Gregory Harvey v. Her Majesty the Queen, [1995] 1 CTC 2507

Bowman J.T.C.C. (orally):-! will now render judgment in the case of Dr. Gregory Harvey v. The Queen, No. 92-69.

This is an appeal from an assessment for the appellant’s 1983 taxation year. Originally an appeal for 1982 was set down for hearing at the same time but it was adjourned sine die on consent of the parties pending the final determination of the case of Schultz v. The Queen.

The 1983 appeal raises essentially four issues:

A. the attribution to Dr. Harvey of $11,910 being interest earned on moneys which Dr. Harvey states he loaned to his infant children;

B. the treatment of certain so-called soft costs relating to a yacht called "Sweet Serenity", purchased by him in 1983 and transported to the British Virgin Islands;

C. investment tax credits on the yacht;

D. certain arguments under the Canadian Charter of Rights and Freedoms.

I shall deal first with attribution of income to the children. In years prior to 1983 Dr. Harvey transferred substantial amounts to his wife as "guardian" of their three children, Kara, Andrew and Jenny who were born in 1976, 1978 and 1980.

Documents described as promissory notes were signed by Shelly Harvey, Dr. Harvey’s wife and the children’s mother, I will read one as representative:

Promissory note $40,000, Wheatly, Ontario, due on demand. May 31, 1978. On demand, I Andrew Harvey covenant, agree and promise to pay to Greg Harvey the sum of $40,000 without interest. In the event I default interest shall be paid from the date of default at the rate of 20 per cent per annum.

This note is deemed for all purposes to be a specialty instrument. To be used as an educational trust fund with Shelly Harvey as trustee.

It is signed by Shelly Harvey and the witness appears to be. R. D. Clarkson. The note, all of the notes, are in Dr. Harvey’s handwriting.

Dr. Harvey admitted that he had no idea what "specialty instrument" meant. The note contains quite a remarkable provision in the event of default.

Interest is to be paid at 20 per cent per annum. This by a child aged two or three years old.

No formal trust agreement was ever signed and no trust was created other than whatever legal fiduciary relationship might have arisen out of Shelly Harvey’s signing the notes.

A schedule of repayment was prepared as the notes were paid off. The Minister attributed the interest on the moneys so advanced by Dr. Harvey to him on the basis that there was no genuine loan of money to the children.

The appellant relies upon the decision of Thurlow J. in Dunkelman v.

[1959] C.T.C. 375, 59 D.T.C. 1242 (Ex. Ct.), which held that for the purposes of the attribution a bona fide loan was not a transfer. Subsection 75(1) as it applied to 1983 read in part, as follows:

Where a taxpayer has, since 1930, transferred property to a person who was under 18 years of age, either directly or indirectly, by means of a trust or by any other means whatever, any income or loss, as the case may be, for a taxation year from the property or from property substituted therefor shall, during the lifetime of the transferor while he is resident in Canada, be deemed to be income or a loss, as the case may be, of the transferor and not of the transferee, unless the transferee has, before the end of the year, attained the age of 18 years.

The Dunkelman case is good law in Canada and has been followed on numerous occasions. The appellant relies also on Interpretation Bulletin IT-260R, paragraphs 3 and 4:

For the purposes of subsection 75(1), a transfer does not include a genuine loan made by a taxpayer to a trust for the benefit of a minor. No all-inclusive statement can be made as to when a loan can be considered to be "genuine", but a written and signed acknowledgment of the loan by the borrower and agreement to repay it within a reasonable time ordinarily is acceptable evidence that it was so. If, in addition, there is evidence that the borrower has given security for the loan, that interest on the loan has been paid, or that actual repayments have been made, it is accepted that the loan was genuine. The fact that no interest is required to be paid does not mean, in itself, that a genuine loan has not been made.

Where a loan has characteristics of a genuine loan (see 3 above) and there is no evidence that the terms of that loan are not being honoured by the minor, the Department considers that such a loan made directly to a minor is not a transfer of property for the purposes of subsection 75(1).

I do not think that we can push the principle in Dunkelman too far. A bona fide loan to a properly constituted trust may well meet the criteria in Dunkelman to avoid the provisions of subsection 75(1). A somewhat loose arrangement between husband and wife where the wife, without any form of documentation, calls herself a guardian of the infant children does not. It must be recognized that subsection 75(1) is designed to prevent income splitting and if one wishes to avoid the section on the basis of Dunkelman the formalities of a real trust must be set up. While a real trust could presumably borrow funds, an infant cannot to do directly. Such a contract is void.

In Upper v. Lightening Fastener Employees Credit Union (St. Catharines) Ltd. (1966), 9 C.B.R. (N.S.) 211 (Colt.), I think it is 9 Bankruptcy Reports. It is a decision of the County Court of Ontario of His Honour Judge Leach. He says at page 212:

In English law, apart from statute, an infant does not possess full legal competence. Since he is regarded as of immature intellect and immature discretion, English law, while treating all the acts of an infant which are for his benefit on the same footing as those of an adult, will carefully protect his interests and not permit him to be prejudiced by anything to his disadvantage.

He goes on to say at page 212:

Infant’s contracts are at common law generally voidable. However, there are certain exceptions to this rule where the contracts are void ab initio.

And, he quotes from Halsbury where he says at page 212:

Contracts which are obviously prejudicial to an infant are wholly void; thus an infant cannot contract a loan or give a penal bond.

Judge Brule of this Court in what appears to be an unreported decision Kallaur dealt with the situation that was virtually identical to this one. He stated:

Prior to the period under appeal and during this period the appellant transferred funds to his wife purportedly as "loans” were non-interest bearing and payable on demand. The investments made with the transferred funds earned...(substantial sums of money) in 1984.

He goes on to say on page 2:

The Minister has relied on subsection 75(1) of the Income Tax Act as it then existed for the years under appeal. That provision contemplated the transfer of property to minors did not include a genuine loan. However minors cannot contract and be parties to a proper loan. The accepted method of achieving a desired result in similar circumstances was by way of a bona fide trust.

In the present case a form of trust was eventually obtained but this was not completed in such a manner to satisfy the requirements of a valid trust.

And to distinguish the Dunkelman case he goes on to cite Lakeview Gardens Corp. v. M.N.R., [1973] C.T.C. 586, 73 D.T.C. 5437 (F.C.T.D.), which states the frequently cited observation that just because you might have been able to achieve a particular result in one way doesn’t mean that if you go about it another way you are going to achieve that result. I am in complete and respectful agreement with the decision of Judge Brule and I am following his decision.

We come now to the matter of the boat. Dr. Harvey has some reason for concern. He bought a boat, in Canada, at the end of November 1983 and had it transported to the British Virgin Islands where he agreed with North South Yacht Charter Ltd. that it would charter it on his behalf.

He treated the cost as $119,450 and sought to deduct $14,000 as a current revenue expense in 1983. This amount was made up of:

The commissioning as I understand the evidence is the work necessary to put the boat into shape to carry on the charter business.

Originally he met with a Mr. Seeley of the Department of National Revenue who indicated that he thought the expenditure should be added to the cost of the yacht and agreed to give Dr. Harvey an additional $14,000 capital cost allowance in lieu of the current deduction he had sought. Dr. Harvey agreed. The Department changed its mind twice. The first time it decided to give him only $3,707 that is 1/ 12th of the capital cost allowance on the yacht, on the basis that it had to prorate the claim over only one month. This resulted in a claim of $3,707 because of the provisions of Regulation 1100(3) based on the assumption that the chartering business had started in December 1983 and its fiscal period was only one month in 1983.

Then the Department retreated further from that position and applied this so-called one-half year rule, reducing the claim to $1,853. Dr. Harvey, quite rightly, took the position that if the Minister of National Revenue was to renege on his original deal he could revert to his original argument that the costs were currently deductible.

I shall consider first the question whether the Minister of National Revenue can retreat from the original deal made in Mr. Seeley’s letter of December 3, 1985. Unfortunately for Dr. Harvey I think he can. The Minister’s obligation is to assess in accordance with the law. It would throw the administration of taxation in this country into chaos if the Minister were bound by every private deal he made, whether in accordance with the law or not.

A recent decision of the Federal Court of Appeal I think underlines exactly that, in Cohen v. R., [1980] C.T.C. 318, 80 D.T.C. 6250 (F.C.A.), case where a deal had been made between the taxpayer and the Montreal office to the effect that they would treat one transaction as being on a capital account and treat the other one on revenue account. The Minister reneged on the deal and the taxpayer argued that a deal is a deal. The Federal Court of Appeal said at page 319 (D.T.C. 6251):

In my view, the trial judge correctly dismissed that argument, "that Minister has a statutory duty to assess the amount of tax payable on the facts as he finds them in accordance with the law as he understands it. It follows that he cannot assess for some amount designed to implement a compromise settlement...."

And he cites Galway v. M.N.R., [1974] C.T.C. 454, 74 D.T.C. 6355 (F.C.T.D.), at page 456 (D.T.C. 6357):

The agreement whereby the Minister would agree to assess income tax otherwise than in accordance with the law, would, in my view, be an illegal agreement. Therefore, even if the record supported the appellant’s contention that the Minister agreed to treat the profit here in question as a capital gain, that agreement would not bind the Minister and would not prevent him from assessing the tax payable by the appellant in accordance with the requirements of the statute.

And I observe that it follows as a corollary that where the taxpayer agrees with the Minister in a private deal like that the taxpayer should not be bound either.

I might also refer to a much older decision of the Exchequer Court Woon v. M.N.R., [1950] C.T.C. 263, 50 D.T.C. 871, where the Minister was held not to be bound by a prior advance ruling that he had given on the basis that estoppels do not bind the Crown.

Secondly, I do not agree that the $14,000 are currently deductible costs. They were incurred prior to the income earning process and form essentially part of the cost of the vessel. They are admittedly laid out to earn income but that is true of any capital expenditure made for business purposes. I think they form part of the cost of the vessel.

Counsel for the Minister said that these were laid out essentially as an expenditure that was anterior to the income earning process. I think I agree with that to a point and this position certainly seems to be supported by a decision of the Exchequer Court, by Mr. Justice Thorson in Daley v. M.N.R., [1950] Ex. C.R. 516, [1950] C.T.C. 254. However, I think the classic statement of what is cost is found in the decision of the Exchequer Court in Sherritt Gordon Mines Ltd. v. M.N.R., [1968] C.T.C. 262, 68 D.T.C. 5180, where Mr. Justice Kerr says at pages 287-88 (D.T.C. 5195):

In the absence of any definition in the statute of the expression "capital cost to the taxpayer of property", and in the absence of the authoritative interpretation of those words as used in paragraph 11 (1 )(a) insofar as they are being considered with reference to the acquisition of capital assets, I am of opinion that they should be interpreted as including outlays of the taxpayer as a business man that were the direct result of the method the adopted to acquire the assets. In the case of the purchase of an asset, this would certainly include the price paid for the asset. It would probably include the legal costs directly related to the acquisition. It might well include, I do not express any opinion on the matter, the cost of moving the asset to the place where it is to be used in the business. When, instead of buying property to be used in the business, the taxpayer has done what is necessary to create it, the capital cost to him of the property clearly includes all moneys paid out for the site and to architects, engineers and contractors.

I regard it as being of some significance that the agreement itself shows the cost as not being $119,000 but $133,000 that the Minister says is the cost of the yacht. And indeed the insurance was based on this as the cost of the yacht. I think the entire $14,000 represented part of the capital cost of the asset.

So far as prorating is concerned I have some concerns. Clearly the half year rule in Regulation 1100(2) applies. The property was purchased in 1983 and the rule that restricts the taxpayer’s 50 per cent of the capital cost to which he would otherwise have been entitled is applicable.

However, I raised with counsel my concerns about the appropriateness of, in addition to giving the taxpayer only 50 per cent of the CCA he might otherwise have been entitled to, reducing that again to 1/ 12th, 1/ 12th of the 50 per cent. I have concluded that the Minister was wrong in doing that. My reasoning is as follows. If am wrong I presume a higher Court will straighten me out.

Paragraph 1100(3) of the Regulations reads as follows:

Where a taxation year is less than 12 months, the amount allowed as a deduction under this section, other than paragraphs 1(c), (e), (f) and (g), shall not exceed that proportion of the maximum amount otherwise allowable that the number of days in the taxation year is of 365.

The key word is "taxation year". The taxation year is defined in subsection 249(1) and says:

For the purposes of this Act, "a taxation year" is:

(a) in the case of a corporation, a fiscal period and

(b) in the case of an individual, a calendar year

and when a taxation is referred to by reference to a calendar year the reference is to the taxation year or years coinciding with, or ending in, that year.

Now, nothing in that section leads me to believe that a taxation year of an individual should be shortened because he starts a business in the final months of that year. That does not, in my view, reduce or curtail or limit the length of his taxation year. Now a short taxation year might arise if a new company were incorporated in the middle of the year and it shows the calendar year as its fiscal period. I can accept that without any difficulty. Or, let us say a corporation has a fiscal period that ends on April 30 and in a preceding calendar year it changed its fiscal period to December 31 where it has a shorter fiscal period and prorating would obviously be appropriate. I can see nothing in the Act that requires a person who starts a new business to shorten his taxation year simply because the business is not in operation for the full year. I think this is consistent with Interpretation Bulletin IT-172R and I am reading particularly from paragraph 3:

Because capital cost allowance is based on the length of the taxation year and not on the period during the year the depreciable property may have been used in earning income, an individual entitled to capital cost allowance on any property can claim a full 12 months’ allowance except with the restriction in Regulation 1100(3) applies or when the individual dies.

Well, patently if the restriction under 1100(2) applies that is certain, but I do not see how the restriction in 1100(3) could apply simply because he buys property at the end of the year.

I shall deal next with the claim for investment tax credit. The appellant claims investment credit under subsection 127(9) on the basis that the vessel was qualified transportation equipment and I shall read only a portion of that definition:

Qualified transportation equipment of a taxpayer means prescribed equipment acquired by him after November 16, 1978 that has not been used, or acquired for use or lease, for any purpose whatever before it was acquired by the taxpayer and that is

(i) to be used by him principally for the purpose of transporting passengers, property or passengers and property in Canada or to and from Canada, in the ordinary course of carrying on a business in Canada....

The property was acquired to carry on a charter business in the British Virgin Islands and no one can seriously contend that the boat falls into that category.

So far as the arguments under the Canadian Charter of Rights are concerned I do not need to review the jurisprudence on this point. I do not think the appellant’s Charter of Rights have been infringed by the Minister’s actions. If the pace at which the Minister dealt with his objection seemed to be leisurely he could always have appealed to this Court after 180 days elapsed from the time of filing notice of objection under section 169.

The appeal is therefore allowed solely for the purpose of allowing the appellant such further capital cost allowance on the yacht as he may claim in accordance with the Income Tax Act but without applying the prorating formula in paragraph 1100(3) of the Regulations but applying the half year rule in paragraph 1100(2). In the circumstances I do not think it is appropriate that costs be awarded.

Appeal allowed without costs.