Citation: 2006TCC248
Date: 20060531
Docket: 2003-2477(IT)G
BETWEEN:
GKN SINTER METALS - ST. THOMAS LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Paris, J.
[1] This is an appeal from a reassessment of the Appellant's 2000 taxation year by which the Minister of National Revenue reduced the Appellant's claim for capital cost allowance ("CCA") by $1,980,476 on the basis that the undepreciated capital cost ("UCC") of the Appellant's depreciable property at the end of that year was $5,480,580 less than the amount reported by the Appellant.
[2] According to the Minister, this error resulted from an improper application of section 5401 of the Income Tax Regulations (the "Regulations") by the Appellant in its 1993 taxation year.
[3] In 1993, the Appellant was in serious financial difficulty and obtained a forgiveness of its debt from its creditors. By virtue of section 80 of the Income Tax Act (the "Act") the Appellant was required to apply the amount of the debt forgiveness to reduce its losses from previous years and to reduce the capital cost of its depreciable property and the adjusted cost base of its capital property. Subsection 5401(1) prescribes how the reduction to the capital cost of depreciable property is to be calculated for the purposes of subsection 80(1) of the Act. The Appellant and the Respondent disagree on the interpretation of subparagraph 5401(1)(a)(ii). This leads to a disagreement about the amount by which the Appellant was required to reduce the capital cost of its depreciable property.
[4] The reduction to the capital cost of the depreciable property reduces the UCC of the property by a like amount, and therefore affects the amount of CCA that may be claimed by a taxpayer in subsequent years. In this case the 1993 closing UCC balance as determined by the Appellant was carried forward each year until 2000, which was the first year after 1993 that the Appellant was profitable and claimed CCA. The issue of the proper application of subsection 5401(1) therefore did not have an impact on tax payable by the Appellant until 2000.
[5] The issue in this appeal is whether section 80 of the Act (as it read for the 1993 taxation year) and subsection 5401 of the Regulations required the Appellant to reduce the cost of its depreciable property to nil in 1993.
FACTS
[6] The facts in this case are not in dispute. They have been set out by the parties in a statement of agreed facts, which, along with the facts admitted in the pleadings show the following:
The Appellant was formed by the amalgamation of two predecessor corporations in 1989. It had a fiscal year end of December 31.
The Appellant operated a manufacturing facility in St. Thomas, Ontario that produced metal parts, mainly for the automotive industry, using powdered metal technology.
The Appellant sustained large losses from its operations and did not deduct any amount in respect of CCA prior to December 31, 1993.
During 1993 the operations of the Appellant were restructured. As a result of negotiations with its creditors the Appellant's liabilities were reduced by $78,247,605.
In consequence of this forgiveness of debt, the Appellant applied section 80 of the Act in the following manner:
- It reduced the balance of its non-capital losses by $33,372,737 to NIL;
- It reduced the UCC of its depreciable property by $5,517,274 such that the closing UCC balance for its depreciable property at December 31, 1993 was $5,480,580; and
- It reduced the adjusted cost base of its non-depreciable capital property by $203,078 to NIL.
The forgiven amounts applied as set out above total $39,093,089 leaving a total unapplied balance of $39,154,516.
In the course of reassessing the Appellant's 1993 taxation year, the Minister reduced the Appellant's closing UCC balance for depreciable property by $5,480,580 to NIL. However, the tax payable for that year was zero.
The Appellant filed all subsequent tax returns including its tax return for the 2000 taxation year on the basis that the 1993 closing UCC balance of its depreciable property was $5,480,580.
STATUTORY PROVISIONS
[7] Subsection 80(1), as it read for the 1993 taxation year[1], provided that where a debt or other obligation of a taxpayer was settled or extinguished without payment of the full principal amount, the difference was applied to reduce the taxpayer's prior years' deductible losses in the order set out, and that where the forgiven amount exceeded those losses the excess was applied to reduce the capital cost of the taxpayer's depreciable property and the adjusted cost base of his capital property.
[8] Subsection 80(1) reads as follows for the 1993 taxation year:
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80(1) Debtor's gain on settlement of debts.
(1) Where at any time in a taxation year a debt or other obligation of a taxpayer to pay an amount is settled or extinguished after 1971 without any payment by him or by the payment of an amount less than the principal amount of the debt or obligation, as the case may be, the amount by which the lesser of the principal amount thereof and the amount for which the obligation was issued by the taxpayer exceeds the amount so paid, if any, shall be applied
(a) to reduce, in the following order, the taxpayer's
(i) non-capital losses,
(i.1) farm losses,
(ii) net capital losses, and
(iii) restricted farm losses,
for preceding taxation years, to the extent of the amount of those losses that would otherwise be deductible in computing the taxpayer's taxable income for the year or a subsequent year, and
(b) to the extent that the excess exceeds the portion thereof required to be applied as provided in paragraph (a), to reduce in prescribed manner the capital cost to him of any depreciable property and the adjusted cost base to the taxpayer of any capital property,...
...
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80(1) Gain d'un débiteur provenant d'un règlement de dettes.
(1) Lorsque, à une date quelconque pendant une année d'imposition, une dette contractée par un contribuable, ou une autre obligation contractée par un contribuable de payer une somme, est réglée ou éteinte après 1971, sans que ce contribuable effectue de paiement, ou par le paiement d'une somme inférieure au principal de la dette ou de l'obligation, selon le cas, la fraction du moins élevé des montants suivants : ce principal ou le montant pour lequel l'obligation a été émise par le contribuable, qui est en sus de la somme ainsi versée, le cas échéant, doit servir
a) à réduire, dans l'ordre suivant :
(i) les pertes autres que les pertes en capital,
(i.1) les pertes agricoles,
(ii) les pertes en capital nettes, et
(iii) les pertes agricoles restreintes,
subies par le contribuable pour des années d'imposition antérieures, jusqu'à concurrence du total de ces pertes qui seraient par ailleurs déductibles lors du calcul du revenu imposable du contribuable pour l'année ou une année postérieure, et
b) dans la mesure où cet excédent est supérieur à la fraction en question qui doit servir, en vertu de l'alinéa a), à réduire, de la manière prescrite, le coût en capital supporté par le contribuable, de tous biens amortissables du contribuable et le prix de base rajusté, pour lui, de tous biens en immobilisation
...
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[9] Sections 5400 and 5401 of the Regulations prescribed the manner in which the taxpayer was required to apply the excess in accordance with paragraph 80(1)(b) of the Act.
[10]Subsection 5400(1) prescribed the order in which a taxpayer was required to apply the excess, and subsection 5400(2) permitted a taxpayer to choose the particular property or properties against which the excess was applied (provided that the order of the application of the excess conformed to subsection 5400(1)). Section 5400 reads as follows:
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5400. (1) Subject to section 5401, the excess referred to in paragraph 80(1)(b) of the Act, after deducting the portion thereof required to be applied as provided in paragraph 80(1)(a) of the Act, shall be applied at the time the debt or obligation is settled or extinguished, in the following order to reduce to the maximum extent possible
(a) the capital cost of depreciable property of a prescribed class or prescribed classes, as the case may be;
(b) the capital cost of depreciable property other than depreciable property of a prescribed class;
(c) the adjusted cost base at that time of capital property, other than depreciable property and personal-use property;
(d) the adjusted cost base at that time of capital property that is listed personal property; and
(e) the adjusted cost base at that time of capital property that is personal-use property, other than listed personal property.
(2) Where an amount is to be applied pursuant to subsection (1), the taxpayer may choose any particular property to make the reduction in the order specified therein.
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5400. (1) Sous réserve de l'article 5401, l'excédent mentionné à l'alinéa 80(1)(b) de la Loi, après déduction de la fraction de cet excédent qui doit être appliquée de la façon prévue à l'alinéa 80(1)a) de la Loi, doit servir, au moment où la dette ou l'obligation est réglée ou éteinte, à réduire, le plus possible et dans l'ordre suivant,
a) le coût en capital de biens amortissables d'une catégorie prescrite ou de catégories prescrites, selon le cas;
b) le coût en capital de biens amortissables autres que des biens amortissables d'une catégorie prescrite;
c) le prix de base rajusté, à ce moment-là, d'immobilisation autres que des biens amortissables et des biens à usage personnel;
d) le prix de base rajusté, à ce moment-là, d'immobilisation qui sont des biens personnels désignés; et
e) le prix de base rajusté, à ce moment-là d'immobilisation qui sont des biens à usage personnel, autres que des biens personnels désignés.
(2) Lorsqu'une somme doit être affectée conformément au paragraphe (1), le contribuable peut choisir tout bien particulier pour effectuer la réduction dans l'ordre spécifié audit paragraphe.
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[11]Subsection 5401 limited the amount by which the taxpayer was required to reduce the capital cost of its depreciable property and the adjusted cost base of its capital property. In the case of depreciable property, the cap or maximum of the amount of the excess that had to be applied to reduce the capital cost was the lesser of the amount determined under paragraph 5401(1)(a) and the amount determined under paragraph 5401(1)(b).
[12]Subsection 5401(1) reads:
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5401. (1) For the purposes of paragraph 5400(1)(a), the amount to be applied to reduce the capital cost of a property shall not exceed the lesser of
(a) the amount by which
(i) the capital cost of the property
exceeds
(ii) all amounts that would have been allowed to the taxpayer in respect of the property, if it had been the only property that was included in a prescribed class, at the rate that was allowed to him in respect of property of the class in which it was included under regulations made under paragraph 20(1)(a) of the Act for the taxation years prior to the year in which the debt or obligation was settled or extinguished; and
(b) the amount by which
(i) the undepreciated capital cost of the class at the time the debt or obligation was settled or extinguished
exceeds
(ii) the amount or the aggregate of amounts, if any, that has already been determined under this subsection in respect of another property of the class at the time referred to in subparagraph (i).
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5401. (1) Aux fins de l'alinéa 5400(1)a), la somme devant servir à réduire le coût en capital d'un bien ne doit pas excéder le moins élevé des montants suivants :
a) la fraction
(i) du coût en capital du bien
qui excède
(ii) tous les montants qui auraient été alloués au contribuable relativement audit bien, si ce bien avait été le seul à être compris dans une catégorie prescrite, au taux qui lui était alloué relativement aux biens de la catégorie dans laquelle il était compris conformément aux règlements établis en vertu de l'alinéa 20(1)a) de la Loi pour les années d'imposition antérieures à l'année au cours de laquelle la dette ou l'obligation a été réglée ou éteinte; et
b) la fraction
(i) du coût en capital non amorti de la catégorie de biens, au moment où la dette ou l'obligation a été réglée ou éteinte,
qui excède
(ii) le montant ou l'ensemble des montants, s'il en est, déjà établi, en vertu du présent paragraphe, à l'égard d'un autre bien de la catégorie, au moment dont il est fait mention au sous-alinéa (i).
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(emphasis added)
[13]As stated earlier, only the amount to be calculated under paragraph 5401(1)(a) (ii) is in issue in this appeal.
POSITION OF THE PARTIES
[14]The Appellant takes the position that the amount described in subparagraph 5401(1)(a)(ii) is the total of all of the CCA that the taxpayer would have been entitled to deduct for the property in all of the taxation years preceding the year in which the debt was forgiven, whether or not the taxpayer in fact deducted it. The Appellant refers to the amount provided for in subparagraph 5401(1)(a)(ii) as "notional CCA". Therefore, the maximum amount of the reduction to the cost of its depreciable property would be the amount by which the cost of the property exceeded the amount of CCA that it could have taken on the property in prior years. This interpretation would result in the CCA that the Appellant was entitled to deduct in prior years remaining available to be claimed in taxation years ending after the settlement of its debts. The Appellant's counsel refers to this as the "protection of pre-settlement CCA".
[15]The Respondent, on the other hand, argues that the amount referred to in subparagraph 5401(1)(a)(ii) is the amount of CCA that can be considered to have actually been deducted by the taxpayer in respect of the particular property. The Respondent's counsel submits that the use of the conditional tense - "all amounts that would have been allowed to the taxpayer in respect of the property" - was necessary because Parliament needed to create a fiction that the CCA was taken on a particular property, whereas under the Act, CCA is only taken on pools of assets which are aggregated into prescribed classes according to the Regulations. The combined cost of all of the depreciable property in the class (less any adjustments for CCA taken in previous years and for proceeds from the sale of assets in the class) make up the UCC of the class on which CCA is calculated.
[16]Both counsel cite the recent decision of the Supreme Court of Canada in Canada Trustco Mortgage Co. v. Canada[2], in which the Court discusses the rules of statutory interpretation in the context of the Income Tax Act and states that there is "but one principle of interpretation: to determine the intent of the legislator having regard to the text, its context, and other indications of legislative purpose".[3]
[17]The Appellant's counsel contends that the wording of subparagraph 5401(1)(a)(ii) is clear and unambiguous.
[18]In support of this position, he referred to two papers written by tax authors and to an excerpt from a tax reporting service which adopt the Appellant's interpretation of subparagraph 5401(1)(a)(ii).
[19]The first paper, entitled "A Practical Look at Section 80" by Alan M. Schwartz, describes the operation effect of subparagraph 5401(1)(a)(ii) in the following terms:
The amount that the original cost of depreciable property of a prescribed class is to be reduced cannot exceed the "notional ucc" of a particular property. The "notional ucc" means the original cost of a particular property less the maximum capital cost allowance that could be deducted in respect of that property for taxation years prior to the year of forgiveness. Accordingly, section 80 cannot result in the reduction of the cost of a particular depreciable property to a negative amount and in a capital gain by virtue of subsection 40(3) [4]
(emphasis added)
[20]In the second paper - "Proposed Changes to the Debt Forgiveness Rules: 1[5] -Evelyn Moskowitz states that the calculation referred to in subparagraph 5401(1)(a)(ii) is to be made in the following manner:
- the capital cost of the property minus the capital cost allowance that would have been allowed (that is, not the amount that was in fact allowed) in respect of the property for all years prior to the year of debt forgiveness if the property had been the only property in the class.[6] (emphasis in the original)
She also states that this provision:
...effectively protects from the debt forgiveness rules the capital cost allowance to which the debtor would have been entitled prior to the debt forgiveness.[7]
[21]The Appellant's counsel also produced an excerpt from the loose-leaf tax service entitled "Income Taxation in Canada"[8] wherein it states that the amount determined by subparagraph 5401(1)(a)(ii) was:
[T]he maximum capital cost allowance that could have been deducted in respect of that property in taxation years prior to the year in which the debt is settled...[9] (emphasis added)
[22]Finally, counsel referred the Court to the statement of the Supreme Court in Canada Trustco Mortgage Co.[10], at paragraph 13 of its reasons, that:
[t]he Income Tax Act remains an instrument dominated by explicit provisions dictating specific consequences, inviting a largely textual interpretation....
[23]Therefore, counsel for the Appellant submits that a textual interpretation of the provision should prevail in this case.
[24]Counsel for the Respondent contends that the Appellant's interpretation of subparagraph 5401(1)(a)(ii) is flawed as it fails to take into account the words "if it had been the only property that was included in the class, at the rate that was allowed to him" which qualifies the phrase "all amounts that would have been allowed to the taxpayer in respect of the property".
[25]She says that the fiction that is created under subparagraph 5401(1)(a)(ii) is designed to attribute a portion of the CCA claimed by the taxpayer on the class of property to a specific property in the class. This fiction or mechanism is needed because subsection 5400(2) allows a taxpayer to choose the properties the cost of which will be used to absorb the excess, whereas CCA under the Act is taken on a pool of properties rather than individual properties in the specified class. The purpose of the fiction is not to create "notional CCA" in the sense of CCA that the taxpayer could have chosen to claim in preceding taxation years.
[26] Furthermore, counsel for the Respondent argues that the words "at the rate that was allowed to him" clarify that Parliament is referring to amounts actually claimed by the taxpayer and allowed by the Minister.
[27] She submits that the word "allowed" in subparagraph 5401(1)(a)(ii) refers to the Minister's response to claims made by the taxpayer under the Act for capital cost allowance and, and not to what is provided for or permitted under the Act. She said that this was so for two reasons.
[28] Firstly, she says that 5401(1)(a)(ii) refers to the rate of CCA that "was allowed to him". This should be taken to mean the tax treatment allowed to a particular taxpayer rather than what is allowed generally under the Act because there is no amount or rate of CCA in the Act that is specific to any one taxpayer. The tax treatment of a taxpayer is based on the taxpayer's returns and in this case on any claims for CCA made in the returns.
[29] Secondly, she argues that if Parliament had intended subparagraph 5401(1)(a)(ii) to cover amounts of CCA which a taxpayer had been entitled to claim but which had not in fact been claimed, instead of Parliament using the words "at the rate allowed to him", it could have easily chosen to use the words "at the rate to which the taxpayer was entitled" similar to what is found in the definition of "depreciable property" in paragraph 13(21)(b) of the Act. That definition reads:
"depreciable property" of a taxpayer as of any time in a taxation year means property acquired by the taxpayer in respect of which the taxpayer has been allowed, or would, if the taxpayer owned the property at the end of the year and this Act were read without reference to subsection (26), 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 added)
[30]The Respondent's counsel submits that it is relevant that section 5400 states that the excess referred to in paragraph 80(1)(b) of the Act shall be applied to reduce the capital cost of its depreciable property and adjusted cost base of capital property "to the maximum extent possible". She said that this is an indication that subparagraph 5401(1)(a)(ii) should be interpreted restrictively in order to create the greatest reduction to the capital cost of a taxpayer's depreciable property.
[31]Counsel for the Respondent also submits that the Appellant's interpretation is inconsistent with the overall policy behind the debt forgiveness rules in section 80 of the Act which is to prevent a taxpayer from recognizing for tax purposes expenditures which have not been borne by him.
[32]In this case, counsel for the Respondent says that the Appellant is seeking a result which would allow it to continue to claim a deduction for CCA on assets of which it has not borne the cost.
[33]Counsel for the Appellant argues that the Appellant has, in fact, borne the cost of the assets, since the assets have depreciated since they were acquired. Counsel said that "depreciation is spent the moment that the machine is used" regardless of whether CCA is claimed.
ANALYSIS
[34]In my view, the wording of subparagraph 5401(1)(a)(ii) is not entirely clear and can reasonably support either of the meanings suggested by the parties. The ambiguity arises out of the use of the words: "at the rate that was allowed to him". I agree with the Respondent's counsel that "allowed" here is capable of two meanings. I think that "rate" is also capable of two meanings. In this context, "rate" could mean either the rate of CCA that is allowed by the Regulations for each class of depreciable property, or the rate at which CCA was taken by the taxpayer in question on a class of his depreciable property, which rate may, in fact, have been less than the maximum rate permitted by the Regulations since CCA is a permissive deduction and a taxpayer can choose whether or not to take CCA which is available to him in any year.
[35]A reading of the French version of subparagraph 5401(1)(a)(ii) does not assist in deciding what meaning to attribute to the words under consideration since the French version contains the same ambiguities as the English version. In the phrase "au taux qui lui était alloué" "taux" and "alloué" could each have either of the two meanings that "rate" and "allowed" could have, as set out earlier in these reasons.
[36]In order to resolve these ambiguities, it is necessary to consider the context in which the provision occurs and its purpose.
[37]Assistance in understanding the statutory scheme of section 5401, as it relates to depreciable property, is found in subsection 5401(2). Subsection 5401(2) parallels subsection 5401(1) to the extent that it fixes a maximum amount by which the cost of "depreciable property other than depreciable property of a prescribed class" must be reduced in accordance with paragraph 5400(1)(b). Subsection 5401(2) reads as follows:
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5401(2) For the purposes of paragraph 5400(1)(b), the amount to be applied to reduce the capital cost of a property shall not exceed
(a) the amount by which the capital cost of the property
exceeds
(b) the amount that was allowed to the taxpayer by virtue of Part XVII in respect of the property before the debt or obligation was settled or extinguished.
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5401(2) Aux fins de l'alinéa 5400(1)b), le montant devant servir à réduire le coût en capital d'un bien ne doit pas excéder
a) la fraction du coût en capital du bien qui
excède
b) le montant alloué au contribuable en vertu de la partie XVII relativement audit bien, avant que la dette ou l'obligation n'ai été réglée ou éteinte.
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[38]"Depreciable property other than depreciable property of a prescribed class" consist of assets that were owned by a taxpayer prior to 1972 and used in farming or fishing and on which capital cost allowance has been or may be claimed under Part XVII of the Regulations[11]. It should be noted that Part XVII of the Regulations does not aggregate these properties into classes for the purpose of taking CCA. CCA is taken on individual properties, such that the amount of CCA taken for a particular property can easily be determined. This is in contrast to depreciable property that is included in prescribed classes, since CCA is taken on the UCC balance of the entire class and is not attributable to individual properties within the class.
[39]Under subsection 5401(2), the maximum reduction to the cost of depreciable property that is not included in a prescribed class is the capital cost of the property to the taxpayer, less the "amount" of CCA "that was allowed to the taxpayer" in respect of the property. There is no reference to the amount of CCA "that would have been allowed to the taxpayer" (as in subparagraph 5401(1)(a)(ii)) and therefore no basis to suggest that the CCA which the taxpayer could have taken, but did not take, on the property is relevant to the calculation of the maximum reduction. In other words, in the case of depreciable property other than property of a prescribed class, the taxpayer's "pre-settlement CCA" is not "protected".
[40]This means that, according to the Appellant's interpretation of subparagraph 5401(1)(a)(ii), the two types of depreciable property would be treated differently under section 5401 of the Regulations. However, in my view there would be no compelling reason for inconsistent treatment of the two types of depreciable property.
[41]In response to the Respondent's argument that section 5400 requires that the reduction to the cost of depreciable property to be made to the maximum extent possible, I would note that section 5400 by its opening words, is made subject to section 5401. Section 5401 limits the amount of the reductions required, and limits these reductions to the lesser of the amounts set out. The wording "to the maximum extent possible" in section 5400 only applies once the limit to the reductions in section 5401 have been calculated.
[42]I now turn to the purpose of section 5401, which, is to "provide rules which are designed to ensure that the reduction of the capital cost of depreciable property pursuant to section 80 cannot result in the recapture of capital cost allowance and that the reduction in the adjusted cost base of capital property other than depreciable property pursuant to section 80 cannot result in a capital gain".[12]
[43]The Appellant's counsel agrees that this is the purpose of the provision but claims that an additional purpose of subparagraph 5401(1)(a)(ii) is to protect a taxpayer's pre-settlement CCA.
[44]The fact that subsection 5401(2) does not protect pre-settlement CCA in the case of depreciable property other than property at a prescribed class is one reason to reject the interpretation of subparagraph 5401(1)(a)(ii) suggested by the Appellant.
[45]Another reason is that such a purpose would run contrary to the general intent of the debt forgiveness rules, which is to prevent a taxpayer from recognizing for tax purposes expenditures that have not been borne by him. This has been expressed in various ways:
The tax policy rationale for triggering a tax gain when a debt forgiveness occurs is that the debt enabled the debtor to acquire property or make expenditures that gave rise to deductions in computing income. To the extent that debt is forgiven, the cost of the expenditures has not been borne by the debtor, and should therefore not be recognized for tax purposes.[13]
and
...Expressed in simple terms a taxpayer is not allowed to claim for tax purposes as losses or cost base any amounts which have not actually been expended....[14]
[46] I do not accept that the Appellant has incurred the "cost of depreciation" of its property, as its counsel claims it has. If a taxpayer does not incur the cost of acquiring a property, he cannot be said to incur the cost of that property's depreciation. In this case, it is assumed that the Appellant did not bear the cost of its depreciable property because the amount of the debts that it did not have to repay exceeded its cost of that property (after applying the forgiven amounts to its prior year's unused losses).
[47]The deduction of CCA sought by the Appellant in the year under appeal is therefore in respect of assets that it owned at the time of the debt forgiveness, and of which it did not ultimately bear the cost. Such a deduction for CCA would amount to tax recognition of expenditures that the Appellant did not incur.
[48]For these reasons, I believe that the policy concerns of section 80 are better met by the Respondent's interpretation of subparagraph 5401(1)(a)(ii) than by the Appellant's.
CONCLUSION
[49]I conclude that the contextual and purposive analysis necessary to resolve the ambiguities identified in the wording of subparagraph 5401(1)(a)(ii) supports the Respondent's interpretation of that provision, and that the Appellant was required to reduce the capital cost of its depreciable property to zero in 1993 as a result of the settlement of its debts with its creditors.
[50]The appeal is dismissed, with costs.
Signed at Ottawa, Canada, this 31st day of May 2006.
"B. Paris"
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