Johnson v. R., [1999] 2 CTC 2606, 99 DTC 603

Bonner T.C.J.:

The Appellants appeal from assessments of tax and penalty under the Income Tax Act (“Act”). The corporate Appellant, formerly known as Allan Contracting Ltd. (“Contracting”) sold real property to one of its principal shareholders, the individual Appellant Allan Johnson (“Johnson”) and to three persons designated by him. One of those persons was Johnson’s son. Another was described by Johnson as his girlfriend. The exact relationship between Johnson and the third person was not clarified but the two evidently did not deal with each other at arm’s length.

The Minister of National Revenue (“Minister”) concluded that the consideration paid in such sales was substantially less than the fair market value of the property sold and that the sales were devices for conferring benefits on the purchasers which benefits were taxable in the hands of Johnson, directly by virtue of subsection 15(1) of the Act in the case of the sale to him and by virtue of subsections 15(1) and 56(2) of the Act in the case of the other three sales. Those two provisions read in part:

Section 15:

(1) Where, at any time in a taxation year, a benefit has been conferred on a shareholder, ... by a corporation ...

the amount or value thereof shall, ... be included in computing the income of the shareholder for the year.

Section 56

(2) À payment or transfer of property made pursuant to the direction of, or with the concurrence of, a taxpayer to some other person for the benefit of the taxpayer or as a benefit that the taxpayer desired to have conferred on the other person ... shall be included in computing the taxpayer’s income to the extent that it would be if the payment or transfer had been made to him.

Contracting carried on the business of a real estate developer, that is, it bought raw land, serviced it, subdivided it and sold the resulting building lots. The four parcels of land formed part of the inventory of that business. The Minister was of the view that the sale of the four parcels for less than fair market value constituted an appropriation of the property of Contracting for the benefit of Johnson, that the sale of the real property at fair market value would have increased the income of Contracting for the 1991] taxation year and that Contracting was deemed to have sold the property for fair market value by virtue of subsection 69(4) of the Act, which reads:

(4) Where property of a corporation has been appropriated in any manner whatever to, or for the benefit of, a shareholder, for no consideration or for a consideration below the fair market value, if the sale thereof at the fair market value would have increased the corporation’s income for a taxation year, for the purpose of determining the corporation’s income for the year, it shall be deemed to have sold the property during the year and to have received therefor the fair market value thereof.

The Minister assessed penalties under subsection 163(2) of the Act in respect of the additions to the income of both Johnson and Contracting.

The Minister’s view was that the sales took place in July, August and September of 1990 when the land was conveyed and he measured the benefit and appropriation by reference to the difference between the value of the parcel conveyed at the time of conveyance and the consideration paid. According to the Appellants the measure of the benefit or appropriation, if any, was the difference between the value of the property in January of 1990 when, it was alleged, Contracting sold or agreed to sell it and the price paid or agreed to be paid. On this theory, value at the time of conveyance was irrelevant.

The primary contention of the Appellants was that the sales took place about six months earlier than the Minister thought, that the value of the land in question was much lower then and that the quantum of the benefit was correspondingly reduced, so much so that an inference that the understatement of income was made knowingly or in circumstances amounting to gross negligence could not be drawn from the failure of either Appellant to fully declare income. The Appellants asserted that the benefits, if any, were conferred by sales made in January of 1990 and not by mere conveyances of legal title made pursuant to such sales. The Appellants contended as well that even if the sales were made in the summer of 1990 the value at that time was less than the amount found by the Minister.

The names of the transferees, the parcels transferred, the consideration paid, the dates of conveyance, values as found by the Minister, and values at the time of conveyance as found by Calvin Ross, an expert called by the Appellants, are set out in the table below.

The land in question formed part of a residential subdivision which was developed by Contracting. It was located in the Westwood area of Coquitlam, British Columbia. In 1988, Contracting received preliminary approval from Coquitlam of a plan to develop a subdivision in which three of the parcels now in question, lots 42, 52 and 4, were divided into twelve building lots each and lot 29 was divided into eleven building lots. Although the requisite underground municipal services were provided for all forty-seven of the smaller lots, the plan did not divide the four larger lots until after the conveyances which led to the assessments now in issue. In other words, each of the four larger lots was, when conveyed, ripe for division into a number of smaller lots.

In January and February of 1990, the construction of four houses commenced, one on each of the four larger lots. Each house was built at one end of the lot on which it was situated. Johnson testified that the houses were sited in this way because of soil conditions, an explanation which I regard as disingenuous. The houses were built at Johnson’s expense. Johnson testified that following the conveyances in July, August and September of 1990, he and the three other transferees moved into the houses and occupied them, in each case as a principal residence, for a period of a month or a little more. The four parcels were then conveyed to Langley Lo-Cost Builders Ltd. (“Langley”), a company controlled by Johnson. Langley, in turn, sold the four houses each with a portion only of the lot on which the house sat at the time of conveyance to Langley. The sales by Langley were, I infer, normal arm’s length retail sales of a house sited on a smaller lot and they left Langley in a position to subdivide and sell the remainder of the larger lots as originally planned.

The leading argument advanced by the Appellants’ counsel was that in December of 1989, Johnson decided that Contracting would sell the four lots and that Johnson acted on this intention in January of 1990 by hiring contractors to construct a home on each of the four lots. According to the argument, possession, use and risk, the primary attributes of beneficial ownership, were at that time transferred to Johnson as evidenced by the construction activity. Registration of a transfer of legal title alone, it was said, is of little significance in determining when the disposition of the property took place.

In my view, the evidence is, at best for the Appellants, equivocal on the subject of possession, use and risk. More to the point, nothing in the evidence demonstrates the existence prior to the time of conveyance of a commitment by Johnson to buy and by Contracting to sell the four lots. It was not suggested that a corporate resolution was passed at any time authorizing sale of the land by Contracting to Johnson and the other three. There was no memorandum in writing produced which established either the existence of a commitment by Contracting to sell the four lots or any of them at a named price and time to a named individual or a commitment by such individual to buy on such terms. The Appellants’ argument wrongly equates the formation of a decision in the mind of a shareholder with a corporate act. Such a decision may lead to a corporate act but is not in itself a corporate act.

The Appellants are not assisted by an entry in the general journal of Contracting bearing an “as of” date of December 31, 1989 recording four agreements for the sale at a total consideration of $1,704,189 of lots which are not identified but which I gather are those in question. A further entry in Contracting’s general journal dated “as of’ May 31, 1990 “reversing” the earlier entry undermines the assertion that the lots were sold in January of 1990. A genuine sale can hardly be reversed by an entry in the books of only one party to the transaction. The evidence did not suggest that any corporate act took place on May 31, 1990 which recognized but sought to modify some supposed prior corporate commitment to sell the lot. The words “as of” generally signify timing which has been arbitrarily attributed to an event. Bookkeeping entries made “as of” a particular date do not prove that the event recorded occurred on that date.

In my view, the evidence amounts to nothing more than proof that Johnson decided at some time early in 1990 to deal with the lots at a price and time to be determined later. That decision was not implemented until the lots were conveyed by the corporation to Johnson and the three other individuals in July, August and September of 1990. It was then and not before that the consideration to be paid to Contracting was fixed and the operation of sections 15 and 69 was triggered. It is therefore not necessary to comment on the Appellants’ submissions regarding the value of the four lots in January of 1990.

The evidence points clearly to a conclusion that the four lots were sold in accordance with a plan whereby the houses which had been built thereon were to be occupied, ostensibly, as principal residences, by the persons named in the table set out above. After occupation for a period of about a month, the properties were to be resold at market value yielding gains which were to be treated as a tax-exempt gains on principal residences. The plan also called for the three persons other than the Appellant Johnson to turn the proceeds over to the later and to be compensated for their trouble by payment of fees. The consideration paid to Contracting was fixed by Johnson who evidently orchestrated the entire scheme.

The evidence indicates that James Johnson, Cira Delaney and Susan Masaro acquired, held and disposed of title to their respective parcels and accounted for the proceeds all in accordance with the directions of the Appellant Johnson. The deliberate sale to Johnson of corporate property at an undervalue involves the conferral by Construction on Johnson, as its shareholder, of a benefit within the meaning of subsection 15(1) of the Act. The scope of subsection 15(1) or, more accurately, its predecessor is described in Minister of National Revenue v. Pillsbury Holdings Ltd., (1964), 64 D.T.C. 5184 (Can. Ex. Ct.) at page 5187, Cattanach, J. stated:

On the other hand, there are transactions between closely held corporations and their shareholders that are devices or arrangements for conferring benefits or advantages on shareholders gua shareholders and paragraph (c) clearly applies to such transactions. (Compare Robson v. M.N.R., [1952] 2 S.C.R. 223 [52 DTC 1088].) It is a question of fact whether a transaction that purports, on its face, to be an ordinary business transaction is such a device or arrangement.

In applying paragraph (c) full weight must be given to all the words of the paragraph. There must be a “benefit or advantage” and that benefit or advantage must be “conferred” by a corporation on a “shareholder”. The word “confer” means “grant” or “bestow”. Even where a corporation has resolved formally to give a special privilege or status to shareholders, it is a question of fact whether the corporation’s purpose was to confer a benefit or advantage on the shareholders Or some purpose having to do with the corporation’s business such as inducing the shareholders to patronize the corporation. If this be so, it must equally be a question of fact in each case where the Minister contends that what appears to be an ordinary business transaction between a corporation and a shareholder is not what it appears to be but is in reality a method, arrangement or device for conferring a benefit or advantage on the shareholder gua shareholder.

The Minister thought it necessary to invoke subsection 56(2) of the Act to deal with the fact that the conveyances of lots 29, 52 and 4 were made not to Johnson but rather to James Johnson, Cira Delaney and Susan Masaro. Quite possibly the Minister was unaware that the three were required to turn over to Johnson the profits realized by them on resale. In any event the conveyances of lots 29, 52 and 4 to James Johnson, Sarah Delaney and Susan Masaro constitute “transfers of property made pursuant to the direction of [Johnson] as benefits that [he] desired to have conferred on .. them within the meaning of subsection 56(2). The evidence indicates that Johnson desired that the benefits be conferred on the three to enable them to act as conduit pipes redirecting the benefits back into his hands. The benefits therefore properly form part of the income of Johnson by virtue of sections 15 and 56 of the Act.

I turn next to the arguments made with regard to the quantum of the benefits. The values used by the Minister in making the assessments in issue were based on appraisal reports made by M.R. Woodward, a senior real estate appraiser employed by the Department of National Revenue. Although Mr. Woodward was not called to testify at the hearing, a copy of his report was entered in evidence by counsel for the Appellants. According to the reports Mr. Woodward estimated the value of the four parcels by the residual approach. This involves calculating by the direct comparison approach the value of the individual building lots which would be produced by completion of the development process and deducting estimated costs of development, profit and sales costs.

Several aspects of Mr. Woodward’s work were challenged by the witness, Calvin G. Ross, an expert called to testify on behalf of the Appellants. Mr. Ross stated that he compared the issues and conclusions reached by Mr. Woodward in relation to the data provided in the Woodward report and in relation to his own experience in the area. He stated further that he conducted an inspection of the properties. He expressed the conclusion that Mr. Woodward provided a relatively good indication of value for the individual building lots by the direct comparison approach. Mr. Ross argued however that Mr. Woodward had omitted a number of development cost items, specifically development charges and financing costs. As well, he said Mr. Woodward’s allowance for developer’s profit was insufficient. He recalculated values and arrived at the figures set out in the table above.

lam not convinced that Mr. Woodward’s figures have been shown to be wrong. It appears to me that he took all proper deductions into account. Although in other cases a greater allowance for developer’s profit might be warranted, it must be remembered that by the summer of 1990 the development process for the four lots was virtually complete. The evidence does not show that Mr. Woodward made insufficient allowance for financing costs. Again, the process of subdividing the property was virtually complete. There is no satisfactory evidence indicating that development fees or charges payable to the municipality remained unpaid. Mr. Johnson could easily have produced evidence of payment of such costs by Langley or by James Johnson, Sarah Delaney and Susan Masaro. He failed to do so. Finally, with respect to the state of the land, I accept the evidence that there were compaction problems with the fill which had been placed on the land, which problems required rectification before houses could be built. There was evidence that rectification was underway in 1989. If further compaction work remained to be done in 1990 then costs would have been incurred by Langley in carrying out that work and it would have been a simple matter for the Appellants to prove the fact by the production of invoices. This they failed to do. I am not satisfied that it has been established that Mr. Woodward’s valuations were in error.

I turn next to the question of the penalties. Counsel for the Appellant approached the matter on the basis that the transactions were designed to take advantage of the principal residence exemption. He pointed to Johnson’s evidence that he reviewed an Interpretation Bulletin published by Revenue Canada and believed that a home qualified as a principal residence. Counsel argued that the burden is on the Respondent to establish that Johnson knowingly or in circumstances amounting to gross negligence failed to report the amounts added to declared income. Counsel asserted that Johnson believed that he was doing what was necessary to make a claim for principal residence status and that he had simply misunderstood the terms of Revenue Canada’s Interpretation Bulletin. Such a misunderstanding, so the argument went, is not a sufficient basis for a finding of gross negligence. It was also argued that Johnson expected the other three to make similar claims and to return the money to him.

In my view the penalties were properly imposed. This case has nothing to do with a misunderstanding of the principal residence exemption. The combined effect of subsections 163(2) and (3) is to impose on the Respondent the onus of establishing that the Appellant knowingly or under circumstances of gross negligence failed to include in computing his income the benefit conferred on him by Contracting and the amounts assessed under subsection 56(2). That onus has been discharged. It is clear that Johnson embarked on a scheme for the extraction of benefits from Contracting in a manner calculated to avoid the imposition of tax on Contracting in respect of the gains which it would have realized on ordinary sales at market value of its stock in trade. The plan was also a deliberate effort to avoid the imposition of tax on Johnson for benefits extracted directly by him and on the other three individuals by way of the transfer to them of Contracting’s property at an undervalue. No doubt Johnson desired that the benefits be conferred by Contracting on the other three to enable them to resell the property in a manner which would not attract tax on the profits which were then to be turned over to him. In my view every element of liability to penalty under section 163 has been established in the case of both Appellants.

For the foregoing reasons the appeals fail except to the extent set out in the Consent dated October 28, 1998. The Respondent shall have her costs on a party and party basis.

Appeal dismissed.