Sunday, June 27, 2010

Zeitler Estate: Whose Responsible for the Taxes?

Alberdina Zeitler sold two properties to her husband, Alfons Zeitler, in 1987, in return for a promissory note and for Alfons Zeitler assuming a mortgage and a demand loan. When he died on April 26, 2007, Mr. Zeitler still owned the properties.

Mr. Zeitler did not leave a will. He did leave what one judge has described as a “’tangle mess’” of private and corporate affairs.” (I have written two previous posts on other aspects of the lawsuit among his wife, his children and the administrator of his estate that followed Mr. Alfons Zeitler’s death here and here.)

On Mr. Zeitler’s death, under the Income Tax Act, Canada, he was deemed to have disposed of these properties. The effect of this deeming provision is that there will be capital gains tax payable on the increase in value of the properties.

The administrator of Mr. Zeitler’s estate obtained a tax opinion from an accounting firm that Mrs. Zeitler would be responsible for any capital gains tax on the properties arising at Mr. Zeitler’s death. This is because the Income Tax Act has an attribution rule that provides that if property is transferred from one spouse to the other spouse, future capital gains are attributable to the transferor, or in other words, to the spouse who originally owned the property. The attribution rule is intended to prevent a high income spouse from transferring property to his or her low income spouse in order to minimize or avoid tax on future gains from the property. In some cases involving transfers at market value, the spouses may elect out of the attribution rule so that the transferee spouse has to pay tax on future gains. But in this case, the accounting firm opined that the attribution rule would apply to attribute the gains to Mrs. Zeitler, even though the increase in value of the property occurred after the transfer.

If Mrs. Zeitler were unable to pay the tax liability, then Canada Revenue Agency could collect from Mr. Zeitler’s estate, because the Income Tax Act makes the transferee jointly liable for any tax. But the tax liability falls on Mrs. Zeitler in the first instance.

Because Mr. Zeitler died without a will, his estate will be divided in accordance with the rules of intestacy under the Estate Administration Act among Mrs. Zeitler and his three children from a previous marriage in the proportions set out by that legislation. If the capital gains tax is payable by Mrs. Zeitler, the effect will be that she will bear the full tax burden of the properties while having to share the benefit of the properties with Mr. Zeitler’s children. The burden in this case is significant, estimated by the accountants at over $230,000.

Mrs. Zeitler sought an order from the court requiring Mr. Zeitler’s estate to indemnify her for any taxes she will be required to pay on the gains on the property. Her claim in this respect was dismissed by the Supreme Court of British Columbia at 2009 BCSC 500.

She appealed to the British Columbia Court of Appeal.

The British Columbia Court of Appeal allowed the appeal in Zeitler v. Zeitler (Estate), 2010 BCCA 216, and held that Mr. Zeitler’s estate is required to indemnify Mrs. Zeitler for any tax liability she may have to pay to Canada Revenue Agency.

Mr. Justice Low held that Canada Revenue Agency’s right to tax Mrs. Zeitler does not determine the rights as between Mrs. Zeitler and her husband’s estate as to who bears the ultimate responsibility between them. He found that there was an implied term in the contract between Mr. Zeitler and Mrs. Zeitler when she transferred the properties to him that he would bear any capital gains tax.

Mr. Justice Low wrote at paragraphs 34 through 36:

[34] The attribution section of the Income Tax Act was not a term of the 1987contract. It did not form part of that transaction, either expressly or implicitly. If the respondent’s position is correct, Ms. Zeitler must live with what the CRA chooses to do with respect to collection of the tax on the capital gain. If it assesses Ms. Zeitler and not the estate, she must pay the tax without recourse against the estate. The respondent says that the court should ignore the fact that the estate received the benefit of the capital gain (as Mr. Zeitler would have had he sold the lots during his lifetime) and that it will merely be a bad break for Ms. Zeitler if she is required to include the gain in her income as though earned by her and not by the estate. This means that whether, as between the parties, Ms. Zeitler or the estate is ultimately responsible for the tax would depend entirely on the whim of the tax collector. It cannot be so.

[35] The 1987 contract was silent on the question of which of the two parties would be responsible for payment of tax on capital gain arising out of a future disposition of the property. There was no need for the contract to be explicit on that topic. With or without knowledge of the attribution provision in the Income Tax Act, it seems to me to be obvious that, if asked at the time they formed the contract which of them was to be responsible for the tax, both parties would have said that Mr. Zeitler would be responsible. He acquired both the legal and the beneficial interest in the property. He was entitled to the gain for his sole use absolutely.

[36] Any other view of the issue would mean that, although Ms. Zeitler contractually divested herself of all interest in the property, she retained a contingent tax liability that was entirely outside her control and for which she was entitled to receive no corresponding benefit. That view of the contract would destroy its business efficacy. It would frustrate the object of the contract. It follows that it is necessary to find as an implied term of the contract that Mr. Zeitler would pay future capital gain tax and save Ms. Zeitler harmless from liability for such tax.

No comments: