Terry v. MNR, 74 DTC 6017, [1973] CTC 837 (FCA)

Thurlow, J (judgment delivered from the Bench, concurred in by Sheppard, DJ):—This is an appeal from a judgment of the Trial Division which dismissed the appellant’s appeal from a reassessment of income tax for the year 1965. By the reassessment in question the appellant was assessed in respect of an amount of $60,851.06 on the basis that under subsection 67(1) of the Income Tax Act he was deemed to have received a dividend of that amount from a personal corporation known as Northland Holdings Limited. The Minister’s ground for applying subsection 67(1) was the fact that in the year the personal corporation (hereafter referred to as Northland) had received from Skeena Navigation Limited, a company of which Northland held 40% of the issued stock, a stock dividend which the Minister regarded as representing, to the extent of $60,851.06, “undistributed income on hand” of that company within the meaning of paragraph 82(1 )(a) of the Act. The issue in the appeal is not concerned with the effect of subsection 67(1) but with the question whether the $60,851.06 was “undistributed income on hand” of the company in question. Both in the Trial Division and on the appeal io this Court the appellant’s position was that Skeena Navigation Limited had no undistributed income on hand at the material time. In the Trial Division the appellant raised two distinct issues in support of his position both of which were decided against him. Both issues were again raised in the appellant’s memorandum of fact and law on the appeal but the second of them was abandoned by counsel at the commencement of his presentation of argument. It is therefore necessary to consider and deal with only the first of them.

Skeena Navigation Limited (which I shall refer to hereafter for convenience as Skeena Amalgamated), the company from which the dividend was received by Northland, was formed by the amalgamation on December 23, 1964 of Skeena Navigation Limited (hereafter Skeena) and The Sannie Transportation Company Limited (hereafter Sannie) both of which had previously been engaged in operating fleets of vessels in the coastal waters of British Columbia. In 1962 both companies had sold their vessels for amounts which, in the case of Skeena, totalled $535,500, and in the case of Sannie $900,000. Thereafter, in order to avoid recapture of capital cost allowances previously claimed in respect of the vessels under the special provisions of the Canadian Vessel Construction Assistance Act, SC 1949, c 11, both companies, with the approval of the Canadian Maritime Commission under and in accordance with the provisions of that Act, disposed of the proceeds of the sales of the vessels by selling such proceeds to other companies which undertook to use them for the construction of new vessels, but at discounts which, in the case of Skeena, amounted to $63,033.56 and, in the case of Sannie, to $108, 310.30.

From the point of view of the purchasers there were, undoubtedly, advantages to be realized from the purchase of such proceeds at a substantial discount in the transactions in question. On the other hand Skeena and Sannie, by accepting or absorbing the discounts, were able lawfully to avoid having to bring the capital cost allowances into their incomes under subsection 20(1) of the Income Tax Act and to pay tax thereon, which was the end which they sought from the transactions. The appellant’s case is that the amounts of these discounts were deductible as expenses falling within subparagraph 82(1)(a)(ii) of the Income Tax Act for the purpose of computing the “undistributed income on hand” of Skeena Amalgamated at the material time. If so, the amounts were more than sufficient to offset the alleged undistributed income on hand of Skeena Amalgamated and there was no basis for treating any part of the dividend received by Northland as undistributed income or for the application of subsection 67(1).

The definition of “undistributed income on hand” in paragraph 82(1 )(a) is long and complicated and no good purpose would be served by reading it in full. Basically, as I understand it, the concept is that of the aggregate of the incomes of the corporation for the taxation years since 1917 minus the aggregate of the following for each of those years:

(1) each loss sustained for a taxation year;

(2) expenses incurred or disbursements made by the corporation which were not deductible in computing income (with certain defined exceptions);

(3) the amount by which capital losses exceeded capital gains;

(4) certain amounts on which special taxes were paid;

(5) dividends; and

(6) certain other specified amounts.

The particular portion of the definition involved in the appellant’s contention reads as follows:

82. (1) In this Act

(a) “undistributed income on hand” of a corporation at the end of, or at any time in, a specified taxation year means the aggregate of the incomes of the corporation for the taxation years beginning with the taxation year that ended in 1917 and ending with the specified taxation year minus the aggregate of the following amounts for each of those years:

(ii) each expense incurred or disbursement made by the corporation during one of those years that was not allowed as a deduction in computing income for one of those years under this Part except

(A) an expense incurred or disbursement made in respect of the acquisition of property (including goodwill) or the repayment of loans or capital,

(B) an outlay or expense the deduction of which was not allowed by reason of subsection (3) of section 12, or

(C) unless the undistributed income on hand is being determined for the purpose of subsection (1) of section 81, any part of the payment referred to in section 76 that has not been allowed as a deduction in computing income for one of those years,

It will be observed that the expenses and disbursements deductible under this provision are not confined to those incurred or made for the purpose of gaining or producing income from the corporation’s business or property (compare paragraph 12(1 )(a)). On the language of the provision that plainly is not the test. As an example income taxes paid by the corporation over the years appear to fall within the provision. Moreover, the exemption in clause (A) of particular types of capital expenditures suggests that at least some items of a capital nature may be included as properly deductible. The fact that the amounts here in question are of a capital nature, thus, in my opinion, does not by itself afford an answer to the appellant’s contention. On the other hand it seems equally clear that not every sum paid out can properly be treated as an expense or disbursement within the meaning of the provision. For example, the payment of a sum to a person as a loan by a corporation otherwise than in the course of its business would not, as I see it, fall within the meaning of expense or disbursement in that provision though if the debt were lost by the debtor becoming insolvent the loss might conceivably qualify as a loss of capital to be taken into account under subparagraphs (iii) and (iv) of paragraph 82(1)(a). Finally, since the deduction of net capital losses as well as of operating or income losses is specifically provided for in subparagraphs (iii) and (iv) and (i) respectively of the paragraph it seems apparent that the words “expense” and “disbursement” in subparagraph (ii) were not used in so broad a sense as to include such losses and that if the amounts here in question are in fact capital losses they cannot at the same time be regarded as expenses or disbursements within the meaning of those terms as used in subparagraph 82(1 )(a)(ii).

I pause at this point to note, first, that it is common ground that Skeena and Sannie had net capital gains rather than losses, and that if the amounts here in question were taken into the computations, as we were informed they were, there would still be in both cases net capital gains rather than losses so that in neither case was there anything to be deducted under subparagraph (iii) or (iv) of paragraph 82(1 )(a), and, second, that counsel for the appellant in the course of argument conceded that the word “disbursement” in subparagraph (ii) was not apt to characterize the amounts in question. What remains then is to determine whether they are capital losses within subparagraph (iii) or (iv) or expenses within subparagraph (ii).

On this I am in agreement with the view of the learned trial Judge that the amounts were not expenses within the meaning of subparagraph 82(1 )(a)(ii) and I am of the opinion that if they properly fall to be deducted under any of the provisions of the definition of undistributed income on hand they do so as capital losses within the meaning of subparagraphs (iii) and (iv) of paragraph 82(1 )(a). The most attractive suggestion put forward by counsel for the appellant was that the amounts should be regarded as expenses incurred to procure the construction of new vessels by the purchasers but I do not think they can be so characterized. Rather, the substance of what appears to me to have transpired is that Skeena and Sannie avoided the recapture of capital cost allowances by losing, or accepting the loss of, a part of the proceeds of the sale of their vessels. The same can be expressed by saying that they accomplished what they sought at the “expense” of losing a part of the proceeds. In either way of stating it, however, the character of what has occurred is not that of an expense but that of a loss of a part of the proceeds as a result of the transaction.

In my opinion the appeal therefore fails and should be dismissed with costs.

Bastin, DJ:—1 concur with the result arrived at by Mr Justice Thurlow but for different reasons.

As stated by the learned trial Judge, the taxpayer has been given three choices on the disposition of a vessel by the Canadian Vessel Construction Assistance Act:

(1) to pay the tax on recaptured capital cost allowance pursuant to section 20 of the Income Tax Act;

(2) to build a replacement using all or part of the proceeds of the disposition;

(3) to have someone else build a replacement using all or part of the proceeds of the disposition.

If he chooses (2) or (3) he escapes tax on the recapture of capital cost allowance.

If he makes the third choice he must offer the company which is to build the replacement a financial inducement to do so. Actually this took the form of a conveyance of a bank account and the security lodged with the Canada Maritime Commission at a discount. This is the means the companies used to avoid payment of the tax in question. The CVCA Act introduces an exception to the provisions of the Income Tax Act and the transactions entered into by the taxpayer to comply with the CVCA Act were not such as were contemplated by the Income Tax Act so the discounts in question are not comprehended within the meaning to be given to “loss” or “expense” as these terms are used in the Income Tax Act.