James F. Kennedy (Appellant)
v.
Minister of National Revenue (Respondent)
Court of Appeal, Jackett CJ., St.-Germain and
Bastin D.JJ.—Toronto, June 26 and 27, 1973.
Income tax—Benefit conferred on shareholder by compa-
ny—Valuation of benefit—Income Tax Act, s. 8(1).
In 1965, an automobile sales company, all of whose
shares belonged to appellant, acquired an old building for its
business at a cost of $344,000. The company then sold the
building to appellant for $259,000, giving him a promissory
note for $53,000, the difference between the sale price and
the amount of a mortgage on the building, which was
assumed by appellant. Appellant then leased the building to
the company for a minimum term of 41 years at a monthly
rental of $1,935. In 1966 the company spent $42,000 on an
addition to the building. In 1965 and 1966 appellant was
assessed to income tax under section 8(1) of the Income Tax
Act on the assumption that in 1965 the company transferred
to him a property worth $344,000 for $259,000 and, in
1966, an additional benefit of $42,000.
Held, the creation of a debt by a company in favour of â
shareholder for no consideration confers a benefit on the
shareholder within the meaning of section 8(1). Accordingly,
the promissory note given appellant in 1965 by the company
must be taken into account for the purposes of section 8(1)
in 1965 and not, as contended by appellant, in the year when
the note was paid. The onus of disproving the assessed
amount of the benefit conferred on appellant is, however, on
appellant (Johnson v. M.N.R. [1948] S.C.R. 486), and in this
case that onus had not been met.
Held also, where a tenant improves leased premises, the
extent to which the improvement confers a benefit on the
landlord will depend on the extent to which the improve
ment increases the value of his reversionary interest and
that, in turn, will depend on the terms and conditions of the
lease and on the nature of the improvement. Since this
matter had not been properly raised in this case but must be
taken into account to avoid substantial injustice, counsel
would be heard further.
INCOME tax appeal.
COUNSEL:
W. D. Goodman, Q.C., and F. E. Cappell
for appellant.
G. W. Ainslie, Q.C., and W. J. A. Hobson
for respondent.
SOLICITORS:
Goodman and Carr, Toronto, for appellant.
Deputy Attorney General of Canada for
respondent.
JACKETT C.J. (orally)—This is an appeal from
a judgment of the Trial Division dismissing with
costs an appeal from the appellant's assess
ments under Part I of the Income Tax Act for
the 1965 and 1966 taxation years. The question,
in respect of each assessment, is whether the
assessment was in error in so far as it included
an amount in the computation of the appellant's
income for that taxation year by virtue of sec
tion 8(1) of the Income Tax Act, which reads as
follows:
8. (1) Where, in a taxation year,
(a) a payment has been made by a corporation to a
shareholder otherwise than pursuant to a bona fide busi
ness transaction,
(b) funds or property of a corporation have been appro
priated in any manner whatsoever to, or for the benefit of,
a shareholder, or
(c) a benefit or advantage has been conferred on a share
holder by a corporation,
otherwise than
(i) on the reduction of capital, the redemption of shares
or the winding-up, discontinuance or reorganization of
its business,
(ii) by payment of a stock dividend, or
(iii) by conferring on all holders of common shares in
the capital of the corporation a right to buy additional
common shares therein,
the amount or value thereof shall be included in computing
the income of the shareholder for the year.
J. F. Kennedy Ford Sales Limited (herein-
after referred to as "the appellant's company"),
a company all of whose shares belonged to the
appellant, operated, at all relevant times, a busi
ness as a car dealer.
In 1965, pursuant to a pre-arranged plan,
(a) the appellant's company acquired a prop
erty with an old building on it at a net cost of
approximately $159,000,'
(b) the appellant's company made the
changes to that property deemed expedient by
the appellant to convert it into premises
appropriate for the car dealer business at an
overall cost of approximately $185,000 (with
the result that the company spent approxi
mately $344,000 in 1965 to acquire premises
deemed by the appellant to be suitable for the
car dealer business);
(c) the appellant's company sold the property
as so improved to the appellant at a net cost
of approximately $259,000, a small amount of
which was paid in cash and the balance of
which was paid by the appellant assuming
payment of mortgages in a total amount of
$311,000 and receiving from his company a
promissory note in the sum of $53,000; and
(d) the appellant leased the premises back to
his company for a minimum term of four and
a half years at a monthly rental of $1,935,
which was calculated to give the appellant a 9
per cent. annual return on his investment of
$259,000.
In 1966, the appellant's company spent some
$42,000 on an addition to the building on the
property in question.
The assessment for the 1965 taxation year
was based on the assumption that the appel
lant's company transferred to the appellant in
that year a property worth approximately $344,-
000 for a consideration of approximately $259,-
000 and thereby conferred on the appellant a
benefit of the kind contemplated by section 8(1)
in an amount of approximately $85,000.
The assessment for the 1966 taxation year
was based on the assumption that the expendi
ture of some $42,000 made by the appellant's
company in improving the appellant's property
conferred on the appellant a benefit of the kind
contemplated by section 8(1) in an equivalent
amount.
The appellant, by his pleading in the Trial
Division, attacked the two assessments on two
main fronts. He contended that, in fact, no
benefit had been conferred on him by his com
pany in the years in question, and, alternatively,
if there were benefits, he disputed the amounts.
Secondly, he said that, if a benefit had been
conferred on him by his company in 1965, it
was conferred "on ... the ... reorganization of
its business" so as to be excluded from section
8(1) by subparagraph (i) thereof with the result
that it was taxable, if at all, by being deemed to
be a dividend in a limited amount by virtue of
section 81(1), which would result in a more
favourable tax position for the appellant.
With regard to the latter point, I agree with
the learned Trial Judge that there was no re
organization of the appellant's company's busi
ness within the meaning of sections 8(1) and
81(1') when the only change, as far as its busi
ness was concerned, was that, after the transac
tions in question, it "operated the same business
from the same premises which were rented by it
rather than being owned by it".
With reference to the question as to what
benefit, if any, was conferred, the two taxation
years must be considered separately.
A preliminary point should be mentioned in
connection with 1965. As has already been
indicated, the assessment was based on the
assumption that the appellant purchased a prop
erty worth $344,000 from his own company for
$259,000 and that payment of the price was
effected by the appellant assuming mortgages in
the sum of $311,000 and being given back a
promissory note for $53,000. The appellant says
that, even if these factual assumptions are all
correct, to the extent of the amount of $53,000
the benefit has not been "conferred" until the
money is in fact paid and none of it was paid in
1965. In support of this contention, the appel
lant relies on authorities regarding the question
as to when amounts such as dividends, interest
and rent become "income" for purposes of
income tax legislation. In my opinion, the ques
tion involved in that sort of case is not the same
as the problem under section 8(1). In the case of
"income", it is assumed, in the absence of spe
cial provision, that Parliament intends the tax to
attach when the amount is paid and not when
the liability is created. (The courts naturally
react against taxation before the income amount
is in the taxpayer's possession.) Here, the ques
tion is when a "benefit" has been "conferred"
within the meaning of those words in section
8(1). In my view, when a debt is created from a
company to a shareholder for no consideration
or inadequate consideration, a benefit is con
ferred. (The amount of the benefit may be a
question for valuation depending on the nature
of the company.) On the other hand, when a
debt is paid, assuming it was well secured, no
benefit is conferred because the creditor has
merely received that to which he is entitled. I
am, therefore, of the opinion that the $53,000
promissory note must be taken into account for
the purposes of section 8(1) in the year in which
it created an indebtedness from the company to
the appellant, namely, 1965.
The question of benefit or no benefit in the
1965 taxation year is, in my view, primarily a
question of fact in connection with which the
onus of proof was on the appellant. This is so,
in the first place, because the assessment was
made on the assumption that a benefit in the
stated amount was conferred on the appellant
by his company and, as a matter of law, the
onus is on the appellant to demolish such an
assumed fact. (See Johnson v. M.N.R. [1948]
S.C.R. 486.) It is also so because, on the facts
of this case, the appellant was in the position of
having, in 1965, caused his company (a) to
expend an amount of some $344,000 on the
acquisition of premises for its business, and (b)
to sell those same premises to himself for some
$259,000, and, in my view, it is to be assumed,
in the absence of evidence to the contrary, that
an experienced business man such as the appel
lant does not make business expenditures that
are not calculated to produce results at least
equal in value to the amounts expended.
The appellant attempted to meet the onus of
showing that there was no benefit in 1965 by
leading the evidence of an expert to show that
the market value of the property when trans
ferred by the appellant's company to the appel
lant was less than the $259,000 paid by the
appellant for the property. As I understand this
evidence, it was based on the view that the
property would only have value as a car dealer's
premises in the short term and that, in the long
run, the highest and best use of the property
would be for some quite different purpose so
that none of the money expended by the appel
lant's company on improvements that were
peculiar to a car dealer's business would have
had any beneficial effect on the market value of
the property.
The learned Trial Judge rejected the view, on
which the appellant's factual case was based,
that the long run highest and best use of the
property was for something other than as prem
ises for a car dealer's business. In my view,
there was evidence on which he could so decide
and it has not been established that this Court
should interfere with that finding. The fact that
an experienced business man spent $344,000 on
the property in 1965 as a car dealer's premises
is very strong evidence that it had a value for
that purpose in that year equal to at least that
amount. This is supported by the fact that three
years later the property was re-sold for use for
the same purpose at a higher amount to a large
automobile manufacturer. No evidence was led
to show that, in fact, there had been any indica
tion that the property was losing its value for
that purpose. I would not myself have been
inclined to accept the evidence on which the
Court was asked to reach a conclusion that such
property in 1965 should be valued as though
there was no demand for it as a car dealer's
place of business. There were inherent weak
nesses in that evidence, which need not be
specified, that in my view give it substantially
less weight than the facts of actual successful
use of the property.
I am further of the view that the appellant did
not establish that the property, at the time of its
transfer to him in 1965, had a market value that
was less than the $344,000 expended by his
company to acquire it and make it suitable for
its car dealer's business.
That is not, however, the end of the matter.
Where a tenant improves the leased premises,
the extent to which, if at all, the improvement
confers a benefit on the landlord will depend on
the extent to which the improvement increases
the value of his reversionary interest and that,
in turn, will depend on the term and conditions
of the lease and on the nature of the improve
ment. If there is a long term lease, it may be that
no benefit will be conferred at all. Compare
King v. Earl Cadogan [1915] 3 K.B. 485 (C.A.).
If the lease is a monthly tenancy, the result may
be a benefit equal to the amount by which the
value of the property was improved. Compare
St-Germain v. M.N.R. [1969] S.C.R. 471. Simi
larly, where property that has been improved by
the owner is sold at an under-value under a
"lease-back" arrangement, the benefit may not
be equivalent to the amount by which the con
sideration is less than market value if the terms
of the lease that has been arranged as part of
the transaction are not based on market value.
Here, it would appear that the rent payable by
the appellant's company to the appellant is
fixed, for a minimum of four and a half years,
on the basis of the consideration given by the
appellant for the property and not on market
value. It would seem, therefore, that there is a
factor here that should have been taken into
account in determining the amount of the ben
efit for 1965, and that that factor was not taken
into account.
The difficulty about this aspect of the matter
is that, while the notice of appeal did indicate
that the appellant challenged the amounts of the
benefits as assessed, no indication was given
that the appellant intended to challenge the
amounts on the basis that the Minister had
computed them without taking account of the
effect of a low rental lease on the value of the
appellant's reversionary interest. Furthermore,
as appears from the opening statement at the
trial and a reading of the whole transcript of the
proceedings at trial, this question was not one in
respect of which either party led evidence. In
fact, it would seem clear that the trial was
conducted on the basis that the issues were
restricted to the other matters to which refer
ence has been made and this question of the
effect of a low rental lease only came out inci
dentally in the course of cross-examination of
the last witness. This undoubtedly explains why
the significance of the matter was not brought
home to the learned Trial Judge.
In these circumstances, there must be room
for doubt that it is open to this Court to deal
with the matter at this stage. Certainly, the
matter should not be dealt with at the appeal
stage in a manner that does not ensure that the
respondent has full opportunity to bring forward
any thing that may be necessary to put the
matter in proper perspective. My own view,
however, is that, whenever it appears that there
is a matter that has not been properly raised at
an appropriate stage but that must be taken into
account in order to avoid substantial injustice, a
way should be found to take account of it if at
all possible without real danger of injustice to
the opposing side.
Whether some such method of disposing of
the 1965 appeal can be found is a matter on
which the Court should have assistance from
counsel.
It would not, however, be amiss to express a
tentative view on how the adjustment to the
1965 benefit should be made assuming that
there are no relevant circumstances other than
those that we have presently in mind. Put
simply, the situation was that, if the property
had been transferred to the appellant without
the obligation to lease it back at an agreed rent,
the appellant could have negotiated a lease at a
rental based on market value instead of on
$259,000, so that each rental payment would
have been the stipulated monthly rental pay
ment plus an additional amount. The depreciat
ing effect of the actual lease on the value of the
appellant's interest in the property was, there
fore, in respect of each rental payment provided
for, the present value, as of the date of the
purchase in 1965, of that additional amount.
Such present value would have to be computed
in respect of each rental payment provided for
and the respective results added up to find the
amount by which the benefit assessed should be
reduced.
With reference to the 1966 assessment, in my
view the improvement made by the appellant's
company to his property was a benefit con
ferred on the appellant by the company that
year. See St-Germain v. M.N.R. (supra). How
ever, having regard to the fact that there were at
least three and a half years left in the lease of
the property at the fixed rent and not a mere
month to month tenancy as in the St-Germain
case, in my view, the amount of the benefit was
not the equivalent of the amount spent on the
improvement. As in the case of the 1965 ben
efit, there is a factor here that should have been
taken into account and that was not taken into
account. (No evidence was led to show that the
market value of the property was not increased
by the amount of the expenditure.) In the
absence of circumstances that I do not have in
mind, I should have thought that the amount of
that factor might be an amount computed in the
manner that I have indicated in reference to the
1965 benefit. What has to be kept in mind, as it
seems to me, is that, if it had been a monthly
tenancy, the appellant could have made a quick
adjustment in rent to take into account the
added value of the premises. As I see it, there
fore, the relevant amount is the present value,
as of the time that the 1966 improvement was
completed, of the respective amounts that he
would have been able to add to the rental pay
ments covered by the lease but could not add
because of the existence of the lease.
I am of opinion that we should hear counsel
on what judgment is appropriate as well as on
costs.
* * *
ST: GERMAIN and BASTIN D.JJ. concurred.
1 For the purpose of these reasons, I am using approxi
mate figures. Nothing turns on the precise amounts.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.