A-73-96
Her Majesty the Queen (Appellant) (Respondent)
v.
J. Paul Fingold (Respondent) (Appellant)
Indexed as: Canadav. Fingold (C.A.)
Court of Appeal, Stone, Strayer and MacGuigan JJ.A. "Toronto, September 4; Ottawa, September 26, 1997.
Income tax — Income calculation — Dividends — Appeal from T.C.C. decision setting aside Minister's assessment of income — Taxpayer's company purchasing, renovating luxurious 5-bedroom penthouse apartment in Florida for $4 million — Condo used for business entertaining 26, 45 times in 2 taxation years at issue — In same building as mother's apartment where taxpayer traditionally holidayed in winter — Income Tax Act, s. 15 deeming amount of benefit conferred on shareholder to be dividend — Whether equity rate of return (interest on amount spent on acquisition, renovation of condominium), or fair market rental value, proper method for assessing shareholder benefits — Existence of business purpose in acquisition, use of property not necessarily determining nature of benefit conferred on shareholder — Trial Judge failed to consider facts leading to conclusion selection, character of apartment primarily for personal accommodation of taxpayer, essentially for his benefit — Respondent would have had to pay equity rate of return to get same benefit from company of which not shareholder.
Evidence — Letters from realtors to Revenue Canada as to fair market rental value of luxury condo apartment provided to shareholder not evidence — Not sworn opinions subject to cross-examination — Not admissions against interest by MNR who produced them because happened to be in files.
This was an appeal from a Tax Court of Canada decision setting aside the Minister's assessment of the respondent's income for 1988 and 1989. The respondent and his brother were the owners of a holding and management company, which in 1987 purchased, renovated and refurnished a 4,610 square foot penthouse condominium in Florida at a cost of $4 million. The condominium was in the same building as the respondent's mother's condominium where the family had traditionally spent their winter vacations. It had five bedrooms with en suite baths, and a restaurant-type kitchen. The apartment was used for business entertaining on 26 occasions in 1988 and 45 times in 1989. On only one occasion did a business guest remain overnight, the rest of the entertaining consisting of dinner, lunch, breakfast or cocktails. The respondent and his wife used the apartment during the Florida season. Income Tax Act, section 15 deems the amount of a benefit conferred on a shareholder to be a dividend. The Minister assumed that the condominium had been acquired for personal use. Using the equity rate of return method, i.e. the amount of interest that could have been earned by the company on the amount spent for the acquisition and renovation of the condominium, together with certain operating costs, he assessed the benefits received as a shareholder as $374,000 in 1988 and $445,675 in 1989. The Tax Court Judge held that the condominium had been acquired and used for business purposes (entertaining) and that where a corporation acquires and uses an asset for such purposes, the shareholder who has use of the asset will be taxed on a benefit that is equal to the fair market rental value of that asset. Apportioning that value between personal and business use, the benefit was valued at $23,129 and $7,583.
Held, the appeal should be allowed.
It was true that the reasoning of the Tax Court Judge herein has been resorted to in a number of cases in that Court and has sometimes been accepted by the Minister. It was not, however, justified by the text of subsection 15(1) but was rather a gloss thereon never adopted by Parliament. It was necessary that closer attention be paid to fundamental principles.
The concept of "business purpose" is relevant in determining whether the advantage was conferred in a normal business transaction i.e. the shareholder obtained something that any other customer of the company could get, or whether he received a special advantage as a shareholder. But the existence of some original business purpose does not necessarily determine the nature of the specific benefit actually conferred on the shareholder.
Having relied upon earlier case law rather than the return to first principles mandated by this Court in Youngman (L.) v. Canada, the Tax Court Judge failed to consider certain relevant facts which lead to the conclusion that the selection and character of the apartment were primarily for the personal accommodation of the taxpayer and essentially for his benefit. Equally important was the total lack of evidence before the Tax Court to support the respondent's position that he was not getting the benefit of a personal residence paid for by the company. The onus was on the respondent to demonstrate that the Minister's assumptions were wrong. The Tax Court Judge should have concluded that the company had provided this shareholder with a benefit consisting of a luxury home of his choice over which he had exclusive use and control. An amount equal to the equity rate of return is what price the shareholder would have had to pay, in similar circumstances, to get the same benefit from a company of which he was not a shareholder.
Furthermore, the Tax Court Judge should not have considered letters from Florida realtors to Revenue Canada as evidence of the fair market rental value of the property. They were not sworn opinions subject to cross-examination, nor were they admissions against interest by the Minister, who produced them only because they happened to be in his files.
statutes and regulations judicially considered
Income Tax Act, S.C. 1970-71-72, c. 63, s. 15(1) (as am. by S.C. 1988, c. 55, s. 8).
cases judicially considered
applied:
Minister of National Revenue v. Pillsbury Holdings Ltd., [1965] 1 Ex. C.R. 676; [1964] C.T.C. 294; (1964), 64 DTC 5184; Youngman (L.) v. Canada, [1990] 2 C.T.C. 10; (1990), 90 DTC 6322; 109 N.R. 276 (F.C.A.).
considered:
Youngman (L.) v. The Queen, [1986] 2 C.T.C. 475; (1986), 86 DTC 6584; 7 F.T.R. 141 (F.C.T.D.); Cartwright (R.I.) v. Canada, [1995] 1 C.T.C. 15; (1994), 94 DTC 6677; 88 F.T.R. 214 (F.C.T.D.).
APPEAL by the Minister from Tax Court decision (Fingold v. R., [1996] 1 C.T.C. 2772; (1995), 96 DTC 1305 (T.C.C.)) assessing a shareholder benefit using the fair market rental value method rather than the equity rate of return method. Appeal allowed.
counsel:
Harry Erlichman and Elizabeth D. Chasson for appellant (respondent).
Morris Cooper for respondent (appellant).
solicitors:
Deputy Attorney General of Canada for appellant (respondent).
Morris Cooper, Toronto, for respondent (appellant).
The following are the reasons for judgment rendered in English by
Strayer J.A.:
Introduction
This is an appeal from a decision of the Tax Court of Canada [Fingold v. R., [1996] 1 C.T.C. 2772] in which the assessment by the Minister of the respondent's income for the 1988 and 1989 taxation years was set aside and the matter referred back to the Minister for reconsideration and reassessment. The matter in issue is the value of benefits received by the respondent as a shareholder for purposes of inclusion in his income pursuant to subsection 15(1) of the Income Tax Act [S.C. 1970-71-72, c. 63 (as am. by S.C. 1988, c. 55, s. 8)]. The Minister had assessed the value of these benefits as $374,000 in respect of 1988 and $445,675 in respect of 1989. The learned Tax Court Judge ordered a reassessment on the basis that the correct figures were, respectively, $23,129 and $7,583. The Minister's assessment was based on the equity rate of return method. The trial Judge adopted instead the fair market rental value as a basis for calculating the benefits.
Facts
It appears that the trial Judge relied on the following facts in coming to this conclusion. At the time in question the respondent and his brother were the owners of Fobasco Limited (Fobasco), a holding and management company which controlled Slater Industries Ltd. (Slater), a public corporation. Slater was a steel producer but had various divisions including a trucking operation. Fobasco also had shares in several other companies. Slater and some of the other companies did extensive business in the United States.
For a number of years the respondent's mother had had a condominium in Palm Beach, Florida. Her family would visit her there for vacations. In 1987 a penthouse condominium in the same building became available and Fobasco purchased it for $1,800,000 (Canadian) and then proceeded to renovate and furnish it at a further cost of about $2,200,000 (Canadian). This was an apartment of 4,610 square feet with, after the renovations, 5 bedrooms each with their own bath and a kitchen "upgraded to restaurant standards". The renovation and furnishing of this apartment was all carried out under the supervision of the wife of the respondent.
According to a log kept by Mrs. Fingold during the two taxation years in question the apartment was used for business entertaining on 26 occasions in 1988 and 45 occasions in 1989. On only one occasion did a business guest remain overnight, the rest of the entertaining consisting of dinner, lunch, or breakfast or cocktails. The respondent and his wife made personal use of the apartment during the Florida season which the trial Judge defined as mid-December to mid-May, approximately 151 days. The respondent travelled extensively but his wife remained at the apartment for most of this time. Occasionally his brother entertained at the apartment although it is not specified in the judgment what the nature of this entertaining was. The respondent and his brother personally paid for the operating costs of the apartment.
The Tax Court Judge accepted the evidence of the respondent that the apartment had been acquired by Fobasco for the purpose of business entertaining. He noted that the dressing room of the master bedroom was equipped as an office.
The learned Tax Court Judge therefore concluded that the condominium had been acquired for a business purpose and had been used for business purposes. In his view it automatically followed that the proper basis for valuation of the benefit received by the respondent through his personal use of the apartment would be fair market rental value which he found to be $60,000 per year, basing himself on two letters from Florida realtors. He regarded these as "evidence". He then proceeded to allocate this rental value as between time devoted to personal use and time devoted to business use. He appears to have regarded each occasion for business entertainment at the apartment, even if only involving a meal or cocktails, as involving a whole day of exclusive business use and precluding any personal use. From the amounts so apportioned for personal use he deducted the expenses incurred by the respondent for the operation of the apartment, producing the amounts at which he has directed the Minister to assess the value of the subsection 15(1) benefits.
It appears that the respondent had reported benefits for these two years based on the assumption that the fair market rental of the condominium would be $60,000 per year, and employing a form of apportionment between personal and business use. The Minister reassessed on, inter alia, the assumptions that the condominium had been acquired for the personal use of the taxpayer and his family and the benefit to him as a shareholder of Fobasco Limited with respect to the condominium should be valued at the amount of interest that could have been earned by the company on the amount spent for the acquisition and renovation of the condominium, together with certain operating costs alleged to have been paid by Fobasco. It is this assessment which is in issue.
Analysis
Subsection 15(1) of the Income Tax Act provides in part as follows:
15. (1) Where, in a taxation year, a benefit has been conferred on a shareholder, or on a person in contemplation of the person becoming a shareholder, by a corporation otherwise than by
. . .
the amount or value thereof shall, except to the extent that it is deemed by section 84 to be a dividend, be included in computing the income of the shareholder for the year.
The learned Tax Court Judge after reviewing a number of cases stated his understanding of the law as follows:
As can be seen by these cases See also: Meeuse v. Minister of National Revenue, [1992] 1 C.T.C. 2470, 92 D.T.C. 1549 (T.C.C.), affirmed (sub nom. Meeuse v. Canada), [1995] 1 C.T.C. 21 (sub nom. Meeuse v. R.), 94 D.T.C. 6640 (F.C.T.D.); Giffin v. Minister of National Revenue, [1991] 1 C.T.C. 2306, 91 D.T.C. 421 (T.C.C.) that [sic] in situations where a corporation acquires an asset for business purposes and uses that asset for business purposes, the shareholder who has use of the asset will be taxed on a benefit that is equal to the fair market rental value of that asset. In cases where the corporation has acquired the asset primarily for the shareholder's use, the courts have found that the fair market rent may not always be the appropriate measure of the benefit conferred on the shareholder.1
With respect it appears to me that the learned Tax Court Judge erred in law in adopting these principles as governing the calculation of value of a benefit conferred on a shareholder by a corporation.
It is true that a number of cases, mostly in the Tax Court of Canada, have applied such reasoning. I can however find nothing in the text of subsection 15(1) which supports a rule that if there is a business purpose in the acquisition and use of a property also used by a shareholder for his private benefit, it necessarily follows without more that the valuation of that benefit must be on the basis of a fair market rental. That is surely a gloss on the section which Parliament itself never adopted. In saying this I hasten to add that it appears from the jurisprudence that in many cases the Minister has in effect adopted the approach embraced by the Tax Court Judge in this case, conceding that if there were a business purpose in the acquisition and use then fair rental value would be an appropriate measure of the shareholder's benefit from any personal use. In the present case, however, the Minister's assumptions include both an assertion that the acquisition was for personal use and the overriding assumption that the benefits should be calculated on the basis of what the company could have earned on the money it had committed to acquisition and renovation of the condominium.
In these circumstances I believe that closer attention must be paid to fundamental principles adverted to in certain of the jurisprudence.
For example in Minister of National Revenue v. Pillsbury Holdings Ltd.,2 a case frequently relied on for the dichotomy reflected in the Tax Court Judge's decision in the present case, Cattanach J. stated:
. . . in my view, there can be no conferring of a benefit or advantage within the meaning of paragraph (c) where a corporation enters into a bona fide transaction with a shareholder. For example, Parliament could never have intended to tax the benefit or advantage that accrues to a customer of a corporation, merely because the particular customer happens to be a shareholder of the corporation, if that benefit or advantage is the benefit or advantage accruing to the shareholder in his capacity as a customer of the corporation. It could not be intended that the Court go behind a bona fide business transaction between a corporation and a customer who happens to be a shareholder and try to evaluate the benefit or advantage accruing from the transaction to the customer.
On the other hand, there are transactions between closely held corporations and their shareholders that are devices or arrangements for conferring benefits or advantages on shareholders qua shareholders and paragraph (c) clearly applies to such transactions . . . . It is a question of fact whether a transaction that purports, on its face, to be an ordinary business transaction is such a device or arrangement.
What Cattanach J. was addressing there was the question of whether there had been a benefit conferred. The concept of "business purpose" is relevant to determining whether the shareholder was getting something like any other customer of the company could get or whether he was receiving some special advantage as a shareholder. In seeking to answer this question it is relevant to see whether the advantage is conferred in a normal business transaction or otherwise. But this does not suggest that the existence of some original business purpose necessarily determines the nature of the specific benefit actually conferred on the shareholder in question.
This emphasis on identifying if there were a benefit and, if so what it was, was emphasized by this Court in Youngman (L.) v. Canada:3
In order to assess the value of a benefit, for the purposes of paragraph 15(1)(c), it is first necessary to determine what that benefit is or, in other words, what the company did for its shareholder; second, it is necessary to find what price the shareholder would have had to pay, in similar circumstances, to get the same benefit from a company of which he was not a shareholder. In the present case, the benefit or advantage conferred on the appellant was not merely the right to use or occupy a house for as long as he wished; it was the right to use or occupy for as long as he wished a house that the company, at his request, had built specially for him in accordance with his specifications. How much would the appellant have had to pay for the same advantage if he had not been a shareholder of the company? Certainly more than what the two experts referred to as the free market rental value since, in my view, the company would have then charged a rent sufficient to produce a decent return on its investment. It is impossible to determine with accuracy the amount of that rent. However, subject to one important reservation, I cannot say that it would have been less than what the Minister assumed it to be.
With respect I believe this correctly brings the focus back to the express provisions of subsection 15(1) of the Income Tax Act.
Most of the jurisprudence considered by the Tax Court Judge predated the Federal Court of Appeal decision in Youngman which was issued in April, 1990. He relied on the Trial Division decision in Youngman.4 In the passage from that decision quoted by the learned Tax Court Judge, McNair J. observed that:
. . . the countervailing factors of business purpose or personal use must play a significant role in determining as a question of fact whether the particular corporate transaction is a bona fide business transaction in the sense of something that might normally accrue to an outsider . . . or whether it was an inside arrangement designed primarily to benefit a shareholder.
When carefully read this does not support the view that where there is some business purpose served in acquisition and use the value of the benefit must be calculated on the basis of fair market rental. Such emphasis as McNair J. did give to "business purpose" was in my view attenuated by the decision of the Federal Court of Appeal on appeal in the passage quoted above, where the Court comes back to the fundamental question of whether there was a shareholder benefit, and if so, how much it was worth.
In Cartwright (R.I.) v. Canada5 a decision of the Federal Court, Trial Division subsequent to the decision of this Court in Youngman, the Trial Judge relied on Youngman. However the passage from his reasons referred to by the Tax Court Judge focusses on a concession in the Youngman case that if the house in question there were built for business purposes and used for such, the Minister's assessment in that case was incorrect. This is another example of the Minister's concessions in earlier cases and reliance in this passage does not, in my view, reflect the very important principles stated by the Court of Appeal in Youngman.
Because the learned Tax Court Judge here had regard to some of the earlier jurisprudence without consideration of the return to first principles mandated by this Court in Youngman he failed, I believe, to take into account some of the relevant facts. In my view those facts lead to a conclusion similar to that in Youngman. Some of these relevant facts are as follows. The respondent himself testified that this particular unit was chosen because it was close to his mother's apartment in the same building.6 He testified that it was a family tradition to vacation in Palm Springs.7 During the years in question the respondent and his family did not take any other winter vacation or go elsewhere than to the condominium.8 He stated that the business entertaining involved only one to five couples at a time.9 The room used in part as an office was some 300 square feet in size10 (compared to the total apartment dimensions of 4,600 square feet). All these matters lead to the conclusion that the selection and character of this apartment were primarily for the personal accommodation of the taxpayer and were essentially for his benefit.
Of equal importance to the analysis is the total lack of certain kinds of evidence before the Tax Court to support the respondent's position that he was not getting the benefit of a personal residence paid for by the company. In noting the absence of evidence in support of the respondent's position it must be emphasized that the onus was on him throughout to demonstrate that the Minister's assumptions were wrong. Thus it is significant that counsel for the respondent could direct us to no evidence that anyone in the company other than the respondent and his brother ever used this condominium; or that the company indeed had any record of its use for business purposes which one might reasonably expect in relation to a $4 million company asset.
In summary, if the learned Tax Court Judge had focussed on the legal test as defined by this Court in Youngman, namely what did Fobasco do for this shareholder, he would have concluded that the company had provided the respondent with a luxurious apartment, chosen by the respondent in a building selected for family reasons, which apartment was renovated and furnished solely at the direction of the respondent or his wife and whose use was at the sole control of the respondent and his family. The apartment was used for winter vacations in the same city, and the same building, where the family had enjoyed winter vacations for years. It may have been anticipated that the respondent would on occasion entertain business visitors there, just as many people in business or in senior salaried positions are expected because of their position to entertain business or professional associates. But nothing in the evidence explains any business need for five bedrooms with ensuite baths or a restaurant-type kitchen, considering that on only one occasion did a business guest stay at the apartment and the number of business guests entertained never exceeded five couples. The presence of an "office", a dressing room fitted with a desk and office equipment amounting to 300 square feet in a 4,600 square foot apartment, is certainly not supportive of the view that the provision to the respondent of the apartment as a whole was a normal business transaction. If it were, thousands of private homes could be considered business premises. This arrangement therefore cannot be seen as a bona fide business transaction entered into with the respondent qua customer or arm's-length contractor with the respondent.
Thus the learned Tax Court Judge should have concluded that Fobasco had provided this shareholder with a benefit consisting of a luxury home of his choice over which he had exclusive use and control. On that basis I can see no error in the assumptions of the Minister. An amount equal to the equity rate of return is, I believe (in the words of this Court in Youngman [at page 14]):
. . . what price the shareholder would have had to pay, in similar circumstances, to get the same benefit from a company of which he was not a shareholder.
Therefore the appeal should be allowed with costs.
While the calculation of fair rental value is thus not relevant, I wish to comment in passing on a passage in the Tax Court judgment [at page 2775] concerning calculation of such an amount. The passage is as follows:
The Appellant produced two letters, one from Sotheby's International Realty and the other from Martha A. Gottfried Inc., both carrying on business in Palm Beach, as to the rental value of the apartment. Both stated that the rental value for such an apartment should be $60,000 per annum. Although those letters are not given as experts' opinions or reports, they are the only evidence of market rental value for the property. The Respondent did not plead with respect to the rental value nor did he adduce any evidence concerning the rental value, but based the assessments solely on a return on the investment which Fobasco had in the apartment.
It will be noted that the learned Tax Court Judge referred to these letters as "evidence". Counsel for the respondent was unable to explain to this Court how these letters could be "evidence". The respondent had obtained these letters from Florida realtors for the purpose, according to counsel, of explaining to Revenue Canada the internal accounting between him and Fobasco with respect to the use of the apartment. Copies had been supplied to Revenue Canada and were among the documents produced by the Department in discovery of documents. They are certainly not sworn opinions subject to cross-examination, nor of course was any sworn oral testimony given to the same effect. They were certainly not admissions against interest of the Minister, who produced them only because they happened to be in his files. Therefore they were never "evidence". Further, the assertion by the learned trial Judge that the Minister had not pleaded with respect to rental value and did not adduce any evidence on this subject cannot, with respect, be seen as a justification for accepting these letters as a basis for the trial Judge fixing the fair market rental value. The onus remained on the taxpayer to prove that the Minister's assessment was wrong, not on the Minister to prove that it was right. The Minister did not plead fair rental value because he did not consider that to be the appropriate measure of value of the benefit and it was certainly not incumbent on him to produce evidence of what fair rental value would have been. I point this out because even if fair market rental value were legally the proper test, there is no evidentiary basis for the value which has been fixed in this case.
Stone J.A.: I agree.
MacGuigan J.A.: I agree.
1 [1996] 1 C.T.C. 2772 (T.C.C.), at pp. 2777-2778.
2 [1965] 1 Ex. C.R. 676, at p. 684.
3 [1990] 2 C.T.C. 10 (F.C.A.), at pp. 14-15.
4 Youngman (L.) v. The Queen, [1986] 2 C.T.C. 475 (F.C.T.D.), at p. 480.
5 [1995] 1 C.T.C. 15 (F.C.T.D.), at pp. 20-21.
6 Appeal Book, at p. 111.
7 Appeal Book, at pp. 112-113.
8 Appeal Book, at p. 119.
9 Appeal Book, at p. 115.
10 Appeal Book, at p. 126.