BETWEEN:
and
____________________________________________________________________
Appeals heard on January 11, 2008, at Calgary, Alberta
By: The Honourable Justice Campbell J. Miller
Appearances:
____________________________________________________________________
JUDGMENT
The appeals from the reassessments made under the Income Tax Act for the 1999 and 2000 taxation years are allowed and the reassessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the Appellant is not taxable on any amounts arising as a result of the journal entries made in January 2003.
Further, the parties have agreed that the Appellant’s 2000 taxable income is to be reduced by a further $2,116 to take into account the impact of the $44,196 advance made by the Appellant to Innovage Technologies Inc.
Costs are awarded to the Appellant.
Signed at Ottawa, Canada, this 6th day of February, 2008.
BETWEEN:
MICHAEL R. KAISER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
[1] This case highlights the difficulties that can arise in applying provisions of the Income Tax Act (the “Act”) to transactions intended to be effective retroactively. Mr. Kaiser directed some after-the-fact accounting due to the breakdown of a common-law relationship with Christina Seymour. This involved deciding in 2003 to make certain journal entries in two companies of which he and Christina were shareholders, Innovage Technologies Inc, (“ITI”) and Innovage Microsystems Inc., (“IMI”). The journal entries were to effect a shift of certain debts in 1999 and 2000 owed by the companies to Mr. Kaiser to Ms. Seymour. The Respondent assessed Mr. Kaiser on the basis that such amounts were to be viewed as a transfer of capital property (the debt owed to Mr. Kaiser) from Mr. Kaiser to Ms. Seymour effective in 1999 and 2000, and the combination of section 73 of the Act and the attribution rules in section 74.2 of the Act would therefore operate to bring the capital gains arising on the disposition of the debt by Ms. Seymour into Mr. Kaiser’s hands.
[2] At trial the Respondent also argued that such amounts represented shareholder loans to Mr. Kaiser alone, and any reduction of such loans was a disposition of capital property in his hands, resulting in a taxable capital gain to him only.
[3] Mr. Kaiser’s position was that no such amounts were actually withdrawn in 1999 and 2000, or alternatively, that there was a transfer of capital property from Mr. Kaiser to Ms. Seymour, but it was not effective in 1999 and 2000, but only in 2003, at a time when Mr. Kaiser and Ms. Seymour were separated, so attribution rules could not apply.
[4] The parties provided an Agreed Statement of Facts which I have attached as Schedule “A” to these Reasons. I will however summarize the significant facts as follows:
I. Mr. Kaiser and Ms. Seymour were common-law spouses in 1999 and 2000, but ceased that relationship in 2001.
II. Mr. Kaiser and Ms. Seymour were both shareholders of ITI and IMI (the “Companies”).
III. Mr. Kaiser acquired shareholder’s loans of other shareholders in the Companies in 1996, representing $1,974,675 of loans in ITI for $4 and representing $1,677,951 of loans in IMI for $4 (the “Loans”).
IV. Both Mr. Kaiser and Ms. Seymour withdrew amounts from the Companies in 1999 and 2000, which were allocated and debited to their respective shareholder loan accounts in draft financial statements prepared in the fall of 2002.
V. In January 2003, Ms. Seymour’s counsel claimed Ms. Seymour was entitled to 50% of the Loans by virtue of certain matrimonial property rights.
VI. As a result, Mr. Kaiser, as a director of the Companies, directed the Companies to make journal entries which debited Mr. Kaiser’s shareholder loan account and credited Ms. Seymour’s shareholder loan
account in the following amounts:
|
1999 |
2000 |
|
ITI - $74,149 |
$240,660 |
|
IMI - $87,800 |
$23,419 |
|
|
|
VII. The Companies and Mr. Kaiser filed their 1999 and 2000 tax returns in February 2003, after the journal entry adjustments. Mr. Kaiser’s returns were nil returns.
Issues
[5] The parties framed the issues differently. The Respondent premises its issue on the understanding that Mr. Kaiser withdrew the shareholder loans at issue (i.e, the amounts subject to the journal entry decreases) from both Companies in 1999 and 2000. The Respondent therefore states that the issue is whether the Minister was correct to reassess Mr. Kaiser:
(a) to include in his income tax for capital gains the amounts of $90,089.24 and $128,678.34 as a result of the disposition of capital property, being the withdrawals from the shareholder loan accounts of ITI and IMI, respectively in the 1999 taxation year; and
(b) to include in his income tax for capital gains the amounts of $257,363.44 and $80,813.59 as a result of the disposition of capital property, being the withdrawals from the shareholder loan accounts of ITI and IMI, respectively in the 2000 taxation year.
[6] I note that this does not reflect the Canada Revenue Agency’s (“CRA”) assessing position as set forth in its letter of November 3, 2005 where CRA accepted there was a transfer of property, being the loans, from Mr. Kaiser to Ms. Seymour, but effective in each of 1999, 2000 and 2001. CRA applied subsection 73(1) and section 74.2 of the Act such that any gain arising from Ms. Seymour’s adjustment to the shareholder loan account would be attributed back to Mr. Kaiser in 1999 and 2000, as he and Ms. Seymour were still together. There would be no attribution in 2001 as they had separated by that point.
[7] The Appellant’s position is that the journal entry decreases did not involve any amounts actually being withdrawn and therefore did not trigger any disposition of capital property as contemplated by the Respondent. The Appellant goes on to frame the issues as follows:
Whether the decreases in the balances owing by ITI and Innovage Microsystems Inc. (“IMI”) (collectively the “Corporations”) to the Appellant under the Appellant’s shareholder loan accounts with the Corporations (collectively the “Loans”) resulting from:
1. the following journal entries made to the Corporations’ accounts on or after January 31, 2003, but purporting to be effective as of October 31, 1999, ought to be included in calculating the amount of capital gains realized by the Appellant in 1999:
(a) a debt of $74,149 against the Appellant’s shareholders loan account with ITI and a corresponding credit to Ms. Seymour’s shareholders loan account with ITI (the “1999 ITI Journal Entry”); and
(b) a debt of $87,800 against the Appellant’s shareholders loan account with IMI and a corresponding credit to Ms. Seymour’s shareholders loan account with IMI (the “1999 IMI Journal Entry”),
(collectively the “1999 Journal Entries”); and
2. the following journal entries made to the Corporation’s accounts on or after January 31, 2003, but purporting to be effective as of October 31, 2000, ought to be included in calculating the amount of the capital gains realized by the Appellant in 2000:
(c) a debt of $240,660 against the Appellant’s shareholders loan account and a corresponding credit to Ms. Seymour’s shareholders loan account (the “2000 ITI Journal Entry”); and
(d) a debit of $23,419 against the Appellant’s shareholders loan account and a corresponding credit to Ms. Seymour’s shareholders loan account (the “2000 IMI Journal Entry”),
(collectively the “2000 Journal Entries”).
[8] The question that begs to be answered is whether the journal entries made in 2003 are effective for tax purposes in 1999 and 2000. If they are, then one of two interpretations follow, both of which lead to the journal entry amounts constituting a capital gain in Mr. Kaiser’s hands. The first interpretation, suggested by the Crown, is that because only Mr. Kaiser could withdraw funds from the shareholder loan accounts, only he can be found to have withdrawn funds in 1999 and 2000. The second interpretation is that the journal entries constituted a transfer of part of the loans from Mr. Kaiser to Ms. Seymour, which she immediately redeemed. Section 73 of the Act would operate such that the transfer would be at Mr. Kaiser’s cost, a nominal amount, and when Ms. Seymour coincidentally redeemed the loans as a result of the journal entries, she triggered a capital gain, attributable back to Mr. Kaiser as a common-law spouse pursuant to section 74.2 of the Act. This latter interpretation would be my preferred interpretation if I were to find the journal entries were effective for tax purposes in 1999 and 2000.
[9] In determining the timing of the effectiveness of the journal entries, I must first address the question of whether Mr. Kaiser is estopped from arguing the journal entries were not effective in 1999 and 2000. Both parties relied on Chief Justice Bowman’s comments in King v. R., [1] to address this matter of estoppel. In King, accounting entries were made in 1988 to effect a credit to Mrs. King’s shareholders loan account in 1987. Mrs. King filed as though the credit was made in 1987 and the assessor assumed as much. At the time of trial the 1988 taxation year was statute-barred. Chief Justice Bowman stated:
… Even if I had held that a capital gain had been realized, but that it was attributable to Mr. King under section 74.2, it would mean putting the taxable capital gain into a statute-barred year of Mr. King. To do so would not disturb me particularly in a case where the Minister had a choice between two years and deliberately and knowingly chose one that turned out to be the wrong one. Here however the Minister acted on the basis of a representation of fact by the appellant in her 1987 tax return that the relevant transactions, whatever their ultimate legal effect, occurred in 1987. While it is trite law that there is no estoppel against the terms of a statue, we have here a classic case of estoppel with respect to a matter of fact. The Crown sometimes argues - - erroneously in my view - - that whenever a taxpayer changes his or her position from that taken in a return of income or in some other document he or she somehow “estopped”. Estoppel by conduct is a much narrower concept. It is a rule that prohibits a person who has made a statement of fact upon which another party had relied and has acted to his or her detriment from denying the truth of that statement as against that other party. That is precisely what happened here. The time at which an event takes place is purely a matter of fact and the Minister, in assessing 1987 on the basis of the statement that the events took place in 1987 and in not assessing 1988, acted in reliance on that statement to his detriment. Accordingly the appellant is estopped from now taking the position that the taxable event took place in 1988.2
2 I should not wish to be taken as condoning the practice of some accountants of recording, by making “year-end adjustments”, as transactions in a prior year events that were not even thought of in that prior year. This case is somewhat unusual in that it gives rise to a pure example of estoppel by conduct. There is a difference between reflecting, after a year-end, a quantification of taxable benefits for a prior year of manager/shareholder of a corporation - - a practice albeit somewhat artificial has at least the virtue of long-standing entrenchment and apparent acceptance by the tax department - - and creating out of airy nothing transactions in a prior year that in that year were not even a gleam in anybody’s eye. It never ceases to amaze me how some accountants think they can retroactively create reality by a subsequent moving of figures around on a piece of paper.
[10] At the time Mr. Kaiser directed the journal entries in January 2003, he did not believe, as evident from filing a nil tax return, that he was subject to tax on amounts he actually withdrew in 1999 and 2000 as against his shareholder’s loan, let alone any amounts that were the subject of the journal entries. It appears neither did Ms. Seymour’s counsel. In a letter dated January 10, 2003, Mr. Dunphy, acting for Ms. Seymour, wrote to the chartered accounting firm of Czechowsky and Graham:
Further, it is our position that the shareholder’s loans of Michael Kaiser that are in a credit balance are matrimonial property and belong 50% to Christina Seymour and accordingly, we are of the view that you may file the tax return of Christina Seymour without having regard to any debit balance in her shareholder’s loan account because we are of the view that it is set-off by the credit balance in the other loan.
[11] So it is not Mr. Kaiser’s filing of a return that can be the conduct, or statement of fact, upon which CRA relied, as a nil return is not indicative that the journal entries were intended to be effective in 1999 and 2000. The conduct, for estoppel purposes, can only be the Companies’ financial statements that reflect the journal entries, that CRA received in 2003. Mr. Kaiser’s counsel argues that these are not Mr. Kaiser’s statements, and therefore estoppel is not applicable. Yet clearly, from a review of the minutes authorizing the journal entries, it was Mr. Kaiser’s conduct that directed such entries. CRA did rely on those entries to assess Mr. Kaiser, knowing that the journal entries were not recorded until 2003. But what statement is Mr. Kaiser allegedly now denying the truth of? He is certainly not denying the journal entries were made. He is arguing that, for tax purposes, the journal entries were not effective in 1999 and 2000 for purposes of triggering attribution rules. This is a conclusion of law, not a denial of a statement of fact. CRA took a different view and maintained, knowing all the circumstances, that attribution applied in 1999 and 2000, but not in 2001. They have suffered no detriment due to any misstatement of fact by Mr. Kaiser. I find the principle of estoppel does not operate in these circumstances to preclude my consideration of the retroactive effect for tax purposes of the journal entries.
[12] The question then is whether the retroactive transfer of property of common-law spouses, due to a breakdown of the relationship, triggers attribution rules for the period between the purported effective date of the transfers and the actual date of the decision to transfer (long after the couple had separated). Or, in the words of Chief Justice Bowman, was the Appellant “creating out of airy nothing transactions in a prior year that in that year were not even a gleam in anybody’s eye?” Transferring the Loans in 1999 and 2000 was not in anyone’s contemplation in 1999 and 2000 – airy nothing, as it were.
[13] I find this conclusion consistent with comments made by Justice Bonner in the case of Wood v. Minister of National Revenue:[2]
13 The portion of Article 79 which requires that a resolution “…be held to relate back to any date therein stated to be the date thereof …” does not operate to require persons other than the company and its shareholders to treat an event as having taken place before it in fact took place. Subsection 29(1) of the Companies Act of Alberta provided:
29(1) The memorandum and articles, when registered, bind the company and the members thereof to the same extent as if they respectively had been signed and sealed by each member, and contained covenants on the part of each member, his heirs, executors, and administrators, and in the case of a corporation, its successors to observe all the provisions of the memorandum and of the articles, subject to the provisions of this Act.
Nothing in the wording of the statute makes the Articles binding on persons other than the company and its members. They do not bind the respondent who is a stranger to them.5 I find unacceptable the notion that a company and its shareholder are entitled, for purposes affecting the rights of third parties to rewrite history, that is to say, treat imaginary events as having happened. A legislature has the power to enact deeming provisions. Others do not.
[14] This is exactly what these journal entries were – a re-writing of history, that are not binding on third parties, in this case CRA. CRA cannot pick and choose which imaginary events are taxable and which are not. For purposes of the determination of Mr. Kaiser’s tax liability, the loans could not have been transferred until he decided to do so, and that was in 2003: a stroke of the accountant’s pen cannot alter that fact.
[15] If the journal entries were not effective for tax purposes in 1999 and 2000, what was Mr. Kaiser’s tax position in those years. He is certainly responsible for tax on the gains arising from his actual withdrawals against his shareholders loans in those years. He is not responsible for tax arising on any monies Ms. Seymour took out of the Companies in those years, however they might have subsequently agreed to treat them due to the breakdown of their relationship.
[16] I am reinforced in my conclusion by the application of logic and common sense. The evidence is clear that the journal entries were made to effect a splitting of the capital property (Loans) as a result of rights Ms. Seymour had to property arising from the common-law relationship with Mr. Kaiser. Section 74.2 of the Act is clear that attribution only arises during the period the parties are common-law partners. It is illogical that a decision to transfer property due to the breakdown of a relationship could create any attribution. Otherwise, what a great deal for the recipient: not only does she get her rightful entitlement to 50% of the property, but her ex remains on the hook for the tax arising on the capital gains on the disposition of such property. Barring any estoppel argument, this is not sensibly how the attribution rules are to operate. Couples who are at the stage of splitting property are no longer in the attribution period, being the period when they remained common-law partners.
[17] I allow the appeal and refer the matter back to the Minister for reconsideration and reassessment on the basis that Mr. Kaiser is not taxable on any amounts arising as a result of the journal entries made in January 2003. Further, the parties have agreed that the Appellant’s 2000 taxable income is to be reduced by a further $2,116 to take into account the impact of the $44,196 advance made by the Appellant to ITI.
[18] Costs are awarded to the Appellant.
Signed at Ottawa, Canada, this 6th day of February, 2008.
“Campbell J. Miller”
Miller J.
Schedule A
COURT FILE NO.: 2006-1125(IT)G
STYLE OF CAUSE: Michael R. Kaiser v. The Queen
PLACE OF HEARING: Calgary, Alberta
DATE OF HEARING: January 11, 2008
REASONS FOR JUDGMENT BY: The Honourable Justice Campbell J. Miller
DATE OF JUDGMENT: February 6, 2008
APPEARANCES:
|
Counsel for the Appellant: |
Douglas Roberts |
|
Counsel for the Respondent: |
Margaret McCabe |
COUNSEL OF RECORD:
Firm:
For the Respondent: John H. Sims, Q.C.
Deputy Attorney General of Canada
Ottawa, Canada