This Article recently appeared in CCH's Dominion Tax Cases newsletter No. 190 dated July 2009.

Transfers constituted capital withdrawals from RRIF

The Minister added $118,097 to the taxpayer's income for 2001 as an alleged benefit he received out of an RRIF. On his appeal to the Tax Court of Canada, the taxpayer argued in part that he thought that he had arranged for a loan, and that amounts routinely being paid to him from his RRIF were merely being assigned to pay down that loan, and did not constitute RRIF withdrawals of capital.

The taxpayer's appeal was dismissed. Regardless of what documentation the taxpayer thought he may have signed, two transfers of capital from his RRIF were in fact made at his direction to another fund which became retroactively deregistered. The result was that these two transfers constituted capital withdrawals from his RRIF that were required to be included in his income under s. 146.3(5) of the Income Tax Act (the "Act".) Even if it could be said that these two transfers were not truly "received" by the taxpayer under s. 146.3(5), they would still have to be included in his income under the indirect payment provisions of s. 56(2) of the Act. The Minister's reassessment was affirmed accordingly.

Bonavia, Jr. 2009 DTC 1167

Gain was income—Units not acquired to be held as long-term investment

The taxpayer's mother was reassessed to include in her income the entire gain she realized on the sale of 498 units (the "Units") in four buildings (the "Gain"). The taxpayer was subsequently assessed vicariously under s. 160 of the Act for the tax owing by her mother following the latter's reassessment. On her appeal to the Tax Court of Canada, the taxpayer argued that the Gain was not income but capital in her mother's hands, with the result that her mother did not owe the amount of tax in respect of which the taxpayer had been vicariously reassessed.

The taxpayer's appeal was allowed in part. Applying the well-established capital versus income criteria, the Gain was income in the hands of the taxpayer's mother, since she had not acquired the Units to be held as a long-term investment. A computational adjustment to reflect an additional tax deduction available to the taxpayer's mother was required, however, to reduce the amount of tax for which the taxpayer was vicariously liable under s. 160. The Minister should be ordered to reassess the taxpayer to reflect the foregoing findings.

Smitlener, Smitlener2009 DTC 1170

Taxpayer's mid- and long-term notes considered limited-recourse amounts

In the fall of 1994, units of a limited partnership (the "Partnership") were acquired by various investors including the four taxpayers, F, S, R, and B. B, R, and other typical investors purchased their units of the Partnership with a combination of cash, short-term notes (the "ST Notes") and long-term notes (the "LT Notes"). F and S, however, paid for their units of the Partnership with LT Notes, and also with mid-term notes (the "MT Notes"), which they tendered in lieu of the cash and ST Notes tendered by the other investors. Units of the Partnership not taken up by the individual investors and the taxpayers were taken up by another partnership (the "KP Partnership"). The KP Partnership paid no cash for these units, but issued a short-term note with no fixed terms (the "KP ST Note"), and a long-term note having the same terms as the LT Notes (the "KP LT Note"). On April 24, 1995, B acquired 97 units in the KP Partnership, tendering a cash component, a short-term note, and a long-term note. Both the Partnership and the KP Partnership were registered tax shelters. In reassessing the taxpayers for various years from 1992 to 1996 beyond the normal reassessment period, the Minister disallowed the deduction of the partnership losses claimed by all the taxpayers with respect to the Partnership, and by B with respect to the KP Partnership. Penalties for gross negligence were imposed on the taxpayers F and S as the directing minds behind the Partnership and the KP Partnership. The Minister's position was that: (a) the notes used by the taxpayers to pay for their purchase of partnership units (the "Notes") were limited-recourse amounts under s. 143.2(1) of the Act, primarily because interest was not paid on it or not paid on it within the 60-day period prescribed by s. 143.2(7) of the Act; (b) as a result, the cost to the taxpayers of their partnership units, and hence the at-risk amount for each taxpayer under s. 96(2.2) of the Act, was reduced, and this, correspondingly, reduced the taxpayers' entitlement to the partnership loss deductions in issue under s. 96(2.1) of the Act; and (c) the Partnership was not a valid partnership in any event, but a sham, and certain of its expenses were unsupported and lacking in credibility. The taxpayers appealed to the Tax Court of Canada.

The taxpayers' appeals were allowed in part. Subsection 143.2(7) of the Act deemed all of the Notes (with the exception of B's and R's ST Notes) to be limited-recourse amounts. The Minister was therefore permitted under s. 143.2(15) to reassess beyond the statute-barred years. The partnership losses claimed by the taxpayers were therefore reduced by the principal amounts of the Notes. The LT Notes were deemed to be limited-recourse amounts under s. 143.2(7) because the taxpayers could not prove interest was paid on them, or that it was paid within 60 days of the end of each taxation year. F's and S's M Notes were also deemed to be limited-recourse amounts because, by their own admission, they did not pay interest on those notes within 60 days of the end of each taxation year. Because both the LT Notes and the MT Notes were limited-recourse amounts, F's and S's entitlement to deduct any of the partnership losses claimed was nil. Because of the non-payment of interest, and because the KP ST Note was not a bona-fide loan, both the KP LT Note and the KP ST Note were deemed limited-recourse amounts. B's entitlement to deduct losses with respect to the KP Partnership was therefore correspondingly reduced. B's and R's entitlement to deduct losses with respect to the Partnership were also reduced by the amounts of their LT Notes. However, because they had acted reasonably and prudently in obtaining professional advice, the Minister was not entitled to reassess either B or R under the reassessment rules in s. 152(4) of the Act, so that their loss deduction entitlement remained unaffected, other than by the non-qualifying losses associated with their LT Notes, and B's KP ST Note and KP LT Note. Although it was unnecessary to consider the Minister's allegations respecting the validity of the Partnership, it was not a sham, because there was no intention on the part of its investors to deceive the Minister. However, it was not a valid partnership under s. 96 of the Act. It was structured so that its revenue levels could never meet its debt levels, with the result that it was never intended to earn a profit. Conversely, the penalties for gross negligence were unjustified since the conduct of F and S could not be characterized as "reprehensibly reckless" (see Klotz v. The Queen, 2004 DTC 2236). The Minister was ordered to reassess in accordance with all of the foregoing findings.

O'Dea et al .2009 DTC 1172

Compensatory payment constituted benefit received from RRSP—To be included in income

The taxpayer's RRSP held units of mutual fund trusts managed by AIC and Franklin Templeton. Following an investigation by the Ontario Securities Commission (the "OSC"), AIC and Franklin Templeton agreed to make compensatory payments to their unitholders who had suffered harm from certain market timing activities. In assessing the taxpayer for 2005, the Minister included in his income $303 in compensatory payments he received from AIC and Franklin Templeton respecting the units of AIC's and Franklin Templeton's funds held in his RRSP. On his appeal to the Tax Court of Canada, the taxpayer argued that this $303 was a non-taxable windfall and not income under s. 3 of the Act. The Minister's position was that the $303 did not meet the windfall criteria set out by the Federal Court of Appeal in The Queen v. Cranswick (82 DTC 6073) or, alternatively, that the $303 should be included in the taxpayer's income under the surrogatum principle enunciated by the Supreme Court of Canada in Tsiaprailis v. The Queen (2005 DTC 5119).

The taxpayer's appeal was dismissed. It was not clear that the taxpayer, or at least the trustee of his RRSP, had no enforceable claim for the harm done from certain market timing activities. In fact, the OSC pursued or negotiated these claims with AIC and Franklin Templeton on behalf of the beneficial owners of the fund units involved. As a result, what the taxpayer and the other affected investors received from AIC and Franklin Templeton was compensation for their losses. Therefore, a number of the windfall criteria set out in the Cranswick case were missing in this case. Also, the application of the surrogatum principle in this case required that the $303 payment received by the taxpayer be treated for tax purposes as though it were part of the taxpayer's RRSP. Therefore, when taking this $303 personally, rather than restoring it to the capital of his RRSP, the taxpayer was receiving a benefit from his RRSP that was required to be included in his income. The Minister's assessment was affirmed accordingly.

Lavoie, 2009 DTC 1183