Hickman Motors Ltd. v. The Queen, 95 DTC 5575, [1995] 2 CTC 320 (FCA), rev'd 97 DTC 5363, [1997] 2 S.C.R. 336

Hugessen J.A.:-This is an appeal from a judgment of the trial division which dismissed the appellant’s appeal from reassessments for the 1985 and 1986 taxation years.

The appellant, Hickman Motors Limited (hereafter sometimes "Motors") is a General Motors distributor in St. John’s, Newfoundland. It was, at all relevant times, a member of a group of several associated companies having common or interlocking ownership. Towards the end of calendar 1984 (which was also the appellant’s fiscal year), the appellant and a number of its associated companies underwent a corporate restructuring. Most of the details of that restructuring and the corporate entities involved do not concern us here and it is necessary to mention only two other members of the group, Hickman Equipment Limited (hereafter sometimes "Equipment") and Hickman Equipment (1985) Limited (hereafter sometimes "Equipment (1985)"). The former was, at the relevant time, a wholly owned subsidiary of the appellant and had been carrying on business in St. John’s in the leasing of heavy equipment, principally supplied by John Deere Limited. For its part, "Equipment (1985)" was also a wholly owned subsidiary [1] of the appellant; it was incorporated on December 21, 1984, and from January 2, 1985, it carried on the same heavy equipment leasing business that had formerly been carried on by "Equipment".

The transactions with which we are here concerned took place on December 28, 1984 (a Friday), and January 2, 1985 (the following Wednesday, after the New Year’s holiday). On the former date ’’Equipment” was voluntarily liquidated and wound-up into its parent "Motors”. Its assets which included depreciable property with an undepreciated capital cost of $5,196,422 thus became the property of "Motors”. On January 2, 1985, those same assets, net of the liabilities of "Equipment", were sold by "Motors" to "Equipment (1985)" for a consideration of $860,000.

In its 1984 tax return, the appellant made a claim for capital cost allowance in the amount of $2,029,942 in respect of the property which it had acquired from "Equipment" on the winding-up of the latter. The Minister disallowed this claim on the grounds that the assets of "Equipment" had not been acquired by the appellant for the purpose of gaining or producing income and the result of such disallowance had consequential adverse impact on the appellant’s 1985 and 1986 tax assessments. There followed the usual notices of objection and an unsuccessful appeal to the trial division. It will be noted that while the contested assessments are for the years 1985 and 1986, the only issue between the parties is as to the claim for capital cost allowance in 1984.

The appellant’s position, if I understand it correctly, is that the provisions of subsection 88(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") create for it an independent right to claim capital cost allowance on the undepreciated capital cost of the property which it acquired on the winding-up of "Equipment". The relevant parts of that subsection read as follows:

88(1) Where a taxable Canadian corporation (in this subsection referred to as the "subsidiary") has been wound up after May 6, 1974 and not less than 90 per cent of the issued shares of each class of the capital stock of the subsidiary were, immediately before the winding-up, owned by another taxable Canadian corporation (in this subsection referred to as the "parent") and all of the shares of the subsidiary that were not owned by the parent immediately before the winding-up were owned at that time by persons with whom the parent was dealing at arm’s length, notwithstanding any other provision of this Act, the following rules apply:

(a) subject to paragraph (a.l), each property of the subsidiary that was distributed to the parent on the winding-up shall be deemed to have been disposed of by the subsidiary for proceeds equal to,

(iii) in the case of any other property, the cost amount to the subsidiary of the property immediately before the winding-up;

(c) the cost to the parent of each property of the subsidiary distributed to the parent on the winding-up shall be deemed to be the amount deemed by paragraph (a) to be the proceeds of disposition of the property, plus, where the property was a capital property (other than depreciable property) owned by the subsidiary at the time that the parent last acquired control of the subsidiary and thereafter without interruption until such time as it was distributed to the parent on the winding-up, the amount determined under paragraph (d) in respect thereof;

(f) where property that was depreciable property of a prescribed class of the subsidiary has been distributed to the parent on the winding-up and the capital cost to the subsidiary of the property exceeds the amount deemed by paragraph (a) to be the subsidiary’s proceeds of disposition thereof, for the purposes of sections 13 and 20 and any regulations made under paragraph 20(l)(a),

(i) notwithstanding paragraph (c) the capital cost to the parent of the property shall be deemed to be the amount that was the capital cost thereof to the subsidiary, and

(ii) the excess shall be deemed to have been allowed to the parent in respect of the property under regulations made under paragraph 20(1 )(a) in computing income for taxation years before the acquisition by the parent of the property.

The appellant argues that the purpose and intent of this legislative provision is to permit a parent company to retain and continue the tax character, attributes and history of its wholly owned subsidiary on the winding-up of the latter so as to allow the parent to step into the ’’tax shoes" of the subsidiary. From this, the appellant argues, it follows that the depreciable property in the hands of its subsidiary "Equipment" necessarily became depreciable property in appellant’s hands following the winding-up, thereby permitting it to claim capital cost allowance on the undepreciated capital cost thereof.

While I am prepared, in general terms, to agree with the appellant’s characterization of the purpose and intent of subsection 88(1), I cannot agree that it gives rise to the results contended for. In and of itself, the subsection creates no rights to any deductions at all. It is neither a charging nor a relieving provision. It produces its effect not at the time when liability for tax arises, at the end of a taxpayer’s taxation year, but rather at the time that the event to which it relates, the winding-up of the subsidiary, takes place. That event is deemed to produce certain results which may be compendiously described as the flow-through from the subsidiary to the parent of the cost, including the undepreciated capital cost, of the subsidiary’s property. That flow- through will of course produce important tax consequences, but they are not to be found in the text of section 88 itself. It nothing serves the appellant to show that it is deemed to have the same undepreciated capital cost for the property which it acquired from "Equipment" as "Equipment" itself had immediately prior to the winding- up; nor that the depreciable property of "Equipment" has become depreci- able property in appellant’s hands. The question, and the only relevant one for our purposes, is to know whether in virtue of the provisions of the Income Tax Act and the Regulations, [2] the appellant is entitled to claim capital cost allowance on such undepreciated capital cost in respect of such depreciable property, whatever it may be.

A very similar question arose in the recent decision of this Court in Mara Properties Ltd. v. Canada, [1995] 2 C.T.C. 86, 95 D.T.C. 5168 (F.C.A.). There the issue was whether property acquired on the winding-up of the subsidiary had become part of the taxpayer’s inventory so as to give rise to a trading loss upon its disposition. Speaking for the majority of this Court, Marceau J.A., said at page 89 (D.T.C. 5169):

I have no doubt that subsection 88(1) of the Income Tax Act contains a rule which is meant to apply automatically. It is even expressed to operate notwithstanding any other provision of the Act. The conditions for application of the provision are clearly set out and have been met. Subsection 88(1) is certainly applicable here.

As I understand the rule enacted in that provision, it is to the effect that on the winding-up of a subsidiary, there shall be a deemed disposition by the subsidiary of each of its properties at the cost amount to it and a deemed acquisition of the property by the parent at the same cost. I cannot read anything else in that provision. More particularly, I cannot read the provision as saying that, if the property was part of the inventory of the subsidiary, it will become part of the inventory of the parent; nor does it specify that unrealized losses of the subsidiary become business losses for the parent. It does not say that the parent will be considered for tax purposes to be in the same situation as the subsidiary was with regard to the property. It determines a deemed cost of acquisition but it does not determine, as I read it, whether that deemed cost and the actual proceeds of sale of the property will enter into the calculation of the parent’s income from its business. That determination must be made according to section 9 of the Act which defines business income. In order to satisfy the requirements of that provision, the parent must demonstrate that the property has become part of its own inventory.

[Emphasis added.]

Counsel for the appellant attempted valiantly to distinguish the decision in Mara Properties on the grounds that it dealt with inventory and trading losses whereas the present case has to do with depreciable property and capital cost allowance, but I must confess that, in my view, the distinction is one without a difference.

The right to claim capital cost allowance is wholly statutory. The general principle with regard to deductions in computing business income is set forth in paragraph 18(l)(a):

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property.

As an exception to that general rule, paragraph 20(1 )(a) provides:

20(1) Notwithstanding paragraphs 18(l)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(a) such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation;

Part XI of the Regulations contains the rules relating to capital cost allowance and Schedule II sets out the various classes of property in respect of which such allowance may be claimed. Paragraph 1102(l)(c) of the Regulations reads:

1102(1) The classes of property described in this Part and in Schedule IT shall be deemed not to include property

(c) that was not acquired by the taxpayer for the purpose of gaining or producing income;

This text is wholly consonant with paragraph 18(l)(a) of the Income Tax Act: deductions for capital cost allowance, like any other deductions, are prohibited if not related to an expenditure incurred for the purpose of gaining or producing income. Depreciable property which was not acquired for such purpose is deemed not to be included in any of the classes of property in respect of which capital cost allowance may be claimed.

The appellant further argues that subsection 1102(14) operates as an exception to this general rule:

1102(14) For the purposes of this Part and Schedule II, where a property is acquired by a taxpayer

(a) in a transaction in respect of which an election was made under subsection 8591) or (2), 97(2) or 98(3) of the Act,

(a.l) in a transaction in respect of which subsection 85(5.1) or 98(5) of the Act is applicable,

(b) by virtue of an amalgamation (within the meaning assigned by subsection 87(1) of the Act),

(c) as the result of the winding-up of a Canadian corporation in respect of which subsection 88(1) of the Act is applicable,

(d) from a person with whom the taxpayer was not dealing at arm’s length at the time the property was acquired, or

(e) for rent or lease to the person from whom the property was acquired or to another person who, at the time the property was acquired, was not dealing at arm’s length with the person from whom the property was acquired, and

the property, immediately before it was so acquired by the taxpayer, was property of a prescribed class or a separate prescribed class of the person from whom it was so acquired, the property shall be deemed to be property of that same prescribed class or separate prescribed class, as the case may be, of the taxpayer.

The appellant points in particular to the provisions of paragraph (c) in this text and claims that its effect is to nullify the general rule in subsection 1102(1), supra, and to put the property which it acquired on the winding-up of "Equipment" into the appropriate prescribed classes in Schedule II for the appellant, whether or not such property was acquired by the appellant for the purposes of gaining or producing income. I cannot agree. Subsection 1102(14) does not have the reach contended for it. It does not say that it operates notwithstanding the general rule set out in subsection 1102(1) or the underlying principle enshrined in paragraph 18(l)(a). The purpose of subsection 1102(14) is manifestly to prevent the acquirer of depreciable property, in the circumstances described in the various paragraphs thereof, from switching such property from one class to another. This is all that it does. One has only to look at the provisions of paragraph 1102(14)(d) (which, incidently, also applies to the acquisition by appellant of the assets of "Equipment") to see that this provision cannot possibly have the effect of automatically allowing a non- arm’s length acquirer to claim capital cost allowance simply because the person from whom the property was acquired had the right to do so.

I conclude, accordingly, that section 88 does not create for the appellant an independent right to claim capital cost allowance on the property which it acquired on the winding-up of its subsidiary "Equipment". Such a claim can only succeed if the appellant can demonstrate that it otherwise meets the requirements of the Act and Regulations. Whether or not the appellant is in its subsidiary’s "tax shoes", it is, like every other taxpayer, entitled only to those deductions which the Act allows.

It is the Minister’s position that the appellant did not acquire the property of "Equipment" for the purposes of gaining or producing income as required by paragraph 1102(l)(c) of the Regulations and that, as a consequence, such property is excluded from the classes in Schedule II and no capital cost allowance may be claimed in respect of it. The appellant, on the other hand, argues that the property of "Equipment" was acquired for income producing purposes and did in fact produce income for it during the five-day period in which it held such property.

The question, as to whether property has been acquired for the purposes of gaining or producing income is, of course, one of fact. The trial judge determined it adversely to the appellant, describing as ’’notional” any attempt by the appellant to earn income from the assets. We must, of course, approach that finding with proper deference.

In my view, the test to be applied in determining whether property has been acquired for the purpose of gaining or producing income is similar to that which was authoritatively settled by the Supreme Court of Canada for determining the analagous question as to whether a taxpayer is carrying on a business with a reasonable expectation of profit. In Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, Dickson J., as he then was, speaking for the Court, said as follows at pages 485-86 (C.T.C. 313-14, D.T.C. 5215):

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer’s training, the taxpayer’s intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive.

Several of the criteria mentioned by Dickson J. in his non- exhaustive list argue strongly against the taxpayer’s contention; there is no evidence to support any which would point the other way.

In particular, "Equipment’s" experience in past years was one of substantial losses; "Motors" was not in the business of leasing heavy equipment; and the intended course of action of the appellant, at the time the assets of "Equipment" were acquired by it, was admittedly to turn such assets over to "Equipment (1985)" within five days’ time. While I would not wish to be taken as suggesting that there is any temporal requirement to a taxpayer’s holding of property for the purposes of earning income, the fact that this taxpayer held the property here in issue only over the period of a long holiday weekend is surely indicative of the fact that it had no intention of actually earning income from the property. For practical purposes, the rollover from the appellant to "Equipment (1985)" might as well have occurred immediately following the winding-up of "Equipment". The trial judge’s use of the word "notional" was appropriate.

The evidence also makes it plain that the appellant itself did not at the time treat the property which it acquired from the winding-up of "Equipment" as being a potential or actual source of income: no such income was shown in the appellant’s books for either its 1984 or its 1985 taxation years. The evidence of the appellant’s sole witness, Mr. Grant, commenting on the notes to the financial statements, is eloquent (at pages 54-55 of the transcript of the proceedings, Trial Division):

A. The last paragraph outlines the wind-up on December 28. And it goes on to state that the assets and liabilities acquired have a net value approximating the above investment of $860,000, and are not reflected in these financial state- ments. So we show that as a net figure, that would be the assets less the liabilities.

Q. Well, if the business of Hickman Equipment Ltd. was wound up into Hickman Motors Ltd. effective December 28, 1984, why did you not show the revenues and expenses of Hickman Equipment Ltd. as part of the revenues and expenses of Hickman Motors Ltd. as at December 31, 1984?

A. Well, in our judgment at that time, the revenue—the income and/or loss that may have been generated would not have adjusted [sic: "justified"?] the auditing expense and the accounting expense to reconstruct the records for the three-, four-day period. We would have had to have had our external auditors involved for a period of time and we would have had to have had our own staff involved.

[Emphasis added. ]

In sum therefore, I am of the view, that the trial judge’s finding of fact to the effect that the appellant did not acquire the property of "Equipment" for the purpose of gaining or producing income is concordant with the applicable principles of law and is solidly based in the evidence. I would not interfere with it.

This brings me to the appellant’s last argument which is based upon a submission which was advanced neither in the original notice of opposition nor in the proceedings in the trial division. Assuming, which I doubt, that the question is properly raised before us,^ [3] it is, in my view, without substance.

If I understand the argument correctly, it is that the appellant is entitled to claim a terminal loss equal to the entire amount of the undepreciated capital cost of the property which it received from "Equipment" and which it still owned as at the close of its fiscal year on December 31, 1984. Since this property is deemed by the operation of subsection 1102(1), supra, not to be included in any of the classes in Schedule II, the appellant, it is argued, did not own any property of the relevant class at year end and is therefore governed by the provisions of subsection 20(16):

20(16) Notwithstanding paragraphs 18(l)(a), (b) and (h), where at the end of a taxation year,

(a) the aggregate of all amounts determined under subparagraphs 13(21)(f)(i) to (ii.l) in respect of depreciable property of a particular prescribed class of a taxpayer exceeds the aggregate of all amounts determined under subparagraphs 13(21)(f)(iii) to (viii) in respect of depreciable property of that class of the taxpayer, and

(b) the taxpayer no longer owns any property of that class, in computing the taxpayer’s income for the year

(c) there shall be deducted the amount of the excess determined under paragraph (a), and

(d) no amount shall be deducted for the year under paragraph (l)(a) in respect of property of that class,

and the amount of the excess determined under paragraph (a) shall be deemed to have been deducted under paragraph (l)(a) in computing the taxpayer’s income for the year from a business or property.

The argument is ingenious but the flaw is obvious. If the effect of subsection 1102(1) is that the appellant did not own any property of the relevant class as of December 31, it equally did not own it on December 28. Assuming without deciding that the effect of paragraph 20(16)(b), supra, is, as the appellant argues, to remove any requirement that there be a disposition in order to trigger a terminal loss, [4] the text makes it abundantly plain that the taxpayer must, at some previous time, have owned property of the relevant class; no other meaning can be attributed to the use by Parliament of the words "no longer owns". Indeed, if it were possible to claim a terminal loss in respect of property which one had never owned it is difficult to see why anyone should ever have to pay any taxes at all.

For all the foregoing reasons, I would dismiss the appeal with costs.

Appeal dismissed.