Arnos v. The Queen, 81 DTC 5126, [1981] CTC 176 (FCTD)

The Associate Chief Justice:—The facts in this case are neither complicated nor unique and they formed the subject of an agreed statement of facts by counsel as follows:

1. The plaintiffs are the trustees of a certain trust known as General Real Estate Shares (“GRES”) and are all residents of the United States of America. The beneficiaries of GRES also are residents of the United States of America. GRES is a real estate investment trust created, and the activities of which are carried on, in the United States of America.

2. In 1963 GRES settled a certain trust (the “Canadian trust”), with GRES itself as sole beneficiary and the Canada Trust Company (“Canada Trust”) as trustee thereof, by conveying to Canada Trust a certain parcel of real property municipally known as 560 Exmouth Street, in the City of Sarnia, in the Province of Ontario (the “Property”).

3. The Property was at all material times real property from which rental revenue was derived.

4. In 1978 Canada Trust conveyed to GRES legal title to the Property.

5. In 1978, shortly after the conveyance referred to in paragraph 4 hereof, GRES sold the Property.

6. The Property was a capital asset and in the year in which it was sold the plaintiffs had no permanent establishment in Canada.

7. In the computation of income of the Canadian trust under Part 1 of the Income Tax Act, RSC 1952, c 148, as amended, (the “Act”), Canada Trust as trustee was allowed capital cost allowance deductions for taxation years prior to 1978 that amounted in the aggregate to $193,500.84. The proceeds of disposition of the property allocable to the building component thereof exceeded the undepreciated capital cost of the building by at least the said amount of $193,500.84.

8. For the 1978 taxation year GRES did not elect pursuant to subsection 216(1) of the Act to file and did not file a return of income under Part 1 of the Act in the form prescribed for a person resident in Canada.

9. By notice of assessment No. 4917498, dated July 10, 1979, for the 1978 taxation year, the Minister of National Revenue (the “Minister”) assessed tax against the plaintiffs as trustees of GRES and in so doing included in computing income an amount of $193,500.84 described by the Minister in the explanatory schedule attached to the said notice of assessment as “capital cost allowance recapture re: 560 Exmouth Street, Sarnia”. The said schedule states that the said inclusion “is in accordance with subsection 216(5) of the Income Tax Act Canada of”. The Minister also assessed a late-filing penalty in the amount of $500 purportedly pursuant to subsection 162(1) of the Act.

10. The plaintiffs duly objected to the said assessment by notice of objection.

11. By notification dated February 26, 1980, the Minister confirmed the said assessment as having been made in accordance with the provisions of the Act and in particular on the ground that:

Recaptured capital cost allowance, amounting to $19,500.84, arising from the disposition of the property at 560 Exmouth Street, City of Sarnia, Province of Ontario, Canada, owned by the taxpayer and previously allowed to the taxpayer on the property on transfer from General Real Estate Shares Trust, in satisfaction of its capital interest in the latter trust, has been properly included in computing the taxpayer’s income from the year, in accordance with the provisions of subsection 13(1), 107(2), and 216(5) of the Act.

Additional testimony consisted only of the evidence of David Mills, who confirmed the facts contained in the agreed statement of facts, and added evidence that the American beneficiaries of the Canadian trust, GRES, had filed a US return reporting the rental income from the Canadian property. The propriety of the return and compliance with United States tax laws in the treatment of revenue from this property is not challenged. In the taxation year 1978, the United States taxpayer disposed of this asset by first, the dissolution of the Canadian trust, and then by a sale of the Canadian property by GRES. The facts are extremely close to those facing the Court in the 1972 action in the Trial Division of this Court before Collier, J in Bessemer Trust Company and Ogden Phipps as Trustee (1957 Trust) v MNR, [1972] CTC 473; 72 DTC 6404, and the issue is exactly the same as the one to be decided in that case, ie, whether the United States owner of this Canadian property was liable for recapture of the capital cost allowance that had been claimed by the Canadian Trustee over the several years of ownership of the building. I should emphasize that none of the actions of the Canadian trustee are in issue here, including, of course, the tax treatment of the return of the property to the non-resident owner.

I have carefully reviewed the jurisprudence put forward at the trial and the decisions in the Bessemer Trust, supra, case and I am unable to find any reason to differ from those conclusions of the learned trial judge, which were reaffirmed in the judgment of Jackett, CJ, in the Federal Court of Appeal in MNR v Bessemer Trust Company and Ogden Phipps as Trustee (1957) Trust [1973] CTC 12; 73 DTC 5045. The first is that capital cost allowance is properly treated as income and the income takes its character from the nature of the business income from which it was deducted, in this case, rental income. Secondly, where the ownership of a rental property is in the hands of a non-resident, an election exists, pursuant to the then section 110, and now section 216, most notably subsections (1) and (5), as follows:

216. (1) Where an amount has been paid during a taxation year to a nonresident 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 partner- ship 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.

(5) Where a person or a trust of which that person is a beneficiary has filed a return of income under Part I for a txation year as permitted by this section or as required by section150 and, in computing the amount of his income under Part I an amount has been deducted under paragraph 20(1 )(a), or is deemed by subsection 107(2) to have been allowed under that paragraph, in respect of real property in Canada, a timber resource property or a timber limit in Canada, he shall, within the time prescribed by section 150 for filing a return of income under Part I, file a return of income under Part I, in the form prescribed for a person resident in Canada, for any subsequent taxation year in which he was a non-resident person and in which that real property, timber resource property or timber limit or any interest therein is disposed of, within the meaning of section 13, by him or by a partnership of which he is a member, 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 any amount paid, or deemed by this Part to have been paid to him or to a partnership of which he is a member in that subsequent taxation year in respect of any interest in real property, timber resource property or timber limit in Canada, to pay tax under Part I for that subsequent taxation year as though

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

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

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

which essentially reduces itself to the option to be treated as a Canadian resident, having as his sole source of income, the revenue property which is the subject of the election. Thirdly, that where the non-resident taxpayer does not elect to be treated as a Canadian taxpayer, his liability for tax is limited by the Canada-USA Tax Convention Act 1943, SC 1943-44, c 21, as amended and in particular, section XIIIA(2), which takes precedence over the relevant provisions of the Income Tax Act, if a conflict exists between them:

ARTICLE XIII A.

2. Rentals from real property derived from sources within Canada by an individual or corporation resident in the United States of America shall receive tax treatment by Canada not less favorable than that accorded under Section 99, The Income Tax Act, as in effect on the date on which this Article goes into effect.

In the Bessemer Trust, supra, case, the taxpayer elected in the year under dispute, to be treated as a Canadian taxpayer and that became the only ground of difference between the decisions at trial and on appeal. Jackett, CJ, said at 15 [5047]:

Apart from the Convention, as it appears to me, the situation is that, at the time of the Tax Convention, a non-resident could elect, in respect of a year when he was paid an amount as rent on real property in Canada, to file a return under Part I, in which event he became liable to pay tax under Part I as though the real property in Canada were his only source of income and he was not bound to file such a return in respect of a subsequent year when he disposed of the property so as to become liable to “recapture”, but, after 1955, if a non-resident so elected to pay tax under Part I in respect of a year when he was paid such an amount as rent, it carried with it a liability, by virtue of the new section 110(5), to file a return in respect of the year of disposition and to pay any tax arising from the “recapture” provision in section 20(1). In my view the application of section 110, including subsection (5), involves “tax treatment” of “rentals from real property derived from sources within Canada” less favourable that that accorded by the old section 99 and is excluded in the case of persons resident in the United States by the Canada-United States of America Tax Convention.

The question remains as to whether, on the facts of this case, the recapture provision was properly invoked by the appellant in assessing the respondent. On this question, I have the misfortune to disagree with the learned trial judge.

In my view, while the respondent was not required to elect to pay tax under Part I for 1969, as it received rental payments from real property in Canada in 1969, it was authorized by section 110(1) to elect to do so, and, having done so, it becomes liable to pay tax computed in accordance with the provisions of Part I “as though ... his interest in real property in Canada . . . were his only source of income”. While, normally, the only amounts included in computing the income of a taxpayer for a year during which his only source of income was real property are the amounts of rent received in respect of the property for the year, section 20 requires that, where such property was "depreciable property”, as this property was, and was disposed of in the year, the amount determined thereby "shall be included in computing his income for the year”. I cannot escape the conclusion that, having elected to pay tax for the 1969 taxation year as though its sole source of income for that year was its real property in Canada, section 20 operates to require that the "recapture” amount be included in computing the respondent’s income for the year.

The conclusion that the taxpayer, through election in the one year only, renders himself liable for recapture from previous years is interesting, but fortunately, one that I need not agonize over here because this point, which was the foundation of the appeal decision, is the very element that is missing from the facts before me. This taxpayer did not make an election in the year of disposition or in any other year, pursuant to section 216, and to repeat, since the tax treatment of the Canadian trustee in any of these years is not in issue here, the matter falls squarely within those aspects of the trial decision in the Bessemer Trust, supra, case which were confirmed on appeal.

The determination, therefore, that this non-resident taxpayer was liable for recapture in the year of disposition of this property was an incorrect assessment and the matter must be returned to the Minister for the appropriate reassessment. The plaintiffs are entitled to their costs.