Tory Estate v. M.N.R., 73 DTC 5354, [1973] CTC 434 (FCA), briefly aff'd 76 DTC 6312, [1976] CTC 415 (SCC)

Bastin, DJ (judgment delivered from the Bench, per curiam):—This is an appeal from a decision of the Trial Division dismissing the appeal of the appellant from a notice of reassessment in respect of the 1965 taxation year. The appeal involves the interpretation of section 64 of the Income Tax Act and specifically the interpretation of subsection 64(3), reading as follows:

64. (3) Rights or things transferred to beneficiaries. Where before the time for making an election under subsection (2) has expired, a right or thing to which that subsection would otherwise apply has been transferred or distributed to beneficiaries or other persons beneficially interested in the estate or trust,

(a) subsection (2) is not applicable to that right or thing, and

(b) an amount received by one of the beneficiaries or other such persons upon the realization or disposition of the right or thing shall be included in computing his income for the taxation year in which he received it.

The essential facts are that the appellant is the executor of the estate of John Donald Tory, a Toronto lawyer, who computed the profits from his practice on a cash received basis. He died on August 27, 1965, leaving surviving him (inter alia) his three children, Mary Virginia Denton, John Arnold Tory and James Maxwell Tory. At his death he had accounts receivable of $483,350. Under the terms of his will Mrs Denton received a cash legacy of $100,000 and was paid $10,000 of this. On February 8, 1966 she made an agreement with the appellant by which the accounts receivable of $483,350 were to be assigned to her in consideration of her releasing the estate from its liability to pay her $90,000, the balance of her legacy, and paying the executor the sum of $380,000 in Canadian funds within one year.

Mrs Denton left Canada on February 11, 1966 to join her husband and children in the United States and she has remained a non-resident of Canada since that date. She collected the full amount of the accounts receivable assigned to her and on February 16, 1967 she paid the appellant the sum of $380,000.

The appellant did not include these accounts receivable in the income tax return for 1965 of the estate on the ground that the right to receive them had been transferred to a beneficiary of the taxpayer within the time prescribed by subsection 64(2) of the Income Tax Act. On June 1, 1966 the respondent assessed tax for the 1965 taxation year on the basis that the sum of $483,350 should have been included in computing the taxpayer’s income for 1965. The appellant duly objected to the assessment and on August 7, 1968 the respondent reassessed tax for 1965 on the basis that the amount properly included pursuant to the provisions of subsection 64(2) of the Income Tax Act for 1965 in respect of these accounts receivable was $380,000. The appellant then commenced the appeal which came before the Trial Division for hearing.

The learned trial judge in his reasons for judgment dated June 25, 1971 held:

Section 64(3) applies to transfers or distributions of the right or thing to a beneficiary or other person beneficially interested in the estate or trust only when such transfer or distribution has been made to him qua beneficiary, and not to the extent that he has acquired it as a purchaser for value. Therefore, had Mrs. Denton been a legatee of an amount equal to or in excess of $483,350 and had accepted the accounts in satisfaction of this legacy, no tax would have been collectable from the estate of the deceased when these accounts were paid, and since Mrs. Denton herself was not taxable in Canada, the accounts would have been collected without payment of income tax on them by anyone, and this would have been a perfectly proper and legitimate application of Section 64(3) of the Act. I cannot interpret this section, however, as applying to all rights or things which may be transferred or distributed by way of a sale for value to a purchaser who also happens to be a beneficiary or other person beneficially interested in an estate or trust irrespective of how small his benefit or beneficial interest in same may be. I therefore find that with respect to the rights or things so transferred which are in excess of the amount for which the purchaser is a beneficiary or person beneficially interested in the estate he is simply a purchaser for value and the estate or trust is taxable under the provisions of Section 64(2) on the amounts so transferred. The appeal is therefore dismissed, with costs.

To interpret the words of a statute, regard must first be had to the scheme of the legislation. The object of section 64 was to provide for the payment of income tax on rights or things owned by a taxpayer who has died which, when realized or disposed of, would have been included in computing his income. The intention of the section was that the value of such rights or things would be taxed either in the hands of the deceased’s executor or administrator or in the hands of the beneficiaries. The appellant submits that the word “transferred” is to be interpreted quite apart from the context in which it is used so that a beneficiary of even a trivial legacy could purchase from the executor rights or things worth any amount. Such an interpretation is not justified.

What must be considered is the entire clause: “Where . . . a right or thing . . . has been transferred or distributed to beneficiaries or other persons beneficially interested in the estate or trust .. .” The words “distributed to beneficiaries” clearly restrict the value of the rights or things to be conveyed to each beneficiary to the amount of the bequest to which he is entitled. If what was contemplated by Parliament was a sale of accounts receivable or similar things to a person who happened to be a beneficiary, the word distributed would be quite inappropriate. If that had been the intention the word “distributed” would not have been inserted in the clause.

In the case at bar, the assignment to Mrs Denton of $90,000 of the accounts receivable was a distribution pursuant to the terms of the will but the assignment of the balance of the accounts receivable was, in fact, a sale to Mrs Denton for valuable consideration. To the extent of $90,000, the assignment was made in satisfaction of the balance of her bequest. The word “distributed” is used to cover cases where the conveyance is to several beneficiaries. The word “transferred” is inserted to provide for a case where the conveyance is to only one person.

The meaning of “transferred” in this clause is limited by its association with the word “distributed”. The rule is expressed in the phrase noscuntur a sociis. To quote from Maxwell on Interpretation of Statutes, 12th edition, at page 289:

Where two or more words which are susceptible of analogous meaning are coupled together, noscuntur a sociis. They are understood to be used in their cognate sense. They take, as it were, their colour from each other, the meaning of the more general being restricted to a sense analogous to that of the less general.

The meaning of both the words “transferred” and “distributed” is also coloured by their conjunction with the words “beneficiaries or persons beneficially interested in the estate or trust”.

The value of the rights or things is therefore restricted to the amount of the inheritance of the beneficiary. If he acquires more than that he takes as a purchaser for value and the estate is taxable on the amount so transferred.

In the memorandum of fact and law, the appellant points out that, under the terms of the testator’s will, Mrs Denton was a beneficiary not only to the extent of the legacy of $100,000 but also to the extent of her immediate interest in the residue of the estate as provided in the course of a company reorganization within subsection 81(1) so as to impute to it the nature of a dividend and render him eligible for a dividend tax credit under section 38. The appellant also contended that since he had not received payment of the promissory note no benefit, to that extent, had been received.

HELD (per curiam):

(1) The corporation’s business had not been reorganized within subsection 81(1).

(2) The debt of $53,000 created by the company did not require to be realized in cash to constitute an income benefit.

(3) The extent to which, if at all, the tenant’s improvements conferred a benefit on the appellant in 1965 and 1966 depended on the extent to which the improvements increased the value of the appellant’s reversionary interest and this depended in part on the nature of the lease. Here the agreed rental was based on the agreed price, not on the real value of the property, and the low rental lease was a factor to be taken into account in determining the appellant’s reversionary interest. Since, however, the latter factor had not been advanced in the notice of appeal, and the respondent therefore had no opportunity to consider the point, counsel should be heard on what judgment would be appropriate.

W D Goodman, QC and F E Cappell for the Appellant.

G W Ainslie, QC and W J A Hobson for the Respondent.

Cases referred to:

R W S Johnston v MNR, [1948] SCR 486; [1948] CTC 195; 3 DTC

1182;

King v Earl Cadogan, [1915] 3 KB 485;

St-Germain v MNR, [1969] SCR 471; [1969] CTC 194; 69 DTC 5086.

The Chief Justice—(per curiam, judgment delivered from the Bench):—This is an appeal from a judgment of the Trial Division dismissing with costs an appeal from the appellant’s assessments under Part I of the Income Tax Act for the 1965 and 1966 taxation years. The question, in respect of each assessment is whether the assessment was in error in so far as it included an amount in the computation of the appellant’s income for that taxation year by virtue of subsection 8(1) of the Income Tax Act, which reads as follows:

8. (1) Where, in a taxation year,

(a) a payment has been made by a corporation to a shareholder otherwise than pursuant to a bona fide business transaction,

(b) funds or property of a corporation have been appropriated in any manner whatsoever to, or for the benefit of, a shareholder, or

(c) a benefit or advantage has been conferred on a shareholder by a corporation,

otherwise than

(i) on the reduction of capital, the redemption of shares or the winding- up, discontinuance or reorganization of its business,

(ii) by payment of a stock dividend, or

(iii) by conferring on all holders of common shares in the capital of the corporation a right to buy additional common shares therein,

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

J F Kennedy Ford Sales Limited (hereinafter referred to as “the appellant’s company”), a company all of whose shares belonged to the appellant, operated, at all relevant times, a business as a car dealer.

In 1965, pursuant to a pre-arranged plan,

(a) the appellant’s company acquired a property with an old building on it at a net cost of approximately $159,000;* [1]

(b) the appellant’s company made the changes to that property deemed expedient by the appellant to convert it into premises appropriate for the car dealer business at an overall cost of approximately $185,000 (with the result that the company spent approximately $344,000 in 1965 to acquire premises deemed by the appellant to be suitable for the car dealer business);

(c) the appellant’s company sold the property as so improved to the appellant at a net cost of approximately $259,000, a small amount of which was paid in cash and the balance of which was paid by the appellant assuming payment of mortgages in a total amount of $311,000 and receiving from his company a promissory note in the sum of $53,000; and

(d) the appellant leased the premises back to his company for a minimum term of four and a half years at a monthly rental of $1,935, which was calculated to give the appellant a 9% annual return on his investment of $259,000.

In 1966 the appellant’s company spent some $42,000 on an addition to the building on the property in question.

The assessment for the 1965 taxation year was based on the assumption that the appellant’s company transferred to the appellant in that year a property worth approximately $344,000 for a consideration of approximately $259,000 and thereby conferred on the appellant a benefit of the kind contemplated by subsection 8(1) in an amount of approximately $85,000.

The assessment for the 1966 taxation year was based on the assumption that the expenditure of some $42,000 made by the appellant’s company in improving the appellant’s property conferred on the appellant a benefit of the kind contemplated by subsection 8(1) in an equivalent amount.

The appellant, by his pleading in the Trial Division, attacked the two assessments on two main fronts. He contended that, in fact, no benefit had been conferred on him by his company in the years in question, and, alternatively, if there were benefits, he disputed the amounts. Secondly, he said that, if a benefit had been conferred on him by his company in 1965, it was conferred “on . . . the . . . reorganization of its business” so as to be excluded from subsection 8(1) by paragraph (i) thereof with the result that it was taxable, if at all, by being deemed to be a dividend in a limited amount by virtue of subsection 81(1), which would result in a more favourable tax position for the appellant.

With regard to the latter point, I agree with the learned trial judge that there was no reorganization of the appellant’s company’s business within the meaning of subsections 8(1) and 81(1) when the only change, as far as its business was concerned, was that, after the transactions in question, it “operated the same business from the same premises which were rented by it rather than being owned by it”.

With reference to the question as to what benefit, if any, was conferred, the two taxation years must be considered separately.

A preliminary point should be mentioned in connection with 1965. As has already been indicated, the assessment was based on the assumption that the appellant purchased a property worth $344,000 from his own company for $259,000 and that payment of the price was effected by the appellant assuming mortgages in the sum of $311,000 and being given back a promissory note for $53,000. The appellant says that, even if these factual assumptions are all correct, to the extent of the amount of $53,000 the benefit has not been “conferred” until the money is in fact paid and none of it was paid in 1965. In support of this contention, the appellant relies on authorities regarding the question as to when amounts such as dividends, interest and rent become “income” for purposes of income tax legislation. In my opinion, the question involved in that sort of case is not the same as the problem under subsection 8(1). 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 subsection 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.) 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 subsection 8(1) in the year in which it created an indebtedness from the company to the appellant, namely, 1965.

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. This is so, in the first place, because the assessment was made on the assumption that a benefit in the stated amount was conferred on the appellant by his company and, as a matter of law, the onus is on the appellant to demolish such an assumed fact.* [2] It is also so because, on the facts of this case, the appellant was in the position of having, in 1965, caused his company

(a) to expend an amount of some $344,000 on the acquisition of premises for its business, and (b) to sell those same premises to himself for some $259,000, and, in my view, it is to be assumed, in the absence of evidence to the contrary, that an experienced businessman such as the appellant does not make business expenditures that are not calculated to produce results at least equal in value to the amounts expended.

The appellant attempted to meet the onus of showing that there was no benefit in 1965 by leading the evidence of an expert to show that the market value of the property when transferred by the appellant’s company to the appellant was less than the $259,000 paid by the appellant for the property. As I understand this evidence, it was based on the view that the property would only have value as a car dealer’s premises in the short term and that, in the long run, the highest and best use of the property would be for some quite different purpose so that none of the money expended by the appellant’s company on improvements that were peculiar to a car dealer’s business would have had any beneficial effect on the market value of the property.

The learned trial judge rejected the view, on which the appellant’s factual case was based, that the long run highest and best use of the property was for something other than as premises for a car dealer’s business. In my view, there was evidence on which he could so decide and it has not been established that this Court should interfere with that finding. The fact that an experienced businessman spent $344,000 on the property in 1965 as a car dealer’s premises is very strong evidence that it had a value for that purpose in that year equal to at least that amount. This is supported by the fact that three years later the property was resold for use for the same purpose at a higher amount to a large automobile manufacturer. No evidence was led to show that, in fact, there had been any indication that the property was losing its value for that purpose. I would not myself have been inclined to accept the evidence on which the Court was asked to reach a conclusion that such property in 1965 should be valued as though there was no demand for it as a car dealer’s place of business. There were inherent weaknesses in that evidence, which need not be specified, that in my view give it substantially less weight than the facts of actual successful use of the property.

I am further of the view that the appellant did not establish that the property, at the time of its transfer to him in 1965, had a market value that was less than the $344,000 expended by his company to acquire it and make it suitable for its car dealer’s business.

That is not, however, the end of the matter. Where a tenant improves the leased premises, the extent to which, if at all, the improvement confers a benefit on the landlord will depend on the extent to which the improvement increases the value of his reversionary interest and that, in turn, will depend on the term and conditions of the lease and on the nature of the improvement. If there is a long term lease, it may be that no benefit will de conferred at all. Compare King v Earl Cadogan, [1915] 3 KB 485 (CA). If the lease is a monthly tenancy, the result may be a benefit equal to the amount by which the value of the property was improved. Compare St-Germain v MNR, [1969] SCR 471; [1969] CTC 194; 69 DTC 5086. Similarly, where property that has been improved by the owner is sold at an undervalue under a “lease-back” arrangement, the benefit may not be equivalent to the amount by which the consideration is less than market value if the terms of the lease that has been arranged as part of the transaction are not based on market value. Here, it would appear that the rent payable by the appellant’s company to the appellant is fixed, for a minimum of four and a half years, on the basis of the consideration given by the appellant for the property and not on market value. It would seem, therefore, that there is a factor here that should have been taken into account in determining the amount of the benefit for 1965, and that that factor was not taken into account.

The difficulty about this aspect of the matter is that, while the notice of appeal did indicate that the appellant challenged the amounts of the benefits as assessed, no indication was given that the appellant intended to challenge the amounts on the basis that the Minister had computed them without taking account of the effect of a low rental lease on the value of the appellant’s reversionary interest. Furthermore, aS appears from the opening statement at the trial and a reading of the whole transcript of the proceedings at trial, this question was not one in respect of which either party led evidence. In fact, it would seem clear that the trial was conducted on the basis that the issues were restricted to the other matters to which reference has been made and this question of the effect of a low rental lease only came out incidentally in the course of cross-examination of the last witness. This undoubtedly explains why the significance of the matter was not brought home to the learned trial judge.

In these circumstances, there must be room for doubt that it is open to this Court to deal with the matter at this stage. Certainly, the matter should not be dealt with at the appeal stage in a manner that does not ensure that the respondent has full opportunity to bring forward any thing that may be necessary to put the matter in proper perspective. My own view, however, is that, whenever it appears that there is a matter that has not been properly raised at an appropriate stage but that must be taken into account in order to avoid substantial injustice, a way should be found to take account of it if at all possible without real danger of injustice to the opposing side.

Whether some such method of disposing of the 1965 appeal can be found is a matter on which the Court should have assistance from counsel.

lt would not, however, be amiss to express a tentative view on how the adjustment to the 1965 benefit should be made assuming that there are no relevant circumstances other than those that we have presently in mind. Put simply, the situation was that, if the property had been transferred to the appellant without the obligation to lease it back at an agreed rent, the appellant could have negotiated a lease at a rental based on market value instead of on $259,000, so that each rental payment would have been the stipulated monthly rental payment plus an additional amount. The depreciating effect of the actual lease on the value of the appellant’s interest in the property was, therefore, in respect of each rental payment provided for, the present value, as of the date of the purchase in 1965, of that additional amount. Such present value would have to be computed in respect of each rental payment provided for and the respective results added up to find the amount by which the benefit assessed should be reduced.

With reference to the 1966 assessment, in my view the improvement made by the appellant’s company to his property was a benefit conferred on the appellant by the company that year. See St-Germain v MNR (supra). However, having regard to the fact that there were at least three and a half years left in the lease of the property at the fixed rent and not a mere month to month tenancy as in the St-Germain case, in my view, the amount of the benefit was not the equivalent of the amount spent on the improvement. As in the case of the 1965 benefit, there is a factor here that should have been taken into account and that was not taken into account. (No evidence was led to show that the market value of the property was not increased by the amount of the expenditure.) In the absence of circumstances that I do not have in mind, I should have thought that the amount of that factor might be an amount computed in the manner that I have indicated in reference to the 1965 benefit. What has to be kept in mind, as it seems to me, is that, if it had been a monthly tenancy, the appellant could have made a quick adjustment in rent to take into account the added value of the premises. As I see it, therefore, the relevant amount is the present value, as of the time that the 1966 improvement was completed, of the respective amounts that he would have been able to add to the rental payments covered by the lease but could not add because of the existence of the lease.

I am of opinion that we should hear counsel on what judgment is appropriate as well as on costs.