Matlas S.A. v. Her Majesty the Queen, [1995] 1 CTC 2047

Archambault J.T.C.C.:—The appellant institutes an appeal pursuant to the general procedure from an income tax assessment of the Minister of National Revenue ("the Minister") for 1989. The appellant, which has owned a rental property in Canada since 1977, filed two income tax returns for the 1989 taxation year, one under Part I of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act”), the other pursuant to Part XIII, more specifically section 216 of the Act. No tax is payable pursuant to the assessment made under section 216 since the appellant realized a rental loss in 1989. This was also the case for each of the taxation years during which it owned that rental property. In its income tax return filed pursuant to Part I, the taxpayer reported a taxable capital gain resulting from the disposition of that property in 1989. However, the appellant deducted the rental loss realized during 1989 as well as those realized in the previous years. The issue is therefore whether, pursuant to subsection 115(1) of the Act, the appellant was able to deduct the rental losses for 1989 and the previous years in computing its taxable income for 1989.

Facts

The parties filed a joint agreement on the facts at the hearing. The relevant passage of that agreement is as follows:

5. The appellant appeals from an assessment bearing the number 3624460 dated March 28, 1991 under which the appellant’s net income and taxable income were revised to $44,068, the whole as appears from the assessment and T7W-8 form attached hereto as Exhibit E-1.

6. The appellant is not resident in Canada.

7. The appellant owned the property from September 23, 1976 to July 27, 1989.

8. The appellant reported rental income in respect of that property for each of the taxation years 1977 to 1989.

9. The appellant disposed of the property on July 27, 1989.

10. The appellant has filed an income tax return with the Department of Revenue for each of its fiscal years since its taxation year ended December 31, 1977, including its taxation year ended December 31, 1988, the whole as appears from the returns filed by the appellant for the taxation years 1977 to 1988 and attached hereto as Exhibit E-2 filed jointly.

11. In filing its income tax returns for 1977 to 1988 inclusive, the appellant made the election in respect of the income tax on rents and timber royalties of non-residents pursuant to subsection 216(1) of the Income Tax Act, the whole as appears from the returns filed by the appellant for the taxation years 1977 to 1988 attached hereto as Exhibit E-2 filed jointly.

12. For its 1989 taxation year, the appellant filed two income tax returns, one in order to make the election permitted under subsection 216(1) of the Income Tax Act in respect of its income from rents generated by the property until the time of the sale, and the other in order to report the taxable capital gain realized on disposition of the property, as required by subsections 2(3) and 115(1) of the Income Tax Act, the whole as appears from the returns filed by the appellant for its 1989 taxation year attached hereto as Exhibit E-3.

13. In consequence of the election made by the appellant described at paragraphs 11 and 12, the Minister of National Revenue did not tax the appellant pursuant to subsection 212(1) of the Income Tax Act on its rental income reported for its taxation years 1977 to 1989 inclusive.

14. For each of the taxation years 1977 to 1989 inclusive, the Minister of National Revenue assessed the appellant under Part I of the Income Tax Act as though it were resident in Canada.

15. For each of the taxation years 1977 to 1989, the appellant reported an operating loss and consequently never paid income tax on its rental income under Part I.

16. At the time of the disposition of the property by the appellant on July 27, 1989, the latter realized a gain of $66,102 and reported $44,068 as a taxable capital gain.

17. The Minister of National Revenue is satisfied that the capital gain realized on the property was $66,102.

18. In computing its taxable income for the 1989 taxation year, the appellant deducted part of the losses incurred during its 1989 and previous taxation years from the capital gain realized during the 1989 taxation year thus reducing its taxable income to zero, the whole as appears from the return filed by the appellant for the 1989 taxation year attached hereto as Exhibit E-3.

19. The Minister of National Revenue denied the appellant the right to deduct from its income for 1989 the losses incurred during the 1989 taxation year as well as part of the losses incurred during the previous taxation years, the whole as appears from the assessment and the T7W-8 form attached hereto as Exhibit E-1.

20. The appellant’s sole activity during the 1989 taxation year was the holding of the property in Canada.

21. The Minister of National Revenue was satisfied that all of the appellant’s world income for the 1989 taxation year was earned in Canada, the whole as appears from the statement of Mr. Jean Tardif attached hereto as Exhibit E-4.

22. On May 21, 1991, the appellant objected to the assessment described at paragraph 1, the whole as appears from the notice of objection attached hereto as Exhibit E-5.

23. On October 21, 1991, the Minister of National Revenue notified the appellant of his decision to confirm the assessment dated March 28, 1991, the whole as appears from a notification attached hereto as Exhibit E-6.

[Translation.]

Appellant’s claims

Counsel for the appellant advanced two arguments in support of its objection to the Department’s assessment. First, the appellant carried on a business in Canada and was entitled to deduct its rental losses under paragraph 115(1 )(c) of the Act and its losses for the previous periods, that is from 1977 to 1988, pursuant to paragraph 115(1)(e) of the Act. Alternatively, if the Court were to decide that the appellant did not carry on a business in Canada, the appellant was entitled to deduct its rental losses pursuant to paragraph 115( 1 )(f) of the Act. The relevant passages of subsection 115(1) of the Act are as follows:

115.(1) For the purposes of this Act, the taxable income earned in Canada for a taxation year of a person who at no time in the year is resident in Canada is the amount of his income for the year that would be determined under section 3 if

(b) the only taxable capital gains and allowable capital losses referred to in paragraph 3(b) were taxable capital gains and allowable capital losses from dispositions of property each of which was a disposition of property or an interest therein (in this Act referred to as a "taxable Canadian property") that was

(i) real property situated in Canada,

(c) the only losses referred to in paragraph 3(d) were losses from businesses carried on by him in Canada,

minus the aggregate of

(e) such of the deductions from income permitted by section 111 as may reasonably be considered to be applicable to the duties of an office or employment performed by him in Canada, a business carried on by him in Canada or a disposition of property, any profit or gain on which would have been required by this subsection to be included in computing his taxable income earned in Canada, and

(f) where all or substantially all of the non-resident person’s income for the year is included in computing his taxable income earned in Canada for the year, such of the other deductions permitted for the purpose of computing taxable income as may reasonably be considered wholly applicable.

Respondent's claim

Counsel for the respondent claimed that the appellant carried on no business in Canada and that the rental losses that it had incurred were in respect of property. The rental income that the appellant earned from its property located in Canada was subject to Part XIII and, by reason of the election made by the appellant pursuant to subsection 216(1) of the Act and of the expenses relating thereto, the appellant had no income tax to pay in respect of its rents. Since the appellant carried on no business, it was not entitled to the deductions provided by paragraphs 115(l)(c) and 115( 1 )(e). As to paragraph 115(1)(f), she claims that the appellant is not entitled thereto either. The appellant cannot make a deduction in computing its taxable income in respect of non-capital losses for the previous years since those losses are specifically excepted by paragraph 115(l)(e). This last paragraph concerns only losses in respect of a business operated in Canada.

Analysis

The issue is essentially to determine whether the appellant, a person not resident in Canada, was entitled to deduct in computing its income arising essentially from a taxable capital gain realized on disposition of a taxable Canadian property, its rental losses incurred in respect of that property in the year of disposition and during the previous years. In order to claim its rental losses, the taxpayer must meet the conditions described at section 115 of the Act. According to paragraph 115( 1 )(c), a non-resident, unlike a Canadian resident who may deduct his property losses under paragraph 3(d), can claim only those arising from businesses carried on in Canada. The same is true for non-capital losses referred to by paragraph 115(l)(e) since those losses must reasonably be considered to be applicable to a business carried on in Canada (see paragraph 115(l)(e) cited above). It is therefore fundamental to determine whether the appellant carried on a business in Canada from 1977 to 1989.

At the hearing, the appellant filed a copy of its articles of incorporation which provide, in particular at article 2, as follows:

The purposes of the corporation are to establish, transact and carry on the business of a financial and investment company in all its branches and any other lawful business, in any part of the world.

The appellant contends that there is a presumption that the activity of holding the Canadian property constituted the carrying on of a business in Canada. In support of that claim, it refers to its financial statements that it filed. I shall cite only the statement of income for the fiscal year ending December 31, 1989 with the comparative figures for 1988.

[Not reproduced. I

The appellant claims that these figures reveal a structure and a significant organization and confirmed the existence of a business. It cited a judgment of the Supreme Court of Canada in Canadian Marconi v. The Queen, [1986] 2 S.C.R. 522, [1986] 2 C.T.C. 465, 86 D.T.C. 6526, in particular the dictum of Wilson J. at page 528 (C.T.C. 468, D.T.C. 6528):

It is frequently stated in both the English and Canadian case law that there is in the case of a corporate taxpayer a rebuttable presumption that income received from or generated by an activity done in pursuit of an object set out in the corporation’s constating documents is income from a business.

She adds at page 530 (C.T.C. 469, D.T.C. 6529):

The case law thus provides ample support for the existence of the presumption and, in my view, rightly so. An inference that income is from a business seems to be an eminently logical one to draw when a company derives income from a business activity in which it is expressly empowered to engage.

As Wilson J. stated in her judgment at page 528, this presumption appears to have originated in a decision rendered by Jessel M.R. in Smith v. Anderson (1880), 15 Ch. D. 247. This presumption may be explained in light of the legislative framework in which corporations were constituted at that time. It is however surprising that the need to apply that presumption is felt in modern corporate law. It is now acknowledged under that law that they have all the powers of a natural person. It is troubling furthermore that the quality of the income earned by a person is determined on the basis of his status, not as a result of the activities that are the source of the income. I feel bound however by the reasons adopted by Wilson J. in Marconi and I must conclude as my colleague Judge Lamarre Proulx did in Étoile Immobilière S.A. v. M.N.R., [1992] 2 C.T.C. 2367, 92 D.T.C. 1984 (Eng.); 92 D.T.C. 1978 (Fr.) (T.C.C.), at page 1984 (C.T.C. 2375):

I am of the view that the recent Supreme Court decision in Marconi sets out the path to follow in this kind of decision to be made. On the one hand, account must be taken of the rebuttable presumption that a corporation’s income is business income if that income derives from an activity consistent with its object, and, on the other hand, consideration must be given to the scope of the corporation’s activities which confirms or rebuts this presumption.

In Burri v. The Queen, [1985] 2 C.T.C. 42, 85 D.T.C. 5287 (F.C.T.D.), cited by Wilson J., Strayer J., although also doubting the existence of the presumption, concluded that if it existed, that presumption had been rebutted on the basis of the facts of that case. The corporation in that case essentially earned a rental income and provided only few services to its tenants. Strayer J. concluded that the income earned by the taxpayer was income earned from property. [1]

I have come to the same conclusion in this appeal. As appears on the financial statements reproduced above, the appellant’s activities were not in any way of sufficient scope to conclude that this was a business. First, the only asset it holds in Canada is a condo whose acquisition cost was $50,000 in 1977. That of the appliances was $1,398. The expenses incurred by the appellant were those arising from the ownership of that condo. The largest was the interest expense which represented more than half of all of the appellant’s expenses for the two fiscal years 1988 and 1989. The next largest expenses were condominium fees, taxes and legal fees. This statement of income does not show in any way that the appellant provided services of an extent sufficient to make it possible to conclude that a business was carried on. On the contrary, those results show that this was income arising from a passive investment and that the appellant’s activities were those of an ordinary owner. I therefore come to the conclusion that the presumption that the Supreme Court of Canada recognized is rebutted and that the appellant carried on no business in Canada.

It must be added that the appellant’s activities cannot at all be compared to the activities that enabled my colleague Judge Lamarre Proulx to conclude in Etoile Immobilière S.A., supra, that the source of the income was a business. In that case, the taxpayer owned a real estate project of 158 townhouses situated on an area of eight acres. This was essentially a private village within the town of Dollars [sic] des Ormeaux. It was adduced in evidence that the corporation had six caretakers, two servicemen, a leasing agent, a full-time supervisor, a lifeguard and a full-time accountant.

Consequently, the taxpayer may not deduct the losses pursuant to paragraphs 115(l)(c) and 115(l)(e) of the Act in computing its taxable income.

Nor can the appellant succeed with its second argument that it is entitled to its loss carryover for the previous years pursuant to paragraph 115(l)(f) of the Act. In order to understand the scope of that section clearly, it is important to reread it in the context of the entire Act. First of all, it is important to note that this section refers to "the other deductions" permitted for the purposes of computing taxable income. However, the deductions in respect of the carryover of non-capital losses are treated in paragraph 115( 1 )(e). As we have concluded above, this section applies only if the appellant carried on a business in Canada. The other deductions referred to at paragraph 115( 1 )(f) are therefore deductions other than those referred to in paragraphs 115(l)(d) and 115(l)(e). The appellant’s interpretation is not consistent with the structure of the Act. It has been seen that the taxpayer had to carry on a business in Canada in order to be entitled to the rental losses for the year of the disposition of its property. Paragraph 115(1)(c) permits only the deduction of losses arising from an office, employment or business that it operates. No reference whatever is made to property losses. Furthermore, it would be totally illogical to be able to deduct rental losses from property for previous years under paragraph 115(l)(f) when losses from the same source may not be deducted in the relevant year. As counsel for the respondent noted, it would also be illogical to allow a carryover of losses in computing the taxable capital gain since the loss carryover is not even permitted for the purposes of calculating tax payable pursuant to the election provided at section 216 of the Act.

For all of these reasons, the appellant may not deduct the rental losses incurred in the 1989 taxation year in computing its income, nor may it deduct in computing its taxable income the non-capital losses incurred during the previous years. The appellant’s appeal is therefore dismissed. I allow the respondent’s costs.

Appeal dismissed.