National Trustco v. The Queen, 96 DTC 6234, [1996] 2 CTC 72 (FCTD)

Wetston J.T.C.C.: — The plaintiff, National Trust Company, is a financial institution, but not a bank. The only issue in this case is the treatment to be given to the reserves of the plaintiff, for the purpose of determining its capital under Part VI of the Income Tax Act (the“Act”), R.S.C. 1952, c. 148, as amended, applicable to the 1986 taxation year. In this regard, the Court must interpret subparagraph 190.12(b)(iv) of the Act, which provides:

190.12. The capital of a corporation for a taxation year is

(b) in the case of a corporation that is not a bank, the total, computed at the end of the year on a non-consolidated basis, of

(iv) its reserves, other than any reserve of a reasonable amount for deferred income tax or that is permitted to be deducted in computing the income of the corporation.

There is no dispute as to the amounts entered by the plaintiff in its 1986 tax return. The only disagreement relates to the treatment of those amounts under subparagraph 190.12(b)(iv).

The parties agree that the plaintiff correctly computed its reserves for financial statement purposes (its “book reserves”), for the 1986 taxation year, in accordance with Generally Accepted Accounting Principles (“GAAP”). The book reserves taken by the plaintiff in 1986 totalled $44,675,802. The parties further agree that the reserves which were deductible by the plaintiff in computing its income under Part I of the Act (the “tax reserves”) were correctly computed to be $68,035,321. The excess of the tax reserves over the book reserves was $23,359,519. In computing its capital for the purposes of determining its liability under Part VI of the Act, the plaintiff included the value of ($23,359,519) under subparagraph 190.12(b)(iv) of the Act, thereby arriving at a total of $358,760,322 as capital for the 1986 taxation year.

By Notice of Reassessment, dated July 17, 1989, the Minister of National Revenue (the “Minister”) increased the plaintiff’s capital by $23,359,519, which was the excess of the plaintiff’s tax reserves over its book reserves. This increase in capital correspondingly resulted in an increase in the plaintiff’s tax liability under Part VI of the Act. The plaintiff filed a Notice of Objection, dated October 11, 1989. However, the reassessment was confirmed by the Minister in a Notice of Confirmation, dated March 20, 1990, which stated that “subparagraph 190.12(b)(iv) does not allow a deduction against other elements of capital when the tax reserve exceeds its complementary book reserve”. A Notice of Appeal to the Tax Court of Canada, dated June 11, 1990, was dismissed, upon consent of the parties, in order to permit the matter to be brought before this Court.

The plaintiff and the defendant disagree as to the proper treatment to be given to the excess of tax reserves over book reserves, when determining a corporation’s capital pursuant to paragraph 190.12(b) of the Act. The plaintiff asserts that the excess of tax reserves over book reserves is deductible in computing its capital under that provision. The plaintiff relies, in part, upon paragraph 61(l)(c) of the Ontario Corporations Tax Act (the “OCTA”), R.S.O. 1990, c. C.40, as amended, which provides that paid-up capital, for the purposes of the Ontario capital tax, includes all reserves “except any reserve, the creation of which is allowed as a deduction under the provisions of Part II”. The Ontario Ministry of Revenue has expressly recognized, in Interpretation Bulletin L-9R, that this provision permits a taxpayer to deduct the excess of tax reserves over book reserves in computing its paid-up capital. Accordingly, the plaintiff argues that the use of the words “other than” in subparagraph 190.12(b)(iv) of the federal Act should be accorded the same meaning as the term “except” in the OCTA, as there is no material difference between the two terms. Therefore, the plaintiff should be permitted, under paragraph 190.12(b), to deduct from capital the excess of tax reserves over book reserves. The plaintiff further asserts that the meaning of the words “other than” in subparagraph 190.12(b)(iv) of the Act is ambiguous, and that this ambiguity should be resolved in favour of the taxpayer.

At the time of the reassessment, the Minister took the position that subparagraph 190.12(b)(iv) of the Act does not allow a deduction where a corporation’s tax reserves exceed the book reserves permitted by GAAP. The Minister now admits that this original position was incorrect, and argues that the provision requires a line-by-line examination of book reserves on an individual basis.

The Minister asserts that paragraph 190.12(b) of the Act does not provide for a deduction where a taxpayer’s total tax reserves exceed its total book reserves. According to the Minister, the formula for computing capital in paragraph 190.12(b) includes the reserves as specified, but does not require or permit the deduction of a negative amount. In other words, the paragraph does not allow a deduction in a situation where total tax reserves exceed total book reserves.

Furthermore, the Minister contends that the extent to which each book reserve is permitted to be deducted in computing net income under Part I of the Act must be determined. Those book reserves which are deductible in Part I are not to be included in the computation of a corporation’s capital in paragraph 190.12(b) of the Act. In the Minister’s view, if the amount of any individual book reserve exceeds the amount of its corresponding tax reserve, this excess amount must be included in computing capital, even where the total tax reserves exceed the total book reserves. The Minister also argues that subparagraph 190.12(b)(iv) of the Act does not permit the reduction of taxable capital by an amount determined to be the excess of any individual tax reserve over its corresponding book reserve. Thus, according to the Minister’s interpretation, only a zero or a positive number can be entered into subparagraph 190.12(b)(iv); a negative number is not possible. The Minister therefore disagrees with the Ontario Ministry’s treatment of reserves for the purpose of computing the capital tax payable by a corporation.

In light of the foregoing, the Minister contends that the amount of $23,359,519 was not deductible in determining the plaintiff’s capital for the 1986 taxation year. While the Minister’s recent interpretation of subparagraph 190.12(b)(iv) of the Act would result in a higher amount of tax payable than would the method which it employed upon initial reassessment, the Minister does not seek to increase the amount of the plaintiff’s Part VI tax liability. The parties have agreed that the action should be dismissed with costs in the event that the Minister is successful.

In Québec (Communauté Urbaine) v. Corp. Notre-Dame de Bon-Secours,, [1994] 3 S.C.R. 3, (sub nom. Notre-Dame de Bon-Secours (Corp.) v. Québec (Communauté Urbaine)) [1995] 1 C.T.C. 241, (sub nom. Corp. Notre-Dame de Bon-Secours v. Québec (Communauté Urbaine)), 95 D.T.C. 5017, at pages 17-18 (C.T.C. 252; D.T.C. 5023), Justice Gonthier summarized the basic principles which apply in the interpretation of a taxation statute.

Firstly, the interpretation of tax legislation is subject to the ordinary rules of construction. Secondly, the underlying purpose of the legislation should be identified in light of the context of the statute, its objective, and the legislative intent. Thirdly, taking a teleological approach, a taxation provision should be given a strict or liberal interpretation, as determined by its underlying purpose. The application of this teleological approach will favour the taxpayer or the Minister, depending solely on the provision in question; the result does not depend on any predetermined presumption in favour of the taxpayer. Only a reasonable doubt, not resolved by the ordinary rules of interpretation, will be settled by recourse to the residual presumption in favour of the taxpayer. Therefore, it is no longer possible, in tax matters, to reduce the rules of interpretation to presumptions in favour of, or against, the taxpayer, or to well-defined categories known to require a liberal, strict, or literal interpretation.

Mr. David Turner, a Chartered Accountant and a Senior Appeals Officer employed by Revenue Canada, appeared on behalf of the Minister. Mr. Turner testified that Part VI of the Act, which imposes a tax on the capital of financial institutions at a fixed point in time, is distinct from Part I of the Act, which deals with income tax. The plaintiff agreed with Mr. Turner that the purpose of the capital tax is to raise revenue. No other fiscal, social, economic, or equitable purpose was advanced by either party.

The phrase “its reserves”, found in subparagraph 190.12(b)(iv) of the Act, does not explicitly reveal whether the reserves in question are the corporation’s book reserves or its tax reserves. However, the provision does provide for the exclusion of any reserve which is a “reserve of a reasonable amount for deferred income tax or that is permitted to be deducted in computing the income of the corporation”. I am of the opinion that this phrase means the tax reserves of the corporation. Accordingly, the phrase “its reserves” in subparagraph (iv) must of necessity mean the corporation’s book reserves. I agree with Mr. Turner that an interpretation to the contrary would result in a zero value for reserves under subparagraph 190.12(b)(iv) in every case.

The language of subparagraph 190.12(b)(iv) of the Act indicates that those reserves which are permitted deductions in calculating net income under Part I of the Act are excluded from the determination of capital under Part VI. According to the evidence of Mr. Turner, paragraph 18( 1 )(e) in Part I of the Act establishes a general limitation disallowing the deduction, from a taxpayer’s business or property income, of any reserves which are not expressly permitted under Part I of the Act. Consequently, of the book reserves which a corporation may take for financial statement purposes, only those which have been expressly flagged in Part I of the Act are considered to be tax reserves which may be deductible when determining net income for the year. Hence, all book reserves are excluded from the calculation of net income, unless specifically set out as deductions under Part I of the Act. With respect to Part VI of the Act, it would appear that the tax reserves deducted under Part I are excluded from the calculation of capital under paragraph 190.12(b), to the benefit of the corporation.

I am of the opinion that the language of subparagraph 190.12(b)(iv) of the Act requires that a corporation total all of its book reserves other than those which are permitted to be deducted for tax purposes. Contrary to the plaintiffs submissions, subparagraph 190.12(b)(iv) does not provide that the taxpayer must total its book reserves and then deduct its total tax reserves. Such an interpretation could result in a negative amount which, of course, occurred in this case. While subparagraph 190.12(b)(iv) does refer to tax reserves which were allowable as deductions under Part I, it does not provide for further deductions of all tax reserves which were deductible in the computation of income tax liability.

I also agree with Mr. Turner that subparagraph 190.12(b)(iv) of the Act necessitates a line-by-line analysis of each book reserve on the corporation’s financial statement. The taxpayer should examine, on an individual basis, its book reserves for the purpose of computing its capital. Only those book reserves singled out in Part I of the Act should be considered in determining the value of the corporation’s tax reserves. If corresponding reserves do exist for certain of the corporation’s book reserves, these tax reserves should be considered in the calculation of the capital of the corporation. However, those tax reserves which do not correspond to any of the individual book reserves itemized on the corporation’s financial statement are immaterial for the purposes of subparagraph 190.12(b)(iv). Accordingly, the total of all tax reserves allowable as deductions in Part I of the Act is of no significance in the calculation of capital under Part VI.

In those cases where a particular book reserve does have a corresponding tax reserve, the book reserve is only included in the computation of capital under paragraph 190.12(b) to the extent that it has not been recognized as a deduction, or tax reserve, in the Act. Therefore, where a book reserve exceeds its corresponding tax reserve, it is only the difference between the two amounts (i.e., the difference arrived at when the tax reserve is subtracted from its matching book reserve) that is considered in the calculation of the corporation’s capital. However, where a particular tax reserve exceeds its matching book reserve, a negative amount should not be included in the calculation of capital; rather, the value of the book reserve should be reduced to zero.

There are a number of reasons for disallowing a negative amount for reserves in subparagraph 190.12(b)(iv) of the Act. As Mr. Turner explained, reserves are included in the calculation in paragraph 190.12(b) to decrease the opportunity for manipulation. If reserves were not added, the corporation could minimize its Part VI tax by simply taking a surfeit of reserves, thereby decreasing its capital and, consequently, its tax liability. According to the evidence of Mr. Turner, a reserve is an appropriation of retained earnings, or other surplus, for a future contingency. This connotes a positive number, or zero; it does not suggest a negative value. Hence, the value of reserves to be included in the computation of capital, pursuant to subparagraph 190.12(b)(iv), cannot be a negative amount. Moreover, a negative amount for reserves would be contrary to the purpose of this provision, which is to calculate the capital upon which the corporation’s capital tax is ultimately based.

While the language in paragraph 61(l)(c) of the OCTA, supra, closely resembles that of subparagraph 190.12(b)(iv) of the Act, the Ontario provision deals with the world paid-up capital of a corporation. Interpretation Bulletin L-9R relates to reserves to be included in computing this paid-up capital. In contrast, in calculating the capital of a corporation under paragraph 190.12(b) of the Act, paid-up capital and reserves are separate elements which are both included in the total calculation. I am not satisfied that the evidence justifies an interpretation of subparagraph 190.12(b)(iv) that permits a negative value for reserves in the calculation of a corporation’s capital.

The approach now advanced by the Minister results in the most precise method for determining the capital of the plaintiff. In my opinion, the plaintiff was therefore in error when it deducted from its total book reserves the total of all tax reserves allowed under Part I of the Income Tax Act. Accordingly, the appeal is dismissed with costs.

Appeal dismissed.