A-91-95
CORAM: STONE J.A.
LINDEN J.A.
HENRY D.J.
IN RE the Income Tax Act
B E T W E E N :
GEORGE H. CORBETT
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
Heard at Vancouver, British Columbia on Monday, October 7, 1996.
Judgment rendered at Ottawa, on Wednesday, October 30, 1996.
REASONS FOR JUDGMENT BY: LINDEN J.A.
CONCURRED IN BY: STONE J.A.
HENRY D.J.
A-91-95
CORAM: STONE J.A.
LINDEN J.A.
HENRY D.J.
IN RE The Income Tax Act
B E T W E E N :
GEORGE H. CORBETT
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
LINDEN J.A.
The main issue in this appeal and five others1 argued with it is whether the proceeds of a disposition of certain rental property in 1987 are to be taxed in accordance with subparagraphs 31(21)(d)(i) and 54(h)(i) or pursuant to subsection 79(c) of the Income Tax Act.2
The Trial Judge decided in favour of the Crown, holding that subsection 79(c), as the more specific provision, should govern the tax treatment of the proceeds of the disposition which occurred as a result of a type of judicial sale called a "Rice Order".
The appellant's counsel contended that this was in error; the correct provisions under which this disposition should be taxed, he suggested, are subparagraphs 13(21)(d)(i) and 54(h)(i) which deal with sales of all kinds, including judicial sales. He argued that subsection 79(c) is meant to cover only acquisitions by foreclosure or other types of takeovers where no fixed price has been set.
Counsel for the Crown defends the decision of the Trial Judge, arguing that subsection 79(c) is a relatively complete code designed to furnish a tax regime for all types of acquisitions by lenders from borrowers (including sales) in order to ensure harmony in their tax treatment.
Subparagraph 13(21)(d)(i) in 1987 read as follows:
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(d) "Proceeds of disposition".--"proceeds of disposition" of property includes |
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(i) the sale price of property that has been sold, |
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(ii) compensation for property unlawfully taken, |
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(iii) compensation for property destroyed and any amount payable under a policy of insurance in respect of loss or destruction of property, |
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(iv) compensation for property taken under statutory authority or the sale price of property sold to a person by whom notice of an intention to take it under statutory authority was given, |
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(v) compensation for property injuriously affected, whether lawfully or unlawfully or under statutory authority or otherwise, |
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(vi) compensation for property damaged and any amount payable under a policy of insurance in respect of damage to property, except to the extent that such compensation or amount, as the case may be, has within a reasonable time after the damage been expended on repairing the damage, |
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(vii) an amount by which the liability of a taxpayer to a mortgagee is reduced as a result of the sale of mortgaged property under a provision of the mortgage, plus any amount received by the taxpayer out of the proceeds of such sale, and |
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(viii) any amount included in computing a taxpayer's proceeds of disposition of the property by virtue of paragraph 79(c); |
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Subparagraph 54(h) then stipulated:
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(h) "Proceeds of disposition".--"proceeds of disposition" of property includes, |
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(i) the sale price of property that has been sold, |
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(ii) compensation for property unlawfully taken, |
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(iii) compensation for property destroyed, and any amount payable under a policy of insurance in respect of loss or destruction of property, |
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(iv) compensation for property taken under statutory authority or the sale price of property sold to a person by whom notice of an intention to take it under statutory authority was given, |
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(v) compensation for property injuriously affected, whether lawfully or unlawfully or under statutory authority or otherwise, |
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(vi) compensation for property damaged and any amount payable under a policy of insurance in respect of damage to property, except to the extent that such compensation or amount, as the case may be, has within a reasonable time after the damage been expended on repairing the damage, |
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(vii) an amount by which the liability of a taxpayer to a mortgagee is reduced as a result of the sale of mortgaged property under a provision of the mortgage, plus any amount received by the taxpayer out of the proceeds of such sale, |
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(viii) any amount included in computing a taxpayer's proceeds of disposition of the property by virtue of paragraph 79(c), and |
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Section 79 then enacted:
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79. Mortgage foreclosures and conditional sales repossessions. |
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Where, at any time in a taxation year, a taxpayer who |
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(a) was a mortgagee or other creditor of another person who had previously acquired property, or |
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(b) had previously sold property to another person under a conditional sales agreement, |
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has acquired or reacquired the beneficial ownership of the property in consequence of the other person's failure to pay all or any part of an amount (in this section referred to as the "taxpayer's claim") owing by him to the taxpayer, the following rules apply: |
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(c) there shall be included, in computing the other person's proceeds of disposition of the property, the principal amount of the taxpayer's claim plus all amounts each of which is the principal amount of any debt that had been owing by the other person, to the extent that it has been extinguished by virtue of the acquisition or reacquisition, as the case may be; |
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(d) any amount paid by the other person after the acquisition or reacquisition, as the case may be, as, on account of or in satisfaction of the taxpayer's claim shall be deemed to be a loss of that person, for his taxation year in which payment of that amount was made, from the disposition of the property; |
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(e) in computing the income of the taxpayer for the year, |
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(i) the amount, if any, claimed by him under subparagraph 40(l)(a)(iii) in computing his gain for the immediately preceding taxation year from the disposition of the property, and |
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(ii) the amount, if any, deducted under paragraph 20(l)(n) in computing the income of the taxpayer for the immediately preceding year in respect of the property, |
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shall be deemed to be nil; |
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(f) the taxpayer shall be deemed to have acquired or reacquired, as the case may be, the property at the amount, if any, by which the cost at that time of the taxpayer's claim exceeds the amount described in subparagraph (e) (i) or (ii), as the case may be, in respect of the property; |
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(g) the adjusted cost base to the taxpayer of the taxpayer's claim shall be deemed to be nil; and |
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(h) in computing the taxpayer's income for the year or a subsequent year, no amount is deductible in respect of the taxpayer's claim by virtue of paragraph 20(l)(l) or (p). |
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The facts in summary are that the appellant invested in a Multiple Unit Residential Building (MURB) called "Sun Creek" in 1981 in the Province of Alberta. His purpose was to profit from rental income as well as from possible capital gains upon the ultimate sale of the property. The property was subject to a mortgage in favour of the Standard Trust Company. During the economic downturn in the mid 1980's, there was default in the mortgage payments, leading to an action in the Alberta Court of Queen's Bench by the mortgagee. On March 15, 1987, the Court issued what is called a "Rice Order", allowing the lender to purchase the property for an amount determined to be $49,000 and including a judgment for the balance of the amount owing. The appellant, relying on subparagraphs 12(21)(d)(i) and 54(h)(i), reported in his 1987 return the value of the disposition at the amount of $49,000 the purchase price paid to him by Standard Trust Company. The Minister, relying on subsection 79(c), reassessed the taxpayer, regarding the proceeds from the disposition as the full principal amount still outstanding on the mortgage, $63,785.00. The appellant in his tax return also deducted the amount of interest he paid on the mortgage in 1987 before the sale of the property pursuant to paragraph 20(l)(c), but the Minister disallowed this, which issue is also to be decided in this appeal.
In my view, the proper tax treatment of this disposition is according to subparagraphs 13(21)(d)(i) and 54(h)(i). Utilizing the "words-in-context" approach to the Income Tax Act, as outlined recently in Friesen v. The Queen3, it is plain to me that paragraphs 13(21)(d) and 54(h) prescribe the amount or value of the proceeds or benefit received from a disposition of property so as to help to determine the appropriate capital gain or loss from that disposition. In the case of a simple sale, the amount of the sale price is the figure that is used4. Other situations are also set out, where specific amounts are received as compensation for the loss of property in various ways such as destruction or expropriation5.
In this case, a specific amount was received by the taxpayer as a result of a "Rice Order" which led to a judicial sale of the property. It is clear to me that a sale is a sale, whether it is done voluntarily or pursuant to a Court order. This is so because the sale price is determined by the Court. It is a definite amount that is paid and received. It leaves nothing to be ascertained later. I see no ambiguity here.
I am not persuaded by Counsel for the Crown who contends that paragraph 79(c) should be used to determine the amount of the disposition, that is, the amount of the debt still owing at the time of the disposition. In my view, this would be a needless exercise in abstraction, not necessary in a case such as this, where there has been a judicial sale at a fixed price. It would not be consistent with the commercial reality of the situation. Normally, the Income Tax Act taxes someone on the basis of what has actually been received, not on the basis of some theoretical formula.
The situations meant to be covered by paragraph 79(c) are acquisitions by the lenders in a context where no fixed price is paid, and where it might take some time to ascertain the true value of what has been disposed of. Paragraph 79(c) provides a useful code for the fair and consistent treatment of dispositions where no definite figure is involved. Such situations include foreclosures and repossessions, where lenders may be forced to keep the property for some time before disposing of it and where different parties may calculate the value of the disposition differently.
Notwithstanding what I view as the clear meaning of the above language, there is, if needed, further support for this interpretation in the marginal notes. Although the Interpretation Act6 states that marginal notes "form no part of an enactment", it is permissible to consider them as part of the context of the legislation as a whole. As Madame Justice Wilson wrote in R. v. Wigglesworth7:
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There is no doubt that the traditional view was that marginal notes could not be used as aids to interpretation as they formed no part of the Act which was passed by Parliament...But reference to marginal notes has been made in some English authorities...And this Court has used statutory headings to assist in interpreting sections of the Charter.... |
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Her Ladyship quotes Mr. Justice Estey in R. v. Skapinker8, where he opined that a "court should not, by the adoption of a technical rule of construction, shut itself off from whatever small assistance might be gathered from an examination of the heading". Madame Justice Wilson observed:
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It must be acknowledged, however, that marginal notes, unlike statutory headings, are not an integral part of the Charter...The case for their utilization as aids to statutory interpretation is accordingly weaker. I believe, however, that the distinction can be adequately recognized by the degree of weight attached to them. |
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Marginal notes, therefore, can be used to aid the Court. In this case, the marginal note is "Mortgage foreclosures and conditional sales repossessions", indicating to me that it is meant to apply to situations where there is no determined sale price. If it were intended to cover all acquisitions by lenders, whether by sale or not, as contended for by the Crown, the marginal notes would have so described the subsection.
Further support for this position can be gleaned from the Interpretation Bulletin, which of course has no binding effect, but which may also be looked at as part of the context of the legislation. In Lowe v. The Queen,9 Mr. Justice Stone quoted Décary J.A. in Vaillancourt v. The Queen10, as follows:
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It is well settled that Interpretation Bulletins only represent the opinion of the Department of National Revenue, do not bind either the Minister, the taxpayer or the courts and are only an important factor in interpreting the Act in the event of doubt as to the meaning of the legislation. Having said that, I note that the courts are having increasing recourse to such Bulletins and they appear quite willing to see an ambiguity in the statute - as a reason for using them - when the interpretation given in a Bulletin squarely contradicts the interpretation suggested by the Department in a given case or allows the interpretation put forward by the taxpayer. When a taxpayer engages in business activity in response to an express inducement by the Government and the legality of that activity is confirmed in an Interpretation Bulletin, it is only fair to seek the meaning of the legislation in question in that bulletin also. As Prof. Coté points out in The Interpretation of legislation in Canada: "The administrations's presumed authority and expertise is never more persuasive than when the judge succeeds in turning it against its author, demonstrating a contradiction between the administration's interpretation and its contentions before the Court. |
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This reasoning is applicable here, where the Interpretation Bulletin IT-505 reads in part as follows:
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Mortgage Foreclosures and Conditional Sales |
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l. This bulletin deals with those rules in section 79 which apply where a mortgagee or similar creditor, hereinafter referred to as the "creditor", acquires or reacquires after November 12, 1981, beneficial ownership of a property in consequence of the failure of a mortgagor or other debtor, hereinafter referred to as the "debtor", to pay all or any part of an amount owed to the creditor, The bulletin deals with the most common situation in which the property which was acquired or reacquired either was the security for the amount owing or had been sold to the debtor under a conditional sales agreement. In this bulletin "creditor" includes a person who is an assignee of the creditor. |
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2. An acquisition or reacquisition of property, for the purpose of l above, may take place by means of |
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(a) a foreclosure order obtained though a court, |
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(b) repossession under a conditional sales agreement, or |
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3. Section 79 will not apply where the creditor purchases property from the debtor merely in anticipation of the debtor's default or where the debtor's property is disposed of to a third party pursuant to a power of sale. |
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It will be noted that there is no mention of a judicial sale to the lender itself, something that could easily have been included if it was thought to be covered by the subsection.
Consequently, this is not a case where, because of a conflict, the Court must choose to apply a specific provision over a general one in accordance with that well-known principle of statutory interpretation; there is no conflict here. Both provisions are specific, but they cover different situations -- paragraphs 13(21)(d) and 54(h), covering sales and other situations where a precise compensation figure is known and paragraph 79(c), applying to foreclosures and repossessions where there is no ascertained amount. If it were otherwise, we would be faced with a situation where a judicial sale to a lender would have to be treated differently by the taxpayer than a sale at the same price to a third person, something that cannot have been intended by Parliament.
The second issue is whether interest paid by the taxpayer in 1987 is deductible under paragraph 20(l)(c) which in 1987 read as follows:
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20. Deductions permitted in computing income from business or property. |
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(1) Notwithstanding paragraphs 18(l)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto: |
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(c) Interest.--an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on |
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(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy), |
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(ii) an amount payable for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy), |
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(iii) an amount paid to the taxpayer under |
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(A) an Appropriation Act and on terms and conditions approved by the Treasury Board for the purpose of advancing or sustaining the technological capability of Canadian manufacturing or other industry, or |
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(B) the Northern Mineral Exploration Assistance Regulations made under an Appropriation Act that provides for payments in respect of the Northern Mineral Grants Program, or |
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(iv) borrowed money used to acquire an interest in an annuity contract to which section 12.2 applies, or would apply if the contract had a third anniversary in the year, except that, where annuity payments have commenced under the contract in a preceding taxation year, the amount of interest paid or payable in the year shall not be deducted to the extent that it exceeds the amount included under section 12.2 or paragraph 56(l)(d.l) in computing the taxpayer's income for the year with respect to his interest in the contract, |
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or a reasonable amount in respect thereof, whichever is the lesser; |
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It is agreed that the money borrowed was used to buy the property in this case. It has also been agreed that the property in this case was acquired for the purpose of gaining or producing income in the form of rents. Therefore, the interest payments deducted from income by the taxpayer from 1980 to 1987 was, it is agreed, properly deducted. However, the attempt to deduct the appellants share of the amount of interest paid from January 1, 1987, to the date of the judicial sale, $2,354.00, was challenged by the Minister, on the ground that, since there was no reasonable expectation of profit during that period, the Moldowan case11 applies to deny the deduction. The Trial Judge agreed and disallowed the deduction of interest for this period. In my respectful view, he was right in doing so, according to the authorities as they exist at this time.12
The appellant relied on Emerson v. The Queen13, a decision of this Court, which held that "an essential requirement for interest deductions...is the continued existence of the source to which the interest expense relates". Further, it was said that, where the "source has been terminated, the interest expense is no longer deductible". Therefore, counsel argued that since the property in this case was owned by the taxpayer until the sale took place, the interest paid on it should be deductible until the sale date. Counsel relied on the statement of the Trial Judge in Emerson to the effect that "had the Plaintiff retained the shares, he would
have been permitted to deduct the interest expense on the loan". In Emerson, however, the facts were different than they are here. The taxpayer had sold his shares at a loss and later took out a loan to repay a previous loan taken out to pay for the shares that had been sold. The Court denied the interest expense on the new loan as the source to which the payment related had been extinguished.
Counsel for the taxpayer relies on two cases decided after the Trial decision in this case. In Tennant v. The Queen14, the Supreme Court of Canada allowed a taxpayer to deduct interest on $1,000,000 borrowed to acquire shares that were later traded for shares in a different company worth $1,000. The Minister denied the expense; the Trial Division of this Court and this Court agreed on the basis that the original shares were no longer a source of income after the exchange. The Supreme Court, however, explained that the interest to be deducted "relates to the amount of the loan, and not the value of the replacement property"15. Mr. Justice Iacobucci found that such a result was dictated by the purpose of the interest deduction provisions which was "to encourage the accumulation of capital which would produce taxable income."16 Counsel for the Crown suggested that the basis for the Tennant decision was that the property in question there was replaced by other eligible property and, hence, the deduction was permitted, whereas in this case there was no such replacement. I agree that Tennant does not apply in these circumstances, which are quite different than those in that case.
The other case relied on by the taxpayer was Tonn v. The Queen17 where deductions for interest inter alia were allowed on loans taken out to buy residential units for the purpose of gaining rental income. When the hoped for profit did not materialize, the Minister had sought to disallow the deductions on the basis of Moldowan to the effect that there was no reasonable expectation of profit during the years in question. This Court, reversing the Tax Court Judge, held that the deductions were properly allowed and suggested that Moldowan be used sparingly in cases where there was no personal element or suspicious circumstances. It stated also that Moldowan not be used to second guess good faith business judgments that were flawed.
There was nothing in Tonn, however, to indicate that the Moldowan principle was not to be applied in cases where interest expenses were deducted in situations where there was no reasonable expectation of profit. The Moldowan test, however, should not be used in paragraph 21(c)(i) cases unless it is clear that no profit is likely to be earned in the taxation year. In cases such as this, therefore, where it is clear that no profit could be earned in the year or forever after because of the judicial sale proceedings, Moldowan is applicable. Indeed, the parties in this case agreed that there was no reasonable expectation of profit in the taxation year 1987. This is not a case of second-guessing poor business decisions that do not yield profit, which was the case in Tonn. In cases where it is not clear whether that profit will be earned eventually, Tonn teaches that taxpayers should be allowed the deductions, when profit is not in fact earned. But where, as here,
no profit is possible in the taxation year and thereafter, the deduction cannot be permitted.
The absurd situation conjured up by counsel for the taxpayer in which interest might be deductible only in profitable years and not in years where no profit was earned, creating havoc among businesses which would not know whether they could deduct interest or not until the end of the year, is not a realistic fear. In applying Moldowan, it is not whether profit is earned, but whether it could reasonably be earned. As long as the business has a reasonable chance of earning profit in the year or in the near future, the interest is deductible, whether or not there actually was a profit earned in a given taxation year. That is the lesson of the Tonn case, which only seeks to restate and clarify the application of the principle of Moldowan. Thus, where as here, if no profit is possible in the year or in the near future, no deduction can be allowed (at least as long as Moldowan continues to govern cases such as these).
The Trial Judge was correct when he held that the amount of interest from January l, 1986 to March 15, 1987, the date of the Rice Order was not deductible.
In conclusion, the appeal should be allowed in part. On the first issue, the taxation of the proceeds of the disposition, the matter should be remitted to the Minister for reconsideration and reassessment on the basis that the plaintiff's "proceeds of disposition" for the taxation year 1987 are to be determined pursuant to subparagraph 13(21)(d)(i) and paragraph 54(h)(i) of the Income Tax Act. The
appeal on the second issue, dealing with the deductibility of interest, should be dismissed. The costs should be to the taxpayer who was successful on the main issue, and should be limited to one set of costs in this appeal and the other five appeals referred to above..
"A.M. Linden"
J.A.
"I agree
A.J. Stone J.A."
"I agree
D.H.W. Henry D.J."
IN THE FEDERAL COURT OF APPEAL
A-91-95
IN RE The Income Tax Act
B E T W E E N :
GEORGE H. CORBETT
Appellant
- and -
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
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1 A-88-95, Brill; A-89-85, Ochitwa; A-90-95, Coad; A-92-95, Farn; A-93-95 Leung. All of these cases are fully reported at 95 D.T.C. 5426-5469. A copy of these Reasons for Judgment shall be filed in each of the other Court files and shall upon filing become Reasons for Judgment therein to the extent applicable.
2 R.S.C. 1985, (5th Supp). c.l, as amended.
3 95 D.T.C. 5551 (S.C.C.)
4 See subparagraph 13(21)(d)(i).
5 See subparagraphs 13(21)(d)(ii) - (vii).
6 R.S.C. 1985, c.I-21, s.14.
7 [1987] 2 S.C.R. 54l (S.C.C.) at pp. 556 - 558 per Wilson J; see also Driedger on the Construction of Statutes, 3rd ed. at p. 274.
8 [1984] l S.C.R. 357, at p.377.
9 A-172-95, dated March 13, 1996.
10 91 D.T.C. 5408, at p.5412.
11 [1978], l S.C.R. 480
12 There has been academic criticism of the law as "mired in technical detail". See Krishna, (1993), 4 Can. Current Tax. c.17. There is something to be said about the unfairness of not allowing a taxpayer to deduct interest paid after a business has been destroyed by fire or closed down by failure.
13 85 D.T.C. 5236 aff''d 86 D.T.C. 6184 (F.C.A.) at p.6185 per Heald J.A.
14 96 D.T.C. 6121.
15 Ibid. at p.6125. See also Dickson C.J. in Bronfman Trust v. M.N.R. 87 D.T.C. 5059.
16 Ibid. at p.6126.
17 96 D.T.C. 6001 (F.C.A.)
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