Sara Shlien v. Minister of National Revenue, [1988] 1 CTC 2244, 88 DTC 1152

Couture, C.J.T.C.:—The appellant has appealed the assessments made by the respondent for the 1979 and 1980 taxation years. At the hearing her counsel consented to judgment dismissing the appeal in relation to the 1979 taxation year.

In assessing the appellant for the 1980 taxation year, the respondent added $73, 655.87 to her declared income of $22,733 alleging that $62,505.87 of the $73,655.87 represented unreported additional income without identifying its source. The remaining $11,150 is said to represent the taxable portion of a capital gain realized by the appellant in 1980. The respondent relies on a net worth assessment to establish the amount of alleged increase in the appellant's net worth between December 31, 1979 and December 31, 1980. This difference amounted to $74,968.25 to which he added personal expenses for the year arriving at an amount of alleged income for the year of $96,388.87. As she had reported $22,733 the difference of $73,655.87 was assessed as unreported income. The respondent also assessed a penalty in the amount of $6,045.03 as due under subsection 163(2) of the Income Tax Act (the Act).

In her notice of appeal the appellant submitted that of the amount of $73,655.87 added by the respondent to her income for the 1980 taxation year, $50,000 was received by her from her late husband's estate and that $11,150 was a non-taxable capital gain realized from the disposition of her principal residence. She also claimed that the penalty should be cancelled.

The appellant testified that she is of Polish origin, born in Grodno, Poland in 1921. In 1939 at the beginning of the war as a result of population displacement she was relocated to Russia and remained there until the war ended. While there she married Abraham Slejen (Shlien) a carpenter. A son was born in Russia of this marriage.

After the war the appellant and her husband returned to Poland and emigrated to Israel around 1949. Her husband carried on his trade in Bat Yam. They were economically comfortable. They owned an apartment and also purchased what I gather was commercial space in a building with the intention of opening some kind of a store, but this was not realized because they decided to emigrate to Canada. They proceeded to liquidate their assets in 1960, selling the apartment and their furniture. This is admitted by the respondent. They also sold whatever equity they owned in the building.

The appellant's late husband never confided in her regarding financial matters so she was not familiar with their financial situation in Israel except that they lived comfortably and were better off than a lot of others. When they were contemplating leaving Israel she said she knew that exchange control regulations were in effect and that under those regulations they were permitted to take only $10 each on leaving the country. Her husband left whatever capital they had with his brother-in-law, one Leo Zuckermann for safekeeping.

On arriving in Canada they lived in a rented apartment for two years. They then purchased a house on Emmanuelle Street in the City of Laval. In 1976 she purchased a house on René Coty Street that was occupied by her son and his family. On March 26, 1977 her husband died. After his death, she moved from the Emmanuelle Street house to live with her son and the Emmanuelle Street property was listed for sale. The appellant was asked these questions by her counsel and gave these replies:

Q. Now after your husband died in March 1977, did you live in the Emmanuelle Street house by yourself?

A. No, my son put an alarm in the house after my husband died and I was all the time with my son.

Q. If we were to take the example of a month, let's say, in 1977 and 1978, would you be in the René Coty house?

A. Then I was all the time in the house.

Q. Ten nights?

A. No, I was ninety-nine percent (99%) there after my husband passed away. I was there because I couldn't stay at home alone, I couldn’t, I couldn't. . .

Q. So you did not sleep at Emmanuelle Street house very often?

A. No, not at all, I couldn't. I wanted to be strong, but I couldn't.

It took about two years to sell the Emmanuelle Street house. It was sold with all her appliances, carpets and drapes.

After the sale of that property she rented an apartment on Melville Street not far from the René Coty Street house. While she was living with her son and his family she was not sure that this arrangement would be permanently satisfactory and as a precautionary measure she rented this apartment although she says she never occupied it, but used it to store some of her furniture.

In 1980 she sold the René Coty house. In filing her income tax return for the 1980 taxation year she did not declare the profit she realized on the disposition of this house, taking the position that it was her principal residence within the meaning of subsection 54(g) of the Act and therefore exempt from taxation and the provisions of paragraph 40(2)(b).

The appellant also testified that she was 65 years of age and in a frail state of health. During 1980 she worked as a cook at the Jewish Convalescent Hospital and had done so for the previous 18 years. She was the universal legatee of her late husband's estate. Her only source of income was her salary and a small amount of investment income both reported in her income tax return. She never carried on any business and has never engaged in what is commonly known as an adventure in the nature of trade. As mentioned before she said that her husband had looked after their financial affairs and that she was not familiar with them. During his lifetime he occasionally alluded to the existence of some sort of financial nest or security for them. He had referred to this concealed fund even when they were living in Israel. When he died there was an unsuccessful search for this property.

In 1980, at the invitation of her previously mentioned brother-in-law who had by then moved to Germany, she visited him and his wife. A few days before returning home she was told that he had something for her. He told her that her husband had left $50,000 with him with instructions that if something happened to him the $50,000 should be turned over to her. He gave her $50,000 in Canadian currency. Not wanting to carry this amount with her, she and her brother-in-law went to a bank and made arrangements to have that sum credited to her bank account at a branch of the Royal Bank of Canada in Chomedey. Banking documents are in evidence that indicate the transfer from a German bank and a net deposit of $48,994 to her bank account with the Royal Bank. The appellant alleges that this money accounts for part of the increase in her capital in 1980 in the amount of $73,655.87 as determined by the respondent. As to the remaining $24,661.97, $22,300 represented her gain from the disposition of the René Coty house.

Three issues arise from the assessment:

(a) Was the house owned by the appellant at 4688 René Coty and disposed of in 1980 her principal residence for the purpose of the Act?

(b) Was the respondent correct in assessing the appellant for $62,505.87 of alleged unreported income?

(c) Was the respondent correct in assessing a penalty of $6,045.03 as due under subsection 163(2) of the Act?

In assessing the appellant for the 1980 taxation year the respondent assumed that the discrepancy amounting to $73,655.87 between her capital at the beginning and the end of the taxation year was income for the purpose of the Act and therefore taxable.

There is a presumption in law in favour of the validity of an assessment and the onus of proof lies upon an appellant to show that the factual basis upon which it rests is wrong. [1] To the extent that an appellant’s evidence establishes on a balance of probability that errors in the factual basis were made by the respondent in his assessment they must be corrected. For an assessment to be valid it must have been made on proper grounds. It is not within the ambit of the respondent's authority to assign to an amount the character of income if all the relevant circumstances established that it was not derived from an income yielding source, or was not an amount that is deemed to be income under the provisions of the Act.

I will deal first with the question of “principal residence”. The respondent's position is that the René Coty property was not the appellant's principal residence and consequently its disposition gave rise to a taxable capital gain. He relies on certain documents which came to his attention such as a notarial declaration made by the appellant in April 1979 in respect of the settlement of her husband's estate in which she gave her residence as 1955 Emmanuelle Street; her income tax return for 1979 and 1980 in which she showed her residence to be 949 Melville Street (the apartment) and other personal papers.

By using the expression “principal residence" Parliament has recognized that while a person may have more than one residence only the gain realized on the disposition of a taxpayer's "principal residence" is exempt from tax. Paragraph 54(g)(i) refers to a housing unit which is "ordinarily inhabited” in the year by the taxpayer. This to me implies much more than a place where one would visit occasionally or use for certain purposes other than ordinary habitation. The determination of which one of many residences may be a taxpayer's “principal residence" must be done in the light of all the circumstances. I do not believe that because the appellant gave one of them as a mailing address this is of itself conclusive respecting the issue of “principal residence" for the purpose of the Act.

The Shorter Oxford English Dictionary defines "inhabit": to dwell in, occupy as an abode. The New Webster Encyclopedia Dictionary of the English Language also defines "inhabit": To live or dwell in; to occupy as a place of settled residence. The word inhabitant is defined as: One who inhabits; one who dwells or resides permanently in a place, as distinguished from an occasional visitor.

Moving in with her son and his family after her husband passed away and living in a house that she owned and listing the house on Emmanuelle Street for sale are strong indications of her intention to cease to reside in the Emmanuelle Street house. The fact that in 1978 and 1979 she still had her house on Emmanuelle Street and after its sale that she rented an apartment that she used to store some of her furniture and which she kept in the event that the living arrangements with her son had to be changed cannot detract from the basic fact that during all those years she was living permanently and on a regular basis, that is not as a visitor, but as a resident at 4688 René Coty. This is what the word inhabiting means. After her husband died the appel- lant never slept at the house on Emmanuelle Street oi at the apartment on Melville Street. At the time of the hearing she was still living with her family in a new house that she had constructed after she sold the one on Rene Coty Street.

I have no hesitation in concluding that the appellant's principal residence during her 1980 taxation year was 4688 René Coty and its disposition does not give rise to a taxable capital gain, it being exempt under the provisions of paragraqph 40(2)(b).

With regard to the second issue of whether the respondent was right in assessing the appellant on alleged unreported income of $62,505.87, I cannot accept his decision having regard to the jurisprudence and the facts that were revealed in evidence.

According to a document filed as an exhibit and prepared by a Mr. Lorenzo Mancini of the special investigation branch of Revenue Canada it was alleged that there was an unexplained increase in the appellant's capital of an amount of $73,655.87. That conclusion triggered the assessment under appeal under which $62,505.87 was added to the appellant’s income together with the taxable portion of what was regarded as a capital gain on the sale of 4688 René Coty amounting to $11,150. In my view there is a fundamental error in Mancini's approach. In his computation of the appellant's net worth as of December 31, 1979, which he established at $113,468.13 the René Coty house was listed at $53,200 including land. In her net worth as of December 31, 1980 that house which had been sold during that year is not shown as an asset at the end of the year, but its net selling price was $75,500 which in my opinion accounts for an increase in her capital for 1980 of $22,300 for which the appellant has not been given any credit. Taking this amount into account leaves a deficit in her net worth of $73,655.87 — $22,300.00 $51,355.87.

To explain the source of that apparent deficit the appellant claimed that the money had been given to her by her brother-in-law as related before. If I accept her version of this strange but not entirely impossible account of the source of her capital in 1980 it fills most of the gap alleged by the respondent. The deficit of $73,655.87 is reduced by $22,300 and by $48,994 or for a total of $71,294 leaving a minor difference of $2,361.76 which could be accounted for merely by the inherent lack of accuracy of the net worth process in computing a net worth.

If, however, I do not accept the appellant's submission as to the source of her capital, there is no evidence before me that the amount of $51,355.87 ($73,655.87 - $22,300) is traceable to a source of income either as earned, investment employment or as the taxable portion of a capital gain resulting from the sale of a capital asset. Her employment income as declared in her income tax return was accepted by the respondent. She testified that she never carried on a business of any kind or never engaged in an adventure in the nature of trade. The respondent did not challenge her evidence and furthermore did not discover any unaccounted additional assets of the appellant in the course of his investigation.

As I said before whether or not I accept the appellant’s evidence as to her source of capital, and I am not prepared to reject it, I am satisfied that she has met the challenge that was incumbent upon her regarding the validity of the assessment under appeal. Based on the balance of probabilities taking into account her age, her state of health and her evidence before this Court I accept that the amount of $62,505.87 was not income that she earned or received during the 1980 taxation year. In the absence of evidence that the amount in question was generated by an income yielding source which would account for the increase in her net worth and support the basis for the assessment, or that it is reasonable to assume that it could have been generated from such a source, I have no option but to accept her version of the source of her additional capital in the taxation year under appeal. Notwithstanding its unusual or staggering nature, it provides the only logical explanation under the circumstances. Otherwise to accept the validity of the assessment would require an arbitrary determination that the amount in question was income for the 1980 taxation year, a conclusion that would be contrary to fundamental legal principles.

Admittedly the respondent is vested with wide powers under the Act but none that allows him to convert capital into income. His right to determine a taxpayer's income for a taxation year on the basis of a net worth analysis cannot be denied, but the exercise of such a determination must be in compliance with the provisions of the Act and in accordance with the principles laid out in the jurisprudence. To issue an assessment knowingly which does not meet this test amounts to abusing the application of the pronouncement of the Supreme Court of Canada referred to above that the onus of challenging the validity of an assessment rests with the appellant. [2]

In my opinion the evidence adduced at the hearing demonstrates clearly that the respondent's decision of assessing the increase in the appellant's net worth as income for the 1980 taxation year was not reached on sound and fundamental principles of law. In so far as the amount of $62,505.87 is concerned there was no information before the respondent at the time of the assessment which could lead to a conclusion that this amount in question was income of the appellant or even that on the balance of probabilities it could be suspected of being income. It was purely an arbitrary decision on his part.

As to the remainder $11,150 which was the alleged taxable gain portion realized on the sale of her principal residence, the said amount is exempt from taxation under the provisions of paragraph 40(2)(b).

The appeal for the 1980 taxation year is allowed. The appellant is entitled to her costs on a party-and-party basis.

Appeal allowed.