William G. Alguire v. Her Majesty the Queen, [1995] 1 CTC 2555

Bell J.T.C.C.:-The issue in this appeal is whether the appellant is entitled, in respect of his 1988 taxation year, to the deduction of $549,908 under the provisions of subparagraph 40( 1 )(a)(iii) of the Income Tax Act, R.S.C. 1985 (5th Supp.), c. 1 (the ’’Act”) as such provision applied to the sale of capital property on January 15, 1981.

Prior to January 15, 1981 the appellant owned all the common shares of Cartier Building (Canada) Inc. ("Corporation”). The financial statements of the Corporation as at January 30, 1981 showed assets in the sum of $2,336,139 and liabilities of $1,268,798. The assets consisted of:

Note 2 showed $175,000 as being unconditionally secured by a Canadian chartered bank, payable in three instalments by December 31, 1983 with interest at nine per cent per annum. It showed an additional $236,098 with interest at eight per cent per annum due on or before February 2, 1983. Note 3 described the investment in a subsidiary company as consisting of shares, at cost, of $231,420 and of advances of $104,251. The appellant said that the corporation’s investment in the subsidiary was in respect of a condominium project in Florida. The appellant said that his name was identical to his father’s name and that his father had an outstanding guarantee of the corporation’s indebtedness and that he, the appellant, had been advised by his lawyers to sever his connection with the corporation due to difficulties in appellant’s financing of certain transactions arising out of disparaging remarks apparently made by bank officials on the basis of mistaken identity. Accordingly, he sold his common shares of the corporation to his mother, Ethel J. Alguire, on January 15, 1981 for $600,000. No written agreement was executed respecting this transaction and no promissory note was given by his mother to him in respect thereof. He stated that his mother would pay him when she received money, by way of dividend, from the corporation. In 1983, his mother received $50,000 as dividends from the corporation and paid such amount to him which he reported in his return of income for that year. He stated further that the corporation had difficulties in 1982, 1983 and 1984 and became insolvent after 1984, the Florida project having been sold at a loss.

The appellant’s evidence, combined with evidence of his chartered accountant, Lawrence Rubinovich, was that the disposition of the shares of the corporation was not, due to oversight, disclosed in the appellant’s 1981 tax return but was disclosed in the 1983 return. Mr. Rubinovich testified that because a reserve in the full amount of the gain would have been claimed, the tax result would be neutral in the 1981 and 1982 taxation years. The reserve claimed in respect of the 1983 taxation year took into account the receipt of the $50,000 aforesaid.

A series of events, the description of which will add nothing to these reasons, resulted in a reassessment of the appellant’s 1988 taxation year which appeared to have included the amount of the reserve that would have been claimed by the appellant in his 1987 income tax return had he in fact claimed same. Consistent with the inappropriate practice of the Department of National Revenue, no explanation of the inclusion of such amount formed part of the reassessment. Such reassessment, made months after Mr. Rubinovich had furnished information to the Department of National Revenue could have been made in form comprehensible to the taxpayer and his representatives. It is only when one reviews the notification of confirmation by the Minister that any description of the 1988 taxation year assessment emerges. It says, in part,

The $549,908 reserve arising from sale of shares in Cartier Building (Canada) Inc. has been included in computing your income in accordance with the provisions of subparagraph 40( 1 )(a)(ii) of the Act.

It is in respect of this reassessment that the appeal is brought.

The original notice of assessment of the taxpayer’s 1988 taxation year dated June 27, 1990 included the following statement under the heading EXPLANATION OF CHANGES:

We have included $366,605, which is two-thirds of your 1987 reserve, in your income as a taxable capital gain. Please see the "Summary of Changes" area for your revised total income.

This was accompanied by a document bearing the same date and described as NOTICE OF CHANGE ON ASSESSMENT which read, in part, as follows:

According to our records, you have a 1984 reserve of $549,908. Under the Income Tax Act you must claim reserves within five years. Since this is your fifth year, your income has been increased to include this reserve.

Clearly, the assessor lacked any comprehension of what had taken place and, apparently, had made no effort to determine the facts upon which to found an informed assessment.

With respect to dispositions occurring before November 13, 1981 section 40 of the Act described a taxpayer’s gain from the disposition of property as the proceeds of disposition minus the adjusted cost base and expenses of such disposition and, in accordance with the words of subparagraph 40( 1 )(a)(iii):

Such amount as he may claim, not exceeding a reasonable amount as a reserve in respect of such of the proceeds of disposition of the property that are not due to him until after the end of the year as may reasonably be regarded as a portion of the amount determined under subparagraph (i) in respect of the property.

The appellant claimed a reserve in respect of his 1983 taxation year based on the premise that the entire amount due would be a reasonable amount as a reserve. The 1988 reassessment which, according to the notification of confirmation aforesaid, included the sum of $549,908 was expressed to be made, as stated in the notification:

In accordance with the provisions of subparagraph 40( 1 )(a)(ii) of the Act.

That subparagraph refers to the amount, if any, claimed by the taxpayer under subparagraph (iii) in computing the taxpayer’s gain for the immediately preceding year from the disposition of the property. The evidence was clear that no reserve amount had been claimed in the preceding year and further that no amount had been included with respect to the gain by way of including in income the amount of reserve, if any, claimed in 1986.

At the trial, counsel for the respondent stated that the respondent would rely solely upon the argument that the amount of reserve claimed was not reasonable in the circumstances. He submitted that reasonableness must be viewed in the commercial context, that a son would not normally sue his parents for debts owing, and that the payment was to be made to the appellant by his mother "if, as or when". He referred to R v. Derbecker, [1984] C.T.C. 138, 84 D.T.C. 6136 (F.C.T.D.); rev’d [1984] C.T.C. 606, 84 D.T.C. 6549 (F.C.A.). In that case the taxpayer sold assets to his daughter in exchange for consideration including a promissory note payable on demand after 1976. The Federal Court of Appeal reversed the Trial Division decision and found that the amount of the promissory note was due if the taxpayer was entitled to enforce payment of it even if he had not done so. Counsel sought to ally that situation to the appellant’s position.

The evidence was clear that the only amount received by the taxpayer from his mother in respect of the sale of shares of the corporation was $50,000. The balance of the purchase price is still owing to the appellant. Although the appellant did not claim a reserve in each year and include that reserve in income in the following year, the effect of the 1988 reassessment is to achieve the result of such inclusion while at the same time denying a reserve deduction.

I have no difficulty in concluding that the appellant was entitled to a reserve in that year and that the amount of $549,908 was a reasonable amount as that reserve, the amount not being capable of being said to be due to him during that year. The computation of such reserve was made exactly in accordance with the formula approved by the Minister as set out in Interpretation Bulletin IT-236R2 dated July 22, 1985, applicable to the date of the transaction. It would be illogical for the appellant to be required to include in income any amount which he has not received unless it is required by statute so to be included. The subparagraph in question was amended with respect to transactions occurring after November 12, 1981. Had the transaction in question occurred after that date a different result would arise. However, no such inclusion requirement existed at the time the transaction in this case was effected.

Vern Krishna, in "The Taxation of Capital Gains", 1983, said:

The use of reserves as a tax shelter became a matter of sufficient concern to the Department of Finance to warrant budget amendments effective November 12, 1981. The initial reaction of the Department was to forbid the use of reserves entirely. Post-budget pressure, however, persuaded the Minister of Finance to modify his initial stance and allow the use of reserves for a limited period of time.

The general thrust of the new rules is to restrict the use of a reserve in respect of capital gains to a maximum period of five years.

I have no impression that the sale of the shares of the corporation was, in any way, intended to be a tax shelter as that term is commonly comprehended. The fiscus is not deprived of any tax in this situation no money or other valuable consideration having changed hands.

There was one other issue in this appeal. It related to the appellant’s share of partnership losses. Counsel advised me at the beginning of the hearing that that matter had been settled on the basis that the penalty levied against the appellant pursuant to subsection 163(2) of the Act be deleted. Counsel stated that they also agreed that no further relief would be granted to the appellant respecting this issue.

The appeal herein is allowed in accordance with these reasons with respect to the reserve issue and in accordance with the stated agreement of counsel regarding the partnership matter.

Costs, payable by the respondent, are awarded to the appellant.

Appeal allowed.