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Docket: 2002-1265(IT)I |
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BETWEEN: |
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BALVINDER KHAIRA, |
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Appellant, |
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and |
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HER MAJESTY THE QUEEN, |
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Respondent. |
____________________________________________________________________
Motion and appeals heard on January 8 and 9, 2003,
at Vancouver, British Columbia,
By: The Honourable Justice M.A. Mogan |
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Appearances: |
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Agent for the Appellant: |
Prem C. Bhalla |
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Counsel for the Respondent: |
George Boyd Aitken and Roger Leclaire |
____________________________________________________________________
JUDGMENT
Upon motion by the Respondent at the commencement of the hearing for an Order quashing the purported appeals from assessments of tax made under the Income Tax Act for the 1997 and 1998 taxation years on the basis that no Notice of Objection had been served for either year;
It is ordered that the appeals from assessments of tax made under the Act for the 1997 and 1998 taxation years are quashed.
The appeals from assessments of tax made under the Act for the 1994 and 1995 taxation years are dismissed; and the appeal from the assessment of tax for the 1996 taxation year is allowed and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the following basis: (i) to exclude the amount of $7,116 from the Appellant's income (and excluding any loss carry-forward) because the Partnership did not have any farm business from which to allocate farm income; and (ii) to permit the Appellant to claim a possible loss (capital or non-capital, depending on the circumstances) with respect to the disposition of his 19,440 preferred shares to his RRSP.
Signed at Ottawa, Canada, this 5th day of February, 2004.
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"M.A. Mogan" |
Mogan J.
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Citation: 2004TCC118 |
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Date: 20040205 |
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Docket: 2002-1265(IT)I |
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BETWEEN: |
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BALVINDER KHAIRA, |
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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
Mogan J.
[1] On November 30, 1994, the Appellant subscribed for five units in the Shyloh 1994-1 Limited Partnership (the "Partnership") at a price of $5,000 per unit for a total subscription price of $25,000. On the same day, the Appellant subscribed for 25 common shares in Shyloh 1994-1 Investments Ltd. (the "Corporation") at a price of one dollar per share for a total subscription price of $25.00. The Partnership and the Corporation held themselves out as having been formed "to carry on the business of acquiring, breeding, raising, showing, exhibiting and selling Straight Egyptian Arabian horses for the purpose of earning farming revenue". See Exhibit R-1, Tab 13. As a result of his investment in the Partnership and the Corporation, the Appellant deducted in computing income farm losses of $8,750 in 1994 and $6,250 in 1995. He also carried forward to 1996 a farm loss of $7,116.
[2] By Notices of Reassessment, the Minister of National Revenue disallowed the deduction of farm losses in 1994 and 1995, and also disallowed the loss carry-forward in 1996. The Appellant filed a Notice of Appeal dated March 12, 2002 claiming to appeal for the years 1994 to 1998. In the Reply, the Respondent alleged that the appeals with respect to 1997 and 1998 were invalid because no Notice of Objection had been served for either year; and the Respondent stated that an application would be made to the Court for an order quashing the appeals for 1997 and 1998. At the commencement of the hearing, the Respondent moved to quash. After hearing brief viva voce evidence, I granted the Respondent's motion and quashed the purported appeals for 1997 and 1998. The hearing then proceeded to determine the appeals for 1994, 1995 and 1996. The Appellant has elected the informal procedure.
[3] The Appellant states in his Notice of Appeal that he was told by Canada Customs and Revenue Agency ("CCRA") that the primary reason for his reassessment was that he did not have a reasonable expectation of profit with respect to the Partnership or the Corporation. The Appellant claims that his only reason for investing in the Partnership and the Corporation was to earn a profit. In the Reply to the Notice of Appeal, the Respondent does not rely on "reasonable expectation of profit" but raises other issues including:
(a) whether the Partnership was validly formed;
(b) whether the Partnership carried on a business;
(c) whether certain expenses deducted by the Partnership in computing income were incurred;
(d) whether certain shares transferred by the Appellant to his Registered Retirement Savings Plan ("RRSP") were "qualified investments" for purposes of the Income Tax Act (the "Act"); and
(e) whether the fair market value of such shares at the time of transfer to the RRSP exceeded $1,600.
The Facts
[4] The Appellant was born in India in 1959, and came to Canada when he was about 12 years old entering Grade 8 in a Canadian elementary school. He completed Grade 12 high school and has been employed ever since. In the years under appeal, he held a responsible position earning a salary in the range of $50,000 to $80,000. He also operated a small enterprise on the side placing pop (i.e. soft drink) machines in offices and office buildings. The Appellant is intelligent, hardworking and enterprising but not sophisticated in matters relating to investments or income tax.
[5] The Appellant was shown an Offering Memorandum (Exhibit R-1, Tab 13) inviting prospective investors to subscribe for 250 "combined interests" on the basis that each combined interest consisted of one unit ($5,000) in the Partnership and five common shares ($5.00) in the Corporation. The Offering Memorandum is an intimidating document of about 75 pages drafted like a prospectus but containing the following two cautions on the first page:
No securities commission or similar authority in Canada has in any way passed upon the merits of the securities offered in the present offering memorandum or reviewed this offering memorandum and any representation to the contrary is an offence.
THE SECURITIES OFFERED HEREBY ARE SPECULATIVE. There is no market for these securities so that it may be difficult or even impossible for the holders to sell them. The resale or transfer of the Units and Common Shares is subject to the restrictions imposed by the Securities Act (British Columbia) ... and, in the case of the Units, by the Limited Partnership Agreement. Holders of Combined Interests may not be able to liquidate their investment; their purchase should be considered only by investors who are able to make long-term investments and who are able to accept the risks inherent in the breeding of horses. ...
These are standard cautions in a private offering of securities which are not described in a prospectus filed with a provincial securities commission for review.
[6] The Offering Memorandum specified that the minimum subscription for a resident of British Columbia was $25,025 representing five Partnership units ($25,000) plus 25 common shares ($25.00) of the Corporation. Because the Appellant resided in British Columbia, he made the minimum investment of $25,025. Exhibit R-4 comprises six documents which may be described briefly as follows:
(a) a subscription for 5 Partnership units for a total subscription price of $25,000 tendering a cheque for $18,750.
(b) a subscription for 25 common shares of the Corporation for a total subscription price of $25.00 tendering a cheque for $25.00.
(c) a loan application in which the Appellant applies to Shyloh Ranches Ltd. to borrow $6,250 being the unpaid balance of the subscription price for the units. Shyloh Ranches Ltd. is a wholly owned subsidiary of Shyloh Management Ltd. which is the general partner of the Partnership.
(d) a promissory note for $6,250 signed by the Appellant in favour of Shyloh Ranches Ltd.
(e) an acknowledgement in Form 20A under the B.C. Securities Act with respect to 25 (sic) units in the Partnership.
(f) an acknowledgement in Form 20A under the B.C. Securities Act with respect to 25 common shares in the Corporation.
All of the above six documents are dated November 30, 1994 indicating that they were signed by the Appellant at Surrey, B.C. on that date.
[7] The two acknowledgements described as items (e) and (f) in paragraph 6 above each contain a statement along the following lines:
The Purchaser by virtue of his net worth and investment experience, or his consultation with a person who is not an insider of the issuer, but who is a registered advisor or dealer, is able to evaluate the prospective investment on the basis of information provided by the issuer.
I have already stated that the Offering Memorandum is an intimidating document of 75 pages. My appraisal of the Appellant from his oral testimony is that he is not sophisticated in matters relating to investments. He does not appear to have significant capital because (i) he borrowed $6,250 from Shyloh Ranches Ltd.; and (ii) he stated that the down payment of $18,750 was obtained partly from personal savings and partly from a loan. The Appellant further stated that he recalled seeing the Offering Memorandum but did not examine the details and could not recall how the Partnership was going to earn a profit. Although the Appellant signed both acknowledgments (e) and (f), I think he is not the kind of person who was able to evaluate the investment in the Partnership and Corporation on the basis of information provided in the Offering Memorandum.
[8] During his examination-in-chief, the Appellant said that he was shown the plan (I think he meant the Offering Memorandum); he was not under any pressure to subscribe; the document showed that it was about horses; he was willing to take the risk; and he thought that the expected profit outweighed the risk. He stated that the was not an accountant and so he trusted the documents. In cross-examination, he was shown Exhibit R-2, Tab 35 with the title "Reconciliation of Limited Partnership Losses of Prior Years". It is a table which was provided to the Appellant by the Partnership. The table lists the years 1990 to 1996 but amounts are entered for only 1994, 1995 and 1996. I therefore conclude that it was provided to the Appellant sometime after December 31, 1996. The amounts shown in Exhibit R-2, Tab 35 (on a per partner basis) may be summarized as follows:
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1994 |
1995 |
1996
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A Cumulative losses beginning of year |
$ -0- |
$6,250 |
$10,000
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B Current year losses |
15,000 |
10,000 |
-0-
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C Subtotal |
15,000 |
16,250 |
10,000
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D Deducted in the year |
8,750 |
6,250 |
7,116
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E Cumulative losses end of year |
6,250 |
10,000 |
2,883 |
[9] Because the Partnership showed actual losses in 1994 and 1995 (line B in above table), and because the losses were regarded as derived from farming, the Appellant deducted only the restricted farm loss under section 31 of the Act. That explains the amounts deducted in 1994 and 1995 in line D of the above table. For 1996, the Appellant reported farming income of $7,116 (see Exhibit R-1, Tab 3); and so he carried forward and deducted prior year losses of only $7,116 (line D in above table) to offset the farming income reported for 1996. It is not clear from the amounts shown in the Appellant's 1996 income tax return (Exhibit R-1, Tab 3) that he actually carried forward a prior year loss of $7,116. Line 150 shows total income of $62,808. Lines 208 to 232 show total deductions of only $20,852 leaving a balance of $41,956. But in line 260, the Appellant shows taxable income of $34,840; and he can get down to that amount only by deducting an additional $7,116 which is not in fact shown on line 251 or 252 of the return.
[10] According to paragraph 8 of the Respondent's Reply to the Notice of Appeal, the Minister reassessed the Appellant in respect of the 1996 taxation year to disallow a restricted farm loss carry-forward of $3,750. I cannot find any evidence to explain the discrepancy between the amount $3,750 in the Respondent's pleading and the amount $7,116 which I conclude the Appellant deducted in 1996 as a loss carry-forward. In my view, the relevant amount is $7,116.
[11] Having regard to the evidence of the Appellant's income and financial circumstances, his investment of $18,750 cash and his obligation to pay a promissory note of $6,250 (Exhibit R-4) were significant transactions. The substance of the promissory note states:
FOR VALUE RECEIVED BALVINDER S. KHAIRA (the "Borrower") hereby promises to pay to or to the order of Shyloh Ranches Ltd. (the "Lender") at 200-1465 Ellis Street, Kelowna, British Columbia V1Y 2A3 or at such other address as the Lender may designate in writing, the principal amount of (1) SIX THOUSAND TWO HUNDRED & TWENTY-FIVE DOLLARS (sic) ($6,250.00) on that date which is forty-five (45) days after the date of the issuance of preferred shares by Shyloh 1994-1 Investments Ltd. upon the transfer of assets from Shyloh 1994-1 Limited Partnership or, in the event that the said preferred shares are not issued by February 15, 1996, on February 15, 1996. The principal amount shall bear interest as and from the due date at the rate of 12% per annum.
In the Appellant's loan application (also part of Exhibit R-4), there is a provision that the loan amount shall not bear interest prior to maturity. I conclude from the terms of the promissory note that its due date or maturity was February 15, 1996 or 45 days after the issuance of certain shares by the Corporation if those shares were issued by February 15, 1996. In other words, the due date of the promissory note could be earlier than but not later than March 31, 1996 (February 15 plus 45 days). After the due date, the loan amount would bear interest at 12% per annum.
[12] The promissory note refers to a transfer of assets from the Partnership to the Corporation in exchange for shares. The Offering Memorandum describes that transfer in greater detail. At page 1:
It is proposed that the Limited Partnership will carry on business until approximately January 15, 1996. Subject to approval by the Limited Partners, the assets of the Limited Partnership will then be transferred to the Corporation (the "Asset Transfer"). In consideration of the Asset Transfer, the Corporation will assume all of the liabilities of, and will issue preferred shares (the "Preferred Shares") to, the Limited Partnership. Within 45 days of the Asset Transfer, the Limited Partnership will be dissolved. Upon dissolution, the Limited Partners will receive all of the Preferred Shares on a pro rata basis. The Corporation will continue operations until December 31, 1999, at which time it will be dissolved. Prior to dissolution, the Corporation's assets will be liquidated in order to permit a final cash distribution on or before the dissolution date.
and at pages 3 and 4:
Subscribers will have the option of repaying the loan from Shyloh Ranches by remitting Class B Preferred Shares of the Corporation to Shyloh Ranches. Upon the proposed transfer of the business of the Limited Partnership to the Corporation on January 15, 1996, Class A and Class B Preferred Shares will be issued to the Limited Partnership. The Loan Application Form provides that each Limited Partner will remit to Shyloh Ranches, upon the dissolution of the Limited Partnership, Class B Preferred Shares having an aggregate redemption price equal to $1,250 per Unit subscribed, in full repayment of the loan. The Class A and Class B Preferred Shares of the Corporation are identical in all material respects.
If the Limited Partner does not wish to repay the loan by remitting Class B Preferred Shares to Shyloh Ranches as described above, he will be required to: (i) send a notice to that effect in prescribed form to Shyloh Ranches by January 15, 1996: and (ii) repay the loan on February 15, 1996. The Limited Partner will then receive Class A Preferred Shares of the Corporation. If the foregoing notice is not received by the Limited Partnership and Shyloh Ranches by January 15, 1996, Class B Preferred Shares will be automatically remitted to Shyloh Ranches in repayment of the loan.
[13] The Offering Memorandum is long but there is a summary of its provisions at pages 6 to 10. From that summary, I consider the following passages relevant:
Income Tax Considerations:
The Limited Partnership will use the cash method of computing income for income tax purposes and anticipates that there will be losses available to the holders of Units in 1994 and 1995. In certain circumstances, the Income Tax Act (Canada) restricts the deductibility from other sources of income of a taxpayer's share of losses from a farming business. ...
Income Tax Deductions:
The table below sets forth, based on a maximum offering hereunder the estimated 1994 and 1995 income tax deductions, income tax savings, and income tax savings as a percentage of total investment for individuals who are British Columbia resident taxpayers who subscribe for five Units for an investment of $25,000 ... and who are Limited Partners on the last day of the Limited Partnership's 1994 and 1995 fiscal periods. ...
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1994 |
1995
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Investment |
$25,000 |
- |
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Loss Allocated to Limited Partner |
15,000 |
10,000 |
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Income Tax Deductions - 100% of first $2,500 |
2,500 |
2,500 |
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- 50% of balance (up to $6,250) |
6,250 |
3,750 |
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$8,750 |
$6,250
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Cumulative Income Tax Savings* |
$4,739 |
$8,124 |
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Cumulative Income Tax Savings as a % of Total Investment |
19.0% |
32.5% |
* Income tax savings assume that the income tax deductions are claimed at the highest marginal rate. The combined highest marginal rate in 1994 is 54.16% in British Columbia. ...
Although the Offering Memorandum was printed and circulated in October 1994, it accurately "estimated" the amount of loss which would be allocated to each limited partner in 1994 and 1995. The amounts in the table in paragraph 8 above showing for 1994 and 1995 actual losses in line B and losses actually deducted in line D match precisely the amounts estimated (loss to be allocated and loss available to be deducted) in the Offering Memorandum as quoted in this paragraph.
[14] It is apparent from the Offering Memorandum that the Partnership would have a limited life span. The Memorandum was dated October 1994 inviting subscriptions for combined interests. The Appellant signed his subscriptions and promissory note; and delivered his cheque for $18,750 on November 30, 1994. See Exhibit R-4. The Memorandum stated on page one:
It is proposed that the Limited Partnership will carry on business until approximately January 15, 1996. ... the assets of the Limited Partnership will then be transferred to the Corporation (the "Asset Transfer"). ... Within 45 days of the Asset Transfer, the Limited Partnership will be dissolved. ...
According to the terms of the Offering Memorandum, the Appellant could not expect to be a member of the Partnership for more than 15 months because he became a limited partner only on November 30, 1994 and the Partnership was, at that time, intended to be dissolved not later than February 29, 1996 (45 days after January 15, 1996). The Offering Memorandum not only projected (in October 1994) losses allocated to each limited partner of $15,000 in 1994 and $10,000 in 1995 (see Exhibit R-1, Tab 13, page 9) but the Partnership lived up to that projection and actually allocated losses to each limited partner of $15,000 in 1994 and $10,000 in 1995 (see Exhibit R-2, Tab 35).
[15] Exhibit R-2, Tab 42 is an agreement dated December 30, 1994 between Montebello Farms Inc. as vendor and Shyloh Ranches Ltd. as purchaser relating to the sale and purchase of six Straight Egyptian Arabian mares and fillies described in Schedule "A" to the Agreement. The purchase price was $400,000 and the transaction was to close on or before December 31, 1994. Exhibit R-2, Tab 43 is the Bill of Sale (also dated December 30, 1994) with respect to the purchase by Shyloh Ranches Ltd. of the six mares and fillies. Exhibit R-2, Tab 36 is another agreement of purchase and sale dated December 30, 1994 between Shyloh Ranches Ltd. as vendor and the Partnership as purchaser relating to the same six mares and fillies. The purchase price was $400,000 and the transaction was to close on or before December 31, 1994. Exhibit R-2, Tab 37 is the Bill of Sale (also dated December 30, 1994) with respect to the purchase by the Partnership of the same six mares and fillies.
[16] Exhibit R-2, Tab 23 is an Amended and Restated Board and Care Agreement dated October 13, 1994 between Montebello Farms Inc. and the Partnership. Under this agreement, Montebello agrees to provide board and care for all horses owned by the Partnership for a fee of $525 per month "payable in advance at such time or times as may be determined by the parties" (paragraph 2). Exhibit R-2, Tab 45 is the financial statements of the Partnership as at December 31, 1994 showing livestock of $400,000 on the balance sheet. Note 3 to the balance sheet states that the livestock consists of three mares, two fillies and one en utero foal. The financial statements show nil sales, expenses of only $1,256 and a net loss of $1,256.
[17] Exhibit R-2, Tab 30 is the Revenue Canada Information Return of the Partnership for its fiscal period ending December 31, 1994. Attached to the Information Return is a "Reconciliation of Net Loss per Financial Statements to Net Farming Loss for Income Tax Purposes". The reconciliation shows how a modest loss of $1,256 in the financial statements is transformed into a net farming loss of $270,000 for 18 partners, or $15,000 per limited partner. This is the amount of loss for 1994 which caused the Appellant to deduct $8,750. See paragraph 8 above. In the reconciliation, two significant deductions are (i) the accounting value of the inventory at December 31, 1994 stated as $400,000; and (ii) prepaid expenses at December 31, 1994 stated as $135,000.
[18] There was no explanation for the prepaid expenses of $135,000 at December 31, 1994. It seems like a high amount for a purported farming operation which acquired its only livestock on December 30 just one day before the end of the fiscal period. Under the board and care agreement (Exhibit R-2, Tab 23), six horses at $525 per month would cost the Partnership as owner of the horses $3,150 per month. Prepaid board and care for a full 12 months would be $37,800. The prepaid expenses of $135,000 are puzzling and in need of explanation. The Appellant was not able to explain that amount. No witness appeared from the Partnership to explain that amount.
[19] Exhibit R-2, Tab 47 is the financial statements of the Partnership as at December 31, 1995 showing nil sales and a net loss of $82,913. Exhibit R-2, Tab 31 is the Revenue Canada Information Return of the Partnership for its fiscal period ending December 31, 1995. Attached to the Information Return is what purports to be a "Reconciliation of Net Loss per Financial Statements to Net Farming Loss for Income Tax Purposes". I say "purports to be" because it is simply not an reconciliation. The document in question commences with the word "loss" but no amount is entered where the financial statement loss of $82,913 ought to have been entered. The arithmetic on the remainder of the page is accurate but it blithely ignores the amount of the loss which it was intended to reconcile.
[20] It appears to me that the amount of $180,000 shown as a farming loss in the purported reconciliation statement is a flawed amount because of the total failure to reconcile it with the loss ($82,913) shown in the Partnership financial statements for 1995. There are, however, so many arbitrary adjustments in the so-called reconciliation statements that the general partner may have been able to achieve a net farming loss of $180,000 even if the financial statement loss of $82,913 had been included in the reconciliation statement. The omission of the amount $82,913 in the reconciliation statement is an indication of the casual, and perhaps careless, bookkeeping of the Partnership. I will comment on this later in these reasons.
[21] Exhibit R-2, Tab 32 is the Revenue Canada Information Return of the Partnership for its fiscal period January 1, 1996 to January 15, 1996. The period is only 15 days because the Partnership transferred its assets to the Corporation on January 15, 1996. This is confirmed in Note 2 to the financial statements of the Corporation for the fiscal period ending December 31, 1996:
2. ASSET TRANSFER
On January 15, 1996, the net assets of the Limited Partnership consisting primarily of livestock, were acquired by the Company as contemplated in the Offering Memorandum. As consideration for the net assets, the company issued 5,138 preferred shares at $1 each for each $5000 unit held in the Limited Partnership, representing a total of 462,438 preferred shares. The preferred shares are redeemable by the Company at the issue price, together with unpaid cumulative dividends.
See Exhibit R-2, Tab 50
Returning to the Partnership Information Return (Exhibit R-2, Tab 32), the Partnership showed nil revenue for the first 15 days of 1996 but income of $128,102 identified as "Farming Income for period ending on dissolution". This amount of $128,102 was allocated among the 18 limited partners on the basis of $7,116 per partner. As stated above, the Appellant reported farm income of $7,116 on his 1996 income tax return and then carried forward a loss of $7,116 from prior years to offset the reported farm income.
[22] It is necessary to consider in more detail what happened when the assets of the Partnership were transferred to the Corporation. Exhibit R-2, Tab 41 is a copy of Revenue Canada form T2058 "Election on Disposition of Property by a Partnership to a Taxable Canadian Corporation" signed by Jim Ramsay on behalf of the Partnership and Corporation. This form showing the Partnership as transferor and the Corporation as transferee states that the assets were transferred on January 15, 1996. The particulars of the property transferred and the consideration received are recorded in form T2058 as follows:
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Property Transferred |
Fair Market Value |
Cost Amount
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Livestock |
$575,000 |
$193,584
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Consideration Received
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Loan payable |
$193,500 |
- |
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381,500 preferred shares |
381,500
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- |
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Total Consideration |
$575,000 |
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[23] The financial statements of the Corporation at December 31, 1996 (Exhibit R-2, Tab 50) state in Note 2 that, upon the transfer of assets from the Partnership to the Corporation, the Corporation issued 462,438 preferred shares on the basis of 5,138 preferred shares for each $5,000 unit in the Partnership. There had been 90 outstanding Partnership units at $5,000 each, of which the Appellant had held five such units. Accordingly, the Appellant received 25,690 preferred shares of the Corporation upon the dissolution of the Partnership. When the Appellant subscribed for five units in the Partnership for a total subscription price of $25,000, he borrowed $6,250 from Shyloh Ranches Ltd. and undertook to repay that loan with 6,250 preferred shares of the Corporation following the dissolution of the Partnership. After repaying the loan of $6,250 from Shyloh Ranches Ltd. with preferred shares, the Appellant was left with 19,440 preferred shares determined as follows:
|
Preferred shares received on dissolution of Partnership |
25,690
|
|
Preferred shares delivered to Shyloh Ranches Ltd. to repay loan |
6,250
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Remainder |
19,440 |
[24] I note in passing a discrepancy between the 381,500 preferred shares shown as part consideration in the Rollover Election form T2058 (Exhibit R-2, Tab 41) and the 462,438 preferred shares issued by the Corporation according to its 1996 financial statements (Exhibit R-2, Tab 50). The difference is 80,938 preferred shares. I do not see any apparent explanation for the difference.
[25] According to subparagraphs 12(tt) and (uu) of the Reply to the Notice of Appeal, the Minister assumed that the Appellant transferred (during 1996) his remaining 19,440 preferred shares to his self-directed RRSP and withdrew from his RRSP cash in the amount of $19,440. The Appellant did not deny that he executed with his RRSP this exchange of preferred shares for cash. Indeed, his Notice of Appeal states:
Shares of Shyloh were eligible for RRSP portfolio and were transferred to my RRSP. These were later disallowed by CCRA which resulted in my having lost the tax savings I deferred in 1996 and 1997 tax years. ...
Such a transaction was contemplated in the Offering Memorandum (Exhibit R-1, Tab 13) at page 8 where the following statement appears:
... The Limited Partnership's transfer of its business operations to the Corporation in exchange for Preferred Shares of the Corporation, and its subsequent distribution of those Preferred Shares to the Limited Partners on the dissolution of the Limited Partnership, can be done on a tax-deferred basis. Provided certain conditions are met, a Common Share or a Preferred Share of the Corporation will be a qualified investment for a registered retirement savings plan or registered retirement income fund of a shareholder. ...
The boldface words appear that way in the Offering Memorandum.
[26] To summarize, the following amounts are in dispute in these appeals:
|
1994 |
Deducted farm loss |
$8,750 |
|
1995 |
Deducted farm loss |
6,250 |
|
1996 |
Farm loss carry-forward |
7,116* |
|
1996 |
RRSP withdrawal |
19,440 |
* There is a collateral question, not stated in the pleadings, as to whether the Partnership had, in 1996, any farming income of which $7,116 could be allocated to the Appellant.
Valuation
[27] The farm losses in 1994 and 1995 and the farm profit in 1996 reported by the Partnership were based in substantial part on the cost of the horses purchased by the Partnership on December 30, 1994 and transferred to the Corporation on January 15, 1996. The Partnership showed no revenue in any of the periods ending December 31, 1994, December 31, 1995 or January 15, 1996. See Exhibits R-2, Tabs 45, 47 and 32. I therefore assume that the six horses purchased by the Partnership on December 30, 1994 were still on hand when the assets of the Partnership were transferred to the Corporation on January 15, 1996. The following statement appears on page four of the Offering Memorandum:
It will be a condition of any purchase that the purchase price paid by the Limited Partnership not be greater than the Fair Market Value of the horse in question, as determined by an independent valuation.
[28] The agreement dated December 30, 1994 under which the Partnership purchased six mares from Shyloh Ranches Ltd. (Exhibit R-2, Tab 36) stated the price at $400,000 (paragraph 2.1) but the price was not allocated among the six horses listed in Schedule "A" to the agreement as follows with their respective dates of birth ("DOB"):
|
Name |
DOB
|
|
Ak Su Sharafa |
04/10/86 |
|
VES Jamaara |
04/17/91 |
|
* CH Princess Pasha (1995 in utero) |
00/00/95 |
|
Imperial Mahreena |
06/09/92 |
|
G. Elizamara |
05/24/93 |
|
Prince's Last Love |
05/02/94 |
* Only the in utero foal is purchased (not the mare)
[29] Exhibit R-9 is a list of horse sales provided to a Revenue Canada auditor when she visited the offices of Shyloh Ranches Ltd. in 1998. The first page of Exhibit R-9 shows that the purchase price of $400,000 was allocated among the six horses as follows:
|
Ak Su Sharafa |
$95,000 |
|
VES Jamaara |
95,000 |
|
EAI Pasha's Jewel (foal of Princess Pasha) |
15,000 |
|
* Imperial Mahreena |
85,000 |
|
G. Elizamara |
55,000 |
|
Prince's Last Love |
55,000
|
|
|
$400,000 |
* The price allocated to Imperial Mahreena is different from the price
($95,000) shown for the same horse in the Offering Memorandum.
According to Exhibit R-8, a letter dated October 9, 1996 from Cabreah International Inc. to James Ramsay (Shyloh Ranches Ltd.), the Corporation did an exchange with Montebello Farms Inc. trading VES Jamaara for Moneeka.
[30] There is no evidence that the purchase price of $400,000 paid by the Partnership on December 30, 1994 for six horses was determined by an independent valuation as required by the Offering Memorandum. See paragraph 27 above. Quite the contrary! The Respondent called an expert witness who stated her opinion that the fair market value of the six horses on December 30, 1994 was substantially less than $400,000. Exhibit R-10 contains the written report of Janet Henderson expressing her opinion with respect to the five mares actually purchased by the Partnership on December 30, 1994, the foal which was born March 8, 1995 to C.H. Princess Pasha, and the mare Moneeka which was later received in exchange for VES Jamaara.
[31] The resumé of Janet Henderson is also part of Exhibit R-10. She has been in the Arabian horse industry for 27 years. She and her husband own a breeding and training facility in Ontario. She belongs to a number of equestrian associations and is recognized as a Nationals/Regionals judge with the International Arabian Horse Association. Her qualifications were not challenged in Court. I have no hesitation in accepting Janet Henderson as an expert witness qualified to express her opinion with respect to the fair market value of Arabian horses. She introduced her report with the following overview of market conditions for Straight Egyptian Arabian Horses in December 1994:
The Arabian horse marketplace saw steadily rising prices through the late 1970's and the early 1980's, and peaked in 1984. The second half of 1985 saw a trend of decline and after the U.S. tax reform in 1986, the average price for Arabians dropped by 30% to 50% per year. The decline bottomed out in the 1990 - 1991 period.
In 1992, overall prices were buoyed by the Gleannloch Final Legacy Sale. In 1994, prices for Egyptian Arabians averaged $6,191.00 USD, while the First Annual Scottsdale Egyptian Sale averaged $6,843.00 USD per head. This sale showed a high selling price of $19,000.00 USD. One stallion and one mare sold at this price, while the balance of mares were sold for an average of $5770.00 USD.
[32] Ms. Henderson provided a detailed description for each of the seven horses she appraised. Because she was engaged to do her appraisal around 2001 or 2002, it was difficult to view the horses themselves but she was able to examine their ancestry, their progeny, and how frequently they had been sold (and the prices) before and after December 1994. For each horse, she expressed her value as between two amounts. In the table below, I have summarized her seven valuations including her range of value for each horse and, in the extreme right column, I have stated the midpoint value within her range.
|
Name |
Valuation Range |
Midpoint
|
|
Ak Su Sharafa |
$20,000 - $22,000 |
$21,000 |
|
VES Jamaara |
$10,000 - $12,000 |
11,000 |
|
Pasha's Jewel (foal of Princess Pasha) |
$ 8,000 - $10,000 |
9,000 |
|
Imperial Mahreena |
$30,000 - $32,000 |
31,000 |
|
G. Elizamara |
$10,000 - $12,000 |
11,000 |
|
Prince's Last Love |
$ 9,000 - $11,000 |
10,000 |
|
Moneeka |
$35,000 - $37,000 |
36,000 |
[33] In the preceding table, I included Moneeka only because it was appraised by Ms. Henderson. Moneeka was acquired by the Partnership in October 1996 in exchange for VES Jamaara. I will therefore exclude Moneeka from the value of horses purchased by the Partnership in December 1994. Excluding Moneeka, the total of the midpoint amounts for the first six horses listed in the table above is $93,000. This aggregate appraised value of $93,000 for the six horses purchased by the Partnership on December 30, 1994 is in sharp contrast with the purchase price of $400,000 paid by the Partnership. The difference of $307,000 is truly significant.
[34] Ms. Henderson's valuation report is dated December 8, 2002 and is part of Exhibit R-10. Also included as part of Exhibit R-10 is a letter dated December 10, 2002 from Ms. Henderson to CCRA in which she states:
I have operated a board and care facility for Arabian horses for twenty-four years. I am familiar with industry practices throughout North America, specifically with respect to the board and care of Arabian horses. As such, I feel that I am qualified to opine of the issue of the reasonable cost of board and care.
I charge $360.00 per month per horse for board and care. The reasonable range for the cost of board and care would be from $360.00 to $450.00 per month per horse. This amount could be increased to $1200.00 per month per horse with training for showing included.
It is not reasonable nor it is the normal business practice for the owner of a horse to prepay board and care for a period of two years.
Analysis
[35] The opinion evidence given by Janet Henderson was not contradicted by any expert witness called by the Appellant. I accepted Ms. Henderson as a well-qualified expert witness. In her appraisal of each horse, she took into account its sire and its dam; the performance of both the sire and dam as show or race horses; and the recorded performance of the progeny of the sire and the dam including sale prices where possible. She also had reference to the first Egyptian Arabian Sale in Scottsdale in February 1994, just 10 months prior to the valuation date. I find that Ms. Henderson's conclusions as to value are objective, balanced and fair. This is important when the opinion relates to fair market value.
[36] The unchallenged opinion evidence of Ms. Henderson is very damaging to the Appellant's case and to the whole Arabian horse farming proposal put forward by the Partnership and the Corporation in the Offering Memorandum (Exhibit R-1, Tab 13). According to the financial statements of the Partnership at December 31, 1994 (Exhibit R-2, Tab 45), 90 limited partnership units of $5,000 each were issued for a total cash consideration of $450,000. The Appellant purchased five of such units. The Offering Memorandum was dated October 1994. Therefore, it may be concluded that the 90 limited partnership units were issued or sold from October to December 1994. The Appellant purchased his five units on November 30, 1994. See Exhibit R-4.
[37] As soon as the limited partnership units were sold and most of the money was in hand, the general partner (Shyloh Management Ltd.) caused the Partnership to purchase six horses at an aggregate price of $400,000 when the fair market value of those six horses was only $93,000. If the person making the decisions for the general partner had little knowledge of Arabian horses, then that person made an imprudent and foolish purchase on behalf of the limited partners. The Partnership lost $307,000 by December 31, 1994 because it paid $400,000 for horses which were worth only $93,000.
[38] If the person making the decisions for the general partner had substantial knowledge of Arabian horses including knowledge of what they were worth on the open market, then that person cheated the limited partners (like the Appellant) by causing them to lose most of their capital through a deceitful purchase of horses. No one testified for or on behalf of the Partnership. There is not enough evidence in this case for me to conclude that the Appellant was the victim of a fraudulent scheme but there is plenty of evidence to conclude that the Appellant's appeals for 1994, 1995 and 1996 must be dismissed.
[39] The summary of the Offering Memorandum covers pages 6 to 10 and concludes with the following note on page 10 (Exhibit R-1, Tab 13):
Conflicts of Interest:
Mr. James Ramsay, the sole officer and director of the General Partner and of the Corporation, is also the sole officer, director and shareholder of Shyloh Ranches. Shyloh Ranches has entered into the Consulting Agreement with the General Partner whereby Shyloh Ranches will provide the services of Mr. Ramsay to assist the General partner in fulfilling its obligations to render management services to the Limited Partnership and to the Corporation. Potential conflicts of interest exist due to other business endeavours in the Straight Egyptian Arabian horse industry in which Shyloh Ranches may be involved. See "Management Interests and potential Conflicts of Interest".
The Appellant had no personal knowledge of what operation or activity (if any) the Partnership performed. He relied on what he was told when he invested his $18,750 and on what he might have read from the Offering Memorandum. I regret that Mr. James Ramsay did not come forward to testify as a witness in support of the Appellant's case. He might have been able to answer some of the following questions which I consider relevant:
1. What did Mr. Ramsay know about Arabian horses in December 1994 when the Partnership purchased six horses for $400,000?
2. Having regard to Ms. Henderson's overview of the market at the beginning of her report, did Mr. Ramsay know that prices of Egyptian Arabians averaged $6,191 (USD) in 1994? Did he know that the first Annual Scottsdale Egyptian Sale in February 1994 averaged $6,843 (USD)?
3. If Mr. Ramsay knew about the average prices of Arabian horses in 1994 as recited in the Henderson Report, why did he agree on behalf of the Partnership to purchase six horses for $400,000 (Can)?
4. If Mr. Ramsay did not have first-hand knowledge of the Arabian horse market in 1994, how could he hold himself out in the Offering Memorandum as a person on whom innocent investors like the Appellant could rely?
5. The Offering Memorandum stated at page 5 ("Purchase of Horses") that the Partnership will purchase from Montebello Farms Inc. the Straight Egyptian mare in Appendix "A" for $95,000. The horse in Appendix "A" is Imperial Mahreena. What does Mr. Ramsay say about Ms. Henderson's opinion that the fair market value of Imperial Mahreena in December 1994 was $31,000?
6. If Mr. Ramsay were to disagree with Ms. Henderson's valuation of Imperial Mahreena in December 1994, on what facts would he rely? Does he know if Imperial Mahreena was sold at arm's length at any time before or after December 1994?
7. Was Shyloh Ranches Ltd. at arm's length with Montebello Farms Inc. in December 1994 when the six mares were purchased for $400,000?
8. The Offering Memorandum at page 4 under the heading "Purchase of Horses" states that the purchase price paid by the Partnership for a horse will not exceed fair market value "as determined by an independent valuation". Did the Partnership ever obtain an independent valuation for any horse it purchased? If so, was the valuation expressed in writing? If it was in writing, why was the written report not produced in this case to support the Appellant's appeal? If the Partnership did not obtain an independent valuation for each horse that it purchased, why did Mr. Ramsay or the general partner fail to honour the undertaking given at page 4 of the Offering Memorandum?
9. Why was Shyloh Ranches Ltd. used first to purchase the six mares from Montebello Farms Inc. on December 30, 1994 (Exhibit R-2, Tab 42) and then to sell the same six mares on the same day at the same price to the Partnership (Exhibit R-2, Tab 36)? What does Mr. Ramsay say about signing Exhibit R-2, Tab 36, on behalf of both vendor and purchaser?
10. Where were the six horses kept in the period from December 30, 1994 to January 15, 1996? Where they boarded at Montebello Farms Inc.? Were the boarding fees prepaid? If so, why? Were the boarding fees prepaid so that the Partnership (on a cash basis for a farming operation) could show a significant loss in its first short fiscal period ending on December 31, 1994?
11. Was the Partnership ever intended to make a profit? If so, why was the profit element not emphasized or promoted in the Offering Memorandum? Why did the Offering Memorandum emphasize (as on page 9) only the loss to be allocated to each limited partner; the tax savings resulting from the deduction of such loss; and the tax savings as a percentage of the limited partner's investment?
12. If the Partnership lost $307,000 on the purchase of its first six horses, how could it possibly make a profit in its projected short life span from October 1994 to February 1996?
13. Did the Partnership operate a business? If so, what was the business? Did it keep any books or records? If so, where are they?
[40] With reference to question 13 above, a Revenue Canada auditor (Ms. Esther Dirksen) testified in this case. She stated that she attended at Shyloh Ranches Ltd. at Kelowna, B.C. in May 1998. She asked for the full accounting records of the Partnership but all she was given were closing general ledger entries as at December 31, 1994 and 1995. These entries appear as photocopies in Exhibit R-2, Tabs 46 and 48. In paragraphs 19 and 20 above, I described a purported reconciliation of the Partnership's net loss in its financial statements to its farming loss for tax purposes for the fiscal period ending December 31, 1995. Similarly, in paragraph 24, I noted a discrepancy of 80,938 preferred shares between the consideration in the rollover agreement and the issued shares according to the Corporation's financial statements. On the evidence before me, I conclude that the Partnership did not maintain books and records up to the standard one would expect from an organization which raised $450,000 from public subscriptions.
[41] I rely on the evidence of the Respondent's expert witness, Janet Henderson, because I found her to be intelligent, knowledgeable and objective. I am satisfied from her evidence that the fair market value of the six horses purchased by the Partnership on December 30, 1994 was $93,000 at the time of purchase. Because the Partnership paid $400,000 for six horses which had a fair market value of only $93,000, I find in the absence of contrary evidence that it was not possible for the Partnership to earn a profit at any time and, in particular, within the projected short life span of the Partnership from October 1994 to February 1996.
[42] I am also satisfied from Ms. Henderson's letter of December 10, 2002 (part of Exhibit R-10) that a reasonable range for the cost of board and care would be $360 to $450 per month per horse; and that it is not reasonable or normal for a horse owner to prepay board and care for a period of two years. Under the terms of a board and care agreement (Exhibit R-2, Tab 23) the Partnership agreed to pay to Montebello Farms Inc. $525 per horse per month for the board and care of the Partnership's horses, payable in advance. And according to the Partnership's financial statements at December 31, 1994 (Exhibit R-2, Tab 45), there were prepaid expenses of $135,000 which I conclude were at least in part for the board and care of horses. In the purchase agreement (Exhibit R-2, Tab 42), the purchase price of $400,000 was payable by Shyloh Ranches Ltd. to Montebello Farms Inc. by a promissory note. There is no evidence that the promissory note was secured.
[43] Having regard to the evidence and conclusions summarized in paragraphs 41 and 42, I draw the inference that the Partnership, Shyloh Ranches Ltd. and Montebello Farms Inc. did not deal with each other at arm's length at any time relevant to this case. Accordingly, I question the good faith of any transaction between or among those parties.
[44] I have already found in paragraph 41 that it was not possible for the Partnership to earn a profit at any time. Considering the terms of the Offering Memorandum, and the fact that all Partnership transactions were with either Shyloh Ranches Ltd. or Montebello Farms Inc., I find that the Partnership was never expected or intended to earn a profit. The Partnership was simply a custodian of certain documents which gave it the façade of "acquiring, breeding, raising, showing, exhibiting and selling" Arabian horses. On the evidence before me, the Partnership never took custody of a single horse. I find that the Partnership did not carry on any business in the period from October 1994 to that date in January 1996 when it purported to (and perhaps did in fact) transfer its assets to the Corporation.
[45] Because the Partnership did not carry on any business, it did not have any loss or profit to allocate to the limited partners in the years 1994, 1995 or 1996. Therefore, there was no farm loss for the Appellant (as a limited partner) to deduct in 1994 or 1995. And there was no farm income of $7,116 for the Appellant to report in 1996.
[46] The decision of the Federal Court of Appeal in Witkin v. The Queen, 2002 DTC 7044, is helpful because Mr. Witkin was claiming to deduct a certain loss allocated to him by a limited partnership. In dismissing Mr. Witkin's appeal, Rothstein J.A. writing for the Court stated in paragraph 15:
While a primary motivation of a taxpayer, in entering a purported partnership, may be to secure a tax loss, there must at least be an ancillary intention to carry on business in common with a view to profit for the test for partnership to be met. (See Continental Bank, supra, at paragraph 43.) In this case, the only evidence accepted by the Tax Court Judge was that the appellant was intending to, and did, purchase a tax loss. Applying the correct, low threshold, test for partnership to the facts as found by the Trial Judge, it is apparent that the appellant was not carrying on business in common with a view to profit in respect of his participation in Claridge Holdings No. 1. ...
[47] In my opinion, the above passage from Witkin applies to this case because the primary purpose of the Offering Memorandum was to promote the use of farm losses for tax purposes, and the possible sale of newly issued shares to an RRSP. See pages 8 and 9 of the Memorandum. The Appellant does not meet the "low threshold" test for partnership because he had no interest in using Arabian horses to operate a farming business for profit. Neither did the general partner and Mr. James Ramsay or they would not have permitted the Partnership to pay $400,000 for six horses having a fair market value of only $93,000.
[48] Considering the 19,440 preferred shares of the Corporation which the Appellant transferred to his RRSP in 1996, I find that those shares had no value. According to the financial statements of the Corporation as at December 31, 1996 (Exhibit R-2, Tab 50), the balance sheet showed a deficit of $152,032. This is not surprising when, according to the rollover election (Exhibit R-2, Tab 41), the Corporation paid $575,000 for livestock which probably had a fair market value of about $100,000. Because the Appellant transferred 19,440 worthless preferred shares into his RRSP and took out $19,440 in cash, he is required to include that $19,440 in his 1996 income.
[49] I have already observed that the Offering Memorandum is an intimidating document. It promotes the opportunity to deduct farm losses for income tax purposes, and the further opportunity to transfer newly issued shares to an RRSP in exchange for cash. The Appellant was attracted to these opportunities like a moth to a flame and paid out $18,750 of his own money. Using the cliché of a century ago, he bought the Brooklyn Bridge!
[50] On the one hand, a person might have some sympathy for an individual like the Appellant who is duped by a highly promotional document. On the other hand, the Offering Memorandum does not have a true ring, and common sense must be given some play in the open market. The appeals for 1994 and 1995 are dismissed. The appeal for 1996 is allowed (i) to exclude the amount $7,116 from the Appellant's income (and excluding any loss carry-forward) because the Partnership did not have any farm business from which to allocate farm income; and (ii) to permit the Appellant to claim a possible loss (capital or non-capital, depending on the circumstances) with respect to the disposition of his 19,440 preferred shares to his RRSP. I am not attempting to decide whether the Appellant realized such a loss, or whether he is entitled to deduct a capital or non-capital loss if the cost of such shares exceeded their value at the time of transfer to his RRSP. He is, however, at least entitled to claim such a loss if circumstances permit.
Signed at Ottawa, Canada, this 5th day of February, 2004.
|
"M.A. Mogan" |
Mogan J.
|
CITATION: |
2004TCC118 |
|
COURT FILE NOS.: |
2002-1265(IT)I |
|
STYLE OF CAUSE: |
Balvinder Khaira and Her Majesty the Queen |
|
PLACE OF HEARING: |
Vancouver, British Columbia |
|
DATE OF HEARING: |
January 8 and 9, 2003 |
|
REASONS FOR JUDGMENT BY: |
The Honourable Justice M.A. Mogan |
|
DATE OF JUDGMENT: |
February 5, 2004 |
|
APPEARANCES: |
|
Agent for the Appellant: |
Prem C. Bhalla |
|
Counsel for the Respondent: |
George Boyd Aitken and Roger Leclaire |
|
COUNSEL OF RECORD: |
|
For the Appellant: |
|
Name: |
N/A |
|
Firm: |
N/A |
|
For the Respondent: |
Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada |