McLellan v. M.N.R., 90 DTC 1405, [1990] 2 CTC 2191 (TCC)

Mogan, T.CJ.:—Prior to 1981, if a taxpayer acquired depreciable property at any time in a particular taxation year, he was entitled to deduct in computing income for that year the full amount of capital cost allowance with respect to that depreciable property whether he owned it for 11 months or only one month in that year. As a result of the federal budget in November 1981, the Income Tax Regulations were amended to restrict the amount of capital cost allowance with respect to newly acquired depreciable property which could be deducted for the taxation year in which such property was acquired. Under the amended Regulations, for the taxation year in which depreciable property is acquired, the taxpayer is entitled to deduct in computing income only one-half of the amount of capital cost allowance which he would otherwise be entitled to deduct if he were to own such property throughout the year. In order to implement the amended Regulations, there was a transitional rule applicable to property acquired after November 12, 1981. The issue in this appeal is whether certain depreciable property acquired in 1981-82 by a limited partnership in which the appellant was a partner falls under the old law or the amended Regulations. In this case, the Court is required to construe the transitional rule.

In January, 1981, the appellant, together with a number of other persons, established a limited partnership known as "Howard Johnson's Hotel Oakville” (the "partnership") to carry on the business of hotel operator. 330059 Ontario Limited (“330059”) and United Building Investment #1 Limited ("United") were the registered owners of certain land in Oakville, Ontario. On February 4, 1981, the partnership entered into an agreement (the "construction agreement") with 330059 and United which provided that 330059 and United would construct a building (the "hotel") on their land in Oakville to the specifications of the partnership to be leased to and used by the partnership as a Howard Johnson's Motor Hotel. The hotel was built in accordance with the construction agreement and was, at all relevant times, used by the partnership in carrying on its hotel business.

Under the terms of the construction agreement, the partnership was obligated to provide all of the furnishings required to render the hotel fully suitable for use as a hotel in accordance with the standards required of anyone licensed to use the "Howard Johnson's" Trade Mark. The specifications and standards were appended as a schedule to the construction agreement which further provided that the partnership was required to pay for carpeting, paving, landscaping and light fixtures for the hotel. In addition, the construction agreement provided that the hotel furnishings, equipment and fixtures of the partnership would secure the partnership's financial obligation to the lessors for rent under the construction agreement.

The partnership entered into a further agreement (the “licence agreement") with Orangeroof Limited ("Orangeroof") dated February 4, 1981 for the operation of a Howard Johnson's Motor Lodge and related facilities. Under the terms of the licence agreement, the partnership was obligated (i) to commence operation of the hotel not later than thirty days following completion of the buildings; and (ii) to conform to the standards of quality and design for all furniture, furnishings, supplies and equipment used in connection with such business as approved by Orangeroof. During 1981 and the early months of 1982, the partnership was engaged in acquiring furnishings, equipment and fixtures for the hotel which opened for business in August 1982.

In computing income for the fiscal period ênding December 31, 1982, the partnership deducted the “full year amount" of capital cost allowance with respect to its depreciable property on the assumption that it qualified under the transitional rule and was not restricted to the “half-year amount" under the amended Regulations. The appellant filed his 1982 income tax return reporting his share of the loss of the partnership as computed by the partnership. The respondent has assessed tax against the appellant for 1982 on the basis that the amended Regulations apply and the partnership is entitled to deduct only the "half-year amount” for 1982. The relevant provisions of the Income Tax Regulations are as follows:

1100. (2.1) Where a taxpayer has, after November 12, 1981 and before 1983, acquired or incurred a capital cost in respect of a property of a class in Schedule II

and

(a) he was obligated to acquire the property under the terms of an agreement in writing entered into before November 13, 1981 (or, where the property is a property described in Class 31 in Schedule II, before 1982),. . . or

(b) . . .

(c) . . ., or

(d) he was obligated to acquire the property under the terms of an agreement in writing entered into before June 1, 1982 where arrangements, evidenced in writing, for the acquisition or leasing of the property were substantially advanced before November 13, 1981,

the following rules apply:

If a taxpayer could satisfy the conditions in any one paragraph (a), (b), (c) or (d) of subsection 1100(2.1), then the depreciable property which he acquired after November 12,1981 and before 1983 would not be subject to the "half-year" rule.

The appellant submits that the construction agreement and the licence agreement obligated the partnership to acquire certain depreciable property within the meaning of paragraph 1100(2.1)(a) and that all property acquired pursuant to this obligation and before 1983 is exempt from the “half-year” rule. The appellant further submits that the two agreements qualify as "arrangements, evidenced in writing, for the acquisition or leasing of the property" within the meaning of paragraph 1100(2.1)(d) and that all property acquired under an agreement in writing entered into before June 1, 1982 is exempt from the “half-year” rule. The respondent submits that to obtain the relief provided by subsection 1100(2.1), the obligation to acquire the depreciable property must be owed to the vendor of such property and, therefore, any obligations which arose under the construction agreement or licence agreement are not adequate to satisfy the conditions in subsection 1100(2.1).

For the purpose of construing paragraph 1100(2.1)(a), I shall extract what appear to be the most important words relevant to this case:

Where a taxpayer has . . . acquired . . . property . . . and he was obligated to acquire the property under the terms of an agreement in writing entered into before November 13,1981 . . .,

I omit the phrase “after November 12, 1981 and before 1983" because the parties are in agreement that all of the property in issue in this appeal was acquired within that time span. What the parties do not agree upon is whether the partnership "was obligated to acquire the property” under a written agreement entered into before November 13, 1981; and their respective positions are set out above.

Subsection 1100(2.1) speaks of property which a taxpayer "has acquired"; and paragraph 1100(2.1)(a) refers to "the property" which the taxpayer was obligated to acquire before a certain date. In my view, the context in which the word "property" appears in both the opening words of subsection 1100(2.1) and in paragraph 1100(2.1)(a) indicate that it refers to specific depreciable property. The construction agreement and the licence agreement did not obligate the partnership to acquire any specific property from a particular vendor but only property of a type or class meeting certain standards of quality. I therefore adopt the argument of the respondent's counsel that the "agreement in writing entered into before November 13, 1981” in paragraph (a) must be an agreement with the vendor of the depreciable property. There was no evidence that the partnership had before November 13,1981 entered into any agreement in writing with a vendor of the depreciable property in issue. On that basis, I find that the appellant, as a partner, has not satisfied the condition in paragraph (a) of subsection 1100(2.1) of the Income Tax Regulations.

For the purposes of construing paragraph 1100(2.1)(d), I shall again extract what appear to be the most important words relevant to this case:

Where a taxpayer has . . . acquired . . . property . . . and he was obligated to acquire the property under the terms of an agreement in writing entered into before June 1, 1982 where arrangements, evidenced in writing, for the acquisition . . . of the property were substantially advanced before November 13, 1981,

I conclude here also that paragraph 1100(2.1)(d) refers to specific property which the taxpayer "has acquired”; and the agreement under which he was obligated to acquire "the property" must be an agreement with a vendor of depreciable property. Paragraph (d) is more lenient to the taxpayer, however, because he can enter into the agreement in writing with the vendor of the depreciable property any time before June 1, 1982. In other words, under paragraph (d), the taxpayer has an additional six months and 18 days to make a written agreement with a vendor of depreciable property but, and there is one further condition, arrangements evidenced in writing for the acquisition of the property must be “substantially advanced before November 13, 1981.”

Within paragraph (d), a taxpayer is required to do certain things before two different dates. Before June 1, 1982, he must be “obligated to acquire the property"; and before November 13, 1981, he must have "arrangements for the acquisition substantially advanced". There is a significant difference between the legal connotations of the words in the two phrases “obligated to acquire" and "arrangements for the acquisition”. “Obligated to acquire" implies that the taxpayer must be bound by contract; whereas "arrangements for the acquisition" implies that the taxpayer need not be bound by contract. I regard paragraph (d) as providing some relief for the taxpayer who could not satisfy the conditions in paragraph (a). Although the construction agreement and the licence agreement did not obligate the partnership to acquire specific depreciable property from an identified vendor, I am satisfied that those agreements were "arrangements evidenced in writing” for the acquisition of the depreciable property in issue; and those arrangements were "substantially advanced before November 13, 1981”. I find that the appellant has satisfied the condition in paragraph (d) of subsection 1100(2.1) for all depreciable property acquired under the terms of any agreement in writing entered into before June 1, 1982. The agreement in writing could, of course, be a purchase order from the buyer or an invoice from the seller.

The appeal will be allowed and the reassessment for 1982 will be referred back to the respondent for reconsideration and reassessment on the basis that all depreciable property acquired by the partnership under the terms of an agreement in writing entered into before June 1,1982 satisfies the condition in paragraph (d) of subsection 1100(2.1) of the Income Tax Regulations.

Appeal allowed.