John M. Fedyna and Fedyna Construction Limited v. Minister of National Revenue, [1991] 2 CTC 2288, 91 DTC 1014

Mogan, T.C.J.: — The appeals of John M. Fedyna v. M.N.R. (88-84IT) and Fedyna Construction Ltd. v. M.N.R. (88-184IT) were heard together on common evidence. In these reasons for judgment, John M. Fedyna will be referred to as “the appellant" and Fedyna Construction Ltd. will be referred to as “the Company”. At all relevant times, the appellant was the sole shareholder of the Company. The years under appeal are 1978, 1979, 1980 and 1981 and the main issue is whether a benefit was conferred on the appellant by the Company in those years within the meaning of paragraph 15(1)(c) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). In order to decide the main issue, it is necessary to construe a contract between the appellant and the Company which was entered into in the circumstances described below.

The appellant was a general contractor engaged to build a nursing home in 1967. When the owner was short of money, the appellant guaranteed the mortgages on the project and prepared himself to administer the project if he were required to take it over. Out of that experience, he decided to develop his own nursing home. In 1969, the Company purchased 16 acres of land in Markham Township just north of the City of Toronto for the purpose of developing a retirement village complex. The property contained a large five- bedroom house into which the appellant and his family moved in the latter part of 1970. It took two years to have the land zoned for institutional" uses. In 1970-71, the Company built a 100-bed nursing home and, in 1973-74, the Company built a 100-bed retirement home, both on the 16-acre parcel of land.

It was necessary for the appellant to live on the site because he supervised the construction of the nursing home and the retirement home; he also supervised other development of the site; and he was the chief administrative officer of the nursing home which opened for business in 1971 and the. retirement home which opened in 1974. The appellant and his family were tenants of the Company in their occupancy of the older five-bedroom house. Around 1973-74, the appellant decided that he and his family should have their own house because he wanted the benefit of a “principal residence" under the Income Tax Act, and he wanted a larger private office in his home separate from the administrative offices which were available to him in the nursing home and retirement home respectively.

The appellant decided that there was enough area between the nursing home and the retirement home to designate a residential lot for his proposed new house. The local zoning by-law required a rural residential lot to be at least two acres in area and to have at least 200 feet of frontage on a 66-foot road allowance. The appellant caused the 16 acres to be surveyed and divided into five parcels. Part 4 was the nursing home; Part 1 was the retirement home; and between them was Part 2, a lot exceeding two acres designated for his new house. The appellant could not get Part 2 severed from the remainder of the 16 acres zoned institutional because Part 2 did not have 200 feet of frontage on a full road allowance but it did have 200 feet of frontage along the private road to the nursing home and along the western limit of the 16 acres.

Because the appellant could not get severance, he required a special amendment to the zoning by-law to permit the construction of his family residence on institutional land. He was confident that severance would come within the next 10 or 20 years because, when he subdivided his land, he would be required to designate a 66-foot road allowance along Part 2 and thereby satisfy the last condition to severance. In September 1974, the Town of Richmond Hill which had taken in the subject land (formerly in Markham Township) passed a special by-law number 46-74 (amending by-law 2325-68 of the Township of Markham) which permitted a single-family dwelling to be erected on the 2-acre site identified as Part 2 on the 16-acre parcel owned by the Company providing that:

(a) The said dwelling may contain office space accessory to the operation of the existing nursing home on the lands and,

(b) Such office space shall not exceed twenty-five per cent (25 per cent) of the gross floor area of the proposed building.

After the by-law was passed, a building permit was issued and the appellant's new house was constructed on the two-acre site identified as Part 2. The appellant and his family moved in at the end of 1975 or early in 1976. Because the house was constructed on land owned by the Company and the Company had paid all of the construction costs, the appellant and his Company had to come to some agreement concerning ownership of the house if the appellant were to achieve his original intention to have a principal residence. Accordingly, a short agreement was typed up and signed in the office of the appellant's accountant sometime in the early months of 1976. The agreement is set out in full below because it is short and its interpretation is the heart of the main issue:

Agreement as at February 29, 1976

This is to confirm that John Fedyna is indebted to Fedyna Construction Limited in the amount of $83,132.76 which is the total of construction costs to February 29, 1976 for the new house at “Country Place”, Richmond Hill. Further, Fedyna Construction hereby agrees to sell the land associated with the house and being approximately 1 A acres to John Fedyna for the sum of $20,000. John Fedyna agrees to repay the company for Construction costs over a period of 20 years at the rate of $4,200 per year, the first payment to become due February 29, 1976. Payments on the land are to commence when title is conveyed and if title is not conveyed to John Fedyna, the $4,200 indicated above is deemed to be rent for the house and contents.

John Fedyna

Fedyna Construction Limited

There was unchallenged evidence that the land associated with the house in Part 2 of the survey exceeded two acres and was not 1 A acres as indicated in the agreement. Having signed the above agreement which is Exhibit A-6 in these appeals, the parties accepted its terms. The appellant paid to the Company $4,200 each year in February in order to retire the construction costs over a 20- year period. The Company did not record the house as its asset but showed on its balance sheet a "shareholder's advance" of approximately $84,000 reduced each year by the $4,200 payment received from the appellant. The basic dispute in these appeals concerns the interpretation of the last clause in Exhibit A-6: ”. . . and if title is not conveyed to John Fedyna, the $4,200 indicated above is deemed to be rent for the house and contents.”

The appellant and the Company argue that the last clause in Exhibit A-6 is a condition subsequent; the annual payments of $4,200 start out as repayment of the $84,000 shareholder advance; and those payments became rent only if, at some future time, it becomes impossible for the Company to convey the land to the appellant. The respondent argues that the last clause in Exhibit A-6 is a condition precedent; the annual payments of $4,200 start out as rent; and those payments are not applied against the cost of the house until after the Company has conveyed the land to the appellant. Counsel did not argue whether the portion of the agreement concerning the sale of the land associated with the house may have been invalid under section 29 of the Planning Act, R.S.O. 1970 Chapter 349. I assume that because the vendor and purchaser were not at arm's length and were fully aware that title could not be conveyed until the Company had achieved severance of the 2-acre parcel, the portion of the agreement concerning the sale of the land associated with the house could be said to be expressly conditional upon compliance with section 29 of the Planning Act. Even if a portion of the agreement were invalid under the Planning Act, I would still have to determine whether the annual payment of the $4,200 was rent or repayment of a loan having regard to other collateral evidence concerning the intention of the parties.

The respondent's interpretation of Exhibit A-6 is the basis for the assessments under appeal. For each of the years 1978, 1979, 1980 and 1981, the respondent added $4,200 to the Company's reported income as "additional rental revenue". For the same years, the respondent added to the appellant's reported income under subsection 15(1) of the Income Tax Act certain amounts identified as "rent benefit obtained” computed as follows:

If the appellant and the Company are successful on the main issue, the value of the house would be excluded from the first line (land and house) in the above schedule, and the amount of $4,200 would be excluded from the Company's income for each year.

There was evidence that, in 1987, the Company entered into a joint venture with an arm's length third party under which the appellant sold the house to the Company and surrendered his right to purchase for $20,000 the land associated with the house.

Counsel for the respondent argued that the 1987 transaction was fatal to the position of the appellant and the Company on the main issue because title to the land associated with the house was not and never could be conveyed to the appellant. After the 1987 transaction, the agreement evidenced in Exhibit A-6 could not be completed by the conveyance of land from the Company to the appellant but that, by itself, is not fatal to the position of the appellant and the Company on the main issue. The 1987 transaction proves that the appellant and the Company terminated the agreement in Exhibit A-6 but it has no bearing on the question of whether the appellant acquired ownership of the house under that agreement.

Counsel for the appellant cited ample authority to establish the proposition that ownership of a building can be severed from ownership of the land on which it is erected: Clark v. Royal Bank (1987), 7 P.P.S.A.C. 214; Plan A Leasing Ltd. v. The Queen, [1976] C.T.C. 261; 76 D.T.C. 6159. It is a question of determining the intention of the parties. When the appellant is the sole shareholder of the Company, I would assume that the intention of the appellant and his Company are identical. Their common intent is best shown in the financial statements of the Company where, from 1976, the house does not appear as an asset but the $84,000 construction costs are shown as an amount receivable from the shareholder. The financial statements of the Company at February 29,1976 contain the following as Note 2:

Also, Exhibit A-6 begins by confirming that the appellant is indebted to the Company in the amount of $83,132.76.

I am satisfied, firstly, that it was the intention of the appellant and the Company that the appellant would be the owner of the house from the time when it was constructed on the Company's land; and secondly, that he would pay the construction costs in 20 equal annual instalments of $4,200 commencing in 1976. I therefore construe the last clause in Exhibit A-6 as being a condition subsequent. For the years under appeal, the annual payments of $4,200 were capital amounts to retire the shareholder loan and those payments were not rent for the use of a house owned by the Company.

Having reached the above conclusion with respect to the annual payments of $4,200, the Company's appeals are allowed for all years and the reassessments are referred back to the Minister of National Revenue for reconsideration and reassessment to exclude the amount of $4,200 from income in each year. Similarly, the appellant's appeals are allowed for all years and the reassessments are referred back to the Minister of National Revenue for reconsideration and reassessment to exclude the value of the house from the computation of rent benefit obtained. There are, however, other amounts remaining in dispute.

Although I would exclude the value of the house when determining the amount of the rent benefit obtained by the appellant each year, I would not exclude the value of the land because (i) the appellant's house was constructed upon and occupied land owned by the Company; (ii) the appellant and his family resided in the house and enjoyed the subjacent and adjacent lands as part of their domestic establishment; (iii) no part of the $4,200 was paid with respect to the land; and (iv) it was a real benefit for the appellant to be able to live on the Company's land close to his places of business.

When the appellant filed his income tax returns for the years 1979, 1980 and 1981, he included as income an amount representing an "interest benefit" under section 80.4 of the Income Tax Act because he assumed that he had a substantial interest-free loan from the Company on which he was repaying only $4,200 of principal each year. When issuing the reassessments under appeal, the respondent extracted from the appellant's income for 1979, 1980 and 1981 the amount of any “interest benefit” because the respondent assumed that the appellant had no loan but was paying annual rent of $4,200. The appellant has succeeded on the main issue. Therefore, the annual payments of $4,200 were not rent but were payments of principal on the interest-free loan. Therefore, I assume that the appellant was correct in reporting an "interest benefit" under section 80.4 and, when the reassessments under appeal are referred back to the respondent to give effect to the success of the appellant and the Company on the main issue, it is probably in order to reinstate an “interest benefit” although no argument was made on this point.

In the above schedule computing "rent benefit obtained”, there are amounts described as "Maintenance costs paid by Fedyna Construction Ltd.”. Those maintenance costs have three components as shown in the table below:

The appellant concedes that there was a shareholder benefit with respect to house insurance premiums paid by the Company. Concerning realty tax, either the Company (as registered owner of the 16 acres) or Country Place Homes Ltd. (as operator of the nursing home and retirement home) received only one municipal tax bill covering the 16 acres and all buildings erected thereon. The tax bill apparently contained a schedule showing the appraised value of all buildings for realty tax purposes. The evidence indicates, although not conclusively, that the amounts shown as "realty tax” in the above table related to the appellant's house, an older house known as Dr. Noble's House and a smaller dwelling nearby.

I conclude that the realty tax with respect to the appellant's house was paid by either the Company or Country Place Homes Ltd. and not by the appellant. As a result of such payment, the appellant has derived a shareholder benefit. There is some doubt concerning what portion of each amount shown as "realty tax" in the above table relates to the appellant's house alone. The onus was on the appellant to prove that the respondent had included in computing the appellant's income the wrong amount with respect to realty tax. Although Mr. Fedyna testified at length and his accountant also testified, I was surprised at the dearth of hard evidence concerning the manner in which realty taxes were allocated to the different buildings.

On balance, I am inclined to accept the fact that the above amounts relate to three different houses. Counsel for the appellant urged me to refer the matter back to the respondent to reassess on some reasonable basis. I will not do that when the onus was on the appellant to prove some allocation more reasonable than the assessment. I am mindful of the fact that the appellant's house was new in 1976 and he described as having 3,800 to 4,000 sq. ft. That is a substantial dwelling and I infer that it is larger than the Dr. Noble House and the smaller dwelling. Of the amounts shown in the above table as "realty tax" ($3,270 for 1978 etc.), I think that 60 per cent of each amount would be a reasonable portion to allocate as the realty tax referable to the appellant's house.

Concerning the third component utilities, the appellant stated that his house was hooked up to the retirement home for certain utilities and that he did not receive any utilities from the Company. In other words, if he received a shareholder benefit with respect to utilities, it came from Country Place Homes Ltd. and not from the appellant. I accept the appellant's evidence that he did not receive any utility benefit from the Company but I do not accept the appellant's argument that, having demolished the respondent's assumed source of the utility benefit, the appeal on this item must succeed. It is the assessment which is under appeal; not the respondent's reasons for assessing. Proving that the utility benefit did not come from the Company showed that the respondent's assumed fact was wrong and placed an onus on the respondent to prove that the appellant did in fact receive a shareholder benefit with respect to utilities. In my view, the respondent discharged that onus when the appellant admitted that ne derived some of his utilities from his other corporation (Country Place Homes Ltd.) and failed to show that he reimbursed Country Place Homes Ltd. for such utility costs. Of the amounts shown in the above table as “utility” ($1,531 for 1978 etc.), I conclude that $300 in each year is a reasonable value of the shareholder benefit derived from Country Place Homes Ltd.

There is a further issue concerning what portion of the house was used by the appellant for business purposes. Although there was an administrative office in both the nursing home and the retirement home, the appellant explained that he was required to use at least a portion of his house for business purposes in the following circumstances. Clients or prospective clients of the nursing home or retirement home (and sometimes their families) would frequently arrive at the Country Place premises and want to see him on weekends or during the evening or at some other time when the administrative offices were not open. When they arrived at his house, sometimes after travelling a considerable distance, he could not tell them to come back during office hours, and he felt that it was more hospitable to meet in the house rather than go about 200 yards to a less hospitable administrative office. The appellant also had a concern for confidentiality because the staff in the nursing home was unionized whereas the staff in the retirement home was not.

I am persuaded that a portion of the appellants house was used for business purposes genuinely connected with the nursing home and retirement home. This situation continued from the time when the appellant and his family first moved into the house in 1975/76. The special by-law (46-74) of the Town of Richmond Hill which permitted the construction of the appellant's house on the Company's institutional lands and the use of a portion of the house for office space expressly stated that "such office space shall not exceed twenty-five percent (25 per cent) of the gross floor area of the proposed building". Notwithstanding the appellant's extensive evidence on the use of his house for business purposes, I shall assume that he was not in breach of the special by-law. I therefore conclude that the use of his house for business purposes did not exceed 25 per cent of the gross floor area and that such use was in fact 20 per cent. I would think (without deciding the issue) that in the 1987 transaction when the house was sold to the Company, 80 per cent of the proceeds of disposition would be for a principal residence within the meaning of paragraph 40(2)(b) of the Income Tax Act and 20 per cent of such proceeds would be for a business property.

Following the reasoning in the preceding paragraph, I conclude that 20 per cent of the furniture in the appellant's house was used for business purposes.

The last issue between the parties is the tax treatment of certain insurance moneys. On September 17, 1979, there was a fire which destroyed a barn on the 16-acre site in the general vicinity of the appellant's house. The barn was owned by the Company; insured by the Company; and insurance proceeds of $18,302 received by the Company were correctly recorded for accounting and income tax purposes. There is no dispute concerning that amount. There was other damage not directly related to the barn but caused by the fire. Such other damage included a garden house, wooden fences, trees, and the cleaning and restocking of a fish pond near the appellant's house. There is some question as to whether the appellant had an insurable interest in fences, trees and pond when he owned only the house and not the adjacent land.

There was an insurance policy (No. 6004-0515 Chubb Insurance) which appears to have covered these other items of fire damage. Premiums on this policy were paid by the Company up to the date of the fire and again in 1982. For. the fiscal periods of the Company ending in February 1980 and 1981, however, the premiums were charged to the appellant personally. In March 1981, the appellant received and retained an insurance cheque in the amount of $8,616 from Chubb Insurance with respect to policy number 6004-0515. The respondent added the amount of $8,616 to the appellant's reported income for 1981 on the basis that he had appropriated that amount from the Company under paragraph 15(1)(b) of the Income Tax Act. Also, the respondent added to the Company's income for its fiscal periods ending in February 1980 and 1981 the amounts of $4,920 and $3,696 respectively.

In the Company's profit and loss statement at February 29, 1980, there is an expense identified as “building repairs and maintenance $4,920”. Also, there are invoices (Exhibits A-10 and A-11) for work done in the last days of September 1979 which add up to that precise amount. Although the evidence is not entirely clear, I have concluded that this expense of $4,920 was not part of the $18,302 but was part of the $8,616 reimbursed to the appellant and retained by him. I can find no evidence that the remaining $3,696 was expended by the Company and infer from the evidence of the appellant that it was to reimburse him for his personal efforts in draining the pond several times and then restocking it with fish.

On this last issue, the respondent was correct in adding the amount of $4,920 to the Company's income for its 1980 taxation year; but the amount of $3,696 should be deleted from the Company's income for its 1981 taxation year. And finally, the amount of $8,616 added to the appellants income for 1981 should be reduced to $4,920 because that is the only amount of insurance proceeds which he appropriated from the Company. In conclusion, I simply observe that there was a disappointing precision in the allocation of expenses when so many of the appellant’s personal expenses were mingled with those of the Company. The appeals are allowed and referred back to the respondent for reconsideration and reassessment in accordance with the above reasons. Because the appellant and the Company were successful on the main issue, they will be entitled to one set of costs flowing from the fact that all appeals were heard on common evidence and related arguments.

Appeals allowed.