In Pascoal v. The Queen, 2009 TCC 608, the Court relied on Dirienzo v. The Queen, 2000 DTC 2230, for the proposition that “the appropriate degree of care, skill and diligence required for a successful due diligence defence is much lower when the directors are family members.” The Court quoted the following passage from the case (per Bowman ACJTC, as he then was):

Do the conclusions stated above absolve the appellant of his responsibilities under section 227.1? On one view of the matter, it could be said that he did not exercise the degree of care, diligence and skill contemplated by subsection 227.1(3) because he exercised none at all. On the other hand, he was a mere nominal director with no powers, no responsibilities and no say in the way the corporation was run. It is all very well to adopt a hectoring, moralizing tone and say that if people take on the responsibility of corporate directorships they should be expected to assume all the consequences of such a position. I am not however concerned with what the situation would be in a perfect world. I have to make a determination of the facts as they exist in a highly imperfect world where malleable young family members are bullied by domineering patriarchs.

According to a long line of cases, the Tax Court cannot render a judgment that increases the amount owing under the assessment under appeal. In Skinner, the taxpayer was appealing from the Minister’s reduction of the taxpayer’s income, which was the result of the refusal to give effect to the reported 15(2) inclusion. The Tax Court held that it must dismiss the appeal from the 2001 reassessment because allowing the appeal would increase the taxpayer’s liability under the Act.

[30] As I read the jurisprudence, however, the governing factor in determining the Court’s jurisdiction is not who is seeking the order or the nature of the remedy sought, but rather, whether the ultimate result would be an increase in the quantum assessed in the assessment under appeal. If that question is answered in the affirmative, the “effect” is, by definition, to permit the Minister to appeal his own assessment and the Court is without authority to make such an order. As shown by both Pedwell and Petro‑Canada, the Court stands in no better position than the Minister where the order granted results in an increase in the taxpayer’s assessment. The effect of an order vacating that assessment is still to increase the tax assessed in that year, an outcome beyond the Court’s power to impose. Thus, whether the request originates with the taxpayer or the Minister and whether the order is to vary or vacate, the effect of ordering such a remedy is the same.

[31] As there is no question that if the Appellants were successful in their appeals of the 2001 Reassessment the result would be an increase in the quantum of their tax liability for that year, I am bound by the jurisprudence to conclude that the Court is without jurisdiction to hear their appeals. The Respondent’s motion to dismiss the appeals of the 2001 Reassessment is therefore granted.

The Tax Court then felt bound to dismiss the appeal for 2002 because the Minister’s reassessment for the previous year reversed the 15(2) inclusion. One of the prerequisites of a deduction under 20(1)(j) is that an amount was included in the taxpayer’s income in a previous year under 15(2). The result of the dismissal of the appeal for 2001 was that no amount was included in the taxpayer’s income under that subsection. Accordingly, the taxpayer’s appeal for 2002 could not succeed because the conditions in paragraph 20(1)(j) were not met.

The subtext of the appeal was that the taxpayer had attempted to engage in what the Minister regarded as abusive tax planning. Unfortunately for the taxpayer, the Minister was able to avoid a hearing on the merits because the taxpayer’s planning required an increase in income for one of the years in question. The Minister simply needed to reverse that increase to undo all of the planning.

I spoke yesterday on Garron and Antle at the Hamilton Law Association’s annual trusts and estates seminar.

What I find interesting about the case is the light it casts on the art-flip schemes. Mr. Donato tried to claim that the cartoons were personal use property because, if they were, he would not be required to realize any gains on donations of individual cartoons that were valued at less than $1,000. Mr. Donato would win the tax game if he could make a donation, claim the credit and not have to realize any taxable gains as a result of making the gift. The art-flip shelters depended on this same aspect of the personal use property rules: a taxpayer could win the game only if he paid an amount for the art, he donated it at a higher amount for tax purposes and he was not required to recognize any of the gain for tax purposes. The latter was possible only if the property was personal use property with a value under $1,000.

Mr. Donato went to some lengths to attempt to ensure that the property donated would be regarded as personal use property (see ¶¶17–30). Nevertheless, the Court found that the cartoons could not be characterized as such.

[41] In determining whether the cartoons are personal-use property, the relevant inquiry is whether the cartoons were used primarily for the personal use or enjoyment of the appellant or his spouse.

[42] The conclusion that I have reached is that the property donated to Brock University in 2001 was not personal-use property of the appellant.

[43] The creation of the cartoons by the appellant was for the purpose of fulfilling his contractual commitment to Sun Media to provide a daily cartoon for use in its newspaper. This purpose is commercial rather than personal.

[44] Over the years, a few of the cartoons were subsequently used for personal purposes. These uses included: gifts to relatives or friends, the display of a few cartoons in the home, a single use by the Donatos in a trivia type game with friends in their home, and trading cartoons with other cartoonists for their work. There was very little, if any, evidence linking these uses to cartoons that were donated in 2001, and in any event the personal use was quite minor. …

[50] Based on the evidence, the tangible works of art were used in connection with the Sun Media contract, and this was the primary use of this property. Whether the appellant also used intellectual property rights is not the appropriate question.

The Court found in favour of the Crown on this point, then, but the taxpayer did not go away empty-handed. The CRA had tried to reassess the taxpayer’s 1999 taxation year beyond the normal reassessment period on the ground that he had made a misrepresentation by treating the cartoons as personal use property.

The Court had little difficulty disposing of this argument. It is trite law that taking a filing position for which a reasonable argument can be made will not obviate the protection of the statute bar. The CRA cannot reassess beyond the normal reassessment period merely because it disagrees with a filing position taken by a taxpayer. While the Court disagreed with Donato about the characterization of his cartoons as personal-use property, it did not think his “error” attributable to neglect or carelessness, and so the reassessment for the barred year was vacated.

On the other hand, some clients “hate” lawyers for good reason, at least according to this post: “Top 10 Reasons Why Entrepreneurs Hate Lawyers“.

For example, to claim an ABIL on a loan, a taxpayer must sustain a capital loss for tax purposes. A taxpayer sustains such a loss, however, only if he or she advances funds for the purposes of gaining or producing income (see subparagraph 40(2)(g)(ii) of the Income Tax Act). Unfortunately, small business owners and their relatives often fail to charge interest on the advances they make to the corporations that own their businesses. The result is that their ability to claim even a capital loss—never mind an ABIL—is put at risk.

All is not lost if the lender is also a shareholder of the borrower: see Byram v. The Queen, [1999] D.T.C. 5117, [1999] 2 C.T.C. 149, 1999 CanLII 7428 (FCA). In that case, the Court held that, in some cases, the prospect of dividends is enough to create a “nexus” between the advance of funds (at no interest) and an income-earning purpose.

But what if wife loans money to a corporation of which her husband is the sole shareholder? The Tax Court has held in a number of cases that the wife is out of luck: see for exampleService v. The Queen, 2004 TCC 592, and Elliott v.The Queen, 2005 TCC 35. Justice Rip (as he then was), in Elliott, wrote the following:

[21] Ms. Elliott’s problem is not unusual, unfortunately. There are many people who lend money and guarantee loans to small businesses to corporations in which their spouses own shares but they do not. Many of these people are not sophisticated in tax matters. They do what they feel is important for the economic well‑being of the family. They do not do consult lawyers or accountants who may advise how to structure the loan or guarantee so, if something goes wrong, then, for tax purposes, they could deduct at least a portion of the money they may lose. Many of these people and their spouses are hard‑working people of modest means. They do what they think is right; they are optimistic. They do not foresee possible failure. When failure does come, they lose everything. On the other hand, a more sophisticated person may impose a rate of interest on the loan to the spouse’s corporation or acquire shares in that company and in the case of a loan guarantee, charge the corporation for the guarantee. In the latter cases, if the loan goes bad or the person must honour the guarantee, because income was a consideration for the loan or guarantee, the person would be eligible to deduct a portion of the amount lost as an ABIL. Our senior courts have told us there is no equity in a taxing statute and as the Act is written, there is not much I can do to help Ms. Elliott. Parliament may well wish to consider the unique situation of family controlled small business corporations and the possibility of permitting family members to deduct a portion of the amount of loans and guarantees made by a shareholder’s spouse for the benefit of such a corporation when the loans go bad or guarantees are exercised. As the law now stands, such taxpayers are not even entitled to claim a capital loss on such misadventure.

[22] The loans made by Ms. Elliott to Construction were not made by her for purpose of earning income for herself as a taxpayer. Her counsel’s submission that she was the beneficial owner of her husband’s shares of Construction is not tenable on the evidence.

Ms. Elliott did not go away empty-handed however. She had given a guarantee of a portion of her husband’s corporation’s debts, and she was required to honour the guarantee. Justice Rip allowed an ABIL in an amount equal to what was paid under the guarantee as follows:

[27] In income tax, persons often become liable for tax as a result of a transaction or legal result that they did not intend. For example, what a person intends to be a capital transaction may turn out to be a transaction on income account, or what a person intends to be a tax free event is held to be a taxable event. While Ms. Elliott’s purpose in paying off the bank was not to earn income—she may not have even been aware of her rights to be subrogated in the rights of the bank—the result of paying the bank entitled her to claim interest from the bank’s debtor, Construction. The purpose of the loan she inherited from the bank was for an income earning purpose. When Ms. Elliott took over the bank’s loan to Construction, she was entitled to claim interest; she became a creditor of a potential income‑producing loan. Had Construction paid her interest on the subrogated loan amount, the interest would be included in her income; once the loan became bad in 1998, she incurred a capital loss that is a business investment loss, and she ought to be entitled to claim an ABIL on the amount she paid to the National Bank.

Mr. Niemeijer was a commercial airline pilot with KLM Royal Dutch Airlines.  He was a resident of Canada, but KLM is based in Amsterdam and Mr. Niemeijer had his paycheques issued in The Netherlands.  KLM made several deductions from Mr. Niemeijer’s pay including an amount for Dutch Health Insurance premiums. The deductions were compulsory and variable depending on income. 

The court held that this kind of fee is not a tax as defined by Article 2 of the Canada-Netherlands Income Tax Convention:

1.      This Convention shall apply to taxes on income imposed on behalf of each of the States, irrespective of the manner in which they are levied.

2.      There shall be regarded as taxes on income all taxes imposed on total income, or on elements of income, including taxes on gains from the alienation of movable or immovable property, taxes on the total amounts of wages or salaries paid by enterprises, as well as taxes on capital appreciation.

…

4.      The Convention shall apply also to any identical or substantially similar taxes which are imposed after the date of signature of the Convention in addition to, or in place of, the existing taxes. The States or the competent authorities of the States shall notify each other of any substantial changes which have been made in their respective taxation laws.

The court then distinguished between taxes and social security charges, adopting Asscher v. Staatssecretaris van Finacikn, [1996] All ER (EC) 757.  That court held that there is a fundamental difference between a tax, which does not give rise to an entitlement to a specific benefit, and a social security contribution which does.

The applicability of this decision to US-Canadian taxes is questionable because Article 2(iii) of the Canada-US Tax Convention provides that social security taxes are taxes under the treaty.  However, the proposed US health care reform would require purchase of private insurance plans on penalty of a fine.  Under the Income Tax Act (Canada) fines do not typically qualify for tax relief. Would the private insurance premiums qualify as a social security tax under article 2(iii) of the treaty?  If they do, would the fines also qualify for treaty relief?  Can payments made to private companies even be thought of as taxes let alone social security taxes?

The court in Niemeijer took a narrow view of what is a “tax” despite the broad wording of Article 2 of the Dutch treaty.  Given the similarity of Article 2 in the Dutch and US treaties, the case is informative in the Canada/US context.  The court’s narrow reading seems to indicate a disinclination to grant tax relief in this type of situation, which in the Canada/US context, depending on the structure of the health reform legislation, could lead to double taxation or potentially unequal tax treatment for premiums vs. fines.

The lawyer kept a trust account with Canada Trust, but he also owed money to the fisc for unpaid taxes. The lawyer began paying amounts by cheques (the “Cheques”) payable to him that were drawn on the trust account and that were deposited into another Canada Trust account that the lawyer held jointly with another individual.

The Crown conceded that Canada Trust was not liable in respect of the amounts held in the trust account or the joint account. Instead, the Crown argued that the Cheques indebted the bank to the lawyer alone and that Canada Trust should have diverted that money to the CRA.

The Tax Court agreed, on the basis that a bank is a debtor of a depositor because the “bank [is] responsible to repay the funds on deposit when asked for it” (¶23) and that the Cheques represented an amount payable to the lawyer when they were presented (¶30). The judge appears to have concluded that it didn’t matter that the payments might have been intended for use for the benefit of the lawyer’s clients. The judge wrote:

[31] I believe that counsel for the Appellant is correct when he said that writing a cheque is not by itself a withdrawal, but just the creation of an instrument. Nevertheless, a cheque is an instrument by which a drawer directs a drawee to pay on the instrument. As soon as the cheque is presented to the bank, it is different. We should not only look at Mr. McLeod as the payee of the cheque, but also as the drawer of the cheque. As the holder of the account, Mr. McLeod was in a position to enforce the payment because of the debtor-creditor relationship that existed; via the cheque he was demanding for the repayment of a portion of a previous deposit. I again emphasize that there was no evidence produced that Mr. McLeod was not the person who presented the cheques to the bank.

But didn’t the trust funds belong to the lawyer’s clients? Justice Little responded as follows:

[37] The Law Society of British Columbia has produced Law Society Rules that govern the practice of law in British Columbia. Rule 3-56(1.3) of the Law Society Rules provides for the withdrawal by cheque of funds from a lawyer’s trust account. Rules 3-56(3) provide expressively that withdrawal of trust funds for the payment of fees must be made by cheque payable to the lawyer’s general account. A lawyer who does not follow those rules is responsible to the Law Society for his failure to follow the rules. Nevertheless, the Appellant is not concerned by those rules. Mr. McLeod could have closed the account and taken all the funds out or transferred them to another account and the Appellant would have had nothing to say. Before releasing money from the account, the Appellant did not have to call the clients to see if there was a problem. There was no limit to the access of the account, and the Appellant was not required to police or monitor the use of the trust account, as provided by the Bank Act, at subsection 437(3).

Appeal dismissed.