The Queen v. Canadian Pacific Ltd., 77 DTC 5383, [1977] CTC 606 (FCA)

Pratte, J (concurred in by Ryan, J and MacKay, DJ):—This is an appeal from a decision of the Trial Division allowing the respondent’s appeal from the assessment of its income tax for the year 1965. The appeal raises problems related to two different questions: the characterization, as interests or dividends, of certain payments received by the respondent and the calculation of the capital cost allowance to which the respondent is entitled.

I. Interest or Dividend

In 1965 the respondent received $841,871 from Soo Line Railroad Company, an American corporation in which it held a controlling interest. That amount represented interest owed by the Soo Line Railroad Company under income bonds held by the respondent. In computing its income, the respondent assumed that the sum of $841,871 was deemed to have been received as a dividend by virtue of subsection 8(3) of the Income Tax Act and that, as a consequence, the respondent was entitled to claim, in respect of that sum, the deduction allowed by subsection 28(1). It is the appellant’s contention, which was rejected by the learned trial judge, that, under subsection 8(3), the sum of $841,871 is not deemed to have been received as a dividend.

Subsection 8(3) reads as follows:

8. (3) Interest on income bonds.—An annual or other periodic amount paid by a corporation to a taxpayer in respect of an income bond or income debenture shall be deemed to have been received by the taxpayer as a dividend unless the corporation is entitled to deduct the amount so paid in computing its income.

It is common ground

(a) that the interest payments here in question were ‘‘annual or other periodic amounts . . . in respect of income bonds’’ within the meaning of subsection 8(3); and

(b) that, in 1965, Soo Line Railroad Company was a corporation incorporated under the laws of the United States, was not a resident of Canada, did not carry on business in Canada and was not subject to the provisions of Part I of the Income Tax Act.

The sole issue between the parties is whether subsection 8(3) applies to interest paid by a corporation which, like Soo Line Railroad Company, is not subject to the provisions of Part I of the Income Tax Act.

According to the appellant, the word “corporation’’ in subsection 8(3) refers exclusively to corporations which are subject to Part I of the Income Tax Act. In support of that contention, counsel, in effect, put forward only one argument. It is clear, he said, that the last part of subsection 8(3)—“unless the corporation is entitled to deduct the amount so paid in computing its income’’—applies only to corporations which are subject to Part I of the Income Tax Act since other corporations do not have to compute their income under Part I of the Act. He added that if the expression “corporation” is thus used in that restricted meaning in the last part of subsection 8(3), it is reasonable to believe that it is used in the same sense in the opening part of the same paragraph.

That argument, in my view, rests on a fallacy. The word “corporation” is not used in a restricted sense in the last part of subsection 8(3). True, the words “unless the corporation is entitled to deduct the amount so paid in computing its income” refer only to corporations which are subject to Part I of the Income Tax Act. But this is not because the word “corporation” is there used in a narrow sense; it is simply because only those corporations which are subject to Part I of the Income Tax Act can meet the condition expressed in that part of the subsection.

I am therefore of the view that the trial judge was right in rejecting the appellant’s contention on this point.

II. The Capital Cost Allowance

The capital cost allowance to which a taxpayer is entitled under the regulations adopted pursuant to paragraph 11(1)(a) is calculated by reference to the ‘capital cost to the taxpayer” of the asset in question.* [1] Moreover, in the cases provided for in subsection 84A(3), that capital cost is deemed to be the amount of the expenditure incurred by the taxpayer.! [2]

In many instances before the end of 1965, the respondent, acting at the request of a third party, made capital expenditures, or expenditures which are deemed to be capital expenditures, after it had been agreed that the third party would pay the respondent an amount not exceeding that of the expenditure. In the computation of its income for 1965, the respondent calculated the capital cost allowance to which it was entitled in respect of the assets it had thus acquired (or was deemed to have acquired) on the basis that, in determining their capital cost, the amounts received from the third parties were not to be taken into consideration. The appellant challenges this method of calculation and contends that the capital cost of those assets, as established by the respondent, must be diminished by an amount equal to the sums received from the third parties. This is, put in general terms, the issue raised by this branch of the case.

As the respondent had entered into many transactions giving rise to that kind of a problem, the parties agreed before trial to adduce evidence in respect of only certain of those transactions, it being understood that the decision of the Court concerning them would be applied by the parties to the solution of the difficulties raised by the others.

Evidence was thus adduced in respect of nine typical transactions. The trial judge agreed with the contention of the appellant (defendant in the court below) in respect of one of those transactions, but, in the eight other cases, decided in favour of the respondent. This appeal is directed against that part of the judgment relating to those eight cases; the respondent does not challenge the decision relating to the other transaction.

In the appellant’s memorandum, the eight transactions here in question are divided into two categories: (1) the instances in which, according to the appellant, the respondent itself made the expenditure on its own account, and (2) the cases in which, according to the appellant, the respondent made the expenditure for the account of the third party who ultimately paid it.

In the first category, the appellant classifies five transactions which may be referred to compendiously as the Canso Cause Way transaction, the Bell Telephone transaction, the 25-Cycle Conversion transaction, the United Grain Growers transaction, and the Federal Grain transaction. In all these five cases the appellant concedes that the respondent itself, at the request of a third party, incurred expenditures for the purpose of improving its property after it had been agreed that the third party would pay the respondent an amount not exceeding the amount of the expenditure.

The contention of the appellant in respect of these transactions is that the “capital cost to the taxpayer of depreciable property”, within the meaning of paragraph 20(5)(e), is the net cost to the taxpayer and that the expenditure to which subsection 84A(3) refers is what the taxpayer ‘has actually expended in net”. Therefore, in the five cases under consideration, the ‘capital cost to” the respondent, or the expenditure incurred by it, is, according to the appellant, the amount of the respondent’s outlay less the contribution of the third party.

The learned trial judge, in my opinion, rightly rejected that contention which appears to me to be inconsistent with the decision of the House of Lords in Birmingham Corporation v Barnes, [1935] AC 292, where it was held that “the actual cost to” a taxpayer of depreciable property is equal to the amount paid by the taxpayer. As Lord Atkin said in that case (at page 298):

What a man pays for construction or for the purchase of a work seems to me to be the cost to him: and that whether someone has given him the money to construct or purchase for himself; or, before the event, has promised to give him the money after he has paid for the work; or, after the event, has promised or given the money which recoups him what he has spent.

Counsel for the appellant has argued that the decision in the Birmingham case is distinguishable on two grounds. In that case, said he, the capital expenditure had not been incurred at the request of the third party and the amount contributed by the third party was not earmarked for any special purpose.

As to the first proposed distinction, I will merely say that it appears to me entirely irrelevant; as to the second one, I do not understand it. In the five cases here in question, the respondent entered into contracts with third parties under which the respondent agreed to make certain capital expenditures and the third parties agreed, in return, to pay the respondent sums not exceeding the amount of the expenditures made or to be made by it. I do not understand how it can be said that, in those circumstances, the sums paid by the third parties were “earmarked” and were not at the respondent’s free disposal.

I am therefore of the view that the trial judge was right in rejecting the appellant’s contention in respect of this first group of five transactions.

The three remaining transactions are those where, according to the appellant, the capital expenditure was not made by the respondent on its own account but was, in effect, made by a third party. I will consider them separately under the headings used in the appellant’s memorandum.

(a) The Athabaska Valley Industrial Park

In 1959, in order to facilitate the development of an Industrial Park established by Alberta Mining Corporation, the respondent agreed with that company to extend its railway so as to serve the Park, it being understood that part of the cost of that extension would be paid by the Alberta Mining Corporation to the respondent. From 1959 to 1962, the respondent spent some $119,000 to construct the extension and it received, in partial reimbursement of that expenditure, sums of $24,793 and $15,949 from Athabaska Valley Development Corporation, which was the successor of Alberta Mining Corporation. It is the appellant’s contention that, in determining the capital cost allowance to which the respondent was entitled, these sums of $24,793 and $15,949 must be deducted from the amount actually expended by the respondent to extend its railway.

I do not see any basis for the appellant’s contention that, in this case, the expenditure was not made by the respondent for its own account. In that respect, I cannot distinguish this transaction from the other five which I have already considered. I am therefore of the view that the learned trial judge was right in rejecting the appellant’s contention with respect to that transaction.

(b) The St Lawrence Seaway Authority

In order to build the St Lawrence Water Way, the St Lawrence Seaway Authority had to acquire part of the respondent’s railroad which had, therefore, to be deviated. For that purpose, on October 30, 1959, the Authority and the respondent entered into an agreement providing, in effect, that:

(a) the Authority was to construct the deviation at its own expense on land to be acquired by it;

(b) the Authority had the right to arrange with the respondent that part of the work involved in the construction of the deviation be done by the respondent, in which case the Authority was to reimburse the respondent the cost of the work done by it; and

(c) upon completion of the railway on the new location, the Authority was to convey it to the respondent which, in return, would convey to the Authority the land it wanted to acquire.

In accordance with that agreement, the Authority acquired the land and did the work necessary for the relocation of the railway line. A small part of the work, however, was done by the respondent at a cost of $314,852, which was reimbursed by the Authority pursuant to the agreement.

The sole question to be answered is whether the respondent is entitled to claim capital cost allowance in respect of that expenditure of $314,852. That question, in my opinion, must be answered in the negative because that expenditure was neither the cost to the respondent of the acquisition of depreciable property nor an expenditure deemed to be of a capital nature by virtue of subsection 84A(3).

The respondent did not spend that sum of $314,852 in order to acquire property, but, rather, for the purpose of doing some work for the St Lawrence Seaway Authority on a railway line then owned by the Authority. True, as a result of its dealings with the Authority, the respondent did acquire a depreciable asset: the new line of railway that was conveyed to it by the Authority in exchange for the old one. However, the capital cost to the respondent of that new line was the value of the old line; it was not the sums expended by the respondent to do, for the benefit of the Authority, some work related to the construction of the new line.

Moreover, in my view, the expenditure of $314,852 is not deemed to be of a capital nature by virtue of subsection 84A(3). By its very words, that subsection applies only to “an expenditure incurred by a taxpayer on or in respect of the repair, replacement, alteration or renovation of depreciable property of the taxpayer’’. The sum of $314,852 was spent by the respondent to do some construction work for the St Lawrence Seaway Authority on a railway line owned by it: it was not an expenditure to which subsection 84A(3) may apply.

I would, therefore, modify the decision of the Trial Division in respect of this transaction.

(c) The Private Sidings

It is a common practice for the respondent to enter into an agreement under which it builds a private siding for a customer. Under such an agreement, the respondent builds the siding for its customer at the customer’s expense with that exception, however, that the respondent supplies, at its own expense, what is called the “track material’’ (which is, apparently, the non-perishable components of the sidings like the rail, the steel work, etc), which track material remains the property of the respondent and is rented to the customer for the duration of the agreement. The agreement also provides for the removal, by the respondent, of its track material at the termination of the agreement.

In the case with which we are concerned, the respondent, instead of removing its track material after the termination of the agreement, entered into a new agreement with its customer under which the latter, in consideration of the sum of $1, assigned and surrendered its interest in the siding to the respondent. As the respondent already owned the track material, it thereby acquired the perishable portion of the siding and, in respect of that new asset, claimed to be entitled to a capital cost allowance based on the building cost of the siding less the cost of the track material. That contention was upheld by the trial judge and is challenged by the appellant.

In my opinion, the respondent is not entitled to a capital cost allowance calculated on that basis. The sum expended by the respondent to build the siding is not, for it, a capital expenditure. That sum merely represents, for the respondent, the cost of carrying out a building contract for the benefit of a customer. Neither is the expenditure in question deemed to be a capital outlay by virtue of subsection 84A(3) since that subsection relates only to expenditures made in respect of property owned by the taxpayer.

It follows that, in my view, the judgment of the Trial Division should also be modified on this point.

For those reasons, I would allow the appeal, set aside the judgment of the Trial Division and refer back the respondent’s income tax assessment for the year 1965 to the Minister of National Revenue for reassessment on the basis

(a) that the respondent is not entitled to the capital cost allowance claimed in respect

(i) of the cost of the perishable portion of the private sidings, and

(ii) of the expenditure of $314,852 made pursuant to the arrangement with the St Lawrence Seaway Authority;

and

(b) that the judgment of the Trial Division is otherwise well founded.

The respondent should, in my view, be entitled to its costs in the Trial Division but should pay the appellant’s cost of the appeal.