Rudolf Merkle and Rosemarie Merkle v. Minister of National Revenue, [1990] 1 CTC 2090, 89 DTC 730

Taylor, T.C.J.:—These are appeals heard on common evidence in Calgary, Alberta on October 24, 1989, against income tax assessments for the year 1987 in which the Minister of National Revenue recalculated the reported income of the taxpayers with reference to the income averaging provisions of the Income Tax Act (the "Act").

It was agreed that the notice of appeal and the reply to notice of appeal, the same for both appellants, would form the basis of the factual material, and only argument needed to be presented to the Court.

Notice of appeal:

Summary of Facts:

On January 27, 1989 the Minister confirmed the original assessment with respect to the taxpayer's 1987 T1 indicating the assessment is in accordance with the averaging provisions of Subsection 119(1) of the Income Tax Act.

The taxpayer selected in 1987 a block averaging period consisting of 1987, 1986, 1983, 1982 and 1981.

We would submit that the Minister erred in his confirmation of the assessment in view of the fact paragraph (a) of Subsection 119(1) refers to the averaging period. This period is further defined in Subsection 119(4) as the earliest year not being earlier that [sic] the sixth year preceding the year of averaging for inclusion in the averaging period.

The earliest year selected by the taxpayer averaging was the sixth preceding year and therefore the taxpayer's averaging period is in full compliance with the law.

Reply to notice of appeal:

STATEMENT OF FACTS

The Minister admits the Appellant elected in his 1987 taxation year a block averaging period consisting of 1987, 1986, 1983, 1982 and 1981.

The Respondent in assessing the 1987 taxation liability calculated the election to average using a block averaging period of 1987, 1986, 1985, 1984 and 1983.

In so assessing the appellant's taxation liability, the respondent assumed the following facts:

(a) The appellant's chief source of income for 1987 and the four (4) immediately preceding years for which he filed returns of income was from farming.

(b) The appellant's 1983 through 1987 returns were all filed on time.

STATUTORY PROVISIONS UPON WHICH THE RESPONDENT

RELIES AND THE REASONS WHICH HE INTENDS TO SUBMIT

The respondent relies, inter alia, upon Section 119 of the Income Tax Act, R.S.C. 1952, c. 148, as amended by S.C. 1970-71-72, c. 63, s. 1, applicable to the 1987 taxation year of the appellant.

The respondent submits that pursuant to the provisions of Subsection 119(1) of the Act, he has correctly assessed the appellant's taxation liability after ascertaining the averaging period to be the year of averaging and the four (4) immediately preceding years.

The respondent further submits that the provisions of Subsection 119(4) do not apply to allow an election as submitted by the appellant.

Argument

The following quotation from the argument of the agent for the appellants indicates the general thrust of the position put forward on their behalf:

The provisions of 119(1) and 119(4) restrict the averaging period to four years where the taxpayer has filed all prior years on time, yet it extends and rewards the taxpayer who doesn't file on time by allowing an extended averaging period of six years under 119(4).

It is in my opinion inconceivable that the intention of Parliament in drafting the provisions of 119 would have been to provide greater flexibility to those who file returns late and restrict those who file on time.

The provisions of 119(4) must be applied not only in circumstances where returns are late filed, but also to all other taxpayers on an equal and equitable basis. There are no restrictions in 119(4) which preclude its application in circumstances where returns are filed on a timely basis.

Accordingly, my client's averaging period consisting of four of the six immediately preceding years should be considered correct within the interpretation of 119(4).

In response thereto, counsel for the respondent stated:

But if Mr. Henrickson’s view were correct clearly Parliament would have chosen to put the provisions of subsection 119(4) within the main definition provision under paragraph 119(1)(a), and that was not done, and in my submission the reason for that was that the intention of Parliament was to contain the averaging period to the taxation year in question, and the four immediately preceding years, subject to the conditions which follow.

Analysis

The specific words of the section of the Act most directly involved are:

119(1) Where an individual’s chief source of income has been farming or fishing for a taxation year (in this section referred to as the "year of averaging”) and the 4 immediately preceding years for which he has filed returns of income as required by this Part (in this section referred to as the "preceding years”), if the individual, on or before the day on or before which he was required to file a return of his income for the year of averaging, or on or before the day on or before which he would have been required to file such a return if any tax had been payable by him for the year of averaging, files with the Minister an election in prescribed form,

and subsection 119(4);

An election under subsection (1) is a nullity unless the earliest of the "preceding years" is one of the 6 years immediately prior to the year of averaging.

and subsection 150(1) and paragraph (1)(d):

A return of income for each taxation year—in the case of an individual, for each taxation year for which tax is payable—shall be filed—on or before April 30 in the next year—.

In my opinion, the “averaging period”, for these taxpayers, is by definition (subsection 119(1)) the years 1987, 1986, 1985, 1984 and 1983, since "returns of income as required" had been appropriately filed during these years. Subsection 119(4) of the Act does not provide a taxpayer with the option (as is argued by his agent) to selectively delete from this averaging period the years 1985 and 1984 and substitute therefor the years 1982 and 1981. For these two years, 1982 and 1981, "returns of income as required” were also filed and they did not extend back beyond a six-year period from the “year of averaging". Subsection 119(4) of the Act does allow for an election to be filed if during one or two of the "six-years immediately prior to the year of averaging" no return of income was required. Simply put, in the event that a taxpayer, otherwise qualifying to use the averaging provision of the Act, did not have income “for which tax is payable" for one or two of these "six years immediately prior to the year of averaging”, he could nevertheless calculate his averaging period using four of the other prior years included in that six year period. He would not be denied the opportunity to average by virtue of the fact that he had not been required to file returns for up to two years during that period. The “six years immediately prior to the year of averaging" merely places a limit on how far back a taxpayer is permitted to go in using the provision.

It was the contention of the agent for the appellants that the determination of the issue, in the manner I have outlined above for subsection 119(4) of the Act, would discriminate against the taxpayer who had filed for a full six years, as contrasted with the taxpayer who, for whatever reasons, had not so filed during two of these years. I do not agree.

As I understand the section of the Act under review, a taxpayer wishing to avail himself of the averaging process, is entitled, indeed mandated, to use the immediately preceding "four years" if these four years required filing a return—the six-year period referenced in subsection 119(4) would not enter into the calculation at all. It seems to me that in order to put the taxpayer with one or two years of no taxable income on the same footing as the taxpayer with a continued taxable income (and consequently the requirement to file), it was necessary to provide the latitude under subsection 119(4). Otherwise the taxpayer who had not been required to file could be attempting to average based on two or three years instead of four years of income. The term "the four immediately preceding years" (subsection 119(1)) is not synonymous with the term “six years immediately prior" (subsection 119(4)) leaving aside the obvious mathematical distinction between "four" and "six". The appellants' notice of objection filed with the Court makes the following assertion:

Section 119(4) allows the averaging period to be the year of averaging and four of the six immediately preceding years — .

That is simply a misinterpretation of the precise words used in section 119.

The pre-condition is not simply that a taxpayer did not file tax returns on time in each year, the stipulation is that he was not required to file such returns. The agent for the appellants put forward for the Court's consideration a possible scenario wherein on purpose a certain taxpayer might decide not to file on time, and rely on the provisions of subsection 119(4) as a form of tax-planning device. Counsel for the respondent suggested that some other sections of the Act might come into play to prevent such a result. While the scenario put forward by the agent is interesting and at least theoretically possible, I am not sure it is plausible, and in any event it does not enter into a determination of this point before the Court.

Before finalizing, I should note that the agent for the appellant referred the Court to the case of Murray v. M.N.R., [1987] 2 C.T.C. 2284; 87 D.T.C. 559, in which the years taken as the "preceding years" were shown in the opening paragraphs as “1977, 1978, 1979 and 1980”, “while the year of averaging" was 1982, no direct reference being made to the year 1981. In my view, the body of the judgment, particularly on page 2288 (D.T.C. 562) in calculating the “fishing income totalling $21,535”, and the "Cape Beale wage payments of $42,700" shows clearly that the preceding years, as far as the presiding judge was concerned, should have been listed as 1978, 1979, 1980 and 1981. The learned judge in recalculating the amount eligible for consideration in the "preceding years" dropped any reference to the 1977 year, and used the correct years 1978 through 1981, in my opinion. I can only conclude that the earlier reference to the year 1977 was related in some way to an effort on the part of the appellant to utilize the years he considered most advantageous to him, not unlike the instant case. The judge did not agree. The appeals are dismissed.

Appeals dismissed.