http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/108983/index.do
Ghaffari v. The Queen (April 8, 2015 – 2015 TCC 62, Masse D.J.).
Précis: This case involved the appeal of spouses, Shahrzad Ghaffari and Bernard Tajick, against an inclusion in their incomes for 2009 by the Minister of $50,550 each. They were co-owners of a building located at 3130 Sainte Catherine Street East, Montréal which was operated by a general partnership owned by them (“Best Dev”) and leased to a corporation owned by them (“Auberge”). The lease to Auberge called for rentals of $9,800 per month, or $117,600 per year. In 2009 they only reported rental of $16,500. They relied upon a clause in the lease that they claimed permitted annual adjustment of the rent payable by Auberge:
[TRANSLATION] There could be an adjustment in rent at the beginning of each year, based on the actual cost of operations and improvements in the building.
The Court rejected the taxpayers’ claim that they hold only exercised their freedom of contract to reduce the lease payments. The reduction was unreasonable and would not have been agreed upon by arm’s length parties.
As a result the appeals were allowed with a minor adjustment in the income inclusion amount.
Decision: CRA calculated the income inclusion for each appellant as follows:
[15] The respondent argued that the appellants neglected to report income of $50,550 (($117,600 - $16,500)/2) in their tax returns for the 2009 taxation year. Therefore, the Minister was justified in adding to the appellants’ income the amount of $50,550 as rental income under subsection 9(1) and paragraph 12(1)(b) of the Income Tax Act, R.S.C. (1985), c. 1 (5th supp.), as amended (the Act).
The Court agreed that the appellants were not entitled to reduce the annual rent to $16,500:
[26] I am not persuaded that this is a case of freedom of contract where two contracting parties wish to correct an error or a misunderstanding in their contractual relationship. It is undisputed that the appellants are the guiding mind of the Auberge and Best Dev. The Auberge and Best Dev are not independent contracting parties; they do not have an arm’s length relationship. In reality, the appellants were renting the building to themselves. The fact that the appellants created the Auberge as a legal person and then rented the building to the Auberge constitutes tax planning. Therefore, the actions of the appellants and the Auberge must be carefully examined to ensure that these actions are legally correct and real. It is certainly reasonable to reduce the rent from $117,600 to $109,200 in the circumstances; but reducing the rent from $117,600 to $16,500 for 2009 is completely unreasonable and would not be tolerated by independent contracting parties. Mr. Tajick told us that in 2009, he had to reduce the rent to $16,500 because the Auberge did not have the means to pay the rent. For the reasons that I have indicated above, I do not agree with this claim.
[27] One also wonders if it is an unexpected coincidence that the rent was so greatly reduced during the same taxation year as that of the sale of the building on Chester Street which resulted in a heavy tax liability for the appellants. I do not believe it. During the taxation years of 2006, 2007 and 2008, the rent was $109,200 per year. The year that the building located on Chester Street was sold, the rent was reduced to $16,500. But the following years, i.e. 2010 and 2011, the rent was again increased to $100,000 and $102,400 respectively. One has to wonder why. I am of the view that the appellants manipulated the rent billed in 2009 for the purpose of avoiding paying taxes as a result of the sale of the building on Chester Street These actions are not legally correct and real as required in Atinco Paper Products, supra, at para. 25. Therefore, this is opportunistic tax planning as a result of the sale of the Chester Street building, which created a significant tax liability for the appellants and that they wanted to avoid.
Nevertheless the Court believed that the inclusion of $117,600 was too high based on the historical record and reduced it to $100,000 per annum:
[29] However, I am of the view that Mr. Zaddoug should have considered the historic data in this case. The rent billed and reported by the appellants was never $117,600 in all the previous years. Therefore, Mr. Zaddoug was not justified in insisting that rent be in all cases established at $117,600. Although the contracting parties do not have a not an arm’s length relationship, they must be allowed reasonable freedom of contract. The rent varied between $100,000 and $109,200 between 2005 and 2010, without considering the 2009 taxation year. These figures are reasonable. While arbitrary, it seems to be to be reasonable to impute rent of $100,000 for the 2009 taxation year instead of $117,600.
As a result the appeals were allowed to that extent. There was no award of costs as this was an Informal Procedure appeal.