Klemen v. R. – TCC: Taxpayer largely successful in dispute over transfer of equipment to related companies

Bill Innes on Current Tax Cases

http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/72944/index.do New Window

Klemen v. The Queen (July 29, 2014 – 2014 TCC 244) was a dispute over the tax and GST consequences of Mr. Klemen transferring equipment to a corporation with which he did not deal at arm’s length, CHL:

[1] In 2004 and 2005, Edward Klemen (the “Appellant”) transferred oilfield equipment (the “Equipment”) to Canadian Hydrex Limited (“CHL”), a company with which he did not deal at arm’s length. As consideration for the Equipment, CHL credited $135,000 and $38,500 to the Appellant’s shareholder loan account in CHL’s taxation years ending September 30, 2004 and 2005 respectively. The Appellant did not report any income from the transfer of the Equipment for his 2004 taxation year, claiming that the proceeds of disposition equalled the Equipment’s adjusted cost base (“ACB”). For his 2005 taxation year, the Appellant reported a capital gain of $43,500. The Appellant did not collect or remit goods and services tax (“GST”) in respect of the transfer of the Equipment in either taxation year. The Minister of National Revenue (the “Minister”) issued in respect of the transfer a series of assessments for unreported business income, unremitted GST, and shareholder benefits conferred, including one assessment issued outside the normal reassessment period. These assessments are the subject of these appeals.

[2] Prior to trial, the parties settled the issue of the assessment of shareholder benefits and made concessions on certain other issues, some of which are detailed in a letter dated April 17, 2014 addressed to the Court and some of which are described below (the “Concessions”). However, four issues remain before the Court. The first issue is whether the Minister was entitled to assess the Appellant outside the normal reassessment period. The second issue is whether the proceeds of disposition from the transfer of the Equipment were on capital or on income account. The third issue concerns the determination of the ACB of the Equipment. The final issue is what amount of GST, if any, the Appellant is liable for in respect of the transfer.

The court rejected the Crown’s reliance upon subsection 165(5):

165(5) Validity of reassessment − The limitations imposed under subsections 152(4) and 152(4.01) do not apply to a reassessment made under subsection (3).

and found that the assessment of Mr. Klemen’s 2004 taxation year was statute-barred on the authority of the Federal Court of Appeal decision in The Queen v. Anchor Pointe Energy Ltd.:

[24] The Minister added an additional $90,093 of unreported income by way of the Second Reassessment on the basis that the fair market value of the equipment was greater than the consideration received by the Appellant from CHL. Under the principles recognized in Anchor Pointe, the Second Reassessment must be vacated unless it can be shown that the conditions laid down in subsection 152(4) of the Act have been met.

[25] There are two conditions for the application of subsection 152(4) of the Act, and the Minister bears the onus of establishing, on a balance of probabilities, that both have been satisfied. The first condition is that the taxpayer have made a misrepresentation. The second condition is that the misrepresentation be attributable to neglect, carelessness or wilful default.

[29] In any event, the Respondent led no evidence to show that the failure to report the income from the sale of the Equipment was attributable to the Appellant’s negligence. It is not sufficient to show that the Appellant misrepresented his income for 2004. The Respondent must show that this misrepresentation is attributable, inter alia, to the Appellant’s negligence. As the Respondent has failed to meet her onus in this regard, the Second Reassessment, which increased the Appellant’s income by an additional $90,093 of unreported income for the 2004 taxation year, must be vacated.

[Footnote omitted]

Next the court concluded that the dispositions were on capital account, based in large part on the extensive record of Mr. Klemen in the oil service industry:

[33] Weighing all of the above factors, I conclude that the Appellant’s gain in each of the 2004 and 2005 taxation years was on account of capital. First of all, the evidence shows that the Equipment was used by the Appellant in his various business ventures over a very long period of time. It was acquired at the beginning in the 1980s and then sold to CHL in 2004 and 2005. There is no evidence to show that the Appellant sold similar equipment in earlier taxation periods. The Appellant did allow CHL and other corporations that he held an interest in to use the Equipment in their business ventures. There is no evidence to show that the Appellant modified or altered the equipment for the purpose of realizing a higher price.

[34] The evidence shows that there was a strong upswing in the oil service industry beginning around 2001 and that the Appellant sold the equipment to CHL in order to benefit from the resulting unexpected significant rise in prices for used oil service equipment.

[35] From all of the above I infer that the Appellant acquired the Equipment for the purpose of using it in his various business ventures. The circumstances surrounding the long holding period corroborate the Appellant’s declaration that he purchased the Equipment to earn income either directly or indirectly therefrom.

The court rejected Mr. Klemen’s evidence that his ACB for the equipment exceeded the $15.00 assumed by the Crown:

[38] At trial and in written submissions, counsel for the Appellant invited the Court to make the inference that the ACB of the Equipment was at least $76,243.86, that is the value of the shareholder loan on the books of Edge Energy in 1999. The Appellant claims that he took some of the Equipment in lieu of repayment of the shareholder loan. The Equipment was consideration in satisfaction of the loan. Counsel for the Appellant submitted that $76,243.86 is likely well below what the Appellant actually paid to acquire the Equipment, but however the Appellant “would be happy with receiving credit for the $76,000 in shareholder loan as ACB”.

[39] The Appellant’s evidence in support of this amount was a balance sheet of Edge Energy as at September 30, 1999. In 1998, the balance sheet showed $76,244 as a shareholder loan due to the Appellant. In 1999, the shareholder loan was written off with no loan shown as owing to the Appellant. However, as counsel for the Respondent points out, there is no evidence, other than the Appellant’s vague testimony, to corroborate the claim that he actually did take any equipment. There is nothing that supports a finding that the Appellant had actually made that loan or that he had contributed any capital assets to Edge Energy. In short, the Appellant’s evidence as to the ACB of the Equipment is insufficient to rebut the Minister’s assumption that it was $15.00 per taxation year.

[Footnotes omitted]

Finally, the court rejected the Crown’s argument that Mr. Klemen received an additional $85,000 on the disposition of the equipment:

[48] The only evidence at trial that corroborates the theory that the Appellant received $80,000 in cash is the financial statements of CHL. However, there is no annotation stating, or any indication, that the Appellant received that amount. The evidence does not support the inference that the Appellant actually received $80,000 in cash. The evidence only illustrates what CHL calculated the ACB to be for the sale of the Equipment to third parties. Hence, there is no credible evidence that contradicts the Appellant’s assertion that he received nothing more than a credit to his shareholder loan account in the 2004-2005 Reporting Period. The actual consideration received by the Appellant for the Equipment was the amounts credited to his shareholder loan account: $135,000 and $38,500 in 2004 and 2005 respectively.

As a result the appeals were allowed. The parties were given thirty days to agree upon costs or failing that to make short (not to exceed 5 pages) submissions on costs.