Saskatchewan Wheat Pool v. R., 99 DTC 5198, [1999] 2 CTC 369 (FCA)

Rothstein J.A.:

Facts

This is an appeal from a decision of Bonner T.C.J. who found that the appellants were not entitled to capitalize interest on money borrowed during the construction of a terminal elevator for purposes of capital cost allowance and investment tax credits under the Income Tax Act! (the “Act”).

The appellants were members of a joint venture of six grain companies that built and operated a terminal grain elevator on Ridley Island near Prince Rupert, British Columbia. The assets of the joint venture were held in a bare trust by Ridley Grain Limited on behalf of the members of the joint venture. Prince Rupert Grain Limited was the operator of the assets on behalf of the members of the joint venture. The appellant, Saskatchewan Wheat Pool, had a thirty percent interest, and the appellant, Alberta Wheat Pool had a thirty-four percent interest in the terminal and related revenues and expenses.

The parties agreed that the terminal elevator was depreciable property for capital cost allowance purposes under paragraph 20(1 )(a) and qualified property, machinery and equipment, for purposes of investment tax credits under section 127 of the Act.

It was agreed that the terminal was under construction in the years 1980 — 1986, inclusive. For the taxation years 1980 — 1986, inclusive, the appellant Saskatchewan Wheat Pool claimed capital cost allowance, and for the taxation years 1980— 1985, inclusive, investment tax credits, on its portion of the capital costs of the terminal. For the taxation years 1980 and 1981, Alberta Wheat Pool claimed capital cost allowance and for the taxation years 1980— 1984, inclusive, investment tax credits on its portion of the capital costs of the terminal. Both appellants capitalized interest costs incurred in each year and included the capitalized interest in the base for the calculation of capital cost allowance and investment tax credits.

The Minister of National Revenue disallowed the capitalization of interest and the capital cost allowance and investment tax credits claimed thereon but, permitted the appellants to expense the interest in each year instead. The appellants appealed to the Tax Court of Canada.

Bonner T.C.J. found that interest during construction may be capitalized under subsection 21(1) of the Act but not otherwise. As the appellants did not elect to capitalize interest under subsection 21(1), he found that they were precluded from doing so for capital cost allowance purposes. He further found that because interest could only be capitalized under section 21, and because subsection 127(11.2) precludes the inclusion of interest added to capital costs by reason of section 21 for investment tax credit purposes, the appellants could not claim investment tax credits on the interest they attempted to capitalize.

I agree with the concise reasoning and conclusion of Bonner T.C.J. [2] I add the following comments only to deal with the specific arguments made by the appellants before us.

Scheme of the Relevant Provisions

Paragraph 20(1 )(a) of the Income Tax Act permits the deduction of capital cost allowance in computing taxable income. Paragraph 20(1)(c) permits the deduction of interest as an expense in computing taxable income. Paragraphs 20(1 )(a) and (c) provide:

20. (1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(a) such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation;

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy),

Subsection 21(1) permits the taxpayer, rather than deducting interest as an expense, to capitalize that interest for the year in which depreciable property was acquired and for the three immediately preceding taxation years. The acquisition of depreciable property includes the construction of that property by the taxpayer. By permitting capitalization of interest for the three years prior to acquisition of the depreciable property, taxpayers are entitled, retroactively, to amend their prior filed returns in those years to convert interest that was deducted as an expense to capitalized interest on which capital cost allowance may be claimed:

21. (1) Where in a taxation year a taxpayer has acquired depreciable property, if he elects under this subsection in his return of income under this Part for the year,

(a) in computing his income for the year and for such of the 3 immediately preceding taxation years as the taxpayer had, if any, paragraphs 20(1)(c), (d) and (e) do not apply to the amount or to the part of the amount specified by him in his election that, but for this subsection, would have been deductible in computing his income (other than exempt income) for the year and for those immediately preceding years, if any, by virtue of those paragraphs in respect of borrowed money used to acquire the depreciable property or the amount payable for the depreciable property acquired by him; and

(b) the amount or the part of the amount, as the case may be, described in paragraph (a) shall be added to the capital cost to him of the depreciable property so acquired by him.

Subsection 21(3) permits the capitalization of interest in years subsequent to the year the depreciable property was acquired, subject to specific conditions:

21. (3) In computing the income of a taxpayer for a taxation year, where the taxpayer

(a) in any preceding year made an election under subsection (1) in respect of borrowed money used to acquire depreciable property or an amount payable for depreciable property acquired by him, and

(b) in each taxation year, if any, after that preceding year and before the taxation year, made an election under this subsection covering the total amount that, but for this subsection, would have been deductible in computing his income (other than exempt income) for each such year by virtue of paragraphs 20(1 )(c), (d) and (e) in respect of the borrowed money used to acquire the depreciable property or the amount payable for the depreciable property acquired by him,

if he elects under this subsection in his return of income under this Part for the year, paragraphs 20(1)(c), (d) and (e) do not apply to the amount or to the part of the amount specified by him in his election that, but for this subsection, would have been deductible in computing his income (other than exempt income) for the year by virtue of any of those paragraphs in respect of the borrowed money used to acquire the depreciable property or the amount payable for the depreciable property acquired by him, and the said amount or part of the amount, as the case may be, shall be added to the capital cost to him of the depreciable property so acquired by him.

Subsection 127(5) provides for investment tax credits whereby there may be deductions from taxes otherwise payable:

127. (5) There may be deducted from the tax otherwise payable by a taxpayer under this Part for a taxation year an amount not exceeding the lesser of

(a) his investment tax credit at the end of the year, and

(b) the aggregate of

(i) $15,000, and

(ii) '/ the amount, if any, by which the tax otherwise payable by him under this Part for the year exceeds $15,000.

Subsection 127(9) sets forth the formula for calculating investment tax credits. Investment tax credits are a percentage of the capital cost of quali- fied property. Qualified property is defined in subsection 127(10) and for purposes of this case, specifically paragraph 127(10)(b):

127. (9) For the purposes of subsections (5) to (8) and subject to subsection (11.1), “investment tax credit” of a taxpayer at the end of a taxation year means the amount, if any, by which the aggregate of

(a) an amount equal to 5% of the aggregate of all amounts each of which is the capital cost to him of a qualified property or qualified transportation equipment acquired by him in the year or the amount of a qualified expenditure in respect of scientific research made by him in the year, determined without reference to subsection 13(7.1),

(10) For the purposes of subsection (9), a “qualified property” of a taxpayer means a property (other than a certified property) that is

(b) prescribed machinery and equipment acquired by the taxpayer after June 23, 1975,

that has not been used, or acquired for use or lease, for any purpose whatever before it was acquired by the taxpayer and that is

By reason of subsection 127(11.2), investment tax credits are to be calculated on the capital costs of qualified property, excluding interest capitalized under section 21:

127. (11.2) For the purposes of subsection (9),

(a) the capital cost to a taxpayer of property shall be computed as if no amount were added thereto by virtue of section 21; and

It is because of subsection 127(11.2) that the appellants did not elect to capitalize interest under section 21 and argue that they are entitled to capitalize interest without making the election required under section 21.

Subsection 18(3.1) requires taxpayers to capitalize interest during construction when the construction involves buildings:

18. (3.1) Notwithstanding any other provision of this Act, in computing a taxpayer’s income for a taxation year,

(a) no deduction shall be made in respect of any outlay or expense made or incurred by the taxpayer, other than an amount deductible by virtue of paragraphs 20(1 )(a) or (aa), that

(1) may reasonably be regarded as a cost incurred during the period of the construction, renovation or alteration of a building and that relates thereto or to costs incurred during that period relating to the ownership, during that period, of land...

(ii) was made or incurred before the completion of the construction, renovation or alteration of the building;

and

(b) the amount of such outlay or expense shall be included in computing the cost or the capital cost to the taxpayer of the land or building, as the case may be.

Where interest is capitalized under subsection 18(3.1), subsection 127(11.2) does not apply and the capitalized interest may be included in the capital cost upon which investment tax credits are calculated. Accordingly, there is a distinction in the Income Tax Act between buildings and other capital assets for purposes of interest costs incurred during construction. In the case of buildings, such interest must be capitalized. For other assets, such as machinery and equipment as in this case (the parties having agreed that no building was involved), taxpayers may elect to capitalize interest under section 21 or to treat the interest as an expense under paragraph 20(1)(c).

Analysis of Appellants’ Arguments

The appellants argued that, contrary to the conclusion of Bonner T.C.J. that interest may be capitalized only under section 21 and not otherwise, the election under section 21 expands a taxpayer’s options. In their case, the appellants say they did not invoke section 21 because, “according to GAAP and well established business principles”, the cost of a capital asset already includes construction period interest. This argument is based upon the dicta of Kerr J. in Sherritt Gordon Mines Ltd. v. Minister of National Revenue? [3] at page 5195:

In the absence of any definition in the statute of the expression “capital cost to the taxpayer of property” and in the absence of any authoritative interpretation of those words as used in section 11(1 )(a), insofar as they are being considered with reference to the acquisition of capital assets, I am of opinion that they should be interpreted as including outlays of the taxpayer as a business man that were the direct result of the method he adopted to acquire the assets... It seems equally clear that it includes the cost to him during the construction period of borrowing the capital required for creating the property, whether the cost is called interest or commitment fee. Such cost is a capital cost that could not be deducted as an operating expense, without special authority.

[emphasis added]

Section 21 was enacted shortly after the Sherritt Gordon Mines decision. Sherritt Gordon would appear to require that construction period interest be included in the cost of depreciable property. However, section 21, which provides for an election, makes it clear that the taxpayer has the option of treating such interest as an expense, deductible under paragraph 20(1 )(c), or of adding it to the cost of the depreciable property under section 21.

The expert evidence led by the parties in the Tax Court appears to have been largely to the effect that where depreciable property is constructed over time, the cost of the property includes construction period interest when the enterprise’s accounting policy is to capitalize interest costs. According to the appellants’ expert, this was the practice during the 1980s and was included as section 3060.26 of the CICA Handbook in 1989. Section 3060.26 provides:

.26 The cost of a capital asset that is acquired, constructed, or developed over time includes carrying costs directly attributable to the acquisition, construction, or development activity such as interest costs when the enterprise’s accounting policy is to capitalize interest costs.

The upshot is that GAAP provides that construction period interest may be included in the cost of capital assets or may be expensed, depending upon the accounting policy of the enterprise. However, the election contemplated by section 21 provides the taxpayer with greater flexibility than GAAP. Subsection 21(1) allows the retroactive amendment in the three years prior to the acquisition of the capital assets, from expensing to capitalizing those interest costs in those years. Subsection 21(3) permits the capitalization of post-acquisition interest costs. Further, the taxpayer need not follow a policy of expensing or capitalizing but may invoke both approaches by allocating varying amounts of interest cost to expense or capitalization as suits its purpose. If, as the appellants contend, the law respecting the capitalization of interest as set forth in Sherritt Gordon survives, then, at least with respect to construction period interest, section 21 would not be applicable, taxpayers would have no option to expense such interest and would be required to capitalize the interest. I have no basis upon which to conclude that construction period interest is not contemplated by section 21. The rule in Sherritt Gordon cannot stand together with section 21. This Court cannot eliminate the option provided by Parliament to taxpayers under section 21 by reference to prior jurisprudence. I am satisfied that section 21 has super- seded Sherritt Gordon, at least with respect to the capitalization of construction period interest.

The appellants then argue that section 21 contains no restrictive words indicating that section 21 is the only way in which interest may be capitalized. Indeed, there is authority that section 21 authorizes the capitalization of interest only “in certain circumstances”: see Thyssen Canada Ltd. v. R. (1986), 87 D.T.C. 5038 (Fed. C.A.), at 5041 . I have no difficulty with the proposition that in circumstances not contemplated by section 21 or other statutory provisions, interest may be capitalized according to GAAP. In fact, as the appellants argued, there may be interest costs incurred in the course of construction that are not deductible as expenses under paragraphs 20(1)(c), (d), or (e). If such interest costs were incurred, they would not be subject to the election in section 21 and may, in appropriate circumstances, be included in the capital cost of the depreciable property for the purposes of both capital cost allowance and investment tax credits. However, in my opinion, the fact that interest may not be deductible under paragraphs 20(1)(c), (d) or (e) does not assist the appellants; section 21 deals explicitly with interest otherwise deductible under paragraphs 20(1 )(c), (d) or (e) and it is paragraph 20(1)(c) interest that is at issue in this case. With respect to that interest, section 21 is the vehicle by which taxpayers may elect, if they so wish, to add that interest to the cost of the depreciable property for the purpose of capital cost allowance. However, if capitalization of interest is elected, the capitalized interest is not part of the capital cost for investment tax credit purposes by reason of subsection 127(11.2).

The fact that there is nothing in the explanatory notes issued by the Department of Finance with the enactment of section 21 to suggest that the section is a complete code as alleged by the appellants is not of significance.

The appellants rely on subsection 18(3.1) which requires that construction period interest be capitalized for the purposes of buildings constructed after November 12, 1981. That subsection does not apply in the present case because the assets in question here are machinery and equipment and, in any event, because construction was in progress on November 12, 1981. However, the appellants say that the mandatory capitalization of construction period interest under subsection 18(3.1) demonstrates that such interest is ordinarily a part of the capital cost of the depreciable property. On the contrary, subsection 18(3.1) can only be read as a statutory requirement to include such interest in the capital cost of the depreciable property irrespec- tive of the election allowed under section 21, GAAP or well established business principles.

Where interest is required to be capitalized under subsection 18(3.1), investment tax credits are calculated on the capital cost including capitalized interest. However, where subsection 18(3.1) is applicable, the taxpayer is given no option to expense interest. It appears that where capitalization is mandatory, taxpayers are entitled to claim investment tax credits on the capitalized interest, whereas where capitalization is optional under section 21, no investment tax credits are applicable.

The appellants observed that the word “included” is used in subsection 18(3.1). They say this means that interest costs incurred during construction are normally treated as part of the cost of the depreciable property. As already noted, however, the word “included” is used where the statute requires inclusion, not because of the “normal” treatment of interest. By contrast, where a taxpayer has the option of capitalizing interest, the term “added” is used in section 21. Use of the term “added” is consistent with the notion of an election in which a taxpayer, only if it suits its circumstances, may add capitalized interest to the cost of the depreciable property and then only for the purposes provided for in the Income Tax Act.

The fact that a taxpayer, required to capitalize construction period interest under subsection 18(3.1) has a larger capital cost base upon which to calculate investment credits, does not detract from the finding of the learned Trial Judge that:

Subsection 127(11.2) is plainly intended to ensure that the base on which the investment tax credit is calculated is no larger in the case of a taxpayer who capitalizes construction period interest than in the case of a taxpayer who deducts interest under paragraphs 20(1)(c) or (d).

It is obvious that Bonner T.C.J. was focusing on the relationship between taxpayers who elect to expense interest under paragraph 20(1)(c) and those who elect to capitalize interest under section 21. In neither case may investment tax credits be calculated on the interest component. A taxpayer who is required to capitalize interest under subsection 18(3.1) is in different circumstances. This taxpayer does not have the option of expensing interest. In these circumstances, Parliament has permitted the taxpayer to calculate investment tax credits on capitalized interest.

Appellants’ counsel explained that the purpose of section 21 is to extend the time frame for the recognition of interest costs when it is advantageous for the taxpayer to do so. As he put it, it is “to preserve losses that might otherwise expire if those interest costs were expensed”. If that is the tax purpose of section 21, it is logical that the base for the calculation of investment tax credits should be the same for taxpayers who elect to expense or capitalize interest because the purpose of capitalization is unrelated to the purpose of investment tax credits.

As appellants’ counsel points out with respect to investment tax credits, the grandfathered taxpayer, i.e. the taxpayer who had construction of a building in progress on November 12, 1981, is “worse off’ than the taxpayer whose construction of the building commenced after November 12, 1981 and who is required to capitalize interest under subsection 18(3.1). However, the grandfathered taxpayer is “better off’ because he or she has the option of expensing interest, which the taxpayer under subsection 18(3.1) may not do. It is also true that different classes of assets are treated differently for investment tax credit purposes. However again, this simply reflects the fact that Parliament chose to treat different assets differently. It is not for the Court to try to create equality where Parliament mandates a difference.

I agree with Bonner T.C.J. that the appellants’ interpretation of section 21 would render subsection 127(11.2) ineffectual. Subsection 127(11.2) operates to preclude a taxpayer who chooses to capitalize interest under section 21 from claiming investment tax credits on such interest. If I adopted the appellants’ interpretation, the taxpayer would be permitted to capitalize interest outside of section 21 and therefore obtain the investment tax credit prohibited by subsection 127(11.2). This would render that provision of no force. It is trite to say that Parliament is not to be presumed to enact legislation without force and effect.

The appeal should therefore be dismissed with costs.

Appeal dismissed.