The Queen v. Canada Southern Railway Co., 86 DTC 6097, [1986] 1 CTC 284 (FCA)

Ryan, J.:—This is an appeal by the Crown from a judgment of the Trial Division allowing an appeal by the respondent, The Canada Southern Railway Company (“Canada Southern”) from assessments made by the Minister of National Revenue (“the Minister”) under the Income Tax Act (“the Act”) with respect to Canada Southern's 1972 and 1973 taxation years.

During those years Canada Southern, a corporation resident in Canada, credited to The Penn Central Transportation Company (“Penn Central”), a non-resident person, amounts on account of dividends. The position taken by the Minister, in making the assessments, was that Penn Central, as a non-resident person, was liable under subsection 212(2) of the Act to pay an income tax on those amounts, ’and that Canada Southern was under a duty, by virtue of subsection 215(1) of the Act, to deduct or withhold the amounts of tax and to remit them to the Receiver General of Canada on behalf of Penn Central. Subsections 212(2) and 215(1) fall within Part XIII of the Act which is headed: “Tax on Income From Canada of Non-Resident Persons”. The Minister assessed Canada Southern for the amounts it ought, in the Minister’s view, to have withheld and remitted, together with interest and penalties. Canada Southern appealed to the Trial Division.

Canada Southern submitted that Penn Central was not liable to pay income tax under subsection 212(2) of the Act because Penn Central carried on business in Canada during the taxation years in question, and the amounts credited to it could reasonably be attributed to that business; the amounts in question, it was submitted, were thus within the exemption provided by subsection 805(1) of the Income Tax Regulations. Regulation 805(1) provided:

805. (1) Where a non-resident person carries on business in Canada he shall be taxable under Part III [Part XIII] of the Act on all amounts otherwise taxable under that Part except those amounts that may reasonably be attributed to the business carried on by him in Canada.

As noted above, Canada Southern succeeded before the Trial Division. The issue in this appeal is whether the amounts credited as dividends by Canada Southern to Penn Central are exempt from non-resident income tax under Part XIII of the Act by virtue of the exemption provided by subsection 805(1) of the Income Tax Regulations.

It may be as well to quote subsection 212(2) and subsection 215(1) of the Act, the subsections on which the Minister relied.

Subsection 212(2) provides:

(2) Every non-resident person shall pay an income tax of 25% on every amount that a corporation resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account or in lieu of payment of, or in satisfaction of a taxable dividend (other than a capital gains dividend within the meaning assigned by subsection 131(1) or 133(7.1)) or a capital dividend.

Subsection 215(1) provides:

215. (1) When a person pays or credits or is deemed to have paid or credited an amount on which an income tax is payable under this Part, he shall, notwithstanding any agreement or any law to the contrary, deduct or withhold therefrom the amount of the tax and forthwith remit that amount to the Receiver General of Canada on behalf of the non-resident person on account of the tax and shall submit therewith a statement in prescribed form.

It is not in issue that the effective rate for the 1972 and 1973 taxation years was 15 per cent. The reason for this need not be examined.

Canada Southern owned railway property in Canada at all times material to this appeal. The trial judge describes the property in this way:

. .. a railway line running north of Lake Erie between the Detroit River and the Niagara River along with a number of branch lines in Canada and appurtenant facilities including most notably, connections with U.S. lines at or near Detroit, Niagara Falls and Buffalo, a railway tunnel under the Detroit River and a bridge across the Niagara River, . . .

I will refer to this property as the “‘railroad property".

The Michigan Central Railroad Company (“Michigan Central") operated the railroad property for some 21 years from 1882 to 1903 under an agreement with Canada Southern. In 1903, Canada Southern leased the railroad property to Michigan Central for a term of 999 years, effective January 1, 1904 (“the 1903 lease’’). A railroad lease is very different from a conventional lease. Under the 1903 lease the management of the railroad property was effectively transferred to Michigan Central: the business of the line became the business of Michigan Central. The rental was to be the amount of money necessary to insure that Canada Southern could declare and pay a dividend of $3 a share on its issued stock. There were 150,000 shares outstanding so that the annual rent was in effect $450,000. Michigan Central owned some of the Canada Southern shares; others were held by outsiders. Michigan Central was itself a subsidiary of The New York Central Railroad Company (“New York Central”). By 1930, New York Central owned about 99 per cent of Michigan Central stock outstanding.

Effective February 1, 1930, Michigan Central leased — more accurately subleased — the railroad property, along with other properties, to New York Central for a term of 99 years (“the 1930 lease"). Under the lease, Michigan Central also “leased" — again more accurately, I think, assigned

— to New York Central the Canada Southern shares owned by it; Michigan Central appears, however, to have remained the shareholder of record of these shares. New York Central agreed in the 1930 lease to pay Michigan Central each year a sum of money that would enable Michigan Central to pay to Canada Southern the rent owing under the 1903 lease. By 1930, Michigan Central had acquired 83,449 shares, 55.6 per cent, of the outstanding shares of Canada Southern stock.

Until 1959, Canada Southern declared and paid dividends in the amount of $450,000 per year to its shareholders. More than half of this amount was payable to New York Central because of the “rental" of the stock and dividends under the 1930 lease; such dividends were paid by cheque by Canada Southern to New York Central. The rental of $450,000 per year payable by Michigan Central to Canada Southern under the 1903 lease was in fact paid by cheque directly to Canada Southern by New York Central.

On June 26, 1959, New York Central, Michigan Central and Canada Southern entered into an agreement (“the waiver agreement”). By the agreement Canada Southern “waived” payment of part of the cash rental owed it by Michigan Central, and New York Central “waived” payment of the part of the cash dividends declared by Canada Southern payable to New York Central. From then on New York Central paid Canada Southern in cash an amount equal to the difference between the rent of the $450,000 payable by Michigan Central to Canada Southern and the dividends declared by Canada Southern and payable to New York Central; this difference would be an amount sufficient to enable Canada Southern to pay dividends declared in favour of and payable to outside shareholders. The waiver agreement provided that the agreement should be deemed to be in compliance with the 1903 lease. The agreement could be terminated on short notice. The waiver agreement is set out in a letter which New York Central wrote to Canada Southern and Michigan Central, a letter quoted by the learned trial judge in his reasons. I quote this passage from the letter (New York Central is “the Central” referred to in the letter):

Pursuant to the provisions of the Michigan Central Lease, the Central has paid to the Canada Southern as part of the rental under the Canada Southern Lease the amount of $450,000 annually (since 1910), being the amount equal to three per cent per annum upon the 150,000 shares of capital stock of the Canada Southern outstanding. From these payments of rent, the Canada Southern has declared and paid dividends on its stock, which (since 1910) have amounted to $1.50 per share semi-annually, or an aggregate of $450,000 annually, equal in other words to the amount of the annual rental payment. Such semi-annual dividends have in the past been made payable during the month following the month in which the semi-annual rental payment is made and it is understood that this practice is expected to continue in the future.

Of the total of 150,000 shares of Canada Southern stock outstanding, 89,163 shares are owned by the Michigan Central, and that company’s right, title and interest in and to such stock is held by the Central under the Michigan Central Lease. The Central has accordingly received the dividends declared and paid by the Canada Southern on such stock since the effective date of the Michigan Central Lease.

The result is that the Central is, in effect, paying rent to itself in respect of the portion of rent paid back as dividends the next month.

In order to eliminate such unnecessary circuity of payments and in order to reflect the true situation more accurately, we propose that, commencing with the rental payment of July 1, 1959, and at each semi-annual payment date thereafter, the Central shall pay, by means of a waiver of dividend as below set forth, that portion of the semi-annual rent expressed to be payable under the Canada Southern Lease as shall amount to the product of the number of shares of stock of the Canada Southern owned on the dividend record date by the Michigan Central and held by the Central under the Michigan Central Lease times the per share rate (but not in excess of $1.50) of any semi-annual dividend declared on Canada Southern stock and unpaid, it being understood that appropriate accounting adjustments will be made by the Central, the Michigan Central and the Canada Southern to reflect the transactions in the accounts on this basis effective as of January 1, 1959.

During the period when such portion of the rent is paid by waiver as aforesaid, the Central shall and does hereby waive its right to receive semi-annual dividends (up to $1.50 per share) which, in each semi-annual period, would otherwise be paid from such rent on the stock of the Canada Southern then owned by the Michigan Central and held by the Central under the Michigan Central Lease.

This arrangement shall be deemed to be in compliance with the provisions of the Canada Southern Lease with respect to the payment of rent thereunder and shall not constitute an amendment or modification of the terms, provisions and conditions of that lease in any way. The arrangement shall continue until terminated by any company party hereto giving to the other parties at least 30 days' written notice prior to the end of any such semi-annual period.

Please signify your concurrences in the foregoing by signing the enclosed copy of this letter in the space provided therefor and return such copy to us.

The trial judge states:

The Plaintiff and Michigan Central concurred. That arrangement was in effect in 1972 and 1973 and, it appears, was applied, in practice, to the shares owned by Penn Central as well as those leased from Michigan Central.

As I read the waiver agreement, the 1903 lease and the 1930 lease remained unaltered by it except as they might relate to the actual payment of sums that would become owing under them. And after the agreement, as before it, New York Central held the Canada Southern shares assigned to it by Michigan Central. I would note that as of 1968 New York Central acquired Canada Southern shares in its own right as well. The effect of the waiver agreement was that the obligation of New York Central to make payments to Michigan Central under the 1930 lease, the obligation of Michigan Central to pay rent to Canada Southern under the 1903 lease, and the obligation of Canada Southern to pay declared dividends to New York Central were all to be satisfied by payment by New York Central to Canada Southern of the sums calculated in the manner specified in the waiver agreement. The purpose of the waiver agreement was to eliminate . unnecessary circuity of payments . . .” and “.. . to reflect the true situation more accurately . . .”.

Mr. Norman Hull testified at the trial. He had been an assistant comptroller and vice-president of Penn Central. There was also extensive documentary evidence. With respect to the effect of the evidence, the trial judge said;

The evidence is that neither Michigan Central nor New York Central would have had any interest in acquiring the Plaintiffs shares if they had not been renting its system, they acquired shares in the market when the price was such that the reduction in outflow of cash by way of dividends advantageously offset the cost of the purchase money. The primary motivation was reduction of payments to third parties. A secondary motivation was the desire eventually to eliminate all third party interests and to make the Plaintiff a wholly owned subsidiary as, in effect, Michigan Central was. The trend to consolidation of ownership into large corporate organizations, as well as the consolidation of operations, through the medium of long term leases, had been a characteristic of the railroad industry in the northeastern United States for about a century and applied in Canada to American operated systems.

The trial judge's conclusions, as stated in the above quotation, are supported by the evidence, particularly that of Mr. Hull. The trial judge concluded his reasons in these words:

It was reasonable for Penn Central to regard the dividends credited to it as de facto payment to itself of rent it was obliged to pay to carry on its railway business in Canada. It follows that they were amounts that may reasonably be attributed to the business carried on by Penn Central in Canada and were amounts taxable under Part I, rather than Part XIII of the Act.

In his judgment, he vacated the assessments in issue and awarded costs. This is the judgment under appeal.

Before moving to the legal issues, I would add this observation:

On February 1, 1968, New York Central merged with The Pennsylvania Railroad Company to form the Penn Central Transportation Company (“Penn Central”). After the merger, Penn Central was, as the trial judge states, in the position that New York Central had previously occupied for purposes relevant to this appeal. In June 1970, pursuant to United States bankruptcy laws, trustees were appointed to take possession of the assets of Penn Central. It would thus, I suppose, be more accurate to refer to the trustees of Penn Central rather than to Penn Central itself when describing events that happened after the appointment of the trustees, but for present purposes nothing turns on this and it is simpler to refer to “Penn Central”.

Counsel for the appellant submitted that the trial judge erred in holding that the amounts credited by way of dividends by Canada Southern to Penn Central could reasonably be attributed to the business carried on in Canada by Penn Central. Counsel also submitted that the trial judge erred in finding, as counsel submitted he had found, that Penn Central was not taxable under Part XIII of the Act, but was taxable under Part I.

Counsel for the respondent submitted that the trial judge had not erred in holding that the dividends could reasonably be attributed to the business carried on in Canada by Penn Central.

The meaning of the words in issue in this appeal, the words in regulation 805(1) “.. . except those amounts that may reasonably be attributed to the business carried on by him in Canada’’, is not, to my mind, so clear as not to require interpretation. The words almost suggest the question: “reasonably attributed” in what sense?

Counsel for the Crown submitted that the answer to this question could best be sought by having regard to the purpose of the exemption provided by Regulation 805(1) as revealed by its legislative history. Counsel submitted that the purpose of Regulation 805(1) is to avoid double taxation or at least to avoid the potential of double taxation. She argued that the amounts made subject to taxation by Part XIII of the Act are, generally speaking, amounts which have their source in property, not in business; they are, therefore, not amounts that would be rendered taxable under Part I by operation of subsection 2(3) of the Act; non-residents are made taxable by subsection 2(3) if they earn income in Canada from being employed in Canada or from carrying on business in Canada; they are not, however, made taxable by the subsection on income from property. It is conceivable, however, that an amount falling within Part XIII, interest or rent, for example, might have its source in business carried on in Canada by a non-resident; in such a case the non-resident would be subject to the possibility of being taxed under both Part I and Part XIII were it not for Regulation 805(1). It is avoidance of this possibility that is the purpose of Regulation 805(1).

Counsel argued that the dividends credited by Canada Southern to Penn Central had their source in property; their source was the Canada Southern shares owned by Penn Central or held by it under assignment, not the railway business carried on by Penn Central in Canada. Not having their source in the business being carried on in Canada, the dividends could not reasonably be attributed to it, however closely they might be associated with it.

Counsel for Canada Southern, on the other hand, submitted in effect that the meaning of the words used in Regulation 805(1) really created little difficulty. He submitted that the test of whether the dividends were made exempt by Regulation 805(1) is simply this: could they reasonably be attributed to the railway business that was unquestionably being carried on by Penn Central in Canada? The trial judge found that they could be and were. There is abundant evidence to support his finding. That really is the end of the matter. the critical issue is not whether, as a matter of law, the source of the dividends was “business” or “property”, but whether, as a matter of fact, the dividends could reasonably be attributed to the business.

Counsel for the Crown relied to a considerable extent on the legislative history of pertinent sections of the Act and of the Regulations in support of her submission that the purpose of Regulation 805(1) is to avoid double taxation.

In the Income Tax Act, R.S.C. 1952, c. 148 (“the 1952 Act”), subsections 2(1) and (2) provided:

2. (1) An income tax shall be paid as hereinafter required upon the taxable income for each taxation year of every person resident in Canada at any time in the year.

(2) Where a person who is not taxable under subsection (1) for a taxation year

(a) was employed in Canada at any time in the year, or

(b) carried on business in Canada at any time in the year,

an income tax shall be paid as hereinafter required upon his taxable income earned in Canada for the year determined in accordance with Division D.

Subsection (2) is now numbered subsection (3): it is worded somewhat differently, but the difference is not significant for present purposes.

Division D, as it appeared in the 1952 Act, was headed: ‘‘Taxable Income earned in Canada by Non-Residents”. It consisted of one section, section

31. Subsection 31(1) read:

31. (1) For the purposes of this Act, a non-resident person's taxable income earned in Canada for a taxation year is

(a) the part of his income for the year that may reasonably be attributed to the duties performed by him in Canada or the business carried on by him in Canada,

minus

(b) the aggregate of such of the deductions from income permitted for determining taxable income as may reasonably be considered wholly applicable and of such part of any other of the said deductions as may reasonably be considered applicable.

Part III of the 1952 Act was headed: “Tax on Income from Canada of Non-Resident Persons”, the same heading as now applies to Part XIII. Subsection 106(1) provided that “Every non-resident person shall pay an income tax of 15% on every amount that a person resident in Canada pays or credits, . . . on account or in lieu of payment of, or in satisfaction of,” certain items, including among others, dividends, interest, and rents and royalties, subject, however, to specified limitations.

Subsection 805(1) of the Regulations was first enacted by SOR/54-682, effective January 12, 1955. It provided:

805. (1) Where a non-resident person, other than a registered non-resident insurance company, carries on business in Canada he shall be taxable under Part III of the Act on all amounts otherwise taxable under that Part except such amounts as are included in computing his income for the purpose of Part I of the Act.

Under this regulation it is clear that an amount that would otherwise fall within Part III as being, for example, a dividend or an interest payment would be exempt from taxation under Part III if it were included in computing his income for the purpose of Part I. Double taxation, at least to this extent, would have been avoided. At this time, a non-resident taxpayer was subject to tax under either Part I or Part Ill, but not both. I would note, however, that a non-resident might nonetheless, by virtue of deductions or exemptions, escape tax entirely.

The wording of regulation 805(1) was changed, effective in 1957, by SOR/57-4. As amended, the regulation read:

(1) Where a non-resident person, other than a registered non-resident insurance company, carries on business in Canada he shall be taxable under Part III of the Act on all amounts otherwise taxable under that Part except that part of his income that may reasonably be attributed to the business carried on by him in Canada.

A consequence of the change in wording was that the exemption provided by Regulation 805(1), so far as it related to carrying on business in Canada, was expressed in exactly the same words as those used in paragraph 31 (1)(a) of the Act. I do not think that a substantive change was intended by this change in the wording of the regulation. Rather, it appears to me that the intent was to make the purpose of avoiding double taxation even more clear by using the very wording of paragraph 31(1)(a) in the exemption provided by Regulation 805(1).

Section 31 of the Act was amended in 1960 by “An Act to amend the Income Tax Act"', S.C. 1960, c. 43. Subsection 6(1) of the amending Act repealed paragraph 31(1)(a) and substituted:

(a) his income for the year from all duties performed by him in Canada and all businesses carried on by him in Canada,

It may be worthy to note once again that, before the 1960 amendment, paragraph 31 (1)(a) of the Act, as it related to business carried on in Canada, provided that a non-resident's taxable income earned in Canada for a taxation year . . is the part of his income for the year that may reasonably be attributed . . . to the business carried on by him in Canada . . .". The 1960 amendment replaced these words by the substituted paragraph 31 (1 )(a), but the words were left unchanged in the regulation. The very problem central to this appeal lurks in the continuing use of these words in the regulation: can an amount credited to a non-resident that has its source in property be considered to be an amount that may reasonably be attributed to the business which the non-resident carried on in Canada?

Regulation 805(1) was revoked and replaced in 1969 by SOR/69-631. The substituted regulation was the one in effect during the taxation years in question in this appeal. I have quoted it earlier in these reasons. I will, however, repeat it here for convenience of reference:

805. (1) Where a non-resident person carries on business in Canada he shall be taxable under Part III (Part XIII) of the Act on all amounts otherwise taxable under that Part except those amounts that may reasonably be attributed to the business carried on by him in Canada.

The amounts which are exempted from the amounts that otherwise would be taxable under Part III are . . those amounts that may reasonably be attributed to the business carried on by him in Canada” whereas, before the amendment, what was exempted was . . that part of his income that may reasonably be attributed to the business carried on by him in Canada".

This was the situation when what is sometimes referred to as “the new Income Tax Act” came into force in 1971, the Act which appears as Chapter 63, S.C. 1970-71-72. The new Act substituted a newly worded Division D for the former Division D. The relevant provisions of the new Division D appear in section 115 of the Act. I will quote subparagraphs 15(1 )(a)(i) and (ii).

115. (1) For the purposes of this Act, a non-resident person's taxable income earned in Canada for a taxation year is the amount of his income for the year that would be determined under section 3 if

(a) he had no income other than

(i) incomes from the duties of offices and employments performed by him in Canada,

(ii) incomes from businesses carried on by him in Canada,

minus the aggregate of such of the deductions from income permitted for the purpose of computing taxable income as may reasonably be considered wholly applicable and of such part of any other of the said deductions as may reasonably be considered applicable.

My examination of the legislative history of Regulation 805(1) leads me to the conclusion that there has been and remains a close link between the exemption it provides in respect of amounts taxable to non-residents under Part XIII of the Act and the tax imposed on non-residents in respect of income they receive from businesses they carry on in Canada. From 1955 to 1957, the exemption in Regulation 805(1) applied only to amounts, received by or credited to non-residents, which would be included in their income for the purpose of computing their taxable income under Part I. From 1957 to 1960, the exemption in Regulation 805(1) was defined in the same words as those used in paragraph 31(1)(a) of the Act to impose a Part I tax on non-residents receiving income from Canada which could reasonably be attributed to business carried on by them in Canada. The 1960 amendment to paragraph 31(1)(a), which made taxable income received by nonresidents from business carried on by them in Canada, did not in my opinion change in substance the law as it was before the amendment: if anything, it simply made quite clear that to be taxable by virtue of subsection 2(3) of the Act income would have to be income from a business carried on by a non-resident in Canada; income properly classifiable as income from property would thus not be caught by subsection 2(3). I am also of the view that the words used in Regulation 805(1) between 1957 and 1960, "that part of his income that may reasonably be attributed to the business carried on by him in Canada , were intended to exempt only income from the business carried on by him in Canada, and not income from property even if it could be attributed to the business in a broad sense.

It follows that the 1960 amendment to paragraph 31(1)(a) of the Act did not create a gap between the amounts that would be exempted by Regulation 805(1) and the amounts that would be included in income for purposes of paragraph 31 (1)(a). The avoidance of double taxation remained the intent throughout, and it was never the intention to create a gap in which there would be no taxation at all. The 1960 amendment was not, as I read it, designed to exclude from paragraph 31(1)(a) income which, before the amendment, would have been caught by the paragraph.

Nor, in my view, did the 1969 amendment to Regulation 805(1) have the effect of broadening the scope of the exemption provided by the regulation. The substitution of the words "except that part of his income results in a wording of the Regulation 805(1) exemption that fits more comfortably with the wording of Part XIII; Part XIII taxes specified “amounts”; section 115 has the effect of taxing “income”.

The legislative history persuades me that, for purposes of Regulation 805(1), the only amounts, otherwise taxable under Part XIII, that can be said to be reasonably attributable to the business carried on in Canada by a non-resident person are amounts which can properly be classified as income from that business. The words in issue, the words used in Regulation 805(1), may be open to either of the views put forward by counsel, but the history of the regulations persuades me that this is the reading which is in accordance with the legislative purpose of the exemption.

Even apart, however, from the legislative history, subsection 2(3), section 115, and Part XIII of the Act, and Regulation 805(1), when considered together, would appear to me to indicate an intention to exempt from taxation amounts that otherwise would fall within Part XIII if they would be subject to taxation under Part I by virtue of falling within subparagraph 1Î5(1 )(a)(ii) of the Act. It is by virtue of subsection 2(3) and Part XIII of the ct that non-residents are made subject to Canadian income tax. It makes good sense to recognize that the amounts specified in Part XIII may occasionally attract tax under Part I, as they would if they were properly classifiable as income from business, and in such cases to exempt them from taxation under Part XIII.

My conclusion that, to be exempt by virtue of Regulation 805(1), an amount must be attributed to the business carried on in Canada in the sense of being an amount earned from that business does not, however, in itself resolve this appeal. A difficulty remains. Income which, at first sight, may appear to be income from property may, on closer analysis, turn out to be income from business. Rental income is an obvious example. Rents from property are generally considered to be income from property, but not if the owner so manages the renting as to make a business of it. For an analysis of the problems involved see Wertman v. M.N.R., [1965] Ex.C.R. 629; [1964] C.T.C. 252, particularly at 644-46 (C.T.C. 263-66).

Could then the dividends in question be regarded as income from Penn Central's railroad business carried on in Canada?

It may be useful to keep in mind that the business carried on in Canada by Penn Central was railway transportation. It is true that Michigan Central was to all intents and purposes a wholly-owned subsidiary of Penn Central and that, by virtue of the shares of Canada Southern owned by Penn Central in its own right or under assignment, Penn Central controlled Canada Southern. It remains, however, that each of these corporations was a separate legal person. It remains, too, that Penn Central had a sublease, a contract, with Michigan Central and that Michigan Central had a lease with Canada Southern; each year sums became owing to Michigan Central by Penn Central and by Michigan Central to Canada Southern. The railway business which Penn Central carried on in Canada, using the railroad property owned by Canada Southern, was the business of Penn Central, not of Michigan Central or of Canada Southern. Canada Southern did not carry on business at all during 1972 and 1973; it received what income it did receive from its property, including the railroad property it rented to Michigan Central. All three corporations were parties to the waiver agreement, but this agreement was essentially designed as a means of settling the accounts periodically accruing in respect of rentals and dividends. The dividendslzredited by Canada Southern to Penn Central were dividends, and the rentals and sums which became owing periodically by Penn Central to Michigan Central and by Michigan Central to Canada Southern were sums owed in respect of “rentals”.

In my opinion, for purposes of the Income Tax Act, the source of the dividends was the Canada Southern shares. The moneys used by Canada Southern to pay the dividends were funds available to the directors of Canada Southern for dividend declaration. These funds were the proceeds of the rental of the railroad property, property owned by Canada Southern, and, I gather, from other investments owned by Canada Southern. It is true that, had it not been for the rental of the railroad property, Canada Southern might not have been able to declare and pay dividends, and that the rentals were so calculated as to ensure that, so far as possible, a $3 dividend would be paid each year on each share outstanding. It is also clear that Penn Central was in effective control of Canada Southern. It remains, however, that the source of the dividends was the shares and that the shares were property: see Canada Safeway Limited v. M.N.R., [1957] S.C.R. 717; [1957] C.T.C. 335, particularly per Mr. Justice Rand at 725-26 (C.T.C. 344-46).

On the facts of the present case, it could not be seriously argued that Penn Central was in the business of dealing in stock, and no such submission was made. There may, however, be another possibility. There is some authority for the proposition that income from property that is being used in a business may, in appropriate circumstances, be income from the business itself; an example might possibly be income in the form of interest from a bank account, the bank account being used in the day-to-day operation of the business. This proposition was applied in Liverpool and London and Globe Insurance Company v. Bennett, [1913] A.C. 610. Its scope and limitations were, however, carefully examined in Bank Line Ltd. v. C.I.R. 49 T.C. 307. In Bank Line, a company engaged in the trade of owning and operating ships established a ship replacement fund. The company invested sums not required for immediate use in government and short-term securities so as to have funds available to meet requirements for replacement of its fleet. The company sought to treat the interest it received from these investments as income from its business or trade, but failed in that attempt. The Lord President said at 316-17:

. . . Before us it was common ground between the parties to the appeal that the test to be applied is the test which was formulated by Buckley L.J. in the insurance company cases reported as Liverpool and London and Globe Insurance Co. v. Bennett 6 T.C. 327. That test, under reference to the opinion of Buckley L.J., at page 374, is whether the interest represented profits of the business as fruit derived from a fund employed and risked in the business. The business, and indeed the only business, of this Company was the business of owning and operating ships, and the question accordingly comes to be whether their ship replacement fund can properly be said to have been “employed and risked” in that business in each of the accounting periods.

Also in Bank Line, Lord Avonside said at 333:

As has already been said, it is found as a fact that the Appellants carry on no activity other than that of owning and operating ships. It is plain, in my opinion, that this fact does not in any way lead to the conclusion that the income from capital funds owned by the Appellants must be looked on as trading receipts. Income becomes a trading receipt when it arises from capital actively employed and at risk in the business, capital which is employed in the business because it is required for its support or, perhaps, to attract customers looking to the credit of the business. Trading income is “the fruit” of the capital employed in the business in a present and active sense. The classic example is the insurance company. Apart from special contracts, the capital of such a company is at immediate risk when a policy is issued and remains at constant risk during the continuance of that policy.

I would observe that the learned trial judge in the present case did say, of the dividends credited to Penn Central by Canada Southern, that they . were amounts taxable under Part I, rather than Part XIII of the Act.” The dividends, however, would be taxable to Penn Central under Part I, only if they fell within subparagraph 115(1)(a)(ii) of the Act, only if they were income from the business carried on by Penn Central in Canada. I have no doubt that, if the dividends did constitute such income, they would be exempted from Part XIII by Regulation 805(1).

I did not, however, understand counsel for the respondent to argue that the dividends were income from the business carried on by Penn Central in Canada and thus subject to tax under Part I. Possibly this was because, on his submission, the dividends, even if income from property, were, as the learned trial judge found, reasonably attributable to the business carried on by Penn Central in Canada. Counsel suggested in oral argument that, having found that the dividends were reasonably attributable to the Canadian business, the trial judge merely meant to indicate that the dividends would be taxable under Part I if they were taxable at all. It remains, however, that the trial judge did say that the dividends were taxable under Part I.

The critical question in determining whether the dividends from the Canada Southern shares may be considered to be income from Penn Central's business carried on in Canada is not whether the dividends were used in the business. The question is rather whether the shares themselves constituted a fund “employed and risked” in the business. I simply do not find it possible on the facts to hold that they were. On this point I have found helpful the judgments of this Court in The Queen v. Marsh & McLennan, Limited, [1984] 1 F.C. 609; [1983] C.T.C. 231 and The Queen v. Ensite Limited, [1983] C.T.C. 296; 83 D.T.C. 5315, although in both cases the essential issue was whether the income in question was income from property used in the business rather than whether it was income from the business.

For all of these reasons, I would allow the appeal with costs. I would set aside the judgment of the Trial Division and substitute a judgment dismiss- . ing with costs the appeal to the Trial Division.

Appeal allowed.