The Queen v. Arnos, 82 DTC 6165, [1982] CTC 186 (FCA)

Thurlow, CJ:—The issue in this appeal is whether the respondents, who are non-resident trustees of a trust for non-resident beneficiaries, are liable for income tax in the 1978 taxation year in respect of an amount of $193,500.84 as recaptured capital cost allowance arising on the disposition of revenue producing real property situate at Sarnia, Ontario.

The property had been vested in the Canada Trust Company, a resident corporation, upon trust for the respondents between 1963 and 1978. During this period Canada Trust Company as trustee claimed and was allowed the $193,500.84 in capital cost allowances in question. In 1978, Canada Trust Company transferred the property to the respondents who thereupon sold it. The respondents did not elect under subsection 216(1) to be taxed under Part I of the Income Tax Act for the 1978 or any other taxation year.

It is not disputed that the effect of subsection 216(5), which was first enacted as subsection 110(5) in 1954, would render the respondents liable for tax on the amount in question in the year of disposition of the property, whether or not an election under subsection 216(1) was made. But as the trustees are residents of the United States the question arises as to whether they are protected by Article XIIIA of the Canada-United States Tax Convention.

This Article became effective in 1951, that is to say prior to the enactment of subsection 216(5) of the Income Tax Act. The Article provides:

1. A resident or corporation organized under the laws of Canada deriving from sources within the United States of America rentals from real property may elect for any taxable year to be subject to the tax imposed by the United States of America on a net basis as if such resident or corporation were engaged in trade or business within the United States of America through a permanent establishment therein during such taxable year.

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 favourable than that accorded under Section 99 The Income Tax Act, as in effect on the date on which this Article goes into effect.

The learned trial judge, following the reasoning of Jackett, CJ in this Court in MNR v Bessemer Trust Company, [1972] FC 1398; [1973] CTC 12; 73 DTC 5045, held that the amount in question had the character of rentals within the meaning of the Convention and that in the absence of an election by the respondents to pay tax under Part I, the effect of Article XIIIA was to protect them from liability for tax on the amount. After referring to the fact that in the Bessemer case the non-resident trustees had elected to be taxed under Part I for the year in question, he said:

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 reasoning of Collier, J in the Trial Division and that of Jackett, CJ, with whom the other members of the Court of Appeal agreed, was that recaptures of capital cost allowances are of the same nature as the revenue from the property in respect of which the capital cost allowance has been deducted, that recapture is in substance a method of bringing into the computation of income for a later year, income received in earlier years and not taxed in them, that in the case of non-resident taxpayers the only tax imposed by the Act in respect of rentals from real property is a tax on gross rentals and the right to the deduction of capital cost allowance and other expenses arises only when the taxpayer elects under subsection 216(1) to be taxed for a taxation year under Part I and that the subjecting of a US resident taxpayer by the enactment of subsection 216(5) to tax on recaptured capital cost allowance, whether he has elected or not to be taxed under Part I, is less favourable tax treatment than accorded under section 99 of the Income Tax Act as in effect on the date when Article XIIIA went into effect.

Counsel for the appellant conceded that the reasoning of the Bessemer case, if sound, leads to the conclusion reached by the learned Trial Judge. He therefore invited the Court to decline to follow it. His principal submission, as I understood his argument, was that the amount subjected to tax as recaptured capital cost allowance is not rentals but proceeds of disposition.

Assuming that this is correct, it would follow that what is required to be brought into the computation of income is something that is not income but capital proceeds. As rentals are the only income produced by the property, it seems to me that to require that on disposition of the property a portion of the proceeds of disposition representing the amount or part of the amount formerly allowed as a deduction in computing rental income be brought into income and subjected to tax, is part of the tax treatment of the rental income within the meaning of Article XI11 A(2) of the Convention and that such treatment is less favourable than that accorded under Section 99 (later section 110 and now section 216) of the Income Tax Act as in effect when Article XIIIA went into effect. Rather than concluding that the reasoning of the Bessemer case is wrong, I am of the view that it is sound.

I would dismiss the appeal with costs.