The Queen v. Merali, 88 DTC 6173, [1988] 1 CTC 320 (FCA)

Desjardins, J.: —The respondent claimed, against his 1981 income earned after he became a resident of Canada, non-capital losses in the amount of $212,013 incurred in the taxation years 1978 and 1979 while he was a nonresident. He had elected, during those years, to file returns under subsec tion 216(1) of the Income Tax Act, S.C. 1970-71-72 c. 63 as amended. The losses came from a property physically situated in Canada.

The issue before us is whether the trial judge, in the circumstances of this case, correctly interpreted paragraph 111(1)(a) of the Income Tax Act so as to authorize the deductions claimed by the respondent.

The Facts

The facts are not in dispute. They appear from an agreed statement of facts reproduced at length in the judgment below to be found in Merali v. M.N.R., [1986] 2 F.T.R. 216; [1986] 1 C.T.C. 521. They can be summed up in the following manner.

During the taxation years 1978, 1979 and 1980, the respondent was a resident of the United States and the owner of an undivided interest in real property (herein called the 'Property'), situated in the Municipality of Richmond in the Province of British Columbia. He computed his liability for tax in Canada, during those years 1978, 1979 and 1980, in respect of rents received on the property in accordance with the provisions of subsection 216(1) of the Income Tax Act. The respondent incurred losses in respect of the property in the amounts of $103,445 and $108,568 in the 1978 and 1979 taxation years respectively, which amounts he reported in filing his returns of income for the 1978 and 1979 taxation years. In the 1980 taxation year, he earned no net income from the property for the reason that the aggregate of expenses and capital cost allowance was equal to his share of rental revenue from the property.

In or about the month of June 1981, he became a resident of Canada.

In computing his taxable income for the portion of the 1981 taxation year during which he was a resident of Canada, the respondent deducted the sum of $212,013 comprised of the two sums of $103,445 and $108,568 previously mentioned on the basis that such amounts were non-capital losses deductible in computing taxable income pursuant to the provisions of paragraph 111(1)(a) of the Income Tax Act. By reassessment, notice of which was dated April 6, 1983, the Minister of National Revenue assessed the respondent to disallow the deduction of non-capital losses in the amount of $212,013. The respondent filed a notice of objection to the assessment. By reassessment dated February 6, 1984, the Minister confirmed the disallowance of the deduction of any portion of the sum of $212,013.

Analysis

It should be made clear at the outset that both residents and non-residents who derive income from Canadian sources are included, by definition, in the term "taxpayer" as it appears in subsection 248(1) of the Income Tax Act, i.e. "any person whether or not liable to pay tax".

Section 2 in Part I of the Act, under the subtitle “Division A - Liability for Tax" provides the following:

2. (1) An income tax shall be paid as hereinafter required upon the taxable income for each taxation year of every person resident in Canada at any time in the year.

(2) The taxable income of a taxpayer for a taxation year is his income for the year minus the deductions permitted by Division C.

(3) Where a person who is not taxable under subsection (1) for a taxation year

(a) was employed in Canada,

(b) carried on a business in Canada, or

(c) disposed of a taxable Canadian property,

at any time in the year or a previous year, an income tax shall be paid as hereinafter required upon his taxable income earned in Canada for the year determined in accordance with Division D.

As a rule, a non-resident, not carrying on a business in Canada, is subject to the withholding tax provisions of Part XIII of the Act with respect to rental income derived from the property. The rate applicable is 25, subject to treaty modifications. Subsection 216(1) provides an alternative method for computing the tax of a non-resident receiving rents. This election is often made whenever the withholding tax on the rent (which is levied on the gross amount) exceeds the amount of tax that would be payable on the actual profit received from the property after deducting all expenses. Under subsection 216(1), a taxpayer may file a return under Part I in the form prescribed for a person resident in Canada for that taxation year. He then becomes liable to tax under Part I as though he were a resident in Canada and as though his income from his interest in real property in Canada were his only income. He is entitled to deduct actual expenses including capital cost allowance, but no Division C deductions such as personal exemptions, medical or charitable outlays and no non-capital losses. He is clearly barred to do so under paragraph 216(1)(c).

Subsection 216(1) states:

216. (1) Where an amount has been paid during a taxation year to a non-resident person, or to a partnership of which he was a member, as, on account or in lieu of payment of, or in satisfaction of, rent on real property in Canada or a timber royalty, he may, within 2 years from the end of the taxation year, file a return of income under Part I in the form prescribed for a person resident in Canada for that taxation year and he shall, without affecting his liability for tax otherwise payable under Part I, thereupon be liable, in lieu of paying tax under this Part on that amount, to pay tax under Part I for that taxation year as though

(a) he were a person resident in Canada and were not exempt from tax under section 149,

(b) his income from his interest in real property in Canada, timber resource properties and timber limits in Canada and his share of the income of a partnership of which he was a member from its interest in real property in Canada, timber resource properties and timber limits in Canada were his only income, and

(c) he were not entitled to any deduction from income for the purpose of computing taxable income.

[My emphasis.]

The definition of "non-capital losses” is to be found in paragraph 111(8)(b) of the Act:

111. (8) In this section,

(b) "non-capital loss" of a taxpayer for a taxation year means the amount, if any, by which

(i) the aggregate of all amounts each of which is the taxpayer's loss for the year from an office, employment, business or property, his allowable business investment loss for the year, and all amounts deductible under section 112 or subsection 113(1) or 138(6) from the taxpayer's income for the year

exceeds

(ii) the amount determined under paragraph 3(c); and . . .

During the taxation years 1978-1979 and 1980, while he was a non-resident, the respondent was barred from deducting his non-capital losses. In 1981, on becoming a resident, the respondent was entitled to claim the deductions contained in Division C, including non-capital losses. Could he however benefit from the carrying over provision provided for in paragraph 111(1)(a) of the Act?

111. (1) For the purpose of computing the taxable income of a taxpayer for a taxation year, there may be deducted from the income for the year such of the following amounts as are applicable:

(a) non-capital losses for the 5 taxation years immediately preceding and the taxation year immediately following the taxation year, but no amount is deductible in respect of non-capital losses from the income of any year except to the extent of the taxpayer's income for the year minus any amount deductible under subsection 138(6) and all deductions permitted by the provisions of this Division other than this paragraph, paragraph (b) or section 109; .. . .

The respondent deducted from the portion of his income earned after June 1981 (see section 114 of the Act) the non-capital losses he incurred while a non-resident which he could not claim in the years 1978 and 1979 on account of paragraph 216(1)(c) of the Act.

The trial judge concluded that paragraph 216(1)(c) had ceased to apply. He stated (AB 88-89, 2 F.T.R. at page 220):

The plaintiff computed in the 1978, 1979 and 1980 taxation years his income from property in accordance with section 9 of the Act. The net rental income thus calculated turned out to be negative and losses were incurred. It is such losses that cannot be applied against income for the year [as determined under paragraph 3(c)] that become non-capital losses. The plaintiff is statutorily precluded from carrying over those losses during the period he is a non-resident [paragraph

216(1)(c)]. From my reading and interpretation of the relevant provisions of the Act, he is not barred from sustaining losses. Those losses exist, but they cannot be used until the taxpayer becomes a resident. Clearly the losses incurred in the 1978 and 1979 taxation years fall within the ambit of paragraph 111(8)(b) which defines the non-capital losses. The statutory authority to carry over those non-capital losses is conferred by paragraph 111(1)(a), but paragraph 216(1)(c) is specifically designed to prevent their carry over. Paragraph 216(1)(c) does not, however, go as far as saying that a non-resident taxpayer is precluded from computing losses on income earning property held by him in Canada.

[My emphasis]

The appellant has pressed upon us that the Income Tax Act contains no provision which permits respondent to apply losses incurred in a nonresident period against income earned by him during a resident period. In effect, the respondent is seeking to retroactively use the residence rules in the Income Tax Act for non-resident losses. Section 114 contemplates a restriction on the use of losses incurred by a non-resident during a period when he becomes resident. The appellant submits that what the taxpayer elected to do under subsection 216(1) cannot affect his tax liability after he has become a resident. Losses not allowed under subsection 216(1) cannot become magically transposed to losses now deductible under paragraph 111(1)(a).

I do not share this view. The proper approach appears to me to be the following.

During the fiscal years 1978 and 1979, the respondent as a non-resident was liable to pay tax on income earned from a source inside Canada. He was a "taxpayer" within the purview of the Income Tax Act. Those years were "taxation years" in which the respondent incurred “non-capital losses", as defined in the Act, except that they could not be deducted on account of the bar contained specifically in paragraph 216(1)(c) of the Act.

In 1981, the respondent became a Canadian resident. For that taxation year, his income tax liability came directly under subsections 2(1) and (2) of the Act, subject to section 114. He was “a taxpayer" as defined in the Act and as referred to in paragraph 111(1)(a). He had previous "taxation years" under paragraph 111(1)(a) by the fact that he had been a taxpayer in 1978, 1979 and 1980. The legal nature of the losses, as non-capital losses, was the same, before and after 1981. The non-capital losses incurred by the respondent in 1978 and in 1979 were not deductible because of the bar pertaining to his election under subsection 216(1), but they still were in the nature of noncapital losses. The trial judge held that "those losses exist, but they cannot be used until the taxpayer becomes a resident". I agree with him.

The correct approach to this issue is not, as submitted by counsel for the appellant, whether the Income Tax Act expressly permits a resident taxpayer to carry forward losses incurred while he was a non-resident but, as submitted by counsel for the respondent, whether there is any prohibition to that effect since paragraph 111 (1)(a) plainly permits that deduction in the absence of an express prohibition.

Whether the correct rule of interpretation of a taxation statute is the traditional strict interpretation or the more modern liberal approach [Pierre- André Côté, The Interpretation of Legislation in Canada, (Cowansville, Quebec: Les Editions Yvon Blais Inc., 1984) at 390-398] the result in the present case is the same. It would be incorrect, in my view, for courts of law to create prohibitions which do not exist in the statute. There is nothing in the Act to prevent a resident from carrying over non-capital losses incurred when he was a non-resident taxpayer having elected during his non-resident years to be treated as a resident under the terms of subsection 216(1) of the Income Tax Act. The restriction on deductions provided for in section 114 applies only to those deductions that cannot reasonably be considered applicable to the period of residency of a Canadian resident for that taxation year that is contemplated. The non-capital losses, in the case at bar, were computed for the taxation years 1978 and 1979 and not for the portion of the taxation year that ran from January to June 1981. Paragraph 216(1)(c) simply ceases to apply when a non-resident taxpayer becomes a resident taxpayer. Paragraph 111(1)(a) then has its full effect.

The present case is to be distinguished from the decision of this Court in Oceanspan Carriers Limited v. The Queen, [1987] 2 F.C. 171; [1987] 1 C.T.C. 210, where a newly resident corporation tried unsuccessfully to deduct noncapital losses earned at a time it had no connection whatsoever with Canada.

I would therefore dismiss the appeal with costs.

Appeal dismissed.