Tax Court of Canada Judgments

Date: 19980121

Docket: 95-3065-IT-G

BETWEEN:

DENNIS MURPHY,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

McArthur, J.T.C.C.

[1]These appeals are from the Minister of National Revenue’s assessments of $137,019.53 and $157,363.43 made under section 160 of the Income Tax Act (the “Act”).[1] The assessments are based upon the transfer of two properties to the Appellant by Ronald Zaruk, namely 6629 Grant Street, Burnaby, British Columbia (the “Burnaby property”) and 5880 268th Street, Aldergrove, British Columbia (the “Aldergrove property”). It is not seriously disputed that the aggregate of all amounts that Mr. Zaruk was liable to pay under the Act in the year the Burnaby property was transferred was $137,019.53 and $157,363.43 in the taxation year that the Aldergrove property was transferred. I am asked to determine “the amount, if any, by which the fair market value of the property at the time it was transferred exceeds the fair market value at that time of the consideration given for the property”.[2]

[2]The facts as I find them, or as agreed by the parties, are as follows. Mr. Zaruk’s tax liability in 1989 was $137,019.33 arising from his 1983, 1984 and 1986 taxation years. Mr. Zaruk and the Appellant were close friends during the relevant years and a close bond between them appears to remain to the present day. From 1987, Mr. Zaruk was having difficulty with his finances in that his construction businesses were losing money. Money was advanced by the Appellant and his wife to Mr. Zaruk’s Corporation over the years.[3] These advances were evidenced by cheques and deposit entries totalling $113,265.00. These transactions took place primarily in 1987 and 1989. Neither party kept any records, the money advanced was in cash or by cheque payable to the Corporation and deposited in its account. There were no other documents kept and the Appellant did not know how much he had advanced and did not ask for interest, security, or any evidence of indebtedness.

[3] In September 1988, Mr. Zaruk granted a mortgage to the Appellant secured by his Burnaby property for $125,000. The Appellant stated he was unaware of this mortgage. He trusted his friend to pay him back somehow, someday, an amount whatever it was he did not know. At the time of registration of the mortgage there were two prior mortgages totalling approximately $146,000, bringing the total encumbrance to $271,000. During 1989, the Burnaby property was listed for sale by Mr. Zaruk and on August 20, 1989, he accepted an offer of purchase and sale in the amount of $300,000. On August 22, 1989, he transferred the property to the Appellant showing a consideration of “$1.00 and other good and valuable consideration”. On October 18, 1989, the Appellant transferred the property to the purchaser, under the terms of the August 20, 1989 agreement, for $300,000.

[4]These somewhat bizarre transactions continued. The Appellant used $111,339.08 of the sale proceeds together with money advanced by Mr. Zaruk to purchase a building lot in Aldergrove on October 18, 1989 for $119,600. A balance from the proceeds of the Burnaby property of $25,385 was paid to Mr. Zaruk. Shortly after, Mr. Zaruk commenced the construction of a 9,000 square foot single family mansion. Mr. Zaruk had never built a residence before. On January 31, 1990, the Appellant executed a deed from himself to Mr. Zaruk of the Aldergrove property in consideration of $1.00. This transfer was not registered until July 4, 1990 when Mr. Zaruk granted a first mortgage to a Credit Union in the amount of $120,000. By instrument dated August 7, 1990 and registered August 20, 1990, Mr. Zaruk granted a mortgage, on the property to the Appellant in the amount of $300,000. By an instrument signed and registered on August 14, 1990, Mr. Zaruk granted a mortgage to his Corporation, Norm-Ron Construction (1988) Ltd. in the amount of $125,000. By instrument signed and registered on November 23, 1990, Mr. Zaruk transferred the Aldergrove property back to the Appellant indicating a consideration of $1.00.

[5]The Appellant testified that he was not aware of the significance of any of the registered transactions and that at all times it was his property. He stated that he attended the lawyer or notary’s office and executed all documents when asked to do so without an explanation or an understanding of the contents. The notary who prepared the documentation stated that he explained the documentation to the Appellant before he signed. The Appellant stated that in order to fund construction in 1990, he borrowed $60,000 in cash from Mr. Zaruk’s wife, he advanced $40,000 of his own cash and he advanced another $57,000 from his own resources being part of the proceeds of a bank certificate.

[6]Mr. Zaruk and his former wife and daughter moved into the mansion in 1991 where he and his wife still live rent free. Prior to this, Mr. Zaruk and family lived in his $120,000 mobile home parked on the property. The property has been never exposed to the market for sale. It is described as a mansion in an appraisal obtained by the Respondent. From a picture of it in the appraisal report one would easily conclude that it is a millionaire’s home. Mr. Zaruk declared personal bankruptcy in 1992.

[7] The statutory provision upon which the Minister relied in assessing the Appellant is subsection 160(1) of the Act, the relevant portions of which provide:

160(1) Where a person has, [...] transferred property, [...] to

[...]

(c) a person with whom the person was not dealing at arm’s length,

[...]

(e) the transferee and transferor are jointly and severally liable to pay under this Act an amount equal to the lesser of

(i) the amount, if any, by which the fair market value of the property at the time it was transferred exceeds the fair market value at that time of the consideration given for the property, and

(ii) the total of all amounts each of which is an amount that the transferor is liable to pay under this Act in or in respect of the taxation year in which the property was transferred or any preceding taxation year, [...]

[8]The fundamental object of subsection 160(1) is to prevent the frustration of the collection of tax, interest and penalties owing under the Act by, among other things, the transfer directly or indirectly by any means whatever of the assets of a debtor to another with whom he is not dealing at arm’s length. The Appellant did not dispute the fact that he and Mr. Zaruk were not dealing with each other at arm’s length. When there are two distinct parties or minds to a transaction who act in a highly interdependent manner, such as the present circumstances, they may be assumed to be acting in concert and not at arm’s length.[4] The remaining determination in the present matter therefore concerns the extent of the Appellant’s liability pursuant to paragraph 160(1)(e) of the Act, relative to the two separate transfers of property.

[9]With regard to the Burnaby property, the Appellant submits that the proper transaction for assessment was the mortgage grant of September 1988, and not the subsequent conveyance to the Appellant in August 1989. The Appellant contends that the mortgage was valid and legal title passed to the Appellant subject to an equity of redemption in favour of Mr. Zaruk.[5] Accordingly, he submits, the mortgage constituted a transfer of property for consideration.

[10] I do not accept the Appellant’s submission. A mortgage consists of two things: (a) a contract on the part of the mortgagor for the payment of a debt to the mortgagee; and (b) a disposition of an estate or interest of the mortgagor to the mortgagee as security for the repayment of the debt.[6] The Appellant did not request mortgage security. He stated that had Mr. Zaruk not been able to repay him it would not concern him. He was unaware that he held a mortgage on the Burnaby property or that there were two prior mortgages. On this evidence it is impossible to conclude that the Appellant had an intention to contract with respect to the mortgage. Such an intention is a necessary prerequisite to the formation of a contract,[7] and in its absence in the present circumstances no contract can be said to have been formed. Accordingly, the mortgage in question was invalid.

[11] Even if the mortgage were valid, the inconsistencies in the evidence bring into question the true substance of the mortgage transaction. In particular,

(1) The cheques from the Appellant for the money in question were made payable to C.M.S. Contractors Ltd. leaving the inference that any indebtedness was the liability of the Corporation, not of Mr. Zaruk personally. Said amount was estimated to be $113,265.

(2) There was no evidence of a personal guarantee from Mr. Zaruk to the Appellant.

(3) No interest rate was ever discussed. The mortgage provided for 12% interest. The Appellant stated it was an interest free loan.

(4) The mortgage document provided for monthly payments that were never made.

[12] I conclude that the registration of the mortgage was a manoeuvre to protect Mr. Zaruk’s equity in the Burnaby property from the Minister of National Revenue. The share of the sale proceeds paid to the Appellant in order to redeem the putative mortgage therefore constituted the monies of Mr. Zaruk.

[13] I find that at the time of the transfer to the Appellant of the Burnaby property in August 1989, its fair market value was $300,000 and subject to the two prior mortgages totalling approximately $146,000. The consideration given by the Appellant was nil. Accordingly, the appeal is dismissed in respect of the assessment concerning the Burnaby property.

[14]With respect to the Aldergrove Property, the Appellant submits that he purchased the lot with his share of the proceeds from the Burnaby sale, and entered into a partnership agreement with Mr. Zaruk, wherein he, the Appellant, would advance all financing necessary to build the mansion. Upon completion they would sell it and divide the profits.

[15] I find the facts are inconsistent with this submission for the following reasons:

(1) The purchase price of the lot was $120,000 and it would appear that Mr. Zaruk advanced the difference between $120,000 and $113,265.

(2) $113,265 was advanced from the proceeds of sale of Mr. Zaruk’s Burnaby home but there is insufficient evidence for me to conclude that this was the Appellant’s money and not Mr. Zaruk’s money.

(3) Shortly after construction began, the Appellant transferred the property to Mr. Zaruk by transfer executed January 31, 1990.

(4) The transfer was registered July 4, 1990 together with a mortgage from Mr. Zaruk to a credit union - a second mortgage was granted to the Appellant and a third mortgage was granted to a corporation of Mr. Zaruk in August 1990. These transactions are consistent with Mr. Zaruk being the owner, rather than the Appellant or a partnership between the Appellant and Mr. Zaruk. The first mortgage to the Credit Union was executed by Mr. Zaruk as owner. He alone was liable under the covenant to pay $120,000. The Appellant did not sign as guarantor or in any other capacity.

(5) Other than the statements of the Appellant and Mr. Zaruk, there was no evidence that the Appellant borrowed $60,000 in cash from Mr. Zaruk’s former wife or that he advanced over $100,000 of his own funds towards the cost of construction.

(6) No records of expenditures were kept.

(7) Mr. Zaruk and his former wife moved into the premises upon completion in 1991 and continue to live there without ever having made rental payments.

(8) The house has never been listed for sale.

(9) The Appellant stated he had no idea of its value.

[16]The evidence does not support the existence of a partnership relationship between the parties carrying on business in common with a view to profit from the re-sale of the property. Mr. Zaruk lived on the site and presently occupies the house constructed upon the lot. I conclude from the evidence that the intention was that Mr. Zaruk would occupy the property as his residence and that it is in fact his house.

[17] The Appellant further contends that only the bare legal title was originally conveyed by himself to Mr. Zaruk in July 1990, and that in re-conveying the bare legal title from Mr. Zaruk to himself on November 23, 1990, no liability attaches to himself from the application of subsection 160(1) of the Act, because the bare legal title had a fair market value of nil. The Appellant relies upon the testimony of Mr. Murphy, Mr. Zaruk and Mr. Chivers, the notary, that the transfers consisted of nothing other than bare legal title.

[18]The standard Form 23 document executed on January 31, 1990, by which the land was transferred from Mr. Zaruk to the Appellant indicates that the transferor “transfer[s] all of my/our estate and interest in the land.” The wording is clear and unambiguous and contains no limitations such that only the bare legal title passed. The corresponding Form A freehold transfer document by which Mr. Zaruk transferred the property back to the Appellant indicates that the “fee simple” freehold estate was transferred. There are no words in this document that would indicate that only bare legal title passed.

[19] The oral testimony of the Appellant’s witnesses is inconsistent with and contradictory to the written documentation evidencing the terms of the transfer, and I do not accept it to the extent that it seeks to modify the terms of the transfer documents.[8] I find that the transfer of the Aldergrove property to and from Mr. Zaruk consisted in substance and form of a transfer of all of the respective transferor’s interests and estate in the property.[9]

[20]At the time of the re-conveyance of the property to the Appellant in November 1990, its fair market value was $400,000. The value of the consideration given by the Appellant in this transaction was approximately $130,000, a figure at which I arrive for the following reasons:

(1) The mortgage of July 4, 1990 of approximately $120,000 in favour of the credit union, and builders’ liens of $10,000, remained on title following the transfer of title back to the Appellant.

(2) With regard to the amounts of $60,000, $40,000 and $57,000 claimed by the Appellant as incurred for the purposes of constructing the residence, there simply is not enough evidence to substantiate these claims. The Appellant is an intelligent self-employed businessman and I cannot conceive that he would undertake such a substantial transaction without planning, record keeping and documentation.

(3) With regard to the $113,265 advanced from the proceeds of sale of Mr. Zaruk’s Burnaby home toward the cost of acquiring the Aldergrove lot, there is insufficient evidence to conclude that this was the Appellant’s money. Further, given the invalidity of the mortgage on the Burnaby property, the share of the sale proceeds paid to the Appellant in order to redeem the mortgage constituted the monies of Mr. Zaruk.

(4) With regard to the $300,000 mortgage in favour of the Appellant and discharged at the time of the re-conveyance in November 1990, for the reasons given with regard to the mortgage on the Burnaby property, I find that the mortgage was invalid.

[21] The difference between the $400,000 value of the property and the $130,000 value of the consideration at the time of the transfer in November 23, 1990, amounts to $270,000. As the amount owing by Mr. Zaruk to the Minister in respect of the taxation year in which the property was transferred was $157,363.43, the Appellant is liable to pay this amount pursuant to subsection 160(1) of the Act.

[22]In conclusion, I find that the Minister correctly assessed the Appellant in accordance with section 160 of the Act. Mr. Zaruk, on both occasions, transferred property to the Appellant for no or inadequate consideration at a time when Mr. Zaruk was liable to pay an amount under the Act.

[23]The appeals are dismissed, with costs.

Signed at Ottawa, Canada, this 21st day of January 1998.

" C.H. McArthur "

J.T.C.C.

---