Protos Shipping Limited v. Her Majesty the Queen, [1989] 1 CTC 1, 88 DTC 6522

Rouleau, J.:—The plaintiff appeals the confirmation by the Minister of National Revenue of a reassessment made of the plaintiff's income tax return for the 1983 taxation year. The question is whether or not the plaintiff qualifies for the small business deduction described in section 125 of the Income Tax Act.

In order to put the relative positions of the parties in some context, it is necessary to briefly review the nature of the deduction claimed and its very precise requirements. The small business deduction is made available only to Canadian controlled private corporations. It is also limited to corporations whose retained earnings do not exceed an amount referred to in the Act as the "business limit” of the corporation. In order to determine whether or not the corporation has reached the permissible "business limit", the Act creates a notional account called the cumulative deduction account (hereinafter CDA). Only those corporations which are considered “small” enough pursuant to the formula contained in the Act are able to benefit from the deduction.

The real dispute between the parties lies in the calculation of the CDA of this taxpayer. The difficulty lies in the fact that although the plaintiff had retained earnings in excess of $1 million prior to 1982 it became a Canadian controlled private corporation, and hence eligible for the small business deduction in that year. The plaintiff prefers an interpretation of the Act which would exclude its earnings for the time during which it was not a Canadian controlled private corporation from the calculation of its CDA. The defendant on the other hand argues that any earnings retained by the plaintiff, even those earned prior to becoming a Canadian controlled private corporation must indeed be included in the calculation.

The case therefore turns on an interpretation of subsections 125(1) and 125(6) of the Act as they then read. I intend to briefly set out the facts of this case and then review each of the provisions of the Act and consider any relevant jurisprudence on the subject. It is to be noted that paragraph 125 (6)(b) and the notion of the CDA was eliminated effective the 1985 taxation year.

The plaintiff is a federally incorporated company governed by the provisions of the Canada Business Corporations Act. Although it is now a "Canadian controlled private corporation" (hereinafter CCPC) within the meaning of paragraph 125(6)(b) of the Income Tax Act, this situation has only existed since 1982. Paragraph 125(6)(b) defined the CCPC as a private corporation other than a corporation which is controlled directly or indirectly by one or more non-resident persons, by one or more public corporations or by any other combination thereof.

Before 1982, the plaintiff was more than 50 per cent owned by nonresident shareholders, so it clearly did not qualify as a CCPC. In 1982, following a redemption of some of the shares held by non-residents, the plaintiff became at least 50 per cent owned and controlled by Canadian residents and hence, a CCPC. The plaintiff therefore concluded that it became entitled to claim the small business deduction for the taxation years 1983 and following.

The Minister of National Revenue was of the view that while the plaintiff may have become a CCPC for the 1983 taxation year, the CDA of the plaintiff was already in excess of the $1 million level and that hence, the plaintiff could not benefit from the small business deduction. A reassessment was issued to this effect and the plaintiff instituted the proceedings now before the Court.

The provisions relating to the small business deduction in the Income Tax Act have been amended significantly from time to time but in general terms the provisions applicable to the 1983 taxation year are the following:

SMALL BUSINESS DEDUCTION

125.(1) There may be deducted from the tax otherwise payable under this Part for a taxation year by a corporation that was, throughout the year, a Canadian-controlled private corporation, an amount equal to 25% of the least of

(a) the amount, if any, by which

(i) the aggregate of all amounts each of which is the income of the corporation

for the year from an active business carried on in Canada,

(ii) the aggregate of all amounts each of which is a loss of the corporation for the year from an active business carried on in Canada,

(b) the amount, if any, by which the corporation's taxable income for the year exceeds the aggregate of

(i) % of the aggregate of amounts deducted under subsection 126(1) from

the tax for the year otherwise payable by it under this Part, and

(ii) 2 times the aggregate of amounts deducted under subsection 126(2)

from the tax for the year otherwise payable by it under this Part,

(c) the corporation's business limit for the year, and

(d) the amount, if any, by which the corporation's total business limit for the year exceeds its cumulative deduction account at the end of the immediately preceding taxation year,

except that in applying this section for a taxation year after the 1972 taxation year, the reference in this subsection to "25%" shall be read as a reference to "24%" for the 1973 taxation year, "23%" for the 1974 taxation year, "22%" for the 1975 taxation year, and "21%" for the 1976 and subsequent taxation years.

AMOUNT OF BUSINESS LIMIT AND TOTAL BUSINESS LIMIT

(2) for the purposes of this section,

(a) a corporation's "business limit” for a taxation year is $150,000, and

(b) its “total business limit" for a taxation year is $750,000, unless the corporation is associated in the year with one or more other Canadian-controlled private corporations in which case, except as otherwise provided in this section, its business limit for the year is nil and its total business limit for the year is nil.

DEFINITIONS

(6) In this section,

"CANADIAN-CONTROLLED PRIVATE CORPORATIONS"

(a) “Canadian-controlled private corporation" means a private corporation that is a Canadian corporation other than a corporation controlled, directly or indirectly in any manner whatever, by one or more non-resident persons, by one or more public corporations or by any combination thereof; and

"CUMULATIVE DEDUCTION ACCOUNT"

(b) “cumulative deduction account" of a corporation at the end of any taxation year means the amount, if any, by which the aggregate of

(i) the corporation's cumulative deduction account at the end of the immediately preceding taxation year,

(ii) the amount, if any, by which the corporation's taxable income for the taxation year exceeds 4 times the least of the amounts determined under subparagraphs 129(3)(a)(i) to (iv) in respect of the corporation for the year,

and

(iii) A of the amount, if any, by which the aggregate of amounts deductible under section 112 or subsection 113(1) from the corporation's income for the year exceeds 4 times the amount of the tax under Part IV payable by the corporation for the year

exceeds

(iv) 43 of the amount, if any, by which the amount of taxable dividends paid by the corporation in the year exceeds 4 times its dividend refund (within the meaning assigned by subsection 129(1)) for the year.

These amendments were inplemented by subsection 59(1) of S.C. 1977, c. 1. Subsection 59(4) of the same enactment stated:

(4) For the purpose of determining a corporation's cumulative deduction account at the end of its 1978 taxation year or, where it has more than one taxation year ending in 1978, the first of those years, subparagraph 125(6)(b)(i) of the said Act shall read as follows:

“(i) the corporation’s cumulative deduction account at the end of its last taxation year ending in 1977 within the meaning of this Act as it read in its application to the corporation's 1977 taxation year.”

It is important to note that some significant amendments relating to the 1982 and following taxation years were implemented to govern tax avoidance between associated companies. These amendments are not relevant to this case, and will not be addressed.

The plaintiff's position is that the definition of “cumulative deduction account" found in paragraph 125(6)(b), supra, only applies to CCPC's. He argues that, for the purposes of this case, the term CDA is only relevant to the small business deduction and hence to the concept of the business limit, so that the term CDA is meaningless in relation to a non-CCPC. For this reason, the taxpayer concludes, its CDA for the years between 1978 and 1982 as a non-CCPC must be deemed to be zero.

In short, I do not intend to give effect to this submission for the following reasons. In my view, the transitional measure found in subsection 59(4) clearly directs the Minister to look to the taxpayer's CDA at the end of 1977 to proceed with a calculation of the CDA for 1978. How in 1977 did one determine the CDA of a taxpayer which has been a non-CCPC during the years prior to the taxation years in question? This precise issue had been considered by the Federal Court of Appeal in the case of The Queen v. B. & J. Music Limited, [1983] C.T.C. 50; 83 D.T.C. 5074. Chief Justice Thurlow stated unequivocally with respect to paragraphs 125(6)(a) and (b) of the Act:

Even if the word “corporation”, wherever it appears in the section and in particular in the definition of “cumulative deduction account”, is read as referring only to a Canadian controlled private corporation, it appears to me that when it is so read and applied as at the end of each of the taxation years 1975, 1976 and 1977 the definition requires that the taxable incomes of that corporation for the years 1972, 1973 and 1974 be brought into the computation. In order to exclude that income from the computation it would, as I see it, be necessary to amend the definition by adding after the words "corporations taxable incomes” wording such as “while a Canadian controlled private corporation". This in my opinion the Court cannot do.

[At page 51 (D.T.C. 5075) I

The definition of the "cumulative deduction account", paragraph 125(6)(b) then read:

(b) “cumulative deduction account” of a corporation at the end of any taxation year means the amount, if any, by which

(i) the corporation's taxable incomes for taxation years commencing after

1971 and ending not later than the end of the particular year, and

(ii) A of the amounts deductible under section 112 or or subsection 113(1) from the corporation's incomes for those years

exceeds the aggregate of

(iii) /3 of the taxable dividends paid by the corporation in those years, and

(iv) 4 times the amount, if any, by which the corporation's refundable dividend tax on hand (within the meaning assigned by subsection 129(3) at the end of the particular year exceeds its dividend refund (within the meaning assigned by subsection 129(1)) for the particular years.

The amendments introduced in the 1978 taxation year (namely s. 59, S.C. 1977, c. 1) had the effect of changing the means of calculation for the CDA by taking the previous year's balance in the CDA as the starting point in the calculation for the new taxation year. It did not however affect the fact that as of 1978, the taxpayer's CDA stood at an amount easily determinable pursuant to the ratio in the B. & J. Music case, paragraph 125(6)(b) before it was amended and subsection 59(4) of S.C. 1977, c. 1. Thereafter, section 59 of S.C. 1977, c. 1, the "new" paragraph 125(6)(b) provides for an annual calcu- laton of the CDA for the purposes of determining the taxpayer's eligibility to claim the small business deduction. I also note as did the Federal Court of Appeal in the B. & J. Music case, that it would have been very easy for the legislator to limit the applicability of paragraph 125(6)(b) to CCPC's only, by simply so stipulating the section. Where a provision applies exclusively to a CCPC, such as in paragraph 125(3)(a) a specific reference is made.

It is true that the term CDA only has application to a CCPC claiming a small business deduction, but there is nothing in the wording of paragraph 125(6)(b) which would allow me to exclude the taxpayer's pre-CCPC days from the calculation of its CDA once it has become a CCPC.

I would also like to add that I do not believe that the taxpayer has been treated unfairly, or prejudicially in any way. It is true that the small business deduction was created to assist CCPC's, but it must not be forgotten that the deduction is for small business.

The "small" business referred to is one whose CDA is under $1 million. During the small business days of this particular taxpayer, it was not a CCPC and not entitled to claim the deduction. I do not feel that any hardship is created in refusing to recognize the eligibility of this company to receive a deduction which it has already outgrown.

The reassessments of the Minister are hence upheld and the action is dismissed. The defendant is entitled to its costs.

Action dismissed.