Badshah B. Husain v. Minister of National Revenue, 91 DTC 278, [1991] 1 CTC 2266 (TCC)

Sarchuk, T.C.J.:—The appeal of Badshah B. Husain (Husain) is from an assessment in respect of her 1984 taxation year. This assessment was made on the basis that Husain received interest in the amount of $26,650 during the year which was not included in computing her income for her preceding taxation year and which was an amount required to be included in computing her income for the year from a business or property pursuant to paragraph 12(1)(c) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act").

The appellant's position is that subsection 20(14) of the Act provides that a transfer of bond whereby the transferee becomes entitled to interest that accrued thereon prior to the transfer may be deducted in computing her income for a taxation year to the extent that the amount was included as interest in computing her income for the year. Accordingly, pursuant to that subsection of the Act, the accrued interest in this case is not subject to tax in the appellant's hands.

The narrow issue in this case is whether the deduction permitted by subsection 20(14) of the Act is available to the appellant in the circumstances of this case.

At the commencement of the trial counsel for both parties advised the Court that an agreement as to facts had been reached and a statement to that effect was filed as Exhibit A-1. It reads:

1. Mrs. Badshah B. Husain (hereinafter referred to as the "Appellant"), of 85 Dawn Hill Trail, Thornhill, Ontario is the surviving spouse of Mr. Mirza M. Husain. 2. On November 6, 1972 Mr. Husain purchased twenty compound interest Canadian Savings Bonds (the " Bonds") numbered S27E-0023206 to 25 in denominations of $1,000.00 each.

3. Mr. Husain was a resident of Canada at the time he purchased the Bonds, but ceased to be a resident of Canada in 1974 and continued to be a non-resident until the time of his death on February 23, 1981.

4. The Appellant was appointed executrix of the Estate of her deceased husband (the "Estate") by his Last Will and Testament dated February 15, 1977. Letters Probate in respect of the Estate of Mr. Husain were issued on August 31, 1981. Please see Appendix "A".*

5. The Appellant was made the sole beneficiary of the Estate under the Last Will and Testament of her deceased husband.

6. On October 7, 1981 the Appellant informed the Bank of Canada (the"Bank") that the Bonds issued to her husband in 1972 could not be found and asked the Bank to replace the Bonds. The Bank issued replacement bonds (the “ Replaced Bonds") in her name as the owner.

7. The Replaced Bonds numbered S27E-0761032 to 51 were issued on January 5, 1983 to the Appellant, at which time she was a resident of Canada, and were redeemed by her in November, 1984. Please see Appendix" B”.

8. The Appellant filed in 1988 an income tax return for her deceased husband, in respect of his terminal year (i.e., the 1981 year), and reported as income $13,150.00 interest accrued on the Bonds from the date of issuance of the Bonds to November 1, 81. Please see Appendix"C".

9. The Appellant reported in her income tax return for the 1984 taxation year an amount of $34,600.00 of capital gains earned from the redemption of the Replaced Bonds. In an amended return dated Jan. 18, 1987, the Appellant revised her return by declaring as interest income from the Replaced Bonds $12,477.80 and as capital gains $7,950.00.

10. The Minister of National Revenue (the"Minister"), by Notice of Reassessment dated April 9, 1986 (the "Assessment"), assessed the Appellant's income for the 1984 taxation year by including $26,650.00 in her income as interest income received by her upon the redemption of the Replaced Bonds.

11. The Assessment in respect of the $26,650.00 interest income was confirmed by a Notice of Confirmation (the"Confirmation") dated July 5, 1988.

12. The Appellant appealed from the Confirmation by filing a Notice of Appeal dated September 27, 1988. Please see Appendix"D".

13. The Reply to the Notice of Appeal was filed on July 5, 1989. Please see Appendix" E”.

14. An Amended Reply to the Notice of Appeal was filed on July 23, 1990. Please see Appendix "F".

There was no further evidence.

The provisions of the Income Tax Act in issue read:

20. (14) Where, by virtue of an assignment or other transfer of a debt obligation (other than an income bond, an income debenture, a small business development bond or a small business bond), the transferee has become entitled to an amount of interest that accrued thereon for a period commencing before the time of transfer and ending at that time that is not payable until after that time, such amount

(a) shall be included as interest in computing the transferor's income for his taxation year in which the transfer occurred, except to the extent that it was otherwise included in computing his income for the year or a preceding taxation year; and

(b) may be deducted in computing the transferee's income for a taxation year to the extent that the amount was included as interest in computing his income for the year.

♦Appendices"A" to"E" not reproduced.

Counsel for the appellant conceded that the accrued interest on the Canada Savings Bonds from 1972 to 1984 must be included in the appellants income in 1984. However he submits that the appellant clearly falls within the provisions of paragraph 20(14)(b) and is entitled to claim a deduction with respect to the interest accrued prior to the time the bonds were transferred to her. More specifically counsel rejects the respondents position that an amount is deductible by the appellant pursuant to subsection 20(14) of the Act in respect of interest received from the bonds only if that amount was included in computing the income of the transferor in the year of the transfer or in any preceding taxation year. Counsel contended that whether the transferor included such amount in his income is irrelevant for the purposes of determining whether or not a transferee is entitled to a deduction under paragraph 20(14)(b) in respect of the same amount.

While conceding that the legislative purpose of subsection 20(14) is to apportion interest and to apportion tax liability between a transferor and a transferee, counsel argued that compliance with the provisions of paragraph

(a) is not a prerequisite to an entitlement by the transferee of a deduction pursuant to paragraph (b). As I understood counsel's argument, for all practical purposes this Court is required to read subsection 20(14) as though paragraphs (a) and (b) were mutually exclusive. In his words paragraph (b) stands alone.

In support of this proposition counsel submitted that if paragraph 20(14)(a) is read as being a prerequisite for the application of paragraph 20(14)(b) "there would be many nonsensical, absurd and unreasonable results". These unreasonable results would arise in part because subsection 214(6) of the Act:

. . . essentially requires the transferee to withhold tax on the interest accrued to the point of transfer. So, what that does is, in the case of a non-resident, there is no income inclusion under 20(14)(a)—in fact, 214(6) specifically says that. 214(6) specifically states that 20(14)(a) cannot apply to a non-resident transferor. So, given that, you cannot ask the transferee now to say that the income was included in the hands of the transferor. The Act makes that an impossibility to show.

We then go to 241(6). It does require tax to be paid by a non-resident transferor unless we are dealing with excluded obligations, such as Canada Savings Bonds. So, in our situation what has happened is the bonds were transferred, and it is agreed between the parties that it was at the time of death. The bonds were transferred. There was no inclusion under 20(14)(a) because there could not be an inclusion under 20(14)(a). 214(6) would have imposed withholding tax and the obligation to withhold the tax would have been on the transferee but for the fact that we are dealing with Canada Savings Bonds.

(Argument, Dattu, transcript, page 8, II. 24-25, page 9, II. 1-22)

Counsel further argued:

Mr. Dattu: I have demonstrated to you, hopefully, that it does not make sense to apply the strict requirement that the Minister seems to be requiring; that if we have a non-resident transferor, the non-resident include that amount in its income because, as the Minister himself will say, a non-resident cannot have income under 20(14)(a), and I have demonstrated that Part XIII would, in fact, allow for tax to be imposed against a non-resident transferor unless, by virtue of the policy of the Act, the Minister has—the Act provides for certain obligations not to be subject to withholding tax. If we were to follow the Minister's proposition, as I said, there would be an element of double taxation and that would clearly discriminate against the non-resident transferor.

(Argument, Dattu, transcript, page 19, II. 14-25, page 20, II. 1-4)

He-went on to say that the reason why were should be no tax in this case is because there is no basis for the tax since the legislators excluded Canada Savings Bonds expressly from the application of withholding tax under subsection 214(6) of the Act. He argues that the appellant complied with the requirements of paragraph 20(14)(b) and that it is improper for the respondent to require her to establish or in some manner ensure that the transferor include the interest income in his hands in order to qualify for the deduction. The appellants position is that she can utilize paragraph 20(14)(b) because she has done all she can to comply with the provision. It was in his words ”. . . impossible for her to have the transferor include that amount in his income". Furthermore, as a non-resident, the transferor was not even required to file a return. Counsel submitted that the relevant provisions applied as they are by the respondent in this case lead to absurd or unjust results. He said:

That's the very proposition that I’m putting forth; that when you read 20(14)(a), (b) in the strict sense, there is no prerequisite that the transferee show that the transferor has included that amount in his or her income. But going further, if 20(14)(a) is inapplicable because the transferor is a non-resident, it just does not make sense to say the transferee still has to somehow demonstrate that the transferor included that amount in his income. . . .

Well, let me read on then. "On the other hand, we are bound to assume that Parliament intends to act reasonably and if a statute, when fairly read, is open to alternate constructions, one of which leads to absurd, unreasonable or unjust results and the other does not lead to such results or leads to less absurd, unreasonable or unjust results, we should adopt the latter alternative construction."

That's what I’m putting forward as my proposition; that it would be unjust and unreasonable to expect the taxpayer in effect to pay tax on Canada Savings Bonds while the Canada Savings Bonds were owned by the transferor because Parliament has said that Canada Savings Bonds are not taxable in the hands of the transferor.

The respondent's primary position is that no amount is deductible by the appellant in computing her income for the 1984 taxation year pursuant to subsection 20(14) as the appellant's deceased spouse was not resident in Canada at the time of the transfer. Counsel for the respondent submitted that the fact that during certain of the years in which these Canada Savings Bonds were held the interest accruing thereon was not taxable on the basis that it was to be received in the hands of a non-resident is simply not relevant. He contended that the fact is that interest was received in the hands of a resident in 1984 and that interest is taxable pursuant to paragraph 12(1)(c) of the Act. He submitted that on any reading of subsection 20(14) it becomes clear that for the purposes of that section a transferor cannot be a non-resident. That can be seen, he says, from the fact that subsection 20(14) presumes that a transferor has income for the taxation year in which the transfer is made and such transferor can only be a person subject to tax under Part I of the Income Tax Act which Mr. Husain clearly was not. In support of this proposition counsel relied on the following cases:

Office Overload Co. v. M.N.R. (1965), 39 Tax A.B.C. 309; 65 D.T.C. 690 (T.A.B.)

Lea-Don Canada Ltd. v. M.N.R., [1970] C.T.C. 346; 70 D.T.C. 6271 (S.C.C.)

Allied Farm Equipment Ltd. v. M.N.R., [1972] C.T.C. 619; 73 D.T.C. 5036 (F.C.A.)

The Queen v. Canadian Pacific Ltd., [1977] C.T.C. 606; 77 D.T.C. 5383 (F.C.A.)

Oceanspan Carriers Ltd. v. The Queen, [1987] 1 C.T.C. 210; 87 D.T.C. 5102 (F.C.A.)

In Office Overload, supra, the appellant, seeking further expansion of its business in the United States, purchased a similar business in Los Angeles. The vendor was a non-resident of Canada, not subject to Canadian income tax, who maintained its records on a cash basis. Under the purchase agreement, shortly after the purchase the vendor and the appellant executed jointly an election to have section 85D (the predecessor of the present section 22 of the Act) apply. This section provided special rules for the treatment of accounts receivable by vendor and purchaser when such accounts were sold as part of a business to be continued by the purchaser. In its 1960 return the appellant, applying subsections 85D(1) and 11(1)(f), deducted certain amounts as bad debts, which deduction was disallowed by the Minister. The provisions of section 85D, which I do not propose to reproduce, are structurally similar to those of subsection 20(14).

The appellant, being the resident purchaser, argued that the fact that the non-resident vendor was not required to file a return and was not subject to Part I tax and therefore could not deduct the amount specified in the section from his income for the year pursuant to paragraph 85D(1)(a) had no bearing on whether the appellant should be or for that matter was entitled to avail itself of the provision and include in its income for the year of sale the amount prescribed within paragraph 85D(1)(b).

The Tax Appeal Board rejected the arguments put forward by the appellant in the following words (pages 320-21 (D.T.C. 697)):

After a careful review and thoughtful consideration of the evidence adduced and of the provisions of section 85D of the Income Tax Act under which this appeal falls to be decided, I have reached the conclusion that the section taken as a whole, which, in my opinion, is the way in which it must be interpreted, is intended to apply to persons who fall to be taxed or otherwise dealt with under the provisions of the Canadian Income Tax Act and who report to the Canadian Government the income arising from the operation of the business or businesses whose sale is the central concern of the said section 85D. That section is, in my opinion, intended to afford a continuity in the treatment of accounts receivable where the sale of a business intervenes, and to this extent I am in accord with counsel for the respondent.

The opening words of section 85D preceding paragraph (a) thereof may be referred to as the preamble to the rules which follow. They set out clearly and precisely the circumstances and conditions which must be present before the rules can be applied. These conditions are a sine qua non to the operation of these rules. Unless both purchaser and vendor can bring themselves completely within these conditions, the rules which follow can have no application.

In construing and interpreting section 85D in its entirety and having examined subsection (1) thereof in detail, I am of the opinion that it has no application where, as in the present appeal, the vendor is a non-resident of Canada, is not doing business in Canada, and is under no obligation to file a return under the Income Tax Act, R.S.C. 1952, c. 148, and amendments thereto.

In Lea-Don Canada Ltd., supra, the appellant was a resident corporation which had sold an aircraft to its non-resident parent company in a non-arm's length transaction at a price that was less than fair market value. The appellant claimed a terminal loss in the year of disposition in respect to the assets of that class. Pursuant to former subsection 17(2) the Minister of National Revenue deemed the appellant to have received proceeds of disposition equivalent to fair market value and reassessed to include in its income a certain amount in respect of recapture, pursuant to subsection 20(1). The appellant disagreed. The question submitted to the Exchequer Court in the stated special case was whether or not the depreciable property had been disposed of in such circumstances that subsection 20(4) was applicable.

The Exchequer Court answered the question in the negative. The Court found that the aircraft was not depreciable property in the hands of the parent company since under the regulations capital cost allowance could be claimed by non-residents only if carrying on business in Canada. On appeal to the Supreme Court of Canada the findings and rulings of the Exchequer Court were concurred in. The appellant again argued that its parent's non-resident status did not affect its status as a taxpayer entitled to deduct capital cost allowance from its income since income includes within its meaning "nonresident and tax exempt income". The Supreme Court unanimously rejected that argument and stated in its reasons at page 349 (D.T.C. 6273):

The argument that the provisions of the Income Tax Act authorizing a deduction on account of the capital cost of depreciable property are applicable to nonresidents who are not subject to assessment for income tax under Part I of the Act because such deduction is from income is wholly untenable. It is clear that subsection 20(4) is concerned with taxpayers entitled to a deduction, not with persons who are not subject to assessment under Part I. A non-resident not carrying on business in Canada is not a person entitled to such a deduction and therefore subsection 20(4) cannot properly be said to be "applicable" to him.

In Allied Farm Equipment Ltd., supra, the appellant, a Canadian corporation, and two other companies were owned and controlled by three brothers, each brother owning and controlling one of the companies. The three brothers together owned a U.S. company. The Minister reassessed the appellant company for the 1960 through 1964 taxation years on the basis that it was associated with each of the two other Canadian companies within the meaning of subsection 39(5) on the grounds that each of the three companies was associated with the U.S. company within the meaning of subsection 39(4). The Federal Court of Appeal held that the U.S. corporation was not associated with the appellant and each of the two other companies within the meaning of subsection 39(4). The Court's rationale was that subsection 39(4) has no application in determining whether two corporations are associated unless they are both subject to income tax under Part I of the Income Tax Act. Because the U.S. corporation was not subject to tax under Part I, subsection 39(4) could not be applied in respect of it and therefore there was no basis for applying subsection 39(5). In reaching its conclusions the Court summarized the scheme of section 39 as follows (at page 620 (D.T.C. 5036)):

Part I of the Income Tax Act imposes an income tax on the annual taxable income of every person resident or carrying on business in Canada (section 2). Section 39 is the provision that fixes the rate at which that tax is computed in so far as corporations (as opposed to individuals) are concerned. [The Court then set out the scheme of section 39.]

In its analysis of section 39 the Federal Court said (at page 622 (D.T.C. 5037)):

(a) that the tests found in subsection 39(4) are only applicable to determine that corporations are "associated" for the purposes of section 39,

(b) that there are three substantive rules in section 39 applicable to corporations that are "associated", and

(c) that each of those rules determines, in certain circumstances, the amount of “the tax payable” under Part I of the Income Tax Act" by each of the corporations” that are” associated”. It follows, in my view, that section 39(4) has no application to determine whether two corporations are associated unless they are both subject to income tax under Part I of the Income Tax Act.

This decision of the Federal Court of Appeal was recently considered and approved in the decision of the Federal Court-Trial Division in Holiday Luggage Mfg. Co. and Falcon Luggage Inc. v. The Queen, [1987] 1 C.T.C. 23; 86 D.T.C. 6601.

Reference was also made to The Queen v. Canadian Pacific Ltd., supra. In that case the taxpayer received interest from an American subsidiary corporation under income bonds it held. In computing its income and relying upon subsection 8(3) of the former Act, the appellant treated this amount as a deemed dividend and claimed a deduction permitted by section 28 of the Act. When the matter was heard by the Federal Court of Appeal the question to be decided was whether subsection 8(3) applied when the corporation paying the dividends was not subject to Part I of the Income Tax Act. The Court held that although the words “ unless the corporation is entitled to deduct the amount so paid in computing its income” in subsection 8(3) referred only to corporations which are subject to Part I of the Income Tax Act this was not because the word “ corporation” was used in a narrow sense but was simply because only those corporations which are subject to Part I can meet the conditions expressed in that Part.

Counsel for the respondent suggested that the same reasoning applies to subsection 20(14) under consideration in this appeal. It speaks of "there shall be included in computing the transferor's income for the taxation year in which the transfer was made .. .”, which presumes that the transferor/ taxpayer is subject to Part I of the Act. Therefore a non-resident transferor such as Mr. Husain simply does not satisfy the conditions expressed in this subsection and it followed that the transferee was precluded from utilizing the section.

Oceanspan Carriers Ltd, v. The Queen, supra, is another decision which is relevant. In that case the appellant was neither resident in Canada nor carrying on business in Canada prior to June 15, 1976. In reporting its income for the 1976 to 1979 taxation years the taxpayer deducted non-capital losses incurred in 1976 and prior years. The Minister assessed on the basis that the appellant was not entitled to carry forward losses incurred in the years prior to becoming a resident of Canada.

The Federal Court of Appeal found that the losses incurred in the years 1972 to 1975 could not be carried forward. A corporate resident which has no income derived from Canadian sources is not” liable to pay tax” and thus has no need to utilize the provision permitting the deduction of non-capital losses. Put another way, such a corporation is not a taxpayer as defined. Furthermore, until it becomes a taxpayer, a non-resident corporation does not have a taxation year for Canadian tax purposes. It could not be given one retroactively.

Counsel for the respondent submitted that while the Federal Court of Appeal specifically dealt with a non-resident not carrying on business, the statement of principle applies to any non-resident. This was relevant because subsection 20(14) refers to the amount of accrued interest being included in computing the transferor's income of the taxation year in which the transfer was made. The rationale of the Federal Court of Appeal in Oceanspan Carriers Ltd, is essentially that a non-resident does not have a taxation year. Accordingly, the requirements of subsection 20(14) cannot be satisfied and the appellant is not entitled to succeed.

I am satisfied that the Minister's position is correct. In order for the provisions of subsection 20(14) to apply all of the relevant elements must be in place. Both the transferor and the transferee must squarely fall within the wording of the section. That means that unless the transferor and transferee are both subject to income tax under Part I of the Act the exception created by subsection 20(14) is not available.

The pôsition of the respondent that subsection 20(14) cannot apply when the transferor is not a resident, is amply supported by the authorities cited.

The alternative position taken by the Minister is that if the condition that the transferor within paragraph 20(14)(a) must include in his income for the year the amount of interest accrued up to the point of transfer has not been satisfied, then paragraph 20(14)(b) is of no assistance to the transferee. Counsel for the appellant argued that this proposition is affirmed in the decision of Canada v. H. Boris Antosko, [1990] 1 C.T.C. 208; 90 D.T.C. 6111.

In view of my conclusion on the primary argument it is not necessary to deal with this submission.

For the foregoing reasons the appeal is dismissed.

Appeal dismissed.