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Docket: 1999-5090(IT)G 2000-271(IT)G 2000-272(IT)G |
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BETWEEN: |
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DANIEL GEHRES JR., |
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Appellant, |
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and |
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HER MAJESTY THE QUEEN, |
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Respondent. |
____________________________________________________________________
Appeals heard on June 25, 2002, at Toronto, Ontario, by
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the Honourable Justice E.A. Bowie |
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Appearances: |
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Counsel for the Appellant: |
Ian Morris and Robert Winters |
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Counsel for the Respondent: |
Marie-Thérèse Boris and Brianna Caryll |
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AMENDED JUDGMENT
The appeals from reassessments of tax made under the Income Tax Act for the 1995, 1996 and 1997 taxation years are allowed and the reassessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that that the Appellant is not subject to the additions to his income made under subsection 74.1(2) of the Act, but is subject to the additions made under paragraphs 6(1)(e) and 6(1)(k). The Appellant is entitled to one set of costs only.
Signed at Ottawa, Canada, this 1st day of August, 2003.
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"E. A. Bowie" |
Bowie J.
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Citation: 2003TCC471 |
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Date: 20030707 |
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Docket: 1999-5090(IT)G 2000-271(IT)G, 2000-272(IT)G
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BETWEEN:
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DANIEL GEHRES JR.,
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Appellant, |
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and |
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HER MAJESTY THE QUEEN, |
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Respondent. |
REASONS FOR JUDGMENT
Bowie J.
[1] These three appeals are brought from reassessments of the Appellant's liability for income tax for the 1995, 1996 and 1997 taxation years. By those reassessments the Minister of National Revenue (the Minister) added to the Appellant's income, as previously assessed, certain amounts that he considered were deemed to be income of the Appellant by reason of subsection 74.1(2) of the Income Tax Act (the Act). That subsection reads:
74.1(2) Where an individual has transferred or lent property, either directly or indirectly, by means of a trust or by any other means whatever, to or for the benefit of a person who was under 18 years of age (other than an amount received in respect of that person as a consequence of the operation of subsection 122.61(1)) and who
(a) does not deal with the individual at arm's length, or
(b) is the niece or nephew of the individual,
any income or loss, as the case may be, of that person for a taxation year from the property or from property substituted therefor, that relates to the period in the year throughout which the individual is resident in Canada, shall be deemed to be income or a loss, as the case may be, of the individual and not of that person unless that person has, before the end of the year, attained the age of 18 years.
[2] The amounts in question are $58,460 for 1995, $41,670 for 1996 and $41,006 for 1997. The Appellant also appealed in respect of additional amounts of $4,841, $5,118 and $4,963 that the Minister added to his income in respect of his use of a company vehicle, but at the commencement of the hearing his counsel abandoned that aspect of the appeals.
[3] The Appellant has been very successful in the business of selling and installing windows and doors. A corporation called 528094 Ontario Limited, which was referred to in the evidence as "Associates", carried on the installation side of the business. The Appellant was the owner of its only issued and outstanding share. At the end of October 1994, with the advice and assistance of his accountants and his lawyers, the Appellant took steps to reorganize his corporate business structure in the following way:
1. On October 28, Associates declared a stock dividend of $100, which was paid by issuing 625,000 Class A Special shares to the Appellant, and adding $100 to Associates' stated capital account;
2. The Appellant transferred these shares to 1102486 Ontario Ltd. (Holding) in exchange for 100 common shares of Holding, pursuant to subsection 85(1) of the Act. By a joint election, Holding added $100 to its stated capital account, and the fair market value of the 100 shares was noted to be $625,000;
3. On October 31, Associates redeemed the 625,000 Class A Special shares held by Holding, paying the redemption amount of $625,000 by transferring to Holding two term deposits issued by Canada Trust. One of these had a face value of $500,000, bore interest at 9.75%, and matured on November 1, 1996. The other had a face value of $125,000, bore interest at 9.5% and matured on November 1, 1995. The holder of these deposits was entitled to cash them on demand, but subject to an adjustment of the rate of interest;
4. The Appellant incorporated Lionsight Holdings Ltd. (Lionsight) on October 28. On October 31, Holding subscribed for 625,000 Class A preference shares in Lionsight at $1.00 per share and paid for them by transferring the term deposits to Lionsight. These Class A preference shares had the right to vote, and to receive non-cumulative monthly dividends at the rate of 0.5% of the redemption price. The redemption price was subject to a price adjustment clause that permitted the directors to adjust the price to conform to the fair market value of the consideration for which they were issued, as determined by the Minister.
5. The Gehres Family Trust (the Trust) had recently been settled by the Appellant's mother-in-law, with capital of $100. The trustees were the Appellant and his wife, and the beneficiaries as to the income of the Trust were his minor children. On October 31, the Trust subscribed for 100 common shares of Lionsight, which was all of its issued and outstanding common shares.
[4] Thereafter, Lionsight used the interest it earned on the term deposits to declare and pay dividends of approximately $58,460 in 1995, $41,670 in 1996 and $41,006 in 1997 on the 100 common shares held by the Trust. The Trust distributed this income to the beneficiaries, who were taxed on it under subsection 104(13). It is these amounts that were added to the Appellant's income by the reassessments under appeal.
[5] This reorganization was carried out under the direction of Mr. Reginald Leftwick, C.A., a Toronto accountant. He testified that there were four objects that he sought to attain by the reorganization. These were to dissociate the two operating companies, to take advantage of the available capital gain exemption, to remove the investment income earned by the term deposits from the operating company that held them, and to split the income from the business and the term deposits between Mr. Gehres and his children. The first three of these objectives were accomplished by Mr. Leftwick's plan without adverse tax consequences. However, the Minister took the view that when Holding exchanged its two term deposits for the 625,000 Class A preference shares of Lionsight the Appellant became subject to the application of the deeming provision found in subsection 74.1(2). In reaching this conclusion, the Minister was applying the decisions of the Federal Court of Appeal in The Queen v. Kieboom[1] and Romkey et al. v. The Queen[2]. Those cases stand for the proposition that an individual who, through a series of transactions, causes the value of his interest in a corporation to be reduced and the value of a beneficial interest held by his children to increase effects an indirect transfer of property to his children within the meaning of subsection 74.1(2).
[6] There was a good deal of discussion at the trial about the relative values of the term deposits and the non-cumulative preference shares of Lionsight that were exchanged for them. Two things are clear from the evidence. One is that the total dividends actually declared on the preference shares amounted to much less than the total dividends declared on the 100 common shares. The other is that the Minister at no time attempted to establish a value for either the term deposits or the preference shares, and no witness was called by either party to give evidence as to their values. Nevertheless, I have reached the conclusion that subsection 74.1(2) has no application in the present case, by reason of subsection 74.5(1), which, so far as it is relevant, reads:
74.5(1) Notwithstanding any other provision of this Act, subsections 74.1(1) and (2) and section 74.2 do not apply to any income, gain or loss derived in a particular taxation year from transferred property or from property substituted therefor if
(a) at the time of the transfer the fair market value of the transferred property did not exceed the fair market value of the property received by the transferor as consideration for the transferred property;
[7] As I have said, there was no evidence led at the trial as to the value of either the term deposits or the preference shares that were issued for them by Lionsight. However, counsel for the Respondent wrote on June 10, 2002, to counsel for the Appellant for the purpose of answering certain undertakings given during the examination for discovery of an officer of the Crown. That letter contains the following sentence:
The "properties" transferred were either the term deposits or the preferred shares, the values of which are equal.
Counsel sought to withdraw this admission during oral argument. However she put no evidence before me to show that the fact admitted was incorrect and that the admission resulted only from inadvertence, and I therefore declined to permit the admission to be withdrawn. The Appellant went to trial on the basis of that admission, and he is entitled to the benefit of it. The result is that paragraph 74.5(1)(a) precludes the operation of subsection 74.1(2) in the circumstances of the present case.
[8] That does not end the matter, however, as the Crown sought to advance an alternative position in support of the assessment, based upon subsection 74.4(2), which reads:
74.4(2) Where an individual has transferred or lent property, either directly or indirectly, by means of a trust or by any other means whatever, to a corporation and one of the main purposes of the transfer or loan may reasonably be considered to be to reduce the income of the individual and to benefit, either directly or indirectly, by means of a trust or by any other means whatever, a person who is a designated person in respect of the individual, in computing the income of the individual for any taxation year that includes a period after the loan or transfer throughout which
(a) the person is a designated person in respect of the individual and would have been a specified shareholder of the corporation if the definition "specified shareholder" in subsection 248(1) were read without reference to paragraphs (a) and (d) of that definition and if the reference therein to "any other corporation that is related to the corporation" were read as a reference to "any other corporation (other than a small business corporation) that is related to the corporation",
(b) the individual was resident in Canada, and
(c) the corporation was not a small business corporation,
the individual shall be deemed to have received as interest in the year the amount, if any, by which
(d) the amount that would be interest on the outstanding amount of the loan or transfer of the property for such periods in the year if the interest were computed thereon at the prescribed rate of interest for such periods
exceeds the total of
(e) any interest received in the year by the individual in respect of the transfer or loan (other than amounts deemed by this subsection to be interest),
(f) 5/4 of all taxable dividends received (other than dividends deemed by section 84 to have been received) by the individual in the year on shares that were received from the corporation as consideration for the transfer or as repayment for the loan that were excluded consideration at the time the dividends were received or on shares substituted therefore that were excluded consideration at that time.
It was made quite clear at trial that this alternative argument formed no part of the Minister's assessing position, but is advanced as an afterthought. Indeed, the assessor, in giving his evidence as to the amounts of tax that would be exigible under this alternative position in each of the three years under appeal, stated that he had made the computations only the night before the trial began. The position taken by counsel for the Appellant is that the Minister's alternative position was not pleaded, or at least not adequately pleaded, and therefore cannot be advanced at trial. For the reasons that follow, I agree with that submission.
[9] The Reply to the Notice of Appeal filed by the Respondent in each of the appeals, refers only briefly and obliquely in Part A. Statement of facts, paragraph 2 to the alternative argument:
2. Save that he denies that the series of transactions which are the subject of this appeal were part of a corporate reorganization, and states that they were merely a scheme in the Appellant's effort to transfer income to non-arm's length parties, he admits the facts stated in paragraphs 4, 5, 6, 10 and 13 of the Notice of Appeal.
Assumptions of fact are pleaded in some detail in paragraph 8, but all of them are directed to the Minister's assessing position based upon subsection 74.1(2), and to the facts relating to the automobile standby charge issue. No additional facts relating to the application of section 74.4(2) are pleaded, as assumptions or otherwise. In particular, there is no allegation that one of the main purposes of the transfer of property may reasonably be considered to be to reduce the income of the Appellant and to benefit a designated person. Nor is there any allegation as to the computation of the income that the Minister alleges to be the deemed income of the Appellant under the subsection. The issues are stated under Part B. issues to be decided as follows:
9. The main issue is whether the Appellant has transferred property, either directly or indirectly, by means of a trust or by any other means whatsoever, to or for the benefit of a person who was under 18 years of age who did not deal with the Appellant at arm's length, such that the income from the property is attributable to the Appellant pursuant to subsection 74.1(2) of the Act.
10. The second issue is whether the Appellant has properly been assessed a standby charge and operating benefit pursuant to paragraphs 6(1)(e) and 6(1)(k) of the Act.
There is no reference at all to the proposed alternative argument. In Part C. Statutory Provisions, Grounds Relied On, and Relief Sought, subsection 74.4(2) is mentioned in a list of nine different provisions of the Act that the Deputy Attorney General of Canada says he relies on. There is no other reference at all to the alternative argument that the Respondent's counsel sought to advance at the trial. In my view, it cannot be said that the Appellant was given fair notice by this pleading of the issues, both factual and legal, that were involved in the proposed alternative argument.
[10] During the course of her argument, after the evidence and argument for the Appellant had been completed, the Appellant sought to deal with this deficiency in the pleading by requesting leave to amend the Replies by adding the allegations of fact and the proposed alternative argument that were missing. It would be wrong in the circumstances of this case to permit such an amendment.
[11] I should make it clear that Mr. Morris put his objection to the alternative position of the Respondent entirely upon the principles of pleading, and not upon the obiter of the Supreme Court of Canada in Continental Bank v. Canada[3] and the recently much-argued issue of the reach of subsection 152(9) of the Act, which was enacted in response to it. In its simplest form, the argument is that the pleading did not give adequate notice of the case to be met, and it is much too late at the end of the trial to seek to amend it. This is a subject on which authority abounds, but I need only refer to two. In The Queen v. Hollinger Inc.,[4] the Federal Court of Appeal dealt with a preliminary issue as to an amendment to the Crown's Reply to the Notice of Appeal advancing a new basis to support the assessment that had been permitted in the Tax Court proceeding. In delivering the unanimous reasons of the Court, Létourneau J.A. held that the Crown was entitled to raise the new argument in support of its assessment, and went on to say:[5]
... The respondent was fully and timely informed of [the new basis] and had ample time to prepare as the hearing of the appeal took place more than three and a half years later. All the relevant evidence was before the Tax Court judge.
In Transcanada Pipelines Limited v. The Queen,[6] the Federal Court of Appeal had to deal with the question whether more than one appeal could be brought by a taxpayer from one assessment. After concluding that only one appeal would lie, Rothstein J.A. said for the unanimous Court:[7]
... I do not rule out an amendment to a notice of appeal to raise additional issues, provided the amendment is timely and is sought in accordance with the Rules of the Tax Court. (emphasis added)
It certainly cannot be said that the proposed amendment to the Replies in the present case is timely, nor has it been sought in accordance with the Rules of the Court. If the Respondent had brought a motion prior to the opening of the trial for leave to amend the Replies, then Orders permitting the amendments could perhaps have been made, on appropriate terms. However, I am not prepared to give such leave in response to an extemporaneous request made in the course of final argument. It is simply too late to permit the new argument to be properly raised for the first time.
[12] The appeals will be allowed and the assessments referred back to the Minister for reconsideration and reassessment on the basis that the Appellant is not subject to the additions to his income made under subsection 74.1(2) of the Act, but he is subject to the additions made under paragraphs 6(1)(e) and 6(1)(k). The Appellant is entitled to one set of costs only.
Signed at Ottawa, Canada, this 7th day of July, 2003.
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"E.A. Bowie" |
E.A. Bowie J.
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CITATION: |
2003TCC471 |
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COURT FILE NO.: |
1999-5090(IT)G, 2000-271(IT)G and 2000-272(IT)G |
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STYLE OF CAUSE: |
Daniel Gehres Jr. and Her Majesty the Queen |
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PLACE OF HEARING: |
Toronto, Ontario |
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DATE OF HEARING: |
June 25, 2002 |
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REASONS FOR JUDGMENT BY: |
The Honourable Justice E.A. Bowie |
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DATE OF JUDGMENT: |
July 7, 2003 |
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APPEARANCES: |
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Counsel for the Appellant: |
Ian Morris and Ross Winter |
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Counsel for the Respondent: |
Marie-Thérèse Boris and Brianna Caryll |
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COUNSEL OF RECORD: |
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For the Appellant: |
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Name: |
Ian Morris and Robert Winters |
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Firm: |
Morris, Morris & Klein |
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For the Respondent: |
Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada |