Bowman T.C.J.:
1 These appeals were heard together on common evidence and concern the 1988 and 1989 taxation years.
2 The appellants are all beneficiaries of one of two family trusts. The trusts sold property in 1987 and treated the gain as capital. Preferred beneficiary elections were filed allocating the capital gain to the beneficiaries. The Minister of National Revenue disagreed with the treatment of the transaction as being on capital account, and reassessed the trusts and the beneficiaries on the basis that the gain was of an income nature. As a result reserves were claimed under paragraph 20(1)(n) of the Income Tax Act. Amended returns and preferred beneficiary elections were filed for 1988 and 1989 under subsection 104(14) to reflect the recharacterization of the gain. The Minister reassessed the trusts and the beneficiary to give effect to the amended returns and amended elections.
3 The profit on the sale proved to be illusory. The purchaser defaulted on the mortgage that was taken back in 1991 and a doubtful debt reserve was claimed by the trusts and the resulting loss was carried back to 1988 and 1989. The appellants filed amended preferred beneficiary elections and amended returns to reflect the reduced income in the trusts which was to be allocated to them. The Minister did not give effect to the amended returns and preferred beneficiary elections. He did however reassess to make some minor technical adjustments and this gave the appellants the opportunity to file notices of objection and subsequently to appeal to this court.
4 While the appeals are the result of the Minister's failure to act upon the second set of amended preferred beneficiary elections, the legal basis upon which the appellants base their challenge to the assessments is their contention that the first amended preferred beneficiary elections were invalid.
5 The foregoing thumbnail sketch of the facts and issues is an oversimplification. The facts are considerably more complex and are set out in a Statement of Agreed Facts, which reads as follows:
1. Certain of the Appellants, namely, Angelo Muscillo, Lisa Muscillo, Mary Muscillo and David Muscillo were at all material times all the income and capital beneficiary of an inter vivos trust known as the Dario Muscillo Family Trust. The remaining Appellants, namely, Angelo Muscillo, Gina Muscillo and Patrizia Muscillo were at all material times the only income and capital beneficiary of an inter vivos trust known as the Pasquale Muscillo Family Trust.
2. The Pasquale Muscillo Family Trust and the Dario Muscillo Family Trust (herein collectively called the “Trusts”) were each 50% owners of a parcel of real property known as Part of Lot 6, Concession 9, in the City of Vaughan, Regional Municipality of York (the “Property”).
3. On May 27, 1987, the Trusts sold the Property to Giovanni Guizzetti Investments Inc. (the “Purchaser”).
4. The Trusts sold the property to the Purchaser (the “Sale”) for a purchase price of $1,800,000 (the “Purchase Price”) and the Trusts took back a mortgage, the principal amount of which was $1,400,000 (the “Mortgage”).
5. The Mortgage provided for interest to be paid on a monthly basis and for payment of the full amount of the principal upon the maturity date, being April 27, 1991.
6. The Trusts initially reported in the 1987 taxation year their gains realized on the sale to the Purchaser as a capital gain and each of the beneficiaries of the Trusts (collectively called the “Beneficiaries”) filed Preferred Beneficiary Elections so as to allocate the entire capital gain realized on the Sale by the Trusts amongst the individual Beneficiaries.
7. For the 1988 taxation year, the Trusts received interest income earned on the Mortgage and each of the Beneficiaries filed preferred beneficiary elections so as to allocate all such interest income out to the Beneficiaries. The Notices of Assessment with respect to the Beneficiaries of the Dario Muscillo Family Trust, namely, Angelo, Lisa, Mary and David Muscillo's 1988 taxation year are dated July 20, 1989, October 16, 1989, July 3, 1989 and October 11, 1989, respectively. The Notices of Assessment with respect to the Beneficiaries of the Pasquale Muscillo Family Trust, namely Angelo, Gina and Patrizia Muscillo's 1988 taxation year are dated October 11, 1989, July 6, 1989 and September 29, 1989, respectively.
8. As a result of an audit of the Trusts' 1987 taxation year, the Minister of National Revenue determined that the gain realized on the Sale was income rather than capital gain (the “Re-Characterization”). The Minister then issued a Notice of Reassessment of the Trusts' 1987 taxation year dated May 30, 1990, the Beneficiaries' 1987 taxation year dated July 3, 1990 or July 4, 1990, and certain of the Beneficiaries' 1988 taxation years dated July 3, 1990 or July 4, 1990.
9. To reflect the Re-Characterization, the Minister of National Revenue, in respect of the 1987 taxation year, treated the unallocated portion of the gain as income to the Trusts and disallowed the capital gains deduction claimed by each Beneficiary and, in respect of the 1988 taxation year, disallowed a minimum tax carryover to the Beneficiaries reassessed in respect of that year.
10. Notices of Assessment were issued in respect of the Beneficiaries of the Dario Muscillo Family Trust, namely, Angelo, Lisa, Mary and David Muscillo's 1989 taxation year are dated July 12, 1990, August 8, 1990, July 12, 1990 and August 8, 1990, respectively. Notices of Assessment with respect to the Beneficiaries of the Pasquale Muscillo Family Trust, namely Angelo, Gina and Patrizia Muscillo's 1989 taxation year are dated July 12, 1990, July 12, 1990 and January 4, 1991, respectively.
11. Notices of Objection in respect of the Beneficiaries 1987 and 1988 taxation years were filed dated August 31, 1990. The Beneficiaries objected to the Re-Characterization which resulted in adjustments to their income through the rejection by the Minister of their capital gain treatment of the Sale.
12. As a consequence of the Re-Characterization, the Trusts filed amended T3 Trust tax returns in respect of the 1987 through 1990 taxation years (the “First Amended Returns”), in order to reflect the Re-Characterization of the gain realized on the sale as income and to claim a reserve with respect to the profit from the Sale to apportion the income from the sale over the maximum three year period permitted under subsection 20(8) of the Income Tax Act (Canada).
13. In addition, as a consequence of the Re-Characterization, the Beneficiaries filed with an officer of the Appeals Division, Mississauga District Office, Revenue Canada (the “Appeals Officer”) amended preferred beneficiary elections (the “First Amended Elections”) to have their proportionate share of the income from the Sale with respect to the 1987 through 1990 taxation years taxed in the hands of the Beneficiaries which period included the 1988 and 1989 taxation years which are the subject matter of this appeal (hereinafter referred to individually as the “1988 Income” and the “1989 Income”).
14. These First Amended Returns and First Amended Elections are dated the 27th day of February, 1992 and were sent in a covering letter to the Appeals Officer by Ronald J. Farano, solicitor for the Trusts and the Beneficiaries.
15. No acknowledgement of receipt of the sending of the First Amended Returns and First Amended Elections was received by the Trusts or any of the Beneficiaries or Ronald J. Farano from Revenue Canada nor was any indication given to the Beneficiaries or the Trusts or Ronald J. Farano that the First Amended Returns and the First Amended Elections would be accepted or rejected.
16. The Minister issued Notices of Reassessment to the Beneficiaries of the Dario Muscillo Family Trust, namely, Angelo, Lisa, Mary and David Muscillo dated May 26, 1992, October 22, 1992, May 14, 1992 and October 21, 1992, respectively and to the Beneficiaries of the Pasquale Muscillo Family Trust, namely Angelo, Gina and Patrizia Muscillo dated July 31, 1992, May 25, 1992 and May 25, 1992, respectively. These Notices of Reassessment (the “1992 Reassessments”) were issued in respect of the 1987 through 1990 taxation years of the Trusts and the Beneficiaries which effected the Re-Characterization. The Trusts were treated as having “Nil Taxable Income” for the subject years.
17. On April 27, 1991, the Mortgage given back to the Purchaser on the sale matured at which time the outstanding principal amount of $1,400,000 became due and payable (the “Maturity Date”).
18. In 1991, the Purchaser defaulted on numerous interest payments and failed to pay the principal amount of the Mortgage on the Maturity Date (the “Default”).
19. Subsequent to the Default, the Trustees of the Trusts obtained a written appraisal of the Property which reflected the fair market value in 1991 to be approximately $812,000.
20. Each of the Trusts claimed a reserve against doubtful accounts in their 1991 taxation year in the amount of $277,500 representing the principal amount owed to each Trust under the Mortgage less the fair market value of the Mortgage security held by the Trusts.
21. The reserve against doubtful accounts claimed by the Trusts in their 1991 tax returns gave rise to a loss in the Trusts (the “Loss”).
22. The Trusts commenced foreclosure proceedings by way of statement of claim issued against the Purchaser on August 2, 1992 and obtained a final order of foreclosure on November 23, 1992 (the “Foreclosure”).
23. The Trusts included in their 1992 taxable income the reserve for doubtful accounts deducted in the 1991 taxation years.
24. On the 10th day of March, 1993, the Trustees together with the Beneficiaries, filed amended T3 Trust tax returns (the “Second Amended Returns”) and amended Preferred Beneficiary Elections (the “Second Amended Elections”) with respect to the 1988 and 1989 taxation years in order to elect to have the Loss applied to the 1988 and 1989 taxable income of the Trusts and also to allocate a reduced net income to the Beneficiaries.
25. The Minister refused to consider the Second Amended Returns and the Second Amended Elections by letter to the taxpayers dated September 17, 1993 indicating that the basis for the rejection was in accordance with the T3 Guide, specifically Request for Loss Carry-backs and then concluded that “No deduction in the amounts previously designated can be made if a preferred beneficiary election has been made for the net taxable capital gains.”
26. On November 3, 1993, November 16, 1993, November 22, 1993 and November 25, 1993 (the “November 1993 Reassessments”) the Minister issued notices of reassessment in respect of the Beneficiaries' 1998 and 1989 taxation years which corrected a minor mathematical error in the 1992 Reassessments.
27. On February 3, 1994, the Beneficiaries filed Notices of Objection for each of the 1988 and 1989 taxation years.
28. On May 26, 1995, the Minister confirmed the November 1993 Reassessments, by way of Notices of Confirmation.
6 What emerges from this recital of the facts is this:(a) The preferred beneficiary elections as well as the returns that were initially filed were premised upon the taxpayers' assumption that the gain was on capital account and that the capital gain could all be allocated in 1987 to the beneficiaries.
(b) In 1988, the interest income earned by the trusts on the mortgage was allocated to the beneficiaries by way of preferred beneficiary elections in respect of that year.
(c) The Minister's decision that the profit on the sale of the property was income rather than capital necessitated reassessments of both the trusts and the beneficiaries. He treated the unallocated portion of the capital gain as income in the trusts' hands, disallowed the capital gains deduction claimed by the beneficiaries and disallowed a minimum tax carryover to the beneficiaries.
(d) Notices of objection to these reassessments were filed.
(e) As a result of the Minister's assessing action whereby he treated the profit as income rather than capital gain, the trusts filed new returns for 1987, 1988, 1989 and 1990 to claim a reserve under paragraph 20(1)(n) to apportion the profit over the three years permitted by subsection 20(8).
This point is critical. When the trusts filed originally on the basis that the gain was on capital account no reserve was claimed under subsection 40(1), presumably on the basis that if the taxable capital gain was taxed entirely in 1987 the rate of inclusion would be 50% whereas if a reserve were taken and included in later years, the rate would be 75%. As a result the only income earned by the trusts in 1988 was the interest earned on the mortgage and this was allocated to the beneficiaries.
Furthermore, the increased income in the trusts' hands in 1988 and 1989 resulting from the reserve claimed under paragraph 20(1)(n) was allocated to the beneficiaries by means of amended preferred beneficiary elections, so that the trusts had no income for those years. It is of some importance to note that these first amended returns and elections were filed at the request of the officer of the Department of National Revenue.
As a result the Minister in 1992 assessed the trusts and the beneficiaries for the taxation years 1987 through 1990 to give effect to the first amended returns and the first amended preferred beneficiary elections.
(f) In 1991, however, the purchaser of the property defaulted and failed to pay the interest payments under the mortgage or the principal amount of $1,400,000, which fell due on April 27, 1991. The only evidence before me of the value of the property in 1991 is the admission that the trustees obtained a written appraisal which indicated the fair market value was about $812,000.
(g) The trusts claimed, for their 1991 taxation year, a reserve under paragraph 20(1)(l) for doubtful debts of $277,500, representing the principal amount owed to each trust under the mortgage, less the fair market value of the mortgage security. The trusts, as a result, had a loss in 1991 which could have been carried back to 1988 and 1989 under section 111 to be applied against their taxable incomes for those years, if they had any. They did not, however, having allocated to the beneficiaries under the preferred beneficiary elections all of the income resulting from the reassessments and the claiming of reserves in the amended returns.
7 It is admitted in the Statement of Agreed Facts that by claiming a reserve for doubtful debts in 1991 the trusts realized a loss. I have therefore not considered whether this claim was appropriate. I note in passing, however, that in 1992 the trusts foreclosed on the mortgage and obtained a final order of foreclosure on November 23, 1992. In computing their income for 1992, the trusts included the reserve claimed under paragraph 20(1)(l). Upon the foreclosure, the provisions of section 79 became applicable. I shall not review in detail the manner in which that section applies here beyond noting that the general effect of a foreclosure is that the loss if any on the mortgage is not recognized until the property reacquired on the foreclosure is disposed of. In Déom c. R. (1995), [1996] 3 C.T.C. 2190 (T.C.C.); aff'd(1996), 97 D.T.C. 5037 (Fed. C.A.)I held that a deduction for bad debts under paragraph 20(1)(p) cannot be made where the debt continues to be secured by a mortgage. Here, however, the claim in 1991 was for a reserve for doubtful debts under paragraph 20(1)(l) and I can see no particular reason in principle why such a claim cannot be made if it is established that the debt is in fact doubtful and the value of the security has decreased to an amount that is less than the principal amount secured. The reserve must be brought into income in the subsequent year, as indeed it was.
8 Assuming, then, that there was a loss in the trusts in 1991 that was capable of being carried back to 1988 and 1989 under section 111, the trusts and the beneficiaries filed new amended returns and amended preferred beneficiary elections in an attempt to allocate to the beneficiaries a reduced net income resulting from the loss reduced taxable income of the trusts by reason of the carry back of the loss to 1988 and 1989. These new amended elections are the “Second Amended Elections”.
9 It should be observed that a loss that is carried back under paragraph 111(1)(a) to an earlier year reduces taxable income, not income.
10 Nonetheless, if it were possible to reverse the effect of the first amended elections the trusts would then have income (and taxable income) that could be absorbed by the loss.
11 The Minister did not give effect to the second amended elections. He might have rejected the application, but it did not get that far since the request was withdrawn (see the quotation from Mr. Dixon's memorandum of November 25, 1995, set out below). Subsequently the beneficiaries were reassessed for 1988 and 1989 to correct a minor mathematical error but otherwise the assessments were left unchanged. This did however allow the beneficiaries to file notices of objection and subsequently to appeal to this court.
12 The Minister's power to allow amendments to elections is found in subsection 220(3.2) of the Income Tax Act, which reads:
Where
(a) an election by a taxpayer or a partnership under a provision of this Act or a regulation that is a prescribed provision was not made on or before the day on or before which the election was otherwise required to be made, or
(b) a taxpayer or partnership has made an election under a provision of this Act or a regulation that is a prescribed provision,
the Minister may, on application by the taxpayer or the partnership, extend the time for making the election referred to in paragraph (a) or grant permission to amend or revoke the election referred to in paragraph (b).
13 The power to allow a taxpayer to amend or revoke an election is plainly a discretionary power of the Minister. It is not within this court's jurisdiction to review the Minister's exercise of that discretion or his refusal to exercise it. If there is such a power of review it lies with the Federal Court of Canada.[FN1: <p>See<em>McNabb Family Trust v. R.</em>(1997), 98 D.T.C. 6001 (Fed. C.A.); reversing(1996), 96 D.T.C. 6425 (Fed. T.D.).</p>]
14 The appellants acknowledge this. They do not ask me to review the Minister's failure to act upon the second amended elections. Rather, they ask me to conclude that the first amended elections were invalid and therefore the assessments which were based upon the amended elections should be vacated. Purely as a matter of jurisdiction I think that this would be within this court's power. Whether I am prepared to grant the appellants the relief sought is another matter.
15 I do not think that it is open to me, as a matter of law, to conclude that the first amended elections are invalid, thereby restoring matters to the status quo that existed before those elections were made. The elections were made in prescribed form and were acted upon. Counsel, in a very thorough and able argument, contends that there was no “application” within the meaning of subsection 220(3.2) and that in any event the appeals officer did not have the authority under section 900 of the Regulations to accept or act upon the first amended elections. He contends further that on February 27, 1992, the Minister had no power to accept the first amended elections because the Regulation empowering the Minister to accept an amended election for the purposes of subsection 104(14) of the Act had not yet been prescribed. The contention is that section 600 of the Regulations which prescribed the provisions of the Act under which the Minister's power under subsection 220(3.2) was applicable was added to the Regulations by P.C. 1992-914 on May 7, 1992. Paragraph (b) of that Regulation refers to subsection 104(14) as a prescribed provision for the purposes of paragraphs 220(3.2)(a) and (b). Section 600 of the Regulations is provided to be effective commencing December 17, 1991.
16 As much as I would like to be able to give effect to these somewhat technical arguments, I am unable to do so. The filing of the amended election in itself constitutes an application. The fact that the procedures set out in Information Circular IC 92-1 may not have been followed does not appear to me to invalidate the elections. The powers of the Minister under subsection 220(3.2) are, it is true, specifically delegated to certain officials of the Department of National Revenue under subsections (2), (6), (7), (10), (12), (16), (17) and (18) of Regulation 900. However it is within an appeals officer's power, in the ordinary course, to act upon amended elections. See paragraph 24(2)(d) of the Interpretation Act, which appear to codify Caltona Ltd. v. Works Commissioners, [1943] 2 All E.R. 560 (Eng. C.A.). Subsection 24(2) of the Interpretation Act reads:
(2) Words directing or empowering a minister of the Crown to do an act or thing, regardless of whether the act or thing is administrative, legislative or judicial, or otherwise applying to that minister as the holder of the office, include
(a) a minister acting for that minister or, if the office is vacant, a minister designated to act in the office by or under the authority of an order in council;
(b) the successors of that minister in the office;
(c) his or their deputy; and
(d) notwithstanding paragraph (c), a person appointed to serve, in the department or ministry of state over which the minister presides, in a capacity appropriate to the doing of the act or thing, or to the words so applying.
17 The French version of paragraph (d) reads:
d) indépendamment de l'alinéa c), de toute personne ayant, dans le ministère ou département d'État en cause, la compétence voulue.
18 It is an arguable question whether that provision supersedes the very specific delegation of authority in section 900 of the Regulations made under paragraph 221(1)(f) of the Income Tax Act. I do not propose to deal with this question in the absence of argument beyond observing that the Interpretation Act provides in section 3 that its provisions apply unless a contrary intention appears. The power to make Regulations authorizing designated officers of the department under paragraph 221(1)(f) may well constitute such a contrary intention. It is of course not the Regulations themselves that provide a contrary intention in construing a statute. It is clear beyond doubt that a Regulation cannot be used to interpret a statute.[FN2: <p>But see:<em>Driedger on the Construction of Statutes</em>, Third Edition, page 246.</p>] However a power to make Regulations contained in a statute may provide such a contrary intention. I prefer rather to put it on the basis that where a taxpayer submits an amended election under subsection 220(3.2) and it is acted on, the taxpayer can expect that it has been properly dealt with: omnia praesumuntur solemniter et rite esse acta. It is not subject to collateral attack at some later date. In any event there is no evidence that the matter was not approved by an appropriately designated official.
19 So far as the date of enactment of the Regulation is concerned I note that the assessments were made after that date. The dates of the assessments giving effect to the first amended elections may be taken as the relevant dates upon which those elections were accepted. In any event, the Regulation is specifically stated to be effective on December 17, 1991. cf. Agnew Estate v. R. (1978), 78 D.T.C. 6237 (Fed. C.A.).
20 I have therefore concluded that the first amended elections were validly made and the officials of the Department, on assessing, had the authority to give effect to them.
21 That having been said there is an obvious injustice here. The beneficiaries are being taxed on income they did not receive and may never receive. The circumstances of this case are precisely those in which the Minister should exercise his discretion under subsection 220(3.2) where a subsequent event beyond the control of the taxpayers, the incurring of a loss, renders the prior filing of the elections erroneous. The only basis suggested for the recommended refusal to accept the second amended elections is that it constituted “retroactive tax planning”. This is in no sense “retroactive tax planning” and had the refusal been based upon the repetition of a formula of words found in an information circular would have been capricious. The unfairness of the position is all the more striking when one considers that the accountant for the trusts and the individuals, Mr. Pillo, testified — and I accept his testimony — that it was at the request of the revenue auditor Mr. Moos that the first amended returns and elections were filed.
22 I do not however, think that the application under subsection 220(3.2) to accept the second amended elections has ever been definitively rejected. In the report on the “Fairness Package” application (tab 20), signed by D.A. Dixon the following appears:
The income in question arose due to the sale of land by the above noted Trusts. Each Trust was a 50% owner of the land. The Trust had originally filed its returns to reflect the sale of the land as Capital in Nature. Preferred Beneficiary Elections under Subsection 104(14) were filed to tax the Capital Gains in the hands of the Beneficiaries.
Audit Division reassessed the Trusts Returns to assess the Land Disposition as Income in Nature. The T3 Supplementaries were accordingly amended to reflect the revised Elected Amounts.
Subsequent to these amendments by Audit Division the Trust found that the Mortgagor had defaulted on the Mortgage held on the said property. As a result the Taxpayers Representative submitted that the Trusts had incurred a Bad Debt with respect to the default. Notices of Objection were filed for the Beneficiaries disputing the Amended Preferred Beneficiary Amounts. Subsequent to the Objections the Representatives made requests under the Fairness Package on behalf of the Trusts and their Beneficiaries to amend the Joint Preferred Beneficiary Elections. Their reason for the request was to place the income back in the hands of the Trusts so that the Bad Debt could be absorbed. There are no provisions in the Act to allow the Beneficiaries to absorb such a loss against the Elected upon income.
The Subsection 104(14) Election falls within Paragraphs 220(3.2)(a) and (b) and Regulation 600(b) for Late, Amended or Revoked Elections therefore there are provisions to allow such amendments provided the request falls within Revenue Canada's Policy and Guidelines outlined in IC 92-1. Our review indicated that the Fairness Request would be denied as the request falls within paragraph 11a of IC 92-I which refers to retroactive tax planning. The taxpayers do not appear to fall within the accepted circumstances outlined in Paragraph 10 of IC 92-1.
Conclusion:
On May 16, 1995, the taxpayer's representative, Ron Farano, withdrew the Fairness Package Requests of March 8, 1995 for all of the above taxpayers. They have accepted our position that there is no Bad Debt at this time as the loss on the Mortgage falls within the Foreclosure Provisions of Section 79. As a result the loss is not recognized until the subsequent disposition of the property. Due to the taxpayers acceptance of this position there is no need to pursue the Preferred Beneficiary Elections as the trust will now be able to reduce any gains on the subsequent disposition by their shortfall and therefore recognize their losses (See IT 505 for calculations on subsequent Income Gains).
23 The statement that the bad debt provisions do not apply in the case of foreclosure (see Déom, supra) and that the loss is recognized when the property that is reacquired on the foreclosure is sold is no doubt correct as far as it goes. Therefore there may be a loss in some year subsequent to 1991. It does not, however, take into account the fact that it is admitted that there was a loss in 1991 arising from the claiming of a doubtful debt (not a bad debt). A loss, if any, that arises on the sale of the property in 1992 or later can only be carried back three years under section 111 and therefore cannot be applied against the income resulting at least in 1988 and possibly in 1989 from the recharacterization of the gain.
24 As stated it is not within my power to force the Minister to exercise his discretion to accept the second amended elections and returns. That power, if it exists anywhere, lies within the jurisdiction of the Federal Court.
25 I propose therefore to withhold the signing of my judgment for six months (or such further time as the appellants may reasonably request) to permit the appellants to apply to the Minister to accept the second amended elections. There appears to be no time limit in which such an application may be made. If the Minister agrees to accept the second amended elections it will affect my disposition of the appeals. If the appellants choose not to do so, or if the Minister refuses to accept the amended elections (subject to such remedies as the appellants may choose to pursue in the Federal Court of Canada) I will be obliged to dismiss the appeals. I am taking this somewhat unusual step because I am of the view that the obvious injustice, not of the appellants' making, and resulting from their acquiescing, in good faith, in a request by the official of the Department of National Revenue to file the first amended elections, an action that they would not otherwise have taken, is susceptible of being remedied and should be remedied. It is not however a remedy that this court is empowered to give.
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