In 1985, the
Government changed the Capital Gains Schedule to Number 3 and has many
computer input numbers for totals. A perusal of the numbers on schedule 3 will
show you the numbers that the computer works on. If you do prepare a separate
schedule to submit your capital gains on, it would be wise to arrange it in
such a way that the numbers used by the computer identify the type of gains
that you have. The less time a real person has to spend interpreting your
schedule, the better.
See the back
of the manual for samples of forms T2017 (reserves) and T657 (capital gains
exemption) and T936 (Cumulative Net Investment Loss - CNIL).
These forms are exceedingly difficult. If you are involved with the filling
out of these forms, I advise you to seek some help with your return.
1988 - 1989 - 1990 - ADJUSTED NET
CAPITAL LOSS AMOUNT
In 1990, the
"taxable percentage" of realized capital gains received changed from 66 2/3%
to 75%. Capital losses also changed from 66 2/3% to 75%.
In 1988, the
amount of capital gains which is taxable changed from 50% of the gain to 66
2/3% of the gain. At the same time, Capital Losses increased from 50% to 66
2/3% of the gain. This creates total confusion when it comes to carrying
losses back. Mr. Wilson and the conservative party should have called it the
Tax Consultants goodwill and retirement fund. Because of this
difference in percentage, it is necessary to adjust the amount of losses to
equal the amount of gains on a yearly basis. i.e., if you made $1,000 taxable
gain in 1985, you need $1,333.33 of allowable capital losses in 1988 and 1989,
to offset the $1,000.00 in 1985.
If you are
carrying losses forward from a prior year, you must adjust the amounts in
reverse, i.e., $1,000 of loss in 1985 cancels $1,333.33 gain in 1988 and 1989.
In other words:
1.
If you are applying net capital losses of prior years (72 TO 87) to
1988, or 1989 multiply the amounts by 4/3. If you are applying the losses to
1990 or 1991, multiply by 3/2. This is confusing but it works. Watch:
1.
$50.00 capital loss.
1.
$66.67 capital loss.
1.
$75.00 capital loss
Losses can go back
three years or forward indefinitely.
1.
If I make a $100.00 Capital Gain in 1990/91, I have a "taxable" gain of
$75.00. To apply this 1990/91 taxable $75.00 gain to a 1987 deductible $50.00
loss, I multiply the 1990/91 gain by 2/3 and get $50.00. Or I multiply the
1987 Loss by 3/2 and get $75.00.
1.
To apply a 1990/91 taxable $75.00 gain to a 1988 deductible $66.67
loss, I multiply the 1990/91 gain by 3/4 and get $66.67. Or I multiply the
1988 loss by 4/3 and get $75.00.
1.
To apply a 1989 taxable $66.67 gain to a 1987 deductible $50.00 loss, I
multiply the 1989 gain by 3/4 and get $50.00. Or I multiply the 1987 loss by
4/3 and get $66.67.
1.
If you are applying a 1988/89 net capital loss to 1985, '86 or '87,
multiply the amount to be claimed by 3/4.
Of course, if you
have a pre-May 23rd, 1985 capital loss, you may apply the lesser of $2,000 or
the unapplied loss against other sources of income. Put your claim on line
253, page 2 of the T1 Return. (do not try and use the T1 Special return, use
the long form).
Your calculation
should look something like Example 1.
*** YOU MUST DO A
SEPARATE CALCULATION FOR EACH YEAR FOR WHICH YOU ARE APPLYING NET CAPITAL
LOSSES ***
Use the
calculation in Example 2
DO NOT FORGET
1.
Net capital losses of earlier years must be claimed first. You must
apply `pre-May 23, 1985' losses before after `May 22, 1985' losses. This has
the effect of reducing your immediate deductions because you cannot use some
1987 losses against 1988/89/90 income and still claim the $2,000 loss on line
253 for the pre-May 23rd loss.
1.
Therefore, if you are applying net capital losses to 1988 or 1989 or
1990 or 1991, the amount at line 7 above is the maximum amount which you can
apply to line 253 of the current year.
1.
To apply a 1991 capital loss to a prior year, you must fill out and
include a form T1A (Request for loss carry back) which you will find
reproduced at the end of this chapter.
Try Example 3 if
you are applying 1989 losses backwards
he previous
worksheet refers to the years 1986, '87, and '88 when talking about the
calculation for 1989. The reason is that capital losses may only be carried
back three years. For 1990, carry backs are to 1987, '88, and '89.
OR
If you deducted a
pre 1989 net capital loss in 1989, use the worksheet in Example 4 to calculate
your remaining balance of unapplied net capital losses.
You should
keep separate balances for each year.
NOW, ON TO GENERAL INFORMATION ABOUT
CAPITAL GAINS
In most cases, for
stock transactions, a single total off your broker's statement will suffice.
For purposes of calculating capital gains and losses, I prefer to use my own
personal asset inventory form (see example) which makes it a lot easier to
determine gains or losses using the median rule or valuation day method. The
result of the calculations on the inventory should be entered in the
appropriate place on the government's Schedule 3, a sample of which is also
provided.
If you do intend
to invest in real estate make sure that you show an intention to hold on for a
long time. Do not lie to the banker to get the mortgage; i.e., telling the
bank manager you intend to buy and fix up and sell (so that he or she will
give you a loan), when you really are just trying to get hold of a house to
live in, will guarantee that you will pay full rates of tax on that house in
the future. And you don't have any credibility - you either lied to the tax
office or the bank, each of which is a fraudulent act . I had a case
similar to this in 1988. During the noon recess, I was cautioned by the judge
on proceeding. It was obvious that the taxpayer had perjured himself at least
once, either with the bank, or with the tax office. Since perjury is a
worse offense than tax evasion, one must be careful and honest .
The situation is
really stupid because of Section 39(4) of the Income Tax Act. This
section allows a person who is not a stockbroker to elect to treat stock
transactions as capital gains or losses instead of straight income profits or
losses. So we end up in the position where one client with over two hundred
stock transactions and a $50,000 loss was only allowed to right off $2,000 as
a capital loss and a single accidental profit of $50,000 on a lot he bought to
live on (and from where he got the $50,000 to lose in the stock market) was
taxed as straight income.
Please do NOT take
any of this for granted. Go to your tax advisor and after he or she has given
you an opinion, ask to see some sample tax cases of other peoples' tax
problems. Read the cases yourself (it will only take an hour) and decide for
yourself whether the opinion you have received is really correct. My
experience is that most people look at this with wishful thinking and when I
show them the cases, they change their own opinion as to the likely
consequences.
Too many big
words, and very confusing! What is a "capital gain"? A capital gain is best
described as an increase in the value of an asset when you do not really have
any control over whether the value of the asset will go up or down, and where
you do not normally "trade" in that asset as your source of income.
You can see that
the situation becomes very difficult when it comes to such cases as the stock
market or the "entrepreneur" who buys an old house, lives in it while fixing
it up and working at another job, and then sells the house at a profit. In
many instances, gains that are normally considered capital gains become, in
the case of stockbrokers who play the market, ordinary business income and are
taxed at full rates. Furthermore, the tax-free gain from the sale of an
"entrepreneur's" personal residence should be considered business income
since, in reality, this person has a part-time business.
WATCH
First of all, if
you sell your personal residence for a profit, you do not have to pay any
capital gains. In the U.S.A. it is quite different. There, as a rule, if you
sell your personal residence, you pay tax on the capital gain unless you use
it to buy another house. Also, if the new house that you buy costs
considerably less than what you received for the old one, there is often a
taxable capital gain. The U.S. also makes provision for short term capital
gains (taxable at the full income rate) for assets kept less than a year, and
for a minimum tax when the total amount of long term capital gain exceeds
certain criteria. In Canada though, it is another case of the rich getting
richer and the poor not having a chance.
For example, if
John owns a $100,000.00 house which he sells five years later for $150,000.00,
he has $50,000.00 tax free, the equivalent of earning $100,000.00 at a job.
George, on the other hand, has a $30,000.00 house he sells for $45,000.00, a
tax-free profit of $15,000.00, the equivalent of about $22,500 earnings. This
is hardly fair and is against the philosophy of our much-abused Carter
Commission on taxation.
OPINION
With regard to
"how many houses", there is just no pat answer. If people keep on buying
houses, fixing them the way they think best and, after finishing, decide that
they do not like the result, why shouldn't they sell and start over on other
houses? But when is it a matter of disliking the finished product, and when is
there an intention to make tax-free capital gains which are really very thinly
disguised part-time business earnings? It is a matter between your conscience
and the tax department.
However, in December 1988, Harjit Atwal
(I was his agent) was forced to pay full tax on a house which he built and
lived in for a short while. He was a contractor at the time and built four
similar houses for sale and one dissimilar house with a basement, etc. which
he moved into. The judge ruled that he had not proven it was built for a
personal residence.
In November, 1991, John and Valerie FALK
They had had three houses in 8 years from 1980 to 1988. Revenue Canada
Taxation tried to tax them on the second house they sold in 1985. The Tax
Court of Canada ruled against Revenue Canada but Revenue Canada still tried to
tax the house. Therefore, it should be obvious that you cannot "sell one a
year", or move back into the rental house for a month to make it tax free. In
fact, moving into the house to make it tax free, "triggers" a tax liability
although it can be delayed.
ADJUSTED COST BASE
Adjusted cost base
usually refers to the original cost of an asset but, as the term implies, it
may be adjusted by the owner for such things as the cost of improvements and
additions in the case of a building, or annual property taxes and interest on
undeveloped LAND. ( NOTE. Undeveloped land must be held for development by
a full time developer for interest and taxes to be written off. If you are a
developer, the land will be taxed at full rates because it is a business
action, not a capital gain).
In every case,
these expenses cannot be deducted from normal income. It should be obvious
here that, in the case of interest, every effort should be made to arrange
your affairs to make this item deductible in the normal course of events, as
there is a full deduction by deducting from income rather than by adding it to
the cost base to give yourself only half the credit some years down the road
when the dollar is worth less.
Please note that
cases mentioned in my TAX GUIDE show that judges are ruling against the
deduction of taxes and interest on vacant land as either a straight deduction
or by adding them to the adjusted cost base to decrease the capital gain. In
the Sterling case in 1985, the Supreme Court (by refusing to hear it) ruled
against the deduction of interest for the purchase of gold. IN 1987, THE
SUPREME COURT RULED AGAINST THE BRONFMAN ESTATE FOR THE PURPOSES OF DEDUCTING
INTEREST WITH "SUBSTITUTED SECURITY".
PERSONAL-USE PROPERTY AND LISTED
PERSONAL PROPERTY
Personal-use
property can best be defined as property that is valuable, but is used mainly
for personal convenience or pleasure. If you lose money on personal-use
property, as most people do with such items as boats, cars, planes, and
household effects, you cannot deduct the loss. However, if you own
personal-use property which you sell for over $1,000.00 and you make a profit
over the adjusted cost base, you must pay capital gains tax on two thirds of
the profit. In making the calculation, if your cost for the particular
property was less than $1,000.00, your adjusted cost base is $1,000.00. I find
the most common articles on which profits can be made are antiques, although
the tax office will also be checking the sales of fiberglass boats now, as
their prices have risen by a phenomenal amount in the last few years. Also, if
you have a vacation property by the beach which you sell at a loss, there is
always the likelihood that the tax department may choose that this is a
personal-use property for which you cannot claim a loss. Listed personal
property is a special kind of personal-use property that comes under the broad
heading of collectors' items. This includes antiques, paintings, manuscripts,
coins and stamps. These are treated almost exactly as personal-use property
with one exception: a capital loss from listed personal property can be used
to offset gains from other listed personal properties, and it can be carried
back one year and forward five years to offset other listed personal losses in
those years. A proposed amendment to the Income Tax Act will permit losses on
listed-personal-property to be carried back 3 years and forward seven years
commencing in 1984. Losses incurred in 1984 may be carried back for 2 years
only. Another proposal affecting listed personal property losses will allow
the tax payer to deduct any portion of the loss against gains of any taxation
year in the carry over period. This amendment applies to listed
personal-property losses commencing in 1983.
SPECIAL NOTE
PRINCIPAL RESIDENCE
This has always
been a confusing one and to enhance that situation the department has changed
the rules again. A family is allowed one residence tax free commencing January
1, 1982. Therefore, a family may no longer enjoy a summer cabin plus the
family home tax free. For those of you owning summer or winter cabins it would
be very worth while obtaining appraisals on your real estate holdings as of
January 1, 1982. Trying to sort out the January 1, 1982 market value of the
cabin when you sell it ten or twenty years from now is going to be a very
real, and likely expensive problem. Remember though, what you think is your
principal residence for tax purposes can be ruled against by DNR. To claim
your residence tax free, fill in form T2091 in back of this book.
TIP
Many accountants
have been telling their clients that they should cease to claim offices in
their homes. I have not yet worked out a case where I feel it is to the
taxpayer's advantage to postpone a claim for an expense today in the hopes of
an expected gain some time in the future. Let me work out a simple example
here. BULLETIN IT-120R3 STATES that the Department will not try and tax a
residence where there have been no structural changes involved with the
renting of a couple of rooms or the incidental use as an office.
If your yearly
expenses for interest, taxes, repairs and maintenance, heat, and light are
$6,000.00 (about right for a $57,000.00 house with a $45,000.00 mortgage), and
you use 20% of your house for business use (office and storage), then you
would deduct $1,200.00 from your income this year and, theoretically, every
year for 10 years at least because as the interest goes down, taxes and
maintenance go up. The $1,200.00 deduction this year in a $20,000.00 tax
bracket would be worth just about $600.00 in real money savings in one year.
Over 10 years this would be worth over $6,000.00 less tax, and over 20 years
$12,000.00 less tax, plus whatever earnings you made from investing the tax
money you had saved.
Remember though,
the above only applies for the 85, 86 and 87 tax years. Beginning in 1988, an
office in the home must be necessary, a private, separate room, and be visited
by clients regularly or the claimants principal place of work such as an
author's den or a painter's studio. This means that `records offices' are
going to be difficult if not impossible to claim and get through. (see Office
in the Home section for more details and examples).
WATCH OUT
I also mention
here that there is a four-year provision that allows your principle residence
to be rented while you are away without changing its classification. The four
years need not be consecutive; you could have been away in 1974 and 1975 and
then returned for six months in 1976 before moving away again for another two
years. If you are in this position you should file an election under Section
45(2) of the Income Tax Act indicating that your wish is to continue using the
property as your principal residence and that you have not changed its' use to
rental property. Failure to file this election could cost you thousands of tax
dollars.
If you are
transferred and meet certain other requirements you may designate your home as
a principle residence forever. Check with your tax consultant, as the rules
are continuously changing in this area. Be particularly careful IF YOU ARE
TRANSFERRED OUT OF THE COUNTRY and try and claim tax free status as a
non-resident. This means that the old family house left behind becomes taxable
in Canada and possibly in the other country as well (particularly if in the
U.S.).
STOCKS, BONDS AND SECURITIES
The person who has
extensive dealings in speculative stocks should be keeping proper records of
all these transactions for capital gains purposes, showing the number of
stocks and their value carried forward from the previous year, as well as the
number of stocks traded (bought or sold) and the amount of each of these
transactions. The transactions should be listed in date order.
If you have shares
of a particular class in a company which you acquired before Valuation Day
(December 22, 1971 for publicly-traded shares, December 31, 1971 otherwise),
when you sell these shares you are deemed to have sold these on a FIFO
(First-in, First-out) basis. After these are gone the identical property rules
apply, and the value of each share you hold is the average cost of all of the
identical shares you hold. This average will change every time you conduct
transactions with these identical shares.
CAPITAL GAINS - CAPITAL OR PROFIT?
$500,000 EXEMPTION - still there? for some!
The old May 23,
1985 budget proposed a lifetime $500,000 capital gains exemption for
each Canadian Taxpayer. At first glance it seemed like the giveaway of the
century. However, it did come with a mixed blessing because along with the
exemption came a concerted effort by the Department of National Revenue to
make what some people think are capital gains into straight income. Confusing?
- not at all, and as actual tax cases at the end of this section will show,
just a renewal of an old argument.
On June 18th,
1987, Mr. Wilson took away the $500,000 for everyone but farmers and small
business people. They will still get up to $500,000 when selling out
the farm (now) or the small business (from 1988 on, shares must have been held
for 24 months, so you cannot incorporate and sell off before 24 months are
up). Everyone else is limited to $100,000 and there is now a new wrinkle.
However, you can
sell a "working" family farm to a big city developer and claim it tax free for
up to $500,000 for each owner.
In cases where
monies borrowed have created investment losses for what was considered to be
future capital gains, the losses must be deducted against the capital gains
exemption. Therefore, it is possible to lose the exemption all together for
the future. Please note that, in any case, it is necessary to fill out a form
T657 for 1988 and a T936 for 1989 to show this CNIL (cumulative net investment
loss).
PLEASE ALSO NOTE:
To get the Capital Gains Exemption, your return must report the gain and
"claim" the exemption on a T657. IF YOU DO NOT REPORT IT BECAUSE IT WASN'T
TAXABLE "AND" DNR catches up to you, it will be too late to claim the
exemption and you will have to pay tax on it. This is a penalty provision to
stop taxpayers from "just overlooking" a gain on the chance that if it is
overlooked, they might be able to claim the full gain in the future because
they don't have a form on file. I continuously run across people who have been
told by friends and even accountants that they will not bother reporting this
because it "isn't taxable anyway". Not reporting it is the fastest way to make
it taxable.
POSSIBLE
EXTREME CASE:
A person borrows
$100,000 at 12% to buy stock. The stock pays $2,000 a year taxable dividends
for the next ten years, resulting in a loss each year of $10,000. At the end
of ten years the person sells the stock for $200,000 and earns a $100,000 `
capital gain '. The ten years of losses at $10,000 a year adds up to
$100,000. The $100,000 losses must be netted out against the $100,000 capital
gain exemption leaving an exemption of zero. Therefore, the person would have
to pay tax on 75% of the capital gain. (from 1990, 75% of capital gains
will be taxed .
A less onerous
situation would be as above where the person receives $10,000 a year taxable
dividends. At the end of ten years there would be a cumulative loss of $20,000
which would be netted out against the $100,000 capital gain exemption. There
would be $80,000 left and the person would have to pay tax on 75% of the
$20,000, or $15,000.
Remember, for 1988
and 1989, the percentage of Capital Gains Taxable goes from 50% to 66 2/3% and
then to 75% for 1990, so ten years from now it will be 75% taxable.
An important note
is that as of Dec 31, 1987, the ability to transfer $200,000 of stock in a
family business to the children "At Your Cost Base" expired.
WHAT IS A CAPITAL GAIN?
A capital gain is
a gain which comes without effort on your part. It usually is a result of
inflation, not of the marketplace, although you could say that inflation is a
result of the marketplace, particularly when it refers to land and the demand
for specific land. For example, waterfront or downtown commercial real estate
makes some land far more expensive than the same amount of land in another
area.
Fifty years of tax
law show that if you buy it wholesale and sell it retail, it is very difficult
to claim capital gains treatment.
HISTORY OF THE PRESENT SITUATION
Up until 1972, a sale was either a tax free capital
gain or it was taxable at straight income tax rates as a venture in the nature
of trade. In 1969, Keele Dufferin Acres Ltd. had bought a 92 acre farm which they farmed
for about four years. They then received an unsolicited offer to buy the farm,
and made a profit in excess of $150,000 which they tried to claim as a tax
free capital gain. The Tax Appeal Board ruled that the gain was taxable as a
venture in trade at full tax rates, even though it was an isolated
transaction.
In 1973, Anderson, Beckingham, McDonald and McDonald
were all
taxed as straight income on the purchase of a parcel of land outside of
Edmonton. Even though it was an isolated transaction, they had obtained their
advice from a noted real estate speculator, and the court ruled that though it
is possible that a similar transaction `could' have been a tax free capital
gain, it was unreasonable in this case to think that the investors bought with
any idea other than resale at a profit.
FAMILY HOME TAXABLE
Neither is the
"family home" free of tax in the right circumstances.
In 1978, John Welton
was taxed at full rates on a $66,000 profit from the sale of his fifth
personal house in 13 years. His regular occupation was that of building
contractor. The Tax Review Board ruled that his past conduct showed a clear
intent to buy, build, live in and sell at a profit.
In December 1988, Harjit Atwal
(I was his agent) was forced to pay full tax on a house which he built and
lived in for a short while. He was a contractor at the time and built four
similar houses for sale and one dissimilar house with a basement, etc. which
he moved into. The judge ruled that he had not proven it was built for a
personal residence.
In December. 1991, in the Case of FALK vs the
Minister of National Revenue
, Mr. Falk won his case. He had had three
houses in 8 years from 1980 to 1988. Revenue Canada Taxation tried to tax him
on the second house he sold in 1985. The Tax Court of Canada ruled against
Revenue Canada but Revenue Canada still tried to tax the house. Therefore, it
should be obvious that you cannot "sell one a year", or Move back into the
house for a month to make it tax free. In fact, Moving into the house to make
it tax free, "triggers" a tax liability although it can be delayed.
You can see that
one buy or sell could be a venture in trade and taxable at full rates, and
that the supposedly "sacrosanct" family home is not always tax free either,
but WHY THE BIG PROBLEM?
Well, as I implied
before, the question of capital gain versus straight income was becoming quite
clear by the start of the seventies. There were years of tax law to work with,
and then the legendary monkey wrench got thrown into the works. In June of
1971, The Minister of Finance introduced Capital Gains tax at full rates on
50% of the gain beginning January 1, 1972.
The tax office
became so engrossed in collecting the new tax that they ceased to pay as much
attention to the difference between capital gains and straight income. As a
consequence, for about eight years, profits which would have been taxed as
straight income under the old act, snuck through as capital gains at half
rates. Then in 1980/81 DNR started to crack down on straight income again. In
fact, they went overboard and attacked every single sale that they could find,
particularly in the west, where fantastic profits were being made by
"flippers".
Unfortunately for
DNR, by the time they did crack down, the losses were flowing like blood in a
slaughterhouse, and the government ended up giving out as many or more dollars
for the straight losses as they collected from the few people that they
managed to tax at straight income.
Those losses have
now been established and the real estate market in Canada is strong. In fact,
collectively, Canadian Real Estate has increased in price 80 out of the last
86 years.
Concerning the
Stock Market, Section 39 (4) contains an election which allows stock market
investors (who might make 50 trades in a year) to elect to treat themselves as
capital gains investors, rather than as traders. This election excludes
professional stock traders and certain officers and directors, but it is there
and makes the rules different between real estate/all other investments and
the stock market.
The tax act
defines "any buy/sell" as a venture in trade, and gives the election exemption
for the stock market and for the family home. This means that by the very
definition, any single buy/sell in real estate that you do not live in is
taxable at straight tax rates. Lets face it. We would look pretty stupid in
court telling the judge that we didn't buy the real estate or the stock to
make a profit.
So what does this
mean?
What it means is
that you are going to have a hard time getting that $100,000 or $500,000
lifetime exemption. The tax office has a policy of going after investors in
the stock market and making them traders based on the volume or number of
trades or the position of the purchaser/seller relative to the companies
involved. In 1984, Louis Wolfin and Frobisher Securities Ltd. were denied the
benefits of section 39 (4) and Capital Gains Tax treatment. The Tax Court of
Canada ruled that the activities of Mr. Wolfin were such that he personally
was responsible for the increased values of the shares he bought and sold in
his own name and that of Frobisher Securities Ltd. Both Mr. Wolfin and
Frobisher Securities have appealed the case to the Federal Court - Trial
Division.
A TRUE STORY THAT DID NOT MAKE IT TO COURT but took a
year to fix.
The combination of
differing treatments of stock trades and real estate trades can create
situations which sound or read like Saturday morning cartoon shows, if it was
not for the worry and heartache for the people involved. In the following
case, which took over a year to solve, the taxpayer involved was driven to
seek bankruptcy counseling, his marriage was "almost" destroyed, and another
citizen wonders "why me??".
What happened? My
client bought a lot with acreage in a rural community. He bought the lot to
build a house on for himself, his wife, and his children. However, a series of
murders and other circumstances caused his wife to decide that she did not
want to live in that area. It seemed fortuitous. He sold the lot and acreage
at the top of the market and made a $50,000 profit. He took a small part of
the money (a mistake as he should have paid cash) and put it down on another
lot on which he promptly built at the top of the market... (i.e., although he
had made a big profit in cash, he signed for a large amount of money at the
peak)... and moved wife and family in. But now that he had some `real money'
to work with he was going to make his fortune. An advisor told him to buy an
Income Averaging Annuity Contract (IAAC) where he could borrow the money back
out and have it to use, so he did.... (Now he has the money to spend, and
doesn't owe all that tax `now').... He took his $40,000 to the stock market,
made over 100 buys and sells, got up every morning to call his broker, and
spent six months of his life losing the $40,000 plus another $10,000 he had
borrowed... This, of course covers two fiscal years of tax which we will call
`80 and '81. He now has a $50,000 capital loss in '81 which he can apply
against the $50,000 capital gain in '80, and does not need his IAAC anymore.
In trying to stop the taxing provisions of the IAAC, he triggers an audit....
The assessor taxes him 100% on the profits on the lot (an isolated instance
bought for personal use and tax free if he had built right away) and only
allows a $2,000 capital loss for the $50,000 stock market loss to which he has
devoted six months of his life and has NOT EVEN MADE a Section 39 (4) ELECTION
TO BE TREATED AS A TRADER.
THANKFULLY,
although the local branch was unreasonable, and frustrating, a NOTICE OF
OBJECTION ( T400A ) resulted in an appeals officer reversing this
inequity without having to go to court. Our argument was that the lot was
Capital Gains and that, if a change was to be made, it should be to allow the
$50,000 stock loss as a business (i.e., trading) loss, which in the long run
is what really did happen. My client and the Tax Office were happy to call it
quits.
The IAAC was
stupid legislation which has thankfully been removed. Most tax shelters are
stupid with the exception of Rasp's and MURBs. When you see a B.C. Cabinet
Minister resigning over his purchase of a Tax Shelter, and others losing
homes, cars and reputation over purchasing Scientific Research Tax Credits
which never took place, you have to realize that the inside of the deal is
more important than what the paperwork looks like.
Sometimes, a deal
can be a combination of capital gain and income.
In 1984, Dorothy May Hughes
had her original loss in the Tax Review Board (in 1980) changed by the Federal
Court - Trial Division. In January 26, 1973, Hughes bought an eighteen suite
apartment block for $235,000. Various personal and financial problems caused
Ms. Hughes to apply for strata conversion in July '73, and although North
Vancouver City Council originally turned the request down, the conversion was
finally approved on January 28, 1974. The strata value was appraised at
$460,000 on January 15, 1974. When filing her 1974 tax return in 1975, Ms.
Hughes claimed capital gains treatment for the change in value from $235,000
to $460,000 and reported straight income on the sale of the strata units over
the $460,000. DNR tried to assess for straight income after the $235,000 cost,
and the Tax Review Board agreed with DNR. However, the Federal Court agreed
with Ms. Hughes, citing the following case, which took three court cases to
settle in the taxpayer's favor. AND, as this case involved the 1967/68 tax
years, capital gains treatment meant no tax.
In 1963, Hiwako Investments Limited,
which was controlled by an individual with a long history of real estate
transactions, bought a number of apartment properties in Toronto. They were
sold 9 months later for substantial profits which were claimed tax free. In
1973, Hiwako lost before the Tax Review Board. In 1974, Hiwako lost before the
Federal Court. And in 1978, Hiwako Investments Limited won in the Federal
Court of Appeal. In settling the Hughes case above, Judge Collier quoted Judge
Jackett in the Hiwako case: "an intention at the time of acquisition of an
investment to sell it in the event that it does not prove profitable does not
make the subsequent sale of the investment the completion of an `adventure or
concern in the nature of trade'".
Please note that
it took from 1974 to 1984 to settle the Hughes case above. It took from 1964
to 1978 to settle the Hiwako case. Ten years and fourteen years are nothing
in tax matters. As of the date of this writing, January 4, 1992, I have
been waiting 15 months for the judge to rule on my 1979, 80, and 81 tax returns
(which of course affects every return from 82 to 92). The case was 10 days
long and would have cost a stranger $150,000 or more for representation.
Please remember
the cost and time involved if and when you decide to challenge the system.
We have now
covered isolated transactions, combined transactions, and multiple
transactions. We have touched on the stock market and seen that there is a
large difference in the treatment of stock and/or real estate transactions.
What about personal assets, like cabins, boats, cars, art and jewelry, and the
family house, particularly where the land exceeds one acre.
LAND IN EXCESS OF ONE ACRE
In 1984, Carl Rudeloff
lost his claim for a tax free sale of his home and ten acres which he had
lived on and in for ten years. The Tax Review Board ruled that although the
excess 9 acres of land certainly `contributed' to the use and enjoyment of his
home, it was not necessary. The facts that the Rudeloff family had a woodlot,
raised horses and chickens, had a family garden and a play area, did not sway
Judge Taylor of the Tax Court of Canada. He said, "I am not persuaded the
relevant section of the Income Tax Act permits of the view espoused by this
taxpayer - that merely because he resided in a housing unit on the property,
and used the balance of the property in one way or another to enhance the
utility and attractiveness of that domestic living style, he can expand the
boundaries of his housing unit to the parameters of the natural domain desired
in his appeal."
This last decision
has been partially turned over in the 1991 Federal Court decision where Judge
Strayer decided that an extra lot was not essential but certainly contributed
to the use and enjoyment of the property. However, I find this ruling unusual
for a country like Canada. Certainly, this country was built on small
holdings, self-sufficiency, the raising of chickens and the growing of food in
a garden. However, it seems that unless you can show that it was necessary for
the use and enjoyment of a housing unit, it will not fly. Perhaps if he could
have shown that he did not have enough money to feed his family, it would have
proved `necessary'. I think I can explain it in other equally ridiculous
terms, though. You buy a car with no doors or roof. It has an engine
(necessary to use), a transmission (necessary to use), four wheels (necessary
to use), a steering mechanism, (necessary to use), and brakes (but brakes are
not necessary to use). Brakes, roofs, and doors are an example of things which
certainly `add' to the use and enjoyment of a vehicle but are not necessary if
you drive in a vacant and level field where it does not rain. Of course, if
you want to drive down a hill, brakes would be necessary, but since you don't
`HAVE TO' drive down the hill, they are not necessary. However, if you want to
drive on a highway, THE LAW SAYS THAT BRAKES ARE NECESSARY. If it rains, you
may say that a roof and doors (and windows) are necessary, but all sorts of
people ride motorcycles in the rain with no doors, roof or windows. (Okay,
okay, a windshield is really nice, but not necessary... my motorcycle does not
have one).
In fact, if any
case should have been appealed to a higher court, the Rudeloff case should
have been, and we at the CEN-TA GROUP had a similar case that was destined to
"go to the top". We took our case to `the top' in 1988.
Unfortunately, the Tax Court ruled against five
members of the Cillis Family and they have decided not to appeal. But I still
feel they should have won. Four generations of one family lived on five acres
in two houses. They used the acreage for a riding ring (one son is now a
full-time professional equestrian), duck ponds, swimming pool, barns, sheds,
and wood lot for themselves. However, as the two houses had been legally
subdivided `out' of the five acres, it was ruled that the excess land was not
`necessary' for the `Use and Enjoyment'.
And The Cillis
family has decided not to appeal with good reason. DNR is treating this entire
situation like parking meters. Either the violation flag is up or it is not.
The courts have been interpreting the word "necessary" to mean "cannot be done
without".
I still feel that
the Cillis Family would have won their case on appeal. You have not really
lost until the final judge has had his or her say. Marianne Fourt found that
out when she did not take "NO" for an answer. Sort of a reverse of the popular
T-shirt which says, "What part of No don't you understand".
In 1991,
Marianne Fourt
received a favorable ruling from the Federal Court Trial Division when
the court ruled in favor of the tax free status of the second lot. The judge
ruled that although not essential to the use and enjoyment of the family home,
it clearly contributed to the use and enjoyment within the meaning of
paragraph 54(g)(v) of the Act. She had lost in 1988 as stated below.
In 1988, Marianne Fourt
paid tax on an adjoining lot she sold. She bought two lots and built her home
on one and used the second lot for an incinerator, storage shed and parking.
Judge Goetz of the Tax court ruled that she could have built everything on one
lot and the other was not necessary, i.e., could not be done without.
It seems that
unless, you have a "Yates" argument, i.e., could not have bought less because
of zoning, you will not get anything more than one acre tax free. (to be fair,
it is really 1.2 acres (1/2 hectare). Because of welfare, etc., the courts are
determining that `eating off the land', i.e., garden, raising animals, etc.,
is not sufficient for necessity.
In 1989, Elmer Augart
won an unusual case when you consider some of the other cases previously
mentioned. (Elmo Baird for instance). He had bought 8.99 acres and he lived on
it for FOURTEEN YEARS BEFORE the land was rezoned to require 80
ACRES FOR A SINGLE FAMILY HOUSE. Judge Mogan of the Tax Court of Canada ruled
that because of the YATES case mentioned before in the text, the entire
8.99 acres was necessary under section 54(g) of the Act.
But also in 1989, the estate of Anna Lewis and the
estate of John Lewis were taxed on the land in excess of one acre even though it was shown
that the 2.11 acres could not be subdivided and sold as separate parcels.
Judge Rip did not apply the Yates argument but he did change the values placed
on the property by DNR resulting in a little less tax.
The
following cases just add to the argument and are here for your information.
They include the YATES CASE.
In 1983, Donald Fraser
lost his claim for an extra half an acre used as a garden and play area. D. E.
Taylor, member of the Tax Review Board, found that the taxpayer had failed to
demonstrate the "necessity" for the garden and play area.
In 1983, Elmo B. Baird,
lost his bid for the tax-free sale of land in excess of one acre. Mr. Baird
had bought 2.41 acres under the Veterans Land Act in 1951. He built
outbuildings, raised farm animals, gardened, and used the size of the land for
a septic field. Certainly "use", although an argument could be made by many
"city dwellers" that tending a garden and cleaning stalls and septic fields is
not "enjoyment", nor necessary. My understanding was that all VLA land was
supposed to be in the 2 1/2 acres size `area'. If that is the case, Mr. Baird
should have won his case because he could not have bought less land under VLA
rules.
In 1991, Glen Windrim
paid tax on the value of some 15 acres of land. He had a mobile home on 17.6
acres for three years and when he sold them, he tried to claim the total tax
free. However, he had only lived there three years and showed no evidence of
use and enjoyment or necessity. It is interesting that DNR voluntarily gave
him 2 hectares (4.6 acres) tax free and Judge Muldoon of the Federal Court
Trial Division went along with it even though the act only allows 1/2 hectare
(about 1.22 acres) and originally allowed only 1 acre.
Interpretation
bulletins IT 120 and IT 120R leave the impression that such matters as zoning
will contribute to a favorable ruling when capital gains on land in excess of
one acre are concerned.
In the case of Mr. Baird,
he could not legally have bought less than 2 1/2 acres (VLA financing
not zoning rules), which is relevant when the next case is mentioned.
The Famous Yates Case
In 1983,
William and May Yates won their case in The Federal Court - Trial
Division. The taxpayers could not legally have occupied their residence
without ten acres because of local zoning laws. It was necessary to have more
than one acre. Even though they had rented the excess out to a farmer, they
only sold the excess 9.3 acres under threat of having the area expropriated.
Judge Mahoney ruled "The defendants could not legally have occupied their
housing unit as a residence on less than ten acres. It follows that the entire
ten acres, subjacent and contiguous, not only `may reasonably' be regarded as
contributing to their use and enjoyment of their housing unit as a residence;
it `must' be so regarded. It also follows that the portion in excess of one
acre was necessary to that use and enjoyment." This case was appealed to the
Federal Court of Appeal. I am pleased to say that In 1986, William Yates
and his wife May Yates won again. Judges Heald, Stone and Ryan found for
the Yates.
But, there is a
sense of futility here. When people need and use the land, they lose, but when
they rent it out and don't use it, they win.
In 1986, the estate of Sarah Raper
won the tax free ownership of an extra 4 acres for 9 out of 10 years. Until
1980, zoning laws prevented the subdivision of the land into less than 5 acre
plots. Even though she did not subdivide the land in 1980, Judge Tremblay of
the Tax Court of Canada ruled that her lifestyle was not sufficient to show
`necessity for use and enjoyment' after 1980, and assessed tax on the capital
gain after 1980. He said that `use and enjoyment' should be decided on a year
to year basis, thus giving credence to my graph in the tax books from 1974 to
'82 wherein I suggest that a taxpayer should be able to designate alternate
years or different years as tax free, rather than the successive years
suggested by DNR.
In 1987, John Wallace Beaton
lost his case for the sale of 2.1 acres tax free showing again how the judge's
mind works in these situations. In 1979 he had bought a `remnant' 4 acres in
an area that required 25 acres to build a house. He built a house and drilled
two wells, one on each half of the property. Neither well was satisfactory. In
1984 he sold 2.1 acres and kept the balance as his residence. He claimed the
2.1 acres was tax free because he needed it for his well and because of the
zoning in place at the time of purchase. Judge Brule of the Tax Court of
Canada ruled that it could not be said that Beaton could not have built on
less than 4 acres as the land in question was already a remnant, and he
certainly didn't need the extra 2.1 acres for his water supply because the
well was unsatisfactory. The taxpayer was able to "do without" the 2.1 acres
(i.e., he didn't need brakes.)
In 1986, Jacob and Ruth Schellenberg
won $221,000 out of a $375,000 sale as tax-free gains from the sale of their
principal residence and an adjoining lot. DNR tried to reverse the figures to
$154,000 for the principal residence, and $221,000 as taxable from the sale of
the lot. Judge Christie of the Tax Court of Canada ruled that the
Schellenberg's figures were correct.
ESTATES and
CAPITAL GAINS and ROLLOVERS
Death can cause
difficulties and hardships with regard to capital gains.
Income Tax is extremely time sensitive. In 1982, the
estate of W. E. Hillis was caught in a time warp which our legislators would not have wanted
to happen. When W. E. Hillis died in testate on February 21, 1977, his lack of
a will (intestacy) delayed normal settlement of the estate, plus left (under
Saskatchewan law) part of the estate to the sons, both of who disclaimed any
interest in the estate in June and July 1979. His widow was granted the entire
estate on December 14, 1979 under the Dependent's Relief Act of the Province
of Saskatchewan. The act specifies that to escape capital gains tax on assets
transferred to a trust or spouse upon the death of a taxpayer, the assets must
vest in that trust or spouse within fifteen months of the death. If not, there
is a deemed disposition at fair market value of any assets of the deceased as
of the date of death.
In this case, it
is obvious that this did not happen. And it is easy to say that the judge was
correct in taxing the assets, but is this what parliament wanted, to tax
widows because of time delays during moments of hardship? This case was
appealed to the Supreme Court of Canada. The Court dismissed the application
in 1985.
And in 1989, the estate of Alexander Boger
suffered the same indignity. Mr. Boger died in 1979 and left his estate to his
wife and 4 daughters. Mrs. Boger contested the will and held up the settling
of the estate for 3 years. Judge Rip of the Tax Court of Canada ruled that the
property had not been transferred to the children within the required 15 month
period. It is obvious that this law needs changing. Fifteen months is not
enough time when there are large numbers of items and potential family claims
that have to be settled. Legislators awake! The results are not what
you expected when fifteen months was allowed in the first place.
But, in 1991, the Boger Estate
fared better. There was a problem with the legal definition of "when the
property transferred" because of a challenge to the will by the wife. To be
tax free the property has to be vested or transferred within 15 months. Judge
Jerome of the Federal Court ruled that it was necessary to look at concepts
and terminology from real property law. As such, he ruled that the property
was vested under the terms of the will under section 70(9) because there were
no conditions precedent to stop the vesting. The Estate had lost in the Tax
Court of Canada. The difference between this and the Hillis Estate, is that
Hillis had no will, therefore, there was no immediate vesting which was
challenged.
Two other cases
dealt with slightly different matters but both dealt with Estates.
In 1989, the Estate of Stanley Earl Lewis
won its case for tax free rollover. Lewis's final 1982 T1 return was filed
showing the rollover of the farm to two grandsons within the 36 months
required under section 70(9) of the act. However as the wife was to receive
the rents and profits until their grandson's 20th birthday on June 17, 1989
when the two grandsons were to receive the farm, DNR tried to turn it over
because the grandsons had not received possession. Judge Kempo ruled that
there was an indefeasible vesting even though actual possession
had not taken place.
Judge Kempo got
another chance to make a wise decision as well.
In 1989, the Estate of Wilbert A. May
received the same treatment. Because May died on May 18, 1982 with an
ambiguous holographic (personally handwritten but not witnessed) will, it took
four years of litigation to reach an agreement as to the disposition of the
estate. Mrs. May the widow was finally given the property subject to some
rights of first refusal on some of the land on April 9, 1986. Judge Kempo
ruled that there was a rollover as defined by section 70(6) of the Act.
And in another estate situation, in 1987, The Estate
of Jeannette Bell Kelley lost its bid for tax free capital gains under the US/Canada Tax Treaty.
JBK died in 1970, and the land in Alberta was sold in 1980. The two heirs both
lived in the United States. Article VIII of the US/Canada Tax Treaty of the
time, exempted Capital Gains earned in one country by a resident of another
country. The estate tried to claim this treaty exemption. Judge Rip of the Tax
Court of Canada ruled that the estate realized the gains and that therefore
gains were only indirect for the residents of the U.S. Furthermore, an
intervening life estate could have nullified the inheritance if the
beneficiary of the life estate had had children, etc.
SELLING YOUR OWN ART HISTORY
In 1981, Murray Schafer,
(one of Canada's foremost musicians and composers) sold a large number of his
original manuscripts, his diary, and other effects to the National Library of
Canada. The tax office taxed him on these items as straight income. Guy
Tremblay of the Tax Review Board ruled that the items were unique and not for
resale and were not a commodity, and were of a personal property capital
nature. The problem of valuation day then came up because if there was no
increase in value from January 1, 1972 there would be no tax on the sale price
of $25,000. However, eight of the documents were written after 1971 and could
not have had any value before 1972. In an unusual move, the court in this case
decided on a value and recommended that both sides accept that value. Guy
Tremblay C.G.A. decided that the value of pre-1972 documents on valuation day
was $15,000 and that they had sold for $20,000 and that they were more
valuable because of their age and relevance than the post 1972 documents,
which he assessed as sold for $5,000. This resulted in a capital gain of
$10,000.
MULTIPLE APARTMENTS
In 1980, Greenbranch Investments Limited
received a favorable ruling from the Federal Court - Trial Division.
Greenbranch had built 152 maisonette units for rental purposes. These units
were sold. In 1971 the taxpayer foreclosed on the property and ran the units
as a rental project for another year and a bit, but the failing health of one
of the principals and serious structural defects caused it to be sold again in
1973. Judge D. J. Grant ruled that the property had been foreclosed on, in an
attempt to keep it, rather than by using an `order for sale' to recover the
monies. Given that the company had built the units once and sold them twice,
you can see that it IS possible to have capital gains tax treatment, even if
outwardly the deal looks like a venture in the nature of trade.
And 10 years later, in 1990, Frank Grouchy, an
auto parts dealer did better in his Real Estate Venture than the Dands did in
their Horse Breeding business (see Expectation of profit section). Grouchy had
bought 14 townhouses in partnership with an experienced real estate investor.
When the partnership received an unsolicited offer soon after the purchase,
they sold at a substantial profit. Judge Martin of the Federal Court ruled
that the taxpayer was an open, frank, and credible witness and allowed him
capital gains treatment even though the partner was taxed at full rates.
And in 1990, corporations do not always lose either.
In 1990, W. Hanley & Company were allowed capital gains treatment on
their 7% share of an apartment condominium project. They had taken the 7% in
lieu of a smaller commission on a project originally built for resale.
However, when the developers decided to keep it and rent it, Hanley got the 7%
ownership. When the project was subsequently sold because of rent controls,
the 7% was $146,000 instead of the $20,500 they had given up in favor of the
7%. Judge Collier of the Federal Court ruled that because the developer had
control of the project and made the decision to sell, Hanley's profit was a
capital gain. Most of the time, these cases end up in court because there is
something different and the next one is no exception to that rule.
BUILDINGS
In 1985, Charles
A. Beghin had his capital gains and possible personal use claim changed to
straight income and penalties were added for the unreported income on the sale
and the interest on the mortgage resulting from the sale.
In 1985, Robert Blais,
who had bought 59 buildings and sold 29, was assessed straight tax. His
purpose in buying the buildings was to improve his financial position.
TRAILER PARKS
In 1985, Leonard Reeves Incorporated
was assessed straight tax on trailer courts sold in Florida. The mobile home
parks were owned with two others but the taxpayer made no attempt to hold on
when the others wished to sell.
In 1985, Paul Zen,
whose regular occupation was that of land developer, had his 1977 return
changed by the Federal Court - Trial Division. Judge Muldoon ruled that the
building had been built in the ordinary course of business and was properly
taxable at straight income rates rather than capital gains. In this case, only
a couple of years were involved and the taxpayer was a builder. In the
following case, 23 and 10 years went by.
HOTELS
In 1985, Climac
Hotels Ltd. and B & C Hotels Ltd. lost their claim for capital gains on the
sale of three hotels. The taxpayers claimed that large sums of capital had
been invested and that theirs had been hands on management. Judge Brule of the
Tax Court of Canada ruled that a profit motive existed and that the profits
had been properly assessed as income.
You will have to
agree that my point about the government taxing as `straight income',
transactions that many people considered capital gains, has been made `in
spades'. There were more cases in 1986 than during the last three or four
years put together. The TAXPAYER usually lost. 1987 saw another 30 reported
cases, 1988 over 30 and another 30 in 1989. 1990 has been a slow year with
only a dozen. I guess that a lot of individuals are looking at the precedents
and not bothering to go to court. 1991 Has been busy again with many capital
gains versus straight income tax cases clogging the courts.
Because of the
extreme number of cases, I have chosen to deal for the most part with cases
from the Federal Court of Canada and above.
In November, 1986, Samuel Edlinger
won his case in the Federal Court of Appeal. Judges Pratte, Hugessen, and
MacGuigan agreed that his collecting of formerly worthless notes acquired with
the shares of a corporation were of a capital nature and not straight income.
He had sold his business to a separate company. When that company failed to
operate the business successfully, he bought the shares back, turned the
business around, and in 1971 and 1972, paid himself for the notes he had
acquired rather than take a salary. DNR tried to tax this as straight income.
The court ruled that the notes were incidental to his purchase of the
business.
In 1986, V. S. Ramachandran and Rolf F. Feldman
lost their bid for capital gains treatment on two buy and sells. They were
dealing with a noted real estate speculator, and although they held the
apartment block for four and a half years and a townhouse development for
three years, they failed to show sufficient determination to hold on for
investment purposes when the going got rough.
In 1986, Demetrios and Dimitra Giannakos
lost their try at capital gains for the last two out of six houses which had
been bought over four years. They had lived in one and rented out three. The
last two were bought when the others were losing money ($1400 a month), and
Judge Cullen of the Federal Court ruled that the taxpayers had failed to
establish that the last two properties were purchased as an investment for
long term holdings. The other three rental houses were treated as capital
gains by the department and were not part of the appeal. This likely explains
why the Giannakos have taken their case to the Federal Court of Appeal.
In 1986, Hyman Fisher and Marsted Holdings Ltd.
lost their appeal from their 1974 tax returns. They had a building which was
sold after a series of disasters and lawsuits. They claimed the rather large
profit as a capital gain. Judge Joyal of the Federal Court disagreed. Mr.
Fisher has appealed his case, so stay tuned (i.e., buy the next edition of
this book).
Judge Rouleau of the Federal Court agreed with the
taxpayer in one case for the little guy (no pun intended). Guy Hebert won his
case in 1986.
He had built a series of rental buildings over the years. In 1977 and 1978 he
sold seven of the buildings to finance the construction of a larger apartment
complex he was building for rental purposes. The judge ruled that he had
demonstrated the intention to produce a living for himself and his family with
his rental units.
In 1986, James Lampard
won his case for capital gains treatment before Judge Christie of the Tax
Court of Canada. He proved to the court's satisfaction that the intention was
to buy and build a shopping center in downtown Red Deer, Alberta. He only
changed his mind when another shopping center was built north of town. The
city could not support two new shopping centers. The Crown has not appealed
this case.
RENTING MOST OF A HOUSE - the tax
free TRIPLEX
In 1986, Fedel Saccomanno won
the sale of his home as a tax free capital gain as his principal residence. He
had bought a triplex with two units rented out, and lived in the third unit
with his wife on weekends when he was not teaching at the University of
Waterloo. When he did not get tenure at Waterloo, and sold the property, DNR
tried to tax two-thirds of the profits. Judge Taylor ruled that the entire
triplex was tax free, giving credence to my claim in my Investment Guide. In
the Investment Guide, I suggest that people with duplexes and triplexes should
claim the whole building tax free in spite of the fact that Bulletins IT 120R2
and R3 stated that half a duplex and two thirds of a triplex would be taxable.
In 1989, Normand J. Robitaille paid
tax on 1/3 of the capital gains on his principal residence during the period
he had rented out part of his house. He did NOT fight the case on the tax free
merits but rather on the amount of capital gains he had reported. I would say
he paid tax he did not owe based upon Saccomanno above.
WHEN DID IT HAPPEN?
In 1987, Mary Finochio lost her attempt to
have the sale proceeds from the sale of some real estate, put into her 1978
taxation year. She sold real estate with a closing date in November 1977. The
deed was registered on November 30, 1977. However, she did not receive the
money (with interest) until January 4, 1978. Judge Cullen of the Federal
Court, Trial Division, found that the transaction had taken place in 1977 and
was properly taxed in that year. She had also lost her case in the Tax Court
in 1984.
In another example
of justice delayed:
In 1985, Imperial General Properties Limited
lost their case in the Federal Court of Appeal. As they had won in the Federal
Court in 1983, and the matters in question took place in 1968, and 1970, one
can see that one cannot always count on advice and professional help. The case
involved the sale of 307 suites. The question was what year did the suites
actually sell because of the subject clauses involved. The subject clauses
involved zoning, soil tests, CMHC approval, and servicing of the land by the
municipality. Two years were allowed for the clauses to be removed. In this
case, the taxpayer wanted the money included in income in 1968. The Tax Office
wanted it to be in 1970's income when the subject clauses had been removed or
fulfilled. The reason was that a corporate amalgamation was taking place, and
the losses of one of the participants could not be carried into the new
amalgamation and used in 1970... we are dealing with a million dollars here.
By moving the profit into later years, DNR cost Imperial
many, many dollars. But the Federal Court agreed with Imperial, so who is
right????
Just remember, any
one of these cases could be you. And as I implied at the start of this
chapter, it will be "REAL HARD" to get that $100,000/500,000
tax-free capital gains exemption.
LARGEST WARNING!!!!
Watch out for
kinky deals. It is quite possible to be dealing with an organization and end
up in a serious audit, simply because you are a client of that organization.
All the investors in The Abacus Cities deals found this out. All the
Community Builders investors found this out. The Imperial Ventures MURB
deals fell apart across the country. And the best I saw was a letter addressed
to clients of a Toronto Investment and Tax Consultant. In this letter,
the Head of Special Investigations tells the investment clients that they will
all be reassessed. When I first saw the deal, I could only say, `this is
crazy'. However, it was sold for several years. In two or three cases that I
have seen, the amount of tax will be in the $50,000 range.
Whenever you are
offered five for one or four for one tax write-offs, run to the nearest
exit... You are asking to have your returns audited. At the very least, you
will find yourself tied up in litigation for years. Many operations are using
the case of Dr. W. S. J. Buckler to sell their four or five to one tax
shelters. If you are tempted to buy because Dr. Buckler won his case, I wish
to advise you (the people selling the deals do not) that the case is under
appeal, and I do not expect Dr. Buckler to win. But before you buy, why not
phone Dr. Buckler in Vancouver and ask him about it. i.e., was it worth the
turmoil???
In 1988 the sale
of containers and the sale of units in two different magazines have received
cease trading orders from the Superintendents of Brokers in Ontario, B.C., and
Saskatchewan, with other provinces expected to follow suit. (Some of these
operations have since had prospectuses approved and are again being offered
for sale.) In November, 1987 I was approached by the seller of one rather
large tax shelter operation. We were being asked to sell the product which
involved an investment of over $100,000. All paperwork indicated that the tax
shelter was `perfect, true and okay'. My research found that 100 of the 900
present investors have had their $25,000 refunds held up in the court system
and they can expect to have to go to court to win. (I do not think they will
win.) Furthermore, in an hour and a half presentation, the chance of profit
was not mentioned once. All that was shown to me was the wonderful tax refunds
to be expected. (For business loss expenses to be deductible against other
income, the primary reason for the investment MUST be the expectation of
profit from the business or investment.)
In December 1991,
investors in one of the Shipping Container investments which I had criticized
were picketing the promoter's residence. In general most of these deals
collapsed.
With so many
S.R.T.C. deals having gone down, with so many unfinished MURB projects a
couple of years ago, with so many people hurting because of extremely
speculative `tax shelter' investments, with so many people hurt in the recent
stock market crash, please think twice before you buy a tax deduction on
December 28th.
After writing the
above, in the week of December 15 to 22, 1987, seven `tax sheltered'
investments were handed to me. All seven likely had merit. However, to `pitch'
them to my clients in the last weeks of the year is an insult to everyone. If
a product is good, it is good in July. Almost all our staff are gone between
Xmas and New Years.
In 1989, there
were over 30 reported cases dealing with whether a profit was a capital gain
or a straight income profit. Obviously, DNR is `not' just rolling over and
allowing people to claim capital gains. And even with the `closing' of the
limits from 50 to 75% of the profit taxable as capital gains, we will still
see more and more cases. i.e., if it is capital gains, then the profit
qualifies for the $100,000 or $500,000 tax free exemption plus reserves for
the unpaid portion of the sale. If the profit is treated as straight income,
there is no exemption and no reserves.
Following are some
of the 1989 cases (those that add to the information).
SALE OF REAL ESTATE (not a principal
residence)
In 1990, Homes Development Ltd.
were taxed as straight income on farm land which they had held for fifteen
years. They bought the land in 1967 as part of a partnership with no thought
at the time of developing or reselling. However, in 1972, they did submit a
plan for subdivision which was turned down. Judge McNnair ruled that their
intention had clearly changed and was now that of the partnership group, to
achieve a residential development of the property for resale and taxed Homes
at straight income rates.
In 1990, Algonquin Enterprises Ltd. and Dartmouth
Developments Ltd paid straight tax on the lease / sale of lots which they had available
for sale on either a straight sale basis or a 50 year lease with an "open"
option to purchase. Judges Pratte, MacGuigan and Hugessen of the Federal Court
of Appeal ruled the only intention was to sell, not convert the lots to a long
term inventory. The only reason for the lease scheme was to make it easier to
sell.
O & M Investments Ltd. lost an isolated sale in 1989.
Judge Jerome of the Federal Court did not even allow the lawyer for National
Revenue to make a closing argument. He was adamant that the evidence
overwhelmingly showed the plaintiffs to be professional real estate traders
and taxed them accordingly on an isolated purchase and sale. His judgment is
wonderful for anyone in this situation. It analyses the "real" world of real
estate from large rental operations who for all intents and purposes "never
sell" to custom builders who only build to order. One source of the full
judgment is CCH's Dominion Tax Cases. It can be found at: 90 DTC 6150
and is worth reading.
In 1989, Robbin and Jason Rodd
lost their capital gains claim on a piece of commercial property on which they
had sought subdivision approval. In addition, their loan application at the
bank contained the following notes to purchase commercial property for
subdivision and sale or development. (remember my prior comments to "watch
what you tell the bank"). Judge Sarchuk of the Tax Court of Canada ruled that
the profit was straight income for tax purposes.
However, also in 1989, William Bell, Renee Makino,
and Fred McCullough won their claim for capital gains treatment on the sale of their
commercial property. Judge Mogan of the Tax Court of Canada ruled that their
long term financing, attempts to secure a tenant and the recessionary downturn
all contributed to their argument that the property had been bought for long
term holding.
In 1986, Fairhaven Estates Ltd. and Jodare Limited
won their case for capital gains treatment in the Federal Court. Judge Roleau
agreed that the land in question had been bought for the purpose of long term
investment. They had originally purchased the land to build a manufacturing
plant. However, their plans were continually thwarted by the municipality. The
situation began in 1966, the land was sold in 1973, and it did not come to
trial until 1986. It was to be heard in 1981 but got lost in the paperwork.
DNR has appealed the case to the Federal Court of Appeal, and Fairhaven has
another ordeal to go through.
In 1986, Future Investments Ltd.
lost their claim that
the sale of three out of ten lots was a capital gain. Judge Cullen of the
Federal Court ruled that it was a venture in trade. Future Investments claimed
that the three lots were only sold to finance the development of the remaining
lots.
In 1986, Regina Shopping Mall Limited
had its claim for
Capital Gains treatment turned down by Judge Pinard. They had been unable to
go ahead with plans to build a large shopping mall. The success of the mall
was dependent upon their obtaining a major department store as a tenant. When
they failed to get the major tenant, they sold the land at a profit. They lost
because they did not have the tenant when they bought the land. Therefore,
they must have had a secondary intention to sell the land if they did not get
the tenant. This case is under appeal to the Federal Court of Appeal. In
1989, Judges Marceau, Stone and Desjardins of the Federal Court of Appeal
dismissed the appeal with costs to DNR.
In 1986, George Schneider, George L. Schneider
Limited, Mohawk Horning Limited, Maplepark Development Limited and Dekston
Limited
lost their claim for the tax free sale of 73 acres which they had bought to
develop and sell. Judges Urie, Heald and Ryan of the Federal Court of Appeal
ruled that even if the intentions of one of the members (the guiding member)
of the consortium changed as was decided in a 1984 case, the sale was still a
venture in the nature of trade and the consortium was bound by their
collective actions.
And, you can apply
for a subdivision and get capital gains treatment.
Also in 1989, Paul and Dorothy Hayes
received a favorable ruling from Judge Bonner of the Tax Court. The taxpayers
had done little more than install culverts and put some gravel on the roads.
There was no business plan. They did no more than take necessary steps to
optimize the sale of their capital asset.
In 1989, Hannibal Holdings Ltd.
was taxed full rates on land which was sold in a short time. Judge Taylor of
the Tax Court ruled that there was no evidence to indicate that the profit was
anything but income in nature.
And in 1989, Irene Unger
also lost her claim for capital gains treatment on her 2% interest in a scheme
to buy, rezone, subdivide and resell industrial land in Brampton. Judge Mogan
ruled that even if she had not signed the joint venture agreement and was a
minor player among the 26 members of the syndicate, her motives were the same
as the major players. Interestingly, George Jellaczyc was a 5% member and his
company was the agent for the deal. (see INTEREST DEDUCTION section under
VACANT LAND NOT DEDUCTIBLE).
In 1985, Dr. Hirsh Rosenfeld and Harry C. Patrick
lost their bid for capital gains on land bought in 1953 and 1966 and sold in
1976. The evidence showed that the taxpayers had been involved in other real
estate deals, some involving subjacent land, and that they had made no efforts
to use this land for their own use but had clearly intended to resell at a
profit. Time was not a factor in determining Capital Gains or Straight Income.
In 1985, Douglas J. Mintenko
was assessed straight income tax on the sale of several parcels of farmland.
He had past experience as a real estate agent and the number of buys and sells
worked against him.
In 1985, Rivermede Developments Limited
were assessed straight income on greenbelt land sold to the Province of
Ontario. Judge Rip of the Tax Court of Canada ruled that the taxpayer had
always been prepared to sell the land when it was to their advantage.
In 1985, F. J. Lamb Farming Ltd.
was assessed straight tax on land which, while used in the farming business
and rented out, had been slated for resale when bought. The evidence showed
that the taxpayer had hired an engineer and retained a real estate agent to
develop the property after the property was bought in 1958. Although the land
was then held for some 16 years, insufficient evidence was presented to show
that there was a change of intention to hold the property forever. However,
you can be a professional developer and get capital gains treatment if you can
prove enough intention to hold for the long term.
In 1989, Hanover Management Ltd. and Candor
Investments Ltd.
won capital gains treatment on a building which was bought, renovated and then
sold in two pieces to the same purchaser in less than 28 months. Judge Kempo
of the Tax Court ruled that the sale was made only because of the collapse of
a Civic Center Project and that it was sold to minimize their losses. The
reason for the two part sale was to accommodate the purchaser's cash flow.
In 1989 John Irwin lost his bid for Capital Gains treatment on
the sale of two farms and the resale of one after a partial foreclosure. Judge
Christie ruled that Mr. Irwin was an intelligent man who understood all the
ramifications of his actions and that his intent was to sell and resell for a
profit.
In 1989, Medici Management Ltd.
lost its claim for capital gains treatment on the purchase and resale of raw
industrial land he had purchased through a trust. Judge Lamarre Proulx of the
Tax Court ruled that he had presented no evidence to prove an intention to
hold as a long term investment. The trustee sold the property with no protest
from the owner.
And in 1989, Matt's Apartments Ltd.
lost its claim for the capital gains treatment also. They had purchased
several properties in Vancouver. Judge Lamarre Proulx ruled that the sales
were ventures in the nature of Trade. There were no rental projections
presented or financial plans presented to show long term intent to hold for
long term investment.
In 1989, 145101 Canada Ltd.
paid straight tax on the sale of land which it owned with another company. The
other company reported the sale as straight income. Judge Christie of the Tax
Court of Canada ruled that it was straight income for the taxpayer company as
well. If you are involved with complicated commercial real estate deals, this
case is worth reading in its entirety. It is Court file No. 87-1008 and can be
found at 89DTC644 in the CCH Reporter series.
Crystal Glass Canada Ltd. received good news in 1989.
Judges
Pratte, Heald and Mahoney of the Federal Court of Appeal ruled that their
losses before the Tax Review Board in 1975 and in the Federal Court in 1977
were in error and that the Trial Judge erred in law in finding that the sale
of an apartment block in 1971 was a trading profit rather than TAX FREE
CAPITAL GAINS. Remember, in 1971 there was NO CAPITAL GAINS TAX. But why
did it take EIGHTEEN YEARS ?
Rudeller Ranches & Livestock Company Ltd. and Marvin
Mogul lost their claim in 1989 for a similar sale. However, they had made fifteen
other such sales and Judge Dube of the Federal Court - Trial Division ruled
that the primary purpose was to facilitate a resale at a profit.
SALE OF FRANCHISES
In 1986, Samoth Financial Corporation Ltd.
lost their bid to have the sale of Century 21 Real Estate Franchises treated
as capital gains rather than straight income. Judges Heald, Mahoney, and Stone
of the Federal Court of Appeal agreed with the Federal Court's 1985 decision.
SALE OF SHAREHOLDINGS
In spite of Section 39(4) which allows traders in
shares to consider themselves investors rather than traders, Ross J. McGroarty
lost capital gains treatment in 1989. He was a licensed stockbroker for eleven years
before becoming the communications officer for a public company. He then
proceeded to buy and sell shares of that company in substantial numbers. In
four years he made over 300 trades but never controlled over 2 or 3% of the
stock. He received no dividends but financed the purchases by mortgages on his
house, bank loans, and margin accounts through the brokers. Judge Garon of the
Tax Court of Canada taxed him at full rates on his net profits of $660,000 for
the years 1978 to 1982.
In 1989, Karben Holdings Ltd.
had to pay tax as a trader on publicly traded stock, 91% of which, had been
held less than twelve months. The company had retained a professional
management company to manage its portfolio. Judge Pinard of the Federal Court
- Trial Division, ruled that the evidence did not support an argument that the
formation of the corporation was to preserve the original capital.
In 1990, John Arthur Pollock
lost his claim for capital gains treatment before Judge McNair of the Federal
Court. He was a professional mining engineer who made $117,000 in 1979 and
$560.000 in 1980 trading in the shares of junior resource companies. Judge
McNair ruled that the volumes were large and dispositions were made shortly
after acquisition for profit. The transactions were "akin" to an ordinary
Trader.
The prior sales involved the sale of public company
shares. However, in 1988, Guy Dumas won capital gains treatment on the sale of the
shares of his company which had acquired a large piece of real estate. Judges
Pratte, Hugessen and Desjardins agreed that he had not intended to sell the
shares when he acquired them. He had simply wanted to carry on his business.
COLLECTING WORTHLESS NOTES
In November, 1986, Samuel Edlinger
won his case in the Federal Court of Appeal. Judges Pratte, Hugessen, and
MacGuigan agreed that his collecting of formerly worthless notes acquired with
the shares of a corporation were of a capital nature and not straight income.
He had sold his business to a separate company. When that company failed to
operate the business successfully, he bought the shares back, turned the
business around, and in 1971 and 1972, paid himself for the notes he had
acquired rather than take a salary. DNR tried to tax this as straight income.
The court ruled that the notes were incidental to his purchase of the
business.
SCIENTIFIC RESEARCH TAX CREDITS
In 1989, Ronald Smith
lost his claim for Capital Gains Treatment on the purchase and resale of a
SRTC. Price Waterhouse had sold him a SRTC which involved purchase and
immediate resale of a note and a debenture. As an example, he bought a
promissory note from CN Ltd. for $100,000 and immediately resold it for
$58,000 getting a $34,000 Scientific Research Tax Credit. He tried to set the
adjusted cost base of the note and a debenture from Canadian Coal as $50,000
each and the $117,000 sale price less the $100,000 ACB as a capital gain. DNR
treated the $117,000 less $100,000 as straight income (it all happened at
once) and Judge Teskay of the Tax Court of Canada agreed. I do too.
Also in 1989, Financial Collection Agencies
lost out on their claim for capital gains on a "quick flip". They bought and
sold their S. R. T. C. the same day and then tried to claim the $14,000 profit
as a capital gain instead of straight income. Judge Rip agreed with Revenue
Canada and taxed it at full rates. The reason in these two cases makes sense.
How can it be a "capital" gain when you knew in advance "exactly what and
when" you were getting in the deal?
But it can go the
other way too, as two other 1989 cases did:
Stanley Drug Products Ltd.
won capital gains treatment when Judge Rowe of the Tax court of Canada ruled
that the transactions were anything "BUT" an adventure in trade. <169>They
were wholly artificial devices which were intended to procure a tax
advantage."
Judge Rowe wasn't
alone in his opinion either that year.
Judge Garon of the Tax Court of Canada made the same
decision for Henry Loewen. He ruled that: "the transaction in its entirety possessed none of the
characteristics of an adventure in the nature of trade." The taxpayer had made
the purchase to get a $102,000 tax credit.
Strangely enough,
Revenue Canada did not appeal Stanley Drug Products, or Henry Loewen, and
Ronald Smith and Financial Collection Agencies did not appeal theirs. This is
unusual under the circumstances. Again without making any comments about the
relative merits of the SRTC's sold to the above 4 taxpayers, so many of the
SRTC's were nothing but completely artificial transactions that the real
tragedy in these deals is the time that Revenue Canada has had to spend on
them.
And that brings me
to another point. I continuously have some one tell me: "The tax office
wouldn't let me." Then I find out that the "turn-down" was an anonymous phone
call to the public information line. SHEESH! It isn't over 'Til it's over!
VAN ON PROPERTY
I like this one. It is one for the little guy. In
1973 Patrick Flanagan bought a waterfront lot on Shuswap Lake in British Columbia. He then
found, as so many people do `after' buying a piece of property, that he could
not build on it without a septic field and that the land was below the high
water mark for a septic field. He tried to negotiate for some land next door
and finally in 1978 bought a lot across the road and ran a pipe under the road
and created a permanent easement for the pipe, thereby giving his original lot
the amenity it needed. In the meantime he parked one of two mobile vans he
owned on the properties when he was there, but did not leave them on the
property when he was not in residence. He did spend most of his time there. He
then sold the first lot in 1982 and the second in 1983. He claimed them both
as tax free sale of a principal residence. Judge Rip ruled that the first lot
was a tax free piece of land contiguous with the van parked on it but that the
second was not attached or contiguous and was therefore subject to capital
gains tax. Remember, this would not apply to any motor home on any lot. In
this case Flanagan spent all his free time there. It was a genuine
vacation home and vacation homes qualify as principal residences.
ROLLOVERS
It is possible to
sell a property and buy another similar property and claim the sale as a tax
free rollover. To qualify, the property must be used in an active business
such as your farm property or business building. It could also be a rental
property or vacation property if it was expropriated.
However, to claim
the tax free "rollover" status, you MUST report the sale and purchase on time.
If you do not, the tax free status may not be claimed and penalties and
interest can be applied. This is to stop you from making a profit which gets
"lost" in the shuffled leaving you free to claim less profit in the future. I
know you would never do this but some people might try and "slide" a profit
through the system on either the $100/500,000 exemption or the rollover
exemption by not reporting it "because it was tax free anyway, wasn't it?"
Then when it was lost in time as it were, they would be able to claim another
gain tax free.
In 1991, Florence Hawkins
found this out about the 1980 exchange of her farm property. No money was
exchanged, just the property. Judge Joyal of the Federal Court ruled that she
was taxable on the $19,000 profit because to be tax free under a Section 44
rollover, one must report the profit and claim the exemption by notifying the
minister. This is one of the exemptions which is not spelled out in the act
with a special form like the T657 for the capital gains exemption.
in 1991, the Boger Estate
fared better. There was a problem with the legal definition of "when the
property transferred" because of a challenge to the will by the wife. To be
tax free the property has to be vested or transferred within 15 months. Judge
Jerome of the Federal Court ruled that it was necessary to look at concepts
and terminology from real property law. As such, he ruled that the property
was vested under the terms of the will under section 70(9) because there were
no conditions precedent to stop the vesting. The Estate had lost in the Tax
Court of Canada. The difference between this and the Hillis Estate, is that
Hillis had no will, therefore, there was no immediate vesting which was
challenged.
ROLLOVER TO CORPORATION
This next case points out the danger in rolling
rental properties into a holding company. Joan and Robert Colbert lost their
expected capital gains and recapture tax treatment in 1989.
They had rolled some
rental property into a corporation. They attempted to have it qualify as
former business property as defined in section 248(1) of the act. To be former
business property, it must have been property from an active business and
Judge Taylor ruled it was rental property. As such, the Colberts had to pay
immediate capital gains and recapture taxes on the deemed disposition, rather
than have the property transfer at the adjusted cost base of the Colberts.
VALUATION DAY
That old Valuation
Day of January 1, 1972 or December 22, 1971 for Publicly traded shares still
rears its ugly head. The following case points out the problem with something
like a Yacht Club membership or a Golf Club Membership.
In 1989, the members of the Northwood Country Club
received a reasonable ruling when David Ades went to court.
The members had claimed a value of $28,000 for the value and DNR had countered
with $4,300. The valuation was required because the golf club was sold for
$24,000,000 plus and the members all received their share. Because 271 of them
were members in 1971, it was up to the court to determine the value of the
land, buildings, etc. on January 1, 1971. Judge Kempo of the Tax Court of
Canada settled on $20,000. The whole case is an interesting read for any
member of a club.
In 1989, George Choquette
had the minister's VD figure accepted by Judge Sarchuk of the Tax Court.
Choquette had claimed a VD of $281,000 and DNR a VD of $105,000. The lower
figure was accepted. Choquette presented no argument to rebut the minister's
highest and best use as a ranch, and his own subdivision for recreation
proposal had nothing to back it up.
The next case was
even further apart with the minister's value being $63 to $99 per acre and the
taxpayer's appraisal being $710 to $2,500 per acre. The main argument was
around whether the land in question was best used as a blueberry farm, a
potential mine, or a woodlot.
In 1986, Bridges Brothers Ltd.
lost their claim for $700 an acre and in 1989, Bridges lost again
before Judge Martin of the Federal Court - Trial Division. Most of the
argument revolved around whether or not a neighboring company would use the
land for a tungsten mine. Both judges decided that since the company had not
made any agreement prior to January 1, 1971, and in fact suspended operations
shortly thereafter, no potential value of a mine could be taken into account.
The Tax Court Judge allowed $100.00 per acre. Judge Martin increased the VD
value to $140 per acre.
SALE OF TIMBER
In 1989, MEL-BAR Ranches Ltd.
won the capital gains treatment for some $294,000 worth of timber it had sold
and originally included in its income as straight income. In 1979 and 1980,
they sold a lot of timber off their land and included it as straight income.
their accountant advised them to report it as capital gains. DNR objected and
the Tax Court of Canada agreed with Mel-Bar Ranches in 1987. DNR appealed and
in 1989, Judge Strayer of the Federal Court again agreed with Mel-Bar Ranches
Ltd.
CANCELLATION OF CONTRACT
In 1989, Schofield Oil Ltd.
lost their appeal to the Federal Court Trial Division. They had a contract to
sell waste oil to Imperial Oil Limited. Imperial Oil bought their way out of
the contract with a payment of $1,300,000 to Schofield. Schofield claimed the
money was a tax free `damages' award because their business was dependent on
the contract for its entire future income stream. Judge Strayer disagreed and
counted the $1,300,000 as straight income and taxable at full rates.
