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FROM: NOV-DEC 2008 ISSUE | BY DON GOODISON
There is an old saying that no good deed goes unpunished. Brenda and Dennis Evans would undoubtedly agree with that saying after their encounter with the Canada Revenue Agency. The Evans became the victims of what I feel is one of the most unfair provisions of the Income Tax Act when they turned their business over to their sons. In Brenda Evans and Dennis Evans v. Her Majesty the Queen [2008 DTC 3953], the taxpayers asked the court to set aside the Minister’s assessment for a deemed disposition resulting from a change in use.
The appellants operated a partnership known as Evans Electric for 35 years. From 1996 to 1998 they constructed a garage on their property and used it as a workshop and storage for the business. They did not claim capital cost allowance on the garage until 2001. In 2003, the Evans turned their business over to their two sons, ended their partnership, and began to work for their sons as employees of the new Evans Electric. They retained ownership of the garage, but permitted the sons to continue to use it in the business in the same manner as before. The sons did not pay rent, but did reimburse the appellants for the costs.
The Appellants did not report any rental income in 2003 as the expenses would have cancelled out the income. The Minister took the position that because the appellants no longer carried on business themselves, they no longer used the garage for the purpose of gaining or producing income. This resulted in a “change in use” of the garage, triggering a deemed disposition under paragraph 13(7) of the Income Tax Act. The taxpayers argued that the use of the building had not changed at all because it was being used by their sons in their business. They also took the position that their continued employment by their sons would not have been possible if they hadn’t allowed them to continue to use the garage. They argued that the source of their employment income was the business, and therefore there was no change in use.
The Evans appealed to the Tax Court of Canada. Paragraph 13(7)(a) reads:
(a) where a taxpayer, having acquired property for the purpose of gaining or producing income, has begun at a later time to use it for some other purpose, the taxpayer shall be deemed to have disposed of it at that later time for proceeds of disposition equal to its fair market value at that time and to have reacquired it immediately thereafter at a cost equal to that fair market value.
The court dismissed their appeal because the appellants ceased to use the property for the purpose of gaining or producing income when they ceased to operate their partnership. This was not overridden by their sons continuing to use the garage in the same manner as before. The sons business was not their business.
The court mentioned two things in the reasons for judgment that are worth noting. First, the transfer of the business from the appellants to their sons was made without the benefit of legal, accounting, or tax advice. Second, had the appellants charged rent, they would not have fallen prey to the deemed disposition rules. Had they sought professional advice, they may have avoided the problem. Unfortunately, they did not and paid the price.
I don’t have a problem with the decision. But I do have a beef with the “deemed disposition” rules. I simply can’t understand the reason for them. A taxpayer has to pay tax without having actually disposed of the property or received any consideration? How is this fair and reasonable? Why not wait until the taxpayer actually disposes of the property? The property is certainly not going to leave the country so it will be available for taxing when sold. Then the taxpayer will have the means to pay the resulting tax. It strikes me that these rules were enacted by legislators of the day who resented anyone who owned anything and sought to punish them for their success. It’s time these rules were changed.
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