled cheques drawn on the account of 710107, bank statements and a book containing carbon copies of bank deposit slips. The accountants were informed of the acquisition by the Appellant of 126 and 130 Earl Street and by 710107 of 128 Earl Street There is no convincing evidence that they were informed by the Appellant of the disposition of 126 and 130 Earl Street. The accountants apparently experienced no difficulty in recording advances made by the Appellant to 710107. The raw materials furnished to the accountants, in particular canceled cheques drawn on 710107’s bank account were sufficient to enable the accountants to identify the renovation expenditures and to charge them to the owner of the property benefited.

The Appellant, as lender, was the source of almost all of the funds used by 710107 to pay for renovations to all three units. A decision to use 710107 to effect payment to suppliers and tradesmen for work on all three properties and to set-off the cost of the work on the two properties owned by the Appellant against the amounts advanced by the Appellant to the corporation was one which, if made, would not have been at all illogical. The existence of such an arrangement is supported by the care taken by the Appellant to note on the face of the cheques issued on 710107’s account the address of the property benefited by the work.

The preparation of tax returns reflecting an agreement between the Appellant and 710107 to effect the set-off would have been a simple task for a firm of chartered accountants if those accountants had been informed of the arrangement. The accountants were told that the Appellant owned 126 and 130 Earl Street and that 710107 owned 128 Earl Street. They were provided with bank statements, canceled cheques and a book containing carbon copies of deposit slips.

Nevertheless, the returns of 710107 failed to reflect the existence of any agreement to set off the amounts in issue. They overstated the cost of renovations to 128 Earl Street and overstated the amount owing to the Appellant by 710107. It was not suggested that the “errors” were caused by the pressure of meeting a tax filing deadline. The Appellant’s returns for the three years now in issue were not prepared or filed until 1991 and then only in response to a written request from Revenue Canada. The Appellant testified that she thought that returns were not required because she believed she was not taxable. The Appellant did not in her 1989 return of income report gains from the disposition of 126 and 130 Earl Street.

The Appellant, who held a Masters degree in Business Administration, stated many times during her testimony that she entrusted everything to her accountants and did not review the results. She asserted that she did not have the ability to perform such a review. The Appellant stated that she had taken a minimum of accounting while studying for her degree.

Genie Orton, a chartered accountant and former partner of the accounting firm which prepared the Appellant’s tax returns and financial statements of 710107, testified at the hearing of the appeal. When the returns were prepared, she was the senior manager who supervised the employees responsible for the actual preparation of the returns and financial statements. I did not find her evidence particularly illuminating. Her testimony revealed that she had no clear recollection of events surrounding the preparation of the Appellant’s returns. She attended the hearing under subpoena and stated that she did not review the file before giving her evidence. Ms. Orton’s evidence does not satisfy me that the failure to record a set-off was the result of an accountant’s error. The junior employees at the accounting firm who were left to bear the blame for the supposed errors were not called to testify. It was not suggested that they were unavailable.

lam far from convinced that the Appellant did not know that the cost of renovating 126 and 128 Earl Street had been treated as a cost incurred by 710107 in renovating 128 Earl Street or that no arrangement had been made for reimbursement of the corporation. The Appellant gave no lucid explanation for the preparation of a schedule in her handwriting of 1988 labour and material costs for 128 Earl Street. The costs set out in that schedule were the total of costs expended on the three properties. The Appellant was asked whether the only transactions not properly reflected in 710107’s shareholder account were renovations to her properties paid by the corporation. She stated that she could not answer. She gave her evidence with a curious air of detachment. I have concluded that much of her testimony was disingenuous.

The scope and purpose of section 15 of the Act has been considered many times, most notably in Minister of National Revenue v. Pillsbury Holdings Ltd. (1964), 64 D.T.C. 5184 (Can. Ex. Ct.). There is little room for doubt that the payment by 710107 of the cost of renovating the Appellant’s properties constituted the conferral of the benefit within the meaning of section 15 absent an agreement for the set-off of those costs against the funds advanced by the Appellant to the corporation. If such an agreement did in fact exist an accidental and innocent failure to reflect it in 710107’s books of account could not give rise to a section 15 benefit. Such a failure, if it occurred, would have amounted to nothing more than an error in recording a fact. It would not have been a device for the conferral of a benefit on a shareholder. Where financial records do not record set-off there are two possibilities. Either there was no agreement to set off in the first place or there was a failure to record a set-off which creditor and debtor agreed would take place. In my view, the credible evidence falls short of establishing on the balance of probabilities an accidental failure to record a set-off on which the Appellant and 710107 had agreed.

The appeals will be dismissed with costs.

Signed at Ottawa, Canada, this 22nd day of October 1997.

Appeal dismissed.