Location Gaétan Lévesque Inc. v. MNR, 91 DTC 1380, [1991] 2 CTC 2795 (TCC)

Lamarre Proulx, T.C.J.:—The appellant instituted an appeal in respect of the reassessments by the respondent Minister of National Revenue for the 1984 and 1985 taxation years.

The issue in this case is whether, during the 1984 and 1985 taxation years, the appellant acquired property within the meaning of paragraph 13(21)(b) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), and is thereby permitted to deduct the portion of the capital cost allowed by regulation, under paragraph 20(1)(a) of the Act, and interest on the cost of acquisition, under paragraph 20(1)(c) of the Act, if the property was rented, to deduct the amounts paid for rental in computing his income.

The appellant argued that the property in question was acquired, and that for the purposes of paragraph 13(21)(b) of the Act, a person may acquire property without being the owner. The respondent argued that the property in question was rented and was not acquired within the meaning of that para- graph.

The facts are as follows:

During the taxation years ending on October 31, 1984 and 1985, the appellant operated a business in forestry and heavy forestry machinery rental. During those years, the appellant obtained various pieces of heavy machinery for the purposes of its business.

These pieces were obtained under lease agreements with "Le Crédit-Bail Banque nationale Inc.” ("National Bank Leasing Inc.”). The agreements entitled [Translation] "leasing contracts", which were produced in evidence, are for a term of approximately five years. Rental is payable monthly, and five months before the expiry of the contract the lessee may exercise an option to purchase for the price of the remaining rental, on sixty (60) days' prior notice. Each lease agreement provides that the appellant is responsible for the maintenance and good condition of the pieces of machinery, in terms of defects, damage, repairs and losses. The possession and use of the pieces are subject to the terms and conditions of the lease agreement. In short, these were normal lease agreements. (See Traité de droit civil, Le Louage des choses Pierre- Gabriel Jobin, Les Éditions Yvon Blais Inc, page 69.)

The pieces of equipment, the financing company and the date of the leasing contract are described in paragraph 9(b) of the reply to the notice of appeal as follows:

Exhibit A-1, entitled [Translation] "Leased Equipment Purchase Order", is an agreement between the supplier, “Hewitt Équipement Ltée”, and the purchaser, “Le Crédit-Bail Banque nationale Inc.”. The lessee, "Location Gaétan Lévesque Inc.", is a party to this agreement. The following words clearly appear in the space for the lessee's signature [Translation]: "signature of lessee approving this order, acknowledging that the lessee has selected the items and asking the purchaser to purchase the items”. Attached to this leased equipment purchase order is a Leasing Contract agreement [sic] dated the same date as the first agreement, between the lessee, "Location Gaétan Lévesque Inc.”, and the lessor, “Le Crédit-Bail Banque nationale Inc.”. This agreement shows the total amount of the rental payments, the amount of insurance required to be paid by the lessee, the term of the contract and the option to purchase.

There is also a specific clause on the face of the leasing contract entitled [Translation] "capital cost allowance”, stipulating that the lessor intended to take the capital cost allowance.

As noted, the appellant obtained the necessary pieces of equipment to meet the needs of its business. When the appellant determined that it needed a certain piece of equipment, it looked for one and identified the piece with a supplier. In order to obtain the equipment, the appellant asked several financial institutions for tenders as to the financing of the equipment. The appellant chose “Le Crédit-Bail Banque nationale Inc." because it offered the best financing terms.

With respect to the various methods of financing pieces of equipment, I would like to cite the remarks of the respondent's witness, the senior manager of “Le Crédit-Bail Banque nationale Inc." for eastern Quebec, taken from the stenographic notes.

[Translation]

A. This purchase order was signed by us at “Hewitt Équipement" at the request of "Location Gaétan Lévesque Inc.”.

Q. Fine. And so, this purchase order, I see that it was accepted by the supplier?

A. Yes.

Q. For you, this contract is . . . what kind of contract?

A. For us, it is a purchase contract.

Q. Do you negotiate other contracts besides leasing contracts?

A. Yes. We do conditional sale contracts and contracts of pledge.

Q. Why would a customer choose a leasing contract over a conditional sale contract, could you explain this to me?

A. Well, for various reasons, the first one being to protect operating funds, given that there is no outlay of funds.

Q. Yes.

A. That is, instead of making a "down payment" [In English in the original version.] of 20% at the time of purchase, plus tax . . .

Q. À "down payment", you mean a "montant de dépôt"

A. Yes, a "montant de dépôt" and paying the taxes immediately; the taxes are deferred and the customer does not have to make a down payment at the time of purchase, that is the first thing.

The second thing is that the customer gets a rate of interest which is reflected in the rental paid, which is lower, given that we are taking the depreciation, so we have tax advantages.

Q. When you say you take the depreciation, that is this clause here?

A. That's right.

Q. Capital cost allowance?

A. That's right.

Q. If you, could you tell us whether you checked for each of the contracts, whether “Le Crédit-Bail Banque nationale" took the capital cost allowance?

A. Yes, I checked, and we took the capital cost allowance.

Q. In each of the contracts there is a purchase option?

A. Yes.

Q. The purchase option clause, does it have to be exercised, at what point does it have to be exercised?

A. At the end of the lease.

Q. Is it at the end of the lease or before the end of the lease?

A. That is in the sixtieth (60th) month; the lease is for sixty-five (65) months, if we take this case, and the purchase option has to be exercised in the sixtieth (60th) month.

Q. That means, before the end of the lease?

A. Before the end of the lease, yes.

Q. Would it be possible to exercise the option in the sixty-second (62nd) month, for example?

A. No, that’s impossible.

Q. It must be exercised in the sixtieth month?

A. The sixtieth month.

Q. Is there any latitude?

A. The latitude for exercising the option to purchase may be about thirty (30) days.

Q. Is it possible for "Location Gaétan Lévesque" to purchase the item before the date provided for the option to be exercised?

A. Normally, no.

Q. Is it possible to negotiate it?

A. It might always be possible, but not very probable.

Q. And if it happened, would the price of the option be the same?

A. No, the price of the option would not be the same.

Q. Is it clear that the capital cost allowance is taken by the lessor?

A. Yes, and it is indicated on our contracts.

Q. But is it more than indicated, or in what manner, when you do this, how is a leasing negotiated? The person goes to see you? How do you do it?

A. The person comes to see us or is already an existing customer or we go to see them. At that point the negotiating is done, if there is an item which could be acquired.

Q. But is it explained to the customer that you are going to take the capital cost allowance?

A. Yes, because, since we provide conventional term financing, it isn't fiscal financing, if you like, the customer has to make a choice as to the type of financing it wants. And so the financing methods have to be explained.

Q. And so what are the various financing methods that you have?

A. We offer financing in the form of a conditional sale contract, a commercial pledge and in the form of a lease.

Q. But does a conditional sale require cash?

A. It requires a down payment, which is generally about 20%, plus taxes.

Q. And a commercial pledge?

A. A commercial pledge does not necessarily require a down payment.

Q. What is the difference with a leasing?

A. The difference is fiscal. The rate of interest is higher on a commercial pledge, since I don't get the fiscal advantages of my lease, because I have no lease. And so I can’t return part of my advantage in the form of a rate reduction.

Q. You are not the owner of the item?

A. No, I am not the owner.

Thus, according to this witness, a leasing is a less expensive kind of financing than a conditional sale or a commercial pledge, because the cost of it depends on the capital depreciation taken by the owner, the financial institution. In the case of a conditional sale or a commercial pledge, the purchaser would be considered by the financial institution to be the owner.

Counsel for the appellant argued that it is not necessary to have legal title as owner of the property in question in order to be entitled to the capital cost depreciation because paragraph 13(21)(b) of the Act only requires that the property be acquired by the taxpayer, but not that it be owned by the taxpayer. He maintained that, having regard to the existing case law, with the exception of the decision of this Court in Fortin & Moreau v. M.N.R., [1990] 1 C.T.C. 2583; 90 D.T.C. 1450 at 2599 (D.T.C. 1461), the appellant had acquired the property in question within the meaning of paragraph 13(21)(b). I am of the view that, on the contrary, this Court has followed the trend in the case law.

Paragraph 13(21)(b) of the Act reads as follows:

“depreciable property" of a taxpayer as of any time in a taxation year means property acquired by the taxpayer in respect of which he has been allowed, or, if

e owned the property at the end of the year, would be entitled to, a deduction under regulations made under paragraph 20(1)(a) in computing income for that year or a previous taxation year; les «biens amortissables» d'un contribuable à toute date de l’année d'imposition sont les biens acquis par le contribuable ou pour lesquels le contribuable aurait le droit, s’il était propriétaire de ces biens à la fin de l’année, d'effectuer une déduction, en vertu des règlements établis en application de l'alinéa 20(1)(a), lors du calcul de son revenu pour cette année ou pour une année d'imposition antérieure;

On this point, I quote verbatim from the comments of counsel for the appellant at page 22 of his written argument;

[Translation]

On the other hand, in respect of capital cost allowance, the Honourable Chief Judge concluded that the taxpayer is not entitled to capital cost allowance, for the reasons set out at page 1460 [see footnote 4] :

With regard to the deduction claimed by the appellant as a capital cost allowance, the Court must determine what constitutes depreciable property within the meaning of paragraph 13(21)(b) (supra). Prior to the 1979 taxation year, the Act referred essentially to property acquired by a taxpayer during a fiscal year, but under chapter 48, section 5(5) of the 1981 Statutes of Canada, an amendment was made to the paragraph applicable to property acquired since December 11, 1979, requiring the taxpayer, from that date, to own such property, at the end of the year, that is, his taxation year.

In view of this amendment, which adds a special dimension to the section, although in terms of the cases to which I referred earlier it appears from the evidence that the appellant acquired the trucks and bins, it did not own them at the end of its taxation year, according to the provisions of the Code.

The Honourable Chief Judge therefore refused to permit the taxpayer to take the capital cost allowance because, although the taxpayer had acquired the property, he did not own it, as required by the amendment to section 13(21)(b) of the Act, which defines depreciable property. With all due respect to the Honourable Chief Judge, the appellant submits that, as a result of that amendment, section 13(21)(b) does not require that the taxpayer own the property. This section of the Act reads as follows:

“depreciable property" of a taxpayer as of any time in a taxation year means property acquired by the taxpayer in respect of which he has been allowed, or, if he owned the property at the end of the year, would be entitled to, a deduction under regulations made under paragraph 20(1)(a) in computing income for that year or a previous taxation year; (emphasis is appellant's)

Section 13(21)(b) provides that depreciable property is property acquired by the taxpayer in respect of which he has been allowed . . . a deduction or, if he owned the property at the end of the year, he would be entitled to a deduction. As may be seen, this section in fact covers two situations and not just one, as the Honourable Chief Judge believed he understood it. It is clear that if, instead of the "or", it read “and”, the Honourable Chief Judge’s analysis would be correct, because then the requirement would be not only that property have been acquired but also that it be owned, which is not the case when the word "or" is used, since it indicates two different situations.

The appellant submits that it acquired the property which is the subject matter in this case, because the evidence presented to this Honourable Court, described under the heading “The Facts” herein, clearly indicates that, in accordance with the principles set out in the case law, it has all the attributes of ownership; possession, use, and the benefits and risks inherent in ownership; accordingly, it has met the requirements of the provisions of the Act and so is entitled thereunder to claim capital cost allowance and the interest paid in respect of the property so acquired.

I believe that the English version of paragraph 13(21)(b) is easier to understand than the French version. What this section means is that a taxpayer's depreciable property is property for which he or she has already claimed and received deductions, and in respect of deductions for the current year, it is property which the taxpayer owns at the end of the year. Ownership of the property is therefore essential if the taxpayer is to be entitled to take deductions in the current year.

Counsel for the appellant referred to Kirsch Construction Ltd. v. The Queen, [1988] 2 C.T.C. 338; 88 D.T.C. 6503, a decision of Strayer, J. of the Federal Court-Trial Division. At page 340 (D.T.C. 6504): “It has been held that property is 'acquired' for the purposes of capital cost allowance when title has either passed to the taxpayer or the taxpayer has obtained all the incidents of title such as possession, use or risk.”

Counsel for the appellant argued that the appellant, too, has possession, use or risk. However, we must look at what these words mean in the context from which they were taken, for which we must refer to Wardean Drilling Ltd. v. M.N.R., [1969] C.T.C. 265; [1969] 2 Ex. C.R. 166 and The Queen v. Henuset Bros. Ltd., [1977] C.T.C. 227; 77 D.T.C. 5169.

In Wardean Drilling Ltd., Mr. Justice Cattanach was of the view that while there was between the vendor and the purchaser an enforceablecontract of purchase and sale, the property had not been transferred, and that where it is claimed that property has been acquired, there must be a right to the property itself, and not merely a right in a contract the subject matter of which is the property. The learned judge added that property may be acquired even if title to the property is not transferred, as in the case of a conditional sale.

In my opinion the proper test as to when property is acquired must relate to the title to the property in question or to the normal incidents of title, either actual or constructive, such as possession, use or risk.

On the facts in the present appeal there is no question whatsoever that the contracts for the purchase and sale of the rig and substructure were completed prior to December 31, 1963. Accordingly there is no question that as at the end of the respondent's 1963 taxation year it had rights under these contracts. Such rights are "property" within the meaning of section 139(1)(a) of the Income Tax Act but Schedule B to the Income Tax Regulations does not include a class of property which is subject to capital cost allowance such as properties which are contractual rights under the contracts here in question. In order to fall within any of the specified classes in Schedule B there must be a right in the property itself rather than rights in a contract relating to the property which is the subject matter of the contract.

As I have indicated above, it is my opinion that a purchaser has acquired assets of a class in Schedule B when title has passed, assuming that the assets exist at that time, or when the purchaser has all the incidents of title, such as possession, use and risk, although legal title may remain in the vendor as security for the purchase price as is the commercial practice under conditional sales agreements. In my view the foregoing is the proper test to determine the acquisition of property described in Schedule B to the Income Tax Regulations.

[Emphasis added.]

I believe that the clear effect of Wardean is that, for the purposes of capital cost depreciation, the person claiming the cost must be the owner of the property, or at the very least have acquired it under a conditional sale, although Cattanach, J. did not have to decide this latter point.

In Henuset Bros., the learned judge Bastin decided that where there was a conditional sale the property had been acquired.

Although the appellant still says that it ultimately acquired the pieces of equipment of which it had the use by means of leasing financing, it might never have become the owner thereof because it had no obligation to become the owner.

[Translation]

In some agreements the customer has an option to purchase, but this is not a standard clause. Of course, the customer may become the owner of the thing at the end of the contract, but that is a mere possibility which, moreover, results in no real right before this final stage. And even when there is an option to purchase, it will be noted that the essence of leasing, in Quebec, does not imply that there is a transfer of ownership. This contract confers no real right on the customer but rather a mere jus ad rem. (Traité de droit civil, Le Louage des choses, Pierre-Gabriel Jobin, Les Éditions Yvon Blais Inc., page 71.)

In D. Dumais et Fils Inc. v. M.N.R., [1991] 1 C.T.C. 2650, in a context identical to what we find in this case, that is, leasing contracts with the same financial institution, Judge Garon of this Court made the following remarks at page 2657:

[Translation]

I have therefore concluded that the appellant is not entitled to deduct capital cost allowance on the two trucks and three trailers in the years at issue because it is not the owner of this property.

I would also quote his comments at page 2658:

[Translation]

Furthermore, from the point at which the appellant can use the property in question, it only has the rights of a lessee determined by the term of the leasing contract. It is therefore not the owner of that property, as we have seen; nor is it possible to say that it acquired that property even by giving a very broad meaning to the word “acquired”, a broad meaning accepted by the Court in Minister of National Revenue v. Wardean Drilling Limited, [1969] C.T.C. 265; [1969] 2 Ex. C.R. 166.

And again, quoting Judge Garon, at page 2658:

[Translation]

The situation might be different if the appellant had the rights of a buyer in the case of a conditional sale. The word “acquired” cannot be applied to the right of a taxpayer who leases property from another under a leasing contract.

The appellant argued that by refusing the deduction of capital cost allowance for these pieces of machinery, which were acquired under a lease agreement, the respondent is acting contrary to its own policy as set out in its interpretation bulletin, IT-233R. This interpretation bulletin provides that in some circumstances a leasing agreement may be considered to be a purchase contract. This argument was only briefly raised by counsel for the appellant, who did not review the various aspects of this bulletin to demonstrate that the appellant's legal situation was similar to one of the situations described in the bulletin. In any event, interpretation bulletins are used by the courts where the Act is ambiguous (/. Camille Harel v. M.N.R., [1977] C.T.C. 441; 77 D.T.C. 5438), which is not the case here. I am of the opinion that the cases cited above are clear as to the manner in which the meaning of the word “acquired” in paragraph 13(21)(b) of the Act is to be interpreted, and that rented property is not property acquired within the meaning of that paragraph. It is also clear, from the overall scheme of the Act, that it is the person who owns the property who may take the capital cost depreciation, since when the property is resold it is that person who will be accountable for the deductions taken for depreciation.

Counsel for the appellant referred at length to accounting practices. Knowledge of such practices may be useful in some cases, but there is no doubt that such practices cannot prevail over the law. The law, as interpreted by the experts and the courts, provides that the words "property acquired" must be taken to mean property in which the taxpayer has a right of ownership, or if not such a right, then all the attributesof a right of ownership, as in the case of a conditional sale. This is not the case here.

Accordingly, the appeal is dismissed.

Appeal dismissed.